UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2019
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: 000-16084
CITIZENS & NORTHERN CORPORATION
(Exact name of Registrant as specified in its charter)
| PENNSYLVANIA | 23-2451943 |
| (State or other jurisdiction of | (I.R.S. Employer |
| incorporation or organization) | Identification No.) |
90-92 MAIN STREET, WELLSBORO, PA 16901
(Address of principal executive offices) (Zip code)
570-724-3411
(Registrant's telephone number including area code)
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 Par Value $1.00 | CZNC | NASDAQ Capital Market |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer 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 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
| Common Stock ($1.00 par value) | 13,687,999 Shares Outstanding on August 6, 2019 |
CITIZENS & NORTHERN CORPORATION
Index
| 2 |
| (In Thousands, Except Share and Per Share Data) (Unaudited) | June 30, | December 31, | ||||||
| 2019 | 2018 | |||||||
| ASSETS | ||||||||
| Cash and due from banks: | ||||||||
| Noninterest-bearing | $ | 20,693 | $ | 20,970 | ||||
| Interest-bearing | 18,812 | 16,517 | ||||||
| Total cash and due from banks | 39,505 | 37,487 | ||||||
| Available-for-sale debt securities, at fair value | 363,465 | 363,273 | ||||||
| Marketable equity security | 976 | 950 | ||||||
| Loans held for sale | 1,131 | 213 | ||||||
| Loans receivable | 1,116,683 | 827,563 | ||||||
| Allowance for loan losses | (8,200 | ) | (9,309 | ) | ||||
| Loans, net | 1,108,483 | 818,254 | ||||||
| Bank-owned life insurance | 18,430 | 19,035 | ||||||
| Accrued interest receivable | 5,306 | 3,968 | ||||||
| Bank premises and equipment, net | 16,114 | 14,592 | ||||||
| Foreclosed assets held for sale | 3,305 | 1,703 | ||||||
| Deferred tax asset, net | 2,171 | 4,110 | ||||||
| Goodwill and other intangibles, net | 30,013 | 11,951 | ||||||
| Other assets | 20,786 | 15,357 | ||||||
| TOTAL ASSETS | $ | 1,609,685 | $ | 1,290,893 | ||||
| LIABILITIES | ||||||||
| Deposits: | ||||||||
| Noninterest-bearing | $ | 299,638 | $ | 272,520 | ||||
| Interest-bearing | 984,505 | 761,252 | ||||||
| Total deposits | 1,284,143 | 1,033,772 | ||||||
| Short-term borrowings | 27,493 | 12,853 | ||||||
| Long-term borrowings | 38,273 | 35,915 | ||||||
| Subordinated debt | 7,000 | 0 | ||||||
| Accrued interest and other liabilities | 13,060 | 10,985 | ||||||
| TOTAL LIABILITIES | 1,369,969 | 1,093,525 | ||||||
| STOCKHOLDERS' EQUITY | ||||||||
| Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation preference per share; no shares issued | 0 | 0 | ||||||
| Common stock, par value $1.00 per share; authorized 20,000,000 shares; issued 13,934,996 and outstanding 13,687,999 at June 30, 2019; issued 12,655,171 and outstanding 12,319,330 December 31, 2018 | 13,935 | 12,655 | ||||||
| Paid-in capital | 103,953 | 72,602 | ||||||
| Retained earnings | 123,112 | 122,643 | ||||||
| Treasury stock, at cost; 246,997 shares at June 30, 2019 and 335,841 shares at December 31, 2018 | (4,716 | ) | (6,362 | ) | ||||
| Accumulated other comprehensive income (loss) | 3,432 | (4,170 | ) | |||||
| TOTAL STOCKHOLDERS' EQUITY | 239,716 | 197,368 | ||||||
| TOTAL LIABILITIES & STOCKHOLDERS' EQUITY | $ | 1,609,685 | $ | 1,290,893 | ||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| 3 |
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| 4 |
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| 5 |
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| 6 |
Consolidated Statements of Changes in Stockholders' Equity
(In Thousands Except Share and Per Share Data) (Unaudited)
| Accumulated | ||||||||||||||||||||||||||||||||
| Other | ||||||||||||||||||||||||||||||||
| Common | Treasury | Common | Paid-in | Retained | Comprehensive | Treasury | ||||||||||||||||||||||||||
| Shares | Shares | Stock | Capital | Earnings | Income (Loss) | Stock | Total | |||||||||||||||||||||||||
| Six Months Ended June 30, 2019 | ||||||||||||||||||||||||||||||||
| Balance, December 31, 2018 | 12,655,171 | 335,841 | $ | 12,655 | $ | 72,602 | $ | 122,643 | $ | (4,170 | ) | $ | (6,362 | ) | $ | 197,368 | ||||||||||||||||
| Net income | 8,739 | 8,739 | ||||||||||||||||||||||||||||||
| Other comprehensive income, net | 7,602 | 7,602 | ||||||||||||||||||||||||||||||
| Cash dividends declared on common stock, $.64 per share | (8,270 | ) | (8,270 | ) | ||||||||||||||||||||||||||||
| Shares issued for dividend reinvestment plan | (33,172 | ) | 251 | 633 | 884 | |||||||||||||||||||||||||||
| Shares issued from treasury and redeemed related to exercise of stock options | (18,071 | ) | (146 | ) | 344 | 198 | ||||||||||||||||||||||||||
| Restricted stock granted | (48,137 | ) | (918 | ) | 918 | 0 | ||||||||||||||||||||||||||
| Forfeiture of restricted stock | 3,144 | 60 | (60 | ) | 0 | |||||||||||||||||||||||||||
| Stock-based compensation expense | 431 | 431 | ||||||||||||||||||||||||||||||
| Purchase of restricted stock for tax withholding | 7,392 | (189 | ) | (189 | ) | |||||||||||||||||||||||||||
| Shares issued for acquisition of Monument Bancorp, Inc., net of equity issuance costs | 1,279,825 | 1,280 | 31,673 | 32,953 | ||||||||||||||||||||||||||||
| Balance, June 30, 2019 | 13,934,996 | 246,997 | $ | 13,935 | $ | 103,953 | $ | 123,112 | $ | 3,432 | $ | (4,716 | ) | $ | 239,716 | |||||||||||||||||
| Six Months Ended June 30, 2018 | ||||||||||||||||||||||||||||||||
| Balance, December 31, 2017 | 12,655,171 | 440,646 | $ | 12,655 | $ | 72,035 | $ | 113,608 | $ | (1,507 | ) | $ | (8,348 | ) | $ | 188,443 | ||||||||||||||||
| Impact of change in enacted income tax rate (a) | 325 | (325 | ) | 0 | ||||||||||||||||||||||||||||
| Impact of change in method of premium amortization of callable debt securities (b) | (26 | ) | 26 | 0 | ||||||||||||||||||||||||||||
| Impact of change in method of accounting for marketable equity security (c) | (22 | ) | 22 | 0 | ||||||||||||||||||||||||||||
| Net income | 10,746 | 10,746 | ||||||||||||||||||||||||||||||
| Other comprehensive loss, net | (4,555 | ) | (4,555 | ) | ||||||||||||||||||||||||||||
| Cash dividends declared on common stock, $.54 per share | (6,619 | ) | (6,619 | ) | ||||||||||||||||||||||||||||
| Shares issued for dividend reinvestment plan | (31,572 | ) | 163 | 598 | 761 | |||||||||||||||||||||||||||
| Shares issued from treasury and redeemed related to exercise of stock options | (7,417 | ) | (75 | ) | 140 | 65 | ||||||||||||||||||||||||||
| Restricted stock granted | (34,552 | ) | (655 | ) | 655 | 0 | ||||||||||||||||||||||||||
| Forfeiture of restricted stock | 7,528 | 141 | (141 | ) | 0 | |||||||||||||||||||||||||||
| Stock-based compensation expense | 338 | 338 | ||||||||||||||||||||||||||||||
| Balance, June 30, 2018 | 12,655,171 | 374,633 | $ | 12,655 | $ | 71,947 | $ | 118,012 | $ | (6,339 | ) | $ | (7,096 | ) | $ | 189,179 | ||||||||||||||||
| (a) | As described in more detail in the Recent Accounting Pronouncements - Adopted section of Note 1, this reclassification resulted from adoption of Accounting Standards Update (ASU) 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, effective January 1, 2018. |
| (b) | As described in more detail in the Recent Accounting Pronouncements - Adopted section of Note 1, this reclassification resulted from adoption of ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20), effective January 1, 2018. |
| (c) | As described in more detail in the Recent Accounting Pronouncements - Adopted section of Note 1, this reclassification resulted from adoption of ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities, effective January 1, 2018. |
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| 7 |
Notes to Unaudited Consolidated Financial Statements
1. BASIS OF INTERIM PRESENTATION AND STATUS OF RECENT ACCOUNTING PRONOUNCEMENTS
The consolidated financial statements include the accounts of Citizens & Northern Corporation and its subsidiaries, Citizens & Northern Bank (“C&N Bank”), Bucktail Life Insurance Company and Citizens & Northern Investment Corporation (collectively, “Corporation”). The consolidated financial statements also include C&N Bank’s wholly-owned subsidiaries, C&N Financial Services Corporation, and Northern Tier Holding LLC. C&N Bank is the sole member of Northern Tier Holding LLC. All material intercompany balances and transactions have been eliminated in consolidation.
The consolidated financial information included herein, except the consolidated balance sheet dated December 31, 2018, is unaudited. Such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, comprehensive income, cash flows and changes in stockholders’ equity for the interim periods; however, the information does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for a complete set of financial statements. Certain 2018 information has been reclassified for consistency with the 2019 presentation.
Operating results reported for the three-month and six-month periods ended June 30, 2019 might not be indicative of the results for the year ending December 31, 2019. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) issues Accounting Standards Updates (ASUs) to the FASB Accounting Standards Codification (ASC). This section provides a summary description of recent ASUs that have significant implications (elected or required) within the consolidated financial statements, or that management expects may have a significant impact on financial statements issued in the near future.
Recent Accounting Pronouncements - Adopted
Effective January 1, 2019, the Corporation adopted ASU 2016-02, Leases (Topic 842), as modified by subsequent ASUs, which changed GAAP by requiring that lease assets and liabilities arising from operating leases be recognized on the balance sheet. Topic 842, as modified, does not significantly change the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee from prior U.S. GAAP. For leases with a term of 12 months or less, the Corporation made an accounting policy election by class of underlying asset not to recognize lease assets and liabilities. The Corporation elected to adopt this pronouncement using an optional transition method resulting in recognition of right-of-use assets and lease liabilities for operating leases of $1,132,000 on its consolidated balance sheets at January 1, 2019, with no adjustment to stockholders’ equity and no material impact to its consolidated statements of income. At June 30, 2019, right-of-use assets of $1,760,000 were included in other assets, and the related liabilities totaling the same amount were included in accrued interest and other liabilities, in the unaudited consolidated balance sheets.
Effective January 1, 2018, the Corporation adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606). Under the ASU, as modified by subsequent ASUs, revenue is recognized when a customer obtains control of promised services in an amount that reflects the consideration the entity expects to receive in exchange for those services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The Corporation applied the five-step method outlined in the ASU to all revenue streams scoped-in by the ASU and elected the modified retrospective implementation method. Substantially all of the Corporation’s interest income and certain noninterest income were not impacted by the adoption of this ASU because the revenue from those contracts with customers is covered by other guidance in U.S. GAAP. The Corporation’s largest sources of noninterest revenue which are subject to the guidance include Trust and financial management revenue, service charges on deposit accounts and interchange revenue from debit card transactions. Adoption of ASU 2014-09 did not change the timing and pattern of the Corporation’s revenue recognition related to scoped-in noninterest income. Disclosures required by the ASU have been included in Note 12.
In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which permits, but does not require, entities to reclassify tax effects stranded in accumulated other comprehensive income resulting from the Tax Cuts and Jobs Act of 2017 to retained earnings. Companies that elect to reclassify these amounts must reclassify stranded tax effects for all items accounted for in accumulated other comprehensive income. The Corporation elected early adoption and adopted this standard update, effective January 1, 2018. The Corporation’s stranded tax effects were related to valuation of the net deferred tax asset attributable to items of accumulated other comprehensive income (loss), which are unrealized gains (losses) on available-for-sale debt securities and unfunded defined benefit plan obligations. Adoption resulted in a reclassification between two categories of stockholders’ equity at January 1, 2018, with an increase of $325,000 in retained earnings and a decrease in accumulated other comprehensive loss for the same amount (no net change in stockholders’ equity).
| 8 |
Effective January 1, 2018, the Corporation elected early adoption of ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20). This Update shortens the amortization period for certain callable debt securities held at a premium. Discounts will continue to be amortized to maturity. Adoption resulted in a reduction in retained earnings and corresponding increase in accumulated other comprehensive loss (no net change in stockholders’ equity) of $26,000 at January 1, 2018 for the cumulative after-tax impact of the change in accounting for debt securities held as of that date.
Effective January 1, 2018, the Corporation adopted ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities. The guidance affects the accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements of financial instruments. ASU 2016-01 was effective for the Corporation on January 1, 2018 and resulted in the following changes:
| · | A marketable equity security previously included in available-for-sale securities on the consolidated balance sheets is presented as a separate asset. |
| · | Changes in the fair value of the marketable equity security are captured in the consolidated statements of income. |
| · | Retained earnings was reduced and a corresponding increase in accumulated other comprehensive loss was recognized (no net change in stockholders’ equity) of $22,000 at January 1, 2018 for the after-tax impact of the change in accounting for the unrealized loss on the marketable equity security. |
| · | Adoption of ASU 2016-01 also resulted in the use of an exit price to determine the fair value of financial instruments not measured at fair value in the consolidated balance sheets. Further information regarding valuation of financial instruments is provided in Note 13. |
Recently Issued But Not Yet Effective Accounting Pronouncements
ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), as modified by subsequent ASUs, changes accounting for credit losses on loans receivable and debt securities from an incurred loss methodology to an expected credit loss methodology. Among other things, ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Accordingly, ASU 2016-13 requires the use of forward-looking information to form credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, though the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, ASU 2016-13 amends the accounting for credit losses on debt securities and purchased financial assets with credit deterioration. The effect of implementing this ASU is recorded through a cumulative-effect adjustment to retained earnings. The Corporation has formed a cross functional management team and is working with an outside vendor assessing alternative loss estimation methodologies, the Corporation’s data and system needs and the impact of loans acquired in the merger with Monument Bancorp, Inc. (described in more detail in Note 2) to evaluate the impact that adoption of this standard will have on the Corporation’s financial condition and results of operations. The amendments in ASU 2016-13 would be effective for the Corporation beginning in the first quarter 2020. In July 2019, the FASB tentatively decided to delay the required implementation date of ASU 2016-13 for smaller reporting companies. If the decision to delay required implementation is finalized, the Corporation would be required to implement the ASU on January 1, 2023.
ASU 2017-04, Intangibles – Goodwill and Other (Topic 350) simplifies the accounting for goodwill impairment. This guidance, among other things, removes step 2 of the goodwill impairment test thus eliminating the need to determine the fair value of individual assets and liabilities of the reporting unit. Upon adoption of this ASU, goodwill impairment will be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This may result in more or less impairment being recognized than under current guidance. This Update will become effective for the Corporation’s annual and interim goodwill impairment tests beginning in the first quarter 2020. The Corporation does not expect adoption of this ASU to have a material impact on its consolidated financial statements.
| 9 |
ASU 2018-13, Fair Value Measurement (Topic 820) modifies disclosure requirements on fair value measurements. This ASU removes requirements to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels and the valuation processes for Level 3 fair value measurements. ASU 2018-13 clarifies that disclosure regarding measurement uncertainty is intended to communicate information about the uncertainty in measurement as of the reporting date. ASU 2018-13 adds certain disclosure requirements, including disclosure of 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 the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The amendments in this ASU are effective for the Corporation beginning in the first quarter 2020. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty should be applied prospectively, while all other amendments should be applied retrospectively for all periods presented. The Corporation does not expect adoption of this ASU to have a material impact on its consolidated financial position or results of operations.
ASU 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans – General (Subtopic 715-20) modifies the disclosure requirements for defined benefit and other postretirement plans. This ASU eliminates certain disclosures associated with accumulated other comprehensive income, plan assets, related parties, and the effects of interest rate basis point changes on assumed health care costs; while other disclosures have been added to address significant gains and losses related to changes in benefit obligations. This ASU also clarifies disclosure requirements for projected benefit and accumulated benefit obligations. The amendments in this ASU are effective for the Corporation beginning in the first quarter 2021. Adoption on a retrospective basis for all periods presented is required. The Corporation does not expect adoption of this ASU to have a material impact on its consolidated financial statements.
ASU 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40) was issued to help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement (hosting arrangement) by providing guidance for determining when the arrangement includes a software license. The amendments align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments. This guidance will become effective for the Corporation beginning in the first quarter 2020, with early adoption permitted. The Corporation does not expect adoption of this ASU to have a material impact on its consolidated financial statements.
2. BUSINESS COMBINATION - MONUMENT BANCORP, INC.
The Corporation completed its acquisition of 100% of the common stock of Monument Bancorp, Inc. (“Monument”) on April 1, 2019. Monument was the parent company of Monument Bank, a commercial bank which operated two community bank offices and one lending office in Bucks County, Pennsylvania. Pursuant to the merger, Monument was merged into Citizens & Northern Corporation and Monument Bank was merged into C&N Bank. Management believes the acquisition provides an opportunity to leverage the Corporation’s capital and deposits in a higher growth market and aligns with the Corporation’s focus to proactively deploy capital to enhance long-term shareholder value.
The unaudited consolidated financial statements include the formerly separate Monument operations from April 1, 2019 through June 30, 2019. Since the activities of the former Monument operations have been combined with those of the Corporation, separate disclosure of Monument-related financial information included in the unaudited consolidated financial statements is not practicable.
Total purchase consideration was $42,651,000, including cash paid to former Monument shareholders totaling $9,517,000 and 1,279,825 shares of Corporation common stock issued with a value of $32,953,000, (net of costs directly related to stock issuance of $181,000 included in the cash portion of merger consideration transferred in the table below).
The merger was accounted for using the acquisition method of accounting and, accordingly, purchased assets, including identifiable intangible assets, and assumed liabilities were recorded at their respective acquisition date fair values. The fair value measurements of assets acquired and liabilities assumed are subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values become available.
The preliminary fair value of assets acquired, excluding goodwill, totaled $374,922,000, while the preliminary fair value of liabilities assumed totaled $348,947,000. Goodwill represents consideration transferred in excess of the fair value of the net assets acquired. At April 1, 2019, the Corporation recognized preliminary goodwill of $16,676,000 associated with the acquisition. The goodwill resulting from the acquisition represents the value expected from the expansion of the Corporation’s market into Southeastern Pennsylvania. Goodwill acquired in the Monument merger is not deductible for tax purposes as the acquisition is accounted for as a tax-free exchange for tax purposes.
| 10 |
The following table summarizes the consideration paid for Monument and the preliminary estimated fair values of the assets acquired and liabilities assumed at the acquisition date:
| (In Thousands) | ||||
| Fair value of consideration transferred: | ||||
| Cash | $ | 9,698 | ||
| Common stock issued | 32,953 | |||
| Total consideration transferred | $ | 42,651 | ||
| Preliminary estimated fair values of assets acquired and (liabilities) assumed: | ||||
| Cash and cash equivalents | $ | 7,920 | ||
| Available-for-sale debt securities | 94,568 | |||
| Loans receivable | 259,295 | |||
| Accrued interest receivable | 1,593 | |||
| Bank premises and equipment | 1,465 | |||
| Foreclosed assets held for sale | 1,064 | |||
| Deferred tax asset, net | 664 | |||
| Core deposit intangible | 1,461 | |||
| Goodwill | 16,676 | |||
| Other assets | 6,892 | |||
| Deposits | (223,303 | ) | ||
| Short-term borrowings | (111,568 | ) | ||
| Subordinated debt | (12,375 | ) | ||
| Accrued interest and other liabilities | (1,701 | ) | ||
| Estimated excess fair value of assets acquired over liabilities assumed | $ | 42,651 | ||
In the consolidated statements of cash flows, noncash investing and financing activities include the issuance of common stock as part of the merger consideration as well as the following categories of assets acquired and liabilities assumed from Monument as reflected in the table above: available-for-sale debt securities, loans receivable, bank premises and equipment, foreclosed assets held for sale, core deposit intangible, goodwill, Federal Home Loan Bank of Pittsburgh stock of $5,478,000 (included in other assets above), deposits, short-term borrowings and subordinated debt.
Acquisition date fair values for available-for-sale securities were determined using Level 1 inputs consistent with the methods discussed further in Note 13. The Corporation sold the acquired securities in April 2019 for approximately no realized gain or loss.
The determination of estimated fair values of the acquired loans required the Corporation to make certain estimates about discount rates, future expected cash flows, market conditions and other future events that are highly subjective in nature. Based on such factors as past due status, nonaccrual status, bankruptcy status, and credit risk ratings, the acquired loans were evaluated, and four loans (from three relationships) displayed evidence of credit quality deterioration. These loans are accounted for under ASC 310-30 (purchased credit impaired, or “PCI”). The majority of the purchased loans did not display evidence of impairment, and thus are accounted for under ASC 310-20. Expected cash flows, both principal and interest, were estimated based on key assumptions covering such factors as prepayments, default rates and severity of loss given default. These assumptions were developed using both Monument’s historical experience and the portfolio characteristics as of the acquisition date as well as available market research. The fair value estimates for acquired loans were based on the amount and timing of expected principal, interest and other cash flows, including expected prepayments, discounted at prevailing market interest rates applicable to the types of acquired loans, which the Corporation considers Level 3 fair value measurements.
| 11 |
Loans acquired from Monument were measured at fair value at the acquisition date with no carryover of an allowance for loan losses. The following table presents performing and PCI loans acquired, by loan segment and class, at April 1, 2019:
| (In Thousands) | ||||||||||||
| Performing | PCI | Total | ||||||||||
| Residential mortgage: | ||||||||||||
| Residential mortgage loans - first liens | $ | 107,645 | $ | 77 | $ | 107,722 | ||||||
| Residential mortgage loans - junior liens | 2,433 | 0 | 2,433 | |||||||||
| Home equity lines of credit | 2,674 | 0 | 2,674 | |||||||||
| 1-4 Family residential construction | 510 | 0 | 510 | |||||||||
| Total residential mortgage | 113,262 | 77 | 113,339 | |||||||||
| Commercial: | ||||||||||||
| Commercial loans secured by real estate | 113,821 | 364 | 114,185 | |||||||||
| Commercial and industrial | 7,571 | 0 | 7,571 | |||||||||
| Commercial construction and land | 4,617 | 0 | 4,617 | |||||||||
| Loans secured by farmland | 267 | 0 | 267 | |||||||||
| Multi-family (5 or more) residential | 17,493 | 0 | 17,493 | |||||||||
| Other commercial loans | 835 | 0 | 835 | |||||||||
| Total commercial | 144,604 | 364 | 144,968 | |||||||||
| Consumer | 988 | 0 | 988 | |||||||||
| Total | $ | 258,854 | $ | 441 | $ | 259,295 | ||||||
The following table presents the preliminary fair value adjustments made to the amortized cost basis of loans acquired at April 1, 2019:
| (In Thousands) | ||||||||||||
| Gross amortized cost at acquisition | $ | 263,334 | ||||||||||
| Market rate adjustment | (1,807 | ) | ||||||||||
| Credit fair value adjustment on non-credit impaired loans | (1,914 | ) | ||||||||||
| Credit fair value adjustment on impaired loans | (318 | ) | ||||||||||
| Estimated fair value of acquired loans | $ | 259,295 | ||||||||||
The market rate adjustment represents the movement in interest rates, irrespective of credit adjustments, compared to the contractual rates of the acquired loans. The credit adjustment made on non-PCI loans represents changes in credit quality of the underlying borrowers from loan inception to the acquisition date.
The credit adjustment on PCI loans is derived in accordance with ASC 310-30 and represents the portion of the loan balances that have been deemed uncollectible for each loan. The PCI loans are secured by real estate and the fair value of each loan was determined based on the estimated proceeds to be derived from selling the collateral, net of selling costs. The PCI loans were placed into nonaccrual status upon acquisition (and remained in nonaccrual status at June 30, 2019) as the Corporation cannot reasonably estimate cash flows expected to be collected in order to compute yield on the loans.
The Corporation recognized a core deposit intangible of $1,461,000. The core deposit intangible represents the estimated value of lower-cost funding provided by the nonmaturity deposits assumed in comparison with the Corporation’s estimated cost of borrowing funds in the market. The core deposit intangible will be amortized over a weighted-average life of 4.4 years.
Deposit liabilities assumed were segregated into two categories: (1) nonmaturity deposits (checking, savings and money market), and (2) time deposits (deposit accounts with a stated maturity). The fair values of both categories of deposits were determined using level 2 fair value measurements. For nonmaturity deposits, the acquisition date outstanding balance of the assumed demand deposit accounts approximates fair value. In determining the fair value of time deposits, the Corporation discounted the contractual cash flows of the deposit accounts using prevailing market interest rates for time deposit accounts of similar type and duration.
| 12 |
Short-term borrowings assumed consisted of advances from the Federal Home Loan Bank of Pittsburgh. The fair value of short-term borrowings was determined using Level 2 measurements by discounting the contractual cash flows of the borrowings using Federal Home Loan Bank interest rates available April 1, 2019 for advances to the same maturities as those of the deposits assumed.
Subordinated debt assumed included two issues: (1) agreements with par values totaling $5,375,000 which were redeemed on April 1, 2019; and (2) agreements with par values totaling $7,000,000, maturing April 1, 2027 and which may be redeemed at par beginning April 1, 2022. The fair value of subordinated debt was determined using Level 2 measurements by comparing the interest rates on the debt to the rates on similar recent issues of comparable size by other similar-sized banking companies.
The Corporation incurred merger-related expenses of $3,301,000 in the second quarter 2019. For the six months ended June 30, 2019, merger-related expenses totaled $3,612,000. Merger-related expenses include costs associated with termination of data processing contracts, conversion of Monument’s customer accounting data into the Corporation’s core system, severance and similar expenses, legal and other professional fees and various other costs.
The following table presents pro forma information as if the merger between the Corporation and Monument had been completed on January 1, 2018. The pro forma information does not necessarily reflect the results of operations that would have occurred had the merger taken place at the beginning of 2018. The supplemental pro forma information excludes merger-related expenses totaling $3,301,000 in the second quarter 2019, or $2,628,000 net of tax. Similarly, the pro forma information excludes merger-related expenses totaling $4,078,000 in the six months ended June 30, 2019 (including $466,000 incurred by Monument), or $3,270,000 net of tax. The pro forma information does not include the impact of possible business model changes nor does it consider any potential impacts of current market conditions or revenues, expense efficiencies or other factors.
| (In Thousands Except Per Share Data) | 3 Months Ended | 6 Months Ended | ||||||||||||||
(Unaudited) | June 30, | June 30, | June 30, | June 30, | ||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Interest income | $ | 17,012 | $ | 16,511 | $ | 34,466 | $ | 32,053 | ||||||||
| Interest expense | 2,730 | 2,511 | 5,861 | 4,764 | ||||||||||||
| Net interest income | 14,282 | 14,000 | 28,605 | 27,289 | ||||||||||||
| (Credit) provision for loan losses | (4 | ) | (10 | ) | (916 | ) | 277 | |||||||||
| Net interest income after (credit) provision for loan losses | 14,286 | 14,010 | 29,521 | 27,012 | ||||||||||||
| Noninterest income | 4,849 | 4,739 | 9,271 | 9,172 | ||||||||||||
| Net gains on securities | 7 | 1,468 | 7 | 2,198 | ||||||||||||
| Other noninterest expenses | 11,464 | 11,524 | 23,883 | 23,092 | ||||||||||||
| Income before income tax provision | 7,678 | 8,693 | 14,916 | 15,290 | ||||||||||||
| Income tax provision | 1,373 | 1,573 | 2,600 | 2,613 | ||||||||||||
| Net income | $ | 6,305 | $ | 7,120 | $ | 12,316 | $ | 12,677 | ||||||||
| Earnings per common share - basic | $ | 0.46 | $ | 0.53 | $ | 0.90 | $ | 0.94 | ||||||||
| Earnings per common share - diluted | $ | 0.46 | $ | 0.52 | $ | 0.90 | $ | 0.93 | ||||||||
| 13 |
3. PER SHARE DATA
Basic earnings per common share are calculated using the two-class method to determine income attributable to common shareholders. Unvested restricted stock awards that contain nonforfeitable rights to dividends are considered participating securities under the two-class method. Distributed dividends and an allocation of undistributed net income to participating securities reduce the amount of income attributable to common shareholders. Income attributable to common shareholders is then divided by weighted-average common shares outstanding for the period to determine basic earnings per common share.
