EAGLE FINANCIAL SERVICES INC

Notes to Consolidated Finan cial Statements (Unaudited)

June 30, 2024

NOTE 1. General

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

In the opinion of management, the accompanying financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position at June 30, 2024 and December 31, 2023, the results of operations and the changes in shareholders' equity for the three and six months ended June 30, 2024 and 2023, and cash flows for the six months ended June 30, 2024 and 2023. The results of operations for the three and six months ended June 30, 2024 are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the Consolidated Financial Statements and related Notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023 (the “2023 Form 10-K”).

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

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

On January 1, 2024, the Company adopted Accounting Standards Update ("ASU") 2023-02, “Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method," ("ASC 323"). These amendments allow reporting entities to elect to account for qualifying tax equity investments using the proportional amortization method, regardless of the program giving rise to the related income tax credits. The adoption resulted in an adjustment of $477 thousand, which reduced the investment balance and shareholders' equity. The Company invests in qualified affordable housing projects. The general purpose of these investments is to encourage and assist participants in investing in low-income residential rental properties located in the Commonwealth of Virginia, develop and implement strategies to maintain projects as low-income housing, provide tax credits and other tax benefits to investors, and to preserve and protect project assets.

NOTE 2. Stock-Based Compensation Plan

On May 16, 2023, the Company’s shareholders approved the 2023 Stock Incentive Plan which allows key employees and directors to increase their personal financial interest in the Company. The 2023 plan permits the issuance of incentive stock options and non-qualified stock options and the award of common stock, restricted stock, and stock units. The plan authorizes the issuance of up to 250,000 shares of common stock. The 2023 Stock Incentive Plan replaced the 2014 Stock Incentive Plan.

The Company periodically grants restricted stock to its directors, executive officers and certain non-executive officers. Restricted stock provides grantees with rights to shares of common stock upon completion of a service period or achievement of Company performance measures. During the restriction period, all shares are considered outstanding and dividends are paid to the grantee. Outside directors are periodically granted restricted shares which vest over a period ofone year. Executive officers have been granted restricted shares which vest over athree year service period and restricted shares which vest based on meeting annual performance measures over atwo year period. Certain non-executive officers also have been granted restricted shares which vest overa three year service period. The Company recognizes compensation expense over the restricted period based on the fair value of the Company's stock on the grant date. The Company's policy is to recognize forfeitures as they occur. As of June 30, 2024, there was $1.1 million of unrecognized compensation cost related to nonvested restricted stock, with a weighted average remaining term of 2.05 years.

The following table presents restricted stock activity for thesix months ended June 30, 2024 and 2023:

NOTE 3. Earnings Per Common Share

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

The following table shows the weighted average number of shares used in computing earnings per share for thethree and six months ended June 30, 2024 and 2023. During 2024 and 2023, there wereno potentially dilutive securities outstanding.

NOTE 4. Securities

Amortized costs and fair values of securities available for sale at June 30, 2024 and December 31, 2023 were as follows:

The amortized cost and estimated fair value of securities at June 30, 2024, by the earlier of contractual maturity or expected maturity, are shown below. The Company has elected to exclude accrued interest receivable, totaling $379 thousand at June 30, 2024, from the amortized cost basis of securities. The deferred tax asset on the securities portfolio at June 30, 2024 and December 31, 2023 was $5.0 million and $4.8 million, respectively, and is included in Other Assets in the Consolidated Balance Sheets. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.

There have been no sales of available for sale securities during the six months ended June 30, 2024 or 2023.

The fair value and gross unrealized losses for securities available for sale, totaled by the length of time that individual securities have been in a continuous gross unrealized loss position, at June 30, 2024 and December 31, 2023 were as follows:

The reference point for determining when securities are in an unrealized loss position is month end. As such, it is possible that a security's market value exceeded its amortized cost on other days during the past twelve-month period.

There were 102 debt securities with a fair value below the amortized cost basis, totaling $128.5 million of aggregate fair value as of June 30, 2024. The Company concluded that a credit loss does not exist in its securities portfolio at June 30, 2024 based on the fact that (1) changes in fair value were caused by non-credit-related factors, primarily fluctuations in interest rates, (2) securities with unrealized losses had generally high credit quality, (3) the Company intends to hold these investments in debt securities to maturity and it is more-likely-than-not that the Company will not be required to sell these investments before a recovery of its investment, and (4) issuers have continued to make timely payments of principal and interest. Additionally, the Company’s mortgage-backed securities and obligations of U.S. government corporations and agencies are entirely issued by either U.S. government agencies or U.S. government-sponsored enterprises. Collectively, these entities provide a guarantee, which is either explicitly or implicitly supported by the full faith and credit of the U.S. government, that investors in such mortgage-backed securities will receive timely principal and interest payments.

