|Closing Price ($)||Shares Out (MM)||Market Cap ($MM)|
|8-K||2019-04-18||Regulation FD, Exhibits|
|8-K||2019-04-18||Earnings, Other Events, Exhibits|
|8-K||2019-01-17||Earnings, Other Events, Exhibits|
|8-K||2018-10-18||Earnings, Other Events, Exhibits|
|8-K||2018-09-27||Enter Agreement, Regulation FD, Exhibits|
|8-K||2018-08-08||Regulation FD, Exhibits|
|8-K||2018-07-19||Earnings, Other Events, Exhibits|
|8-K||2018-06-11||Regulation FD, Exhibits|
|8-K||2018-01-18||Earnings, Other Events, Exhibits|
|BMCH||BMC Stock Holdings||1,350|
|Item 1. Business|
|Item 1A. Risk Factors|
|Item 1B. Unresolved Staff Comments|
|Item 2. Properties|
|Item 3. Legal Proceedings|
|Item 4. Mine Safety Disclosure|
|Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities|
|Item 6. Selected Financial Data|
|Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations|
|Item 8. Financial Statements|
|Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure|
|Item 9A. Controls and Procedures|
|Item 9B. Other Information|
|Item 10. Directors, Executive Officers and Corporate Governance|
|Item 11. Executive Compensation|
|Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters|
|Item 13. Certain Relationships and Related Transactions, and Director Independence|
|Item 14. Principal Accountant Fees and Services|
|Item 15. Exhibits and Financial Statement Schedules|
|Balance Sheet||Income Statement||Cash Flow|
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
¨ 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: 0-16084
CITIZENS & NORTHERN CORPORATION
(Exact name of Registrant as specified in its charter)
|(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)
(Registrant's telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:
|Title of Each Class||Name of Exchange Where Registered|
|Common Stock Par Value $1.00||The NASDAQ Stock Market LLC|
Securities registered pursuant to section 12(g) of the Act: None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
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 (§ 232.405 of this chapter) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions 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
The aggregate market value of the registrant's common stock held by non-affiliates at June 30, 2018, the registrant’s most recently completed second fiscal quarter, was $308,413,394.
The number of shares of common stock outstanding at February 14, 2019 was 12,392,682.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s proxy statement for the annual meeting of its shareholders to be held April 18, 2019 are incorporated by reference into Parts III and IV of this report.
TABLE OF CONTENTS
|Item 1. Business||3-4|
|Item 1A. Risk Factors||4-6|
|Item 1B. Unresolved Staff Comments||6|
|Item 2. Properties||7|
|Item 3. Legal Proceedings||7|
|Item 4. Mine Safety Disclosure||7|
|Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities||8-10|
|Item 6. Selected Financial Data||11-12|
|Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations||13-34|
|Item 8. Financial Statements and Supplementary Data||35-81|
|Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure||82|
|Item 9A. Controls and Procedures||82|
|Item 9B. Other Information||83|
|Item 10. Directors, Executive Officers and Corporate Governance||83|
|Item 11. Executive Compensation||83|
|Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters||83|
|Item 13. Certain Relationships and Related Transactions, and Director Independence||83|
|Item 14. Principal Accountant Fees and Services||83|
|Item 15. Exhibits and Financial Statement Schedules||84-87|
Citizens & Northern Corporation (“Corporation”) is a holding company whose principal activity is community banking. The Corporation’s principal office is located in Wellsboro, Pennsylvania. The largest subsidiary is Citizens & Northern Bank (“C&N Bank” or the “Bank”). The Corporation’s other wholly-owned subsidiaries are Citizens & Northern Investment Corporation and Bucktail Life Insurance Company (“Bucktail”). Citizens & Northern Investment Corporation was formed in 1999 to engage in investment activities. Bucktail reinsures credit and mortgage life and accident and health insurance on behalf of C&N Bank.
On September 28, 2018, the Corporation, along with Monument Bancorp, Inc. (“Monument”), announced the signing of an Agreement and Plan of Merger. Monument is the parent company of Monument Bank, a commercial bank which operates two community bank offices and one loan production office in Bucks County, Pennsylvania. As of December 31, 2018, Monument reported total assets of $363 million. Under the terms of the Agreement and Plan of Merger, Monument will merge into the Corporation, and Monument Bank will merge into C&N Bank. In the transaction, Monument shareholders will elect to receive either 1.0144 shares of Corporation common stock or $28.10 in cash for each share of Monument common stock owned, subject to proration to ensure that, overall, 20% of the Monument shares will be converted into cash and 80% of the Monument shares will be converted into Corporation stock. The estimated total purchase consideration would be valued at approximately $42.7 million based on the closing price of the Corporation’s common stock on September 27, 2018. The transaction, which has been approved by the Board of Directors of both companies, is expected to be completed during the second quarter 2019. Consummation of the Merger is subject to approval by Monument’s shareholders, regulatory approvals and other customary conditions of closing.
C&N Bank is a Pennsylvania banking institution that was formed by the consolidation of Northern National Bank of Wellsboro and Citizens National Bank of Towanda on October 1, 1971. Subsequent mergers included: First National Bank of Ralston in May 1972; Sullivan County National Bank in October 1977; Farmers National Bank of Athens in January 1984; and First National Bank of East Smithfield in May 1990. In 2005, the Corporation acquired Canisteo Valley Corporation and its subsidiary, First State Bank, a New York State chartered commercial bank with offices in Canisteo and South Hornell, NY. In 2010, the First State Bank operations were merged into C&N Bank and Canisteo Valley Corporation was merged into the Corporation. On May 1, 2007, the Corporation acquired Citizens Bancorp, Inc. (“Citizens”), with banking offices in Coudersport, Emporium and Port Allegany, Pennsylvania. Citizens Trust Company, the banking subsidiary of Citizens, was merged with and into C&N Bank as part of the transaction. C&N Bank has held its current name since May 6, 1975, at which time C&N Bank changed its charter from a national bank to a Pennsylvania bank.
C&N Bank provides an extensive range of banking services, including deposit and loan products for personal and commercial customers. The Bank also maintains a trust division that provides a wide range of financial services, such as 401(k) plans, retirement planning, estate planning, estate settlements and asset management. In January 2000, C&N Bank formed a subsidiary, C&N Financial Services Corporation (“C&NFSC”). C&NFSC is a licensed insurance agency that provides insurance products to individuals and businesses. In 2001, C&NFSC added a broker-dealer division, which offers mutual funds, annuities, educational savings accounts and other investment products through registered agents. C&NFSC’s operations are not significant in relation to the total operations of the Corporation.
In December 2017, C&N Bank established Northern Tier Holding LLC, to acquire, hold and dispose of real property acquired by the Bank. C&N Bank is the sole member of Northern Tier Holding LLC.