Diluted earnings per common share are calculated under the more dilutive of either the treasury method or the two-class method. Diluted earnings per common share is computed using weighted-average common shares outstanding, plus weighted-average common shares available from the exercise of all dilutive stock options, less the number of shares that could be repurchased with the proceeds of stock option exercises based on the average share price of the Corporation's common stock during the period.
(In Thousands, Except Share and Per Share Data)
| 3 Months Ended | 6 Months Ended | |||||||||||||||
| June 30, | June 30, | June 30, | June 30, | |||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Basic | ||||||||||||||||
| Net income | $ | 3,649,000 | $ | 6,371,000 | $ | 8,739,000 | $ | 10,746,000 | ||||||||
| Less: Dividends and undistributed earnings allocated to participating securities | (19,000 | ) | (32,000 | ) | (46,000 | ) | (55,000 | ) | ||||||||
| Net income attributable to common shares | $ | 3,630,000 | $ | 6,339,000 | $ | 8,693,000 | $ | 10,691,000 | ||||||||
| Basic weighted-average common shares outstanding | 13,597,848 | 12,210,902 | 12,956,916 | 12,200,245 | ||||||||||||
| Basic earnings per common share (a) | $ | 0.27 | $ | 0.52 | $ | 0.67 | $ | 0.88 | ||||||||
| Diluted | ||||||||||||||||
| Net income attributable to common shares | $ | 3,630,000 | $ | 6,339,000 | $ | 8,693,000 | $ | 10,691,000 | ||||||||
| Basic weighted-average common shares outstanding | 13,597,848 | 12,210,902 | 12,956,916 | 12,200,245 | ||||||||||||
| Dilutive effect of potential common stock arising from stock options | 25,106 | 37,243 | 25,445 | 36,273 | ||||||||||||
| Diluted weighted-average common shares outstanding | 13,622,954 | 12,248,145 | 12,982,361 | 12,236,518 | ||||||||||||
| Diluted earnings per common share (a) | $ | 0.27 | $ | 0.52 | $ | 0.67 | $ | 0.87 | ||||||||
| Weighted-average nonvested restricted shares outstanding | 70,366 | 61,172 | 68,016 | 63,175 | ||||||||||||
(a) Basic and diluted earnings per share under the two-class method are determined on net income reported on the consolidated statements of income, less earnings allocated to non-vested restricted shares with nonforfeitable dividends (participating securities).
Anti-dilutive stock options are excluded from net income per share calculations. There were no anti-dilutive instruments in the three-month or six-month periods ended June 30, 2019 and 2018.
| 14 |
4. COMPREHENSIVE INCOME
Comprehensive income is the total of (1) net income, and (2) all other changes in equity from non-stockholder sources, which are referred to as other comprehensive income (loss). The components of other comprehensive income (loss), and the related tax effects, are as follows:
| (In Thousands) | Before-Tax | Income Tax | Net-of-Tax | |||||||||
| Amount | Effect | Amount | ||||||||||
| Six Months Ended June 30, 2019 | ||||||||||||
| Unrealized gains on available-for-sale debt securities: | ||||||||||||
| Unrealized holding gains on available-for-sale securities | $ | 9,431 | $ | (1,980 | ) | $ | 7,451 | |||||
| Reclassification adjustment for (gains) realized in income | (7 | ) | 1 | (6 | ) | |||||||
| Other comprehensive income on available-for-sale debt securities | 9,424 | (1,979 | ) | 7,445 | ||||||||
| Unfunded pension and postretirement obligations: | ||||||||||||
| Changes from plan amendments and actuarial gains and losses included in other comprehensive income | 214 | (45 | ) | 169 | ||||||||
| Amortization of prior service cost and net actuarial loss included in net periodic benefit cost | (15 | ) | 3 | (12 | ) | |||||||
| Other comprehensive income on unfunded retirement obligations | 199 | (42 | ) | 157 | ||||||||
| Total other comprehensive income | $ | 9,623 | $ | (2,021 | ) | $ | 7,602 | |||||
| (In Thousands) | Before-Tax | Income Tax | Net-of-Tax | |||||||||
| Amount | Effect | Amount | ||||||||||
| Six Months Ended June 30, 2018 | ||||||||||||
| Unrealized losses on available-for-sale debt securities: | ||||||||||||
| Unrealized holding losses on available-for-sale securities | $ | (6,131 | ) | $ | 1,287 | $ | (4,844 | ) | ||||
| Reclassification adjustment for losses realized in income | 282 | (59 | ) | 223 | ||||||||
| Other comprehensive loss on available-for-sale debt securities | (5,849 | ) | 1,228 | (4,621 | ) | |||||||
| Unfunded pension and postretirement obligations: | ||||||||||||
| Changes from plan amendments and actuarial gains and losses included in other comprehensive income | 93 | (19 | ) | 74 | ||||||||
| Amortization of prior service cost and net actuarial loss included in net periodic benefit cost | (10 | ) | 2 | (8 | ) | |||||||
| Other comprehensive income on unfunded retirement obligations | 83 | (17 | ) | 66 | ||||||||
| Total other comprehensive loss | $ | (5,766 | ) | $ | 1,211 | $ | (4,555 | ) | ||||
| 15 |
| (In Thousands) | Before-Tax | Income Tax | Net-of-Tax | |||||||||
| Amount | Effect | Amount | ||||||||||
| Three Months Ended June 30, 2019 | ||||||||||||
| Unrealized gains on available-for-sale debt securities: | ||||||||||||
| Unrealized holding gains on available-for-sale debt securities | $ | 5,170 | $ | (1,085 | ) | $ | 4,085 | |||||
| Reclassification adjustment for (gains) realized in income | (7 | ) | 1 | (6 | ) | |||||||
| Other comprehensive income on available-for-sale debt securities | 5,163 | (1,084 | ) | 4,079 | ||||||||
| Unfunded pension and postretirement obligations: | ||||||||||||
| Changes from plan amendments and actuarial gains and losses included in other comprehensive income | 0 | 0 | 0 | |||||||||
| Amortization of prior service cost and net actuarial loss included in net periodic benefit cost | (7 | ) | 1 | (6 | ) | |||||||
| Other comprehensive loss on unfunded retirement obligations | (7 | ) | 1 | (6 | ) | |||||||
| Total other comprehensive income | $ | 5,156 | $ | (1,083 | ) | $ | 4,073 | |||||
| (In Thousands) | Before-Tax | Income Tax | Net-of-Tax | |||||||||
| Amount | Effect | Amount | ||||||||||
| Three Months Ended June 30, 2018 | ||||||||||||
| Unrealized losses on available-for-sale debt securities: | ||||||||||||
| Unrealized holding losses on available-for-sale debt securities | $ | (1,292 | ) | $ | 272 | $ | (1,020 | ) | ||||
| Reclassification adjustment for losses realized in income | 282 | (59 | ) | 223 | ||||||||
| Other comprehensive loss on available-for-sale debt securities | (1,010 | ) | 213 | (797 | ) | |||||||
| Unfunded pension and postretirement obligations: | ||||||||||||
| Changes from plan amendments and actuarial gains and losses included in other comprehensive income | 0 | 0 | 0 | |||||||||
| Amortization of prior service cost and net actuarial loss included in net periodic benefit cost | (5 | ) | 1 | (4 | ) | |||||||
| Other comprehensive loss on unfunded retirement obligations | (5 | ) | 1 | (4 | ) | |||||||
| Total other comprehensive loss | $ | (1,015 | ) | $ | 214 | $ | (801 | ) | ||||
| 16 |
Changes in the components of accumulated other comprehensive income (loss) are as follows and are presented net of tax:
| (In Thousands) | Unrealized | Accumulated | ||||||||||
| Gains | Unfunded | Other | ||||||||||
| (Losses) | Retirement | Comprehensive | ||||||||||
| on Securities | Obligations | Income (Loss) | ||||||||||
| Six Months Ended June 30, 2019 | ||||||||||||
| Balance, beginning of period | $ | (4,307 | ) | $ | 137 | $ | (4,170 | ) | ||||
| Other comprehensive income during six months ended June 30, 2019 | 7,445 | 157 | 7,602 | |||||||||
| Balance, end of period | $ | 3,138 | $ | 294 | $ | 3,432 | ||||||
| Six Months Ended June 30, 2018 | ||||||||||||
| Balance, beginning of period | $ | (1,566 | ) | $ | 59 | $ | (1,507 | ) | ||||
| Impact of change in enacted income tax rate | (337 | ) | 12 | (325 | ) | |||||||
| Impact of change in the method of premium amortization of callable debt securities | 26 | 0 | 26 | |||||||||
| Impact of change in the method of accounting for marketable equity security | 22 | 0 | 22 | |||||||||
| Other comprehensive (loss) income during six months ended June 30, 2018 | (4,621 | ) | 66 | (4,555 | ) | |||||||
| Balance, end of period | $ | (6,476 | ) | $ | 137 | $ | (6,339 | ) | ||||
| Three Months Ended June 30, 2019 | ||||||||||||
| Balance, beginning of period | $ | (941 | ) | $ | 300 | $ | (641 | ) | ||||
| Other comprehensive income (loss) during three months ended June 30, 2019 | 4,079 | (6 | ) | 4,073 | ||||||||
| Balance, end of period | $ | 3,138 | $ | 294 | $ | 3,432 | ||||||
| Three Months Ended June 30, 2018 | ||||||||||||
| Balance, beginning of period | $ | (5,679 | ) | $ | 141 | $ | (5,538 | ) | ||||
| Other comprehensive (loss) during three months ended June 30, 2018 | (797 | ) | (4 | ) | (801 | ) | ||||||
| Balance, end of period | $ | (6,476 | ) | $ | 137 | $ | (6,339 | ) | ||||
Items reclassified out of each component of other comprehensive income (loss) are as follows:
| For the Six Months Ended June 30, 2019 | ||||||
| (In Thousands) | Reclassified from | |||||
| Accumulated Other | ||||||
| Details about Accumulated Other | Comprehensive | Affected Line Item in the Consolidated | ||||
| Comprehensive Income (Loss) Components | Income (Loss) | Statements of Income | ||||
| Unrealized gains and losses on available-for-sale debt securities | $ | (7 | ) | Realized gains on available-for-sale debt securities, net | ||
| 1 | Income tax provision | |||||
| (6 | ) | Net of tax | ||||
| Amortization of defined benefit pension and postretirement items: | ||||||
| Prior service cost | (15 | ) | Other noninterest expense | |||
| 3 | Income tax provision | |||||
| (12 | ) | Net of tax | ||||
| Total reclassifications for the period | $ | (18 | ) | |||
| 17 |
| For the Six Months Ended June 30, 2018 | ||||||
| (In Thousands) | ||||||
| Reclassified from | ||||||
| Accumulated Other | ||||||
| Details about Accumulated Other | Comprehensive | Affected Line Item in the Consolidated | ||||
| Comprehensive Income (Loss) Components | Income (Loss) | Statements of Income | ||||
| Unrealized gains and losses on available-for-sale debt securities | $ | 282 | Realized losses on available-for-sale debt securities, net | |||
| (59 | ) | Income tax provision | ||||
| 223 | Net of tax | |||||
| Amortization of defined benefit pension and postretirement items: | ||||||
| Prior service cost | (16 | ) | Other noninterest expense | |||
| Actuarial loss | 6 | Other noninterest expense | ||||
| (10 | ) | Total before tax | ||||
| 2 | Income tax provision | |||||
| (8 | ) | Net of tax | ||||
| Total reclassifications for the period | $ | 215 | ||||
For the Three Months Ended June 30, 2019 | ||||||
| (In Thousands) | ||||||
| Reclassified from | ||||||
| Accumulated Other | ||||||
| Details about Accumulated Other | Comprehensive | Affected Line Item in the Consolidated | ||||
| Comprehensive Income (Loss) Components | Income (Loss) | Statements of Income | ||||
| Unrealized gains and losses on available-for-sale debt securities | $ | (7 | ) | Realized gains on available-for-sale debt securities, net | ||
| 1 | Income tax provision | |||||
| (6 | ) | Net of tax | ||||
| Amortization of defined benefit pension and postretirement items: | ||||||
| Prior service cost | (7 | ) | Other noninterest expense | |||
| 1 | Income tax provision | |||||
| (6 | ) | Net of tax | ||||
| Total reclassifications for the period | $ | (12 | ) | |||
| For the Three Months Ended June 30, 2018 | ||||||
| (In Thousands) | ||||||
| Reclassified from | ||||||
| Accumulated Other | ||||||
| Details about Accumulated Other | Comprehensive | Affected Line Item in the Consolidated | ||||
| Comprehensive Income (Loss) Components | Income (Loss) | Statements of Income | ||||
| Unrealized gains and losses on available-for-sale debt securities | $ | 282 | Realized losses on available-for-sale debt securities, net | |||
| (59 | ) | Income tax provision | ||||
| 223 | Net of tax | |||||
| Amortization of defined benefit pension and postretirement items: | ||||||
| Prior service cost | (8 | ) | Other noninterest expense | |||
| Actuarial loss | 3 | Other noninterest expense | ||||
| (5 | ) | Total before tax | ||||
| 1 | Income tax provision | |||||
| (4 | ) | Net of tax | ||||
| Total reclassifications for the period | $ | 219 | ||||
5. CASH AND DUE FROM BANKS
Cash and due from banks at June 30, 2019 and December 31, 2018 include the following:
| (In thousands) | June 30, | Dec. 31, | ||||||
| 2019 | 2018 | |||||||
| Cash and cash equivalents | $ | 34,945 | $ | 32,827 | ||||
| Certificates of deposit | 4,560 | 4,660 | ||||||
| Total cash and due from banks | $ | 39,505 | $ | 37,487 | ||||
Certificates of deposit are issues by U.S. banks with original maturities greater than three months. Each certificate of deposit is fully FDIC-insured. The Corporation maintains cash and cash equivalents with certain financial institutions in excess of the FDIC insurance limit.
| 18 |
The Corporation is required to maintain reserves against deposit liabilities in the form of cash and balances with the Federal Reserve Bank of Philadelphia. The reserves are based on deposit levels, account activity, and other services provided by the Federal Reserve Bank. Required reserves were $17,335,000 at June 30, 2019 and $18,141,000 at December 31, 2018.
6. SECURITIES
Amortized cost and fair value of available-for-sale debt securities at June 30, 2019 and December 31, 2018 are summarized as follows:
| June 30, 2019 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Unrealized | Unrealized | |||||||||||||||
| Amortized | Holding | Holding | Fair | |||||||||||||
| (In Thousands) | Cost | Gains | Losses | Value | ||||||||||||
| Obligations of U.S. Government agencies | $ | 16,918 | $ | 652 | $ | 0 | $ | 17,570 | ||||||||
| Obligations of states and political subdivisions: | ||||||||||||||||
| Tax-exempt | 73,897 | 1,676 | (74 | ) | 75,499 | |||||||||||
| Taxable | 30,591 | 927 | (9 | ) | 31,509 | |||||||||||
| Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies: | ||||||||||||||||
| Residential pass-through securities | 55,098 | 365 | (322 | ) | 55,141 | |||||||||||
| Residential collateralized mortgage obligations | 139,513 | 610 | (639 | ) | 139,484 | |||||||||||
| Commercial mortgage-backed securities | 43,476 | 1,020 | (234 | ) | 44,262 | |||||||||||
| Total available-for-sale debt securities | $ | 359,493 | $ | 5,250 | $ | (1,278 | ) | $ | 363,465 | |||||||
| December 31, 2018 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Unrealized | Unrealized | |||||||||||||||
| Amortized | Holding | Holding | Fair | |||||||||||||
| (In Thousands) | Cost | Gains | Losses | Value | ||||||||||||
| Obligations of U.S. Government agencies | $ | 12,331 | $ | 169 | $ | 0 | $ | 12,500 | ||||||||
| Obligations of states and political subdivisions: | ||||||||||||||||
| Tax-exempt | 84,204 | 949 | (1,201 | ) | 83,952 | |||||||||||
| Taxable | 27,618 | 208 | (127 | ) | 27,699 | |||||||||||
| Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies: | ||||||||||||||||
| Residential pass-through securities | 54,827 | 48 | (1,430 | ) | 53,445 | |||||||||||
| Residential collateralized mortgage obligations | 148,964 | 238 | (3,290 | ) | 145,912 | |||||||||||
| Commercial mortgage-backed securities | 40,781 | 166 | (1,182 | ) | 39,765 | |||||||||||
| Total available-for-sale debt securities | $ | 368,725 | $ | 1,778 | $ | (7,230 | ) | $ | 363,273 | |||||||
| 19 |
The following table presents gross unrealized losses and fair value of available-for-sale debt securities with unrealized loss positions that are not deemed to be other-than-temporarily impaired, aggregated by length of time that individual securities have been in a continuous unrealized loss position at June 30, 2019 and December 31, 2018:
| June 30, 2019 | Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
| (In Thousands) | Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | ||||||||||||||||||
| Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
| Obligations of states and political subdivisions: | ||||||||||||||||||||||||
| Tax-exempt | $ | 0 | $ | 0 | $ | 10,872 | $ | (74 | ) | $ | 10,872 | $ | (74 | ) | ||||||||||
| Taxable | 0 | 0 | 3,790 | (9 | ) | 3,790 | (9 | ) | ||||||||||||||||
| Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies: | ||||||||||||||||||||||||
| Residential pass-through securities | 0 | 0 | 35,572 | (322 | ) | 35,572 | (322 | ) | ||||||||||||||||
| Residential collateralized mortgage obligations | 0 | 0 | 56,230 | (639 | ) | 56,230 | (639 | ) | ||||||||||||||||
| Commercial mortgage-backed securities | 0 | 0 | 9,098 | (234 | ) | 9,098 | (234 | ) | ||||||||||||||||
| Total temporarily impaired available-for-sale debt securities | $ | 0 | $ | 0 | $ | 115,562 | $ | (1,278 | ) | $ | 115,562 | $ | (1,278 | ) | ||||||||||
| December 31, 2018 | Less Than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
| (In Thousands) | Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | ||||||||||||||||||
| Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
| Obligations of states and political subdivisions: | ||||||||||||||||||||||||
| Tax-exempt | $ | 5,084 | $ | (11 | ) | $ | 32,684 | $ | (1,190 | ) | $ | 37,768 | $ | (1,201 | ) | |||||||||
| Taxable | 980 | (2 | ) | 11,418 | (125 | ) | 12,398 | (127 | ) | |||||||||||||||
| Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies: | ||||||||||||||||||||||||
| Residential pass-through securities | 5,592 | (4 | ) | 42,309 | (1,426 | ) | 47,901 | (1,430 | ) | |||||||||||||||
| Residential collateralized mortgage obligations | 1,892 | (8 | ) | 101,662 | (3,282 | ) | 103,554 | (3,290 | ) | |||||||||||||||
| Commercial mortgage-backed securities | 0 | 0 | 32,552 | (1,182 | ) | 32,552 | (1,182 | ) | ||||||||||||||||
| Total temporarily impaired available-for-sale debt securities | $ | 13,548 | $ | (25 | ) | $ | 220,625 | $ | (7,205 | ) | $ | 234,173 | $ | (7,230 | ) | |||||||||
Gross realized gains and losses from available-for-sale securities were as follows:
| (In Thousands) | 3 Months Ended | 6 Months Ended | ||||||||||||||
| June 30, | June 30, | June 30, | June 30, | |||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Gross realized gains from sales | $ | 7 | $ | 0 | $ | 7 | $ | 0 | ||||||||
| Losses from other-than-temporary impairment | 0 | (282 | ) | 0 | (282 | ) | ||||||||||
| Net realized gains (losses) | $ | 7 | $ | (282 | ) | $ | 7 | $ | (282 | ) | ||||||
| 20 |
The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of June 30, 2019. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.
| Amortized | Fair | |||||||
| (In Thousands) | Cost | Value | ||||||
| Due in one year or less | $ | 11,329 | $ | 11,372 | ||||
| Due from one year through five years | 37,122 | 37,822 | ||||||
| Due from five years through ten years | 42,498 | 43,451 | ||||||
| Due after ten years | 30,457 | 31,933 | ||||||
| Sub-total | 121,406 | 124,578 | ||||||
| Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies: | ||||||||
| Residential pass-through securities | 55,098 | 55,141 | ||||||
| Residential collateralized mortgage obligations | 139,513 | 139,484 | ||||||
| Commercial mortgage-backed securities | 43,476 | 44,262 | ||||||
| Total | $ | 359,493 | $ | 363,465 | ||||
The Corporation’s mortgage-backed securities and collateralized mortgage obligations have stated maturities that may differ from actual maturities due to borrowers’ ability to prepay obligations. Cash flows from such investments are dependent upon the performance of the underlying mortgage loans and are generally influenced by the level of interest rates. In the table above, mortgage-backed securities and collateralized mortgage obligations are shown in one period.
Investment securities carried at $211,400,000 at June 30, 2019 and $229,418,000 at December 31, 2018 were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. See Note 9 for information concerning securities pledged to secure borrowing arrangements.
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 evaluation. Consideration is given to (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, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery.
A summary of information management considered in evaluating debt and equity securities for other-than-temporary impairment (“OTTI”) at June 30, 2019 is provided below.
Debt Securities
At June 30, 2019 and December 31, 2018, management performed an assessment for possible OTTI of the Corporation’s debt securities on an issue-by-issue basis, relying on information obtained from various sources, including publicly available financial data, ratings by external agencies, brokers and other sources. The extent of individual analysis applied to each security depended on the size of the Corporation’s investment, as well as management’s perception of the credit risk associated with each security. Based on the results of the assessment, management believes impairment of debt securities at June 30, 2019 and December 31, 2018 to be temporary.
In the second quarter 2018, the Corporation recorded a pre-tax impairment loss on available-for-sale debt securities of $282,000. The loss represents the unrealized loss at June 30, 2018 on securities that were sold in July 2018. The securities sold included obligations of U.S. Government agencies and states and political subdivisions. The realized losses on the sales totaled $329,000, including $282,000 recorded in the second quarter 2018. Proceeds from the sales totaling $17,858,000 were reinvested in residential collateralized mortgage obligations.
Equity Securities
The Corporation’s marketable equity security, with a carrying value of $976,000 at June 30, 2019 and $950,000 at December 31, 2018, consisted exclusively of one mutual fund. There was an unrealized loss on the mutual fund of $24,000 at June 30, 2019 and $50,000 at December 31, 2018. There was a decrease in the unrealized loss of $14,000 in the second quarter 2019 and an increase in the unrealized loss of $8,000 in the second quarter 2018. There was a decrease in the unrealized loss of $26,000 in the six months ended June 30,2019 and an increase of $23,000 in the unrealized loss in the six months ended June 30, 2018. Changes in the unrealized losses on this security are included in other noninterest income in the consolidated statements of income.
| 21 |
C&N Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 11 regional Federal Home Loan Banks. As a member, C&N Bank is required to purchase and maintain stock in FHLB-Pittsburgh. There is no active market for FHLB-Pittsburgh stock, and it must ordinarily be redeemed by FHLB-Pittsburgh in order to be liquidated. C&N Bank’s investment in FHLB-Pittsburgh stock, included in Other Assets in the consolidated balance sheet, was $7,485,000 at June 30, 2019 and $5,582,000 at December 31, 2018. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at June 30, 2019 and December 31, 2018. In making this determination, management concluded that recovery of total outstanding par value, which equals the carrying value, is expected. The decision was based on review of financial information that FHLB-Pittsburgh has made publicly available.
In the second quarter 2018, the Corporation recorded a pre-tax gain on a restricted equity security (Visa Class B stock) of $1,750,000. The Corporation had received 19,789 shares of Visa Class B stock pursuant to Visa’s 2007 initial public offering. Until the second quarter 2018, the carrying value of the shares was $0, which represented the Corporation’s cost basis. Class B shares are subject to restrictions on transfer, essentially limiting their transferability to other owners of Class B shares. In June 2018, the Corporation sold 10,000 of the shares for a price of $88.43 per share in a transaction that settled in July 2018. As required by ”U.S. GAAP”, companies must consider the pricing of observable transactions in determining the carrying value of equity securities that do not have readily determinable fair values. Accordingly, the Corporation’s second quarter 2018 gain was based on the price per share of the sale initiated in June 2018, applied to the total of 19,789 shares. In the third quarter 2018, the Corporation sold the remaining 9,789 shares for $1,437,000, recognizing an additional gain of $571,000.
A summary of the realized and unrealized gains and losses recognized on equity securities is as follows:
| (In Thousands) | ||||||||||||||||
| 3 Months Ended | 6 Months Ended | |||||||||||||||
| June 30, | June 30, | June 30, | June 30, | |||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Net gains recognized during the period on equity securities | $ | 14 | $ | 1,742 | $ | 26 | $ | 1,727 | ||||||||
| Less: net gains recognized during the period on equity securities sold during the period | 0 | (884 | ) | 0 | (884 | ) | ||||||||||
| Unrealized gains recognized during the period on equity securities still held at the reporting date | $ | 14 | $ | 858 | $ | 26 | $ | 843 | ||||||||
| 22 |
7. LOANS
The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans. Loans outstanding at June 30, 2019 and December 31, 2018 are summarized by segment, and by classes within each segment, as follows:
| Summary of Loans by Type | ||||||||
| (In Thousands) | June 30, | Dec. 31, | ||||||
| 2019 | 2018 | |||||||
| Residential mortgage: | ||||||||
| Residential mortgage loans - first liens | $ | 484,479 | $ | 372,339 | ||||
| Residential mortgage loans - junior liens | 28,880 | 25,450 | ||||||
| Home equity lines of credit | 35,224 | 34,319 | ||||||
| 1-4 Family residential construction | 27,994 | 24,698 | ||||||
| Total residential mortgage | 576,577 | 456,806 | ||||||
| Commercial: | ||||||||
| Commercial loans secured by real estate | 279,267 | 162,611 | ||||||
| Commercial and industrial | 115,264 | 91,856 | ||||||
| Political subdivisions | 52,308 | 53,263 | ||||||
| Commercial construction and land | 21,197 | 11,962 | ||||||
| Loans secured by farmland | 7,251 | 7,146 | ||||||
| Multi-family (5 or more) residential | 26,749 | 7,180 | ||||||
| Agricultural loans | 5,234 | 5,659 | ||||||
| Other commercial loans | 13,037 | 13,950 | ||||||
| Total commercial | 520,307 | 353,627 | ||||||
| Consumer | 19,799 | 17,130 | ||||||
| Total | 1,116,683 | 827,563 | ||||||
| Less: allowance for loan losses | (8,200 | ) | (9,309 | ) | ||||
| Loans, net | $ | 1,108,483 | $ | 818,254 | ||||
In the table above, outstanding loan balances are presented net of deferred loan origination fees of $2,063,000 at June 30, 2019 and $1,999,000 at December 31, 2018.
