Western New England Bancorp, Inc. (WNEB) FY 2021 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The
following discussion should be read in conjunction with the Company’s Consolidated Financial Statements and notes thereto,
each appearing elsewhere in this Annual Report on Form 10-K.

Overview.

We
strive to remain a leader in meeting the financial service needs of the local community and to provide quality service to the
individuals and businesses in the market areas that we have served since 1853. Historically, we have been a community-oriented
provider of traditional banking products and services to business organizations and individuals, including products such as residential
and commercial real estate loans, consumer loans and a variety of deposit products. We meet the needs of our local community through
a community-based and service-oriented approach to banking.

We
have adopted a growth-oriented strategy that continues to focus on increasing commercial lending and residential lending. Our
strategy also calls for increasing deposit relationships, specifically core deposits, and broadening our product lines and services.
We believe that this business strategy is best for our long-term success and viability, and complements our existing commitment
to high quality customer service.

In
connection with our overall growth strategy, we seek to:

You
should read the following financial results for the year ended December 31, 2021 in the context of this strategy.

For
the twelve months ended December 31, 2021, net income was $23.7 million, or $1.02 diluted earnings per share, compared to net
income of $11.2 million, or $0.45 diluted earnings per share, for the twelve months ended December 31, 2020. The results for the
twelve months ended December 31, 2021 showed a decrease in interest expense, a credit for loan losses, and an increase in non-interest
income, which were all partially offset by a decrease in interest income and an increase in non-interest expense. The provision
for loan losses was a credit of $925,000 for the year ended December 31, 2021, compared to a provision for loan losses of $7.8
million for the year ended December 31, 2020.  The allowance for loan losses was $19.8 million, or 1.06% of total loans,
at December 31, 2021 and $21.2 million, or 1.10%, at December 31, 2020. Excluding PPP loans, the allowance for loan losses as
a percentage of total loans was 1.08% and 1.20% at December 31, 2021 and 2020, respectively. At December 31, 2021, the allowance
for loan losses as a percentage of nonperforming loans was 398.6%, compared to 269.8% at December 31, 2020. The twelve months
ended 2020 was impacted by a higher provision for loan losses resulting from the COVID-19 pandemic mandated shutdowns and economic
disruption that caused elevated unemployment levels and deterioration in household, business, economic and market conditions.

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Net
interest income increased $8.7 million, or 13.6%, to $73.2 million for the twelve months ended December 31, 2021, compared to
$64.4 million for the twelve months ended December 31, 2020. The increase in net interest income was due to a decrease in interest
expense of $11.8 million, or 63.8%, partially offset by a decrease in interest and dividend income of $3.0 million, or 3.7%. For
the twelve months ended December 31, 2021, interest and dividend income included $6.8 million in PPP income, compared to $4.8
million during the twelve months ended December 31, 2020. During the twelve months ended December 31, 2020, the Company recorded
$976,000 in positive purchase accounting adjustments and $193,000 in interest income and late charges from the full payoff of
a $3.5 million credit-marked substandard classified loan, compared to $55,000 in positive purchase accounting adjustments during
the twelve months ended December 31, 2021. The Company recorded prepayment penalties of $181,000 and $409,000 during the twelve
months ended December 31, 2021 and 2020, respectively. Excluding the items mentioned above, net interest income increased $8.3
million, or 14.3%, from the same period in 2020. The decrease in interest expense of $11.8 million, or 63.8%, was due to a decrease
in interest expense on deposits of $8.0 million, or 59.2%, and a decrease in interest expense on borrowings of $3.8 million, or
77.6%.

General.

Our
consolidated results of operations depend primarily on net interest and dividend income. Net interest and dividend income is the
difference between the interest income earned on interest-earning assets and the interest paid on interest-bearing liabilities.
Interest-earning assets consist primarily of commercial real estate loans, commercial and industrial loans, residential real estate
loans and securities. Interest-bearing liabilities consist primarily of certificates of deposit and money market accounts, demand
deposit accounts and savings account deposits and borrowings from the FHLB. The consolidated results of operations also depend
on the provision for loan losses, non-interest income, and non-interest expense. Non-interest income includes service fees and
charges, income on bank-owned life insurance, gains on sales of mortgages, gains on non-marketable equity investments and gains
(losses) on securities. Non-interest expense includes salaries and employee benefits, occupancy expenses, data processing, advertising
expense, FDIC insurance assessment, professional fees and other general and administrative expenses.

RECENT
DEVELOPMENTS: CORONAVIRUS PANDEMIC RESPONSE AND ACTIONS.

The
Company continues to monitor COVID-19’s impact on its business and customers, however, the extent to which COVID-19 will
impact its results and operations will depend on future developments, which are highly uncertain and cannot be predicted with
confidence, including the scope, severity and duration of the pandemic, the actions taken to contain the pandemic or mitigate
its impact, and the direct and indirect economic effects of the pandemic and containment measures.

Our
business is dependent upon the willingness and ability of our employees and customers to conduct banking and other financial transactions.
The COVID-19 global public health crisis and the resulting “stay-at-home” orders resulted in widespread volatility,
severe disruptions in the U.S. economy at large, and for small businesses in particular, deterioration in household, business,
economic and market conditions.

Paycheck
Protection Program.