All phases of the Bank’s business are competitive. The Bank primarily competes in Tioga, Bradford, Sullivan, Lycoming, Potter, Cameron and McKean counties in Pennsylvania, and Steuben and Chemung counties in New York. The Bank competes with local commercial banks headquartered in our market area as well as other commercial banks with branches in our market area. Some of the banks that have branches in our market area are larger in overall size. With respect to lending activities and attracting deposits, the Bank also competes with savings banks, savings and loan associations, insurance companies, regulated small loan companies and credit unions. Also, the Bank competes with mutual funds for deposits. C&N Bank competes with insurance companies, investment counseling firms, mutual funds and other business firms and individuals for trust, investment management, brokerage and insurance services. The Bank is generally competitive with all financial institutions in our service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans. The Bank serves a diverse customer base and is not economically dependent on any small group of customers or on any individual industry.
Major initiatives within the last 3 years included the following:
|·||in 2016, approved a new treasury stock repurchase program authorizing repurchase of up to 600,000 shares of the Corporation's common stock. Through December 31, 2017, there have been no repurchases of shares under this program.|
|·||in March 2017, opened a loan production office in Elmira, New York.|
|·||in 2018, enhanced mobile and online products including People Pay, a P2P application, added online deposit account opening capabilities and an online mortgage loan application portal.|
|·||as described above, in September 2018 the Corporation entered into an agreement to acquire Monument Bancorp, Inc. which is expected to close in the second quarter 2019.|
At December 31, 2018, C&N Bank had total assets of $1,276,158,000 total deposits of $1,041,526,000, net loans outstanding of $818,254,000 and 299 full-time equivalent employees.
Most activities of the Corporation and its subsidiaries are regulated by federal or state agencies. The primary regulatory relationships are described as follows:
|·||The Corporation is a bank holding company formed under the provisions of Section 3 of the Federal Reserve Act. The Corporation is under the direct supervision of the Federal Reserve and must comply with the reporting requirements of the Federal Bank Holding Company Act.|
|·||C&N Bank is a state-chartered, nonmember bank, supervised by the Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking and Securities.|
|·||C&NFSC is a Pennsylvania corporation. The Pennsylvania Department of Insurance regulates C&NFSC’s insurance activities. Brokerage products are offered through third party networking agreements.|
|·||Bucktail is incorporated in the state of Arizona and supervised by the Arizona Department of Insurance.|
A copy of the Corporation’s annual report on Form 10-K, quarterly reports on Form 10-Q, current events reports on Form 8-K, and amendments to these reports, will be furnished without charge upon written request to the Corporation’s Treasurer at P.O. Box 58, Wellsboro, PA 16901. Copies of these reports will be furnished as soon as reasonably possible, after they are filed electronically with the Securities and Exchange Commission. The information is also available through the Corporation’s web site at www.cnbankpa.com.
The Corporation is subject to the many risks and uncertainties applicable to all banking companies, as well as risks specific to the Corporation’s geographic locations. Although the Corporation seeks to effectively manage risks, and maintains a level of equity that exceeds the banking regulatory agencies’ thresholds for being considered “well capitalized” (see Note 18 to the consolidated financial statements), management cannot predict the future and cannot eliminate the possibility of credit, operational or other losses. Accordingly, actual results may differ materially from management's expectations. Some of the Corporation’s significant risks and uncertainties are discussed below.
Credit Risk from Lending Activities - A significant source of risk is the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements. Most of the Corporation’s loans are secured, but some loans are unsecured. With respect to secured loans, the collateral securing the repayment of these loans may be insufficient to cover the obligations owed under such loans. Collateral values may be adversely affected by changes in economic, environmental and other conditions, including declines in the value of real estate, changes in interest rates, changes in monetary and fiscal policies of the federal government, wide-spread disease, terrorist activity, environmental contamination and other external events. In addition, collateral appraisals that are out of date or that do not meet industry recognized standards may create the impression that a loan is adequately collateralized when it is not. The Corporation has adopted underwriting and credit monitoring procedures and policies, including regular reviews of appraisals and borrower financial statements, that management believes are appropriate to mitigate the risk of loss. Also, as discussed further in the “Provision and Allowance for Loan Losses” section of Management’s Discussion and Analysis, the Corporation attempts to estimate the amount of losses that may be inherent in the portfolio through a quarterly evaluation process that includes several members of management and that addresses specifically identified problem loans, as well as other quantitative data and qualitative factors. Such risk management and accounting policies and procedures, however, may not prevent unexpected losses that could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.
Interest Rate Risk - Business risk arising from changes in interest rates is an inherent factor in operating a banking organization. The Corporation’s assets are predominantly long-term, fixed-rate loans and debt securities. Funding for these assets comes principally from shorter-term deposits and borrowed funds. Accordingly, there is an inherent risk of lower future earnings or decline in fair value of the Corporation’s financial instruments when interest rates change. Significant fluctuations in interest rates could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.
Limited Geographic Diversification - The Corporation grants commercial, residential and personal loans to customers primarily in the Pennsylvania counties of Tioga, Bradford, Sullivan, Lycoming, Potter, Cameron and McKean, and in Steuben and Chemung Counties in New York State. 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. Deterioration in economic conditions could adversely affect the quality of the Corporation's loan portfolio and the demand for its products and services, and accordingly, could have a material adverse effect on the Corporation's financial condition, results of operations or liquidity.
Competition - All phases of the Corporation’s business are competitive. Some competitors are much larger in total assets and capitalization than the Corporation, have greater access to capital markets and can offer a broader array of financial services. There can be no assurance that the Corporation will be able to compete effectively in its markets. Furthermore, developments increasing the nature or level of competition could have a material adverse effect on the Corporation's financial condition, results of operations or liquidity.
Growth Strategy –As described in Item 1, in September 2008, the Corporation entered into an agreement to acquire Monument Bancorp, Inc., a banking company with total assets of approximately $363 million as of December 31, 2018. Management expects the acquisition of Monument to close in the second quarter 2019. Further, management intends to continue to pursue additional acquisition opportunities. The Corporation’s future financial performance will depend on its ability to execute its strategic plan and manage its future growth. Failure to execute these plans could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.
Breach of Information Security and Technology Dependence - The Corporation relies on software, communication, and information exchange on a variety of computing platforms and networks and over the Internet. Despite numerous safeguards, the Corporation cannot be certain that its systems are entirely free from vulnerability to attack or other technological difficulties or failures. The Corporation relies on the services of a variety of vendors to meet its data processing and communication needs. If information security is breached or other technology difficulties or failures occur, information may be lost or misappropriated, services and operations may be interrupted, and the Corporation could be exposed to claims from customers. Any of these results could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.
Government Regulation and Monetary Policy - The Corporation and the banking industry are subject to extensive regulation and supervision under federal and state laws and regulations. The requirements and limitations imposed by such laws and regulations limit the way the Corporation conducts its business, undertakes new investments and activities and obtains financing. These regulations are designed primarily for the protection of the deposit insurance funds and consumers and not to benefit the Corporation's shareholders. Financial institution regulation has been the subject of significant legislation in recent years and may be the subject of further significant legislation in the future, none of which is in the control of the Corporation. Significant new laws or changes in, or repeals of, existing laws could have a material adverse effect on the Corporation's financial condition, results of operations or liquidity. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects short-term interest rates and credit conditions, and any unfavorable change in these conditions could have a material adverse effect on the Corporation's financial condition, results of operations or liquidity.