As described in Note 2, effective April 1, 2019, the Corporation acquired loans pursuant to the acquisition of Monument. The loans acquired from Monument were recorded at an initial fair value of $259,295,000. As described in Note 2, the gross amortized cost of loans acquired from Monument on April 1, 2019 was reduced $1,807,000 based on movements in interest rates (market rate adjustment) and was also reduced $1,914,000 based on a credit fair value adjustment on non-impaired loans and by $318,000 based on a credit fair value adjustment on impaired loans. In the second quarter 2019, accretion was recognized (included in Interest and fees on loans in the consolidated statements of income) on the market rate adjustment of $149,000 and on the credit fair value adjustment on non-impaired loans of $261,000, and income of $3,000 was recognized from recovery of principal on purchased credit impaired loans. At June 30, 2019, the outstanding loan balances in the table above are presented net of the unaccreted market rate adjustment of $1,658,000, the unaccreted credit fair value adjustment of $1,653,000 and the credit fair value adjustment on impaired loans of $315,000.
The Corporation grants loans to individuals as well as commercial and tax-exempt entities. Commercial, residential and personal loans are made to customers geographically concentrated in northcentral Pennsylvania, the southern tier of New York State and southeastern Pennsylvania. Although the Corporation has a diversified loan portfolio, a significant portion of its debtors’ ability to honor their contracts is dependent on the local economic conditions within the region. There is no concentration of loans to borrowers engaged in similar businesses or activities that exceed 10% of total loans at either June 30, 2019 or December 31, 2018.
The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance 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, 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 that may be susceptible to significant revision as more information becomes available. In the process of evaluating the loan portfolio, management also considers the Corporation’s exposure to losses from unfunded loan commitments. As of June 30, 2019 and December 31, 2018, management determined that no allowance for credit losses related to unfunded loan commitments was required.
| 23 |
Transactions within the allowance for loan losses, summarized by segment and class, for the three-month periods and six-month periods ended June 30, 2019 and 2018 were as follows:
| Three Months Ended June 30, 2019 | March 31, | June 30, | ||||||||||||||||||
| (In Thousands) | 2019 Balance | Charge-offs | Recoveries | Provision (Credit) | 2019 Balance | |||||||||||||||
| Allowance for Loan Losses: | ||||||||||||||||||||
| Residential mortgage: | ||||||||||||||||||||
| Residential mortgage loans - first liens | $ | 3,178 | $ | (33 | ) | $ | 1 | $ | (16 | ) | $ | 3,130 | ||||||||
| Residential mortgage loans - junior liens | 329 | 0 | 0 | 4 | 333 | |||||||||||||||
| Home equity lines of credit | 286 | 0 | 1 | (7 | ) | 280 | ||||||||||||||
| 1-4 Family residential construction | 198 | 0 | 0 | 22 | 220 | |||||||||||||||
| Total residential mortgage | 3,991 | (33 | ) | 2 | 3 | 3,963 | ||||||||||||||
| Commercial: | ||||||||||||||||||||
| Commercial loans secured by real estate | 1,887 | 0 | 0 | (310 | ) | 1,577 | ||||||||||||||
| Commercial and industrial | 1,069 | (6 | ) | 1 | 182 | 1,246 | ||||||||||||||
| Commercial construction and land | 114 | 0 | 0 | 38 | 152 | |||||||||||||||
| Loans secured by farmland | 98 | 0 | 0 | 4 | 102 | |||||||||||||||
| Multi-family (5 or more) residential | 112 | 0 | 0 | 38 | 150 | |||||||||||||||
| Agricultural loans | 43 | 0 | 0 | (1 | ) | 42 | ||||||||||||||
| Other commercial loans | 121 | 0 | 0 | (2 | ) | 119 | ||||||||||||||
| Total commercial | 3,444 | (6 | ) | 1 | (51 | ) | 3,388 | |||||||||||||
| Consumer | 236 | (29 | ) | 13 | 44 | 264 | ||||||||||||||
| Unallocated | 585 | 0 | 0 | 0 | 585 | |||||||||||||||
| Total Allowance for Loan Losses | $ | 8,256 | $ | (68 | ) | $ | 16 | $ | (4 | ) | $ | 8,200 | ||||||||
| Three Months Ended June 30, 2018 | March 31, | June 30, | ||||||||||||||||||
| (In Thousands) | 2018 Balance | Charge-offs | Recoveries | Provision (Credit) | 2018 Balance | |||||||||||||||
| Allowance for Loan Losses: | ||||||||||||||||||||
| Residential mortgage: | ||||||||||||||||||||
| Residential mortgage loans - first liens | $ | 3,067 | $ | (34 | ) | $ | 1 | $ | 21 | $ | 3,055 | |||||||||
| Residential mortgage loans - junior liens | 351 | 0 | 2 | 0 | 353 | |||||||||||||||
| Home equity lines of credit | 286 | (12 | ) | 0 | 18 | 292 | ||||||||||||||
| 1-4 Family residential construction | 239 | 0 | 0 | 8 | 247 | |||||||||||||||
| Total residential mortgage | 3,943 | (46 | ) | 3 | 47 | 3,947 | ||||||||||||||
| Commercial: | ||||||||||||||||||||
| Commercial loans secured by real estate | 2,635 | 0 | 0 | (22 | ) | 2,613 | ||||||||||||||
| Commercial and industrial | 1,036 | (133 | ) | 1 | 69 | 973 | ||||||||||||||
| Commercial construction and land | 137 | 0 | 0 | (2 | ) | 135 | ||||||||||||||
| Loans secured by farmland | 102 | 0 | 0 | 4 | 106 | |||||||||||||||
| Multi-family (5 or more) residential | 169 | 0 | 0 | 5 | 174 | |||||||||||||||
| Agricultural loans | 205 | 0 | 0 | (159 | ) | 46 | ||||||||||||||
| Other commercial loans | 149 | 0 | 0 | (15 | ) | 134 | ||||||||||||||
| Total commercial | 4,433 | (133 | ) | 1 | (120 | ) | 4,181 | |||||||||||||
| Consumer | 174 | (32 | ) | 9 | 53 | 204 | ||||||||||||||
| Unallocated | 499 | 0 | 0 | 0 | 499 | |||||||||||||||
| Total Allowance for Loan Losses | $ | 9,049 | $ | (211 | ) | $ | 13 | $ | (20 | ) | $ | 8,831 | ||||||||
| 24 |
| Six Months Ended June 30, 2019 | Dec. 31, | June 30, | ||||||||||||||||||
| (In Thousands) | 2018 Balance | Charge-offs | Recoveries | Provision (Credit) | 2019 Balance | |||||||||||||||
| Allowance for Loan Losses: | ||||||||||||||||||||
| Residential mortgage: | ||||||||||||||||||||
| Residential mortgage loans - first liens | $ | 3,156 | $ | (83 | ) | $ | 2 | $ | 55 | $ | 3,130 | |||||||||
| Residential mortgage loans - junior liens | 325 | (24 | ) | 0 | 32 | 333 | ||||||||||||||
| Home equity lines of credit | 302 | 0 | 4 | (26 | ) | 280 | ||||||||||||||
| 1-4 Family residential construction | 203 | 0 | 0 | 17 | 220 | |||||||||||||||
| Total residential mortgage | 3,986 | (107 | ) | 6 | 78 | 3,963 | ||||||||||||||
| Commercial: | ||||||||||||||||||||
| Commercial loans secured by real estate | 2,538 | 0 | 0 | (961 | ) | 1,577 | ||||||||||||||
| Commercial and industrial | 1,553 | (6 | ) | 3 | (304 | ) | 1,246 | |||||||||||||
| Commercial construction and land | 110 | 0 | 0 | 42 | 152 | |||||||||||||||
| Loans secured by farmland | 102 | 0 | 0 | 0 | 102 | |||||||||||||||
| Multi-family (5 or more) residential | 114 | 0 | 0 | 36 | 150 | |||||||||||||||
| Agricultural loans | 46 | 0 | 0 | (4 | ) | 42 | ||||||||||||||
| Other commercial loans | 128 | 0 | 0 | (9 | ) | 119 | ||||||||||||||
| Total commercial | 4,591 | (6 | ) | 3 | (1,200 | ) | 3,388 | |||||||||||||
| Consumer | 233 | (66 | ) | 22 | 75 | 264 | ||||||||||||||
| Unallocated | 499 | 0 | 0 | 86 | 585 | |||||||||||||||
| Total Allowance for Loan Losses | $ | 9,309 | $ | (179 | ) | $ | 31 | $ | (961 | ) | $ | 8,200 | ||||||||
| Six Months Ended June 30, 2018 | Dec. 31, | June 30, | ||||||||||||||||||
| (In Thousands) | 2017 Balance | Charge-offs | Recoveries | Provision (Credit) | 2018 Balance | |||||||||||||||
| Allowance for Loan Losses: | ||||||||||||||||||||
| Residential mortgage: | ||||||||||||||||||||
| Residential mortgage loans - first liens | $ | 3,200 | $ | (87 | ) | $ | 2 | $ | (60 | ) | $ | 3,055 | ||||||||
| Residential mortgage loans - junior liens | 224 | 0 | 3 | 126 | 353 | |||||||||||||||
| Home equity lines of credit | 296 | (12 | ) | 0 | 8 | 292 | ||||||||||||||
| 1-4 Family residential construction | 243 | 0 | 0 | 4 | 247 | |||||||||||||||
| Total residential mortgage | 3,963 | (99 | ) | 5 | 78 | 3,947 | ||||||||||||||
| Commercial: | ||||||||||||||||||||
| Commercial loans secured by real estate | 2,584 | (21 | ) | 0 | 50 | 2,613 | ||||||||||||||
| Commercial and industrial | 1,065 | (133 | ) | 3 | 38 | 973 | ||||||||||||||
| Commercial construction and land | 150 | 0 | 0 | (15 | ) | 135 | ||||||||||||||
| Loans secured by farmland | 105 | 0 | 0 | 1 | 106 | |||||||||||||||
| Multi-family (5 or more) residential | 172 | 0 | 0 | 2 | 174 | |||||||||||||||
| Agricultural loans | 57 | 0 | 0 | (11 | ) | 46 | ||||||||||||||
| Other commercial loans | 102 | 0 | 0 | 32 | 134 | |||||||||||||||
| Total commercial | 4,235 | (154 | ) | 3 | 97 | 4,181 | ||||||||||||||
| Consumer | 159 | (73 | ) | 21 | 97 | 204 | ||||||||||||||
| Unallocated | 499 | 0 | 0 | 0 | 499 | |||||||||||||||
| Total Allowance for Loan Losses | $ | 8,856 | $ | (326 | ) | $ | 29 | $ | 272 | $ | 8,831 | |||||||||
In the evaluation of the loan portfolio, management determines two major components for the allowance for loan losses – (1) a specific component based on an assessment of certain larger relationships, mainly commercial purpose loans, on a loan-by-loan basis; and (2) a general component for the remainder of the portfolio, except for performing loans recently purchased from Monument, based on a collective evaluation of pools of loans with similar risk characteristics. The general component is assigned to each pool of loans based on both historical net charge-off experience, and an evaluation of certain qualitative factors. An unallocated component 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 above methodologies for estimating specific and general losses in the portfolio.
| 25 |
Loans acquired from Monument that were identified as having a deterioration in credit quality (purchased credit impaired, or PCI) were valued at $441,000 at April 1, 2019 and June 30, 2019. The remainder of the portfolio was deemed to be the performing component of the portfolio. The calculation of the preliminary fair value of performing loans included a discount for credit losses of $1,914,000, reflecting a preliminary estimate of the present value of credit losses based on market expectations. As noted above, the balance of the credit fair value mark on performing (non-impaired) loans was $1,653,000 at June 30, 2019. None of the performing loans purchased were found to be impaired in the second quarter 2019, and the recently purchased performing loans were excluded from the loan pools for which the general component of the allowance for loan losses was calculated.
The credit for loan losses (reduction in expense) was $961,000 in the first six months of 2019 as compared to a provision of $272,000 in the first six months of 2018. The credit for loan losses in 2019 reflects the impact of eliminations of specific allowances on commercial loans that are no longer considered impaired. Specific allowances totaling $1,365,000 at December 31, 2018 on two commercial loans were eliminated in the first quarter 2019 as these two loans were no longer considered impaired and were returned to full accrual status in the first quarter 2019. In total, the credit for loan losses in the first six months of 2019 included a credit of $1,160,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period, partially offset by a net increase of $199,000 in the collectively determined and unallocated portions of the allowance for loan losses.
In determining the larger loan relationships for detailed assessment under the specific allowance component, the Corporation uses an internal risk rating system. Under the risk rating system, the Corporation classifies problem or potential problem loans as “Special Mention,” “Substandard,” or “Doubtful” on the basis of currently existing facts, conditions and values. Substandard loans include those characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that do not currently expose the Corporation to sufficient risk to warrant classification as Substandard or Doubtful, but possess weaknesses that deserve management’s close attention, are deemed to be Special Mention. Risk ratings are updated any time that conditions or the situation warrants. Loans not classified are included in the “Pass” column in the table that follows.
The following tables summarize the aggregate credit quality classification of outstanding loans by risk rating as of June 30, 2019 and December 31, 2018:
| June 30, 2019 | ||||||||||||||||||||||||
| (In Thousands) | ||||||||||||||||||||||||
| Pass | Special Mention | Substandard | Doubtful | Purchased Credit Impaired | Total | |||||||||||||||||||
| Residential Mortgage: | ||||||||||||||||||||||||
| Residential mortgage loans - first liens | $ | 475,592 | $ | 644 | $ | 8,081 | $ | 85 | $ | 77 | $ | 484,479 | ||||||||||||
| Residential mortgage loans - junior liens | 28,289 | 85 | 506 | 0 | 0 | 28,880 | ||||||||||||||||||
| Home equity lines of credit | 34,620 | 59 | 545 | 0 | 0 | 35,224 | ||||||||||||||||||
| 1-4 Family residential construction | 27,813 | 0 | 181 | 0 | 0 | 27,994 | ||||||||||||||||||
| Total residential mortgage | 566,314 | 788 | 9,313 | 85 | 77 | 576,577 | ||||||||||||||||||
| Commercial: | ||||||||||||||||||||||||
| Commercial loans secured by real estate | 267,985 | 5,494 | 5,424 | 0 | 364 | 279,267 | ||||||||||||||||||
| Commercial and Industrial | 104,548 | 7,736 | 2,980 | 0 | 0 | 115,264 | ||||||||||||||||||
| Political subdivisions | 52,308 | 0 | 0 | 0 | 0 | 52,308 | ||||||||||||||||||
| Commercial construction and land | 16,343 | 4,781 | 73 | 0 | 0 | 21,197 | ||||||||||||||||||
| Loans secured by farmland | 4,953 | 314 | 1,984 | 0 | 0 | 7,251 | ||||||||||||||||||
| Multi-family (5 or more) residential | 26,749 | 0 | 0 | 0 | 0 | 26,749 | ||||||||||||||||||
| Agricultural loans | 4,159 | 398 | 677 | 0 | 0 | 5,234 | ||||||||||||||||||
| Other commercial loans | 12,917 | 0 | 120 | 0 | 0 | 13,037 | ||||||||||||||||||
| Total commercial | 489,962 | 18,723 | 11,258 | 0 | 364 | 520,307 | ||||||||||||||||||
| Consumer | 19,765 | 0 | 34 | 0 | 0 | 19,799 | ||||||||||||||||||
| Totals | $ | 1,076,041 | $ | 19,511 | $ | 20,605 | $ | 85 | $ | 441 | $ | 1,116,683 | ||||||||||||
| 26 |
| December 31, 2018 | ||||||||||||||||||||
| (In Thousands) | Special | |||||||||||||||||||
| Pass | Mention | Substandard | Doubtful | Total | ||||||||||||||||
| Residential Mortgage: | ||||||||||||||||||||
| Residential mortgage loans - first liens | $ | 363,407 | $ | 937 | $ | 7,944 | $ | 51 | $ | 372,339 | ||||||||||
| Residential mortgage loans - junior liens | 24,841 | 176 | 433 | 0 | 25,450 | |||||||||||||||
| Home equity lines of credit | 33,659 | 59 | 601 | 0 | 34,319 | |||||||||||||||
| 1-4 Family residential construction | 24,698 | 0 | 0 | 0 | 24,698 | |||||||||||||||
| Total residential mortgage | 446,605 | 1,172 | 8,978 | 51 | 456,806 | |||||||||||||||
| Commercial: | ||||||||||||||||||||
| Commercial loans secured by real estate | 156,308 | 740 | 5,563 | 0 | 162,611 | |||||||||||||||
| Commercial and Industrial | 84,232 | 5,230 | 2,394 | 0 | 91,856 | |||||||||||||||
| Political subdivisions | 53,263 | 0 | 0 | 0 | 53,263 | |||||||||||||||
| Commercial construction and land | 11,887 | 0 | 75 | 0 | 11,962 | |||||||||||||||
| Loans secured by farmland | 5,171 | 168 | 1,796 | 11 | 7,146 | |||||||||||||||
| Multi-family (5 or more) residential | 7,180 | 0 | 0 | 0 | 7,180 | |||||||||||||||
| Agricultural loans | 4,910 | 84 | 665 | 0 | 5,659 | |||||||||||||||
| Other commercial loans | 13,879 | 0 | 71 | 0 | 13,950 | |||||||||||||||
| Total commercial | 336,830 | 6,222 | 10,564 | 11 | 353,627 | |||||||||||||||
| Consumer | 17,116 | 0 | 14 | 0 | 17,130 | |||||||||||||||
| Totals | $ | 800,551 | $ | 7,394 | $ | 19,556 | $ | 62 | $ | 827,563 | ||||||||||
The general component of the allowance for loan losses covers pools of loans including commercial loans not considered individually impaired, as well as smaller balance homogeneous classes of loans, such as residential real estate, home equity lines of credit and other consumer loans. Accordingly, the Corporation generally does not separately identify individual consumer and residential loans for impairment disclosures, unless such a loan: (1) is subject to a restructuring agreement, or (2) has an outstanding balance of $400,000 or more and a credit grade of Special Mention, Substandard or Doubtful. The pools of loans are evaluated for loss exposure based upon average historical net charge-off rates for each loan class, adjusted for qualitative factors (described in the following paragraphs). The time period used in determining the average historical net charge-off rate for each loan class is based on management’s evaluation of an appropriate time period that captures an historical loss experience relevant to the current portfolio. At June 30, 2019 and December 31, 2018, a five-year average net charge-off rate was used for commercial loans secured by real estate and for multi-family residential loans, while a three-year average net charge-off rate was used for all other loan classes.
Qualitative risk factors are evaluated for the impact on each of the three segments (residential mortgage, commercial and consumer) within the loan portfolio. Each qualitative factor is assigned a value to reflect improving, stable or declining conditions based on management’s judgment using relevant information available at the time of the evaluation. The adjustment for qualitative factors is applied as an increase or decrease to the average net charge-off rate for each loan class within each segment.
The qualitative factors used in the general component calculations are designed to address credit risk characteristics associated with each segment. The Corporation’s credit risk associated with all of the segments is significantly impacted by these factors, which include economic conditions within its market area, the Corporation’s lending policies, changes or trends in the portfolio, risk profile, competition, regulatory requirements and other factors.
Loans are classified as impaired, when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. 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 shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans, by the fair value of the collateral (if the loan is collateral dependent), by future cash flows discounted at the loan’s effective rate or by the loan’s observable market price.
| 27 |
The scope of loans reviewed individually each quarter to determine if they are impaired include all commercial loan relationships greater than $200,000 and any residential mortgage or consumer loans of $400,000 or more for which there is at least one extension of credit graded Special Mention, Substandard or Doubtful. Loans that are individually reviewed, but which are determined to not be impaired, are combined with all remaining loans that are not reviewed on a specific basis, and such loans are included within larger pools of loans based on similar risk and loss characteristics for purposes of determining the general component of the allowance. The loans that have been individually reviewed, but which have been determined to not be impaired, are included in the “Collectively Evaluated” column in the table summarizing the allowance and associated loan balances as of June 30, 2019 and December 31, 2018. All loans classified as troubled debt restructurings (discussed in more detail below) and all commercial loan relationships less than $200,000 or other loan relationships less than $400,000 in the aggregate, but with an estimated loss of $100,000 or more, are individually evaluated for impairment.
The following tables present a summary of loan balances and the related allowance for loan losses summarized by portfolio segment and class for each impairment method used as of June 30, 2019 and December 31, 2018. For some classes of purchased performing loans, the outstanding balances at June 30, 2019 exceeded the corresponding totals at April 1, 2019 (as shown in Note 2) because of additional advances made on acquired loans in the second quarter 2019 on lines of credit, construction loans and other loans.
| June 30, 2019 | Loans: | Allowance for Loan Losses: | ||||||||||||||||||||||||||
| (In Thousands) | ||||||||||||||||||||||||||||
| Individually Evaluated | Collectively Evaluated | Purchased Performing | Totals | Individually Evaluated | Collectively Evaluated | Totals | ||||||||||||||||||||||
| Residential mortgage: | ||||||||||||||||||||||||||||
| Residential mortgage loans - first liens | $ | 970 | $ | 376,837 | $ | 106,672 | $ | 484,479 | $ | 0 | $ | 3,130 | $ | 3,130 | ||||||||||||||
| Residential mortgage loans - junior liens | 289 | 26,113 | 2,478 | 28,880 | 114 | 219 | 333 | |||||||||||||||||||||
| Home equity lines of credit | 0 | 32,490 | 2,734 | 35,224 | 0 | 280 | 280 | |||||||||||||||||||||
| 1-4 Family residential construction | 0 | 27,555 | 439 | 27,994 | 0 | 220 | 220 | |||||||||||||||||||||
| Total residential mortgage | 1,259 | 462,995 | 112,323 | 576,577 | 114 | 3,849 | 3,963 | |||||||||||||||||||||
| Commercial: | ||||||||||||||||||||||||||||
| Commercial loans secured by real estate | 1,649 | 166,555 | 111,063 | 279,267 | 0 | 1,577 | 1,577 | |||||||||||||||||||||
| Commercial and industrial | 1,230 | 110,026 | 4,008 | 115,264 | 135 | 1,111 | 1,246 | |||||||||||||||||||||
| Political subdivisions | 0 | 52,308 | 0 | 52,308 | 0 | 0 | 0 | |||||||||||||||||||||
| Commercial construction and land | 0 | 16,079 | 5,118 | 21,197 | 0 | 152 | 152 | |||||||||||||||||||||
| Loans secured by farmland | 1,531 | 5,456 | 264 | 7,251 | 48 | 54 | 102 | |||||||||||||||||||||
| Multi-family (5 or more) residential | 0 | 9,203 | 17,546 | 26,749 | 0 | 150 | 150 | |||||||||||||||||||||
| Agricultural loans | 595 | 4,639 | 0 | 5,234 | 0 | 42 | 42 | |||||||||||||||||||||
| Other commercial loans | 0 | 12,570 | 467 | 13,037 | 0 | 119 | 119 | |||||||||||||||||||||
| Total commercial | 5,005 | 376,836 | 138,466 | 520,307 | 183 | 3,205 | 3,388 | |||||||||||||||||||||
| Consumer | 0 | 18,811 | 988 | 19,799 | 0 | 264 | 264 | |||||||||||||||||||||
| Unallocated | 585 | |||||||||||||||||||||||||||
| Total | $ | 6,264 | $ | 858,642 | $ | 251,777 | $ | 1,116,683 | $ | 297 | $ | 7,318 | $ | 8,200 | ||||||||||||||
| 28 |
| December 31, 2018 | Loans: | Allowance for Loan Losses: | ||||||||||||||||||||||
| (In Thousands) | ||||||||||||||||||||||||
| Individually | Collectively | Individually | Collectively | |||||||||||||||||||||
| Evaluated | Evaluated | Totals | Evaluated | Evaluated | Totals | |||||||||||||||||||
| Residential mortgage: | ||||||||||||||||||||||||
| Residential mortgage loans - first liens | $ | 991 | $ | 371,348 | $ | 372,339 | $ | 0 | $ | 3,156 | $ | 3,156 | ||||||||||||
| Residential mortgage loans - junior liens | 293 | 25,157 | 25,450 | 116 | 209 | 325 | ||||||||||||||||||
| Home equity lines of credit | 0 | 34,319 | 34,319 | 0 | 302 | 302 | ||||||||||||||||||
| 1-4 Family residential construction | 0 | 24,698 | 24,698 | 0 | 203 | 203 | ||||||||||||||||||
| Total residential mortgage | 1,284 | 455,522 | 456,806 | 116 | 3,870 | 3,986 | ||||||||||||||||||
| Commercial: | ||||||||||||||||||||||||
| Commercial loans secured by real estate | 4,302 | 158,309 | 162,611 | 781 | 1,757 | 2,538 | ||||||||||||||||||
| Commercial and industrial | 2,157 | 89,699 | 91,856 | 659 | 894 | 1,553 | ||||||||||||||||||
| Political subdivisions | 0 | 53,263 | 53,263 | 0 | 0 | 0 | ||||||||||||||||||
| Commercial construction and land | 0 | 11,962 | 11,962 | 0 | 110 | 110 | ||||||||||||||||||
| Loans secured by farmland | 1,349 | 5,797 | 7,146 | 49 | 53 | 102 | ||||||||||||||||||
| Multi-family (5 or more) residential | 0 | 7,180 | 7,180 | 0 | 114 | 114 | ||||||||||||||||||
| Agricultural loans | 665 | 4,994 | 5,659 | 0 | 46 | 46 | ||||||||||||||||||
| Other commercial loans | 0 | 13,950 | 13,950 | 0 | 128 | 128 | ||||||||||||||||||
| Total commercial | 8,473 | 345,154 | 353,627 | 1,489 | 3,102 | 4,591 | ||||||||||||||||||
| Consumer | 17 | 17,113 | 17,130 | 0 | 233 | 233 | ||||||||||||||||||
| Unallocated | 499 | |||||||||||||||||||||||
| Total | $ | 9,774 | $ | 817,789 | $ | 827,563 | $ | 1,605 | $ | 7,205 | $ | 9,309 | ||||||||||||
Summary information related to impaired loans at June 30, 2019 and December 31, 2018 is provided in the table immediately below. Purchased credit impaired loans are excluded from the table.
| (In Thousands) | June 30, 2019 | December 31, 2018 | ||||||||||||||||||||||
| Unpaid | Unpaid | |||||||||||||||||||||||
| Principal | Recorded | Related | Principal | Recorded | Related | |||||||||||||||||||
| Balance | Investment | Allowance | Balance | Investment | Allowance | |||||||||||||||||||
| With no related allowance recorded: | ||||||||||||||||||||||||
| Residential mortgage loans - first liens | $ | 729 | $ | 701 | $ | 0 | $ | 750 | $ | 721 | $ | 0 | ||||||||||||
| Residential mortgage loans - junior liens | 50 | 50 | 0 | 54 | 54 | 0 | ||||||||||||||||||
| Commercial loans secured by real estate | 1,649 | 1,649 | 0 | 1,787 | 1,787 | 0 | ||||||||||||||||||
| Commercial and industrial | 436 | 436 | 0 | 817 | 817 | 0 | ||||||||||||||||||
| Loans secured by farmland | 1,048 | 1,048 | 0 | 862 | 862 | 0 | ||||||||||||||||||
| Agricultural loans | 595 | 595 | 0 | 665 | 665 | 0 | ||||||||||||||||||
| Consumer | 0 | 0 | 0 | 17 | 17 | 0 | ||||||||||||||||||
| Total with no related allowance recorded | 4,507 | 4,479 | 0 | 4,952 | 4,923 | 0 | ||||||||||||||||||
| With a related allowance recorded: | ||||||||||||||||||||||||
| Residential mortgage loans - first liens | 269 | 269 | 0 | 270 | 270 | 0 | ||||||||||||||||||
| Residential mortgage loans - junior liens | 239 | 239 | 114 | 239 | 239 | 116 | ||||||||||||||||||
| Commercial loans secured by real estate | 0 | 0 | 0 | 2,515 | 2,515 | 781 | ||||||||||||||||||
| Commercial and industrial | 794 | 794 | 135 | 1,340 | 1,340 | 659 | ||||||||||||||||||
| Loans secured by farmland | 483 | 483 | 48 | 487 | 487 | 49 | ||||||||||||||||||
| Total with a related allowance recorded | 1,785 | 1,785 | 297 | 4,851 | 4,851 | 1,605 | ||||||||||||||||||
| Total | $ | 6,292 | $ | 6,264 | $ | 297 | $ | 9,803 | $ | 9,774 | $ | 1,605 | ||||||||||||
In the table immediately above, two loans to one borrower are presented under the Residential mortgage loans – first liens and Residential mortgage loans – junior liens classes. These loans are collateralized by one property, and the allowance associated with these loans was determined based on an analysis of the total amounts of the Corporation’s exposure in comparison to the estimated net proceeds if the Corporation were to sell the property.
| 29 |
The average balance of impaired loans, excluding purchased credit impaired loans, and interest income recognized on these impaired loans is as follows:
| Average Investment in Impaired Loans | Interest Income Recognized on Impaired Loans on a Cash Basis | |||||||||||||||||||||||||||||||
| (In Thousands) | 3 Months Ended | 6 Months Ended | 3 Months Ended | 6 Months Ended | ||||||||||||||||||||||||||||
| June 30, | June 30, | June 30, | June 30, | |||||||||||||||||||||||||||||
| 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | |||||||||||||||||||||||||
| Residential mortgage: | ||||||||||||||||||||||||||||||||
| Residential mortgage loans - first lien | $ | 970 | $ | 1,108 | $ | 977 | $ | 1,077 | $ | 8 | $ | 11 | $ | 18 | $ | 30 | ||||||||||||||||
| Residential mortgage loans - junior lien | 289 | 299 | 290 | 300 | 0 | 4 | 2 | 7 | ||||||||||||||||||||||||
| Total residential mortgage | 1,259 | 1,407 | 1,267 | 1,377 | 8 | 15 | 20 | 37 | ||||||||||||||||||||||||
| Commercial: | ||||||||||||||||||||||||||||||||
| Commercial loans secured by real estate | 1,722 | 4,592 | 2,582 | 5,237 | 7 | 35 | 17 | 70 | ||||||||||||||||||||||||
| Commercial and industrial | 1,241 | 280 | 1,546 | 394 | 8 | 1 | 34 | 7 | ||||||||||||||||||||||||
| Loans secured by farmland | 1,533 | 1,360 | 1,471 | 1,362 | 18 | 10 | 19 | 16 | ||||||||||||||||||||||||
| Multi-family (5 or more) residential | 0 | 392 | 0 | 392 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
| Agricultural loans | 626 | 568 | 639 | 457 | 12 | 7 | 24 | 18 | ||||||||||||||||||||||||
| Total commercial | 5,122 | 7,192 | 6,238 | 7,842 | 45 | 53 | 94 | 111 | ||||||||||||||||||||||||
| Consumer | 0 | 19 | 6 | 19 | 0 | 0 | 0 | 0 | ||||||||||||||||||||||||
| Total | $ | 6,381 | $ | 8,618 | $ | 7,511 | $ | 9,238 | $ | 53 | $ | 68 | $ | 114 | $ | 148 | ||||||||||||||||
Loans are placed on nonaccrual status for all classes of loans when, in the opinion of management, collection of interest is doubtful. Any unpaid interest previously accrued on those loans is reversed from income. Interest income is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on loans for which the risk of further loss is greater than remote are applied as a reduction of the loan principal balance. Interest income on other nonaccrual loans, including impaired loans, is recognized only to the extent of interest payments received. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments. Also, the amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status.