As
a Preferred Lender with the SBA, the Company was in a position to react quickly to the PPP component of the March 27, 2020 $2.2
trillion fiscal stimulus bill known as the CARES Act launched by the Treasury and the SBA. An eligible business was able to apply
for a PPP loan up to the lesser of: (1) 2.5 times its average monthly “payroll costs,” or (2) $10.0 million. PPP loans
have: (a) an interest rate of 1.0%, (b) a two-year loan term to maturity, subsequently extended to a five-year loan term maturity
for loans granted on or after June 5, 2020 and (c) principal and interest payments deferred from six months to ten months from
the date of disbursement. The SBA will guarantee 100% of the PPP loans made to eligible borrowers. The entire principal amount
of the borrower’s PPP loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount under
the PPP so long as employee and compensation levels of the business are maintained and 60% of the loan proceeds are used for payroll
expenses, with the remaining 40% of the loan proceeds used for other qualifying expenses. As of December 31, 2021, the Company
received funding approval from the SBA for 2,146 applications totaling $302.2 million.

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As
of December 31, 2021, the Company processed 1,982 PPP loan forgiveness applications totaling $276.9 million. Total PPP loans decreased
$141.9 million, or 84.9%, from $167.3 million at December 31, 2020 to $25.3 million at December 31, 2021.

As
PPP loans are forgiven, the Company is accelerating the recognition of PPP loan origination fees that were being amortized over
the original lives of the loans. The majority of the PPP loan portfolio has been repaid through forgiveness and earnings were
favorably impacted by the additional PPP origination fee income during the year ended December 31, 2021. During the twelve months
ended December 31, 2021, the Company recognized $6.8 million in PPP loan origination fee income and PPP interest income (“PPP
income”), compared to $4.8 million during the twelve months ended December 31, 2020. As of December 31, 2021, the Company
had $781,000 in remaining deferred PPP loan processing fees.

Loan
Modifications/Troubled Debt Restructurings.

The
banking regulatory agencies, through an Interagency Statement dated April 7, 2020, have encouraged financial institutions to work
“prudently” with borrowers who request loan modifications or deferrals as a result of the economic impacts of COVID-19.
Pursuant to Section 4013 of the CARES Act, loans less than 30 days past due as of December 31, 2019 will be considered current
for COVID-19 modifications. Financial institutions can then suspend the requirements under U.S. GAAP for loan modifications related
to COVID-19 that would otherwise be categorized as a TDR, and suspend any determination of a loan modified as a result of COVID-19
as being a TDR, including the requirement to determine impairment for accounting under U.S. GAAP. The Company has adopted this
policy election to address COVID-19 loan modification requests that have been received from the earlier of either January 1, 2022
or the 60th day after the end of the COVID-19 national emergency.

As
a result of the COVID-19 pandemic, the Company granted deferred loan payments for impacted commercial, residential and consumer
customers who experienced financial hardship due to COVID-19. The loan payment deferrals can be up to 90 days, depending upon
the financial needs of each customer. Further deferrals will be re-evaluated on a customer-by-customer basis upon the expiration
of the existing deferral period. As of December 31, 2021, of the $42.5 million in remaining modifications granted under the CARES
Act, eight loans in the amount of $33.5 million, or 78.8%, of the remaining modifications, were granted to the hotel industry,
and one loan in the amount of $9.0 million was granted to an assisted living facility. Of the $42.5 million in remaining outstanding
modifications, $33.5 million, or 78.8%, have resumed interest only payments.

The
table below breaks out the remaining modifications granted under the CARES Act at December 31, 2021:

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Allowance
for Loan Losses.

In
determining the allowance for loan losses, the Company considers quantitative loss factors and a number of qualitative factors,
such as underwriting policies, current economic conditions, delinquency statistics, the adequacy of the underlying collateral
and the financial strength of the borrower. Beginning at the end of March 2020, a record number of Americans filed for unemployment
benefits. The global pandemic could cause the Company to experience higher credit losses in its lending portfolio, reduced demand
for our products and services and other negative impacts on our financial position, results of operations and prospects. As of
December 31, 2021, the Company’s delinquency and nonperforming assets have not been materially impacted by the COVID-19
pandemic, and therefore, have not resulted in material credit losses within the lending portfolio.

The
COVID-19 pandemic materially impacted the Company’s determination of the allowance for loan losses for the twelve months
ended December 31, 2021 and 2020. The Company recorded a credit for loan losses of $925,000 for the twelve months ended December
31, 2021, compared to a provision for loan losses of $7.8 million for the twelve months ended December 31, 2020. In addition,
on an ongoing basis, the Company has continually evaluated the loan portfolio acquired on October 24, 2016 from Chicopee. The
acquired portfolio was initially recorded at fair value without a related allowance for loan losses. Subsequent to acquisition,
there have been no indications that there has been any subsequent deterioration to the acquired portfolio. During the three months
ended September 30, 2020, the Company determined that it was prudent to provide an allowance for loan losses related to the acquired
portfolio, which increased the provision by $2.5 million during 2020. The Company is continuing to monitor COVID-19’s impact
on its business and its customers, however, the extent to which COVID-19 will impact its results and operations will depend on
future developments, which are highly uncertain and cannot be predicted with confidence, including the scope, severity and duration
of the pandemic, the actions taken to contain the pandemic or mitigate its impact and the direct and indirect economic effects
of the pandemic and containment measures.

