10-Q 1 tm2014619d1_10q.htm FORM 10-Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10Q

 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2020

 

or

 

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

 

For the transition period from ________ to ________

 

Commission File Number: 000-21344

 

FIRST KEYSTONE CORPORATION
(Exact name of registrant as specified in its charter)

 

Pennsylvania  23-2249083
(State or other jurisdiction of  (I.R.S. Employer
incorporation or organization)  Identification No.)
    
111 West Front Street, Berwick, PA  18603
(Address of principal executive offices)  (Zip Code)

 

Registrant’s telephone number, including area code: (570) 752-3671

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x      No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x      No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “small reporting company,” and emerging growth company in Rule 12b-2 of the Exchange Act

Large accelerated filer  ¨  Accelerated filer  x
Non-accelerated filer  ¨  Smaller reporting company  x
Emerging growth company  ¨      

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Exchange Act. ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

 

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

 

Title of each class Trading symbol Name of each exchange on which registered
Common stock FKYS OTC: Pink

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date:

Common Stock, $2 Par Value, 5,832,107 shares as of May 7, 2020.

 

 

   

 

 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(Dollars in thousands, except share and per share data)

 

   March 31,   December 31, 
   2020   2019 
ASSETS          
Cash and due from banks  $7,785   $10,251 
Interest-bearing deposits in other banks   1,013    473 
Total cash and cash equivalents   8,798    10,724 
Time deposits with other banks   247    247 
Debt securities available-for-sale, at fair value   283,663    277,928 
Marketable equity securities, at fair value   1,394    1,933 
Restricted investment in bank stocks, at cost   6,740    4,224 
Loans   659,274    645,440 
Loans held for sale   2,342    2,292 
Allowance for loan losses   (7,179)   (7,005)
Net loans   654,437    640,727 
Premises and equipment, net   19,244    19,387 
Operating lease right-of-use assets   1,312    1,470 
Accrued interest receivable   3,622    3,405 
Cash surrender value of bank owned life insurance   23,737    23,583 
Investments in low-income housing partnerships   1,737    1,828 
Goodwill   19,133    19,133 
Foreclosed assets held for resale   169    119 
Other assets   2,974    2,518 
TOTAL ASSETS  $1,027,207   $1,007,226 
LIABILITIES          
Deposits:          
Non-interest bearing  $153,029   $134,648 
Interest bearing   581,768    626,980 
Total deposits   734,797    761,628 
Short-term borrowings   106,379    54,663 
Long-term borrowings   50,000    55,000 
Operating lease liabilities   1,577    1,663 
Accrued interest payable   550    606 
Deferred income taxes   351    438 
Other liabilities   3,403    4,476 
TOTAL LIABILITIES   897,057    878,474 
STOCKHOLDERS’ EQUITY          
Preferred stock, par value $2.00 per share; authorized 1,000,000 shares as of March 31, 2020 and December 31, 2019;  issued 0 as of March 31, 2020 and December 31, 2019   ―    ― 
Common stock, par value $2.00 per share; authorized 20,000,000 shares as of March 31, 2020 and December 31, 2019; issued 6,063,719 as of March 31, 2020 and 6,048,506 as of  December 31, 2019; outstanding 5,832,107 as of March 31, 2020 and 5,816,894 as of December 31, 2019   12,127    12,097 
Surplus   38,645    38,365 
Retained earnings   80,261    79,778 
Accumulated other comprehensive income   4,826    4,221 
Treasury stock, at cost, 231,612 shares as of March 31, 2020 and December 31, 2019   (5,709)   (5,709)
TOTAL STOCKHOLDERS’ EQUITY   130,150    128,752 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $1,027,207   $1,007,226 

 

See accompanying notes to consolidated financial statements.

 

 2 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(Unaudited)

 

(Dollars in thousands, except per share data)        
         
   2020   2019 
Interest and fees on loans  $7,758   $7,074 
Interest and dividend income on securities:          
Taxable   1,276    1,218 
Tax-exempt   630    1,018 
Dividends   12    11 
Dividend income on restricted investment in bank stocks   90    184 
Interest on interest-bearing deposits in other banks   2    9 
Total interest income   9,768    9,514 
           
INTEREST EXPENSE          
Interest on deposits   1,884    1,378 
Interest on short-term borrowings   242    1,115 
Interest on long-term borrowings   266    200 
Total interest expense   2,392    2,693 
Net interest income   7,376    6,821 
Provision for loan losses   194    92 
Net interest income after provision for loan losses   7,182    6,729 
           
NON-INTEREST INCOME          
Trust department   221    261 
Service charges and fees   499    514 
Bank owned life insurance income   154    155 
ATM fees and debit card income   399    377 
Gains on sales of mortgage loans   93    40 
Net securities (losses) gains   (467)   103 
Other   84    57 
Total non-interest income   983    1,507 
           
NON-INTEREST EXPENSE          
Salaries and employee benefits   3,219    3,132 
Occupancy, net   518    464 
Furniture and equipment   134    140 
Computer expense   260    280 
Professional services   242    270 
Pennsylvania shares tax   224    192 
FDIC insurance   —    65 
ATM and debit card fees   209    211 
Data processing fees   294    267 
Foreclosed assets held for resale expense   9    38 
Advertising   91    153 
Other   715    643 
Total non-interest expense   5,915    5,855 
Income before income tax expense   2,250    2,381 
Income tax expense   197    138 
NET INCOME  $2,053   $2,243 
           
PER SHARE DATA          
Net income per share:          
Basic  $0.35   $0.39 
Diluted   0.35    0.39 
Dividends per share   0.27    0.27 

 

See accompanying notes to consolidated financial statements.

 

 3 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(Unaudited)

 

 

(Dollars in thousands)

 

   March 31, 
   2020   2019 
Net Income  $2,053   $2,243 
           
Other comprehensive income:          
Unrealized net holding gains on debt securities available-for-sale arising during the period, net of income taxes of $176 and $986, respectively   661    3,709 
           
Less reclassification adjustment for net realized gains included in net income, net of income taxes of $(15) and $(18), respectively (a) (b)   (56)   (67)
           
Total other comprehensive income   605    3,642 
           
Total Comprehensive Income  $2,658   $5,885 

 

_______________________

(a) Gross amounts are included in net securities (losses) gains on the consolidated statements of income in non-interest income.

(b) Income tax amounts are included in income tax expense on the consolidated statements of income.

 

 

See accompanying notes to consolidated financial statements.

 

 4 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(Unaudited)

 

(Dollars in thousands, except per share data)

 

                   Accumulated         
                   Other       Total 
   Common Stock       Retained   Comprehensive   Treasury   Stockholders’ 
   Shares   Amount   Surplus   Earnings   Income   Stock   Equity 
                             
Balance at January 1, 2020   6,048,506   $12,097   $38,365   $79,778   $4,221   $(5,709)  $128,752 
Net Income                  2,053              2,053 
Other comprehensive income, net of taxes                       605         605 
Issuance of common stock under dividend reinvestment plan   15,213    30    280                   310 
Dividends - $0.27 per share                  (1,570)             (1,570)
Balance at March 31, 2020   6,063,719   $12,127   $38,645   $80,261   $4,826   $(5,709)  $130,150 
                                    
                                    
                                    
Balance at January 1, 2019   5,996,322   $11,993   $37,255   $75,798   $(2,581)  $(5,709)  $116,756 
Net Income                  2,243              2,243 
Other comprehensive income, net of taxes                       3,642         3,642 
Issuance of common stock under dividend reinvestment plan   12,312    24    254                   278 
Dividends - $0.27 per share                  (1,557)             (1,557)
Balance at March 31, 2019   6,008,634   $12,017   $37,509   $76,484   $1,061   $(5,709)  $121,362 

 

See accompanying notes to consolidated financial statements.

 

 5 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(Unaudited)

 

(Dollars in thousands)

 

   2020   2019 
OPERATING ACTIVITIES          
Net income  $2,053   $2,243 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   194    92 
Depreciation and amortization   488    254 
Net premium amortization on investment securities   498    733 
Deferred income tax (benefit) expense   (247)   62 
Gains on sales of mortgage loans   (93)   (40)
Proceeds from sales of mortgage loans originated for resale   3,137    1,250 
Originations of mortgage loans originated for resale   (3,100)   (964)
Net securities losses (gains)   467    (103)
Net losses on sales of foreclosed real estate held for resale, including write-downs   —    20 
(Increase) decrease in accrued interest receivable   (217)   367 
Earnings on investment in bank owned life insurance   (154)   (155)
Net losses on disposals of premises and equipment   —    4 
Increase in other assets   (537)   (1,860)
Amortization of investment in real estate ventures   91    88 
(Decrease) increase in accrued interest payable   (56)   58 
(Decrease) increase in other liabilities   (1,159)   1,198 
NET CASH PROVIDED BY OPERATING ACTIVITIES   1,365    3,247 
           
INVESTING ACTIVITIES          
Proceeds from sales of debt securities available-for-sale   11,182    32,374 
Proceeds from maturities and redemptions of debt securities available-for-sale   15,324    4,520 
Purchases of debt securities available-for-sale   (31,902)   — 
Net change in restricted investment in bank stocks   (2,516)   1,173 
Net increase in loans   (13,877)   (11,891)
Purchases of premises and equipment   (120)   (234)
Proceeds from sales of foreclosed assets held for resale   —    197 
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES   (21,909)   26,139 
           
FINANCING ACTIVITIES          
Net (decrease) increase in deposits   (26,831)   25,867 
Net increase (decrease) in short-term borrowings   51,716    (42,966)
Repayment of long-term borrowings   (5,000)   (10,000)
Common stock issued   303    278 
Dividends paid   (1,570)   (1,557)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES   18,618    (28,378)
           
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS   (1,926)   1,008 
CASH AND CASH EQUIVALENTS, BEGINNING   10,724    10,950 
CASH AND CASH EQUIVALENTS, ENDING  $8,798   $11,958 
           
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION          
Interest paid   2,448    2,635 
Income taxes paid   (249)   62 
           
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES          
Loans transferred to foreclosed assets held for resale   50    — 
Common stock subscription receivable   7    — 
Right-of-use assets obtained in exchange for lease liabilities   —    1,465 

 

 

See accompanying notes to consolidated financial statements.

 6 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

NOTE 1 ― BASIS OF PRESENTATION, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND SUBSEQUENT EVENTS

 

The consolidated financial statements include the accounts of First Keystone Corporation (the “Corporation”) and its wholly owned subsidiary First Keystone Community Bank (the “Bank”) (collectively the “Company”). All significant intercompany accounts and transactions have been eliminated.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included. Operating results for the three month period ended March 31, 2020, are not necessarily indicative of the results for the year ending December 31, 2020. For further information, refer to the consolidated financial statements and notes thereto included in First Keystone Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019.

 

Subsequent Events

 

The Corporation has evaluated events and transactions occurring subsequent to the consolidated balance sheet date of March 31, 2020 for items that should potentially be recognized or disclosed in these consolidated financial statements. The evaluation was conducted through the date these consolidated financial statements were issued.

 

As a result of the spread of the COVID-19 coronavirus, economic uncertainties have arisen which are likely to negatively impact net interest income. The Corporation may experience difficulties collecting monthly payments on time from its borrowers, property values may decline, and certain types of loans may need to be extended or modified. The extent of the impact of COVID-19 on the Corporation’s operational and financial performance will depend on certain developments including the duration and spread of the outbreak and the impact on our customers, employees and vendors.

 

The Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted on March 27, 2020 in the United States. The Corporation is approved by the U.S. Small Business Administration (“SBA”) to fund loans under the SBA’s Paycheck Protection Program (“PPP”) created as part of the CARES Act. To date, the Bank has received 456 applications for PPP loans for a combined total of $32,367,000. As of April 30, 2020, 432 PPP loan applications were approved, and 152 of the loans were funded for $16,010,000. The PPP loans have 1.00% interest rates, lender fees, and two-year terms. These forgivable loans funded by the Corporation are subject to the terms and conditions applicable to all loans made pursuant to the PPP as administered by the SBA under the CARES Act.

 

In addition, subsequent to March 31, 2020, there have been loan modification requests to defer principal and/or interest payments or modify interest rates in the wake of the COVID-19 pandemic. As of April 30, 2020, there have been 493 loan modifications approved across all loan segments, for customers with current loan balances of $181,704,000. At this time, there have been no material fluctuations in loan delinquencies because of COVID-19.

 

Other financial impact could occur, though such potential impact is unknown at this time.

 

 7 

 

NOTE 2 ― RECENT ACCOUNTING STANDARDS UPDATES (“ASU”)

 

Recently adopted ASUs:

 

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The ASU simplified the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Instead, under the amendments, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value with its carrying amount. Additionally, an entity should consider income tax effects from any tax-deductible goodwill on the carrying amount when measuring the goodwill impairment loss, if applicable. The update also eliminated the requirements for zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. The amendments are effective for public business entities for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. The adoption of this update on January 1, 2020 did not have a material impact on the Corporation’s consolidated financial position or results of operations.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) – Disclosure Framework – Changes to Disclosure Requirements for Fair Value Measurement. The amendments in this Update removed required disclosures regarding: 1. The amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, 2. The policy for timing of transfers between levels, 3. The valuation processes for Level 3 fair value measurements, and 4. The Update modified the disclosure requirements on fair value measurements in Topic 820: a) The changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and b) The range and weighted average significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information (such as the median or arithmetic average) in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The amendments in this Update are effective for all entities for fiscal years, and interim periods within those fiscal years beginning after December 15, 2019. The adoption of this update on January 1, 2020 did not have a material impact on the Corporation’s consolidated financial statements and related disclosures.

 

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848), which provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by the discontinuation of the London Interbank Offered Rate (“LIBOR”), or by another reference rate that is expected to be discontinued. The amendments are effective for all entities as of March 12, 2020 through December 31, 2022. The Corporation has evaluated the impact of the provisions of ASU 2020-04 on our financial condition, results of operations and cash flows, and determined that there is no material impact on the consolidated financial statements and related disclosures.

 

Pending ASUs:

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU No. 2016-13 requires financial assets measured at amortized cost to 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 measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. ASU No. 2016-13 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2019. In November 2019, the FASB issued ASU 2019-10, Financial Instruments-Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), to delay the effective date for smaller reporting companies to fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. While the Corporation (a smaller reporting company) is currently evaluating the provisions of ASU 2016-13 to determine the potential impact of the new standard will have on the Corporation’s consolidated financial statements, it has taken steps to prepare for the implementation when it becomes effective, such as: forming an internal committee, gathering pertinent data, consulting with outside professionals, subscribing to a new software system, and running existing and new methodologies concurrently through the period of implementation.

 

 8 

 

 

NOTE 3 — SECURITIES

 

The Corporation classifies its securities as either “Held-to-Maturity” or “Available-for-Sale” at the time of purchase. Securities are accounted for on a trade date basis. Debt securities are classified as Held-to-Maturity when the Corporation has the ability and positive intent to hold the securities to maturity. Securities classified as Held-to-Maturity are carried at cost adjusted for amortization of premium and accretion of discount to maturity.

 

Debt securities not classified as Held-to-Maturity are included in the Available-for-Sale category and are carried at fair value. The amount of any unrealized gain or loss, net of the effect of deferred income taxes, is reported as accumulated other comprehensive income (loss) (AOCI) in the consolidated balance sheets and consolidated statements of changes in stockholders’ equity. Management’s decision to sell Available-for-Sale securities is based on changes in economic conditions, controlling the sources and applications of funds, terms, availability of and yield of alternative investments, interest rate risk and the need for liquidity.