The breakdown by portfolio segment and class of nonaccrual loans and loans past due ninety days or more and still accruing is as follows:
| (In Thousands) | June 30, 2019 | December 31, 2018 | ||||||||||||||
| Past Due | Past Due | |||||||||||||||
| 90+ Days and | 90+ Days and | |||||||||||||||
| Accruing | Nonaccrual | Accruing | Nonaccrual | |||||||||||||
| Residential mortgage: | ||||||||||||||||
| Residential mortgage loans - first liens | $ | 1,677 | $ | 3,426 | $ | 1,633 | $ | 4,750 | ||||||||
| Residential mortgage loans - junior liens | 106 | 239 | 151 | 239 | ||||||||||||
| Home equity lines of credit | 57 | 73 | 219 | 27 | ||||||||||||
| Total residential mortgage | 1,840 | 3,738 | 2,003 | 5,016 | ||||||||||||
| Commercial: | ||||||||||||||||
| Commercial loans secured by real estate | 225 | 2,224 | 394 | 3,958 | ||||||||||||
| Commercial and industrial | 59 | 1,170 | 18 | 2,111 | ||||||||||||
| Commercial construction and land | 0 | 52 | 0 | 52 | ||||||||||||
| Loans secured by farmland | 476 | 1,483 | 459 | 1,297 | ||||||||||||
| Agricultural loans | 5 | 595 | 0 | 665 | ||||||||||||
| Total commercial | 765 | 5,524 | 871 | 8,083 | ||||||||||||
| Consumer | 26 | 27 | 32 | 14 | ||||||||||||
| Totals | $ | 2,631 | $ | 9,289 | $ | 2,906 | $ | 13,113 | ||||||||
The amounts shown in the table immediately above include loans classified as troubled debt restructurings (described in more detail below), if such loans are past due ninety days or more or nonaccrual.
| 30 |
The table below presents a summary of the contractual aging of loans as of June 30, 2019 and December 31, 2018:
| As of June 30, 2019 | As of December 31, 2018 | |||||||||||||||||||||||||||||||
| Current & | Current & | |||||||||||||||||||||||||||||||
| (In Thousands) | Past Due | Past Due | Past Due | Past Due | Past Due | Past Due | ||||||||||||||||||||||||||
| Less than | 30-89 | 90+ | Less than | 30-89 | 90+ | |||||||||||||||||||||||||||
| 30 Days | Days | Days | Total | 30 Days | Days | Days | Total | |||||||||||||||||||||||||
| Residential mortgage: | ||||||||||||||||||||||||||||||||
| Residential mortgage loans - first liens | $ | 476,950 | $ | 4,091 | $ | 3,438 | $ | 484,479 | $ | 361,362 | $ | 6,414 | $ | 4,563 | $ | 372,339 | ||||||||||||||||
| Residential mortgage loans - junior liens | 28,482 | 53 | 345 | 28,880 | 24,876 | 184 | 390 | 25,450 | ||||||||||||||||||||||||
| Home equity lines of credit | 34,739 | 428 | 57 | 35,224 | 33,611 | 480 | 228 | 34,319 | ||||||||||||||||||||||||
| 1-4 Family residential construction | 27,994 | 0 | 0 | 27,994 | 24,531 | 167 | 0 | 24,698 | ||||||||||||||||||||||||
| Total residential mortgage | 568,165 | 4,572 | 3,840 | 576,577 | 444,380 | 7,245 | 5,181 | 456,806 | ||||||||||||||||||||||||
| Commercial: | ||||||||||||||||||||||||||||||||
| Commercial loans secured by real estate | 276,687 | 566 | 2,014 | 279,267 | 160,668 | 226 | 1,717 | 162,611 | ||||||||||||||||||||||||
| Commercial and industrial | 115,078 | 78 | 108 | 115,264 | 90,915 | 152 | 789 | 91,856 | ||||||||||||||||||||||||
| Political subdivisions | 52,308 | 0 | 0 | 52,308 | 53,263 | 0 | 0 | 53,263 | ||||||||||||||||||||||||
| Commercial construction and land | 21,145 | 0 | 52 | 21,197 | 11,910 | 0 | 52 | 11,962 | ||||||||||||||||||||||||
| Loans secured by farmland | 5,292 | 493 | 1,466 | 7,251 | 5,390 | 487 | 1,269 | 7,146 | ||||||||||||||||||||||||
| Multi-family (5 or more) residential | 26,749 | 0 | 0 | 26,749 | 7,104 | 76 | 0 | 7,180 | ||||||||||||||||||||||||
| Agricultural loans | 5,215 | 8 | 11 | 5,234 | 5,624 | 29 | 6 | 5,659 | ||||||||||||||||||||||||
| Other commercial loans | 13,037 | 0 | 0 | 13,037 | 13,950 | 0 | 0 | 13,950 | ||||||||||||||||||||||||
| Total commercial | 515,511 | 1,145 | 3,651 | 520,307 | 348,824 | 970 | 3,833 | 353,627 | ||||||||||||||||||||||||
| Consumer | 19,609 | 137 | 53 | 19,799 | 16,991 | 93 | 46 | 17,130 | ||||||||||||||||||||||||
| Totals | $ | 1,103,285 | $ | 5,854 | $ | 7,544 | $ | 1,116,683 | $ | 810,195 | $ | 8,308 | $ | 9,060 | $ | 827,563 | ||||||||||||||||
Nonaccrual loans are included in the contractual aging in the immediately preceding table. A summary of the contractual aging of nonaccrual loans at June 30, 2019 and December 31, 2018 is as follows:
| Current & | ||||||||||||||||
| (In Thousands) | Past Due | Past Due | Past Due | |||||||||||||
| Less than | 30-89 | 90+ | ||||||||||||||
| 30 Days | Days | Days | Total | |||||||||||||
| June 30, 2019 Nonaccrual Totals | $ | 2,929 | $ | 1,447 | $ | 4,913 | $ | 9,289 | ||||||||
| December 31, 2018 Nonaccrual Totals | $ | 5,793 | $ | 1,166 | $ | 6,154 | $ | 13,113 | ||||||||
Loans whose terms are modified are classified as Troubled Debt Restructurings (TDRs) if the Corporation grants such borrowers concessions, and it is deemed that those borrowers are experiencing financial difficulty. Loans classified as TDRs are designated as impaired. The outstanding balance of loans subject to TDRs, as well as contractual aging information at June 30, 2019 and December 31, 2018 is as follows:
| Current & | ||||||||||||||||||||
| (In Thousands) | Past Due | Past Due | Past Due | |||||||||||||||||
| Less than | 30-89 | 90+ | ||||||||||||||||||
| 30 Days | Days | Days | Nonaccrual | Total | ||||||||||||||||
| June 30, 2019 Totals | $ | 972 | $ | 0 | $ | 74 | $ | 415 | $ | 1,461 | ||||||||||
| December 31, 2018 Totals | $ | 612 | $ | 43 | $ | 0 | $ | 2,884 | $ | 3,539 | ||||||||||
At June 30, 2019 and December 31, 2018, there were no commitments to loan additional funds to borrowers whose loans have been classified as TDRs.
| 31 |
There were no TDRs that occurred during the three-month periods ended June 30, 2019 and 2018. TDRs that occurred during the six-month periods ended June 30, 2019 and 2018 are as follows:
| (Balances in Thousands) | ||||||||||||||||
| 2019 | 2018 | |||||||||||||||
| Post- | Post- | |||||||||||||||
| Number | Modification | Number | Modification | |||||||||||||
| of | Recorded | of | Recorded | |||||||||||||
| Loans | Investment | Loans | Investment | |||||||||||||
| Residential mortgage - first liens, | ||||||||||||||||
| Reduced monthly payments for a six-month period | 0 | $ | 0 | 1 | $ | 80 | ||||||||||
| Residential mortgage - junior liens, | ||||||||||||||||
| Reduced monthly payments and extended maturity date | 1 | 18 | 0 | 0 | ||||||||||||
| Commercial loans secured by real estate, | ||||||||||||||||
| Extended interest only payments for a six-month period | 0 | 0 | 2 | 36 | ||||||||||||
| Commercial and industrial: | ||||||||||||||||
| Extended interest only payments for a six-month period | 0 | 0 | 1 | 46 | ||||||||||||
| Reduced monthly payments and extended maturity date | 9 | 448 | 0 | 0 | ||||||||||||
| Agricultural loans, | ||||||||||||||||
| Reduced monthly payments and extended maturity date | 1 | 84 | 0 | 0 | ||||||||||||
| Total | 11 | $ | 550 | 4 | $ | 162 | ||||||||||
All of the loans for which TDRs were granted in the table above in the six-month period ended June 30, 2019 are associated with one relationship.
In the six-month periods ended June 30, 2019 and 2018, there were no defaults on loans for which modifications considered to be TDRs were entered into within the previous 12 months.
The carrying amount of foreclosed residential real estate properties held as a result of obtaining physical possession (included in Foreclosed assets held for sale in the unaudited consolidated balance sheets) is as follows:
| (In Thousands) | June 30, | Dec. 31, | ||||||
| 2019 | 2018 | |||||||
| Foreclosed residential real estate | $ | 368 | $ | 64 | ||||
The recorded investment of consumer mortgage loans secured by residential real properties for which formal foreclosure proceedings were in process is as follows:
| (In Thousands) | June 30, | Dec. 31, | ||||||
| 2019 | 2018 | |||||||
| Residential real estate in process of foreclosure | $ | 1,456 | $ | 1,097 | ||||
8. GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Information related to the core deposit intangibles are as follows:
(In Thousands)
| June 30, | December 31, | |||||||
| 2019 | 2018 | |||||||
| Gross amount | $ | 3,495 | $ | 2,034 | ||||
| Accumulated amortization | (2,100 | ) | (2,025 | ) | ||||
| Net | $ | 1,395 | $ | 9 | ||||
| 32 |
Amortization expense was $73,000 in the second quarter 2019, including $72,000 related to the core deposit intangible recognized in the Monument acquisition as described in Note 2. In comparison, amortization expense was $1,000 in the second quarter 2018. Amortization expense totaled $75,000 in the six-month period ended June 30, 2019 and $2,000 in the six-month period ended June 30, 2018.
Changes in the carrying amount of goodwill are summarized in the following table:
(In Thousands)
| 3 Months | 3 Months | |||||||
| and 6 Months | and 6 Months | |||||||
| Ended | Ended | |||||||
| June 30, | June 30, | |||||||
| 2019 | 2018 | |||||||
| Balance, beginning of period | $ | 11,942 | $ | 11,942 | ||||
| Goodwill arising in business combination | 16,676 | 0 | ||||||
| Balance, end of period | $ | 28,618 | $ | 11,942 | ||||
9. BORROWED FUNDS AND SUBORDINATED DEBT
Short-term borrowings (initial maturity within one year) include the following:
| (In Thousands) | June 30, | Dec. 31, | ||||||
| 2019 | 2018 | |||||||
| FHLB-Pittsburgh borrowings – overnight | $ | 3,000 | $ | 7,000 | ||||
| Other short-term advances from FHLB-Pittsburgh | 21,301 | 0 | ||||||
| Customer repurchase agreements | 3,192 | 5,853 | ||||||
| Total short-term borrowings | $ | 27,493 | $ | 12,853 | ||||
The Corporation engages in repurchase agreements with certain commercial customers. These agreements provide that the Corporation sells specified investment securities to the customers on an overnight basis and repurchases them on the following business day. The weighted average interest rate paid by the Corporation on customer repurchase agreements was 0.10% at June 30, 2019 and December 31, 2018. The carrying value of the underlying securities was $3,240,000 at June 30, 2019 and $5,890,000 at December 31, 2018.
The FHLB-Pittsburgh loan facilities are collateralized by qualifying loans secured by real estate with a book value totaling $741,242,000 at June 30, 2019 and $495,143,000 at December 31, 2018. Also, the FHLB-Pittsburgh loan facilities require the Corporation to invest in established amounts of FHLB-Pittsburgh stock. The carrying values of the Corporation’s holdings of FHLB-Pittsburgh stock (included in Other Assets) were $7,485,000 at June 30, 2019 and $5,582,000 at December 31, 2018.
Overnight borrowings from FHLB-Pittsburgh had interest rates of 2.46% at June 30, 2019 and 2.62% at December 31, 2018. At June 30,2019, other short-term advances from FHLB-Pittsburgh included four advances totaling $21,379,000 which are presented in the table net of the unamortized purchase accounting-related adjustment, with a weighted-average effective interest rate of 2.66%.
Long-term borrowings from FHLB-Pittsburgh are as follows:
| (In Thousands) | June 30, | Dec. 31, | ||||||
| 2019 | 2018 | |||||||
| Loans matured in 2019 with a weighted-average rate of 2.17% | $ | 0 | $ | 17,000 | ||||
| Loans maturing in 2019 with a weighted-average rate of 2.59% | 15,000 | 15,000 | ||||||
| Loans maturing in 2020 with a weighted-average rate of 2.77% | 5,171 | 3,271 | ||||||
| Loans maturing in 2022 with a weighted-average rate of 2.16% | 14,000 | 0 | ||||||
| Loans maturing in 2023 with a weighted-average rate of 2.31% | 3,500 | 0 | ||||||
| Loan maturing in 2025 with a rate of 4.91% | 602 | 644 | ||||||
| Total long-term FHLB-Pittsburgh borrowings | $ | 38,273 | $ | 35,915 | ||||
In connection with the Monument acquisition, the Corporation assumed subordinated debt agreements with par values totaling $7,000,000, maturing April 1, 2027, which may be redeemed at par beginning April 1, 2022. The agreements have fixed annual interest rates of 6.50%. The subordinated debt was recorded at fair value, which was deemed to be equal to par value, and thus is carried on the unaudited consolidated balance sheet at $7,000,000 at June 30, 2019.
| 33 |
10. STOCK-BASED COMPENSATION PLANS
The Corporation has a Stock Incentive Plan for a selected group of officers and an Independent Directors Stock Incentive Plan. In the first quarter 2019, the Corporation awarded 40,517 shares of restricted stock under the Stock Incentive Plan and 7,620 shares of restricted stock under the Independent Directors Stock Incentive Plan. The 2019 restricted stock awards under the Stock Incentive Plan vest ratably over three years and vesting for one-half of the 27,380 restricted shares awarded to Executive Officers depends on the Corporation meeting a return on average equity (“ROAE”) target each year. The 2019 restricted stock issued under the Independent Directors Stock Incentive Plan vests over one year.
Compensation cost related to restricted stock is recognized based on the fair value of the stock at the grant date over the vesting period, adjusted for estimated and actual forfeitures. Management has estimated restricted stock expense in the second quarter and first six months of 2019 based on an assumption that the ROAE target for awards to Executive Officers in 2017, 2018 and 2019 will be met.
Total annual stock-based compensation for the year ending December 31, 2019 is estimated to total $880,000. Total stock-based compensation expense attributable to restricted stock awards amounted to $202,000 in the second quarter 2019 and $155,000 in the second quarter 2018. Total stock-based compensation expense attributable to restricted stock awards amounted to $431,000 in the six-month period ended June 30, 2019 and $338,000 in the six-month period ended June 30, 2018.
11. CONTINGENCIES
In the normal course of business, the Corporation may be subject to pending and threatened lawsuits in which claims for monetary damages could be asserted. In management’s opinion, the Corporation’s financial position and results of operations would not be materially affected by the outcome of such pending legal proceedings.
12. REVENUE RECOGNITION
As disclosed in Note 1, as of January 1, 2018, the Corporation adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606), as well as subsequent ASUs that modified ASC 606. The Company has elected to apply the ASU and all related ASUs using the modified retrospective implementation method. The implementation of the guidance had no material impact on the measurement or recognition of revenue of prior periods. The Corporation generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.
Additional disclosures related to the Corporation’s largest sources of noninterest income within the consolidated statements of income that are subject to ASC 606 are as follows:
Trust and financial management revenue – C&N Bank’s trust division provides a wide range of financial services, including wealth management services for individuals, businesses and retirement funds, administration of 401(k) and other retirement plans, retirement planning, estate planning and estate settlement services. Trust clients are located primarily within the Corporation’s geographic markets. Assets held in a fiduciary capacity by C&N Bank are not the Corporation’s assets and are therefore not included in the consolidated balance sheets. The fair value of trust assets under management was approximately $948,998,000 at June 30, 2019 and $862,517,000 at December 31, 2018. Trust and financial management revenue is included within noninterest income in the consolidated statements of income.
Trust revenue is recorded on a cash basis, which is not materially different from the accrual basis. The majority (approximately 81%, based on annual 2018 results) of trust revenue is earned and collected monthly, with the amount determined based on a percentage of the fair value of the trust assets under management. Wealth management fees are contractually agreed with each customer, and fee levels vary based mainly on the size of assets under management. The services provided under such a contract represent a single performance obligation under the ASU because it embodies a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. None of the contracts with trust customers provide for incentive-based fees. In addition to wealth management fees, trust revenue includes fees for provision of services, including employee benefit plan administration, tax return preparation and estate planning and settlement. Fees for such services are billed based on contractual arrangements or established fee schedules and are typically billed upon completion of providing such services. The costs of acquiring trust customers are incremental and recognized within noninterest expense in the consolidated statements of income.
| 34 |
Service charges on deposit accounts - Deposits are included as liabilities in the consolidated balance sheets. Service charges on deposit accounts include: overdraft fees, which are charged when customers overdraw their accounts beyond available funds; automated teller machine (ATM) fees charged for withdrawals by deposit customers from other financial institutions’ ATMs; and a variety of other monthly or transactional fees for services provided to retail and business customers, mainly associated with checking accounts. 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. Incremental costs of obtaining deposit contracts are not significant and are recognized as expense when incurred within noninterest expense in the consolidated statements of income.
Interchange revenue from debit card transactions – The Corporation issues debit cards to consumer and business customers with checking, savings or money market deposit accounts. Debit card and ATM transactions are processed via electronic systems that involve several parties. The Corporation’s debit card and ATM transaction processing is executed via contractual arrangements with payment processing networks, a processor and a settlement bank. As described above, all deposit liabilities are considered to have one-day terms and therefore interchange revenue from customers’ use of their debit cards to initiate transactions are recognized in income at the time when the services are provided and related fees received in the Corporation’s deposit account with the settlement bank. Incremental costs associated with ATM and interchange processing are recognized as expense when incurred within noninterest expense in the consolidated statements of income.
13. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS
The Corporation measures certain assets at fair value. Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. FASB Accounting Standards Codification (ASC) topic 820, “Fair Value Measurements and Disclosures” establishes a framework for measuring fair value that includes a hierarchy used to classify the inputs used in measuring fair value. The hierarchy prioritizes the inputs used in determining valuations into three levels. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. The levels of the fair value hierarchy are as follows:
Level 1 – Fair value is based on unadjusted quoted prices in active markets that are accessible to the Corporation for identical assets. These generally provide the most reliable evidence and are used to measure fair value whenever available.
Level 2 – Fair value is based on significant inputs, other than Level 1 inputs, that are observable either directly or indirectly for substantially the full term of the asset through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets, quoted market prices in markets that are not active for identical or similar assets and other observable inputs.
Level 3 – Fair value is based on significant unobservable inputs. Examples of valuation methodologies that would result in Level 3 classification include option pricing models, discounted cash flows and other similar techniques.
The Corporation monitors and evaluates available data relating to fair value measurements on an ongoing basis and recognizes transfers among the levels of the fair value hierarchy as of the date of an event or change in circumstances that affects the valuation method chosen. Examples of such changes may include the market for a particular asset becoming active or inactive, changes in the availability of quoted prices, or changes in the availability of other market data.
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At June 30, 2019 and December 31, 2018, assets measured at fair value and the valuation methods used are as follows:
| June 30, 2019 | ||||||||||||||||
| Quoted Prices | Other | |||||||||||||||
| in Active | Observable | Unobservable | Total | |||||||||||||
| Markets | Inputs | Inputs | Fair | |||||||||||||
| (In Thousands) | (Level 1) | (Level 2) | (Level 3) | Value | ||||||||||||
| Recurring fair value measurements | ||||||||||||||||
| AVAILABLE-FOR-SALE DEBT SECURITIES: | ||||||||||||||||
| Obligations of U.S. Government agencies | $ | 0 | $ | 17,570 | $ | 0 | $ | 17,570 | ||||||||
| Obligations of states and political subdivisions: | ||||||||||||||||
| Tax-exempt | 0 | 75,499 | 0 | 75,499 | ||||||||||||
| Taxable | 0 | 31,509 | 0 | 31,509 | ||||||||||||
| Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies: | ||||||||||||||||
| Residential pass-through securities | 0 | 55,141 | 0 | 55,141 | ||||||||||||
| Residential collateralized mortgage obligations | 0 | 139,484 | 0 | 139,484 | ||||||||||||
| Commercial mortgage-backed securities | 0 | 44,262 | 0 | 44,262 | ||||||||||||
| Total available-for-sale debt securities | 0 | 363,465 | 0 | 363,465 | ||||||||||||
| Marketable equity security | 976 | 0 | 0 | 976 | ||||||||||||
| Servicing rights | 0 | 0 | 1,322 | 1,322 | ||||||||||||
| Total recurring fair value measurements | $ | 976 | $ | 363,465 | $ | 1,322 | $ | 365,763 | ||||||||
| Nonrecurring fair value measurements | ||||||||||||||||
| Impaired loans with a valuation allowance | $ | 0 | $ | 0 | $ | 1,785 | $ | 1,785 | ||||||||
| Valuation allowance | 0 | 0 | (297 | ) | (297 | ) | ||||||||||
| Impaired loans, net | 0 | 0 | 1,488 | 1,488 | ||||||||||||
| Foreclosed assets held for sale | 0 | 0 | 3,305 | 3,305 | ||||||||||||
| Total nonrecurring fair value measurements | $ | 0 | $ | 0 | $ | 4,793 | $ | 4,793 | ||||||||
| 36 |
| December 31, 2018 | ||||||||||||||||
| Quoted Prices | Other | |||||||||||||||
| in Active | Observable | Unobservable | Total | |||||||||||||
| Markets | Inputs | Inputs | Fair | |||||||||||||
| (In Thousands) | (Level 1) | (Level 2) | (Level 3) | Value | ||||||||||||
| Recurring fair value measurements | ||||||||||||||||
| AVAILABLE-FOR-SALE DEBT SECURITIES: | ||||||||||||||||
| Obligations of U.S. Government agencies | $ | 0 | $ | 12,500 | $ | 0 | $ | 15,500 | ||||||||
| Obligations of states and political subdivisions: | ||||||||||||||||
| Tax-exempt | 0 | 83,952 | 0 | 83,952 | ||||||||||||
| Taxable | 0 | 27,699 | 0 | 27,699 | ||||||||||||
| Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies: | ||||||||||||||||
| Residential pass-through securities | 0 | 53,445 | 0 | 53,445 | ||||||||||||
| Residential collateralized mortgage obligations | 0 | 145,912 | 0 | 145,912 | ||||||||||||
| Commercial mortgage-backed securities | 0 | 39,765 | 0 | 39,765 | ||||||||||||
| Total available-for-sale debt securities | 0 | 363,273 | 0 | 363,273 | ||||||||||||
| Marketable equity security | 950 | 0 | 0 | 950 | ||||||||||||
| Servicing rights | 0 | 0 | 1,404 | 1,404 | ||||||||||||
| Total recurring fair value measurements | $ | 950 | $ | 363,273 | $ | 1,404 | $ | 365,627 | ||||||||
| Nonrecurring fair value measurements | ||||||||||||||||
| Impaired loans with a valuation allowance | $ | 0 | $ | 0 | $ | 4,851 | $ | 4,851 | ||||||||
| Valuation allowance | 0 | 0 | (1,605 | ) | (1,605 | ) | ||||||||||
| Impaired loans, net | 0 | 0 | 3,246 | 3,246 | ||||||||||||
| Foreclosed assets held for sale | 0 | 0 | 1,703 | 1,703 | ||||||||||||
| Total nonrecurring fair value measurements | $ | 0 | $ | 0 | $ | 4,949 | $ | 4,949 | ||||||||
Management’s evaluation and selection of valuation techniques and the unobservable inputs used in determining the fair values of assets valued using Level 3 methodologies include sensitive assumptions. Other market participants might use substantially different assumptions, which could result in calculations of fair values that would be substantially different than the amount calculated by management.