Critical
Accounting Policies.

Our accounting policies are disclosed in Note 1 to
our consolidated financial statements. Given our current business strategy and asset/liability structure, the more critical policy is
the allowance for loan losses and provision for loan losses. In addition to the informational disclosure in the notes to the consolidated
financial statements, our policy on this accounting policy is described in detail in the applicable sections of “Management’s
Discussion and Analysis of Financial Condition and Results of Operations.” Senior management has discussed the development and
selection of this accounting policy and the related disclosures with the Audit Committee of our Board of Directors.

The process of evaluating the loan portfolio, classifying
loans and determining the allowance and provision is described in detail in Part I under “Business – Lending Activities
- Allowance for Loan Losses.” This evaluation is inherently subjective as it requires material estimates that may be susceptible
to significant change. Our methodology for assessing the allocation of the allowance consists of two key components, which are a specific
allowance for impaired loans and a general allowance for the remainder of the portfolio. Measurement of impairment can be based on present
value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or
the fair value of the collateral, if the loan is collateral dependent. The allocation of the allowance is also reviewed by management
based upon our evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such
as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral
values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date
and the impact that such conditions were believed to have had on the collectability of the loan portfolio.

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Beginning in March 2020, the Bank added a new qualitative
factor category to the allowance calculation – “Economic Impact of COVID-19”. The allocation of additional reserves
for the COVID-19 qualitative factor during the year was based upon continued analysis of the loan portfolio that included identifying
borrowers sensitive to the shutdown (i.e. accommodation and food service, recreation, construction, manufacturing, and wholesale &
retail trade) as well as a general allocation for the negative economic outlook given the record number of unemployment benefits claims
during the period. In addition, on an ongoing basis, the Company has continually evaluated the loan portfolio acquired on October 24,
2016 from Chicopee Bancorp, Inc. (“Chicopee”). The acquired portfolio was initially recorded at fair value without a related
allowance for loan losses. Due to the ongoing impacts and extended nature of the pandemic, during the year ended December 31, 2020, the
Company determined that it was prudent to provide an allowance for loan losses related to the acquired portfolio. Although management
believes it has established and maintained the allowance for loan losses at adequate levels, if management’s assumptions and judgments
prove to be incorrect due to continued deterioration in economic, real estate and other conditions, and the allowance for loan losses
is not adequate to absorb inherent losses, our earnings and capital could be significantly and adversely affected. There were no changes
to the Company’s allowance for loan losses methodology during the year ended December 31, 2021.

Analysis
of Net Interest Income.

The
Company’s earnings are largely dependent on its net interest income, which is the difference between interest earned on
loans and investments and the cost of funding (primarily deposits and borrowings). Net interest income expressed as a percentage
of average interest-earning assets is referred to as net interest margin. For more information regarding the Company’s use
of Non-GAAP financial measures see “Explanation of Use of Non-GAAP Financial Measurements.”

Average
Balance Sheet.

The
following table sets forth information relating to the Company for the years ended December 31, 2021, 2020 and 2019. The average
yields and costs are derived by dividing interest income or interest expense by the average balance of interest-earning assets
or interest-bearing liabilities, respectively, for the periods shown. Average balances are derived from average daily balances.
The yields include fees which are considered adjustments to yields. Loan interest and yield data does not include any accrued
interest from non-accruing loans.

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Rate/Volume
Analysis.

The
following table shows how changes in interest rates and changes in the volume of interest-earning assets and interest-bearing
liabilities have affected our interest and dividend income and interest expense during the periods indicated. Information is provided
in each category with respect to: (1) interest income changes attributable to changes in volume (changes in volume multiplied
by prior rate); (2) interest income changes attributable to changes in rate (changes in rate multiplied by prior volume); and
(3) the net change.

The
changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume
and the changes due to rate.

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Explanation
of Use of Non-GAAP Financial Measurements.

We
believe that it is common practice in the banking industry to present interest income and related yield information on tax-exempt
loans and securities on a tax-equivalent basis and that such information is useful to investors because it facilitates comparisons
among financial institutions. However, the adjustment of interest income and yields on tax-exempt loans and securities to a tax-equivalent
amount is considered a non-GAAP financial measure. A reconciliation from GAAP to non-GAAP is provided below.

Comparison
of Financial Condition at December 31, 2021 and December 31, 2020.

At
December 31, 2021, total assets of $2.5 billion increased $172.5 million, or 7.3%, from December 31, 2020. The balance sheet composition
and changes since December 31, 2020 are discussed below.

Cash
and Cash Equivalents.

Cash
and cash equivalents is comprised of cash on hand and amounts due from banks, interest-earning deposits in other financial institutions
and federal funds sold. Cash and cash equivalents totaled $103.5 million, or 4.1% of total assets, at December 31, 2021 and $87.4
million, or 3.7% of total assets, at December 31, 2020. Balances in cash and cash equivalents will fluctuate due primarily to
the timing of net deposit flows, borrowing and loan inflows and outflows, investment purchases and maturities, calls and sales
proceeds, and the immediate liquidity needs of the Company. The increase in cash and cash equivalents at both December 31, 2021
and 2020 is primarily due to an increase in deposits during both periods.

Investments.