Bank Secrecy Act and Related Laws and Regulations - These laws and regulations have significant implications for all financial institutions. In recent years, they have increased due diligence requirements and reporting obligations for financial institutions, created new crimes and penalties, and required the federal banking agencies, in reviewing merger and other acquisition transactions, to consider the effectiveness of the parties to such transactions in combating money laundering activities. Even innocent noncompliance and inconsequential failure to follow the regulations could result in significant fines or other penalties, which could have a material adverse impact on the Corporation's financial condition, results of operations or liquidity.
The Federal Home Loan Bank of Pittsburgh - Through its subsidiary (C&N Bank), the Corporation is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 11 regional Federal Home Loan Banks. The Corporation has a line of credit with the FHLB-Pittsburgh that is secured by a blanket lien on its loan portfolio. Access to this line of credit is critical if a funding need arises. However, there can be no assurance that the FHLB-Pittsburgh will be able to provide funding when needed, nor can there be assurance that the FHLB-Pittsburgh will provide funds specifically to the Corporation should its financial condition deteriorate and/or regulators prevent that access. The inability to access this source of funds could have a materially adverse effect on the Corporation’s financial flexibility if alternate financing is not available at acceptable interest rates. The failure of the FHLB-Pittsburgh or the FHLB system in general, may materially impair the Corporation’s ability to meet short- and long-term liquidity needs or to meet growth plans.
The Corporation owns common stock of the FHLB-Pittsburgh to qualify for membership in the FHLB system and access services from the FHLB-Pittsburgh. The FHLB-Pittsburgh faces a variety of risks in its operations including interest rate risk, counterparty credit risk, and adverse changes in its regulatory framework. In addition, the 11 Federal Home Loan Banks are jointly liable for the consolidated obligations of the FHLB system. To the extent that one FHLB cannot meet its obligations, other FHLBs can be called upon to make required payments. Such risks affecting the FHLB-Pittsburgh could adversely impact the value of the Corporation’s investment in the common stock of the FHLB-Pittsburgh and/or affect its access to credit.
Soundness of Other Financial Institutions - In addition to the FHLB-Pittsburgh, the Corporation maintains other credit facilities that provide it with additional liquidity. These facilities include secured and unsecured borrowings from the Federal Reserve Bank and third-party commercial banks. The Corporation believes that it maintains a strong liquidity position and that it is well positioned to withstand foreseeable market conditions. However, legal agreements with counterparties typically include provisions allowing them to restrict or terminate the Corporation’s access to these credit facilities with or without advance notice and at their sole discretion.
Financial institutions are interconnected because of trading, clearing, counterparty, and other relationships. Financial market conditions have been negatively impacted in the past and such disruptions or adverse changes in the Corporation's results of operations or financial condition could, in the future, have a negative impact on available sources of liquidity. Such a situation may arise due to circumstances that are outside the Corporation’s control, such as general market disruptions or operational problems affecting the Corporation or third parties. The Corporation’s efforts to monitor and manage liquidity risk may not be successful or sufficient to deal with dramatic or unanticipated reductions in available liquidity. In such events, the Corporation’s cost of funds may increase, thereby reducing net interest income, or the Corporation may need to sell a portion of its securities and/or loan portfolio, which, depending upon market conditions, could necessitate realizing a loss.
Securities Markets – The fair value of the Corporation's available-for-sale securities, as well as the revenues the Corporation earns from its Trust and Financial Management and brokerage services, are sensitive to price fluctuations and market events.
Declines in the values of the Corporation’s securities holdings, combined with adverse changes in the expected cash flows from these investments, could result in other-than-temporary impairment charges.
For additional information regarding debt securities, see the “Securities” section of Management’s Discussion and Analysis and Note 7 to the consolidated financial statements.
The Corporation's Trust and Financial Management revenue is determined, in part, from the value of the underlying investment portfolios. Accordingly, if the values of those investment portfolios decrease, whether due to factors influencing U.S. or international securities markets, in general, or otherwise, the Corporation's revenue could be negatively impacted. In addition, the Corporation's ability to sell its brokerage services is dependent, in part, upon consumers' level of confidence in securities markets.
Mortgage Banking – Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program. Since 2014, the Corporation has also originated and sold residential mortgage loans to the secondary market through the MPF Original program. Both of these programs are administered by the Federal Home Loan Banks of Pittsburgh and Chicago. At December 31, 2018, the total outstanding balance of residential mortgages sold and serviced through the two programs amounted to $171,742,000. The Corporation must strictly adhere to the MPF Xtra and MPF Original program guidelines for origination, underwriting and servicing loans, and failure to do so may result in the Corporation being forced to repurchase loans or being dropped from the program. As of December 31, 2018, the total outstanding balance of residential mortgage loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $2,146,000. If the volume of such forced repurchases of loans were to increase significantly, or if the Corporation were to be dropped from the programs, it could have a material adverse effect on the Corporation’s financial condition, results of operations or liquidity.
The Bank owns each of its properties, except for the branch facilities located in Towanda, Williamsport and South Williamsport, PA, which are leased. All of the properties are in good condition. None of the owned properties are subject to encumbrance.
A listing of properties is as follows:
|Main administrative offices:|
|90-92 Main Street||or||10 Nichols Street|
|Wellsboro, PA 16901||Wellsboro, PA 16901|
|Branch offices - Citizens & Northern Bank:|
|428 S. Main Street||514 Main Street||41 Main Street|
|Athens, PA 18810||Laporte, PA 18626||Tioga, PA 16946|
|10 North Main Street||4534 Williamson Trail||428 Main Street**|
|Coudersport, PA 16915||Liberty, PA 16930||Towanda, PA 18848|
|111 W. Main Street||1085 S. Main Street||64 Elmira Street|
|Dushore, PA 18614||Mansfield, PA 16933||Troy, PA 16947|
|563 Main Street||612 James Monroe Avenue||90-92 Main Street|
|East Smithfield, PA 18817||Monroeton, PA 18832||Wellsboro, PA 16901|
|104 W. Main Street||3461 Route 405 Highway||1510 Dewey Avenue|
|Elkland, PA 16920||Muncy, PA 17756||Williamsport, PA 17701|
|135 East Fourth Street||100 Maple Street||130 Court Street**|
|Emporium, PA 15834||Port Allegany, PA 16743||Williamsport, PA 17701|
|230 Railroad Street||1827 Elmira Street||1467 Golden Mile Road|
|Jersey Shore, PA 17740||Sayre, PA 18840||Wysox, PA 18854|
|102 E. Main Street||2 East Mountain Avenue**|
|Knoxville, PA 16928||South Williamsport, PA 17702|
|3 Main Street||6250 County Rte 64|
|Canisteo, NY 14823||Hornell, NY 14843|
Loan production office of Citizens & Northern Bank:
250 East Water Street
Elmira, NY 14901
Facilities management office:
13 Water Street
Wellsboro, PA 16901
** designates leased branch facility
The Corporation and the 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.