 

Equity securities with readily determinable fair values are stated at fair value with realized and unrealized gains and losses reported in income. Equity securities without readily determinable fair values are recorded at cost less impairment, if any.

 

The cost of debt securities classified as Held-to-Maturity or Available-for-Sale is adjusted for amortization of premiums to the earliest call date and accretion of discounts to expected maturity. Such amortization and accretion, as well as interest and dividends, are included in interest and dividend income from investment securities. Realized gains and losses are included in net securities gains and losses. The cost of securities sold, redeemed or matured is based on the specific identification method.

 

The amortized cost, related estimated fair value, and unrealized gains and losses for debt securities classified as “Available-For-Sale” were as follows at March 31, 2020 and December 31, 2019:

 

   Debt Securities Available-for-Sale 
(Dollars in thousands)     Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
March 31, 2020:  Cost   Gains   Losses   Value 
U.S. Treasury securities  $—   $—   $—   $— 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed   62,235    1,055    (785)   62,505 
Other   12,341    7    (119)   12,229 
Other mortgage backed debt securities   10,187    —    (824)   9,363 
Obligations of state and political subdivisions   131,424    9,052    (9)   140,467 
Asset backed securities   42,889    —    (2,123)   40,766 
Corporate debt securities   18,479    118    (264)   18,333 
Total  $277,555   $10,232   $(4,124)  $283,663 

 

 

   Debt Securities Available-for-Sale 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
December 31, 2019:  Cost   Gains   Losses   Value 
U.S. Treasury securities  $2,852   $3    $―   $2,855 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed   77,131    539    (387)   77,283 
Other   10,381    4    (88)   10,297 
Other mortgage backed securities   11,145    3    (10)   11,138 
Obligations of state and political subdivisions   114,934    5,490    (48)   120,376 
Asset backed securities   37,596    115    (175)   37,536 
Corporate debt securities   18,546    182    (285)   18,443 
Total  $272,585   $6,336   $(993)  $277,928 

 

Securities Available-for-Sale with an aggregate fair value of $183,713,000 at March 31, 2020 and $201,468,000 at December 31, 2019, were pledged to secure public funds, trust funds, securities sold under agreements to repurchase and the Federal Discount Window aggregating $128,721,000 at March 31, 2020 and $143,546,000 at December 31, 2019.

 

 9 

 

 

The amortized cost and estimated fair value of debt securities, by contractual maturity, are shown below at March 31, 2020. 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.

 

(Dollars in thousands)

 

   March 31, 2020 
   Debt Securities Available-For-Sale 
       U.S. Government   Other   Obligations         
       Corporations &   Mortgage   of State   Asset   Corporate 
   U.S. Treasury   Agencies   Backed Debt   & Political   Backed   Debt 
   Securities   Obligations1   Securities1   Subdivisions   Securities   Securities 
Within 1 Year:                              
Amortized cost  $—   $―   $—   $1,001   $—   $2,000 
Fair value   —    ―    —    1,011    —    1,968 
                               
1 - 5 Years:                              
Amortized cost   —    772    —    21,473    2,872    16,479 
Fair value   —    788    —    22,070    2,737    16,365 
                               
5 - 10 Years:                              
Amortized cost   —    21,610    —    23,936    4,686    — 
Fair value   —    21,337    —    25,293    4,462    — 
                               
After 10 Years:                              
Amortized cost   —    52,194    10,187    85,014    35,331    — 
Fair value   —    52,609    9,363    92,093    33,567    — 
                               
Total:                              
Amortized cost  $—   $74,576   $10,187   $131,424   $42,889   $18,479 
Fair value   —    74,734    9,363    140,467    40,766    18,333 

______________________

1Mortgage-backed securities are allocated for maturity reporting at their original maturity date.

 

There were no aggregate securities with a single issuer (excluding the U.S. Government and U.S. Government Agencies and Corporations) which exceeded ten percent of consolidated stockholders’ equity at March 31, 2020. The quality rating of the obligations of state and political subdivisions are generally investment grade, as rated by Moody’s, Standard and Poor’s or Fitch. The typical exceptions are local issues which are not rated, but are secured by the full faith and credit obligations of the communities that issued these securities.

 

Proceeds from sales of investments in Debt Securities Available-For-Sale for the three months ended March 31, 2020 and 2019 were $11,182,000 and $32,374,000, respectively. Gross gains realized on these sales were $176,000 and $187,000, respectively. Gross losses realized on these sales were $105,000 and $102,000, respectively. There were no impairment losses realized on Debt Securities Available-For-Sale during the three months ended March 31, 2020 or 2019.

 

At March 31, 2020 and December 31, 2019, the Corporation had $1,394,000 and $1,933,000, respectively, in equity securities recorded at fair value. The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three months ended March 31, 2020 and 2019:

 

 10 

 

 

(Dollars in thousands)

 

   Three months ended   Three months ended 
   March 31, 2020   March 31, 2019 
Net (losses) and gains recognized during the period on equity securities  $(538)  $18 
Less: Net gains and (losses) recognized during the period on equity securities sold during the period   —    — 
Unrealized (losses) and gains recognized during the reporting period on equity securities still held at the reporting date  $(538)  $18 

 

There were no proceeds from sales of investments in Held-to-Maturity debt securities during the first three months of 2020 or 2019. Therefore, there were no gains or losses realized during these periods.

 

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. Securities classified as Available-for-Sale or Held-to-Maturity are generally evaluated for OTTI under FASB ASC 320, Investments - Debt and Equity Securities. In determining OTTI under the FASB ASC 320 model, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity 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. 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.

 

When OTTI occurs on debt securities, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, 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. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected, and the realized loss is recognized as impairment charges on securities on the consolidated statements of income. The amount of the total OTTI related to the other factors shall be recognized in other comprehensive income (loss), net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

 

The Corporation and its investment advisors monitor the entire portfolio monthly with particular attention given to securities in a continuous loss position of at least ten percent for over twelve months. Based on the factors described above, management did not consider any securities to be other-than-temporarily impaired at March 31, 2020 or December 31, 2019.

 

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The summary below shows the gross unrealized losses and fair value of the Corporation’s debt securities. Totals are aggregated by investment category where individual securities have been in a continuous loss position for less than 12 months or 12 months or more as of March 31, 2020 and December 31, 2019:

 

March 31, 2020

 

(Dollars in thousands)  Less Than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
Available-for-Sale:  Value   Loss   Value   Loss   Value   Loss 
U.S. Treasury securities  $—   $—   $—   $—   $—   $— 
Obligations of U.S. Government                              
Corporations and Agencies:                              
Mortgage-backed   20,750    (466)   7,747    (319)   28,497    (785)
Other   6,092    (64)   4,396    (55)   10,488    (119)
Other mortgage backed debt securities   7,492    (824)   —    —    7,492    (824)
Obligations of state and political subdivisions   1,507    (9)   —    —    1,507    (9)
Asset backed securities   40,766    (2,123)   —    —    40,766    (2,123)
Corporate debt securities   4,041    (118)   7,355    (146)   11,396    (264)
Total  $80,648   $(3,604)  $19,498   $(520)  $100,146   $(4,124)

 

 

December 31, 2019

 

(Dollars in thousands)

 

   Less Than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
Available-for-Sale:  Value   Loss   Value   Loss   Value   Loss 
U.S. Treasury securities  $―   $―   $—   $—   $―   $― 
Obligations of U.S. Government                              
Corporations and Agencies:                              
Mortgage-backed   39,085    (221)   12,650    (166)   51,735    (387)
Other   4,382    (24)   4,594    (64)   8,976    (88)
Other mortgage backed debt securities   4,056    (10)   ―    ―    4,056    (10)
Obligations of state and political subdivisions   1,993    (15)   1,081    (33)   3,074    (48)
Asset backed securities   19,236    (175)   —    —    19,236    (175)
Corporate debt securities   3,484    (16)   7,231    (269)   10,715    (285)
Total  $72,236   $(461)  $25,556   $(532)  $97,792   $(993)

 

The Corporation invests in various forms of agency debt including mortgage-backed securities and callable debt. The mortgage-backed securities are issued by Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”) or Government National Mortgage Association (“GNMA”). The municipal securities consist of general obligations and revenue bonds. The fair market value of the above securities is influenced by market interest rates, prepayment speeds on mortgage securities, bid-offer spreads in the market place and credit premiums for various types of agency debt. These factors change continuously and therefore the market value of these securities may be higher or lower than the Corporation’s carrying value at any measurement date. Management does not believe any of their 27 debt securities with a less than one year unrealized loss position, or any of their 13 debt securities with a one year or greater unrealized loss position as of March 31, 2020, represent an other-than-temporary impairment, as the unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities. The Corporation expects to collect all principal and interest payments defined under the original terms as all contracted payments on securities in the portfolio are current as of March 31, 2020.

 

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NOTE 4 — LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans

 

Net loans are stated at their outstanding recorded investment, net of deferred fees and costs, unearned income and the allowance for loan losses. Interest on loans is recognized as income over the term of each loan, generally, by the accrual method. Loan origination fees and certain direct loan origination costs have been deferred with the net amount amortized using the straight line method or the interest method over the contractual life of the related loans as an interest yield adjustment.

 

Residential mortgage loans held for sale are carried at the lower of cost or market on an aggregate basis determined by independent pricing from appropriate federal or state agency investors. These loans are sold without recourse. Loans held for sale amounted to $2,342,000 and $2,292,000 at March 31, 2020 and December 31, 2019, respectively.

 

As an addition to the commercial loans receivable portfolio, the Corporation may purchase the guaranteed portion of loans secured by the U.S. Government. The originating bank retains the unguaranteed portion of the loan. The loans are sponsored by one of the various government agencies including the U.S. Small Business Administration (SBA), United States Department of Agriculture (USDA), and the Farm Service Agency (FSA). Government Guaranteed Loans (“GGLs”) carry no credit risk due to an unconditional and irrevocable guarantee on all principal and accrued interest, which is supported by the full faith and credit of the U.S. Government. As of March 31, 2020, the Corporation’s balance of GGLs amounted to $6,059,000, compared to $6,150,000 at December 31, 2019.

 

The loans receivable portfolio is segmented into commercial, residential and consumer loans. Commercial loans consist of the following classes: Commercial and Industrial, and Commercial Real Estate.

 

Commercial and Industrial Lending

 

The Corporation originates commercial and industrial loans primarily to businesses located in its primary market area and surrounding areas. These loans are used for various business purposes, which include short-term loans and lines of credit to finance machinery and equipment, inventory and accounts receivable. Generally, the maximum term for loans extended on machinery and equipment is based on the projected useful life of such machinery and equipment. Most business lines of credit are written on demand and are reviewed annually.

 

Commercial and industrial loans are generally secured with short-term assets; however, in many cases, additional collateral such as real estate is provided as additional security for the loan. Loan-to-value maximum thresholds have been established by the Corporation and are specific to the type of collateral. Collateral values may be determined using invoices, inventory reports, accounts receivable aging reports, business financial statements, collateral appraisals, etc. Commercial and industrial loans are typically supported by personal guarantees of the borrower.

 

In underwriting commercial and industrial loans, an analysis is performed to evaluate the borrower's character and capacity to repay the loan, the adequacy of the borrower's capital and collateral, as well as the conditions affecting the borrower. Evaluation of the borrower’s past, present and future cash flows is also an important aspect of the Corporation's analysis of the borrower’s ability to repay.

 

Commercial and industrial loans generally present a higher level of risk than other types of loans due primarily to the effect of general economic conditions. Commercial and industrial loans are typically made on the basis of the borrower’s ability to make repayment from cash flows from the borrower’s primary business activities. As a result, the availability of funds for the repayment of commercial and industrial loans is dependent on the success of the business itself, which in turn, is likely to be dependent upon the general economic environment.

 

Commercial Real Estate Lending

 

The Corporation engages in commercial real estate lending in its primary market area and surrounding areas. The Corporation’s commercial real estate portfolio is secured primarily by commercial retail space, commercial office buildings, residential housing and hotels. Generally, commercial real estate loans have terms that do not exceed twenty years, have loan-to-value ratios of up to eighty percent of the value of the collateral property, and are typically supported by personal guarantees of the borrowers.

 

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In underwriting these loans, the Corporation performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the property securing the loan. The value of the property is determined by either independent appraisers or internal evaluations by Bank officers.

 

Commercial real estate loans generally present a higher level of risk than residential real estate secured loans. Repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate project and/or the effect of the general economic conditions on income producing properties.

 

Residential Real Estate Lending (Including Home Equity)

 

The Corporation’s residential real estate portfolio is comprised of one-to-four family residential mortgage loan originations, home equity term loans and home equity lines of credit. These loans are generated by the Corporation’s marketing efforts, its present customers, walk-in customers and referrals. These loans originate primarily within or with customers from the Corporation’s market area.

 

The Corporation’s one-to-four family residential mortgage originations are secured primarily by properties located in its primary market area and surrounding areas. The Corporation offers fixed-rate mortgage loans with terms up to a maximum of thirty years for both permanent structures and those under construction. Loans with terms of thirty years are normally held for sale and sold without recourse; most of the residential mortgages held in the Corporation’s residential real estate portfolio have maximum terms of twenty years. Generally, the majority of the Corporation’s residential mortgage loans originate with a loan-to-value of eighty percent or less, or those with primary mortgage insurance at ninety-five percent or less. Home equity term loans are secured by the borrower’s primary residence and typically have a maximum loan-to-value of eighty percent and a maximum term of fifteen years. In general, home equity lines of credit are secured by the borrower’s primary residence with a maximum loan-to-value of eighty percent and a maximum term of twenty years.

 

In underwriting one-to-four family residential mortgage loans, the Corporation evaluates the borrower’s ability to make monthly payments, the borrower’s repayment history and the value of the property securing the loan. The ability and willingness to repay is assessed based upon the borrower’s employment history, current financial conditions and credit background. A majority of the properties securing residential real estate loans made by the Corporation are appraised by independent appraisers. The Corporation generally requires mortgage loan borrowers to obtain an attorney’s title opinion or title insurance and fire and property insurance, including flood insurance, if applicable.

 

Residential mortgage loans, home equity term loans and home equity lines of credit generally present a lower level of risk than consumer loans because they are secured by the borrower’s primary residence. Risk is increased when the Corporation is in a subordinate position, especially to another lender, for the loan collateral.

 

Consumer Lending

 

The Corporation offers a variety of secured and unsecured consumer loans, including vehicle loans, stock loans and loans secured by financial institution deposits. These loans originate primarily within or with customers from the Corporation’s market area.

 

Consumer loan terms vary according to the type and value of collateral and creditworthiness of the borrower. In underwriting personal loans, a thorough analysis is performed regarding the borrower’s willingness and financial ability to repay the loan as agreed. The ability and willingness to repay is assessed based upon the borrower’s employment history, current financial condition and credit background.

 

Consumer loans may entail greater credit risk than residential real estate loans, particularly in the case of personal loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles or recreational equipment. In such cases, repossessed collateral for a defaulted personal loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, personal loan collections are dependent on the borrower’s continuing financial stability and therefore, are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

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Delinquent Loans

 

Generally, a loan is considered to be past-due when scheduled loan payments are in arrears 10 days or more. Delinquent notices are generated automatically when a loan is 10 or 15 days past-due, depending on loan type. Collection efforts continue on past-due loans that have not been brought current, when it is believed that some chance exists for improvement in the status of the loan. Past-due loans are continually evaluated with the determination for charge-off being made when no reasonable chance remains that the status of the loan can be improved.