At
December 31, 2021, the investment portfolio of $428.5 million, or 16.9% of total assets, increased $214.7 million, compared to
$213.8 million, or 9.0% of total assets, at December 31, 2020. Held-to-maturity securities, which are recorded at amortized cost,
comprised the majority of the portfolio and represented 51.9% of total investments at December 31, 2021. The Company did not hold
any held-to-maturity securities in 2020. The Company allocated some of its excess liquidity to the investment portfolio as an
alternative to cash and cash equivalents. This shift from overnight investments to held-to-maturity securities assisted the Company
with managing the yield on interest-earning assets in the low interest rate environment that we experienced in 2021 while providing
ongoing cash flows from payments and pay downs. The primary objective of the investment portfolio is to provide liquidity and
maximize income while preserving the safety of principal. Available-for-sale securities, which are carried at fair value, totaled
$194.4 million, or 45.4% of investments, at December 31, 2021, compared to $201.9 million, or 94.4% of investments, at December
31, 2020. The marketable equity securities portfolio totaled $11.9 million and $12.0 million at December 31, 2021 and 2020.

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The
Bank is required to purchase FHLB stock at par value in association with advances from the FHLB. The stock is classified as a
restricted investment and carried at cost which management believes approximates fair value. The Company’s investment in
FHLB capital stock amounted to $2.2 million at both December 31, 2021 and December 31, 2020, respectively.

At
December 31, 2021 and 2020, the Company held $423,000 of Atlantic Community Bankers Bank stock. The stock is restricted and carried
in other assets at cost. The stock is evaluated for impairment based on an estimate of the ultimate recovery to the par value.

Loans.

Total
loans were $1.9 billion as of December 31, 2021, a decrease of $62.7 million, or 3.3%, from December 31, 2020, primarily due to
a decrease in PPP loans of $141.9 million, or 84.9%. Excluding PPP loans, total loans increased $79.3 million, or 4.5%, driven
by an increase in commercial real estate loans of $146.0 million, or 17.5%, partially offset by a decrease in commercial and industrial
loans of $10.5 million, or 4.9%. Residential real estate loans, which include home equity loans, decreased $56.5 million, or 8.0%,
as we continue to sell low coupon, fixed rate residential loans to the secondary market in order to diversify our loan mix and
reduce our interest rate risk. In accordance with the Company’s asset/liability management strategy, during the twelve months
ended December 31, 2021, the Company sold $59.7 million of fixed rate, low coupon residential real estate loans to the secondary
market. There were no loans sold during 2020. As of December 31, 2021, the Company serviced $88.2 million in loans sold to the
secondary market, compared to $38.1 million at December 31, 2020. Servicing rights will likely continue to be retained on all
loans written and sold to the secondary market.

Bank-Owned
Life Insurance ("BOLI").

The
Company indirectly utilizes the earnings on BOLI to offset the cost of the Company’s benefit plans. The cash surrender value
of BOLI was $72.9 million at both December 31, 2021 and 2020, respectively.

Deposits.

At
December 31, 2021, total deposits were $2.3 billion, an increase of $213.5 million, 10.5%, from December 31, 2020, primarily due
to an increase in core deposits of $401.8 million, or 27.7%. Core deposits, which the Company defines as all deposits except time
deposits, increased from $1.4 billion, or 71.0% of total deposits, at December 31, 2020, to $1.8 billion, or 82.1% of total deposits,
at December 31, 2021. Non-interest-bearing deposits increased $99.5 million, or 18.4%, to $641.3 million, interest-bearing checking
accounts increased $50.8 million, or 53.5%, to $145.7 million, savings accounts increased $41.6 million, or 23.6%, to $217.6 million,
and money market accounts increased $209.5 million, or 32.7%, to $850.3 million. The increase in core deposits can be attributed
to the government stimulus, lower consumer spending, PPP loan proceeds deposited into borrower checking accounts, as well as the
three new branches opened in 2020. We anticipate that some of the deposit growth from PPP will be temporary as customers look
to make capital improvements and diversify investments as risk from the COVID-19 pandemic eases over time.

Borrowed
Funds.

At
December 31, 2021, total borrowings decreased $35.6 million, or 61.5%, from $57.9 million at December 31, 2020, to $22.3 million.
FHLB advances decreased $55.2 million, or 95.4%, to $2.7 million and subordinated debt issued during the three months ended June
30, 2021 totaled $20.0 million at December 31, 2021.

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Shareholders’
Equity.

At
December 31, 2021, shareholders’ equity was $223.7 million, or 8.8% of total assets, compared to $226.6 million, or 9.6%
of total assets, at December 31, 2020. The decrease in shareholders’ equity reflects $23.1 million for the repurchase of
the Company’s common stock, the payment of regular cash dividends of $4.7 million and an increase in accumulated other comprehensive
loss of $1.0 million, partially offset by net income of $23.7 million. Total shares outstanding as of December 31, 2021 were 22,656,515.

The
Company’s book value per share was $9.87 at December 31, 2021 compared to $8.97 at December 31, 2020, while tangible book
value per share increased $0.85, or 10.2%, from $8.36 at December 31, 2020 to $9.21 at December 31, 2021. As of December 31, 2021,
the Company’s and the Bank’s regulatory capital ratios continued to exceed the levels required to be considered “well-capitalized”
under federal banking regulations.

Assets
under Management.