QUARTERLY SHARE DATA
Trades of the Corporation’s stock are executed through various brokers who maintain a market in the Corporation’s stock. The Corporation’s stock is listed on the NASDAQ Capital Market with the trading symbol CZNC. As of December 31, 2018, there were 2,160 shareholders of record of the Corporation’s common stock.
The following table sets forth the high and low sales prices of the common stock during 2018 and 2017.
Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. Also, the Corporation and C&N Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities. These restrictions are described in Note 18 to the consolidated financial statements.
Effective April 21, 2016, the Corporation’s Board of Directors approved a treasury stock repurchase program. Under this 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.
The following table sets forth a summary of purchases by the Corporation, in the open market, of its equity securities during the fourth quarter 2018:
Paid per Share
|Total Number of Shares|
Purchased as Part of
Plans or Programs
|Maximum Number of Shares|
that May Yet be Purchased
Under the Plans or Programs
|October 1 - 31, 2018||0||$||-||0||600,000|
|November 1 - 30, 2018||0||$||-||0||600,000|
|December 1 - 31, 2018||0||$||-||0||600,000|
Set forth below is a chart comparing the Corporation’s cumulative return to stockholders against the cumulative return of the Russell 2000 and a Peer Group Index of similar banking organizations selected by the Corporation for the five-year period commencing December 31, 2013 and ended December 31, 2018. The index values are market-weighted dividend-reinvestment numbers, which measure the total return for investing $100.00 five years ago. This meets Securities & Exchange Commission requirements for showing dividend reinvestment share performance over a five-year period and measures the return to an investor for placing $100.00 into a group of bank stocks and reinvesting any and all dividends into the purchase of more of the same stock for which dividends were paid.
|Citizens & Northern Corporation||100.00||105.68||113.09||148.34||141.81||163.00|
|Russell 2000 Index||100.00||104.89||100.26||121.63||139.44||124.09|
Peer Group includes all publicly traded SEC filing Commercial Banks & Thrifts within NJ, NY, OH and PA with assets between $750M and $3.5B as of 9/30/18
Source: S&P Global Market Intelligence
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth information concerning the Stock Incentive Plan and Independent Directors Stock Incentive Plan, both of which have been approved by the Corporation’s shareholders. The figures shown in the table below are as of December 31, 2018.
|Securities to be||average||Remaining|
|Issued Upon||Exercise||for Future|
|Exercise of||Price of||Issuance Under|
|Equity compensation plans approved by shareholders||165,660||$||18.49||369,698|
|Equity compensation plans not approved by shareholders||0||N/A||0|
More details related to the Corporation’s equity compensation plans are provided in Notes 1 and 13 to the consolidated financial statements.
|As of or for the Year Ended December 31,|
|INCOME STATEMENT (In Thousands)||2018||2017||2016||2015||2014|
|Interest and fee income||$||50,328||$||45,863||$||44,098||$||44,519||$||46,009|
|Net interest income||45,703||41,948||40,405||39,917||40,887|
|Provision for loan losses||584||801||1,221||845||476|
|Net interest income after provision for loan losses||45,119||41,147||39,184||39,072||40,411|
|Noninterest income excluding securities gains||18,597||16,153||15,511||15,478||15,420|
|Net gains on securities||2,033||257||1,158||2,861||1,104|
|Loss on prepayment of debt||0||0||0||2,573||0|
|Noninterest expense excluding loss on prepayment of debt||39,486||36,967||34,744||33,030||34,157|
|Income before income tax provision||26,263||20,590||21,109||21,808||22,778|
|Income tax provision||4,250||7,156||5,347||5,337||5,692|
|Net income attributable to common shares||$||21,903||$||13,365||$||15,677||$||16,387||$||17,009|
|PER COMMON SHARE:|
|Basic earnings per share||$||1.79||$||1.10||$||1.30||$||1.35||$||1.38|
|Diluted earnings per share||$||1.79||$||1.10||$||1.30||$||1.35||$||1.38|
|Cash dividends declared per share||$||1.08||$||1.04||$||1.04||$||1.04||$||1.04|
|Book value per common share at period-end||$||16.02||$||15.43||$||15.36||$||15.39||$||15.34|
|Tangible book value per common share at period-end||$||15.05||$||14.45||$||14.37||$||14.41||$||14.36|
|Weighted average common shares outstanding - basic||12,219,209||12,115,840||12,032,820||12,149,252||12,333,933|
|Weighted average common shares outstanding - diluted||12,257,368||12,155,136||12,063,055||12,171,084||12,355,916|
|END OF PERIOD BALANCES (Dollars In Thousands)|
|Available-for-sale debt securities||$||363,273||$||355,937||$||394,106||$||417,904||$||508,153|
|Marketable equity securities||950||971||971||2,386||8,654|
|Allowance for loan losses||9,309||8,856||8,473||7,889||7,336|
|Common shares outstanding||12,319,330||12,214,525||12,113,228||12,180,623||12,279,980|
|AVERAGE BALANCES (In Thousands)|
ITEM 6. SELECTED FINANCIAL DATA (Continued)
|As of or for the Year Ended December 31,|
|Return on average assets||1.72||%||1.08||%||1.28||%||1.32||%||1.38||%|
|Return on average equity||11.72||%||7.11||%||8.37||%||8.72||%||9.21||%|
|Average equity to average assets||14.72||%||15.14||%||15.32||%||15.19||%||14.96||%|
|Net interest margin (1)||3.90||%||3.82||%||3.76||%||3.69||%||3.80||%|
|Cash dividends as a % of diluted earnings per share||60.34||%||94.55||%||80.00||%||77.04||%||75.36||%|
|Tier 1 leverage||14.78||%||14.23||%||14.27||%||14.31||%||13.89||%|
|Tier 1 risk-based capital||23.24||%||21.95||%||22.48||%||23.29||%||26.26||%|
|Total risk-based capital||24.42||%||23.07||%||23.60||%||24.40||%||27.60||%|
|Tangible common equity/tangible assets||14.50||%||13.95||%||14.15||%||14.49||%||14.34||%|
|Nonperforming assets/total assets||1.37||%||1.47||%||1.43||%||1.31||%||1.34||%|
|Nonperforming loans/total loans||1.94||%||2.10||%||2.07||%||2.09||%||2.45||%|
|Allowance for loan losses/total loans||1.12||%||1.09||%||1.13||%||1.12||%||1.16||%|
|Net charge-offs/average loans||0.02||%||0.05||%||0.09||%||0.04||%||0.29||%|
(1) Rates of return on tax-exempt securities and loans are calculated on a fully-taxable equivalent basis.