 

Commercial and Industrial and Commercial Real Estate loans are charged off in whole or in part when they become sufficiently delinquent based upon the terms of the underlying loan contract and when a collateral deficiency exists. Because all or part of the contractual cash flows are not expected to be collected, the loan is considered to be impaired, and the Bank estimates the impairment based on its analysis of the cash flows or collateral estimated at fair value less cost to sell. Should a Government Guaranteed Loan default, demand is made to the originating bank for repurchase of the loan. If the originating bank does not repurchase the loan, demand for repurchase is then made to the appropriate government agency which has provided the guarantee for the loan.

 

Residential Real Estate and Consumer loans are charged off when they become sufficiently delinquent based upon the terms of the underlying loan contract and when the value of the underlying collateral is not sufficient to support the loan balance and a loss is expected. At that time, the amount of estimated collateral deficiency, if any, is charged off for loans secured by collateral, and all other loans are charged off in full. Loans with collateral are written down to the estimated fair value of the collateral less cost to sell.

 

Existing loans in which the borrower has declared bankruptcy are considered on a case by case basis to determine whether repayment is likely to occur (eg. reaffirmation by the borrower with demonstrated repayment ability). Otherwise, loans are charged off in full or written down to the estimated fair value of collateral less cost to sell.

 

Generally, a loan is classified as non-accrual and the accrual of interest on such a loan is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan may currently be performing. A loan may remain on accrual status if it is well secured (or supported by a strong guarantee) and in the process of collection. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against interest income. Certain non-accrual loans may continue to perform; that is, payments are still being received. Generally, the payments are applied to principal. These loans remain under constant scrutiny, and if performance continues, interest income may be recorded on a cash basis based on management's judgment regarding the collectability of principal.

 

Allowance for Loan Losses

 

The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses and subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is maintained at a level estimated by management to be adequate to absorb potential loan losses. Management’s periodic evaluation of the adequacy of the allowance for loan losses is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.

 

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are individually classified as impaired. Select loans are not aggregated for collective impairment evaluation, as such; all loans are subject to individual impairment evaluation should the facts and circumstances pertinent to a particular loan suggest that such evaluation is necessary. Factors considered by management in determining impairment include payment status and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. 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. If a loan is impaired, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from collateral. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loans may be reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Corporation determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

 

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The general component covers all other loans not identified as impaired (aside from Government Guaranteed Loans, which do not require an allowance) and is based on historical losses and qualitative factors. The historical loss component of the allowance is determined by losses recognized by portfolio segment over a time period that management has determined represents the current credit cycle. Qualitative factors impacting each portfolio segment may include: delinquency trends, loan volume trends, Bank policy changes, management processes and oversight, economic trends (including change in consumer and business disposable incomes, unemployment and under-employment levels, and other conditions), concentrations by industry or product, internal and external loan review processes, collateral value and market conditions, and external factors including regulatory issues and competition.

 

Government Guaranteed Loans do not require an associated allowance for loan losses due to the underlying irrevocable and unconditional guarantee, which is supported by the full faith and credit of the U.S. Government. Should a GGL default, the loan will be repurchased by the originating bank or the appropriate government agency that has provided the guarantee for the loan.

 

The unallocated component of the allowance is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

 

A reserve for unfunded lending commitments is provided for possible credit losses on off-balance sheet credit exposures. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and, if necessary, is recorded in other liabilities on the consolidated balance sheets. As of March 31, 2020 and December 31, 2019, the amount of the reserve for unfunded lending commitments was $161,000 and $117,000, respectively.

 

The Corporation is subject to periodic examination by its federal and state examiners, and may be required by such regulators to recognize additions to the allowance for loan losses based on their assessment of credit information available to them at the time of their examinations.

 

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the original loan agreement. Under current accounting standards, the allowance for loan losses related to impaired loans is based on discounted cash flows using the loan’s effective interest rate at inception or the fair value of the collateral for certain collateral dependent loans.

 

From time to time, the Bank may agree to modify/restructure the contractual terms of a borrower’s loan. The restructuring of a loan is considered a “troubled debt restructuring” if both the following conditions are met: (i) the borrower is experiencing financial difficulties, and (ii) the Corporation has granted a concession. The most common concessions granted include one or more modifications to the terms of the debt, such as (a) a reduction in the interest rate for the remaining life of the debt, (b) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk, (c) a temporary period of interest-only payments, and (d) a reduction in the contractual payment amount for either a short period or remaining term of the loan. A less common concession is the forgiveness of a portion of the principal.

 

The determination of whether a borrower is experiencing financial difficulties takes into account not only the current financial condition of the borrower, but also the potential financial condition of the borrower were a concession not granted. Similarly, the determination of whether a concession has been granted is very subjective in nature. For example, simply extending the term of a loan at its original interest rate or even at a higher interest rate could be interpreted as a concession unless the borrower could readily obtain similar credit terms from a different lender.

 

Loans modified in a troubled debt restructuring are considered impaired and may or may not be placed on non-accrual status until the Corporation determines the future collection of principal and interest is reasonably assured, which generally requires that the borrower demonstrates a period of performance according to the restructured terms of six months. Any loan modifications made in response to the COVID-19 pandemic are not considered troubled debt restructurings as long as the criteria set forth in Section 4013 of the CARES Act are met.

 

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The Bank utilizes a risk grading matrix as a tool for managing credit risk in the loan portfolio and assigns an asset quality rating (risk grade) to all Commercial and Industrial, Commercial Real Estate, Residential Real Estate and Consumer borrowings. An asset quality rating is assigned using the guidance provided in the Corporation’s loan policy. Primary responsibility for assigning the asset quality rating rests with the credit department. The asset quality rating is validated periodically by both an internal and external loan review process.

 

The commercial loan grading system focuses on a borrower’s financial strength and performance, experience and depth of management, primary and secondary sources of repayment, the nature of the business and the outlook for the particular industry. Primary emphasis is placed on financial condition and trends. The grade also reflects current economic and industry conditions; as well as other variables such as liquidity, cash flow, revenue/earnings trends, management strengths or weaknesses, quality of financial information, and credit history.

 

The loan grading system for Residential Real Estate and Consumer loans focuses on the borrower’s credit score and credit history, debt-to-income ratio and income sources, collateral position and loan-to-value ratio.

 

Risk grade characteristics are as follows:

 

Risk Grade 1 – MINIMAL RISK through Risk Grade 6 – MANAGEMENT ATTENTION (Pass Grade Categories)

 

Risk is evaluated via examination of several attributes including but not limited to financial trends, strengths and weaknesses, likelihood of repayment when considering both cash flow and collateral, sources of repayment, leverage position, management expertise, and repayment history.

 

At the low-risk end of the rating scale, a risk grade of 1 – Minimal Risk is the grade reserved for loans with exceptional credit fundamentals and virtually no risk of default or loss. Loan grades then progress through escalating ratings of 2 through 6 based upon risk. Risk Grade 2 – Modest Risk are loans with sufficient cash flows; Risk Grade 3 – Average Risk are loans with key balance sheet ratios slightly above the borrower’s peers; Risk Grade 4 – Acceptable Risk are loans with key balance sheet ratios usually near the borrower’s peers, but one or more ratios may be higher; and Risk Grade 5 – Marginally Acceptable are loans with strained cash flow, increasing leverage and/or weakening markets. Risk Grade 6 – Management Attention are loans with weaknesses resulting from declining performance trends and the borrower’s cash flows may be temporarily strained. Loans in this category are performing according to terms, but present some type of potential concern.

 

Risk Grade 7 − SPECIAL MENTION (Non-Pass Category)

 

Generally, these loans are currently protected, but are “potentially weak.” They constitute an undue and unwarranted credit risk but not to the point of justifying a classification of substandard.

 

Assets in this category are protected but have potential weakness which may, if not checked or corrected, weaken the asset or inadequately protect the Corporation’s credit position at some future date. No loss of principal or interest is envisioned; however, they constitute an undue credit risk that may be minor but is unwarranted in light of the circumstances surrounding a specific asset. Risk is increasing beyond that at which the loan originally would have been granted. Historically, cash flows are inconsistent; financial trends show some deterioration. Liquidity and leverage are above industry averages. Financial information could be incomplete or inadequate. A Special Mention asset has potential weaknesses that deserve management’s close attention.

 

Risk Grade 8 − SUBSTANDARD (Non-Pass Category)

 

Generally, these assets are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have “well-defined” weaknesses that jeopardize the full liquidation of the debt.

 

These loans are characterized by the distinct possibility that the Corporation will sustain some loss if the aggregate amount of substandard assets is not fully covered by the liquidation of the collateral used as security. Substandard loans have a high probability of payment default and require more intensive supervision by Corporation management.

 

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Risk Grade 9 − DOUBTFUL (Non-Pass Category)

 

Generally, loans graded doubtful have all the weaknesses inherent in a substandard loan with the added factor that the weaknesses are pronounced to a point whereby the basis of current information, conditions, and values, collection or liquidation in full is deemed to be highly improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to strengthen the asset, its classification is deferred until, for example, a proposed merger, acquisition, liquidation procedure, capital injection, perfection of liens on additional collateral and/or refinancing plan is completed. Loans are graded doubtful if they contain weaknesses so serious that collection or liquidation in full is questionable.

 

The following table presents the classes of the loan portfolio summarized by risk rating as of March 31, 2020 and December 31, 2019:

 

   Commercial and         
(Dollars in thousands)  Industrial   Commercial Real Estate 
   March 31,   December 31,   March 31,   December 31, 
   2020   2019   2020   2019 
Grade:                    
1-6    Pass  $85,418   $84,999   $399,740   $382,510 
7       Special Mention    —    2    —    944 
8       Substandard   963    1,068    12,229    11,590 
9       Doubtful   —    —    —    ― 
Add (deduct): Unearned discount and   —    —    —    ― 
  Net deferred loan fees and costs   642    643    827    757 
Total loans  $87,023   $86,712   $412,796   $395,801 

 

 

   Residential Real Estate         
   Including Home Equity   Consumer 
   March 31,   December 31,   March 31,   December 31, 
   2020   2019   2020   2019 
Grade:                
1-6   Pass  $155,124   $158,301   $5,570   $5,662 
7      Special Mention    —    117    31    83 
8      Substandard   1,089    1,048    8    35 
9      Doubtful   —    —    —    ― 
Add (deduct): Unearned discount and   —    —    —    — 
  Net deferred loan fees and costs   (108)   (116)   83    89 
Total loans  $156,105   $159,350   $5,692   $5,869 

 

 

   Total Loans 
   March 31,   December 31, 
   2020   2019 
Grade:        
1-6   Pass  $645,852   $631,472 
7      Special Mention    31    1,146 
8      Substandard   14,289    13,741 
9      Doubtful   —    — 
Add (deduct): Unearned discount and   —    — 
  Net deferred loan fees and costs   1,444    1,373 
Total loans  $661,616   $647,732 

 

Commercial and Industrial and Commercial Real Estate include loans categorized as tax-free in the amounts of $17,117,000 and $1,966,000 at March 31, 2020 and $17,848,000 and $2,007,000 at December 31, 2019. Commercial and Industrial loans also included $6,059,000 and $6,150,000 of Government Guaranteed Loans as of March 31, 2020 and December 31, 2019, respectively. Loans held for sale amounted to $2,342,000 at March 31, 2020 and $2,292,000 at December 31, 2019.

 

 18 

 

 

The activity in the allowance for loan losses, by loan class, is summarized below for the periods indicated.

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the three month period ended
March 31, 2020:		                        
Allowance for Loan Losses:                              
Beginning balance  $634   $4,116   $1,665   $114   $476   $7,005 
Charge-offs   (4)   —    —    (16)   —    (20)
Recoveries   —    —    —    —    —    — 
Provision   33    212    (22)   15    (44)   194 
Ending Balance  $663   $4,328   $1,643   $113   $432   $7,179 
Ending balance: individually evaluated for impairment  $―   $1   $—   $―   $―   $1 
Ending balance: collectively evaluated for impairment  $663   $4,327   $1,643   $113   $432   $7,178 
                               
Loans Receivable:                              
Ending Balance  $87,023   $412,796   $156,105   $5,692   $―   $661,616 
Ending balance: individually evaluated for impairment  $1,077   $11,510   $1,109   $―   $―   $13,696 
Ending balance: collectively evaluated for impairment  $85,946   $401,286   $154,996   $5,692   $―   $647,920 

 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
                         
As of and for the three month period ended
March 31, 2019:		                        
Allowance for Loan Losses:                              
Beginning balance  $724   $3,700   $1,650   $117   $554   $6,745 
Charge-offs   —    (64)   —    (15)   —    (79)
Recoveries   1    —    2    1    —    4 
Provision   7    229    (11)   7    (140)   92 
Ending Balance  $732   $3,865   $1,641   $110   $414   $6,762 
Ending balance: individually evaluated for impairment  $―   $4   $—   $―   $―   $4 
Ending balance: collectively evaluated for impairment  $732   $3,861   $1,641   $110   $414   $6,758 
                               
Loans Receivable:                              
Ending Balance  $93,575   $359,073   $159,624   $5,711   $―   $617,983 
Ending balance: individually evaluated for impairment  $1,116   $15,557   $491   $―   $―   $17,164 
Ending balance: collectively evaluated for impairment  $92,459   $343,516   $159,133   $5,711   $―   $600,819 

 

 19 

 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the year ended                              
December 31, 2019                              
Allowance for Loan Losses:                              
Beginning balance  $724   $3,700   $1,650   $117   $554   $6,745 
Charge-offs   ―    (64)   (69)   (71)   —    (204)
Recoveries   6    ―    2    6    —    14 
Provision   (96)   480    82    62    (78)   450 
Ending Balance  $634   $4,116   $1,665   $114   $476   $7,005 
Ending balance: individually                              
evaluated for impairment  $—   $1   $—   $—   $—   $1 
Ending balance: collectively                              
evaluated for impairment  $634   $4,115   $1,665   $114   $476   $7,004 
                               
Loans Receivable:                              
Ending Balance  $86,712   $395,801   $159,350   $5,869   $—   $647,732 
Ending balance: individually                              
evaluated for impairment  $1,084   $11,158   $712   $—   $—   $12,954 
Ending balance: collectively                              
evaluated for impairment  $85,628   $384,643   $158,638   $5,869   $—   $634,778 

 

Of the $169,000 in foreclosed assets held for resale at March 31, 2020, $38,000 was represented by land, $50,000 was represented by residential real estate, and $81,000 was represented by commercial real estate. Of the $119,000 in foreclosed assets held for resale at December 31, 2019, $38,000 was represented by land and $81,000 was represented by commercial real estate. At March 31, 2020 and December 31, 2019, all foreclosed assets were held as the result of obtaining physical possession. Consumer mortgage loans secured by residential real estate for which the Bank has entered into formal foreclosure proceedings but for which physical possession of the property has yet to be obtained amounted to $996,000 at March 31, 2020 and $617,000 at December 31, 2019. These balances were not included in foreclosed assets held for resale at March 31, 2020 or December 31, 2019.

 

The outstanding recorded investment of TDRs as of March 31, 2020 and December 31, 2019 was $8,470,000 and $8,678,000, respectively. The decrease in TDRs at March 31, 2020 as compared to December 31, 2019 is mainly attributable to payments and payoffs on existing troubled debt restructurings that were completed during the first quarter of 2020. There were no unfunded commitments on TDRs at March 31, 2020 and December 31, 2019.