Total
assets under management includes loans serviced for others and investment assets under management. Loans serviced for others and
investment assets under management are not carried as assets on the Company's consolidated balance sheet, and as such, total assets
under management is not a financial measurement recognized under GAAP, however, management believes its disclosure provides information
useful in understanding the trends in total assets under management.

The
Company provides a wide range of investment advisory and wealth management services. Investment assets under management of $188.1
million increased $16.4 million, or 9.6%, for the year ended December 31, 2021, from $171.7 million for the year ended December
31, 2020.

Comparison
of Operating Results for Years Ended December 31, 2021 and 2020.

General.

For
the twelve months ended December 31, 2021, the Company reported net income of $23.7 million, or $1.02 per diluted share, compared
to $11.2 million, or $0.45 per diluted share, for the twelve months ended December 31, 2020.

Net
Interest Income and Net Interest Margin.

During
the twelve months ended December 31, 2021, net interest income increased $8.7 million, or 13.6%, to $73.2 million, compared to
$64.4 million for the twelve months ended December 31, 2020. The increase in net interest income was due to a decrease in interest
expense of $11.8 million, or 63.8%, partially offset by a decrease in interest and dividend income of $3.0 million, or 3.7%. For
the twelve months ended December 31, 2021, interest and dividend income included $6.8 million in PPP income, compared to $4.8
million during the twelve months ended December 31, 2020. During the twelve months ended December 31, 2020, the Company recorded
$976,000 in positive purchase accounting adjustments and $193,000 in interest income and late charges from the full payoff of
a $3.5 million credit-marked substandard classified loan, compared to $55,000 in positive purchase accounting adjustments during
the twelve months ended December 31, 2021. The Company recorded prepayment penalties of $181,000 and $409,000 during the twelve
months ended December 31, 2021 and 2020, respectively. Excluding the items mentioned above, net interest income increased $8.3
million, or 14.3%, from the same period in 2020. The decrease in interest expense of $11.8 million, or 63.8%, was due to a decrease
in interest expense on deposits of $8.0 million, or 59.2%, and a decrease in interest expense on borrowings of $3.8 million, or
77.6%.

The
net interest margin for the twelve months ended December 31, 2021 was 3.14%, compared to 2.93% for the twelve months ended December
31, 2020. The net interest margin, on a tax-equivalent basis, was 3.16% for the twelve months ended December 31, 2021, compared
to 2.95% for the twelve months ended December 31, 2020. Excluding the adjustments discussed above, the net interest margin increased
from 2.83% for the twelve months ended December 31, 2020 to 2.99% for the twelve months ended December 31, 2021.

The
average yield on interest-earning assets decreased 34 basis points from 3.77% for the twelve months ended December 31, 2020 to
3.43% for the twelve months ended December 31, 2021. The yield on average loans decreased from 4.05% during the twelve months
ended December 31, 2020 to 3.93% during the twelve months ended December 31, 2021. Excluding the adjustments discussed above of
$6.9 million and $6.4 million for the twelve months ended December 31, 2021 and 2020, respectively, the yield on average loans
decreased 23 basis points from 4.02% for the twelve months ended December 31, 2020 to 3.79% for the twelve months ended December
31, 2021.

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During
the twelve months ended December 31, 2021, the average cost of total funds, including non-interest bearing demand accounts and
borrowings, decreased 59 basis points from 0.89% for the twelve months ended December 31, 2020 to 0.30%. For the twelve months
ended December 31, 2021, the average cost of core deposits, including non-interest-bearing demand deposits, decreased 10 basis
points to 0.17%, from 0.27% for same period in 2020. The average cost of time deposits decreased 107 basis points from 1.60% for
the twelve months ended December 31, 2020 to 0.53% during the same period in 2021. The average cost of borrowings increased 45
basis points from 2.59% for the twelve months ended December 31, 2020 to 3.04% for the twelve months ended December 31, 2021 due
to the issuance of $20.0 million in subordinated debt during the twelve months ended December 31, 2021.

For
the twelve months ended December 31, 2021, average demand deposits, an interest-free source of funds, increased $119.4 million,
or 24.4%, from $489.6 million, or 26.0% of total average deposits, for the twelve months ended December 31, 2020 to $609.0 million,
or 28.0% of total average deposits, for the twelve months ended December 31, 2021.

During
the twelve months ended December 31, 2021, average interest-earning assets increased $132.2 million, or 6.0%, to $2.3 billion.
The increase in average interest-earning assets was due to an increase in average securities of $105.5 million, or 49.2%, and
an increase in short-term investments of $66.1 million, or 144.1%, partially offset by a decrease in average loans of $34.7 million,
or 1.8%. Excluding PPP loans, average interest-earning assets increased $167.1 million or 8.1%, and average loans remained unchanged
at $1.8 billion.

Provision
for Loan Losses.

The
provision for loan losses is reviewed by management based upon our evaluation of then-existing economic and business conditions
affecting our key lending areas and other conditions, such as new loan products, credit quality trends (including trends in nonperforming
loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions
within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have
had on the collectability of the loan portfolio.

The
Company decreased the provision for loan losses by $8.7 million, or 111.9%, from $7.8 million for the twelve months ended December
31, 2020, to a credit balance of $925,000 for the twelve months ended December 31, 2021. This change was reflective of the impact
of the COVID-19 pandemic on the Company’s allowance for loan losses during both periods.