(2) The efficiency ratio is calculated by dividing: (a) total noninterest expense excluding losses from prepayment of debt, by (b) the sum of net interest income (including income from tax-exempt securities and loans on a fully-taxable equivalent basis) and noninterest income excluding securities gains or losses.
Certain statements in this section and elsewhere in this Annual Report on Form 10-K 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.|
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
In 2018, net income totaled $22,013,000, or $1.79 per diluted common share as compared to $1.10 per share in 2017. The results for 2018 represented a return on average assets of 1.72% and a return on average equity of 11.72%. Annual earnings for 2018 included a net benefit of $0.13 per share from gains on a restricted equity security (Visa Class B stock) and a loss on available-for-sale debt securities. Annual 2017 earnings were negatively impacted by a reduction in the federal corporate income tax rate to 21%, effective January 1, 2018, from the 35% marginal tax rate prior to the change. In 2017, the Corporation recorded additional income tax expense of $0.18 per share related to a reduction in the carrying value of the net deferred tax asset due to the change in tax rate. Annual 2017 earnings also included a net benefit of $0.02 per share from net gains on sales of available-for-sale debt securities.
As described in more detail below, the Corporation’s 2018 earnings results, as compared to 2017, include a significant benefit from the reduction in the federal income tax rate.
Excluding the effect of the income tax rate change on 2017 earnings and the after-tax impact of the gain on Visa Class B stock and net (losses) gains on available-for-sale debt securities as described above, adjusted annual 2018 net income of $20,407,000 exceeded adjusted net income for 2017 of $15,426,000 by $4,981,000 (32.3%). Pre-tax income, excluding the gain on Visa Class B stock and net (losses) gains on available-for-sale debt securities, totaled $24,230,000 in 2018, an increase of $3,897,000 (19.2%) over adjusted pre-tax income of $20,333,000 in 2017. Excluding the additional income tax provision in 2017 resulting from the change in the federal income tax rate as well as the gain on Visa Class B stock and net (losses) gains on available-for-sale debt securities, the effective tax rate was 15.8% in 2018, significantly lower than the comparative adjusted 2017 effective tax rate of 24.1%.
The following table provides a reconciliation of the Corporation’s 2018 and 2017 earnings under U.S. generally accepted accounting principles (U.S. GAAP) to comparative non-U.S. GAAP results excluding the 2017 impact of the change in the federal income tax rate as well as the 2018 gain on Visa Class B stock and gains and losses on available-for-sale debt securities in both years. Management believes disclosure of 2018 and 2017 earnings results, adjusted to exclude the impact of these items, provides useful information to investors for comparative purposes.
RECONCILIATION OF NET INCOME AND
DILUTED EARNINGS PER SHARE TO NON-U.S.
(Dollars In Thousands, Except Per Share Data)
|Year Ended Dec. 31, 2018||Year Ended Dec. 31, 2017|
|Results as Presented Under U.S. GAAP||$||26,263||$||4,250||$||22,013||$||1.79||$||20,590||$||7,156||$||13,434||$||1.10|
|Additional Income Tax Provision Resulting from Change in Tax Rate||0||0||(2,159||)||2,159|
|Less: Gain on Restricted Equity Security||(2,321||)||(487||)||(1,834||)||0||0||0|
|Net Losses (Gains) on Available-for-sale Debt Securities||288||60||228||(257||)||(90||)||(167||)|
|Adjusted Earnings, Excluding Effect of Change in|
|Tax Rate, Gain on Restricted Equity Security and|
|Net Gains and Losses on Available-for-sale|
|Debt Securities (Non-U.S. GAAP)||$||24,230||$||3,823||$||20,407||$||1.66||$||20,333||$||4,907||$||15,426||$||1.26|
|(1)||Income tax has been allocated to the gain on restricted equity security and net losses (gains) on available-for-sale debt securities at marginal income tax rates of 21% for 2018 and 35% for 2017.|
Other significant earnings-related variances were as follows:
|·||Net interest income was higher by $3,755,000 (9.0%) for 2018 as compared to 2017. The net interest margin was 3.90% for 2018, up from 3.82% for 2017. The average yield on earning assets was 4.28% in 2018, up from 4.16% in 2017, reflecting an increase in average yield on loans of 0.18%. Average total loans outstanding were higher by $41.7 million (5.3%) for 2018 as compared to 2017, while average total available-for-sale debt securities were lower by $10.7 million. Average total deposits were $36.9 million (3.7%) higher in 2018 as compared to 2017. The average rate paid on interest-bearing liabilities was 0.56% in 2018, up 0.08% as compared to 2017. The average rate paid on interest-bearing deposits was up 0.16% in 2018 as compared to 2017, while the average cost of borrowed funds dropped to 1.83% from 2.54% because of the pay-off of higher-cost borrowings that matured in the latter portion of 2017.|
|·||The provision for loan losses was $584,000 in 2018, down from $801,000 in 2017. The 2018 provision included a charge of $457,000 related to specific loans (net increase in specific allowances on loans of $326,000 and net charge-offs of $131,000) and a net $127,000 charge attributable mainly to loan growth. In comparison, the provision in 2017 included $1,023,000 related to the change in total specific allowances on impaired loans, as adjusted for net charge-offs during the period and a $101,000 increase in the unallocated portion of the allowance, with a reduction in the provision of $323,000 related to a reduction in the collectively determined allowance for loan losses.|
|·||Noninterest income increased $2,444,000 (15.1%) in 2018 over the 2017 amount. The overall increase in noninterest income included significant increases in total Trust and brokerage revenue of $660,000 (10.7%), service charges on deposit accounts of $611,000 (13.4%) and interchange revenue from debit card transactions of $325,000 (14.6%). Other noninterest income increased $878,000, including $438,000 from a life insurance arrangement in which benefits were split between the Corporation and heirs of a former employee, as well as increases in dividends received on Federal Home Loan Bank of Pittsburgh stock, income from state tax credits, credit card interchange fees and revenue from merchant services.|
|·||Total noninterest expense increased $2,519,000 (6.8%) in 2018 over the 2017 amount. Salaries and wages expense increased $1,385,000 (8.8%), including the effects of annual performance-based salary adjustments for employees along with an increase in cash and stock-based incentive compensation expense and an increase in the average number of full-time equivalent employees (FTEs) to 297 in 2018 from 292 in 2017. Other expense categories with significant increases in 2018 included data processing expenses, which increased $344,000 (14.3%) and professional fees, which increased $268,000 (30.7%). Other noninterest expense increased $389,000, including an increase in donations expense of $229,000. In June 2018, the Corporation donated its Towanda banking facility to a nonprofit organization, resulting in donations expense of $250,000. The Corporation entered into a lease with the nonprofit organization and continues to provide banking services there until a new location in the Towanda market can be obtained and prepared for use.|
More detailed information concerning fluctuations in the Corporation’s earnings results are provided in other sections of Management’s Discussion and Analysis.