At June 30, 2019 and December 31, 2018, quantitative information regarding significant techniques and inputs used for assets measured on a recurring basis using unobservable inputs (Level 3 methodologies) are as follows:
| Fair Value at | ||||||||||||||
| 6/30/19 | Valuation | Unobservable | Method or Value As of | |||||||||||
| Asset | (In Thousands) | Technique | Input(s) | 6/30/19 | ||||||||||
| Servicing rights | $ | 1,322 | Discounted cash flow | Discount rate | 12.50 | % | Rate used through modeling period | |||||||
| Loan prepayment speeds | 147.00 | % | Weighted-average PSA | |||||||||||
| Servicing fees | 0.25 | % | of loan balances | |||||||||||
| 4.00 | % | of payments are late | ||||||||||||
| 5.00 | % | late fees assessed | ||||||||||||
| $ | 1.94 | Miscellaneous fees per account per month | ||||||||||||
| Servicing costs | $ | 6.00 | Monthly servicing cost per account | |||||||||||
| $ | 24.00 | Additional monthly servicing cost per loan on loans more than 30 days delinquent | ||||||||||||
| 1.50 | % | of loans more than 30 days delinquent | ||||||||||||
| 3.00 | % | annual increase in servicing costs | ||||||||||||
| 37 |
Fair Value at | ||||||||||||||
| 12/31/18 | Valuation | Unobservable | Method or Value As of | |||||||||||
| Asset | (In Thousands) | Technique | Input(s) | 12/31/18 | ||||||||||
| Servicing rights | $ | 1,404 | Discounted cash flow | Discount rate | 12.50 | % | Rate used through modeling period | |||||||
| Loan prepayment speeds | 114.00 | % | Weighted-average PSA | |||||||||||
| Servicing fees | 0.25 | % | of loan balances | |||||||||||
| 4.00 | % | of payments are late | ||||||||||||
| 5.00 | % | late fees assessed | ||||||||||||
| $ | 1.94 | Miscellaneous fees per account per month | ||||||||||||
| Servicing costs | $ | 6.00 | Monthly servicing cost per account | |||||||||||
| $ | 24.00 | Additional monthly servicing cost per loan on loans more than 30 days delinquent | ||||||||||||
| 1.50 | % | of loans more than 30 days delinquent | ||||||||||||
| 3.00 | % | annual increase in servicing costs | ||||||||||||
The fair value of servicing rights is affected by expected future interest rates. Increases (decreases) in future expected interest rates tend to increase (decrease) the fair value of the Corporation’s servicing rights because of changes in expected prepayment behavior by the borrowers on the underlying loans. Unrealized gains (losses) in fair value of servicing rights are included in Loan servicing fees, net, in the unaudited consolidated statements of income.
Following is a reconciliation of activity for Level 3 assets measured at fair value on a recurring basis:
| (In Thousands) | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2019 | ||||||||||||||||||||||
| Restricted Equity Security | Servicing Rights | Total | Restricted Equity Security | Servicing Rights | Total | |||||||||||||||||||
| Balance, beginning of period | $ | 0 | $ | 1,347 | $ | 1,347 | $ | 0 | $ | 1,404 | $ | 1,404 | ||||||||||||
| Issuances of servicing rights | 0 | 46 | 46 | 0 | 66 | 66 | ||||||||||||||||||
| Unrealized gains (losses) included in earnings | 0 | (71 | ) | (71 | ) | 0 | (148 | ) | (148 | ) | ||||||||||||||
| Balance, end of period | $ | 0 | $ | 1,322 | $ | 1,322 | $ | 0 | $ | 1,322 | $ | 1,322 | ||||||||||||
| (In Thousands) | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2018 | ||||||||||||||||||||||
| Restricted Equity Security | Servicing Rights | Total | Restricted Equity Security | Servicing Rights | Total | |||||||||||||||||||
| Balance, beginning of period | $ | 0 | $ | 1,369 | $ | 1,369 | $ | 0 | $ | 1,299 | $ | 1,299 | ||||||||||||
| Issuances of servicing rights | 0 | 47 | 47 | 0 | 97 | 97 | ||||||||||||||||||
| Unrealized gains (losses) included in earnings | 866 | (46 | ) | 820 | 866 | (26 | ) | 840 | ||||||||||||||||
| Balance, end of period | $ | 866 | $ | 1,370 | $ | 2,236 | $ | 866 | $ | 1,370 | $ | 2,236 | ||||||||||||
Loans are classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Foreclosed assets held for sale consist of real estate acquired by foreclosure. For impaired commercial loans secured by real estate and foreclosed assets held for sale, estimated fair values are determined primarily using values from third-party appraisals. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property. For commercial and industrial and agricultural loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging data or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.
| 38 |
At June 30, 2019 and December 31, 2018, quantitative information regarding significant techniques and inputs used for nonrecurring fair value measurements using unobservable inputs (Level 3 methodologies) are as follows:
| (In Thousands, Except | Weighted- | |||||||||||||||||||
| Percentages) | Average | |||||||||||||||||||
| Balance at | Valuation Allowance at | Fair Value at | Valuation | Unobservable | Discount at | |||||||||||||||
| Asset | 6/30/19 | 6/30/19 | 6/30/19 | Technique | Inputs | 6/30/19 | ||||||||||||||
| Impaired loans: | ||||||||||||||||||||
| Residential mortgage loans - first and junior liens | $ | 508 | $ | 114 | $ | 394 | Sales comparison | Discount to appraised value | 26 | % | ||||||||||
| Commercial: | ||||||||||||||||||||
| Commercial and industrial | 75 | 75 | 0 | Sales comparison | Discount to appraised value | 100 | % | |||||||||||||
| Commercial and industrial | 719 | 60 | 659 | Liquidation of accounts receivable | Discount to borrower's financial statement value | 14 | % | |||||||||||||
| Loans secured by farmland | 483 | 48 | 435 | Sales comparison | Discount to appraised value | 46 | % | |||||||||||||
| Total impaired loans | $ | 1,785 | $ | 297 | $ | 1,488 | ||||||||||||||
| Foreclosed assets held for sale - real estate: | ||||||||||||||||||||
| Residential (1-4 family) | $ | 368 | $ | 0 | $ | 368 | Sales comparison | Discount to appraised value | 37 | % | ||||||||||
| Land | 110 | 0 | 110 | Sales comparison | Discount to appraised value | 61 | % | |||||||||||||
| Commercial real estate | 2,827 | 0 | 2,827 | Sales comparison | Discount to appraised value | 30 | % | |||||||||||||
| Total foreclosed assets held for sale | $ | 3,305 | $ | 0 | $ | 3,305 | ||||||||||||||
| (In Thousands, Except | Weighted- | |||||||||||||||||||
| Percentages) | Average | |||||||||||||||||||
| Balance at | Valuation Allowance at | Fair Value at | Valuation | Unobservable | Discount at | |||||||||||||||
| Asset | 12/31/18 | 12/31/18 | 12/31/18 | Technique | Inputs | 12/31/18 | ||||||||||||||
| Impaired loans: | ||||||||||||||||||||
| Residential mortgage loans - first and junior liens | $ | 509 | $ | 116 | $ | 393 | Sales comparison | Discount to appraised value | 26 | % | ||||||||||
| Commercial: | ||||||||||||||||||||
| Commercial loans secured by real estate | 2,515 | 781 | 1,734 | Sales comparison | Discount to appraised value | 16 | % | |||||||||||||
| Commercial and industrial | 75 | 75 | 0 | Sales comparison | Discount to appraised value | 100 | % | |||||||||||||
| Commercial and industrial | 1,265 | 584 | 681 | Sales comparison | Discount to borrower's financial statement value | 36 | % | |||||||||||||
| Loans secured by farmland | 487 | 49 | 438 | Sales comparison | Discount to appraised value | 56 | % | |||||||||||||
| Total impaired loans | $ | 4,851 | $ | 1,605 | $ | 3,246 | ||||||||||||||
| Foreclosed assets held for sale - real estate: | ||||||||||||||||||||
| Residential (1-4 family) | $ | 64 | $ | 0 | $ | 64 | Sales comparison | Discount to appraised value | 68 | % | ||||||||||
| Land | 110 | 0 | 110 | Sales comparison | Discount to appraised value | 61 | % | |||||||||||||
| Commercial real estate | 1,529 | 0 | 1,529 | Sales comparison | Discount to appraised value | 20 | % | |||||||||||||
| Total foreclosed assets held for sale | $ | 1,703 | $ | 0 | $ | 1,703 | ||||||||||||||
Certain of the Corporation’s financial instruments are not measured at fair value in the consolidated financial statements. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements. Therefore, the aggregate fair value amounts presented may not represent the underlying fair value of the Corporation.
| 39 |
The estimated fair values, and related carrying amounts, of the Corporation’s financial instruments that are not recorded at fair value are as follows:
| (In Thousands) | Fair Value | June 30, 2019 | December 31, 2018 | |||||||||||||||
| Hierarchy | Carrying | Fair | Carrying | Fair | ||||||||||||||
| Level | Amount | Value | Amount | Value | ||||||||||||||
| Financial assets: | ||||||||||||||||||
| Cash and cash equivalents | Level 1 | $ | 39,505 | $ | 39,505 | $ | 32,827 | $ | 32,827 | |||||||||
| Certificates of deposit | Level 2 | 4,560 | 4,655 | 4,660 | 4,634 | |||||||||||||
| Restricted equity securities (included in Other Assets) | Level 2 | 7,675 | 7,675 | 5,712 | 5,712 | |||||||||||||
| Loans, net | Level 3 | 1,108,483 | 1,131,884 | 818,254 | 825,809 | |||||||||||||
| Accrued interest receivable | Level 2 | 5,306 | 5,306 | 3,968 | 3,968 | |||||||||||||
| Financial liabilities: | ||||||||||||||||||
| Deposits with no stated maturity | Level 2 | 888,594 | 888,594 | 804,207 | 804,207 | |||||||||||||
| Time deposits | Level 2 | 395,549 | 397,820 | 229,565 | 229,751 | |||||||||||||
| Short-term borrowings | Level 2 | 27,493 | 27,350 | 12,853 | 12,617 | |||||||||||||
| Long-term borrowings | Level 2 | 38,273 | 38,420 | 35,915 | 35,902 | |||||||||||||
| Accrued interest payable | Level 2 | 443 | 443 | 142 | 142 | |||||||||||||
The Corporation has commitments to extend credit and has issued standby letters of credit. Standby letters of credit are conditional guarantees of performance by a customer to a third party. Estimates of the fair value of these off-balance sheet items were not made because of the short-term nature of these arrangements and the credit standing of the counterparties
| 40 |
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements in this section and elsewhere in this quarterly report on Form 10-Q are forward-looking statements. Citizens & Northern Corporation and its wholly-owned subsidiaries (collectively, the Corporation) intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995. Forward-looking statements, which are not historical facts, are based on certain assumptions and describe future plans, business objectives and expectations, and are generally identifiable by the use of words such as, "should", “likely”, "expect", “plan”, "anticipate", “target”, “forecast”, and “goal”. These forward-looking statements are subject to risks and uncertainties that are difficult to predict, may be beyond management’s control and could cause results to differ materially from those expressed or implied by such forward-looking statements. Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following:
| · | changes in monetary and fiscal policies of the Federal Reserve Board and the U. S. Government, particularly related to changes in interest rates |
| · | changes in general economic conditions |
| · | legislative or regulatory changes |
| · | downturn in demand for loan, deposit and other financial services in the Corporation’s market area |
| · | increased competition from other banks and non-bank providers of financial services |
| · | technological changes and increased technology-related costs |
| · | changes in accounting principles, or the application of generally accepted accounting principles |
| · | failure to achieve merger-related synergies and difficulties in integrating the business and operations of acquired institutions. |
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
EARNINGS OVERVIEW
Merger with Monument Bancorp, Inc.
The Corporation’s merger with Monument Bancorp, Inc. (“Monument”) was completed April 1, 2019. Monument was the parent company of Monument Bank, a commercial bank which operated two community bank offices and one lending office in Bucks County, Pennsylvania. Total purchase consideration was $42.7 million, including 1,279,825 shares of the Corporation’s common stock issued with a value of $33.1 million and cash paid totaling $9.6 million. Holders of Monument common stock prior to the consummation of the merger held approximately 9.4% of the Corporation’s common stock outstanding immediately following the merger.
In connection with the merger, effective April 1, 2019, the Corporation recorded goodwill of $16.7 million and a core deposit intangible asset of $1.5 million. Total loans acquired on April 1, 2019 were valued at $259.3 million, while total deposits assumed were valued at $223.3 million, borrowings were valued at $111.6 million and subordinated debt was valued at $12.4 million. The subordinated debt included an instrument with a fair value of $5.4 million that was redeemed on April 1, 2019 with no realized gain or loss. The Corporation acquired available-for-sale debt securities valued at $94.6 million and sold the securities in early April for approximately no realized gain or loss. The assets purchased and liabilities assumed in the merger were recorded at their estimated fair values at the time of closing and may be adjusted for up to one year subsequent to the acquisition.
The Corporation incurred merger-related expenses in the second quarter 2019 of $3.3 million, including costs associated with termination of data processing contracts, conversion of Monument’s customer accounting data into the Corporation’s core system, severance and similar expenses, legal and other professional fees and various other costs. Merger-related expenses for the six months ended June 30, 2019 totaled $3.6 million. Management expects additional merger-related expenses associated with the Monument merger subsequent to June 30, 2019 will be insignificant.
Unaudited Financial Information
Net income was $0.27 per diluted share in the second quarter 2019 as compared to $0.41 in the first quarter 2019 and $0.52 in the second quarter 2018. For the six months ended June 30, 2019, net income per diluted share was $0.67 as compared to $0.87 per share for the first six months of 2018. Earnings for the second quarter 2019 and six months ended June 30, 2019 were significantly impacted by the Monument acquisition, including the effects of non-recurring merger-related expenses described earlier. Further, interest income on loans acquired from Monument, partially offset by interest expense on deposits, borrowings and subordinated debt assumed, contributed to growth in the Corporation’s net interest income, while costs associated with the expansion contributed to an increase in noninterest expenses.
| 41 |
Earnings for the second quarter 2018 and six months ended June 30, 2018 included the benefit of a realized gain on a restricted equity security (Visa Inc. Class B stock) partially offset by the impact of a loss on available-for-sale debt securities. In the second quarter 2018, the Corporation recorded a pre-tax gain on a restricted equity security (Visa Class B stock) of $1,750,000 and a pre-tax impairment loss on available-for-sale debt securities (sold in July 2018) of $282,000.
The following table provides a reconciliation of the Corporation’s second quarter and June 30, 2019 year-to-date unaudited earnings results under U.S. generally accepted accounting principles (U.S. GAAP) to comparative non-U.S. GAAP results excluding Monument merger-related expenses and realized gains and losses on securities. Management believes disclosure of unaudited second quarter and six-months ended June 30, 2019 and 2018 earnings results, adjusted to exclude the impact of these items, provides useful information to investors for comparative purposes.
RECONCILIATION OF NET INCOME AND
DILUTED EARNINGS PER SHARE TO NON-U.S.
GAAP MEASURE
| (Dollars In Thousands, Except Per Share Data) | ||||||||||||||||||||||||||||||||
| (Unaudited) | 2nd Quarter 2019 | 2nd Quarter 2018 | ||||||||||||||||||||||||||||||
| Income | Diluted | Income | Diluted | |||||||||||||||||||||||||||||
| Before | Income | Earnings | Before | Income | Earnings | |||||||||||||||||||||||||||
| Income | Tax | per | Income | Tax | per | |||||||||||||||||||||||||||
| Tax | Provision | Net | Common | Tax | Provision | Net | Common | |||||||||||||||||||||||||
| Provision | (1) | Income | Share | Provision | (1) | Income | Share | |||||||||||||||||||||||||
| Results as Presented Under U.S. GAAP | $ | 4,342 | $ | 693 | $ | 3,649 | $ | 0.27 | $ | 7,748 | $ | 1,377 | $ | 6,371 | $ | 0.52 | ||||||||||||||||
| Add: Merger-Related Expenses | 3,301 | 673 | 2,628 | |||||||||||||||||||||||||||||
| Less: Gain on Restricted Equity Security | (1,750 | ) | (368 | ) | (1,382 | ) | ||||||||||||||||||||||||||
| Net (Gains) Losses on Available-for-Sale Debt Securities | (7 | ) | (1 | ) | (6 | ) | 282 | 59 | 223 | |||||||||||||||||||||||
| Adjusted Earnings, Excluding Effect of Merger- Related Expenses, Gain on Restricted Equity Security and Net Gains and Losses on Available-for-Sale Debt Securities (Non-U.S. GAAP) | $ | 7,636 | $ | 1,365 | $ | 6,271 | $ | 0.46 | $ | 6,280 | $ | 1,068 | $ | 5,212 | $ | 0.42 | ||||||||||||||||
| 6 Months Ended June 30, 2019 | 6 Months Ended June 30, 2018 | |||||||||||||||||||||||||||||||
| Income | Diluted | Income | Diluted | |||||||||||||||||||||||||||||
| Before | Income | Earnings | Before | Income | Earnings | |||||||||||||||||||||||||||
| Income | Tax | per | Income | Tax | per | |||||||||||||||||||||||||||
| Tax | Provision | Net | Common | Tax | Provision | Net | Common | |||||||||||||||||||||||||
| Provision | (1) | Income | Share | Provision | (1) | Income | Share | |||||||||||||||||||||||||
| Results as Presented Under U.S. GAAP | $ | 10,413 | $ | 1,674 | $ | 8,739 | $ | 0.67 | $ | 12,864 | $ | 2,118 | $ | 10,746 | $ | 0.87 | ||||||||||||||||
| Add: Merger-Related Expenses | 3,612 | 739 | 2,873 | |||||||||||||||||||||||||||||
| Less: Gain on Restricted Equity Security | (1,750 | ) | (368 | ) | (1,382 | ) | ||||||||||||||||||||||||||
| Net (Gains) Losses on Available-for-sale Debt Securities | (7 | ) | (1 | ) | (6 | ) | 282 | 59 | 223 | |||||||||||||||||||||||
| Adjusted Earnings, Excluding Effect of Merger- Related Expenses, Gain on Restricted Equity Security and Net Gains and Losses on Available-for-Sale Debt Securities (Non-U.S. GAAP) | $ | 14,018 | $ | 2,412 | $ | 11,606 | $ | 0.89 | $ | 11,396 | $ | 1,809 | $ | 9,587 | $ | 0.78 | ||||||||||||||||
| (1) | Income tax has been allocated based on an income tax rate of 21%. The tax benefit associated with merger-related expenses has been adjusted to reflect the estimated nondeductible portion of the expenses. |
Additional highlights related to the Corporation’s second quarter and June 30, 2019 year-to-date unaudited earnings results as compared to the first quarter 2019 and comparative periods of 2018 are presented below.
| 42 |
Second Quarter 2019 as Compared to Second Quarter 2018
Net income was $3,649,000 in the second quarter 2019. As noted in the table above, second quarter 2019 net income, excluding the impact of merger-related expenses and net securities gains, would be $6,271,000. In comparison, second quarter 2018 net income was $6,371,000, and excluding net securities gains, would be $5,212,000. Other significant variances were as follows:
| · | Net interest income of $14,205,000 was $2,950,000 (26.2%) higher in the second quarter 2019 as compared to the total for the second quarter 2018. The growth in net interest income resulted mainly from growth related to the Monument acquisition. The net interest margin of 3.89% for the second quarter 2019 was slightly higher than the second quarter 2018 margin of 3.87%. The average yield on earning assets was 0.45% higher in the second quarter 2019 as compared to the same period in 2018, while the average rate paid on interest-bearing liabilities increased 0.60% between periods. The increase in average rate on interest-bearing liabilities resulted primarily from comparatively higher rates on time deposits and short-term borrowings assumed from Monument. Accretion and amortization of purchase accounting-related adjustments from marking financial instruments to fair value had a positive effect on net interest income in the second quarter 2019 of $214,000, including an increase in income on loans of $413,000 partially offset by increases in interest expense on time deposits of $137,000 and on short-term borrowings of $62,000. The net positive impact to the second quarter 2019 net interest margin from accretion and amortization of purchase accounting adjustments was 0.06%. |
| · | Second quarter 2019 noninterest income was $160,000 higher than the second quarter 2018 total. Total trust and brokerage revenue increased $147,000, interchange revenue from debit card transactions increased $58,000 and net gains from sales of residential mortgage loans increased $55,000. Other noninterest income decreased $92,000, as there was no revenue from realization of tax credits in the second quarter 2019 while the second quarter 2018 total included revenue of $154,000 from tax credits associated with a donation of real estate. |
| · | Noninterest expense, excluding merger-related expenses, increased $1,738,000 in the second quarter 2019 over the second quarter 2018 amount. Salaries and wages expense increased $1,083,000, including $656,000 related to the former Monument operations and an increase of $185,000 in cash and stock-based incentive compensation expense. Other noninterest expense increased $277,000. Within other noninterest expense, expenses and net losses on other real estate properties increased $137,000, with other increases in loan collection expenses of $63,000, amortization of core deposit intangibles of $72,000, credit card operating costs of $51,000, other taxes of $36,000 and insurance of $31,000. Also, within other noninterest expense, donations expense decreased $249,000 reflecting a second quarter 2018 donation of real estate that resulted in expense of $250,000 with no similar item in 2019. Data processing expenses increased $268,000, reflecting the costs of operating two core processing systems for most of the second quarter 2019 as well as costs related to product development efforts in connection with a fintech organization and other increases in software licensing costs. |
Six Months Ended June 30, 2019 as Compared to Six Months Ended June 30, 2018
Net income for the six-month period ended June 30, 2019 was $8,739,000, or $0.67 per diluted share, while net income for the first six months of 2018 was $10,746,000, or $0.87 per share. Excluding the impact of merger-related expenses and net securities gains, adjusted earnings for the first six months of 2019 would be $11,606,000 or $0.89 per share as compared to similarly adjusted earnings of $9,587,000 or $0.78 per share for the first six months of 2018. Other significant variances were as follows:
| · | Net interest income was up $3,768,000 (17.0%) for the first six months of 2019 over the same period in 2018, reflecting the benefits of growth related to the Monument acquisition. The net interest margin was 3.96% for the first six months of 2019, up from 3.86% in 2018. The net interest margin for the first six months of 2019 included a net positive impact from accretion and amortization of purchase accounting adjustments of 0.03%. For the first six months of 2019, the average yield on earning assets was up 0.38% as compared to the same period in 2018, while the average rate paid on interest-bearing liabilities was up 0.42% between periods. Despite compression in the interest rate spread, the increase in the net interest margin reflected growth in average earning assets of $157.9 million, while in comparison, average interest-bearing liabilities increased $106.6 million. The excess growth in earning assets was funded mainly by an increase of $35.7 million in average noninterest-bearing demand deposits and by an increase in average stockholders’ equity (excluding accumulated other comprehensive income) of $26.9 million. |
| 43 |
| · | The credit for loan losses (reduction in expense) was $961,000 for the first six months of 2019 as compared to a provision of $272,000 in the first six months of 2018. The credit for loan losses in 2019 reflects the impact of eliminations of specific allowances on commercial loans that are no longer considered impaired. |
| · | Noninterest income was $160,000 higher for the first six months of 2019 as compared to the first six months of 2018. Total trust and brokerage revenue increased $180,000 and interchange revenue from debit card transactions increased $122,000. Loan servicing fees, net, decreased $126,000, as the fair value of servicing rights decreased $148,000 in 2019 as compared to a decrease of $26,000 in 2018. |
| · | Noninterest expense, excluding merger-related expenses, increased $2,539,000 for the six months ended June 30, 2019 over the total for the first six months of 2018. Significant variances included the following: |
| Ø | Salaries and wages expense increased $1,452,000, including $656,000 related to the former Monument operations and an increase of $351,000 in cash and stock-based incentive compensation expense. |
| Ø | Other noninterest expense increased $735,000. Within other noninterest expense, expenses and net losses on other real estate properties increased $416,000, with other increases in loan collection expenses of $172,000, credit card operating costs of $83,000, amortization of core deposit intangibles of $73,000, insurance of $49,000, other taxes of $36,000 and consulting related to the overdraft privilege program of $35,000. Also within other noninterest expense, donations expense decreased $249,000 reflecting the second quarter 2018 donation of real estate referred to above that resulted in expense of $250,000 with no similar item in 2019. |
| Ø | Data processing expenses increased $430,000, reflecting the costs of operating two core processing systems for most of the second quarter 2019 as well as costs related to product development efforts in connection with a fintech organization and other increases in software licensing costs. |
| Ø | Automated teller machine and interchange expense decreased $175,000, reflecting cost reductions pursuant to a renegotiated service contract. |
More detailed information concerning fluctuations in the Corporation’s earnings results and other financial information are provided in other sections of Management’s Discussion and Analysis.
| TABLE I - QUARTERLY FINANCIAL DATA | ||||||||||||||||||||||||
| (Dollars In Thousands, Except Per Share Data) | For the Three Months Ended: | |||||||||||||||||||||||
| (Unaudited) | June 30, | March 31, | Dec. 31, | Sept. 30, | June 30, | March 31, | ||||||||||||||||||
| 2019 | 2019 | 2018 | 2018 | 2018 | 2018 | |||||||||||||||||||
| Interest income | $ | 17,139 | $ | 13,065 | $ | 13,304 | $ | 12,800 | $ | 12,334 | $ | 11,890 | ||||||||||||
| Interest expense | 2,934 | 1,350 | 1,312 | 1,241 | 1,079 | 993 | ||||||||||||||||||
| Net interest income | 14,205 | 11,715 | 11,992 | 11,559 | 11,255 | 10,897 | ||||||||||||||||||
| (Credit) provision for loan losses | (4 | ) | (957 | ) | 252 | 60 | (20 | ) | 292 | |||||||||||||||
| Net interest income after (credit) provision for loan losses | 14,209 | 12,672 | 11,740 | 11,499 | 11,275 | 10,605 | ||||||||||||||||||
| Noninterest income | 4,849 | 4,406 | 5,040 | 4,462 | 4,689 | 4,406 | ||||||||||||||||||
| Net gains (losses) on securities | 7 | 0 | (4 | ) | 569 | 1,468 | 0 | |||||||||||||||||
| Merger-related expenses | 3,301 | 311 | 127 | 200 | 0 | 0 | ||||||||||||||||||
| Other noninterest expenses | 11,422 | 10,696 | 9,947 | 9,633 | 9,684 | 9,895 | ||||||||||||||||||
| Income before income tax provision | 4,342 | 6,071 | 6,702 | 6,697 | 7,748 | 5,116 | ||||||||||||||||||
| Income tax provision | 693 | 981 | 1,021 | 1,111 | 1,377 | 741 | ||||||||||||||||||
| Net income | $ | 3,649 | $ | 5,090 | $ | 5,681 | $ | 5,586 | $ | 6,371 | $ | 4,375 | ||||||||||||
| Net income attributable to common shares | $ | 3,630 | $ | 5,063 | $ | 5,654 | $ | 5,558 | $ | 6,339 | $ | 4,352 | ||||||||||||
| Basic earnings per common share | $ | 0.27 | $ | 0.41 | $ | 0.46 | $ | 0.45 | $ | 0.52 | $ | 0.36 | ||||||||||||
| Diluted earnings per common share | $ | 0.27 | $ | 0.41 | $ | 0.46 | $ | 0.45 | $ | 0.52 | $ | 0.36 | ||||||||||||
| 44 |
CRITICAL ACCOUNTING POLICIES
The presentation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates.
A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. Management believes the allowance for loan losses is adequate and reasonable. Analytical information related to the Corporation’s aggregate loans and the related allowance for loan losses is summarized by loan segment and classes of loans in Note 7 to the unaudited consolidated financial statements. Additional discussion of the Corporation’s allowance for loan losses is provided in a separate section later in Management’s Discussion and Analysis. As described in more detail in the Provision and Allowance for Loan Losses section of Management’s Discussion and Analysis, none of the performing loans purchased from Monument were found to be impaired in the second quarter 2019, and the recently purchased performing loans were excluded from the loan pools for which the general component of the allowance for loan losses was calculated. Accordingly, there was no allowance for loan losses at June 30, 2019 on loans purchased from Monument, which was the main reason the allowance dropped to 0.73% of total outstanding loans at June 30, 2019 from 1.12% at December 31, 2018. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.