The
Company recorded net charge-offs of $445,000 for the twelve months ended December 31, 2021, as compared to net charge-offs of
$720,000 for the twelve months ended December 31, 2020. During the twelve months ended December 31, 2021, the Company recorded
charge-offs of $645,000, compared to $963,000 during the same period in 2020. During the twelve months ended December 31, 2021,
the Company recorded recoveries of $200,000, compared to recoveries of $243,000 during the same period in 2020.

The
allowance for loan losses as a percentage of total loans was 1.06% at December 31, 2021, compared to 1.10% at December 31, 2020.
At December 31, 2021, the allowance for loan losses as a percentage of nonperforming loans was 398.6%, compared to 269.8% at December
31, 2020. The allowance for loan losses as a percentage of total loans, excluding PPP loans, was 1.08% and 1.20% at December 31,
2021 and 2020, respectively.

Although
management believes it has established and maintained the allowance for loan losses at appropriate levels, future adjustments
may be necessary if economic, real estate and other conditions differ substantially from the current operating environment.

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Non-Interest
Income.

For
the twelve months ended December 31, 2021, non-interest income of $12.6 million increased $3.3 million, or 35.8%, compared to
$9.3 million for the twelve months ended December 31, 2020. During the twelve months ended December 31, 2021, non-interest income
included the recognition of $555,000 in BOLI death benefits. Excluding the BOLI death benefits, non-interest income increased
$2.8 million, or 30.1%.

Service
charges and fees increased $1.3 million, or 18.3%, primarily due to an increase in card-based transaction usage across our checking
account base. Mortgage banking income was $1.4 million for the twelve months ended December 31, 2021, due to the sale of fixed
rate residential real estate loans to the secondary market. During the twelve months ended December 31, 2021, the Company sold
$59.7 million in loans to the secondary market. The Company did not sell any fixed rate residential real estate loans during the
twelve months ended December 31, 2020. Income from bank-owned life insurance increased $103,000, or 5.7%, and other income from
loan-level swap fees on commercial loans decreased $596,000, or 91.1%.

During
the twelve months ended December 31, 2021, the Company reported unrealized losses on marketable equity securities of $168,000,
compared to unrealized gains of $109,000 during the twelve months ended December 31, 2020. In addition, during the twelve months
ended December 31, 2021, the Company reported realized losses on the sale of securities of $72,000 and a gain of $898,000 on non-marketable
equity securities, compared to realized gains of $2.0 million on the sale of securities during the twelve months ended December
31, 2020. During the twelve months ended December 31, 2021, the Company reported a loss on derivatives of $402,000, compared to
a loss on derivatives of $2.4 million during the twelve months ended December 31, 2020.

Non-Interest
Expense.

For
the twelve months ended December 31, 2021, non-interest expense increased $3.2 million, or 6.2%, to $54.9 million compared to
$51.8 million, for the twelve months ended December 31, 2020. During the year ended December 31, 2020, the Company prepaid $50.0
million of FHLB borrowings. The transaction was accounted for as an early debt extinguishment resulting in a loss of $987,000,
compared to $45,000 during the twelve months ended December 31, 2021. Excluding these losses, non-interest expense increased $4.1
million, or 8.1%, from the twelve months ended December 31, 2020 to the twelve months ended December 31, 2021.

The
increase in non-interest expense was primarily due to an increase in salaries and employee benefits expenses of $2.9 million,
or 9.7%. The increase in salary and employee benefits was due to several factors, including higher commissions and incentives
associated with increased residential loan production as well as annual staff salary increases. Furniture and equipment increased
$547,000, or 35.6%, other non-interest income increased $647,000, or 8.1%, advertising expense increased $186,000, or 16.8%, and
occupancy expense increased $136,000, or 3.0%. FDIC insurance expense decreased $34,000, or 3.3%, professional fees decreased
$187,000, or 7.9%, and data processing fees remain flat at $2.9 million. For the twelve months ended December 31, 2021, the efficiency
ratio was 64.6%, compared to 68.6% for the twelve months ended December 31, 2020.

Income
Taxes.

Income
tax expense for the twelve months ended December 31, 2021 was $8.0 million, or an effective tax rate of 25.3%, compared to $2.9
million, or an effective tax rate of 20.8%, for twelve months ended December 31, 2020. The increase in the Company’s effective
tax rate was primarily due to the effect of higher pre-tax income for the fiscal year ended December 31, 2021.

63

Liquidity
and Capital Resources.

The
term “liquidity” refers to our ability to generate adequate amounts of cash to fund loan originations, loan purchases,
deposit withdrawals and operating expenses. Our primary sources of liquidity are deposits, scheduled amortization and prepayments
of loan principal and mortgage-backed securities, maturities and calls of investment securities and funds provided by our operations.
We also can borrow funds from the FHLB based on eligible collateral of loans and securities. Our material cash commitments include
funding loan originations, fulfilling contractual obligations with third-party service providers, maintaining operating leases
for certain of our Bank properties and satisfying repayment of our long-term debt obligations.

Primary
Sources of Liquidity

At
December 31, 2021 and December 31, 2020, outstanding borrowings from the FHLB were $2.7 million and $57.9 million, respectively.
At December 31, 2021, we had $480.5 million in available borrowing capacity with the FHLB. We have the ability to increase our
borrowing capacity with the FHLB by pledging investment securities or additional loans.