Securities having a carrying value of $6.9 million at June 30, 2024 were pledged as security for trust accounts.

The composition of restricted investments at June 30, 2024 and December 31, 2023 was as follows:

NOTE 5. Loans and Allowance for Credit Losses on Loans

The composition of loans at June 30, 2024 and December 31, 2023 was as follows:

At June 30, 2024, the Company was servicing $10.0 million of loans for other financial institutions which are not included in the table above. Also excluded from the table above are net servicing assets of $181 thousand at June 30, 2024, which are recorded in other assets in the Consolidated Balance Sheets. When loans are sold with servicing retained, servicing assets are recorded which represent the Company's right to service loans that were sold. Servicing assets are initially recorded by the Company at fair value and are subsequently amortized in proportion to, and over the period of, estimated net servicing income.

Changes in the allowance for credit losses on loans for thethree and six months ended June 30, 2024 and 2023 were as follows:

Past due loans by class at June 30, 2024 and December 31, 2023 were as follows:

Nonaccrual loans by class at June 30, 2024 and December 31, 2023 were as follows:

The allowance for credit losses on loans by segment at June 30, 2024 and December 31, 2023 was as follows:

The following table presents the amortized cost basis of collateral-dependent loans by loan portfolio segment:

The Company did not identify any significant changes in the extent to which collateral secures its collateral dependent loans, whether in the form of general deterioration or from other factors during the period ended June 30, 2024.

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually to classify the loans as to credit risk. This analysis is performed on a quarterly basis. The following table presents risk ratings by loan portfolio segment and origination year. Description of these ratings are as follows:

Credit quality information by class at June 30, 2024 was as follows:

Credit quality information by class at December 31, 2023 was as follows:

Unfunded Commitments: The Company maintains a separate reserve for credit losses on unfunded commitments, which is included in Other Liabilities on the Consolidated Balance Sheet. The reserve for credit losses on off-balance-sheet credit exposures is adjusted as a provision for credit losses in the consolidated income statement. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded, utilizing the same models and approaches for the Company's other loan portfolio segments, as these unfunded commitments share similar risk characteristics as its loan portfolio segments. The Company has identified the unfunded portion of certain lines of credit as unconditionally cancellable credit exposures, meaning the Company can cancel the unfunded commitment at any time. No credit loss estimate is reported for off-balance-sheet credit exposures that are unconditionally cancellable by the Company or for undrawn amounts under such arrangements that maybe drawn prior to the cancellation of the arrangement.

During the three and six months ended June 30, 2024, a reduction to the unfunded commitment reserve of $134 thousand was recorded as a credit to the provision for credit losses in the consolidated income statement. On January 1, 2023, the Company recorded an adjustment for unfunded commitments of $406 thousand for the adoption of ASC 326. For thethree and six months ended June 30, 2023, a reduction to the unfunded commitment reserve of $7 thousand and $52 thousand, respectively, was recorded as a credit to the provision for credit losses in the consolidated income statement. The reserve for unfunded commitments at June 30, 2024 and 2023 and December 31, 2023 was $345 thousand, $417 thousand, and $479 thousand, respectively.

NOTE 6. Restructurings for Borrowers Experiencing Financial Difficulty

There wereno loans modified during thethree and six months ended June 30, 2024, or the three months ended June 30, 2023. The following table presents the amortized cost oftwo loans that were modified during thesix months ended June 30, 2023 by loan portfolio segment:

None of the loans that were modified defaulted during the six months ended June 30, 2023 and the loans remain current with contractual payments as of June 30, 2024. The financial effects of the term extensions during the prior-year period added a weighted average of 1.0 years to the life of loans which reduced the payment amounts for the borrowers.

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

NOTE 7. Deposits

The composition of deposits at June 30, 2024 and December 31, 2023 was as follows:

NOTE 8. Leases

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

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

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

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

NOTE 9. Fair Value Measurements

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

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

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

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

Derivative instruments are recorded at fair value on a recurring basis. The Company utilizes derivative instruments as part of the management of interest rate risk to modify the re-pricing characteristics of certain portions of the Company’s interest-bearing assets and liabilities. The Company has contracted with a third-party vendor to provide valuations for derivatives using standard valuation techniques and therefore classifies such valuations as Level 2. The Company has considered counterparty credit risk in the valuation of its derivative assets and has considered its own credit risk in the valuation of its derivative liabilities.

The following table presents balances of financial assets and liabilities measured at fair value on a recurring basis at June 30, 2024 and December 31, 2023:

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

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

Loans Held for Sale: Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). The Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale duringsix months ended June 30, 2024 and the year ended December 31, 2023.