Another material estimate is the calculation of fair values of the Corporation’s debt securities. For most of the Corporation’s debt securities, the Corporation receives estimated fair values of debt securities from an independent valuation service, or from brokers. In developing fair values, the valuation service and the brokers use estimates of cash flows, based on
historical performance of similar instruments in similar interest rate environments. Based on experience, management is aware that estimated fair values of debt securities tend to vary among brokers and other valuation services.
As described in Note 6 to the unaudited consolidated financial statements, management evaluates securities for other-than-temporary impairment (OTTI). In making that evaluation, consideration is given to (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, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery. Management’s assessments of the likelihood and potential for recovery in value of securities are subjective and based on sensitive assumptions.
NET INTEREST INCOME
The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense. Tables II, III and IV include information regarding the Corporation’s net interest income for the three-month and six-month periods ended June 30, 2019 and 2018. In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis. Accordingly, the net interest income amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the related Tables.
Three-Month Periods Ended June 30, 2019 and 2018
For the three-month periods, fully taxable equivalent net interest income was $14,469,000 in 2019, which was $2,883,000 (24.9%) higher than in 2018. Interest income was $4,738,000 higher in 2019 as compared to 2018, while interest expense was higher by $1,855,000 in comparing the same periods. As presented in Table III, the Net Interest Margin of 3.89% in 2019 was slightly higher than the margin of 3.87% in 2018, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) decreased to 3.56% in 2019 from 3.71% in 2018. Although the Interest Rate Spread compressed, the increase in Net Interest Margin reflected growth in average earning assets of $292,413,000, while in comparison, average interest-bearing liabilities increased $228,411,000. The excess growth in earning assets was funded mainly by an increase in average noninterest-bearing demand deposits of $45,930,000 and an increase in average stockholders’ equity (excluding accumulated other comprehensive income) of $43,358,000.
Overall, second quarter 2019 growth in earning assets and funding sources was driven mainly by the Monument acquisition. Total loans acquired on April 1, 2019 were valued at $259,295,000, while total deposits assumed were valued at $223,303,000, borrowings were valued at $111,568,000 and subordinated debt (excluding the $5,375,000 portion redeemed on April 1, 2019) was valued at $7,000,000. The Corporation also acquired available-for-sale debt securities valued at $94,568,000 which were sold in early April 2019.
| 45 |
Accretion and amortization of purchase accounting-related adjustments from marking financial instruments to fair value had a positive effect on net interest income in the second quarter 2019 of $214,000, including an increase in income on loans of $413,000 partially offset by increases in interest expense on time deposits of $137,000 and on short-term borrowings of $62,000. The net positive impact to the second quarter 2019 net interest margin from accretion and amortization of purchase accounting adjustments was 0.06%.
INTEREST INCOME AND EARNING ASSETS
Interest income totaled $17,403,000 in 2019, an increase of $4,738,000 (37.4%) from 2018. Interest and fees from loans receivable increased $4,473,000, or 43.5%, in 2019 as compared to 2018. Table IV shows the increase in interest on loans includes $3,762,000 attributable to an increase in average volume and $711,000 related to an increase in rate. The average balance of loans receivable increased $279,738,000 (33.9%) to $1,105,243 in 2019 from $825,505,000 in 2018, including the effects of loans acquired from Monument as well as additional growth in commercial and residential mortgage loans, particularly in the second quarter 2019. The average yield on loans in the second quarter of 2019 was 5.35% compared to 5.00% in the second quarter 2018 as current rates on variable rate loans and rates on recent new loan originations have increased due to increases in market interest rates that occurred over the first several months of 2018. Further, accretion of purchase accounting-related adjustments provided a positive impact of 0.15% to the second quarter 2019 yield on loans.
Interest income from available-for-sale debt securities increased $211,000 (9.3%) in 2019 over 2018. Total average available-for-sale debt securities (at amortized cost) in 2019 increased to $362,969,000 from $350,610,000 in 2018. The average rate of return on available-for-sale debt securities was 2.75% for 2019, up from 2.61% in 2018. The increase in average rate of return on available-for-sale debt securities is mainly the result of lower yielding securities maturing with the proceeds reinvested in higher yielding securities as rates increased throughout most of 2018.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
For the three-month periods, interest expense increased $1,855,000 to $2,934,000 in 2019 from $1,079,000 in 2018. Interest expense on deposits increased $1,484,000, as the average rate on interest-bearing deposits increased to 0.97% in 2019 from 0.45% in 2018. The increase in average rates on deposits includes increases of 0.92% on time deposit, 0.24% on money market accounts, 0.19% on interest checking accounts and 0.07% on saving accounts. Total average deposits (interest-bearing and noninterest-bearing) amounted to $1,269,218,000 in 2019, an increase of $240,679,000 (23.4%) from 2018. The increase in total average deposits included deposits assumed from Monument. The increase in average rate on interest-bearing liabilities resulted primarily from comparatively higher rates on deposits assumed from Monument.
Further contributing to the increase in average rate on deposits was an increase in higher-cost deposits as a proportion of total deposits. The average balance of time deposits increased $153,941,000 to 39% of total average interest-bearing deposits in the second quarter 2019 from 29% in the second quarter 2018. The growth in time deposits resulted from changes in mix attributable to deposits assumed from Monument and from an increase in time deposits within the Corporation’s legacy markets in the second quarter 2019. Amortization of purchase accounting-related adjustments resulted in an increase in the average rate on time deposits of 0.14% and on total interest-bearing deposits of 0.06%.
Interest expense on total borrowed funds increased $371,000 in 2019 as compared to 2018. The average balance of total borrowed funds increased to $79,446,000 in the second quarter 2019 from $45,784,000 in the second quarter 2018, while the average rate on borrowed funds increased to 2.88% in the second quarter 2019 from 1.75% in the second quarter 2018.
Interest expense on short-term borrowings increased $146,000 to $228,000 in 2019 from $82,000 in 2018. The average balance of short-term borrowings increased to $37,279,000 in 2019 from $23,610,000 in 2018. The total average short-term borrowings balance for the second quarter 2019 included the assumption of FHLB advances from Monument which had an average balance of $27,991,000 for the second quarter. The average rate on short-term borrowings increased to 2.45% in 2019 from 1.39% in 2018, reflecting increases in short-term rates consistent with the four quarterly increases in the Federal Reserve’s target rate in 2018.
Interest expense on long-term borrowings increased $110,000 to $228,000 in 2019 from $118,000 in 2018. The average balance of long-term borrowings was $35,167,000 in 2019, up from an average balance of $22,174,000 in 2018. Borrowings are classified as long-term within the Tables based on their term at origination. The average balance of long-term borrowings in 2019 and 2018 consisted mainly of FHLB advances with terms longer than 12 months at origination. The average rate on long-term borrowings was 2.60% in 2019 compared to 2.13% in the second quarter of 2018, reflecting increases in market rates that occurred in 2018.
| 46 |
Interest expense on subordinated debt assumed from Monument was $115,000 in the second quarter 2019 with no comparative amount in 2018.
Six-Month Periods Ended June 30, 2019 and 2018
For the six-month periods, fully taxable equivalent net interest income was $26,485,000 in 2019, $3,673,000 (16.1%) higher than in 2018. Interest income was $5,885,000 higher in 2019 as compared to 2018, while interest expense was higher by $2,212,000 in comparing the same periods. As presented in Table III, the Net Interest Margin was 3.96% in 2019 as compared to 3.86% in 2018, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) was 3.66% in 2019, down from 3.70% in 2018. Similar to the discussion above regarding the second quarter 2019, the overall growth in net interest income, despite margin compression, resulted mainly from the infusion of loans, deposits and borrowings from Monument.
INTEREST INCOME AND EARNING ASSETS
Interest income totaled $30,769,000 in 2019, an increase of $5,885,000 (23.7%) from 2018. Interest and fees on loans receivable increased $5,230,000, or 25.9%, to $25,412,000 in 2019 from $20,182,000 in 2018. Table IV shows the increase in interest on loans includes $3,859,000 attributable to an increase in volume and $1,371,000 related to an increase in average rate. The average balance of loans receivable increased $144,047,000 (17.5%) to $965,272,000 in 2019 from $821,225,000 in 2018. The increase in average balance reflects the Corporation’s purchase of Monument on April 1, 2019. The average rate on taxable loans in 2019 was 5.42% compared to 5.09% in 2018 as current rates on variable rate loans and rates on recent new loan originations have increased, consistent with increases in market interest rates. The yield on tax-exempt loans receivable increased to 3.88% in 2019 compared to 3.69% in 2018.
Interest income on available-for-sale debt securities totaled $5,072,000 in 2019, an increase of $533,000 from the total for 2018. As indicated in Table III, average available-for-sale debt securities (at amortized cost) totaled $362,452,000 in 2019, an increase of $10,645,000 (3.0%) from 2018. The average yield on available-for-sale debt securities increased to 2.82% in 2019 from 2.60% in 2018.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense increased $2,212,000 to $4,284,000 in 2019 from $2,072,000 in 2018. Table III shows that the overall cost of funds on interest-bearing liabilities increased to 0.93% in 2019 from 0.51% in 2018.
Interest expense on deposits increased $1,808,000 in 2019 over 2018. Total average deposit balances (interest-bearing and noninterest-bearing) increased 13.1%, to $1,145,831,000 in 2019 from $1,013,113,00 in 2018, mainly as a result of the Monument acquisition. The average rate on interest-bearing deposits increased to 0.79% in 2019 from 0.42% in 2018. Similar to the discussion above, the increase in average rate on deposits reflects comparatively higher rates on deposits assumed from Monument, including significant growth in higher-cost time deposits.
Interest expense on borrowed funds increased $404,000 in 2019 as compared to 2018. Total average borrowed funds increased $9,598,000 to $65,115,000 in 2019 from $55,517,000 in 2018. The average rate on total borrowed funds was 2.69% in 2019 compared to 1.69% in 2018. The increase in the average rate on borrowed funds in 2019 reflects the impact of increases in market rates over the course of 2018 and the impact of higher-cost subordinated debt assumed from Monument.
| 47 |
TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE
| Three Months Ended | Six Months Ended | |||||||||||||||||||||||
| June 30, | Increase/ | June 30, | Increase/ | |||||||||||||||||||||
| (In Thousands) | 2019 | 2018 | (Decrease) | 2019 | 2018 | (Decrease) | ||||||||||||||||||
| INTEREST INCOME | ||||||||||||||||||||||||
| Interest-bearing due from banks | $ | 149 | $ | 96 | $ | 53 | $ | 265 | $ | 146 | $ | 119 | ||||||||||||
| Available-for-sale debt securities: | ||||||||||||||||||||||||
| Taxable | 1,826 | 1,381 | 445 | 3,660 | 2,744 | 916 | ||||||||||||||||||
| Tax-exempt | 663 | 897 | (234 | ) | 1,412 | 1,795 | (383 | ) | ||||||||||||||||
| Total available-for-sale debt securities | 2,489 | 2,278 | 211 | 5,072 | 4,539 | 533 | ||||||||||||||||||
| Loans receivable: | ||||||||||||||||||||||||
| Taxable | 14,098 | 9,575 | 4,523 | 24,046 | 18,776 | 5,270 | ||||||||||||||||||
| Tax-exempt | 656 | 706 | (50 | ) | 1,366 | 1,406 | (40 | ) | ||||||||||||||||
| Total loans receivable | 14,754 | 10,281 | 4,473 | 25,412 | 20,182 | 5,230 | ||||||||||||||||||
| Other earning assets | 11 | 10 | 1 | 20 | 17 | 3 | ||||||||||||||||||
| Total Interest Income | 17,403 | 12,665 | 4,738 | 30,769 | 24,884 | 5,885 | ||||||||||||||||||
| INTEREST EXPENSE | ||||||||||||||||||||||||
| Interest-bearing deposits: | ||||||||||||||||||||||||
| Interest checking | 319 | 213 | 106 | 546 | 394 | 152 | ||||||||||||||||||
| Money market | 252 | 122 | 130 | 430 | 215 | 215 | ||||||||||||||||||
| Savings | 74 | 38 | 36 | 113 | 75 | 38 | ||||||||||||||||||
| Time deposits | 1,718 | 506 | 1,212 | 2,327 | 924 | 1,403 | ||||||||||||||||||
| Total interest-bearing deposits | 2,363 | 879 | 1,484 | 3,416 | 1,608 | 1,808 | ||||||||||||||||||
| Borrowed funds: | ||||||||||||||||||||||||
| Short-term | 228 | 82 | 146 | 307 | 281 | 26 | ||||||||||||||||||
| Long-term | 228 | 118 | 110 | 446 | 183 | 263 | ||||||||||||||||||
| Subordinated debt | 115 | 0 | 115 | 115 | 0 | 115 | ||||||||||||||||||
| Total borrowed funds | 571 | 200 | 371 | 868 | 464 | 404 | ||||||||||||||||||
| Total Interest Expense | 2,934 | 1,079 | 1,855 | 4,284 | 2,072 | 2,212 | ||||||||||||||||||
| Net Interest Income | $ | 14,469 | $ | 11,586 | $ | 2,883 | $ | 26,485 | $ | 22,812 | $ | 3,673 | ||||||||||||
Note: Interest income from tax-exempt securities and loans has been adjusted to a fully tax-equivalent basis, using the Corporation’s federal income tax rate of 21%.
| 48 |
TABLE III - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
(Dollars in Thousands)
| 3 Months | 3 Months | 6 Months | 6 Months | |||||||||||||||||||||||||||||
| Ended | Rate of | Ended | Rate of | Ended | Rate of | Ended | Rate of | |||||||||||||||||||||||||
| 6/30/2019 | Return/ | 6/30/2018 | Return/ | 6/30/2019 | Return/ | 6/30/2018 | Return/ | |||||||||||||||||||||||||
| Average | Cost of | Average | Cost of | Average | Cost of | Average | Cost of | |||||||||||||||||||||||||
| Balance | Funds % | Balance | Funds % | Balance | Funds % | Balance | Funds % | |||||||||||||||||||||||||
| EARNING ASSETS | ||||||||||||||||||||||||||||||||
| Interest-bearing due from banks | $ | 22,398 | 2.67 | % | $ | 22,286 | 1.73 | % | $ | 21,358 | 2.50 | % | $ | 18,231 | 1.61 | % | ||||||||||||||||
| Available-for-sale debt securities, at amortized cost: | ||||||||||||||||||||||||||||||||
| Taxable | 289,041 | 2.53 | % | 247,809 | 2.24 | % | 285,443 | 2.59 | % | 248,819 | 2.22 | % | ||||||||||||||||||||
| Tax-exempt | 73,928 | 3.60 | % | 102,801 | 3.50 | % | 77,009 | 3.70 | % | 102,988 | 3.51 | % | ||||||||||||||||||||
| Total available-for-sale debt securities | 362,969 | 2.75 | % | 350,610 | 2.61 | % | 362,452 | 2.82 | % | 351,807 | 2.60 | % | ||||||||||||||||||||
| Loans receivable: | ||||||||||||||||||||||||||||||||
| Taxable | 1,035,672 | 5.46 | % | 747,889 | 5.14 | % | 894,208 | 5.42 | % | 744,292 | 5.09 | % | ||||||||||||||||||||
| Tax-exempt | 69,571 | 3.78 | % | 77,616 | 3.65 | % | 71,064 | 3.88 | % | 76,933 | 3.69 | % | ||||||||||||||||||||
| Total loans receivable | 1,105,243 | 5.35 | % | 825,505 | 5.00 | % | 965,272 | 5.31 | % | 821,225 | 4.96 | % | ||||||||||||||||||||
| Other earning assets | 1,423 | 3.10 | % | 1,219 | 3.29 | % | 1,257 | 3.21 | % | 1,175 | 2.92 | % | ||||||||||||||||||||
| Total Earning Assets | 1,492,033 | 4.68 | % | 1,199,620 | 4.23 | % | 1,350,339 | 4.59 | % | 1,192,438 | 4.21 | % | ||||||||||||||||||||
| Cash | 20,325 | 18,010 | 18,629 | 17,445 | ||||||||||||||||||||||||||||
| Unrealized gain/loss on securities | (101 | ) | (8,242 | ) | (2,352 | ) | (6,893 | ) | ||||||||||||||||||||||||
| Allowance for loan losses | (8,378 | ) | (9,161 | ) | (8,856 | ) | (9,082 | ) | ||||||||||||||||||||||||
| Bank premises and equipment | 16,214 | 15,425 | 15,367 | 15,438 | ||||||||||||||||||||||||||||
| Intangible Assets | 30,040 | 11,952 | 21,045 | 11,953 | ||||||||||||||||||||||||||||
| Other assets | 49,935 | 41,575 | 46,573 | 42,174 | ||||||||||||||||||||||||||||
| Total Assets | $ | 1,600,068 | $ | 1,269,179 | $ | 1,440,745 | $ | 1,263,473 | ||||||||||||||||||||||||
| INTEREST-BEARING LIABILITIES | ||||||||||||||||||||||||||||||||
| Interest-bearing deposits: | ||||||||||||||||||||||||||||||||
| Interest checking | $ | 218,731 | 0.58 | % | $ | 217,607 | 0.39 | % | $ | 208,872 | 0.53 | % | $ | 215,307 | 0.37 | % | ||||||||||||||||
| Money market | 199,092 | 0.51 | % | 180,667 | 0.27 | % | 188,042 | 0.46 | % | 180,297 | 0.24 | % | ||||||||||||||||||||
| Savings | 173,922 | 0.17 | % | 152,663 | 0.10 | % | 165,354 | 0.14 | % | 151,149 | 0.10 | % | ||||||||||||||||||||
| Time deposits | 383,361 | 1.80 | % | 229,420 | 0.88 | % | 305,769 | 1.53 | % | 224,267 | 0.83 | % | ||||||||||||||||||||
| Total interest-bearing deposits | 975,106 | 0.97 | % | 780,357 | 0.45 | % | 868,037 | 0.79 | % | 771,020 | 0.42 | % | ||||||||||||||||||||
| Borrowed funds: | ||||||||||||||||||||||||||||||||
| Short-term | 37,279 | 2.45 | % | 23,610 | 1.39 | % | 26,666 | 2.32 | % | 37,878 | 1.50 | % | ||||||||||||||||||||
| Long-term | 35,167 | 2.60 | % | 22,174 | 2.13 | % | 34,929 | 2.57 | % | 17,639 | 2.09 | % | ||||||||||||||||||||
| Subordinated debt | 7,000 | 6.59 | % | 0 | 0.00 | % | 3,520 | 6.59 | % | 0 | 0.00 | % | ||||||||||||||||||||
| Total borrowed funds | 79,446 | 2.88 | % | 45,784 | 1.75 | % | 65,115 | 2.69 | % | 55,517 | 1.69 | % | ||||||||||||||||||||
| Total Interest-bearing Liabilities | 1,054,552 | 1.12 | % | 826,141 | 0.52 | % | 933,152 | 0.93 | % | 826,537 | 0.51 | % | ||||||||||||||||||||
| Demand deposits | 294,112 | 248,182 | 277,794 | 242,093 | ||||||||||||||||||||||||||||
| Other liabilities | 15,454 | 8,848 | 13,210 | 8,859 | ||||||||||||||||||||||||||||
| Total Liabilities | 1,364,118 | 1,083,171 | 1,224,156 | 1,077,489 | ||||||||||||||||||||||||||||
| Stockholders' equity, excluding other comprehensive income/loss | 235,733 | 192,375 | 218,175 | 191,258 | ||||||||||||||||||||||||||||
| Accumulated other comprehensive income/loss | 217 | (6,367 | ) | (1,586 | ) | (5,274 | ) | |||||||||||||||||||||||||
| Total Stockholders' Equity | 235,950 | 186,008 | 216,589 | 185,984 | ||||||||||||||||||||||||||||
| Total Liabilities and Stockholders' Equity | $ | 1,600,068 | $ | 1,269,179 | $ | 1,440,745 | $ | 1,263,473 | ||||||||||||||||||||||||
| Interest Rate Spread | 3.56 | % | 3.71 | % | 3.66 | % | 3.70 | % | ||||||||||||||||||||||||
| Net Interest Income/Earning Assets | 3.89 | % | 3.87 | % | 3.96 | % | 3.86 | % | ||||||||||||||||||||||||
| Total Deposits (Interest-bearing and Demand) | $ | 1,269,218 | $ | 1,028,539 | $ | 1,145,831 | $ | 1,013,113 | ||||||||||||||||||||||||
(1) Annualized rates of return on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation’s federal income tax rate of 21%.
(2) Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings.
(3) Rates of return on earning assets and costs of funds are presented on an annualized basis.
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TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES
| (In Thousands) | 3 Months Ended 6/30/19 vs. 6/30/18 | 6 Months Ended 6/30/19 vs. 6/30/18 | ||||||||||||||||||||||
| Change in | Change in | Total | Change in | Change in | Total | |||||||||||||||||||
| Volume | Rate | Change | Volume | Rate | Change | |||||||||||||||||||
| EARNING ASSETS | ||||||||||||||||||||||||
| Interest-bearing due from banks | $ | 1 | $ | 52 | $ | 53 | $ | 28 | $ | 91 | $ | 119 | ||||||||||||
| Available-for-sale debt securities: | ||||||||||||||||||||||||
| Taxable | 247 | 198 | 445 | 435 | 481 | 916 | ||||||||||||||||||
| Tax-exempt | (260 | ) | 26 | (234 | ) | (472 | ) | 89 | (383 | ) | ||||||||||||||
| Total available-for-sale debt securities | (13 | ) | 224 | 211 | (37 | ) | 570 | 533 | ||||||||||||||||
| Loans receivable: | ||||||||||||||||||||||||
| Taxable | 3,838 | 685 | 4,523 | 3,970 | 1,300 | 5,270 | ||||||||||||||||||
| Tax-exempt | (76 | ) | 26 | (50 | ) | (111 | ) | 71 | (40 | ) | ||||||||||||||
| Total loans receivable | 3,762 | 711 | 4,473 | 3,859 | 1,371 | 5,230 | ||||||||||||||||||
| Other earning assets | 1 | 0 | 1 | 1 | 2 | 3 | ||||||||||||||||||
| Total Interest Income | 3,751 | 987 | 4,738 | 3,851 | 2,034 | 5,885 | ||||||||||||||||||
| INTEREST-BEARING LIABILITIES | ||||||||||||||||||||||||
| Interest-bearing deposits: | ||||||||||||||||||||||||
| Interest checking | 1 | 105 | 106 | (12 | ) | 164 | 152 | |||||||||||||||||
| Money market | 11 | 119 | 130 | 9 | 206 | 215 | ||||||||||||||||||
| Savings | 6 | 30 | 36 | 8 | 30 | 38 | ||||||||||||||||||
| Time Deposits | 386 | 826 | 1,212 | 420 | 983 | 1,403 | ||||||||||||||||||
| Total interest-bearing deposits | 404 | 1,080 | 1,484 | 425 | 1,383 | 1,808 | ||||||||||||||||||
| Borrowed funds: | ||||||||||||||||||||||||
| Short-term | 68 | 78 | 146 | (99 | ) | 125 | 26 | |||||||||||||||||
| Long-term | 81 | 29 | 110 | 213 | 50 | 263 | ||||||||||||||||||
| Subordinated debt | 115 | 0 | 115 | 115 | 0 | 115 | ||||||||||||||||||
| Total borrowed funds | 264 | 107 | 371 | 229 | 175 | 404 | ||||||||||||||||||
| Total Interest Expense | 668 | 1,187 | 1,855 | 654 | 1,558 | 2,212 | ||||||||||||||||||
| Net Interest Income | $ | 3,083 | $ | (200 | ) | $ | 2,883 | $ | 3,197 | $ | 476 | $ | 3,673 | |||||||||||
(1) Changes in income on tax-exempt securities and loans are presented on a fully tax-equivalent basis, using the Corporation’s federal income tax rate of 21%.