 

The following table presents the outstanding recorded investment of TDRs at the dates indicated:

 

(Dollars in thousands)  March 31,   December 31, 
   2020   2019 
Non-accrual TDRs  $1,725   $112 
Accruing TDRs   6,745    8,566 
Total  $8,470   $8,678 

 

At March 31, 2020, nine Commercial Real Estate loans classified as TDRs with a combined recorded investment of $1,377,000 were not in compliance with the terms of their restructure, compared to March 31, 2019 when six Commercial Real Estate loans classified as TDRs with a combined recorded investment of $597,000 and one Commercial and Industrial loan classified as a TDR with a recorded investment of $5,000 were not in compliance with the terms of their restructure.

 

 20 

 

 

No loans were modified as TDRs within the twelve months preceding March 31, 2020. Of the loans that were modified as TDRs during the twelve months preceding March 31, 2019, two Commercial Real Estate Loans with a combined recorded investment of $113,000 experienced payment defaults during the three months ended Mach 31, 2019.

 

No loans were modified as TDRs during the three months ended March 31, 2020 and 2019.

 

On March 27, 2020, in response to the COVID-19 pandemic, the CARES Act was signed into law. Section 4013 of the CARES Act provides financial institutions the option to suspend requirements to categorize certain loan modifications as TDRs as long as specific criteria are met. To qualify, the loan modifications must be short-term (granted for temporary relief, ex. six months), made on a good-faith basis in response to the COVID-19 pandemic, and the contractual payments of the loan must have been paid current (less than 30 days past due prior to any relief) at the time a modification was implemented. While requests for modifications had been made, no modifications had been completed as part of this program as of March 31, 2020.

 

The recorded investment, unpaid principal balance, and the related allowance of the Corporation’s impaired loans are summarized below at March 31, 2020 and December 31, 2019.

 

(Dollars in thousands)  March 31, 2020   December 31, 2019 
       Unpaid           Unpaid     
   Recorded   Principal   Related   Recorded   Principal   Related 
   Investment   Balance   Allowance   Investment   Balance   Allowance 
With no related allowance recorded:                              
Commercial and Industrial  $1,077   $1,077   $—   $1,084   $1,084   $— 
Commercial Real Estate   11,396    14,289    —    11,130    14,147    — 
Residential Real Estate   1,089    1,174    —    712    822    — 
                               
With an allowance recorded:                              
Commercial and Industrial   —    —    —    —    —    — 
Commercial Real Estate   114    114    1    28    28    1 
Residential Real Estate   20    20    —    —    —    — 
Total  $13,696   $16,674   $1   $12,954   $16,081   $1 
                               
Total consists of:                              
Commercial and Industrial  $1,077   $1,077   $—   $1,084   $1,084   $— 
Commercial Real Estate  $11,510   $14,403   $1   $11,158   $14,175   $1 
Residential Real Estate  $1,109   $1,194   $—   $712   $822   $— 

______________________

At March 31, 2020 and December 31, 2019, $8,470,000 and $8,678,000 of loans classified as TDRs were included in impaired loans both with a total allocated allowance of $1,000, respectively. The recorded investment represents the loan balance reflected on the consolidated balance sheets net of any charge-offs. The unpaid balance is equal to the gross amount due on the loan.

 

 21 

 

 

The average recorded investment and interest income recognized for the Corporation’s impaired loans are summarized below for the three months ended March 31, 2020 and 2019.

 

(Dollars in thousands)  For the Three Months Ended   For the Three Months Ended 
   March 31, 2020   March 31, 2019 
   Average   Interest   Average   Interest 
   Recorded   Income   Recorded   Income 
   Investment   Recognized   Investment   Recognized 
With no related allowance recorded:                    
Commercial and Industrial  $1,079   $6   $1,122   $14 
Commercial Real Estate   11,131    76    15,574    150 
Residential Real Estate   925    —    440    1 
                     
With an allowance recorded:                    
Commercial and Industrial   —    —    —    — 
Commercial Real Estate   118    1    94    1 
Residential Real Estate   21    1    —    ― 
Total  $13,274   $84   $17,230   $166 
                     
Total consists of:                    
Commercial and Industrial  $1,079   $6   $1,122   $14 
Commercial Real Estate  $11,249   $77   $15,668   $151 
Residential Real Estate  $946   $1   $440   $1 

_____________________

Of the $84,000 and $166,000 in interest income recognized on impaired loans for the three months ended March 31, 2020 and 2019, respectively, $5,000 and $0 in interest income was recognized with respect to non-accrual loans.

 

Total non-performing assets (which includes loans receivable on non-accrual status, foreclosed assets held for resale and loans past-due 90 days or more and still accruing interest) as of March 31, 2020 and December 31, 2019 were as follows:

 

(Dollars in thousands)        
   March 31,   December 31, 
   2020   2019 
Commercial and Industrial  $768   $— 
Commercial Real Estate   5,094    3,697 
Residential Real Estate   1,089    691 
Total non-accrual loans   6,951    4,388 
Foreclosed assets held for resale   169    119 
Loans past-due 90 days or more and still accruing interest   579    100 
Total non-performing assets  $7,699   $4,607 

 

The following tables present the classes of the loan portfolio summarized by past-due status at March 31, 2020 and December 31, 2019:

 

(Dollars in thousands)                          90 Days 
                           Or Greater 
                           Past Due 
           90 Days       Current–       and Still 
   30-59 Days   60-89 Days   or Greater   Total   29 Days   Total   Accruing 
    Past Due     Past Due     Past Due     Past Due     Past Due    Loans   Interest 
March 31, 2020:                                   
Commercial and Industrial  $698   $380   $91   $1,169   $85,854   $87,023   $92 
Commercial Real Estate   2,942    301    4,935    8,178    404,618    412,796    487 
Residential Real Estate   1,303    177    913    2,393    153,712    156,105    — 
Consumer   20    5    —    25    5,667    5,692    — 
Total  $4,963   $863   $5,939   $11,765   $649,851   $661,616   $579 

 

 22 

 

 

(Dollars in thousands)                          90 Days 
                           Or Greater 
                           Past Due 
           90 Days       Current–       and Still 
   30-59 Days   60-89 Days   or Greater   Total   29 Days   Total   Accruing 
    Past Due     Past Due     Past Due     Past Due     Past Due    Loans   Interest 
December 31, 2019:                                   
Commercial and Industrial  $—   $26   $—   $26   $86,686   $86,712   $— 
Commercial Real Estate   880    957    3,502    5,339    390,462    395,801    — 
Residential Real Estate   1,118    506    613    2,237    157,113    159,350    100 
Consumer   24    5    —    29    5,840    5,869    — 
Total  $2,022   $1,494   $4,115   $7,631   $640,101   $647,732   $100 

 

At March 31, 2020 and December 31, 2019, commitments to lend additional funds with respect to impaired loans consisted of one irrevocable letter of credit totaling $1,249,000 that was associated with a loan to a developer of a residential sub-division.

 

NOTE 5 — DEPOSITS

 

Major classifications of deposits at March 31, 2020 and December 31, 2019 consisted of:

 

(Dollars in thousands)        
   March 31,   December 31, 
   2020   2019 
Non-interest bearing demand  $153,029   $134,648 
Interest bearing demand   211,598    218,847 
Savings   173,769    173,069 
Time certificates of deposits less than $250,000   176,383    210,916 
Time certificates of deposits $250,000 or greater   18,639    23,006 
Other time deposits   1,379    1,142 
Total deposits  $734,797   $761,628 

 

Total Deposits decreased $26,831,000 to $734,797,000 as of March 31, 2020 due to decreases in interest bearing, savings, and time deposits. The decrease in deposits was mainly due to the Corporation calling $40,000,000 worth of brokered CDs during the quarter ended March 31, 2020 due to the changing rate environment.

 

NOTE 6 — BORROWINGS

 

Short-Term Borrowings

 

Short-term borrowings include federal funds purchased, securities sold under agreements to repurchase, the Federal Discount Window, and Federal Home Loan Bank (“FHLB”) advances, which generally represent overnight or less than 30-day borrowings. Short-term borrowings and weighted–average interest rates at March 31, 2020 and December 31, 2019 are as follows:

 

(Dollars in thousands)  March 31, 2020   December 31, 2019 
       Average       Average 
   Amount   Rate   Amount   Rate 
Federal funds purchased  $—    —   $—    2.01%
Securities sold under agreements to repurchase   12,551    1.05%   14,042    1.03%
Federal Discount Window   —    —    —    2.92%
Federal Home Loan Bank   93,828    1.64%   40,621    2.59%
Total  $106,379    1.50%  $54,663    2.37%

 

The increase in short-term borrowings is due to advances taken from the Federal Home Loan Bank, including a 21-day $50,000,000 term note, to fund decreased deposit balances resulting from the call of brokered CDs.

 

 23 

 

 

Securities Sold Under Agreements to Repurchase (“Repurchase Agreements”)

 

The Corporation enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities. Under these arrangements, the Corporation may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Corporation to repurchase the assets.

 

As a result, these repurchase agreements are accounted for as collateralized financing agreements (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability on the Corporation’s consolidated balance sheets, while the securities underlying the repurchase agreements remain in the respective investment securities asset accounts. In other words, there is not offsetting or netting of the investment securities assets with the repurchase agreement liabilities. In addition, as the Corporation does not enter into reverse repurchase agreements, there is no such offsetting to be done with the repurchase agreements.

 

The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral would be used to settle the fair value of the repurchase agreement should the Corporation be in default (e.g., fails to make an interest payment to the counterparty). The collateral is held by a correspondent bank in the counterparty’s custodial account. The counterparty has the right to sell or repledge the investment securities.

 

The following table presents the short-term borrowings subject to an enforceable master netting arrangement or repurchase agreements as of March 31, 2020 and December 31, 2019.

 

(Dollars in thousands)      Gross   Net Amounts             
       Amounts   of Liabilities             
       Offset   Presented             
   Gross   in the   in the             
   Amounts of   Consolidated   Consolidated       Cash     
   Recognized   Balance   Balance   Financial   Collateral   Net 
   Liabilities   Sheet   Sheet   Instruments   Pledge   Amount 
March 31, 2020                              
Repurchase agreements (a)  $12,551   $―   $12,551   $(12,551)  $―   $― 
                               
December 31, 2019                              
Repurchase agreements (a)  $14,042   $―   $14,042   $(14,042)  $―   $― 

______________________

(a) As of March 31, 2020 and December 31, 2019, the fair value of securities pledged in connection with repurchase agreements was $21,779,000 and $22,413,000, respectively.

 

The following table presents the remaining contractual maturity of the master netting arrangement or repurchase agreements as of March 31, 2020:

 

(Dollars in thousands)  Remaining Contractual Maturity of the Agreements 
   Overnight       Greater         
   and   Up to   30 -90   than     
March 31, 2020:  Continuous   30 days   Days   90 Days   Total 
Repurchase agreements and repurchase-to-maturity transactions:                         
U.S. Treasury and/or agency securities  $12,551   $―   $―   $―   $12,551 
Total  $12,551   $―   $―   $―   $12,551 

 

Long-Term Borrowings

 

Long-term borrowings are comprised of advances from the FHLB. Under terms of a blanket agreement, collateral for the FHLB loans is certain qualifying assets of the Corporation’s banking subsidiary. The principal assets are certain real estate mortgages and investment securities.

 

 24 

 

NOTE 7 — COMMITMENTS AND CONTINGENCIES

 

In the normal course of business, there are various pending legal actions and proceedings that are not reflected in the consolidated financial statements. Management does not believe the outcome of these actions and proceedings will have a material effect on the consolidated financial position or results of operations of the Corporation.

 

The Bank currently leases three branch banking facilities and one parcel of land under operating leases. At March 31, 2020, right-of-use assets and lease liabilities were recorded related to these operating leases totaling $1,312,000 and $1,577,000, respectively. At December 31, 2019, right-of-use assets and lease liabilities stood at $1,470,000 and $1,663,000, respectively. Further options to extend or terminate the lease are not applicable for any of the four leases. No significant assumptions or judgements were made in determining whether a contract contained a lease or in the consideration of lease versus non-lease components. None of the leases contained an implicit rate; therefore, our incremental borrowing rate was used for each of the leases.

 

The Bank recognized total operating lease costs for the three months ended March 31, 2020 and March 31, 2019 of $111,000 and $48,000, respectively. Cash payments totaled $38,000 for the three months ended March 31, 2020 and 2019.

 

The following table displays the weighted-average term and discount rates for operating leases outstanding as of March 31, 2020 and December 31, 2019.

 

   March 31,   December 31, 
   2020   2019 
   Operating   Operating 
Weighted-average term (years)   25.56    25.63 
Weighted-average discount rate   3.86%   3.85%

 

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

 

     
(Dollars in thousands)  March 31, 
   2020 
Minimum lease payments due:     
Within one year  $139 
After one but within two years   106 
After two but within three years   75 
After three but within four years   68 
After four but within five years   68 
After five years   2,309 
Total undiscounted cash flows   2,765 
Discount on cash flows   (1,188)
Total lease liability  $1,577 

 

NOTE 8 — FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF CREDIT RISK

 

Financial Instruments with Off-Balance Sheet Risk

 

The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments. The Corporation does not engage in trading activities with respect to any of its financial instruments with off-balance sheet risk.

 

The Corporation’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments.

 25 

 

 

The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

 

The Corporation may require collateral or other security to support financial instruments with off-balance sheet credit risk.

 

The contract or notional amounts at March 31, 2020 and December 31, 2019 were as follows:

 

(Dollars in thousands)

 

   March 31, 2020   December 31, 2019 
Financial instruments whose contract amounts represent credit risk:          
Commitments to extend credit  $140,367   $122,082 
Financial standby letters of credit  $335   $335 
Performance standby letters of credit  $3,230   $3,230 

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses that may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, owner-occupied income-producing commercial properties, and residential real estate.

 

Standby letters of credit are conditional commitments issued by the Corporation to guarantee payment to a third party when a customer either fails to repay an obligation or fails to perform some non-financial obligation. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation may hold collateral (similar to the items held as collateral for commitments to extend credit) to support standby letters of credit for which collateral is deemed necessary.

 

Financial Instruments with Concentrations of Credit Risk

 

The Corporation originates primarily commercial and residential real estate loans to customers in northeastern Pennsylvania. The ability of the majority of the Corporation’s customers to honor their contractual loan obligations is dependent on the economy and real estate market in this area. At March 31, 2020, the Corporation had $568,901,000 in loans secured by real estate, which represented 86.0% of total loans. The real estate loan portfolio is largely secured by lessors of residential buildings and dwellings, lessors of non-residential buildings, and lessors of hotels/motels. As of March 31, 2020 and December 31, 2019, management is of the opinion that there were no concentrations exceeding 10% of total loans with regard to loans to borrowers who were engaged in similar activities that were similarly impacted by economic or other conditions.

 

As all financial instruments are subject to some level of credit risk, the Corporation requires collateral and/or guarantees for all loans. Collateral may include, but is not limited to property, plant, and equipment, commercial and/or residential real estate property, land, and pledge of securities. In the event of a borrower’s default, the collateral supporting the loan may be seized in order to recoup losses associated with the loan. The Corporation also establishes an allowance for loan losses that constitutes the amount available to absorb losses within the loan portfolio that may exist due to deficiencies in collateral values.

 

NOTE 9 — FAIR VALUE MEASUREMENTS

 

Fair value measurement and disclosure guidance defines fair value as the price that would be received to sell the asset or transfer the liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. This guidance provides additional information on determining when the volume and level of activity for the asset or liability has significantly decreased. The guidance also includes information on identifying circumstances when a transaction may not be considered orderly.

 

 26 

 

 

Fair value measurement and disclosure guidance provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with the fair value measurement and disclosure guidance.