In
addition, we have available lines of credit of $15.0 million and $50.0 million with other correspondent banks. Interest rates
on these lines are determined and reset on a daily basis by each respective bank. At December 31, 2021 and 2020, we did not have
an outstanding balance under either of these lines of credit. In addition, we may enter into reverse repurchase agreements with
approved broker-dealers. Reverse repurchase agreements are agreements that allow us to borrow money using our securities as collateral.

We
also have outstanding at any time, a significant number of commitments to extend credit and provide financial guarantees to third
parties. These arrangements are subject to strict credit control assessments. Guarantees specify limits to our obligations. Because
many commitments and almost all guarantees expire without being funded in whole or in part, the contract amounts are not estimates
of future cash flows. We are also obligated under agreements with the FHLB to repay borrowed funds and are obligated under leases
for certain of our branches and equipment.

Maturing
investment securities are a relatively predictable source of funds. However, deposit flows, calls of securities and prepayments
of loans and mortgage-backed securities are strongly influenced by interest rates, general and local economic conditions and competition
in the marketplace. These factors reduce the predictability of the timing of these sources of funds.

The
Company’s primary activities are the origination of commercial real estate loans, commercial and industrial loans and residential
real estate loans, as well as and the purchase of mortgage-backed and other investment securities. During the year ended December
31, 2021, we originated $611.4 million in loans, compared to $654.6 million in 2020. We purchased securities totaling $296.6 million
for the year ended December 31, 2021, compared to purchases of $159.0 million for the year ended December 31, 2020. At December
31, 2021, the Company had approximately $217.2 million in loan commitments and letters of credit to borrowers and approximately
$326.0 million in available home equity and other unadvanced lines of credit.

Deposit
in flows and out flows are affected by the level of interest rates, the products and interest rates offered by competitors and
by other factors. At December 31, 2021, time deposit accounts scheduled to mature within one year totaled $363.0 million. Based
on the Company’s deposit retention experience and current pricing strategy, we anticipate that a significant portion of
these time deposits will remain on deposit. We monitor our liquidity position frequently and anticipate that it will have sufficient
funds to meet our current funding commitments for the next 12 months and beyond.

At
December 31, 2021, the Company and the Bank exceeded each of the applicable regulatory capital requirements (See Note 13, Regulatory
Capital, to our consolidated financial statements for further information on our regulatory requirements).

64

Material
Cash Commitments

The
Company entered into a long-term contractual obligation with a vendor for use of its core provider and ancillary services beginning
in 2016. Total remaining contractual obligations outstanding with this vendor as of December 31, 2021 were estimated to be $14.2
million, with $4.5 million expected to be paid within one year and the remaining $9.7 million to be paid within the next five
years. Further, the Company has operating leases for certain of its banking offices and ATMs. Our leases have remaining lease
terms of less than one year to seventeen years, some of which include options to extend the leases for additional five-year terms
up to fifteen years. Lease liabilities totaled $10.5 million as of December 31, 2021. Principal payments expected to be made on
our lease liabilities during the twelve months ended December 31, 2022 were $1.4 million. The remaining lease liability payments
totaled $9.1 million and are expected to be made after December 31, 2022 (See Note 12, Leases, to our consolidated financial
statements for further information on our lease obligations).

In
addition, the Company completed an offering of $20 million in aggregate principal amount of its 4.875% fixed-to-floating rate
subordinated notes (the “Notes”) to certain qualified institutional buyers in a private placement transaction on April
20, 2021. Unless earlier redeemed, the Notes mature on May 1, 2031. The Notes will bear interest from the initial issue date to,
but excluding, May 1, 2026, or the earlier redemption date, at a fixed rate of 4.875% per annum, payable quarterly in arrears
on May 1, August 1, November 1 and February 1 of each year, beginning August 1, 2021, and from and including May 1, 2026, but
excluding the maturity date or earlier redemption date, equal to the benchmark rate, which is the 90-day average secured overnight
financing rate, plus 412 basis points, determined on the determination date of the applicable interest period, payable quarterly
in arrears on May 1, August 1, November 1 and February 1 of each year. The Company may also redeem the Notes, in whole or in part,
on or after May 1, 2026, and at any time upon the occurrence of certain events, subject in each case to the approval of the Board
of Governors of the Federal Reserve (See Note 8, Long-Term Debt, to our consolidated financial statements for further information
on our long-term debt).

We
do not anticipate any material capital expenditures during the calendar year 2022, except in pursuance of the Company’s
strategic initiatives. The Company does not have any balloon or other payments due on any long-term obligations or any off-balance
sheet items other than the commitments and unused lines of credit noted above.

Off-Balance
Sheet Arrangements.

The
Company does not have any off-balance sheet arrangements, other than noted above and in Note 16, Commitments and Contingencies,
to our consolidated financial statements, that have or are reasonably likely to have a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital
resources that is material to investors.

Management
of Market Risk.

As
a financial institution, our primary market risk is interest rate risk since substantially all transactions are denominated in
U.S. dollars with no direct foreign exchange or changes in commodity price exposure. Fluctuations in interest rates will affect
both our level of income and expense on a large portion of our assets and liabilities. Fluctuations in interest rates will also
affect the market value of all interest-earning assets and interest-bearing liabilities.