Individually Evaluated Collateral-Dependent Loans: The estimated fair value of individually evaluated collateral-dependent loans is based on the value of the underlying collateral or the value of the underlying collateral, less estimated cost to sell, as appropriate. Collateral is generally real estate; however, collateral may include vehicles, equipment, inventory, accounts receivable, and/or other business assets. The value of real estate collateral is determined using a market valuation approach based on an appraisal conducted by an independent, licensed appraiser. The value of other assets may also be based on an appraisal, market quotations, aging schedules or other sources. Collateral-dependent individually evaluated loans are classified within Level 3 of the fair value hierarchy. Any fair value adjustments are recorded in the period incurred as a provision for credit losses on the Consolidated Statements of Income. At June 30, 2024 there was one collateral-dependent relationship totaling $969 thousand, which was individually evaluated and being carried at fair value of $623 thousand. This relationship consists of three commercial business loans collateralized by equipment. There were no individually evaluated collateral dependent loans recorded at fair value at December 31, 2023.

Other Real Estate Owned: Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the fair value of the property, less estimated selling costs, establishing a new costs basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for credit losses. Costs of significant property improvements are capitalized, whereas costs relating to holding property are expensed. The portion of interest costs relating to development of real estate is capitalized. Valuations are periodically obtained by management, and any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to fair value less cost to sell. The fair value measurement of real estate held in other real estate owned is assessed in the same manner as collateral-dependent loans described above. We believe that the fair value follows the provisions of GAAP. The Company heldno other real estate owned at June 30, 2024 or December 31, 2023.

Repossessed Assets: Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the fair value of the asset, less estimated selling costs, establishing a new costs basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for credit losses. Costs of significant improvements are capitalized, whereas costs relating to holding assets are expensed. Valuations are periodically obtained by management, and any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of an asset to fair value less cost to sell. The fair value measurement of repossessed assets is assessed in the same manner as collateral dependent loans described above. We believe that the fair value follows the provisions of GAAP. The Company held $403 thousand and $304 thousand at June 30, 2024 and December 31, 2023.

The following table displays quantitative information about Level 3 Fair Value Measurements for certain financial assets measured at fair value on a nonrecurring basis for June 30, 2024 and December 31, 2023.

(1)Weighted based on the relative fair value of the specific items measured at fair value.

The following table summarizes the Company's nonfinancial assets that were measured at fair value on a nonrecurring basis at June 30, 2024 and December 31, 2023.

The carrying value and fair value of the Company’s financial instruments at June 30, 2024 and December 31, 2023 were as follows:

NOTE 10. Change in Accumulated Other Comprehensive Income (Loss)

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

Changes to accumulated other comprehensive income (loss) by component are shown in the following table for the periods indicated:

For the three and six months ended June 30, 2024 and 2023, there wereno reclassifications out of accumulated other comprehensive income (loss).

NOTE 11. Other Real Estate Owned

The following table is a summary of other real estate owned (“OREO”) activity for thesix months ended June 30, 2024 and 2023 and the year ended December 31, 2023:

There were no loans collateralized by residential real estate in the process of foreclosure at June 30, 2024 and December 31, 2023.

NOTE 12. Qualified Affordable Housing Project Investments

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

On January 1, 2024, the Company adopted ASU 2023-02, “Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method." The adoption resulted in an adjustment of $477 thousand, which reduced the investment and shareholders' equity balances.

At June 30, 2024 and December 31, 2023, the balance of the investment for qualified affordable housing projects was $1.4 million and $2.0 million, respectively. These balances are reflected in Other assets on the Consolidated Balance Sheets. Total unfunded commitments related to the investments in qualified affordable housing projects totaled zero at both June 30, 2024 and December 31, 2023.

During each of the three months ended June 30, 2024 and June 30, 2023, the Company recognized amortization expense of $74 thousand and $54 thousand, respectively. Amortization expense for thesix months ended June 30, 2024 and 2023 was $147 thousand and $158 thousand, respectively.

Beginning in 2024, upon adoption of ASU 2023-02, the amortization expense was included in income tax expense, while in 2023 and prior it was included in Other operating expenses on the Consolidated Statements of Income.

Total estimated credits to be received during 2024 are$306 thousand based on the most recent quarterly estimates received from the funds. Total tax credits and other tax benefits recognized during the six months ended June 30, 2024 and 2023, were$153 thousand and $180 thousand, respectively.

NOTE 13. Recent Accounting Pronouncements and Other Authoritative Guidance

There are no recent accounting pronouncements that are expected to have a material impact on the Company's consolidated financial statements.