 

This guidance clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. The guidance provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own belief about the assumptions market participants would use in pricing the asset or liability based upon the best information available in the circumstances. Fair value measurement and disclosure guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

Level 1 Inputs: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

 

Level 2 Inputs: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability;

 

Level 3 Inputs: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

 

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth as follows.

 

Financial Assets Measured at Fair Value on a Recurring Basis

 

At March 31, 2020 and December 31, 2019, securities measured at fair value on a recurring basis and the valuation methods used are as follows:

 

(Dollars in thousands)

 

March 31, 2020  Level 1   Level 2   Level 3   Total 
Debt Securities Available-for-Sale:                    
U.S. Treasury securities  $—   $—   $—   $— 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed   —    62,505    —    62,505 
Other   —    12,229    —    12,229 
Other mortgage backed debt securities   —    9,363    —    9,363 
Obligations of state and political subdivisions   —    140,467    —    140,467 
Asset backed securities   —    40,766    —    40,766 
Corporate debt securities   —    18,333    —    18,333 
Total debt securities available-for-sale   —    283,663    —    283,663 
Marketable equity securities   1,394    —    —    1,394 
Total recurring fair value measurements  $1,394   $283,663   $—   $285,057 

 

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(Dollars in thousands)

  

December 31, 2019  Level 1   Level 2   Level 3   Total 
Debt Securities Available-for-Sale:                    
U.S. Treasury securities  $—   $2,855   $—   $2,855 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgaged-backed   —    77,283    —    77,283 
Other   —    10,297    —    10,297 
Other mortgage backed debt securities   —    11,138    —    11,138 
Obligations of state and political subdivisions   —    120,376    —    120,376 
Asset backed securities   —    37,536    —    37,536 
Corporate debt securities   —    18,443    —    18,443 
Total debt securities available-for-sale   —    277,928    —    277,928 
Marketable equity securities   1,933    —    —    1,933 
Total recurring fair value measurements  $1,933   $277,928   $—   $279,861 

 

The estimated fair values of equity securities classified as Level 1 are derived from quoted market prices in active markets; these assets consist mainly of stocks held in other banks. The estimated fair values of all debt securities classified as Level 2 are obtained from nationally-recognized third-party pricing agencies. The estimated fair values are derived primarily from cash flow models, which include assumptions for interest rates, credit losses, and prepayment speeds. The significant inputs utilized in the cash flow models are based on market data obtained from sources independent of the Corporation (observable inputs), and are therefore classified as Level 2 within the fair value hierarchy. The Corporation does not have any Level 3 inputs for securities. There were no transfers between Level 1 and Level 2 during 2020 or 2019.

 

Financial Assets Measured at Fair Value on a Nonrecurring Basis

 

At March 31, 2020 and December 31, 2019, impaired loans measured at fair value on a nonrecurring basis are as follows:

 

(Dollars in thousands)

 

   Level 1   Level 2   Level 3   Total 
Assets at March 31, 2020                
Impaired loans:                    
Commercial Real Estate  $―   $―   $6,287   $6,287 
Residential Real Estate   ―    ―    189    189 
Total impaired loans  $―   $―   $6,476   $6,476 

 

 

(Dollars in thousands)                
   Level 1   Level 2   Level 3   Total 
Assets at December 31, 2019                    
Impaired loans:                    
Commercial Real Estate  $—   $—   $6,218   $6,218 
Residential Real Estate   —    —    221    221 
Total impaired loans  $—   $—   $6,439   $6,439 

 

These assets are included as Level 3 fair values, based upon the lowest level that is significant to the fair value measurements. The fair value consists of the impaired loan balances less the valuation allowance and/or charge-offs. There were no transfers between valuation levels in 2020 and 2019.

 

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Nonfinancial Assets Measured at Fair Value on a Nonrecurring Basis

 

At March 31, 2020 and December 31, 2019, foreclosed assets held for resale measured at fair value on a nonrecurring basis are as follows:

 

(Dollars in thousands)                
    Level 1   Level 2   Level 3   Total 
Assets at March 31, 2020                    
Foreclosed assets held for resale:                    
Commercial Real Estate  $―   $―   $81   $81 
Total foreclosed assets held for resale  $―   $―   $81   $81 

 

 

(Dollars in thousands)                
    Level 1   Level 2   Level 3   Total 
Assets at December 31, 2019                
Foreclosed assets held for resale:                    
Commercial Real Estate  $—   $—   $81   $81 
Total foreclosed assets held for resale  $—   $—   $81   $81 

 

These assets are included as Level 3 fair values, based upon the lowest level that is significant to the fair value measurements. There were no transfers between valuation levels in 2020 and 2019.

 

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

 

(Dollars in thousands)                
   Quantitative Information about Level 3 Fair Value Measurements
   Fair Value            Weighted
March 31, 2020  Estimate   Valuation Technique  Unobservable Input  Range  Average
Impaired loans  $3,366   Appraisal of collateral1,3  Appraisal adjustments2  (13%) – (77%)  (17%)
Impaired loans  $3,110   Discounted cash flow  Discount rate  (5%) – (9%)  (7%)
Foreclosed assets held for resale  $81   Appraisal of collateral1,3  Appraisal adjustments2  (35%) – (35%)  (35%)
                  
December 31, 2019                 
Impaired loans  $3,419   Appraisal of collateral1,3  Appraisal adjustments2  (10%) – (77%)  (17%)
Impaired loans  $3,020   Discounted cash flow  Discount rate  (7%) – (8%)  (7%)
Foreclosed assets held for resale  $81   Appraisal of collateral1,3  Appraisal adjustments2  (35%) – (35%)  (35%)

____________________

1Fair value is generally determined through independent appraisals of the underlying collateral, as defined by Bank regulators.

2Appraisals may be adjusted downward by management for qualitative factors such as economic conditions and estimated liquidation expenses. The typical range of appraisal adjustments are presented as a percent of the appraisal value.

3Includes qualitative adjustments by management and estimated liquidation expenses.

 

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Fair Value of Financial Instruments

 

(Dollars in thousands)                    
   Carrying   Fair Value Measurements at March 31, 2020 
   Amount   Level 1   Level 2   Level 3   Total 
FINANCIAL ASSETS:                         
Cash and due from banks  $7,785   $7,785   $―   $―   $7,785 
Interest-bearing deposits in other banks   1,013    —    1,013    —    1,013 
Time deposits with other banks   247    —    251    —    251 
Restricted investment in bank stocks   6,740    —    6,740    —    6,740 
Net loans   654,437    —    —    681,960    681,960 
Mortgage servicing rights   278    —    —    278    278 
Accrued interest receivable   3,622    —    3,622    —    3,622 
                          
FINANCIAL LIABILITIES:                         
Demand, savings and other deposits   538,396    —    538,396    —    538,396 
Time deposits   196,401    —    199,153    —    199,153 
Short-term borrowings   106,379    —    106,310    —    106,310 
Long-term borrowings   50,000    —    52,570    —    52,570 
Accrued interest payable   550    —    550    —    550 
                          
OFF-BALANCE SHEET FINANCIAL                         
INSTRUMENTS   ―    ―    ―    ―    ― 

 

 

(Dollars in thousands)  Carrying   Fair Value Measurements at December 31, 2019 
   Amount   Level 1   Level 2   Level 3   Total 
FINANCIAL ASSETS:                         
Cash and due from banks  $10,251   $10,251   $—   $—   $10,251 
Interest-bearing deposits in other banks   473    —    473    —    473 
Time deposits with other banks   247    —    250    —    250 
Restricted investment in bank stocks   4,224    —    4,224    —    4,224 
Net loans   640,727    —    —    655,301    655,301 
Mortgage servicing rights   283    —    —    283    283 
Accrued interest receivable   3,405    —    3,405    —    3,405 
                          
FINANCIAL LIABILITIES:                         
Demand, savings and other deposits   526,564    —    526,564    —    526,564 
Time deposits   235,064    —    235,134    —    235,134 
Short-term borrowings   54,663    —    54,655    —    54,655 
Long-term borrowings   55,000    —    55,809    —    55,809 
Accrued interest payable   606    —    606    —    606 
                          
OFF-BALANCE SHEET FINANCIAL                         
INSTRUMENTS   —    —    —    —    — 

 

NOTE 10 — REVENUE RECOGNITION

 

In accordance with ASU 2014-09 Revenue from Contracts with Customers – Topic 606, and all subsequent ASUs that modified ASC 606, the main types of revenue contracts included in non-interest income within the consolidated statements of income are as follows:

 

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Deposits related fees and service charges

 

Service charges and fees on deposits, which are included as liabilities in the consolidated balance sheets, consist of fees related to monthly fees for various retail and business checking accounts, automated teller machine (“ATM”) fees (charged for withdrawals by our deposit customers from other bank ATMs) and insufficient funds fees (“NSF”) (which are charged when customers overdraw their accounts beyond available funds). All deposit liabilities are considered to have one-day terms and therefore related fees are recognized in income at the time when the services are provided to the customers. The Corporation elected to adopt practical expedient related to incremental costs of obtaining deposit contracts. As such, any costs associated with acquiring the deposits, except for certificate of deposits (“CDs”) with maturities in excess of one year, are recognized as an expense within non-interest expense in the consolidated statements of income when incurred as the amortization period of the deposit liabilities that otherwise would have been recognized is one year or less.

 

Wealth/Asset/Trust Management Fees

 

Wealth management services are delivered to individuals, corporations and retirement funds located primarily within our geographic markets. The Trust Department of the Corporation conducts the wealth management operations, which provides a broad range of personal and corporate fiduciary services, including the administration of estates.

 

Assets held in a fiduciary capacity by the Trust Department are not assets of the Corporation and, therefore, are not included in our consolidated financial statements. Wealth management fees, which are contractually agreed with each customer, are earned each month and recognized on a cash basis based on average fair value of the trust assets under management. The services provided under such a contract are considered a single performance obligation under ASC 606 because they embody a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. Wealth management fees charged by the Trust Department follow a tiered structure based on the type and size of the assets under management. Wealth management fees are included within non-interest income in the consolidated statements of income. As of March 31, 2020 and December 31, 2019, the fair value of trust assets under management was $111,199,000 and $111,160,000, respectively. The costs of acquiring asset management customers are incremental and recognized within non-interest expense in the consolidated statements of income.

 

Interchange Fees and Surcharges

 

Interchange fees are related to the acceptance and settlement of debit card transactions, both point-of-sale and ATM, to cover operating costs and risks associated with the approval and settlement of the transactions. Interchange fees vary by type of transaction and each merchant sector. Net income recognized from interchange fees is included in non-interest income on the consolidated statements of income. A surcharge is assessed for use of the Corporation’s ATMs by non-customers. All interchange fees and surcharges are recognized as received on a daily basis for the prior business day’s transactions. All expenses related to the settlement of debit card transactions (both point-of-sale and ATM) are recognized on a monthly basis and included in non-interest expense on the consolidated statements of income.

 

NOTE 11 — EARNINGS PER SHARE

 

Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Corporation. At March 31, 2020 and 2019, there were no potential common shares outstanding. The following table sets forth the computation of basic and diluted earnings per share.

 

(In thousands, except earnings per share)  Three Months Ended 
   March 31, 
   2020   2019 
Net income  $2,053   $2,243 
Weighted-average common shares outstanding   5,817    5,765 
Basic and diluted earnings per share  $0.35   $0.39 

 

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Item 2. First Keystone Corporation Management’s Discussion and Analysis of Financial Condition and Results of Operation

 

This quarterly report contains certain forward-looking statements, which are included pursuant to the “safeharbor” provisions of the Private Securities Litigation Reform Act of 1995, and reflect management’s beliefs and expectations based on information currently available. These forward-looking statements are inherently subject to significant risks and uncertainties, including changes in general economic and financial market conditions, the Corporation’s ability to effectively carry out its business plans and changes in regulatory or legislative requirements. Other factors that could cause or contribute to such differences are changes in competitive conditions, and pending or threatened litigation. Although management believes the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially.

 

CRITICAL ACCOUNTING ESTIMATES

 

The Corporation has chosen accounting policies that it believes are appropriate to accurately and fairly report its operating results and financial position, and the Corporation applies those accounting policies in a consistent manner. The Significant Accounting Policies are summarized in Note 1 to the consolidated financial statements included in the 2019 Annual Report on Form 10-K. There have been no changes to the Critical Accounting Estimates since the Corporation filed its Annual Report on Form 10-K for the year ended December 31, 2019.

 

RESULTS OF OPERATIONS

 

Quarter ended March 31, 2020 compared to quarter ended March 31, 2019

 

First Keystone Corporation realized earnings for the first quarter of 2020 of $2,053,000, a decrease of $190,000, or 8.5% from the first quarter of 2019. The decrease in net income for the three months ended March 31, 2020 was primarily due to a decrease in net securities gains, offset by an increase in net interest income.

 

On a per share basis, for the three months ended March 31, 2020, net income was $0.35 versus $0.39 for the same three month period of 2019. Cash dividends amounted to $0.27 per share for the three months ended March 31, 2020 and 2019.

 

NET INTEREST INCOME

 

The major source of operating income for the Corporation is net interest income, defined as interest income less interest expense. In the three months ended March 31, 2020, interest income amounted to $9,768,000, an increase of $254,000 or 2.7% from the three months ended March 31, 2019, while interest expense amounted to $2,392,000 in the three months ended March 31, 2020, a decrease of $301,000 or 11.2% from the three months ended March 31, 2019. As a result, net interest income increased $555,000 or 8.1% to $7,376,000 from $6,821,000 for the same period in 2019.

 

The Corporation’s net interest margin for the three months ended March 31, 2020 was 3.28% compared to 3.15% for same period in 2019. The increase in net interest margin was primarily a result of an increase in yield on the loan portfolio.

 

PROVISION FOR LOAN LOSSES

 

The provision for loan losses for the three months ended March 31, 2020 and March 31, 2019 was $194,000 and $92,000, respectively. The increase in the provision for loan losses resulted from the Corporation’s analysis of the current loan portfolio, including historic losses, past-due trends, current economic conditions, loan portfolio growth, and other relevant factors. Charge-off and recovery activity in the allowance for loan losses resulted in net charge-offs of $20,000 and $75,000 for the three months ended March 31, 2020 and 2019, respectively. See Allowance for Loan Losses on page 36 for further discussion.

 

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NON-INTEREST INCOME

 

Total non-interest income was $983,000 for the three months ended March 31, 2020, as compared to $1,507,000 for the same period in 2019, a decrease of $524,000, or 34.8%. The decrease was the result of a decrease in net securities (losses) gains due to the Corporation recording $538,000 in losses on held equity securities in the first quarter of 2020. Net securities gains decreased $570,000 to $(467,000) for the three months ended March 31, 2020 as compared to the three months ended March 31, 2019. Trust department income decreased $40,000 or 15.3% to $221,000 for the three months ended March 31, 2020 as compared to the same period in 2019. Service charges and fee income decreased $15,000 or 2.9%. ATM fees and debit card income increased $22,000 or 5.8% to $399,000 for the three months ended March 31, 2020. Gains on sales of mortgage loans increased $53,000 or 132.5% due to twice as many sold loans in the first quarter of 2020 as compared to 2019.

 

NON-INTEREST EXPENSE

 

Total non-interest expense was $5,915,000 for the three months ended March 31, 2020, as compared to $5,855,000 for the three months ended March 31, 2019. Non-interest expense increased $60,000 or 1.0%.