The
Company’s interest rate management strategy is to limit fluctuations in net interest income as interest rates vary up or
down and control variations in the market value of assets, liabilities and net worth as interest rates vary. We seek to coordinate
asset and liability decisions so that, under changing interest rate scenarios, net interest income will remain within an acceptable
range.

In
order to achieve the Company’s objectives of managing interest rate risk, the Asset and Liability Management Committee (“ALCO”)
meets periodically to discuss and monitor the market interest rate environment relative to interest rates that are offered on
our products. ALCO presents quarterly reports to the Board of Directors which includes the Company’s interest rate risk
position and liquidity position.

65

The
Company’s primary source of funds are deposits, consisting primarily of time deposits, money market accounts, savings accounts,
demand accounts and interest-bearing checking accounts, which have shorter terms to maturity than the loan portfolio. Several
strategies have been employed to manage the interest rate risk inherent in the asset/liability mix, including but not limited
to:

In
2021, cash flows from deposit inflows were used to pay down high cost FHLB borrowings, fund loan growth and purchase held-to-maturity
securities. The Company continues its emphasis on growing commercial loans, which typically have variable interest rates and shorter
maturities than residential loans.

The
actual amount of time before loans are repaid can be significantly affected by changes in market interest rates. Prepayment rates
will also vary due to a number of other factors, including the regional economy in the area where the loans were originated, seasonal
factors, demographic variables and the assumability of the loans. However, the major factors affecting prepayment rates are prevailing
interest rates, related financing opportunities and competition. We monitor interest rate sensitivity so that we can adjust our
asset and liability mix in a timely manner and minimize the negative effects of changing rates.

The
Company’s liquidity sources are vulnerable to various uncertainties beyond our control. Loan amortization and investment
cash flows are a relatively stable source of funds, while loan and investment prepayments and calls, as well as deposit flows
vary widely in reaction to market conditions, primarily prevailing interest rates. Asset sales are influenced by pledging activities,
general market interest rates and unforeseen market conditions. Our financial condition is affected by our ability to borrow at
attractive rates, retain deposits at market rates and other market conditions. We consider our sources of liquidity to be adequate
to meet expected funding needs and also to be responsive to changing interest rate markets.

Interest
Rate Risk.

Interest
rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income
and expense streams associated with our financial instruments also change, thereby impacting net interest income, the primary
component of our earnings. ALCO utilizes the results of a detailed and dynamic simulation model to quantify the estimated exposure
of net interest income to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity
over a rolling two-year horizon, they also utilize additional tools to monitor potential longer-term interest rate risk.

The
simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all
interest-earning assets and interest-bearing liabilities reflected on our consolidated balance sheet, as well as for derivative
financial instruments. This sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for
net interest income exposure over a one and two-year horizon, assuming no balance sheet growth.

The
repricing and/or new rates of assets and liabilities moved in tandem with market rates. However, in certain deposit products,
the use of data from a historical analysis indicated that the rates on these products would move only a fraction of the rate change
amount. Pertinent data from each loan account, deposit account and investment security was used to calculate future cash flows.
The data included such items as maturity date, payment amount, next repricing date, repricing frequency, repricing index, repricing
spread, caps and floors. Prepayment speed assumptions were based upon the difference between the account rate and the current
market rate. We also evaluate changes in interest rate sensitivity under various scenarios including but not limited to nonparallel
shifts in the yield curve, variances in prepayment speeds and variances to correlations of instrument rates to market indexes.

66

The
table below shows our net interest income sensitivity analysis reflecting the following changes to net interest income for the
first and second years of the simulation model. The analysis assumes no balance sheet growth, a parallel shift in interest rates,
and all rate changes were “ramped” over the first 12-month period and then maintained at those levels over the remainder
of the simulation horizon.

The
preceding sensitivity analysis does not represent a forecast of net interest income, nor do the calculations represent any actions
that management may undertake in response to changes in interest rates. They should not be relied upon as being indicative of
expected operating results. These hypothetical estimates are based upon numerous assumptions including, among others, the nature
and timing of interest rate levels, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions
on loans and deposits and reinvestment/replacement of asset and liability cash flows. While assumptions are developed based upon
current economic and local market conditions, we cannot make any assurances as to the predictive nature of these assumptions,
including how customer preferences or competitor influences might change.

Periodically,
if deemed appropriate, we may use interest rate swaps, floors and caps, which are common derivative financial instruments, to
hedge our interest rate exposure to interest rate movements. The Board of Directors has approved hedging policy statements governing
the use of these instruments. These interest rate swaps are designated as cash flow hedges and involve the receipt of variable
rate amounts from a counterparty in exchange for our making fixed payments. We did not have any interest rate swap agreements
designated as cash flow hedges at December 31, 2021.

Recent
Accounting Pronouncements.

Refer
to Note 1 to our consolidated financial statements for a summary of the recent accounting pronouncements.

Impact
of Inflation and Changing Prices.

The
Company’s consolidated financial statements and accompanying notes have been prepared in accordance with GAAP. GAAP generally
requires the measurement of financial position and operating results in terms of historical dollars without consideration for
changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased
cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result,
changes in market interest rates have a greater impact on performance than do the effects of inflation.