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. 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. Management believes the allowance for loan losses is adequate and reasonable. Notes 1 and 8 to the consolidated financial statements provide an overview of the process management uses for evaluating and determining the allowance for loan losses, and additional discussion of the allowance for loan losses is provided in a separate section later in Management’s Discussion and Analysis. 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 7 to the 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 I, II and III include information regarding the Corporation’s net interest income in 2018 and 2017. 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 tables.
The calculations of fully taxable-equivalent yields on tax-exempt loans and securities in Tables I, II and III reflect inherent tax benefit based on the Corporation’s marginal federal income tax rate of 21% for 2018 and a 35% marginal federal income tax rate for 2017. In 2018, the tax benefit from tax-exempt loans and securities was reduced as a result of the change to a 21% federal income tax rate.
Fully taxable equivalent net interest income was $47,004,000 in 2018, $2,296,000 (5.1%) higher than in 2017. Interest income was $3,006,000 higher in 2018 as compared to 2017; interest expense was also higher by $710,000 in comparing the same periods. As presented in Table II, the Net Interest Margin was 3.90% in 2018 as compared to 3.82% in 2017, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) increased to 3.72% in 2018 from 3.68% in 2017.
INTEREST INCOME AND EARNING ASSETS
Interest income totaled $51,629,000 in 2018, an increase of 6.2% from 2017. Interest and fees on loans receivable increased $3,474,000, or 9.1%, to $41,491,000 in 2018 from $38,017,000 in 2017. Table III shows the increase in interest on loans includes $2,039,000 attributable to an increase in volume and $1,435,000 related to an increase in average rate. The average balance of loans receivable increased $41,706,000 (5.3%) to $822,346,000 in 2018 from $780,640,000 in 2017. The increase in average balance reflects growth in the average balance of both commercial and residential mortgage loans. The average rate on taxable loans in 2018 was 5.18% compared to 4.90% in 2017 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 decreased to 3.71% in 2018 compared to 4.52% in 2017. This decrease reflects the reduced tax benefit on tax-exempt assets as compared to taxable assets resulting from the marginal tax rate being reduced to 21% in 2018 from 35% in 2017.
Interest income on available-for-sale debt securities totaled $9,687,000 in 2018, a reduction of $683,000 from the total for 2017. As indicated in Table II, average available-for-sale debt securities (at amortized cost) totaled $360,123,000 in 2018, a decrease of $11,702,000 (3.1%) from 2017. The average yield on available-for-sale debt securities decreased to 2.69% in 2018 from 2.79% in 2017. The reduction in yield on available-for-sale debt securities includes the impact of a reduced tax benefit on tax-exempt municipal bonds from the reduction in the federal income tax rate.
Interest income from interest-bearing deposits in banks totaled $415,000 in 2018, an increase of $225,000 over the total for 2017. The most significant categories of assets within this category include interest-bearing balances held with the Federal Reserve and investments in certificates of deposit issued by other banks. The increase in interest income from interest-bearing deposits with banks includes the effects of an increase in yield to 1.90% in 2018 from 1.14% in 2017, consistent with market increases in short-term interest rates, and an increase in average balance to $21,800,000 in 2018 from $16,634,000 in 2017.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense increased $710,000, or 18.1%, to $4,625,000 in 2018 from $3,915,000 in 2017. Table II shows that the overall cost of funds on interest-bearing liabilities increased to 0.56% in 2018 from 0.48% in 2017.
Total average deposit balances (interest-bearing and noninterest-bearing) increased 3.7%, to $1,027,831,000 in 2018 from $990,917,000 in 2017. Increases in the average balances of demand deposits, certificates of deposit, savings and interest checking were partially offset by reductions in money market and Individual Retirement Accounts.
Interest expense on deposits increased $1,299,000 in 2018 over 2017. The average rate on interest-bearing deposits increased to 0.48% in 2018 from 0.32% in 2017. Interest expense on certificates of deposit increased $580,000 in 2018 of which $420,000 is from an increase in average rate and $160,000 due to an increase in volume. Interest expense on interest checking accounts increased $476,000 and on money market accounts increased $194,000, in 2018 as compared to 2017, primarily due to increases in the average rates paid.
Interest expense on borrowed funds decreased $589,000 in 2018 as compared to 2017, including a reduction in interest expense on long-term borrowings partially offset by an increase in interest expense on short-term borrowings. Total average borrowed funds decreased $8,984,000 to $50,435,000 in 2018 from $59,419,000 in 2017. The average rate on total borrowed funds was 1.83% in 2018 compared to 2.54% in 2017.
Interest expense on short-term borrowings in 2018 exceeded interest expense in the same period of 2017 by $153,000 as result of a series of advances from FHLB-Pittsburgh that matured in monthly amounts of $3,000,000 through October 2018, as well as an increase in short-term interest rates. These short-term advances were originated in the third and fourth quarters of 2017 to pay off a portion of a total of $37,000,000 in long-term borrowings that matured during that time period. Average short-term borrowings totaled $25,226,000 in 2018, an increase of $1,465,000 over 2017. The weighted-average rate on short-term borrowings was 1.45% in 2018 as compared to 0.90% in 2017.
Interest expense on long-term debt decreased $742,000 in 2018 as compared to 2017, mainly from repayment of the $37 million in higher-cost borrowings (weighted-average rate of 3.65%) in the third and fourth quarters of 2017 referred to above. Borrowings are classified as long-term within the Tables based on their term at origination. The average balance of long-term borrowings in 2018 of $25,209,000 consisted mainly of FHLB advances with 13-month terms at origination and had a weighted-average rate of 2.21%. In comparison, average long-term borrowings in 2017 totaled $35,658,000, with an average rate of 3.64%.