 

Expenses associated with employees (salaries and employee benefits) continue to be the largest category of non-interest expense. Salaries and benefits amounted to $3,219,000 or 54.4% of total non-interest expense for the three months ended March 31, 2020, as compared to $3,132,000 or 53.5% for the same three months of 2019. The increase was primarily due to performance salaries increases and an increase in commissions and referral fees associated with loan growth and retail non-deposit activity.

 

Net occupancy, furniture and equipment, and computer expense amounted to $912,000 for the three months ended March 31, 2020, an increase of $28,000 or 3.2%. Professional services decreased $28,000 or 10.4% to $242,000 as of March 31, 2020. The decrease was due to consent fees paid to the Corporation’s previous auditors for a review of the 2018 10K in the first quarter of 2019. Pennsylvania shares tax expense amounted to $224,000 for the three months ended March 31, 2020, an increase of $32,000 or 16.7% as compared to the same three months in 2019. The increase was the result of an increase in total equity.

 

FDIC insurance expense decreased $65,000 or 100.0% for the three months ended March 31, 2020. This decrease was due to small bank assessment credits received from the FDIC for the fourth quarter of 2019 effectively reducing the expense for the first quarter of 2020. FDIC insurance expense varies with changes in net asset size, risk ratings, and FDIC derived assessment rates. ATM and debit card fees expense amounted to $209,000 for the three months ended March 31, 2020, a decrease of $2,000 or 1.0% as compared to the same three months of 2019. Data processing expenses amounted to $294,000 for the three months ended March 31, 2020, an increase of $27,000 or 10.1% as compared to the first quarter of 2019. The increase was a result of annual contracted pricing increases from our main third-party data processor. Foreclosed assets held for resale expense decreased $29,000 in the first quarter of 2020. The decrease is the result of the Bank having fewer foreclosed properties in 2020. Advertising expense decreased $62,000 or 40.5% during the three months ended March 31, 2020. This decrease was due to a more aggressive advertising approach in early 2019, as the first quarter of 2020 saw less newspaper advertising, billboard advertising, digital and social media advertising and ad creation.

 

Other non-interest expense amounted to $715,000 for the three months ended March 31, 2020, an increase of $72,000 or 11.2% as compared to the three months ended March 31, 2019. The increase was due to an increase in the provision for unfunded commitments due to higher officer commitment balances requiring a reserve.

 

INCOME TAXES

 

Income tax expense amounted to $197,000 for the three months ended March 31, 2020, as compared to $138,000 for the three months ended March 31, 2019, an increase of $59,000. The effective total income tax rate was 8.8% for the first quarter of 2020 as compared to 5.8% for the first quarter of 2019. The increase in the effective tax rate was mainly due to a net decrease in tax-exempt income from investments in and loans to state and local units of government. The Corporation recognized $101,000 of tax credits from low-income housing partnerships in the first quarter of 2020.

 

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FINANCIAL CONDITION

 

SUMMARY

 

Total assets increased to $1,027,207,000 as of March 31, 2020, an increase of $19,981,000 from year-end 2019. Total assets as of December 31, 2019 amounted to $1,007,226,000.

 

Total debt securities available-for-sale increased $5,735,000 or 2.1% to $283,663,000 as of March 31, 2020 from December 31, 2019.

 

Total loans increased $13,884,000 or 2.1% to $661,616,000 as of March 31, 2020 from December 31, 2019. Loan demand grew in the three months ended March 31, 2020 as the Bank has realized an increase in loan originations, primarily in the commercial real estate portfolio.

 

Total deposits decreased $26,831,000 or 3.5% to $734,797,000 as of March 31, 2020 from December 31, 2019. The decrease was mainly due to the call of $40,000,000 in brokered CDs.

 

The Corporation continues to maintain and manage its asset growth. The Corporation’s strong equity capital position provides an opportunity to further leverage its asset growth. Total borrowings increased in the first three months of 2020 by $46,716,000 to $156,379,000 from $109,663,000 as of December 31, 2019. Borrowings increased mainly due to decreased deposit balances and growth in the loan portfolio.

 

Total stockholders’ equity increased to $130,150,000 at March 31, 2020, an increase of $1,398,000 or 1.1% from December 31, 2019 due to an increase in accumulated other comprehensive income and retained earnings.

 

SEGMENT REPORTING

 

Currently, management measures the performance and allocates the resources of the Corporation as a single segment.

 

EARNING ASSETS

 

Earning assets are defined as those assets that produce interest income. By maintaining a healthy asset utilization rate, i.e., the volume of earning assets as a percentage of total assets, the Corporation maximizes income. The earning asset ratio (average interest earning assets divided by average total assets) equaled 92.8% at March 31, 2020 and 92.4% at March 31, 2019. This indicates that the management of earning assets is a priority and non-earning assets, primarily cash and due from banks, fixed assets and other assets, are maintained at minimal levels. The primary earning assets are loans and investment securities.

 

Our primary earning asset, total loans, increased to $661,616,000 as of March 31, 2020, up $13,884,000, or 2.1% since year-end 2019. The loan portfolio continues to be well diversified. Non-performing assets increased since year-end 2019, but overall asset quality has remained consistent. Total non-performing assets were $7,699,000 as of March 31, 2020, an increase of $3,092,000, or 67.1% from $4,607,000 reported in non-performing assets as of December 31, 2019. Total allowance for loan losses to total non-performing assets was 93.25% as of March 31, 2020 and 152.05% at December 31, 2019. The increase in non-performing assets during the first quarter of 2020 was mainly due to several loans that were moved to non-accrual status during the three months ended March 31, 2020. See the Non-Performing Assets section on Page 37 for more information.

 

In addition to loans, another primary earning asset is our overall investment portfolio, which increased in size from December 31, 2019 to March 31, 2020. Debt securities available-for-sale amounted to $283,663,000 as of March 31, 2020, an increase of $5,735,000 from year-end 2019.

 

Interest-bearing deposits in other banks increased as of March 31, 2020, to $1,013,000 from $473,000 at year-end 2019. Time deposits with other banks were $247,000 at March 31, 2020 and December 31, 2019.

 

 34 

 

LOANS

 

Total loans increased to $661,616,000 as of March 31, 2020 as compared to $647,732,000 as of December 31, 2019. The table on page 18 provides data relating to the composition of the Corporation’s loan portfolio on the dates indicated. Total loans increased by $13,884,000 or 2.1%.

 

Steady demand for borrowing by businesses accounted for the 2.1% increase in the loan portfolio from December 31, 2019 to March 31, 2020. The Commercial and Industrial portfolio increased $311,000 to $87,023,000 as of March 31, 2020, as compared to $86,712,000 at December 31, 2019. The increase in the Commercial and Industrial portfolio (which includes tax-free Commercial and Industrial loans) was attributed to new loan originations totaling $3,128,000 offset by a $687,000 decrease in utilization of existing Commercial and Industrial lines of credit and loan payoffs of $823,000, as well as regular principal payments and other typical fluctuations and activity in the Commercial and Industrial portfolio. The Commercial Real Estate portfolio (which includes tax-free Commercial Real Estate loans) increased $16,995,000 to $412,796,000 at March 31, 2020, as compared to $395,801,000 at December 31, 2019. The increase was mainly the result of $25,848,000 in new loan originations net against a $286,000 decrease in utilization of existing Commercial Real Estate lines of credit and $5,321,000 in loan payoffs, in addition to regular principal payments and other typical amortizations in the Commercial Real Estate portfolio. Residential Real Estate loans decreased $3,245,000 to $156,105,000 at March 31, 2020, as compared to $159,350,000 at December 31, 2019. The decrease was the result of $4,012,000 in new loan originations offset by a $150,000 decrease in utilization of existing Residential Real Estate (Home Equity) lines of credit, loan payoffs of $3,054,000, net loans sold of $1,338,000 and regular principal payments and other typical amortization in the Residential Real Estate portfolio. Net loans sold in the Residential Real Estate portfolio for the three months ended March 31, 2020 consisted of total loans sold during the three months ended March 31, 2020 of $3,044,000, offset with loans opened and sold in the same quarter during the first quarter of 2020 which amounted to $1,706,000. The Corporation continues to originate and sell certain long-term fixed rate residential mortgage loans which conform to secondary market requirements. The Corporation derives ongoing income from the servicing of mortgages sold in the secondary market. The Corporation continues its efforts to lend to creditworthy borrowers.

 

Management believes that the loan portfolio is well diversified. The total commercial portfolio was $499,819,000 at March 31, 2020. Of total loans, $412,796,000 or 62.4% were secured by commercial real estate, primarily lessors of residential buildings and dwellings and lessors of non-residential buildings. The Corporation continues to monitor these portfolios.

 

Overall, the portfolio risk profile as measured by loan grade is considered low risk, as $645,852,000 or 97.8% of gross loans are graded Pass; $31,000 or 0.1% are graded Special Mention; $14,289,000 or 2.1% are graded Substandard; and $0 are graded Doubtful. The rating is intended to represent the best assessment of risk available at a given point in time, based upon a review of the borrower’s financial statements, credit analysis, payment history with the Bank, credit history and lender knowledge of the borrower. See Note 4 — Loans and Allowance for Loan Losses for risk grading tables.

 

Overall, non-pass grades decreased to $14,320,000 at March 31, 2020, as compared to $14,887,000 at December 31, 2019. Commercial and Industrial non-pass grades decreased to $963,000 as of March 31, 2020 as compared to $1,070,000 as of December 31, 2019. Commercial Real Estate non-pass grades decreased to $12,229,000 as of March 31, 2020 as compared to $12,534,000 as of December 31, 2019. The Residential Real Estate and Consumer loan non-pass grades decreased to $1,128,000 as of March 31, 2020 as compared to $1,283,000 as of December 31, 2019.

 

The Corporation continues to internally underwrite each of its loans to comply with prescribed policies and approval levels established by its Board of Directors.

 

Total Loans

 

         
(Dollars in thousands)  March 31,   December 31, 
   2020   2019 
Commercial and Industrial  $87,023   $86,712 
Commercial Real Estate   412,796    395,801 
Residential Real Estate   156,105    159,350 
Consumer   5,692    5,869 
Total loans  $661,616   $647,732 

 

 35 

 

ALLOWANCE FOR LOAN LOSSES

 

The allowance for loan losses constitutes the amount available to absorb losses within the loan portfolio. As of March 31, 2020, the allowance for loan losses was $7,179,000 as compared to $7,005,000 as of December 31, 2019. The allowance for loan losses is established through a provision for loan losses charged to expenses. Loans are charged against the allowance for possible loan losses when management believes that the collectability of the principal is unlikely. The risk characteristics of the loan portfolio are managed through various control processes, including credit evaluations of individual borrowers, periodic reviews, and diversification by industry. Risk is further mitigated through the application of lending procedures such as the holding of adequate collateral and the establishment of contractual guarantees.

 

Management performs a quarterly analysis to determine the adequacy of the allowance for loan losses. The methodology in determining adequacy incorporates specific and general allocations together with a risk/loss analysis on various segments of the portfolio according to an internal loan review process. This assessment results in an allocated allowance. Management maintains its loan review and loan classification standards consistent with those of its regulatory supervisory authority.

 

Management considers, based upon its methodology, that the allowance for loan losses is adequate to cover foreseeable future losses. However, there can be no assurance that the allowance for loan losses will be adequate to cover significant losses, if any, that might be incurred in the future. In response to the COVID-19 pandemic and its impact on the current economy, the qualitative factors across all loan segments were increased by two basis points for the first quarter of 2020.

 

The Analysis of Allowance for Loan Losses table contains an analysis of the allowance for loan losses indicating charge-offs and recoveries for the three months ended March 31, 2020 and 2019. For the three months ended March 31, 2020 and 2019, net charge-offs as a percentage of average loans was 0.003% and 0.012%, respectively. Net charge-offs amounted to $20,000 for the first three months of 2020 as compared to $75,000 for the first three months of 2019. The decrease in net charge-offs during the three months ended March 31, 2020 as compared to the three months ended March 31, 2019 is mainly due to one charge-off that was completed during the three months ended March 31, 2019 on a Commercial Real Estate loan to a landscaping company in the amount of $51,000.

 

For the first three months of 2020, the provision for loan losses was $194,000 as compared to $92,000 for the first three months of 2019. The provision, net of charge-offs and recoveries, resulted in the quarter end Allowance for Loan Losses of $7,179,000 of which 9.2% was attributed to the Commercial and Industrial component; 60.3% attributed to the Commercial Real Estate component; 22.9% attributed to the Residential Real Estate component; 1.6% attributed to the Consumer component; and 6.0% being the unallocated component (refer to the activity in Note 4 – Loans and Allowance for Loan Losses on page 13). The Corporation determined that the provision for loan losses made during the current quarter was sufficient to maintain the allowance for loan losses at a level necessary for the probable losses inherent in the loan portfolio as of March 31, 2020.

 

 36 

 

 

Analysis of Allowance for Loan Losses

 

(Dollars in thousands)  March 31,   March 31, 
   2020   2019 
Balance at beginning of the three month period  $7,005   $6,745 
Charge-offs:          
Commercial and Industrial   4    — 
Commercial Real Estate   —    64 
Residential Real Estate   —    — 
Consumer   16    15 
    20    79 
Recoveries:          
Commercial and Industrial   —    1 
Commercial Real Estate   —    — 
Residential Real Estate   —    2 
Consumer   —    1 
    —    4 
           
Net charge-offs   20    75 
Additions charged to operations   194    92 
Balance at end of the three month period  $7,179   $6,762 
           
Ratio of net charge-offs during the period to average loans outstanding during the period   0.003%   0.012%
Allowance for loan losses to average loans outstanding during the period   1.097%   1.101%

 

It is the policy of management and the Corporation’s Board of Directors to make a provision for both identified and unidentified losses inherent in its loan portfolio. A provision for loan losses is charged to operations based upon an evaluation of the potential losses in the loan portfolio. This evaluation takes into account such factors as portfolio concentrations, delinquency trends, trends of non-accrual and classified loans, economic conditions, and other relevant factors.

 

The loan review process, which is conducted quarterly, is an integral part of the Bank’s evaluation of the loan portfolio. A detailed quarterly analysis to determine the adequacy of the Corporation’s allowance for loan losses is reviewed by the Board of Directors.

 

With the Bank’s manageable level of net charge-offs and the additions to the reserve from the provision out of operations, the allowance for loan losses as a percentage of average loans amounted to 1.097% at March 31, 2020 and 1.101% at March 31, 2019.

 

NON-PERFORMING ASSETS

 

The table on page 40 details the Corporation’s non-performing assets and impaired loans as of the dates indicated. Generally, a loan is classified as non-accrual and the accrual of interest on such a loan is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan currently is performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against current period income. A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification constitutes a concession that the Corporation would not otherwise consider. Modifications to loans classified as TDRs generally include reductions in contractual interest rates, principal deferments and extensions of maturity dates at a stated interest rate lower than the current market for a new loan with similar risk characteristics. While unusual, there may be instances of loan principal forgiveness. Any loan modifications made in response to the COVID-19 pandemic are not considered troubled debt restructurings as long as the criteria set forth in Section 4013 of the CARES Act are met. Foreclosed assets held for resale represent property acquired through foreclosure, or considered to be an in-substance foreclosure.