(2) The change in interest due to both volume and rates has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amount of the change in each.
| 50 |
NONINTEREST INCOME
TABLE V - COMPARISON OF NONINTEREST INCOME | ||||||||||||||||
| (Dollars in Thousands) | ||||||||||||||||
| 3 Months Ended | ||||||||||||||||
| June 30, | $ | % | ||||||||||||||
| 2019 | 2018 | Change | Change | |||||||||||||
| Trust and financial management revenue | $ | 1,583 | $ | 1,526 | $ | 57 | 3.7 | % | ||||||||
| Brokerage revenue | 361 | 271 | 90 | 33.2 | % | |||||||||||
| Insurance commissions, fees and premiums | 48 | 13 | 35 | 269.2 | % | |||||||||||
| Service charges on deposit accounts | 1,277 | 1,302 | (25 | ) | -1.9 | % | ||||||||||
| Service charges and fees | 89 | 82 | 7 | 8.5 | % | |||||||||||
| Interchange revenue from debit card transactions | 699 | 641 | 58 | 9.0 | % | |||||||||||
| Net gains from sales of loans | 221 | 166 | 55 | 33.1 | % | |||||||||||
| Loan servicing fees, net | 35 | 61 | (26 | ) | -42.6 | % | ||||||||||
| Increase in cash surrender value of life insurance | 99 | 98 | 1 | 1.0 | % | |||||||||||
| Other noninterest income | 437 | 529 | (92 | ) | -17.4 | % | ||||||||||
| Total noninterest income, excluding realized gains (losses) on securities, net | $ | 4,849 | $ | 4,689 | $ | 160 | 3.4 | % | ||||||||
Total noninterest income shown in Table V in the second quarter 2019 and 2018 exclude net (losses) gains on available-for-sale debt securities and in 2018, the gain on a restricted equity security (Visa Class B stock). Within the totals, the most significant variances include the following:
| · | Total Trust and brokerage revenue increased $147,000 due to increased volume of brokerage transactions compared to 2018. |
| · | Interchange revenue from debit card transactions was up $58,000 reflecting an increase in volumes. |
| · | Net gains from sale of loans increased $55,000 due to increased production of loans sold. |
| · | Other noninterest income decreased $92,000, as there was no revenue from realization of tax credits in the second quarter 2019 while the second quarter 2018 total included revenue of $154,000 from tax credits associated with a donation of real estate. |
TABLE VI - COMPARISON OF NONINTEREST INCOME | ||||||||||||||||
| (Dollars in Thousands) | ||||||||||||||||
| 6 Months Ended | ||||||||||||||||
| June 30, | $ | % | ||||||||||||||
| 2019 | 2018 | Change | Change | |||||||||||||
| Trust and financial management revenue | $ | 2,943 | $ | 2,948 | $ | (5 | ) | -0.2 | % | |||||||
| Brokerage revenue | 668 | 483 | 185 | 38.3 | % | |||||||||||
| Insurance commissions, fees and premiums | 78 | 57 | 21 | 36.8 | % | |||||||||||
| Service charges on deposit accounts | 2,527 | 2,506 | 21 | 0.8 | % | |||||||||||
| Service charges and fees | 168 | 168 | 0 | 0.0 | % | |||||||||||
| Interchange revenue from debit card transactions | 1,342 | 1,220 | 122 | 10.0 | % | |||||||||||
| Net gains from sales of loans | 308 | 350 | (42 | ) | -12.0 | % | ||||||||||
| Loan servicing fees, net | 63 | 189 | (126 | ) | -66.7 | % | ||||||||||
| Increase in cash surrender value of life insurance | 191 | 195 | (4 | ) | -2.1 | % | ||||||||||
| Other noninterest income | 967 | 979 | (12 | ) | -1.2 | % | ||||||||||
| Total noninterest income, excluding realized gains (losses) on securities, net | $ | 9,255 | $ | 9,095 | $ | 160 | 1.8 | % | ||||||||
| 51 |
Total noninterest income shown in Table VI in the first six months of 2019 and 2018 excludes net gains (losses) on available-for-sale debt securities and in 2018, the gain on a restricted equity security (Visa Class B stock). Within the totals, the most significant variances include the following:
| · | Total Trust and brokerage revenue increased $180,000 due to increased volume of brokerage transactions compared to 2018. |
| · | Interchange revenue from debit card transactions was up $122,000 reflecting an increase in volumes. |
| · | Loan servicing fees, net, decreased $126,000, as the fair value of mortgage servicing rights decreased by $148,000 in the first six months of 2019 as compared to a decrease of $26,000 in the first six months of 2018. |
| · | Net gains from sale of loans decreased $42,000 due to decreased volumes. |
NONINTEREST EXPENSE
| TABLE VII - COMPARISON OF NONINTEREST EXPENSE | ||||||||||||||||
| (Dollars in Thousands) | ||||||||||||||||
| 3 Months Ended | ||||||||||||||||
| June 30, | $ | % | ||||||||||||||
| 2019 | 2018 | Change | Change | |||||||||||||
| Salaries and wages | $ | 5,276 | $ | 4,193 | $ | 1,083 | 25.8 | % | ||||||||
| Pensions and other employee benefits | 1,225 | 1,200 | 25 | 2.1 | % | |||||||||||
| Occupancy expense, net | 665 | 613 | 52 | 8.5 | % | |||||||||||
| Furniture and equipment expense | 333 | 313 | 20 | 6.4 | % | |||||||||||
| Data processing expenses | 962 | 694 | 268 | 38.6 | % | |||||||||||
| Automated teller machine and interchange expense | 277 | 319 | (42 | ) | -13.2 | % | ||||||||||
| Pennsylvania shares tax | 347 | 336 | 11 | 3.3 | % | |||||||||||
| Professional fees | 331 | 279 | 52 | 18.6 | % | |||||||||||
| Telecommunications | 176 | 157 | 19 | 12.1 | % | |||||||||||
| Directors' fees | 141 | 168 | (27 | ) | -16.1 | % | ||||||||||
| Other noninterest expense | 1,689 | 1,412 | 277 | 19.6 | % | |||||||||||
| Total noninterest expense, excluding merger- related expenses | 11,422 | 9,684 | 1,738 | 17.9 | % | |||||||||||
| Merger-related expenses | 3,301 | 0 | 3,301 | 0.0 | % | |||||||||||
| Total noninterest expense | $ | 14,723 | $ | 9,684 | $ | 5,039 | 52.0 | % | ||||||||
As shown in Table VII, total noninterest expense, excluding merger-related expenses, increased $1,738,000 (17.9%) for the three months ended June 30, 2019 over the total for the three months ended June 30, 2018. The most significant variances include the following:
| · | Salaries and wages expense increased $1,083,000, including $656,000 related to the former Monument operations and an increase of $185,000 in cash and stock-based incentive compensation expense. Mainly due to the recent acquisition, the number of full-time equivalent employees increased to 332 at June 30, 2019 from 299 at March 31, 2019 and 296 at June 30, 2018. |
| · | Pensions and other employee benefits expense increased by only $25,000 despite the increase in personnel from the additional staffing for former Monument locations. In the second quarter 2019, the Corporation received a credit of $201,000 for overpayment of healthcare claims on the partially self-insured plan. |
| · | Other noninterest expense increased $277,000. Within other noninterest expense, expenses and net losses on other real estate properties increased $137,000, with other increases in loan collection expenses of $63,000, amortization of core deposit intangibles of $72,000, credit card operating costs of $51,000, other taxes of $36,000 and insurance of $31,000. Also, within other noninterest expense, donations expense decreased $249,000 reflecting a second quarter 2018 donation of real estate that resulted in expense of $250,000 with no similar item in 2019. |
| 52 |
| · | Data processing expenses increased $268,000, reflecting the costs of operating two core processing systems for most of the second quarter 2019 as well as costs related to product development efforts in connection with a fintech organization and other increases in software licensing costs. |
TABLE VIII - COMPARISON OF NONINTEREST EXPENSE | ||||||||||||||||
| (Dollars in Thousands) | ||||||||||||||||
| 6 Months Ended | ||||||||||||||||
| June 30, | $ | % | ||||||||||||||
| 2019 | 2018 | Change | Change | |||||||||||||
| Salaries and wages | $ | 9,769 | $ | 8,317 | $ | 1,452 | 17.5 | % | ||||||||
| Pensions and other employee benefits | 2,843 | 2,810 | 33 | 1.2 | % | |||||||||||
| Occupancy expense, net | 1,322 | 1,250 | 72 | 5.8 | % | |||||||||||
| Furniture and equipment expense | 634 | 584 | 50 | 8.6 | % | |||||||||||
| Data processing expenses | 1,765 | 1,335 | 430 | 32.2 | % | |||||||||||
| Automated teller machine and interchange expense | 466 | 641 | (175 | ) | -27.3 | % | ||||||||||
| Pennsylvania shares tax | 694 | 672 | 22 | 3.3 | % | |||||||||||
| Professional fees | 553 | 555 | (2 | ) | -0.4 | % | ||||||||||
| Telecommunications | 340 | 390 | (50 | ) | -12.8 | % | ||||||||||
| Directors' fees | 324 | 352 | (28 | ) | -8.0 | % | ||||||||||
| Other noninterest expense | 3,408 | 2,673 | 735 | 27.5 | % | |||||||||||
| Total noninterest expense, excluding merger- related expenses | 22,118 | 19,579 | 2,539 | 13.0 | % | |||||||||||
| Merger-related expenses | 3,612 | 0 | 3,612 | 0.0 | % | |||||||||||
| Total noninterest expense | $ | 25,730 | $ | 19,579 | $ | 6,151 | 31.4 | % | ||||||||
As shown in Table VIII, total noninterest expense, excluding merger-related expenses, increased $2,539,000 (13.0%) for the six months ended June 30, 2019 over the total for the first six months of 2018. The most significant variances include the following:
| · | Salaries and wages expense increased $1,452,000, including $656,000 related to the former Monument operations and an increase of $351,000 in cash and stock-based incentive compensation expense. |
| · | Other noninterest expense increased $735,000. Within other noninterest expense, expenses and net losses on other real estate properties increased $416,000, with other increases in loan collection expenses of $172,000, credit card operating costs of $83,000, amortization of core deposit intangibles of $73,000, insurance of $49,000, other taxes of $36,000 and consulting related to the overdraft privilege program of $35,000. Also, within other noninterest expense, donations expense decreased $249,000 reflecting the second quarter 2018 donation of real estate referred to above that resulted in expense of $250,000 with no similar item in 2019. |
| · | Data processing expenses increased $430,000, reflecting the costs of operating two core processing systems for most of the second quarter 2019 as well as costs related to product development efforts in connection with a fintech organization and other increases in software licensing costs. |
| · | Automated teller machine and interchange expense decreased $175,000, reflecting cost reductions pursuant to a renegotiated service contract. |
INCOME TAXES
The income tax provision in interim periods is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The income tax provision for the first six months of 2019 was $1,674,000, or 16.1% of pre-tax earnings, which was $444,000 lower than the provision for the first six months of 2018 of $2,118,000, or 16.5% of pre-tax income. The Corporation’s effective tax rates differ from the statutory rate of 21% in the first six months of 2019 and 2018 principally because of the effects of tax-exempt interest income.
| 53 |
The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. The net deferred tax asset at June 30, 2019 and December 31, 2018 represents the following temporary difference components:
| June 30, | December 31, | |||||||
| (In Thousands) | 2019 | 2018 | ||||||
| Deferred tax assets: | ||||||||
| Unrealized holding losses on available-for-sale debt securities | $ | 0 | $ | 1,145 | ||||
| Allowance for loan losses | 1,766 | 2,005 | ||||||
| Other deferred tax assets | 2,926 | 2,049 | ||||||
| Total deferred tax assets | 4,692 | 5,199 | ||||||
| Deferred tax liabilities: | ||||||||
| Unrealized holding gains on available-for-sale debt securities | 834 | 0 | ||||||
| Unfunded retirement obligations | 79 | 37 | ||||||
| Bank premises and equipment | 914 | 907 | ||||||
| Core deposit intangibles | 293 | 2 | ||||||
| Other deferred tax liabilities | 401 | 143 | ||||||
| Total deferred tax liabilities | 2,521 | 1,089 | ||||||
| Deferred tax asset, net | $ | 2,171 | $ | 4,110 | ||||
At June 30, 2019, the net deferred tax asset was $2,171,000, down from $4,110,000 at December 31, 2018. The most significant change in temporary difference components was a net decrease of $1,979,000 in the deferred tax asset resulting from appreciation in available-for-sale debt securities resulting from lower interest rates.
The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income, including taxable income in prior carryback years, as well as future taxable income.
Management believes the recorded net deferred tax asset at June 30, 2019 is fully realizable; however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings.
FINANCIAL CONDITION
This section includes information regarding the Corporation’s lending activities or other significant changes or exposures that are not otherwise addressed in Management’s Discussion and Analysis. Significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the “Net Interest Income” section of Management’s Discussion and Analysis. Other significant balance sheet items, including the allowance for loan losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis. There are no significant concerns that have arisen related to the Corporation’s off-balance sheet loan commitments or outstanding standby letters of credit at June 30, 2019. Management does not expect capital expenditures or the Monument acquisition to have a material, detrimental effect on the Corporation’s financial condition in 2019.
Net loans outstanding (excluding mortgage loans held for sale) were $1,108,483,000 at June 30, 2019, up from $817,136,000 at March 31, 2019 and up 36.9% from $809,816,000 at June 30, 2018. As previously noted, a significant portion of the increase in loans in the second quarter 2019 was related to the Monument acquisition. In comparing outstanding balances at June 30, 2019 and 2018, total commercial loans increased $167.3 million (47.4%), total residential mortgage loans increased $126.9 million (28.2%) and total consumer loans increased $3.9 million (24.5%). At June 30, 2019, the outstanding balance of commercial loan participations with other financial entities was $66.3 million as compared to $68.4 million at March 31, 2019 and $62.9 million at June 30, 2018.
Total loans outstanding at March 31, 2019 amounted to $825,392,000. The adjusted total, including the recorded fair value of loans purchased from Monument on April 1, 2019, would be $1,084,687,000. Second quarter 2019 loan growth was significant, as total loans outstanding increased $31,996,000 from the adjusted prior quarter ending balance, including an increase in commercial loans outstanding of $24,546,000. Approximately half of the second quarter 2019 loan growth, subsequent to the initial acquisition, was attributable to lending activity in southeastern Pennsylvania (former Monument offices).
| 54 |
While the Corporation’s lending activities are primarily concentrated in its market area, a portion of the Corporation’s commercial loan segment consists of participation loans. Participation loans represent portions of larger commercial transactions for which other institutions are the “lead banks”. Although not the lead bank, the Corporation conducts detailed underwriting and monitoring of participation loan opportunities. Participation loans are included in the “Commercial and industrial,” “Commercial loans secured by real estate”, “Political subdivisions” and “Other commercial” classes in the loan tables presented in this Form 10-Q. Total participation loans outstanding amounted to $66,289,000 at June 30, 2019 as compared to $67,340,000 at December 31, 2018 and $62,949,000 at June 30, 2018. At June 30, 2019, the balance of participation loans outstanding includes a total of $58,187,000 to businesses located outside of the Corporation’s market area. Also, included within participation loans outstanding are “leveraged loans,” meaning loans to businesses with minimal tangible book equity and for which the extent of collateral available is limited, though typically at the time of origination the businesses have demonstrated strong cash flow performance in their recent histories. Leveraged participation loans outstanding totaled $11,923,000 at June 30, 2019 and $13,315,000 at December 31, 2018.
Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Xtra program consist primarily of conforming, prime loans sold to the Federal National Mortgage Association (Fannie Mae), a quasi-government entity. In 2014, the Corporation began to originate and sell residential mortgage loans to the secondary market through the MPF Original program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Prior to the April 2019 merger, Monument Bank had participated in the MPF Original program. Residential mortgages originated and sold through the MPF Original program consist primarily of conforming, prime loans sold to the Federal Home Loan Bank of Pittsburgh.
For loan sales originated under the MPF Xtra and Original programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met. Such repurchases or reimbursements generally result from an underwriting or documentation deficiency. At
June 30, 2019, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,865,000, and the corresponding total outstanding balance repurchased at December 31, 2018 was $2,146,000.
At June 30, 2019, outstanding balances of loans sold and serviced through the two programs totaled $172,910,000, including loans sold through the MPF Xtra program of $98,825,000 and loans sold through the Original program of $74,085,000. In addition, the outstanding balance of loans sold under the MPF Original program by Monument totaled $21,808,000. The loans sold by Monument are not serviced by the Corporation; however, the Corporation has assumed the credit enhancement obligation on these loans (as discussed in the next paragraph). At December 31, 2018, outstanding balances of loans sold and serviced through the two programs totaled $171,742,000, including loans sold through the MPF Xtra program of $96,841,000 and loans sold through the Original program of $74,901,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of June 30, 2019 and December 31, 2018.
For loans sold under the Original program, the Corporation provides a credit enhancement whereby the Corporation would assume credit losses in excess of a defined First Loss Account (“FLA”) balance, up to specified amounts. The FLA is funded by the Federal Home Loan Bank of Pittsburgh based on a percentage of the outstanding balance of loans sold. At June 30, 2019, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $4,553,000, and the Corporation has recorded a related allowance for credit losses of $297,000 which is included in “Accrued interest and other liabilities” in the accompanying consolidated balance sheets. At December 31, 2018, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $4,157,000, and the related allowance for credit losses was $328,000. The Corporation does not provide a credit enhancement for loans sold through the Xtra program.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction of the investment in loans. Note 7 to the unaudited consolidated financial statements provides an overview of the process management uses for evaluating and determining the allowance for loan losses.
While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.
| 55 |
The allowance for loan losses was $8,200,000 at June 30, 2019, down from $9,309,000 at December 31, 2018. Table VIII shows total specific allowances on impaired loans decreased $1,308,000 to $297,000 at June 30, 2019 from $1,605,000 at December 31, 2018. This decrease is the result of a net reduction in specific allowances totaling $1,308,000 in the first six months of 2019 and was the main cause of the credit for loan losses recorded in the period. In particular, specific allowances totaling $1,365,000 at December 31, 2018 on two commercial loans were eliminated in the first quarter 2019. These two loans were no longer considered impaired at March 31, 2019, were returned to full accrual status in the first quarter 2019 and remained in full accrual status at June 30, 2019. A specific allowance of $781,000 at December 31, 2018 on a real estate secured commercial loan was eliminated in the first quarter 2019 due to the borrower’s improved financial performance and receipt of an updated, higher appraised value of the underlying collateral. Also, a specific allowance of $584,000 on a commercial loan was eliminated, consistent with improvements in both the borrower’s financial position and the Corporation’s security position on the credit.
Loans acquired from Monument that were identified as having a deterioration in credit quality (purchased credit impaired, or PCI), were valued at $441,000 at April 1, 2019 and June 30, 2019. The remainder of the portfolio was deemed to be the performing component of the portfolio. The calculation of the fair value of performing loans included a discount for credit losses of $1,907,000, reflecting an estimate of the present value of credit losses based on market expectations. None of the performing loans purchased were found to be impaired in the second quarter 2019, and the recently purchased performing loans were excluded from the loan pools for which the general component of the allowance for loan losses was calculated. Accordingly, there was no allowance for loan losses at June 30, 2019 on loans purchased from Monument, which was the main reason the allowance dropped to 0.73% of total outstanding loans at June 30, 2019 from 1.12% at December 31, 2018.
The (credit) provision for loan losses by segment in the three-month and six-month periods ended June 30, 2019 and 2018 are as follows:
| (In Thousands) | 3 Months Ended | 6 Months Ended | ||||||||||||||
| June 30, | June 30, | June 30, | June 30, | |||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Residential mortgage | $ | 3 | $ | 47 | $ | 78 | $ | 78 | ||||||||
| Commercial | (51 | ) | (120 | ) | (1,200 | ) | 97 | |||||||||
| Consumer | 44 | 53 | 75 | 97 | ||||||||||||
| Unallocated | 0 | 0 | 86 | 0 | ||||||||||||
| Total | $ | (4 | ) | $ | (20 | ) | $ | (961 | ) | $ | 272 | |||||
The (credit) provision for loan losses is further detailed as follows:
| 3 Months | 3 Months | 6 Months | 6 Months | |||||||||||||
| Residential mortgage segment | Ended | Ended | Ended | Ended | ||||||||||||
| (In thousands) | June 30, | June 30, | June 30, | June 30, | ||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs | $ | 31 | $ | 41 | $ | 99 | $ | 92 | ||||||||
| Increase (decrease) in collectively determined portion of the allowance attributable to: | ||||||||||||||||
| Loan growth | 54 | 43 | 56 | 23 | ||||||||||||
| Changes in historical loss experience factors | 2 | (37 | ) | 7 | (37 | ) | ||||||||||
| Changes in qualitative factors | (84 | ) | 0 | (84 | ) | 0 | ||||||||||
| Total provision for loan losses - Residential mortgage segment | $ | 3 | $ | 47 | $ | 78 | $ | 78 | ||||||||
| 56 |
| 3 Months | 3 Months | 6 Months | 6 Months | |||||||||||||
| Commercial segment | Ended | Ended | Ended | Ended | ||||||||||||
| (In thousands) | June 30, | June 30, | June 30, | June 30, | ||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Decrease in total specific allowance on impaired loans, adjusted for the effect of net charge-offs | $ | (196 | ) | $ | (142 | ) | $ | (1,303 | ) | $ | (31 | ) | ||||
| Increase (decrease) in collectively determined portion of the allowance attributable to: | ||||||||||||||||
| Loan growth (reduction) | 310 | (18 | ) | 324 | 35 | |||||||||||
| Changes in historical loss experience factors | (314 | ) | 40 | (312 | ) | 93 | ||||||||||
| Changes in qualitative factors | 149 | 0 | 91 | 0 | ||||||||||||
| Total (credit) provision for loan losses - Commercial segment | $ | (51 | ) | $ | (120 | ) | $ | (1,200 | ) | $ | 97 | |||||
| 3 Months | 3 Months | 6 Months | 6 Months | |||||||||||||
| Consumer segment | Ended | Ended | Ended | Ended | ||||||||||||
| (In thousands) | June 30, | June 30, | June 30, | June 30, | ||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs | $ | 16 | $ | 23 | $ | 44 | $ | 52 | ||||||||
| Increase (decrease) in collectively determined portion of the allowance attributable to: | ||||||||||||||||
| Loan growth | 18 | 5 | 18 | 9 | ||||||||||||
| Changes in historical loss experience factors | (10 | ) | 16 | 0 | 26 | |||||||||||
| Changes in qualitative factors | 20 | 9 | 13 | 10 | ||||||||||||
| Total provision for loan losses - Consumer segment | $ | 44 | $ | 53 | $ | 75 | $ | 97 | ||||||||
| 3 Months | 3 Months | 6 Months | 6 Months | |||||||||||||
| Total - All segments | Ended | Ended | Ended | Ended | ||||||||||||
| (In thousands) | June 30, | June 30, | June 30, | June 30, | ||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| (Decrease) increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs | $ | (149 | ) | $ | (78 | ) | $ | (1,160 | ) | $ | 113 | |||||
| Increase (decrease) in collectively determined portion of the allowance attributable to: | ||||||||||||||||
| Loan growth | 382 | 30 | 398 | 67 | ||||||||||||
| Changes in historical loss experience factors | (322 | ) | 19 | (305 | ) | 82 | ||||||||||
| Changes in qualitative factors | 85 | 9 | 20 | 10 | ||||||||||||
| Subtotal | (4 | ) | (20 | ) | (1,047 | ) | 272 | |||||||||
| Unallocated | 0 | 0 | 86 | 0 | ||||||||||||
| Total (credit) provision for loan losses - All segments | $ | (4 | ) | $ | (20 | ) | $ | (961 | ) | $ | 272 | |||||
For the periods shown in the tables immediately above, the provision related to increases or decreases in specific allowances on impaired loans was affected by changes in the results of management’s assessment of the amount of probable or actual (charged-off) losses associated with a small number of larger, individual loans. This line item also includes net charge-offs or recoveries from smaller loans that had not been individually evaluated for impairment prior to charge-off.
| 57 |
In the tables immediately above, the portion of the net change in the collectively determined allowance attributable to loan growth was determined by applying the historical loss experience and qualitative factors used in the allowance calculation at the end of the preceding period to the net increase or decrease in loans outstanding (excluding loans specifically evaluated for impairment) for the period.
The effect on the provision of changes in historical loss experience and qualitative factors, as shown in the tables above, was determined by: (1) calculating the net change in each factor used in determining the allowance at the end of the period as compared to the preceding period, and (2) applying the net change in each factor to the outstanding balance of loans at the end of the preceding period (excluding loans specifically evaluated for impairment).
Table IX presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs). Total nonperforming loans as a percentage of outstanding loans was 1.07% at June 30, 2019, down from 1.94% at December 31, 2018, and nonperforming assets as a percentage of total assets was 0.95% at June 30, 2019, down from 1.37% at December 31, 2018. Table IX presents data at June 30, 2019 and at the end of each of the years ended December 31, 2014 through 2018. Table IX shows that total nonperforming loans as a percentage of loans of 1.07% at June 30, 2019 was lower than the corresponding year-end ratio from 2014 through 2018. Similarly, the June 30, 2019 ratio of total nonperforming assets as a percentage of assets of 0.95% was lower than the corresponding ratio from 2014 through 2018. These improved credit-related ratios reflect: (1) the impact of acquired loans from Monument with minimal nonperforming loans at June 30, 2019; and (2) reductions in total nonperforming assets due to improved conditions on the two larger loans referenced above.
Total impaired loans of $6,264,000 at June 30, 2019 are down $3,510,000 from the corresponding amount at December 31, 2018 of $9,774,000. In the first six months of 2019, the two commercial loans referred to above for which specific allowances were eliminated were not considered to be impaired at June 30, 2019 but were considered impaired at December 31, 2018. Total outstanding balances of these loans were $3,781,000 at December 31, 2018. Other significant changes in impaired loans in 2019 included: (1) addition to impaired status of a commercial and industrial loan with a balance of $719,000 and a specific allowance of $60,000 at June 30, 2019; and (2) removal from impaired status of a commercial loan with an outstanding balance of $326,000 at December 31, 2018 for which foreclosure proceedings were completed and the related real estate acquired in the first quarter 2019 (included in Foreclosed assets held for sale with a carrying value of $326,000 at June 30, 2019). Table IX shows that the total balance of impaired loans at June 30, 2019 was lower than the year-end amounts over the period 2014-2018, which ranged from a low of $9,511,000 in 2017 to a high of $12,316,000 in 2014.
Total nonperforming assets of $15,225,000 at June 30, 2019 are $2,497,000 lower than the corresponding amount at December 31, 2018, summarized as follows:
| · | Total nonaccrual loans at June 30, 2019 of $9,289,000 was $3,824,000 lower than the corresponding December 31, 2018 total of $13,113,000, including the effect of reducing nonaccrual loans due to the return to full accrual status of the two commercial loans described above with balances totaling $3,781,000 at December 31, 2018. |
| · | Total loans past due 90 days or more and still accruing interest amounted to $2,631,000 at June 30, 2019, a decrease of $275,000 from the total at December 31, 2018. |
| · | Foreclosed assets held for sale consisted of real estate, and totaled $3,305,000 at June 30, 2019, an increase of $1,602,000 from $1,703,000 at December 31, 2018. Of this increase, $1,064,000 related to two properties acquired through the Monument acquisition. At June 30, 2019, the Corporation held fourteen such properties for sale, with total carrying values of $368,000 related to residential real estate, $110,000 of land and $2,827,000 related to commercial real estate. At December 31, 2018, the Corporation held six such properties for sale, with total carrying values of $64,000 related to residential real estate, $110,000 of land and $1,529,000 related to commercial real estate. The Corporation evaluates the carrying values of foreclosed assets each quarter based on the most recent market activity or appraisals for each property. |
Over the period 2014-2018 and the first six months of 2019, each period includes a few large commercial relationships that have required significant monitoring and workout efforts. As a result, a limited number of relationships may significantly impact the total amount of allowance required on impaired loans and may significantly impact the amount of total charge-offs reported in any one period.
| 58 |
Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of June 30, 2019. Management continues to closely monitor its commercial loan relationships for possible credit losses and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.