TABLE I - ANALYSIS OF INTEREST INCOME AND EXPENSE
|Years Ended December 31,||Increase/|
|Total available-for-sale securities||9,687||10,370||(683||)|
|Dividends on marketable equity security||22||21||1|
|Interest-bearing due from banks||415||190||225|
|Loans held for sale||14||25||(11||)|
|Total loans receivable||41,491||38,017||3,474|
|Total Interest Income||51,629||48,623||3,006|
|Certificates of deposit||1,576||996||580|
|Individual Retirement Accounts||473||434||39|
|Other time deposits||1||1||0|
|Total interest-bearing deposits||3,702||2,403||1,299|
|Total borrowed funds||923||1,512||(589||)|
|Total Interest Expense||4,625||3,915||710|
|Net Interest Income||$||47,004||$||44,708||$||2,296|
|(1)||Interest income from tax-exempt securities and loans has been adjusted to a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 21% in 2018 and 35% in 2017.|
|(2)||Fees on loans are included with interest on loans and amounted to $912,000 in 2018 and $883,000 in 2017.|
TABLE II - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
(Dollars in Thousands)
|Ended||Rate of||Ended||Rate of|
|Average||Cost of||Average||Cost of|
|Balance||Funds %||Balance||Funds %|
|Available-for-sale securities, at amortized cost:|
|Total available-for-sale securities||360,123||2.69||%||371,825||2.79||%|
|Marketable equity security||950||2.32||%||1,000||2.10||%|
|Interest-bearing due from banks||21,800||1.90||%||16,634||1.14||%|
|Loans held for sale||210||6.67||%||470||5.32||%|
|Total loans receivable||822,346||5.05||%||780,640||4.87||%|
|Total Earning Assets||1,205,429||4.28||%||1,169,569||4.16||%|
|Unrealized gain/loss on securities||(8,343||)||88|
|Allowance for loan losses||(9,033||)||(8,820||)|
|Bank premises and equipment||15,156||15,541|
|Certificates of deposit||134,478||1.17||%||117,366||0.85||%|
|Individual Retirement Accounts||91,587||0.52||%||97,519||0.45||%|
|Other time deposits||995||0.10||%||1,014||0.10||%|
|Total interest-bearing deposits||778,422||0.48||%||760,723||0.32||%|
|Total borrowed funds||50,435||1.83||%||59,419||2.54||%|
|Total Interest-bearing Liabilities||828,857||0.56||%||820,142||0.48||%|
|Stockholders' equity, excluding other comprehensive income/loss||194,333||188,756|
|Other comprehensive income/loss||(6,438||)||202|
|Total Stockholders' Equity||187,895||188,958|
|Total Liabilities and Stockholders' Equity||$||1,276,140||$||1,247,759|
|Interest Rate Spread||3.72||%||3.68||%|
|Net Interest Income/Earning Assets||3.90||%||3.82||%|
|Total Deposits (Interest-bearing and Demand)||$||1,027,831||$||990,917|
|(1)||Rates of return on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 21% in 2018 and 35% in 2017.|
|(2)||Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings.|
TABLE III - ANALYSIS OF VOLUME AND RATE CHANGES
|Year Ended 12/31/18 vs. 12/31/17|
|Change in||Change in||Total|
|Total available-for-sale securities||(511||)||(172||)||(683||)|
|Marketable equity security||(1||)||2||1|
|Interest-bearing due from banks||71||154||225|
|Loans held for sale||(16||)||5||(11||)|
|Total loans receivable||2,039||1,435||3,474|
|Total Interest Income||1,582||1,424||3,006|
|Certificates of deposit||160||420||580|
|Individual Retirement Accounts||(27||)||66||39|
|Other time deposits||0||0||0|
|Total interest-bearing deposits||139||1,160||1,299|
|Total borrowed funds||(303||)||(286||)||(589||)|
|Total Interest Expense||(164||)||874||710|
|Net Interest Income||$||1,746||$||550||$||2,296|
|(1)||Changes in income on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 21% for 2018 and 35% in 2017.|
|(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 amounts of the change in each.|
The table below presents a comparison of noninterest income and excludes realized gains and losses on securities, which are discussed in the “Earnings Overview” section of Management’s Discussion and Analysis.
TABLE IV - COMPARISON OF NONINTEREST INCOME
|Trust and financial management revenue||$||5,838||$||5,399||$||439||8.1|
|Insurance commissions, fees and premiums||105||115||(10||)||(8.7||)|
|Service charges on deposit accounts||5,171||4,560||611||13.4|
|Service charges and fees||343||345||(2||)||(0.6||)|
|Interchange revenue from debit card transactions||2,546||2,221||325||14.6|
|Net gains from sales of loans||682||818||(136||)||(16.6||)|
|Loan servicing fees, net||347||244||103||42.2|
|Increase in cash surrender value of life insurance||394||379||15||3.9|
|Other noninterest income||2,153||1,275||878||68.9|
|Total noninterest income before realized gains on securities, net||$||18,597||$||16,153||$||2,444||15.1|
Total noninterest income, excluding realized gains and losses on securities, increased $2,444,000 (15.1%) in 2018 compared to 2017. Changes of significance are discussed in the narrative that follows.
Total Trust and brokerage revenue increased $660,000 (10.7%), reflecting growth in the average value of assets under management as well as increased volume of brokerage transactions.
Service charges on deposit accounts increased $611,000 (13.4%), mainly due to increased fees from the overdraft privilege program and reflecting the benefit of operational improvements to the program that were instituted early in 2018.
Interchange revenue from debit card transactions increased $325,000 (14.6%), reflecting an increase in transaction volume.
Loan servicing fees, net, increased $103,000, as the fair value of mortgage loan servicing rights decreased $83,000 in 2018 as compared to a decrease of $168,000 in 2017.
Net gains from sales of loans decreased $136,000 (16.6%), as the dollar volume of residential mortgage loans sold decreased by approximately 12% in 2018 as compared to 2017. Gains on sales of loans totaled 3.2% of the origination cost of loans sold in 2018 as compared to 3.4% in 2017.
Other noninterest income increased $878,000, including $438,000 from a life insurance arrangement in which benefits were split between the Corporation and heirs of a former employee. Income from state tax credits totaled $322,000 in 2018, an increase of $122,000 over 2017, including $154,000 recorded in 2018 related to the donation of the Towanda facility described in the Earnings Overview section of Management’s Discussion and Analysis. Also, dividends on FHLB-Pittsburgh stock increased $146,000 to $320,000 in 2018 from $174,000 in 2017, interchange revenue from credit card transactions increased $105,000 to $126,000 in 2018 from $21,000 in 2017 and revenue from merchant services increased $50,000 to $374,000 in 2018 from $324,000 in 2017.
Total noninterest expenses increased $2,519,000 (6.8%) in 2018 as compared to 2017. Changes of significance are discussed in the narrative that follows.
TABLE V - COMPARISON OF NONINTEREST EXPENSE
(Dollars In Thousands)
|Year to Date|
|Salaries and wages||$||17,191||$||15,806||$||1,385||8.8|
|Pensions and other employee benefits||5,259||5,348||(89||)||(1.7||)|
|Occupancy expense, net||2,497||2,340||157||6.7|
|Furniture and equipment expense||1,196||1,299||(103||)||(7.9||)|
|Data processing expenses||2,750||2,406||344||14.3|
|Automated teller machine and interchange expense||1,304||1,284||20||1.6|
|Pennsylvania shares tax||1,318||1,329||(11||)||(0.8||)|
|Other noninterest expense||5,377||4,988||389||7.8|
|Total noninterest expense||$||39,486||$||36,967||$||2,519||6.8|
Salaries and wages expense increased $1,385,000 (8.8%), including the effects of annual performance-based salary adjustments for employees along with an increase of $672,000 in cash and stock-based incentive compensation expense and an increase in the average number of full-time equivalent employees (FTEs) to 297 in 2018 from 292 in 2017.