 

 37 

 

Total non-performing assets amounted to $7,699,000 as of March 31, 2020, as compared to $4,607,000 as of December 31, 2019. The economy, in particular, the political unrest both domestic and abroad, the looming presidential election, the various tariffs both imposed and threatened, the concerns and discussions of a potential recession, the recent rate cuts by the Fed, and the continued slowness in the housing industries in our market areas has had a direct effect on the Corporation’s non-performing assets. The Corporation is closely monitoring its Commercial Real Estate portfolio because of the current uncertain economic environment. Non-accrual loans totaled $6,951,000 as of March 31, 2020, as compared to $4,388,000 as of December 31, 2019. Foreclosed assets held for resale increased to $169,000 as of March 31, 2020, compared to $119,000 as of December 31, 2019. Loans past-due 90 days or more and still accruing interest amounted to $579,000 at March 31, 2020, as compared to $100,000 as of December 31, 2019. At March 31, 2020, loans past-due 90 days or more and still accruing interest consisted of two Commercial and Industrial loans and one Commercial Real Estate loan which were all well secured and in the process of collection.

 

The increase in non-accrual loans at March 31, 2020, as compared to December 31, 2019 is mainly due to the addition of several large loans/loan relationships to non-accrual status during the first quarter of 2020. Five loans to a plastic processing company focused on non-post-consumer recycling totaling $1,323,000 were moved to non-accrual status during the first quarter of 2020 due to strained liquidity and the borrower’s inability to make required payments, as the owner has ceased operations and is exploring options to liquidate the business. A loan in the amount of $846,000 to a golf course and catering venue was moved to non-accrual status during the first quarter of 2020 due to the borrower’s inability to make monthly payments due to cash flow challenges exacerbated by the seasonality of the industry. A residential mortgage in the amount of $356,000 to the owner of a manufacturing company was also moved to non-accrual status during the first quarter of 2020, as poor payment performance has led to foreclosure proceedings related to the associated property.

 

Non-performing assets to total loans was 1.16% at March 31, 2020 and 0.71% at December 31, 2019. Non-performing assets to total assets was 0.75% at March 31, 2020 and 0.46% at December 31, 2019. The allowance for loan losses to total non-performing assets was 93.25% as of March 31, 2020 as compared to 152.05% as of December 31, 2019. Additional detail can be found on page 40 in the Non-Performing Assets and Impaired Loans table and page 22 in the Non-Performing Assets table. Asset quality is a priority and the Corporation retains a full-time loan review officer to closely track and monitor overall loan quality, along with a full-time workout department to manage collection and liquidation efforts.

 

Potential problem loans are defined as performing substandard loans which are not deemed to be impaired. These loans have characteristics that cause management to have doubts regarding the ability of the borrower to perform under present loan repayment terms and which may result in reporting these loans as non-performing loans in the future. Potential problem loans amounted to $2,861,000 at March 31, 2020, compared to $4,074,000 at December 31, 2019.

 

Impaired loans were $13,696,000 at March 31, 2020 and $12,954,000 at December 31, 2019. The largest impaired loan relationship at March 31, 2020 consisted of a non-performing participation loan to a student housing holding company which was secured by commercial real estate. The Corporation’s share of the loan at March 31, 2020 was $3,176,000, net of $1,904,000 that had been charged off to date. The second largest impaired loan relationship at March 31, 2020 consisted of one performing loan to a student housing holding company, which was classified as a TDR. The loan was secured by commercial real estate and carried a balance of $2,977,000 as of March 31, 2020, net of $943,000 that had been charged off to date. The third largest impaired loan relationship at March 31, 2020 consisted of a substandard performing loan to a developer of a residential sub-division in the amount of $1,463,000, which was secured by commercial real estate and classified as a TDR.

 

The Corporation estimates impairment based on its analysis of the cash flows or collateral estimated at fair value less cost to sell. For collateral dependent loans, the estimated appraisal adjustments and cost to sell percentages are determined based on the market area in which the real estate securing the loan is located, among other factors, and therefore, can differ from one loan to another. Of the $13,696,000 in impaired loans at March 31, 2020, none were located outside of the Corporation’s primary market area.

 

 38 

 

The outstanding recorded investment of loans categorized as TDRs was $8,470,000 as of March 31, 2020 as compared to $8,678,000 as of December 31, 2019. The decrease in TDRs at March 31, 2020 as compared to December 31, 2019 is mainly attributable to payments and payoffs on existing troubled debt restructurings that were completed during the first quarter of 2020. Of the twenty-six restructured loans at March 31, 2020, six loans are classified in the Commercial and Industrial portfolio, nineteen loans are classified in the Commercial Real Estate portfolio, and one loan is classified in the Residential Real Estate portfolio. At March 31, 2020, nine Commercial Real Estate loans classified as TDRs with a combined recorded investment of $1,377,000 were not in compliance with the terms of their restructure, compared to March 31, 2019 when six Commercial Real Estate loans classified as TDRs with a combined recorded investment of $597,000 and one Commercial and Industrial loan classified as a TDR with a recorded investment of $5,000 were not in compliance with the terms of their restructure. Troubled debt restructurings at March 31, 2020 consisted of eleven term modifications beyond the original stated term, three interest rate modifications, and eleven payment modifications. At March 31, 2020, there was also one troubled debt restructuring that experienced all three types of modifications—payment, rate, and term. TDRs are separately evaluated for payment disclosures, and if necessary, a specific allocation is established. There were specific allocations of $1,000 attributable to the TDRs at both March 31, 2020 and December 31, 2019, respectively. There were no unfunded commitments attributable to TDRs at March 31, 2020 and December 31, 2019.

 

No loans were modified as TDRs within the twelve months preceding March 31, 2020. Of the loans that were modified as TDRs during the twelve months preceding March 31, 2019, two Commercial Real Estate Loans with a combined recorded investment of $113,000 experienced payment defaults during the three months ended March 31, 2019.

 

The Corporation’s non-accrual loan valuation procedure for any loans greater than $250,000 requires an appraisal to be obtained and reviewed annually at year end. A quarterly collateral evaluation is performed which may include a site visit, property pictures and discussions with realtors and other similar business professionals to ascertain current values.

 

For non-accrual loans less than $250,000 upon classification and typically at year end, the Corporation completes a Certificate of Inspection, which includes the results of an onsite inspection, insured values, tax assessed values, recent sales comparisons and a review of the previous evaluations.

 

Improving loan quality is a priority. The Corporation actively works with borrowers to resolve credit problems and will continue its close monitoring efforts in 2020. Excluding the assets disclosed in the Non-Performing Assets and Impaired Loans tables on page 40 and the Troubled Debt Restructurings section in Note 4 — Loans and Allowance for Loan Losses, management is not aware of any information about borrowers’ possible credit problems which cause serious doubt as to their ability to comply with present loan repayment terms.

 

The economic climate is unclear at this time. The COVID-19 pandemic has caused much upheaval and uncertainty in the national and state economy. Experts at all levels are uncertain as to the intermediate or long term affects that may arise. Borrowers may experience difficulty, and the level of impaired loans and non-performing assets, charge-offs and delinquencies could rise and possibly require additional increases in the Corporation’s allowance for loan losses.

 

In addition, regulatory authorities, as an integral part of their examinations, periodically review the allowance for possible loan losses. They may require additions to allowances based upon their judgments about information available to them at the time of examination.

 

A concentration of credit exists when the total amount of loans to borrowers, who are engaged in similar activities that are similarly impacted by economic or other conditions, exceed 10% of total loans. As of March 31, 2020 and December 31, 2019, management is of the opinion that there were no loan concentrations exceeding 10% of total loans.

 

 39 

 

 

Non-Performing Assets and Impaired Loans

 

(Dollars in thousands)  March 31,   December 31, 
   2020   2019 
Non-Performing Assets:          
Non-accrual loans  $6,951   $4,388 
Foreclosed assets held for resale   169    119 
Loans past-due 90 days or more and still accruing interest   579    100 
Total non-performing assets  $7,699   $4,607 
           
Impaired Loans:          
Non-accrual loans  $6,951   $4,388 
Accruing TDRs   6,745    8,566 
Total impaired loans   13,696    12,954 
Allocated allowance for loan losses   (1)   (1)
Net investment in impaired loans  $13,695   $12,953 
           
Impaired loans with a valuation allowance  $134   $28 
Impaired loans without a valuation allowance   13,562    12,926 
Total impaired loans  $13,696   $12,954 
           
Allocated valuation allowance as a percent of impaired loans   0.01%   0.01%
Impaired loans to total loans   2.07%   2.00%
Non-performing assets to total loans   1.16%   0.71%
Non-performing assets to total assets   0.75%   0.46%
Allowance for loan losses to impaired loans   52.42%   54.08%
Allowance for loan losses to total non-performing assets   93.25%   152.05%

 

Real estate mortgages comprise 86.0% of the loan portfolio as of March 31, 2020, as compared to 85.7% as of December 31, 2019. Real estate mortgages consist of both residential and commercial real estate loans. The real estate loan portfolio is well diversified in terms of borrowers, collateral, interest rates, and maturities. Also, the residential real estate loan portfolio is largely comprised of fixed rate mortgages. The real estate loans are concentrated primarily in the Corporation’s market area and are subject to risks associated with the local economy. The commercial real estate loans typically reprice approximately every three to five years and are also concentrated in the Corporation’s market area. The Corporation’s loss exposure on its impaired loans continues to be mitigated by collateral positions on these loans. The allocated allowance for loan losses associated with impaired loans is generally computed based upon the related collateral value of the loans. The collateral values are determined by recent appraisals, but are generally discounted by management based on historical dispositions, changes in market conditions since the last valuation and management’s expertise and knowledge of the borrower and the borrower’s business.

 

DEPOSITS AND OTHER BORROWED FUNDS

 

Consumer and commercial retail deposits are attracted primarily by the Bank’s eighteen full service office locations, one loan production office and through its internet banking presence. The Bank offers a broad selection of deposit products and continually evaluates its interest rates and fees on deposit products. The Bank regularly reviews competing financial institutions’ interest rates, especially when establishing interest rates on certificates of deposit.

 

Total deposits decreased $26,831,000 to $734,797,000 as of March 31, 2020 as non-interest bearing deposits increased by $18,381,000 and interest bearing deposits decreased by $45,212,000 from year-end 2019. Total deposits decreased due to the Corporation calling $40,000,000 worth of brokered CDs during the quarter ended March 31, 2020 due to the changing rate environment. Total short-term and long-term borrowings increased to $156,379,000 as of March 31, 2020, from $109,663,000 at year-end 2019, an increase of $46,716,000 or 42.6%. The increase in total borrowings was the result of decreasing deposit balances and increases in the loan and securities portfolios.

 

 40 

 

CAPITAL STRENGTH

 

Normal increases in capital are generated by net income, less dividends paid out. During the first three months of the year, net income less dividends paid increased capital by $483,000. Accumulated other comprehensive income (loss) derived from net unrealized gains on debt securities available-for-sale also impacts capital. At December 31, 2019 accumulated other comprehensive income was $4,221,000. Accumulated other comprehensive income stood at $4,826,000 at March 31, 2020, an increase of $605,000. Fluctuations in interest rates have regularly impacted the gain/loss position in the Bank’s investment portfolio, as well as its decision to sell securities at a gain or loss. In order to protect the Bank from market risk in the event of further interest rate increases, the Bank chose to sell a portion of its securities during the first three months of 2020 at an overall net gain of $71,000. The fluctuations from net unrealized gains on debt securities available-for-sale do not affect regulatory capital, as the Bank elected to opt-out of the inclusion of this item with the filing of the March 31, 2015 Call Report.

 

The Corporation held 231,612 shares of common stock as treasury stock at March 31, 2020 and December 31, 2019. This had an effect of reducing our total stockholders’ equity by $5,709,000 as of March 31, 2020 and December 31, 2019.

 

Total stockholders’ equity was $130,150,000 as of March 31, 2020, and $128,752,000 as of December 31, 2019.

 

At March 31, 2020 the Bank met the definition of a “well-capitalized” institution under the regulatory framework for prompt corrective action and the minimum capital requirements under Basel III. The following table presents the Bank’s capital ratios as of March 31, 2020 and December 31, 2019:

 

           To Be Well
Capitalized		 
           Under Prompt 
   March 31,   December 31,   Corrective Action 
   2020   2019   Regulations 
Tier 1 leverage ratio (to average assets)   9.54%   9.42%   5.00%
Common Equity Tier 1 capital ratio (to risk-weighted assets)   13.24%   13.50%   6.50%
Tier 1 risk-based capital ratio (to risk-weighted assets)   13.24%   13.50%   8.00%
Total risk-based capital ratio   14.27%   14.53%   10.00%

 

Under the final capital rules that became effective on January 1, 2015, there was a requirement for a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer requirement was phased in over three years beginning in 2016. The capital buffer requirement effectively raises the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1 capital ratio to 8.5%, and the total capital ratio to 10.5% on a fully phased-in basis as of January 1, 2019. As of March 31, 2020, the Bank meets all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis.

 

The Corporation’s capital ratios are not materially different than those of the Bank.

 

LIQUIDITY

 

The Corporation’s objective is to maintain adequate liquidity to meet funding needs at a reasonable cost and to provide contingency plans to meet unanticipated funding needs or a loss of funding sources, while minimizing interest rate risk. Adequate liquidity is needed to provide the funding requirements of depositors’ withdrawals, loan growth, and other operational needs.

 

Sources of liquidity are as follows:

 

·Growth in the core deposit base;
·Proceeds from sales or maturities of investment securities;
·Payments received on loans and mortgage-backed securities;
·Overnight correspondent bank borrowings on various credit lines, notes, etc., with various levels of capacity;
·Securities sold under agreements to repurchase; and
·Brokered CDs.

 

 41 

 

 

At March 31, 2020, the Corporation had $367,482,000 in available borrowing capacity at FHLB (which takes into account FHLB long-term notes and FHLB short-term borrowings); the maximum borrowing capacity at ACBB was $15,000,000 and the maximum borrowing capacity of the Federal Discount Window was $5,743,000.

 

The Corporation enters into “Repurchase Agreements” in which it agrees to sell securities subject to an obligation to repurchase the same or similar securities. Because the agreement both entitles and obligates the Corporation to repurchase the assets, the Corporation may transfer legal control of the securities while still retaining effective control. As a result, the repurchase agreements are accounted for as collateralized financing agreements (secured borrowings) and act as an additional source of liquidity. Securities sold under agreements to repurchase were $12,551,000 at March 31, 2020.

 

Asset liquidity is provided by investment securities maturing in one year or less, other short-term investments, federal funds sold, and cash and due from banks. The liquidity is augmented by repayment of loans and cash flows from mortgage-backed and asset-backed securities. Liability liquidity is accomplished primarily by maintaining a core deposit base, acquired by attracting new deposits and retaining maturing deposits. Also, short-term borrowings provide funds to meet liquidity needs.

 

Net cash flows provided by operating activities were $1,365,000 and $3,247,000 at March 31, 2020 and 2019 respectively. Net income amounted to $2,053,000 for the three months ended March 31, 2020 and $2,243,000 for the three months ended March 31, 2019. During the three months ended March 31, 2020 and 2019, net premium amortization on investment securities amounted to $498,000 and $733,000, respectively. Proceeds (including gains) from sales of mortgage loans originated for resale exceeded cash utilized for originations of mortgage loans originated for resale by $37,000 and $286,000 for the three months ended March 31, 2020 and 2019, respectively. Net securities losses were $467,000 for the three months ended March 31, 2020, compared to net securities gains of $103,000 for the three months ended March 31, 2019. Other assets increased by $537,000 and $1,860,000 during the three months ended March 31, 2020 and 2019, respectively. Other liabilities decreased $1,159,000 during the three months ended March 31, 2020, compared to an increase of $1,198,000 during the three months ended March 31, 2019.