Tables VII through X present historical data related to loans and the allowance for loan losses.
| TABLE VII - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES | ||||||||||||||||||||||||||||
| (Dollars In Thousands) | ||||||||||||||||||||||||||||
| June 30, | June 30, | Years Ended December 31, | ||||||||||||||||||||||||||
| 2019 | 2018 | 2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||||||||
| Balance, beginning of year | $ | 9,309 | $ | 8,856 | $ | 8,856 | $ | 8,473 | $ | 7,889 | $ | 7,336 | $ | 8,663 | ||||||||||||||
| Charge-offs: | ||||||||||||||||||||||||||||
| Residential mortgage | (107 | ) | (53 | ) | (158 | ) | (197 | ) | (73 | ) | (217 | ) | (327 | ) | ||||||||||||||
| Commercial | (6 | ) | (21 | ) | (165 | ) | (132 | ) | (597 | ) | (251 | ) | (1,715 | ) | ||||||||||||||
| Consumer | (66 | ) | (41 | ) | (174 | ) | (150 | ) | (87 | ) | (94 | ) | (97 | ) | ||||||||||||||
| Total charge-offs | (179 | ) | (115 | ) | (497 | ) | (479 | ) | (757 | ) | (562 | ) | (2,139 | ) | ||||||||||||||
| Recoveries: | ||||||||||||||||||||||||||||
| Residential mortgage | 6 | 2 | 8 | 19 | 3 | 1 | 25 | |||||||||||||||||||||
| Commercial | 3 | 2 | 317 | 4 | 35 | 214 | 264 | |||||||||||||||||||||
| Consumer | 22 | 12 | 41 | 38 | 82 | 55 | 47 | |||||||||||||||||||||
| Total recoveries | 31 | 16 | 366 | 61 | 120 | 270 | 336 | |||||||||||||||||||||
| Net charge-offs | (148 | ) | (99 | ) | (131 | ) | (418 | ) | (637 | ) | (292 | ) | (1,803 | ) | ||||||||||||||
| (Credit) Provision for loan losses | (961 | ) | 292 | 584 | 801 | 1,221 | 845 | 476 | ||||||||||||||||||||
| Balance, end of period | $ | 8,200 | $ | 9,049 | $ | 9,309 | $ | 8,856 | $ | 8,473 | $ | 7,889 | $ | 7,336 | ||||||||||||||
| Net charge-offs as a % of average loans | 0.02 | % | 0.01 | % | 0.02 | % | 0.05 | % | 0.09 | % | 0.04 | % | 0.29 | % | ||||||||||||||
| TABLE VIII - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES | ||||||||||||||||||||||||
| (In Thousands) | ||||||||||||||||||||||||
| June 30, | As of December 31, | |||||||||||||||||||||||
| 2019 | 2018 | 2017 | 2016 | 2015 | 2014 | |||||||||||||||||||
| ASC 310 - Impaired loans | $ | 297 | $ | 1,605 | $ | 1,279 | $ | 674 | $ | 820 | $ | 769 | ||||||||||||
| ASC 450 - Collective segments: | ||||||||||||||||||||||||
| Commercial | 3,205 | 3,102 | 3,078 | 3,373 | 3,103 | 2,732 | ||||||||||||||||||
| Residential mortgage | 3,849 | 3,870 | 3,841 | 3,890 | 3,417 | 3,295 | ||||||||||||||||||
| Consumer | 264 | 233 | 159 | 138 | 122 | 145 | ||||||||||||||||||
| Unallocated | 585 | 499 | 499 | 398 | 427 | 395 | ||||||||||||||||||
| Total Allowance | $ | 8,200 | $ | 9,309 | $ | 8,856 | $ | 8,473 | $ | 7,889 | $ | 7,336 | ||||||||||||
| 59 |
| TABLE IX - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS | ||||||||||||||||||||||||
| AND TROUBLED DEBT RESTRUCTURINGS (TDRs) | ||||||||||||||||||||||||
| (Dollars In Thousands) | ||||||||||||||||||||||||
| June 30, | As of December 31, | |||||||||||||||||||||||
| 2019 | 2018 | 2017 | 2016 | 2015 | 2014 | |||||||||||||||||||
| Impaired loans with a valuation allowance | $ | 1,785 | $ | 4,851 | $ | 4,100 | $ | 3,372 | $ | 1,933 | $ | 3,241 | ||||||||||||
| Impaired loans without a valuation allowance | 4,479 | 4,923 | 5,411 | 7,488 | 8,041 | 9,075 | ||||||||||||||||||
| Total impaired loans | $ | 6,264 | $ | 9,774 | $ | 9,511 | $ | 10,860 | $ | 9,974 | $ | 12,316 | ||||||||||||
| Total loans past due 30-89 days and still accruing | $ | 4,407 | $ | 7,142 | $ | 9,449 | $ | 7,735 | $ | 7,057 | $ | 7,121 | ||||||||||||
| Nonperforming assets: | ||||||||||||||||||||||||
| Total nonaccrual loans | $ | 9,289 | $ | 13,113 | $ | 13,404 | $ | 8,736 | $ | 11,517 | $ | 12,610 | ||||||||||||
| Total loans past due 90 days or more and still accruing | 2,631 | 2,906 | 3,724 | 6,838 | 3,229 | 2,843 | ||||||||||||||||||
| Total nonperforming loans | 11,920 | 16,019 | 17,128 | 15,574 | 14,746 | 15,453 | ||||||||||||||||||
| Foreclosed assets held for sale (real estate) | 3,305 | 1,703 | 1,598 | 2,180 | 1,260 | 1,189 | ||||||||||||||||||
| Total nonperforming assets | $ | 15,225 | $ | 17,722 | $ | 18,726 | $ | 17,754 | $ | 16,006 | $ | 16,642 | ||||||||||||
| Loans subject to troubled debt restructurings (TDRs): | ||||||||||||||||||||||||
| Performing | $ | 972 | $ | 655 | $ | 636 | $ | 5,803 | $ | 1,186 | $ | 1,807 | ||||||||||||
| Nonperforming | 489 | 2,884 | 3,027 | 2,874 | 5,178 | 5,388 | ||||||||||||||||||
| Total TDRs | $ | 1,461 | $ | 3,539 | $ | 3,663 | $ | 8,677 | $ | 6,364 | $ | 7,195 | ||||||||||||
| Total nonperforming loans as a % of loans | 1.07 | % | 1.94 | % | 2.10 | % | 2.07 | % | 2.09 | % | 2.45 | % | ||||||||||||
| Total nonperforming assets as a % of assets | 0.95 | % | 1.37 | % | 1.47 | % | 1.43 | % | 1.31 | % | 1.34 | % | ||||||||||||
| Allowance for loan losses as a % of total loans | 0.73 | % | 1.12 | % | 1.09 | % | 1.13 | % | 1.12 | % | 1.16 | % | ||||||||||||
| Allowance for loan losses as a % of nonperforming loans | 68.79 | % | 58.11 | % | 51.70 | % | 54.40 | % | 53.50 | % | 47.47 | % | ||||||||||||
| TABLE X - SUMMARY OF LOANS BY TYPE | ||||||||||||||||||||||||
| Summary of Loans by Type | ||||||||||||||||||||||||
| (In Thousands) | June 30, | December 31, | ||||||||||||||||||||||
| 2019 | 2018 | 2017 | 2016 | 2015 | 2014 | |||||||||||||||||||
| Residential mortgage: | ||||||||||||||||||||||||
| Residential mortgage loans - first liens | $ | 484,479 | $ | 372,339 | $ | 359,987 | $ | 334,102 | $ | 304,783 | $ | 291,882 | ||||||||||||
| Residential mortgage loans - junior liens | 28,880 | 25,450 | 25,325 | 23,706 | 21,146 | 21,166 | ||||||||||||||||||
| Home equity lines of credit | 35,224 | 34,319 | 35,758 | 38,057 | 39,040 | 36,629 | ||||||||||||||||||
| 1-4 Family residential construction | 27,994 | 24,698 | 26,216 | 24,908 | 21,121 | 16,739 | ||||||||||||||||||
| Total residential mortgage | 576,577 | 456,806 | 447,286 | 420,773 | 386,090 | 366,416 | ||||||||||||||||||
| Commercial: | ||||||||||||||||||||||||
| Commercial loans secured by real estate | 279,267 | 162,611 | 159,266 | 150,468 | 154,779 | 145,878 | ||||||||||||||||||
| Commercial and industrial | 115,264 | 91,856 | 88,276 | 83,854 | 75,196 | 50,157 | ||||||||||||||||||
| Political subdivisions | 52,308 | 53,263 | 59,287 | 38,068 | 40,007 | 17,534 | ||||||||||||||||||
| Commercial construction and land | 21,197 | 11,962 | 14,527 | 14,287 | 5,122 | 6,938 | ||||||||||||||||||
| Loans secured by farmland | 7,251 | 7,146 | 7,255 | 7,294 | 7,019 | 7,916 | ||||||||||||||||||
| Multi-family (5 or more) residential | 26,749 | 7,180 | 7,713 | 7,896 | 9,188 | 8,917 | ||||||||||||||||||
| Agricultural loans | 5,234 | 5,659 | 6,178 | 3,998 | 4,671 | 3,221 | ||||||||||||||||||
| Other commercial loans | 13,037 | 13,950 | 10,986 | 11,475 | 12,152 | 13,334 | ||||||||||||||||||
| Total commercial | 520,307 | 353,627 | 353,488 | 317,340 | 308,134 | 253,895 | ||||||||||||||||||
| Consumer | 19,799 | 17,130 | 14,939 | 13,722 | 10,656 | 10,234 | ||||||||||||||||||
| Total | 1,116,683 | 827,563 | 815,713 | 751,835 | 704,880 | 630,545 | ||||||||||||||||||
| Less: allowance for loan losses | (8,200 | ) | (9,309 | ) | (8,856 | ) | (8,473 | ) | (7,889 | ) | (7,336 | ) | ||||||||||||
| Loans, net | $ | 1,108,483 | $ | 818,254 | $ | 806,857 | $ | 743,362 | $ | 696,991 | $ | 623,209 | ||||||||||||
| 60 |
LIQUIDITY
Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand. At June 30, 2019, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $14,253,000.
The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity. Also, the Corporation maintains borrowing facilities with the Federal Home Loan Bank of Pittsburgh, secured by various mortgage loans.
The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. Management intends to use this line of credit as a contingency funding source. As collateral for the line, the Corporation has pledged available-for-sale debt securities with a carrying value of $18,126,000 at June 30, 2019.
The Corporation’s outstanding, available, and total credit facilities at June 30, 2019 and December 31, 2018 are as follows:
| Outstanding | Available | Total Credit | ||||||||||||||||||||||
| (In Thousands) | June 30, | Dec. 31, | June 30, | Dec. 31, | June 30, | Dec. 31, | ||||||||||||||||||
| 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | |||||||||||||||||||
| Federal Home Loan Bank of Pittsburgh | $ | 62,652 | $ | 42,915 | $ | 473,536 | $ | 318,699 | $ | 536,188 | $ | 361,614 | ||||||||||||
| Federal Reserve Bank Discount Window | 0 | 0 | 17,576 | 15,262 | 17,576 | 15,262 | ||||||||||||||||||
| Other correspondent banks | 0 | 0 | 45,000 | 45,000 | 45,000 | 45,000 | ||||||||||||||||||
| Total credit facilities | $ | 62,652 | $ | 42,915 | $ | 536,112 | $ | 378,961 | $ | 598,764 | $ | 421,876 | ||||||||||||
The significant increase in credit available from the Federal Home Loan Bank of Pittsburgh at June 30, 2019 resulted from an increase in the borrowing base created by the acquisition of real estate secured loans from Monument. At June 30, 2019, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $3,000,000, short-term borrowings of $21,379,000 and long-term borrowings of $38,273,000. At December 31, 2018, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $7,000,000 and long-term borrowings with a total amount of $35,915,000. Additional information regarding borrowed funds is included in Note 9 to the unaudited consolidated financial statements.
Additionally, the Corporation uses “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis. If required to raise cash in an emergency situation, the Corporation could sell available-for-sale securities to meet its obligations or use repurchase agreements placed with brokers to borrow funds secured by investment assets. At June 30, 2019, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $213,662,000.
Management believes the Corporation is well-positioned to meet its short-term and long-term obligations, including the impact of additional lending opportunities and other potential cash requirements arising from the Monument merger.
STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY
As required by the Economic Growth, Regulatory Relief, and Consumer Protection Act (discussed further in the Recent Legislative Developments section of Management’s Discussion and Analysis), in August 2018, the Federal Reserve Board issued an interim final rule that expanded applicability of the Board’s small bank holding company policy statement. The interim final rule raised the policy statement’s asset threshold from $1 billion to $3 billion in total consolidated assets for a bank holding company or savings and loan holding company that: (1) is not engaged in significant nonbanking activities; (2) does not conduct significant off-balance sheet activities; and (3) does not have a material amount of debt or equity securities, other than trust-preferred securities, outstanding. The interim final rule provides that, if warranted for supervisory purposes, the Federal Reserve may exclude a company from the threshold increase. Management believes the Corporation meets the conditions of the Federal Reserve’s small bank holding company policy statement and is therefore excluded from consolidated capital requirements at June 30, 2019; however, C&N Bank remains subject to regulatory capital requirements administered by the federal banking agencies.
Details concerning capital ratios at June 30, 2019 and December 31, 2018 are presented below. Management believes, as of June 30, 2019, that C&N Bank meets all capital adequacy requirements to which it is subject and maintains a capital conservation buffer (described in more detail below) that allows the Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Further, as reflected in the table below, the Corporation’s and C&N Bank’s capital ratios at June 30, 2019 and December 31, 2018 exceed the Corporation’s Board policy threshold levels.
| 61 |
| (Dollars in Thousands) | Minimum To Be Well | |||||||||||||||||||||||||||||||||||||||
| Minimum | Minimum To Maintain | Capitalized Under | Minimum To Meet | |||||||||||||||||||||||||||||||||||||
| Capital | Capital Conservation | Prompt Corrective | the Corporation's | |||||||||||||||||||||||||||||||||||||
| Actual | Requirement | Buffer at Reporting Date | Action Provisions | Policy Thresholds | ||||||||||||||||||||||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||||||||||||||
| June 30, 2019: | ||||||||||||||||||||||||||||||||||||||||
| Total capital to risk-weighted assets: | ||||||||||||||||||||||||||||||||||||||||
| Consolidated | $ | 222,061 | 20.97 | % | N/A | N/A | N/A | N/A | N/A | N/A | $ | 111,163 | ³10.5 | % | ||||||||||||||||||||||||||
| C&N Bank | 199,619 | 18.93 | % | 84,369 | ³8 | % | 110,734 | ³10.5 | % | 105,461 | ³10 | % | 110,734 | ³10.5 | % | |||||||||||||||||||||||||
| Tier 1 capital to risk-weighted assets: | ||||||||||||||||||||||||||||||||||||||||
| Consolidated | 206,564 | 19.51 | % | N/A | N/A | N/A | N/A | N/A | N/A | 89,989 | ³8.5 | % | ||||||||||||||||||||||||||||
| C&N Bank | 191,122 | 18.12 | % | 63,276 | ³6 | % | 89,642 | ³8.5 | % | 84,369 | ³8 | % | 89,642 | ³8.5 | % | |||||||||||||||||||||||||
| Common equity tier 1 capital to risk-weighted assets: | ||||||||||||||||||||||||||||||||||||||||
| Consolidated | 206,564 | 19.51 | % | N/A | N/A | N/A | N/A | N/A | N/A | 74,109 | ³7 | % | ||||||||||||||||||||||||||||
| C&N Bank | 191,122 | 18.12 | % | 47,457 | ³4.5 | % | 73,822 | ³7.0 | % | 68,549 | ³6.5 | % | 73,822 | ³7 | % | |||||||||||||||||||||||||
| Tier 1 capital to average assets: | ||||||||||||||||||||||||||||||||||||||||
| Consolidated | 206,564 | 13.13 | % | N/A | N/A | N/A | N/A | N/A | N/A | 125,831 | ³8 | % | ||||||||||||||||||||||||||||
| C&N Bank | 191,122 | 12.27 | % | 62,291 | ³4 | % | N/A | N/A | 77,864 | ³5 | % | 124,582 | ³8 | % | ||||||||||||||||||||||||||
| December 31, 2018: | ||||||||||||||||||||||||||||||||||||||||
| Total capital to risk-weighted assets: | ||||||||||||||||||||||||||||||||||||||||
| Consolidated | $ | 199,226 | 24.42 | % | N/A | N/A | N/A | N/A | N/A | N/A | $ | 85,653 | ³10.5 | % | ||||||||||||||||||||||||||
| C&N Bank | 176,499 | 21.75 | % | 64,916 | ³8 | % | 80,130 | ³9.875 | % | 81,145 | ³10 | % | 85,202 | ³10.5 | % | |||||||||||||||||||||||||
| Tier 1 capital to risk-weighted assets: | ||||||||||||||||||||||||||||||||||||||||
| Consolidated | 189,589 | 23.24 | % | N/A | N/A | N/A | N/A | N/A | N/A | 69,338 | ³8.5 | % | ||||||||||||||||||||||||||||
| C&N Bank | 166,862 | 20.56 | % | 48,687 | ³6 | % | 63,901 | ³7.875 | % | 64,916 | ³8 | % | 68,973 | ³8.5 | % | |||||||||||||||||||||||||
| Common equity tier 1 capital to risk-weighted assets: | ||||||||||||||||||||||||||||||||||||||||
| Consolidated | 189,589 | 23.24 | % | N/A | N/A | N/A | N/A | N/A | N/A | 57,102 | ³7 | % | ||||||||||||||||||||||||||||
| C&N Bank | 166,862 | 20.56 | % | 36,515 | ³4.5 | % | 51,730 | ³6.375 | % | 52,744 | ³6.5 | % | 56,801 | ³7 | % | |||||||||||||||||||||||||
| Tier 1 capital to average assets: | ||||||||||||||||||||||||||||||||||||||||
| Consolidated | 189,589 | 14.78 | % | N/A | N/A | N/A | N/A | N/A | N/A | 102,634 | ³8 | % | ||||||||||||||||||||||||||||
| C&N Bank | 166,862 | 13.16 | % | 50,715 | ³4 | % | N/A | N/A | 63,394 | ³5 | % | 101,430 | ³8 | % | ||||||||||||||||||||||||||
Capital rations presented in the table above were modestly lower at June 30, 2019 as compared to December 31, 2018, reflecting the impact of the Monument acquisition, but remain at levels well in excess of regulatory requirements. Management expects C&N Bank to maintain capital levels that exceed the regulatory standards for well-capitalized institutions and the applicable capital conservation buffer for the next 12 months and for the foreseeable future.
Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. As described in more detail below, C&N Bank is subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities. Further, although the Corporation is no longer subject to the specific consolidated capital requirements described herein, the Corporation’s ability to pay dividends, repurchase stock or engage in other activities may be limited by the Federal Reserve if the Corporation fails to hold capital commensurate with its overall risk profile.
In July 2013, the federal regulatory authorities issued a new capital rule based, in part, on revisions developed by the Basel Committee on Banking Supervision to the Basel capital framework (Basel III). This capital rule provides that, to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization subject to the rule must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets. In 2019, the minimum risk-based capital ratios, and the capital ratios including the capital conservation buffer, are as follows:
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| Minimum common equity tier 1 capital ratio | 4.5 | % | ||
| Minimum common equity tier 1 capital ratio plus capital conservation buffer | 7.0 | % | ||
| Minimum tier 1 capital ratio | 6.0 | % | ||
| Minimum tier 1 capital ratio plus capital conservation buffer | 8.5 | % | ||
| Minimum total capital ratio | 8.0 | % | ||
| Minimum total capital ratio plus capital conservation buffer | 10.5 | % |
A banking organization with a buffer greater than 2.5% over the minimum risk-based capital ratios would not be subject to additional limits on dividend payments or discretionary bonus payments; however, a banking organization with a buffer less than 2.5% would be subject to increasingly stringent limitations as the buffer approaches zero. Also, a banking organization is prohibited from making dividend payments or discretionary bonus payments if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% as of the beginning of that quarter. Eligible net income is defined as net income for the four calendar quarters preceding the current calendar quarter, net of any distributions and associated tax effects not already reflected in net income. A summary of payout restrictions based on the capital conservation buffer is as follows:
| Capital Conservation Buffer | Maximum Payout | |||
| (as a % of risk-weighted assets) | (as a % of eligible retained income) | |||
| Greater than 2.5% | No payout limitation applies | |||
| ≤2.5% and >1.875% | 60 | % | ||
| ≤1.875% and >1.25% | 40 | % | ||
| ≤1.25% and >0.625% | 20 | % | ||
| ≤0.625% | 0 | % | ||
At June 30, 2019, C&N Bank’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 10.93%.
The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale debt securities. The difference between amortized cost and fair value of available-for-sale debt securities, net of deferred income tax, is included in Accumulated Other Comprehensive Income (Loss) within stockholders’ equity. The balance in Accumulated Other Comprehensive Income (Loss) related to unrealized gains (losses) on available-for-sale debt securities, net of deferred income tax, amounted to $3,138,000 at June 30, 2019 and ($4,307,000) at December 31, 2018. Changes in accumulated other comprehensive income (loss) are excluded from earnings and directly increase or decrease stockholders’ equity. If available-for-sale debt securities are deemed to be other-than-temporarily impaired, unrealized losses are recorded as a charge against earnings, and amortized cost for the affected securities is reduced. Note 6 to the unaudited consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale securities for other-than-temporary impairment at June 30, 2019.
Stockholders’ equity is also affected by the underfunded or overfunded status of defined benefit pension and postretirement plans. The balance in Accumulated Other Comprehensive Income related to defined benefit plans, net of deferred income tax, was $294,000 at June 30, 2019 and $137,000 at December 31, 2018.
COMPREHENSIVE INCOME
Comprehensive Income is the total of (1) net income, and (2) all other changes in equity from non-stockholder sources, which are referred to as Other Comprehensive Income. Changes in the components of Accumulated Other Comprehensive Income (Loss) are included in Other Comprehensive Income, and for the Corporation, consist of changes in unrealized gains or losses on available-for-sale debt securities and changes in underfunded or overfunded defined benefit plans. Fluctuations in interest rates significantly affect fair values of available-for-sale debt securities, and accordingly have an effect on Other Comprehensive Income (Loss) in each period.
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Comprehensive Income totaled $7,772,000 for the three months ended June 30, 2019 as compared to $5,570,000 in the second quarter 2018. For the three months ended June 30, 2019, Comprehensive Income included: (1) Net Income of $3,649,000, which was $2,722,000 lower than in the second quarter 2018; (2) Other Comprehensive Income from available-for-sale debt securities of $4,079,000 as compared to Other Comprehensive Loss of ($797,000) in the second quarter 2018; and (3) Other Comprehensive Loss from defined benefit plans of ($6,000) for the second quarter 2019 as compared to ($4,000) for the second quarter 2018.
For the six months ended June 30, 2019, Comprehensive Income totaled $16,341,000 as compared to $6,191,000 for the first six months of 2018. For the six months ended June 30, 2019, Comprehensive Income included: (1) Net Income of $8,739,000, down $2,007,000 from net income for the first six months of 2018; (2) Other Comprehensive Income from available-for-sale debt securities of $7,445,000 as compared to Other Comprehensive Loss of $4,621,000 from net unrealized losses on available-for-sale debt securities in the first six months of 2018; and (3) Other Comprehensive Income from defined benefit plans of $157,000 for the six months ended June 30, 2019 as compared to Other Comprehensive Income of $66,000 for the first six months of 2018.
RECENT LEGISLATIVE DEVELOPMENTS
On May 24, 2018, President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Act”), which was designed to ease certain restrictions imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Most of the changes made by the new Act can be grouped into five general areas: mortgage lending; certain regulatory relief for “community” banks; enhanced consumer protections in specific areas, including subjecting credit reporting agencies to additional requirements; certain regulatory relief for large financial institutions, including increasing the threshold at which institutions are classified as systemically important financial institutions (from $50 billion to $250 billion) and therefore subject to stricter oversight, and revising the rules for larger institution stress testing; and certain changes to federal securities regulations designed to promote capital formation.
As noted in the Stockholders’ Equity and Capital Adequacy section of Management’s Discussion and Analysis, as required by the Act, the Federal Reserve Board issued an interim final rule that expanded applicability of the Board’s small bank holding company policy statement, raising the policy statement’s asset threshold from $1 billion to $3 billion in total consolidated assets for a bank holding company or savings and loan holding company, subject to other conditions. Management believes the Corporation meets the conditions of the Federal Reserve’s small bank holding company policy statement and is therefore excluded from consolidated capital requirements at June 30, 2019. Further, qualification as a small bank holding company allows the Corporation to file more abbreviated, and less frequent, consolidated and holding company reports with the Federal Reserve.
Also, as required by the Act, in November 2018 the Federal Reserve Board, FDIC and Office of the Comptroller of the Currency issued a joint proposal that would provide qualifying community banking organizations an option to calculate a simple leverage ratio, rather than multiple measures of capital adequacy. Under the proposal, a community banking organization would be eligible to elect the community bank leverage ratio framework if it has less than $10 billion in total consolidated assets, limited amounts of certain assets and off-balance sheet exposures, and a community bank leverage ratio greater than 9%. A qualifying community banking organization that has chosen the proposed framework would not be required to calculate the existing risk-based and leverage capital requirements. Such a community banking organization would be considered to have met the capital ratio requirements to be well capitalized for the agencies’ prompt corrective action rules provided it has a community bank leverage ratio greater than 9 percent. The Corporation is in the process of evaluating whether it will adopt the optional community bank leverage ratio framework if a final rule is issued consistent with the proposal.
Some of the other key provisions of the Act as it relates to community banks and bank holding companies include, but are not limited to: (i) designating mortgages held in portfolio as “qualified mortgages” for banks with less than $10 billion in assets, subject to certain documentation and product limitations; (ii) exempting banks with less than $10 billion in assets from Volcker Rule requirements relating to proprietary trading; (iii) assisting smaller banks with obtaining stable funding by providing an exception for reciprocal deposits from FDIC restrictions on acceptance of brokered deposits; (iv) raising the eligibility for use of short-form Call Reports from $1 billion to $5 billion in assets; and (v) clarifying definitions pertaining to high volatility commercial real estate loans (HVCRE), which require higher capital allocations, so that only loans with increased risk are subject to higher risk weightings.
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ITEM 4. CONTROLS AND PROCEDURES
The Corporation’s management, under the supervision of and with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has carried out an evaluation of the design and effectiveness of the Corporation’s disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934 as of the end of the period covered by this report. This evaluation did not include an assessment of those disclosure controls and procedures that are involved in, and did not include an assessment of, internal control over financial reporting as it relates to Monument Bancorp, Inc. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Corporation’s disclosure controls and procedures are effective to ensure that all material information required to be disclosed in reports 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 Securities and Exchange Commission’s rules and forms.
Except as described in the following paragraph, there were no significant changes in the Corporation’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or that are reasonably likely to affect, our internal control over financial reporting.
The Monument Bancorp, Inc. acquisition was completed April 1, 2019, and during the second quarter 2019 the Corporation began the process of integrating processes and internal control over financial reporting for the former Monument locations into those of the Corporation. Throughout most of the second quarter 2019, information related to former Monument loans, deposits and other customer data was processed using Monument’s legacy computer system. In late June 2019, the integration of Monument’s core customer data system into the Corporation’s system was completed. Though completion of the Monument core system conversion was a significant milestone, at June 30, 2019, the Corporation’s management had not yet completed changes to processes, information technology systems and other components of internal control over financial reporting as part of integration activities.
| Item 1. | Legal Proceedings |
The Corporation and C&N Bank are involved in various legal proceedings incidental to their business. Management believes the aggregate liability, if any, resulting from such pending and threatened legal proceedings will not have a material, adverse effect on the Corporation’s financial condition or results of operations.
| Item 1A. | Risk Factors |
There have been no material changes from the risk factors previously disclosed in Item 1A of the Corporation’s Form 10-K filed February 21, 2019.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Issuer Purchases of Equity Securities
The following table sets forth a summary of the purchases by the Corporation of its common stock during the second quarter 2019.
| Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs | ||||||||||||
| April 1 - 30, 2019 | 0 | $ | 0 | 0 | 600,000 | |||||||||||
| May 1 - 31, 2019 | 0 | $ | 0 | 0 | 600,000 | |||||||||||
| June 1 - 30, 2019 | 0 | $ | 0 | 0 | 600,000 | |||||||||||
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Note to Table: Effective April 21, 2016, the Corporation’s Board of Directors approved a treasury stock repurchase program. Under this stock repurchase program, the Corporation is authorized to repurchase up to 600,000 shares of the Corporation's common stock or slightly less than 5% of the Corporation's issued and outstanding shares at April 19, 2016. The Board of Directors’ April 21, 2016 authorization provides that: (1) the new treasury stock repurchase program shall be effective when publicly announced and shall continue thereafter until suspended or terminated by the Board of Directors, in its sole discretion; and (2) all shares of common stock repurchased pursuant to the new program shall be held as treasury shares and be available for use and reissuance for purposes as and when determined by the Board of Directors including, without limitation, pursuant to the Corporation’s Dividend Reinvestment and Stock Purchase Plan and its equity compensation program. To date, no purchases have been made under this repurchase program.
| Item 3. | Defaults Upon Senior Securities |
None
| Item 4. | Mine Safety Disclosures |
Not applicable
| Item 5. | Other Information |
None
Item 6. Exhibits
| 2. Plan of acquisition, reorganization, arrangement, liquidation or succession | Not applicable | |
| 3. (i) Articles of Incorporation | Incorporated by reference to Exhibit 3.1 of the Corporation's Form 8-K filed September 21, 2009 | |
| 3. (ii) By-laws | Incorporated by reference to Exhibit 3.1 of the Corporation's Form 8-K filed April 19, 2013 | |
| 4. Instruments defining the rights of Security holders, including Indentures | Not applicable | |
| 10. Material contracts | Filed herewith | |
| 10.1 Form of Indemnification Agreement dated April 18, 2019 Between the Corporation and Clark S. Frame | ||
| 15. Letter re: unaudited interim information | Not applicable | |
| 18. Letter re: change in accounting principles | Not applicable | |
| 19. Report furnished to security holders | Not applicable | |
| 22. Published report regarding matters submitted to vote of security holders | Not applicable | |
| 23. Consents of experts and counsel | Not applicable | |
| 24. Power of attorney | Not applicable | |
| 31. Rule 13a-14(a)/15d-14(a) certifications: | ||
| 31.1 Certification of Chief Executive Officer | Filed herewith | |
| 31.2 Certification of Chief Financial Officer | Filed herewith | |
| 32. Section 1350 certifications | Filed herewith | |
| 99. Additional exhibits | Not applicable | |
| 100. XBRL-related documents | Not applicable | |
| 101. Interactive data file | Filed herewith |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| CITIZENS & NORTHERN CORPORATION | ||
| August 6, 2019 | By: /s/ J. Bradley Scovill | |
| Date | President and Chief Executive Officer | |
| August 6, 2019 | By: /s/ Mark A. Hughes | |
| Date | Treasurer and Chief Financial Officer |
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