NOTE 14. Borrowings

On March 31, 2022, the Company entered into Subordinated Note Purchase Agreements with certain purchasers pursuant to which the Company issued and sold $30.0 million in aggregate principal amount of its 4.50% Fixed-to-Floating Rate Subordinated Notes due April 1, 2032 (the “Notes”).

The Company uses the net proceeds of the Notes offering for general corporate purposes, organic growth and to support the Bank’s regulatory capital ratios. The Notes were structured to qualify as Tier 2 capital for regulatory capital purposes at the holding company and bear an initial interest rate of 4.50% until April 1, 2027, with interest during this period payable semi-annually in arrears. From and including April 1, 2027, to but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an annual floating rate equal to three-month SOFR, plus 2.35%, with interest during this period payable quarterly in arrears. The Notes are redeemable by the Company at its option, in whole or in part, on or after April 1, 2027. Initial debt issuance costs were $673 thousand. The debt balance of $30.0 million is presented net of unamortized issuance costs of $522 thousand at June 30, 2024.

The Company had $145.0 million in total borrowings with the Federal Home Loan Bank of Atlanta ("FHLB") at June 30, 2024, with no short-term borrowings outstanding and $145.0 million being long-term borrowings. The interest rates on the long-term borrowings with the FHLB ranged from 4.43% to 4.83%, with a weighted average rate of 4.65%. Of the long-term FHLB borrowings, $50.0 million is due in 2024, $55.0 million is due in 2025 and $40.0 million is due in 2026. At December 31, 2023, the Company had $145.0 million in long-term and $20.0 million in short-term outstanding borrowings with the FHLB. The Company had $122.0 million in irrevocable letters of credit at June 30, 2024 with the FHLB to secure public deposits.

NOTE 15. Derivatives

The Company uses derivative financial instruments primarily to manage risks to the Company associated with changing interest rates, and to assist customers with their risk management objectives. Derivative contracts that are not designated in a qualifying hedging relationships include customer accommodation loan swaps. The Company enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The Bank simultaneously enters into interest rate swaps with dealer counterparties, with identical notional amounts and offsetting terms. The net result of these interest rate swaps is that the customer pays a fixed rate of interest and the Company receives a floating rate. These back-to-back loan swaps are derivative financial instruments and are reported at fair value in “other assets” and “other liabilities” in the Consolidated Balance Sheets. Changes in the fair value of loan swaps are recorded in other noninterest income and sum to zero because of the offsetting terms of the swaps with borrowers and the swaps with dealer counterparties.

The following tables summarize key elements of the Company's derivative instruments at June 30, 2024 and December 31, 2023.

NOTE 16. Business Segments

The Company has three reportable operating segments: community banking, marine lending and wealth management. Revenue from community banking operations consist primarily of net interest income related to investments in loan and securities and outstanding deposits and borrowings, fees earned on deposit accounts and debit card interchange activity. Revenue from marine lending operations consist primarily of net interest income related to commercial and consumer marine loans. The wealth management division's net revenues are comprised primarily of income from offering wealth management services and insurance products through third-party service providers.

On August 23, 2023, the Company completed a sale of specific assets from its marine lending segment. As part of the sale, the Company sold its interest in marine vessel floor plan loans totaling $52.8 million, its rights to service loans that had been sold to secondary market investors prior to the date of sale (valued at $595 thousand on balance sheet prior to sale), and other assets that were not individually significant. The Company received total consideration, net of selling expenses, of $53.5 million and recognized a gain of $435 thousand. The assets sold as well as their related revenues and contribution to earnings did not constitute a significant portion of the Company's assets or operating results for the year ended December 31, 2023. Subsequent to the sale of these assets, the Company retained ownership of its marine vessel retail loans which continue to constitute a significant portion of the Company's assets, revenues, and earnings. The Company expects to cease accepting new marine lending business and hold the retained outstanding loans until they are ultimately repaid.

Financial information of the parent company is included in the "All Other" category. The parent company's revenue and expenses are comprised primarily of interest expense associated with subordinated debt.

The following tables provide income and asset information as of June 30, 2024 and December 31, 2023 and for three and six months ended June 30, 2024 and 2023, which are included within the Consolidated Balance Sheets and Consolidated Statements of Income. The results by business segment are based on management’s accounting process, which assigns income statement items and assets to each operating segment. Given the Company's reportable segments are contained within the Bank, management must make certain allocations of expenses, which may not be representative of the costs expected to be incurred if the specific business segments operated as stand-alone entities. The Company expects it will continue to evaluate its business segments and internal reporting structure, including the production of discrete financial information to the chief operating decision-maker.