 

Investing activities used cash of $21,909,000 during the three months ended March 31, 2020 and provided cash of $26,139,000 during the three months ended March 31, 2019. Net activity in the available-for-sale securities portfolio (including proceeds from sale, maturities, and redemptions net against purchases) used cash of $5,396,000 during the three months ended March 31, 2020 and provided cash of $36,894,000 during the three months ended March 31, 2019. Net cash used to originate loans amounted to $13,877,000 and $11,891,000 during the three months ended March 31, 2020 and 2019, respectively.

 

Financing activities provided cash of $18,618,000 during the three months ended March 31, 2020 and used cash of $28,378,000 during the three months ended March 31, 2019. Deposits decreased by $26,831,000 during the three months ended March 31, 2020 and increased by $25,867,000 during the three months ended March 31, 2019. Short-term borrowings increased by $51,716,000 and decreased by $42,966,000 during the three months ended March 31, 2020 and 2019, respectively. Repayment of long-term borrowings amounted to $5,000,000 for the three months ended March 31, 2020 and $10,000,000 for the three months ended March 31, 2019. Dividends paid amounted to $1,570,000 and $1,557,000 during the three months ended March 31, 2020 and 2019, respectively.

 

Managing liquidity remains an important segment of asset/liability management. The overall liquidity position of the Corporation is maintained by an active asset/liability management committee. The Corporation believes that its core deposit base is stable even in periods of changing interest rates. Liquidity and funds management are governed by policies and are measured on a monthly basis. These measurements indicate that liquidity generally remains stable and exceeds the Corporation’s minimum defined levels of adequacy. Other than the trends of continued competitive pressures and volatile interest rates, there are no known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way. Given our financial strength, we expect to be able to maintain adequate liquidity as we manage through the current environment, utilizing current funding options and possibly utilizing new options, such as the Federal Reserve’s Paycheck Protection Program Liquidity Facility (“PPPLF”).

 

 42 

 

MARKET RISK

 

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. The Corporation’s market risk is composed primarily of interest rate risk. The Corporation’s interest rate risk results from timing differences in the repricing of assets, liabilities, off-balance sheet instruments, and changes in relationships between rate indices and the potential exercise of explicit or embedded options.

 

Increases in the level of interest rates also may adversely affect the fair value of the Corporation’s securities and other earning assets. Generally, the fair value of fixed-rate instruments fluctuates inversely with changes in interest rates. As a result, increases in interest rates could result in decreases in the fair value of the Corporation’s interest-earning assets, which could adversely affect the Corporation’s results of operations if sold, or, in the case of interest-earning assets classified as available-for-sale, the Corporation’s stockholders’ equity, if retained. Under FASB ASC 320-10, Investments – Debt Securities, changes in the unrealized gains and losses, net of taxes, on debt securities classified as available-for-sale are reflected in the Corporation’s stockholders’ equity. The Corporation does not own any trading assets.

 

Asset/Liability Management

 

The principal objective of asset/liability management is to manage the sensitivity of the net interest margin to potential movements in interest rates and to enhance profitability through returns from managed levels of interest rate risk. The Corporation actively manages the interest rate sensitivity of its assets and liabilities. Several techniques are used for measuring interest rate sensitivity. Interest rate risk arises from the mismatches in the repricing of assets and liabilities within a given time period, referred to as a rate sensitivity gap. If more assets than liabilities mature or reprice within the time frame, the Corporation is asset sensitive. This position would contribute positively to net interest income in a rising rate environment. Conversely, if more liabilities mature or reprice, the Corporation is liability sensitive. This position would contribute positively to net interest income in a falling rate environment. The Corporation’s cumulative gap at one year indicates the Corporation is liability sensitive at March 31, 2020.

 

Earnings at Risk

 

The Bank’s Asset/Liability Committee (“ALCO”) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to interest rate risk. The guidelines established by ALCO are reviewed by the Corporation’s Board of Directors. The Corporation recognizes that more sophisticated tools exist for measuring the interest rate risk in the balance sheet beyond interest rate sensitivity gap. Although the Corporation continues to measure its interest rate sensitivity gap, the Corporation utilizes additional modeling for interest rate risk in the overall balance sheet. Earnings at risk and economic values at risk are analyzed.

 

Earnings simulation modeling addresses earnings at risk and net present value estimation addresses economic value at risk. While each of these interest rate risk measurements has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk to the Corporation.

 

Earnings Simulation Modeling

 

The Corporation’s net income is affected by changes in the level of interest rates. Net income is also subject to changes in the shape of the yield curve. For example, a flattening of the yield curve would result in a decline in earnings due to the compression of earning asset yields and increased liability rates, while a steepening would result in increased earnings as earning asset yields widen.

 

Earnings simulation modeling is the primary mechanism used in assessing the impact of changes in interest rates on net interest income. The model reflects management’s assumptions related to asset yields and rates paid on liabilities, deposit sensitivity, size and composition of the balance sheet. The assumptions are based on what management believes at that time to be the most likely interest rate environment. Earnings at risk is the change in net interest income from a base case scenario under various scenarios of rate shock increases and decreases in the interest rate earnings simulation model.

 

 43 

 

The table below presents an analysis of the changes in net interest income and net present value of the balance sheet resulting from various increases or decreases in the level of interest rates, such as two percentage points (200 basis points) in the level of interest rates. The calculated estimates of change in net interest income and net present value of the balance sheet are compared to current limits approved by ALCO and the Board of Directors. The earnings simulation model projects net interest income would decrease 4.83%, 10.05% and 14.76% in the 100, 200 and 300 basis point increasing rate scenarios presented. In addition, the earnings simulation model projects net interest income would decrease 1.74% and 6.33% in the 100 and 200 basis point decreasing rate scenarios presented. All of these forecasts are within the Corporation’s one year policy guidelines.

 

The analysis and model used to quantify the sensitivity of net interest income becomes less reliable in a decreasing rate scenario given the current unprecedented low interest rate environment with federal funds trading in the 0 – 25 basis point range. Results of the decreasing basis point declining scenarios are affected by the fact that many of the Corporation’s interest-bearing liabilities are at rates below 1% and therefore likely may not decline 100 or more basis points. However, the Corporation’s interest-sensitive assets are able to decline by these amounts. For the three months ended March 31, 2020, the cost of interest-bearing liabilities averaged 1.30%, and the yield on interest-earning assets, on a fully taxable equivalent basis, averaged 4.30%.

 

Net Present Value Estimation

 

The net present value measures economic value at risk and is used for helping to determine levels of risk at a point in time present in the balance sheet that might not be taken into account in the earnings simulation model. The net present value of the balance sheet is defined as the discounted present value of asset cash flows minus the discounted present value of liability cash flows. At March 31, 2020, the 100 and 200 basis point immediate decreases in rates are estimated to affect net present value with decreases of 79.23% and 190.73%, respectively. Additionally, net present value is projected to increase 50.60%, 78.02%, and 89.72% in the 100, 200, and 300 basis point immediate increase scenarios, respectively. These scenarios presented are within the Corporation’s policy limits, aside from the 100 basis point immediate decrease scenario at (79.23)% vs. a policy limit of (20)% and the 200 basis point immediate decrease scenario at (190.73)% vs. a policy limit of (30.0)%.

 

The computation of the effects of hypothetical interest rate changes are based on many assumptions. They should not be relied upon solely as being indicative of actual results, since the computations do not account for actions management could undertake in response to changes in interest rates.

 

Effect of Change in Interest Rates

 

   Projected Change 
Effect on Net Interest Income     
1-Year Net Income Simulation Projection     
+300 bp Shock vs. Stable Rate   (14.76)%
+200 bp Shock vs. Stable Rate   (10.05)%
+100 bp Shock vs. Stable Rate   (4.83)%
Flat rate     
-100 bp Shock vs. Stable Rate   (1.74)%
-200 bp Shock vs. Stable Rate   (6.33)%
      
Effect on Net Present Value of Balance Sheet     
Static Net Present Value Change     
+300 bp Shock vs. Stable Rate   89.72%
+200 bp Shock vs. Stable Rate   78.02%
+100 bp Shock vs. Stable Rate   50.60%
Flat rate     
-100 bp Shock vs. Stable Rate   (79.23)%
-200 bp Shock vs. Stable Rate   (190.73)%

 

 44 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Information with respect to quantitative and qualitative disclosures about market risk is included in the information under Management’s Discussion and Analysis in Item 2.

 

 

Item 4. Controls and Procedures

 

a)Evaluation of Disclosure Controls and Procedures. First Keystone Corporation maintains disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) designed to ensure that information required to be disclosed in the reports that the Corporation files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those disclosure controls and procedures performed as of the end of the period covered by this report, the Chief Executive Officer and Chief Financial Officer of the Corporation concluded that the Corporation’s disclosure controls and procedures were effective as of March 31, 2020.

 

b)Changes in internal control over financial reporting. There were no other changes in the Corporation’s internal control over financial reporting during the fiscal quarter ended March 31, 2020, that materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

 

 

 

 45 

 

PART II - OTHER INFORMATION

 

Item 1.Legal Proceedings

 

Although the Corporation is subject to various claims and legal actions that occur from time to time in the ordinary course of business, the Corporation is not party to any pending legal proceedings that management believes could have a material adverse effect on its business, results of operations, financial condition or cash flows.

  

Item 1A.Risk Factors

 

The COVID-19 pandemic could have a material adverse effect on our ability to operate, results of operations, liquidity, and financial condition.

 

The World Health Organization has declared the COVID-19 outbreak a pandemic, and the virus continues to spread in areas where we operate. The COVID-19 pandemic and similar issues in the future could have a material adverse effect on our ability to operate, results of operations, liquidity, and financial condition. Several public health organizations have recommended, and some local governments have implemented, certain measures to slow and limit the transmission of the virus, including shelter in place and social distancing ordinances. Such preventive measures, or others we may voluntarily put in place, may have a material adverse effect on our business for an indefinite period, such as the limitation of hours at branch locations, decreased employee availability, disruptions to the businesses of our vendors, and others. Our customers may also face these and other challenges, which could lead to a disruption in demand for our services. Although these disruptions may continue to occur, the long-term economic impact and near-term financial impacts of the COVID-19 pandemic, including but not limited to, possible impairment and other charges, cannot be reliably quantified or estimated at this time due to the uncertainty of future developments.

 

Other than the item listed above, there have been no material changes to the risk factors disclosed in Item 1A “Risk Factors” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019.

 

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

 

Period

(a)

Total Number of Shares Purchased

(b)

Average Price Paid per Share

(c)

Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs

(d)

Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs

January 1 —

January 31, 2020

―

―

―

120,000

February 1 —

February 29, 2020

―

―

―

120,000

March 1 —

March 31, 2020

―

―

―

120,000

Total

―

―

―

120,000

 

 

 

 46 

 

 

Item 3.Defaults Upon Senior Securities

 

None.

 

Item 4.Mine Safety Disclosures

 

Not applicable.

 

Item 5.Other Information

 

None.

 

 47 

 

 

Item 6.Exhibits and Reports on Form 8-K

 

(a)Exhibits required by Item 601 Regulation S-K

 

Exhibit NumberDescription of Exhibit
3iArticles of Incorporation, as amended (Incorporated by reference to Exhibit 3(i) to the Registrant’s Report on Form 8-K dated August 28, 2018).

 

3iiBy-Laws, as amended and restated (Incorporated by reference to Exhibit 3(ii) to the Registrant’s Report on Form 8-K dated August 28, 2018).

 

10.1(a)Supplemental Employee Retirement Plan – J. Gerald Bazewicz (Incorporated by reference to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2013).*

 

10.1(b)Supplemental Employee Retirement Plan – David R. Saracino (Incorporated by reference to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2013).*

 

10.1(d)Supplemental Employee Retirement Plan – Elaine Woodland (Incorporated by reference to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2013).*

 

10.2Management Incentive Compensation Plan (Incorporated by reference to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2018).*

 

10.4First Keystone Corporation 1998 Stock Incentive Plan (Incorporated by reference to Exhibit 10 to Registrant’s Report on Form 10-Q for the quarter ended September 30, 2006).*

 

14First Keystone Corporation Directors and Senior Management Code of Ethics (Incorporated by reference to Exhibit 99.1 to Registrant’s Report on Form 8-K dated August 27, 2013).

 

31.1Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.**

 

31.2Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.**

 

32.1Section 1350 Certification of Chief Executive Officer.**

 

32.2Section 1350 Certification of Chief Financial Officer.**

 

101.INSXBRL Instance Document.**

 

101.SCHXBRL Taxonomy Extension Schema Document.**

 

101.CALXBRL Taxonomy Extension Calculation Linkbase Document.**

 

101.DEFXBRL Taxonomy Extension Definition Linkbase Document.**

 

101.LABXBRL Taxonomy Extension Label Linkbase Document.**

 

101.PREXBRL Taxonomy Extension Presentation Linkbase Document.**

 

*Denotes a compensatory plan.
**Filed herewith.

 

The Corporation will provide a copy of any exhibit upon receipt of a written request for the particular exhibit or exhibits desired. All requests should be addressed to the Corporation’s principal executive offices.

 

 48 

 

 

FIRST KEYSTONE CORPORATION

 

 

SIGNATURES

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly cause this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

   FIRST KEYSTONE CORPORATION
   Registrant
    
    
May 8, 2020  /s/ Elaine A. Woodland
   Elaine A. Woodland
   President and Chief Executive Officer
   (Principal Executive Officer)
    
    
    
May 8, 2020  /s/ Diane C.A. Rosler
   Diane C.A. Rosler
   Senior Vice President and Chief Financial Officer
   (Principal Financial Officer)

 

 49 

 

 

INDEX TO EXHIBITS

 

ExhibitDescription
3iArticles of Incorporation, as amended (Incorporated by reference to Exhibit 3(i) to the Registrant’s Report on Form 8-K dated August 28, 2018).

 

3iiBy-Laws, as amended and restated (Incorporated by reference to Exhibit 3(ii) to the Registrant’s Report on Form 8-K dated August 28, 2018).

 

10.1(a)Supplemental Employee Retirement Plan – J. Gerald Bazewicz (Incorporated by reference to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2013).*

 

10.1(b)Supplemental Employee Retirement Plan – David R. Saracino (Incorporated by reference to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2013).*

 

10.1(d)Supplemental Employee Retirement Plan – Elaine Woodland (Incorporated by reference to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2013).*

 

10.2Management Incentive Compensation Plan (Incorporated by reference to Exhibit 10 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2018).*

 

10.4First Keystone Corporation 1998 Stock Incentive Plan (Incorporated by reference to Exhibit 10 to Registrant’s Report on Form 10-Q for the quarter ended September 30, 2006).*

 

14First Keystone Corporation Directors and Senior Management Code of Ethics (Incorporated by reference to Exhibit 99.1 to Registrant’s Report on Form 8-K dated August 27, 2013).

 

31.1Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.**

 

31.2Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.**

 

32.1Section 1350 Certification of Chief Executive Officer.**

 

32.2Section 1350 Certification of Chief Financial Officer.**

 

101.INSXBRL Instance Document.**

 

101.SCHXBRL Taxonomy Extension Schema Document.**

 

101.CALXBRL Taxonomy Extension Calculation Linkbase Document.**

 

101.DEFXBRL Taxonomy Extension Definition Linkbase Document.**

 

101.LABXBRL Taxonomy Extension Label Linkbase Document.**

 

101.PREXBRL Taxonomy Extension Presentation Linkbase Document.**

 

*Denotes a compensatory plan.
**Filed herewith.

 

The Corporation will provide a copy of any exhibit upon receipt of a written request for the particular exhibit or exhibits desired. All requests should be addressed to the Corporation’s principal executive offices.

 

 50