Other noninterest expense increased $389,000. Donations expense increased $229,000, including $250,000 from the June 2018 donation of the Towanda banking facility to a nonprofit organization. The Corporation entered into a lease with the nonprofit organization and continues to provide banking services there until a new location in the Towanda market can be obtained and prepared for use. Other significant variances within this category include an increase of $118,000 in consulting expense related to the overdraft privilege program, an increase of $104,000 in credit card processing and rewards expenses, a decrease of $247,000 in net loan collection expense and a decrease in other taxes of $118,000 from sales tax refunds received.
Data processing expenses increased $344,000 (14.3%), including increases in costs associated with document imaging and a new loan origination system implemented in 2018.
Professional fees increased $268,000 (30.7%). The increase in professional fees expense included $158,000 related to the pending acquisition of Monument, along with consulting costs related to Board governance and committee structures, implementation of new accounting standards, certification of a compliance-related software system and other corporate projects.
Telecommunications expense increased $173,000, including higher costs associated with data lines from a new telephone system.
Occupancy expense increased $157,000 (6.7%), including the effects of accelerated depreciation on the Ralston, Pennsylvania branch closed in November 2018 and an increase in repairs and maintenance expense at several locations.
Furniture and equipment expense decreased $103,000 (7.9%), mainly due to a reduction in depreciation expense related to certain items of equipment still in service that became fully depreciated in 2017 and 2018.
Pensions and other employee benefits expense decreased $89,000, reflecting a reduction of $202,000 in health insurance expense due to lower claims from the Corporation’s partially self-insured plan.
The effective income tax rate was 16.2% of pre-tax income in 2018, down from 34.8% in 2017. The Corporation’s effective tax rates differed from the statutory rate of 21% in 2018 and 35% in 2017 principally because of the effects of tax-exempt interest income. In 2018, the Corporation realized a decrease in the income tax provision (expense) due to the Tax Cuts and Jobs Act of 2017 enacted in December 2017 that, among other things, lowered the federal corporate income tax rate to 21% effective January 1, 2018, from the 35% marginal tax rate in effect for prior periods. Because of the change in the marginal tax rate, the Corporation was required to write-down deferred tax assets at December 31, 2017. Excluding the effect of the write-down, the effective income tax rate for the year ended December 31, 2017 would have been 24.3%.
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. At December 31, 2018, the net deferred tax asset was $4,110,000, an increase from the balance at December 31, 2017 of $3,289,000. The most significant change in temporary difference components was a net increase of $639,000 related to unrealized losses on available-for-sale securities. At December 31, 2018, the net deferred tax asset associated with the unrealized loss was $1,145,000, while at December 31, 2017, the deferred tax asset associated with the unrealized loss was $506,000, including $843,000 recorded as an offset to the pre-tax unrealized loss within accumulated other comprehensive loss, partially offset by $337,000 charged against retained earnings
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. Further, the value of the benefit from realization of deferred tax assets would be impacted if income tax rates were changed from currently enacted levels.
Management believes the recorded net deferred tax asset at December 31, 2018 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.
Additional information related to income taxes is presented in Note 14 to the consolidated financial statements.
The objectives of the Corporation’s available-for-sale debt securities (investment) portfolio are to maintain high credit quality, achieve good portfolio balance, support liquidity needs, maximize return on earning assets within reasonable risk parameters, provide an adequate amount of pledgeable securities, support local communities by purchasing securities they issue for public projects and programs, provide a means to hedge the Corporation’s interest rate risk exposure, and minimize taxes. Management continually evaluates the size and mix of securities held in the available-for-sale debt securities portfolio while considering these objectives.
Table VI shows the composition of the available-for-sale debt securities portfolio at December 31, 2018 and 2017. Comparison of the amortized cost totals of available-for-sale debt securities at each year-end presented reflects an increase of $10,408,000 to $368,725,000 at December 31, 2018 from $358,317,000 at December 31, 2017. The Corporation’s holdings of mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies increased to $244,572,000 at December 31, 2018 from $221,187,000 at December 31, 2017. Total amortized cost of tax-exempt obligations of states and political subdivisions (municipal bonds) decreased to $84,204,000 at December 31, 2018 from $103,673,000 at December 31, 2017. The reduction in tax-exempt municipal bonds resulted from market conditions, as management identified opportunities to reinvest proceeds from maturities and sales of municipal bonds into other types of debt securities, considering the Corporation’s liquidity and interest rate risk management needs and current market yields for various categories of securities.
As reflected in Table VI, the fair value of available-for-sale securities as of December 31, 2018 was $5,452,000, or 1.5%, less than the total amortized cost basis. In comparison, the aggregate unrealized loss position at December 31, 2017 was $2,380,000, or 0.7% of the total amortized cost basis. Increases in interest rates over the course of 2018 and 2017 were the major cause of the decrease in fair values of debt securities. Also, the fair values of tax-exempt municipal bonds have been negatively impacted by the reduced benefit of their tax-exempt nature resulting from the reduction in the federal corporate income tax rate. The Corporation had net realized losses from sales of available-for-sale debt securities of $288,000 in 2018, as management identified opportunities to sell selected securities with the proceeds reinvested in securities with higher yields. In comparison, net realized gains from sales of available-for-sale debt securities totaled $257,000 in 2017.
Management has reviewed the Corporation’s holdings as of December 31, 2018 and concluded that unrealized losses on all of the securities in an unrealized loss position are considered temporary. Notes 6 and 7 to the consolidated financial statements provide more detail concerning the Corporation’s processes for evaluating securities for other-than-temporary impairment. Management will continue to closely monitor the status of impaired securities in 2019.
TABLE VI - INVESTMENT SECURITIES
|As of December 31,|
|AVAILABLE-FOR-SALE DEBT SECURITIES:|
|Obligations of U.S. Government agencies||$||12,331||$||12,500||$||8,026||$||7,873|
|Obligations of states and political subdivisions:|
|Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:|
|Residential pass-through securities||54,827||53,445||52,992||52,347|
|Residential collateralized mortgage obligations||148,964||145,912||134,314||131,814|
|Commercial mortgage-backed securities||40,781||39,765||33,881||33,219|
|Total Available-for-Sale Debt Securities||$||368,725||$||363,273||$||358,317||$||355,937|
The following table presents the contractual maturities and the weighted-average yields (calculated based on amortized cost) of investment securities as of December 31, 2018. Yields on tax-exempt securities are presented on a fully taxable-equivalent basis. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.
|(In Thousands, Except for Percentages)||Year||Yield||Years||Yield||Years||Yield||Years||Yield||Total||Yield|
|AVAILABLE-FOR-SALE DEBT SECURITIES:|
|Obligations of U.S. Government agencies||$||0||0.00||%||$||0||0.00||%||$||2,516||3.51||%||$||9,815||3.45||%||$||12,331||3.46||%|
|Obligations of states and political subdivisions:|
|Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:|
|Residential pass-through securities||54,827||2.41||%|
|Residential collateralized mortgage obligations||148,964||2.52||%|
|Commercial mortgage-backed securities||40,781||2.60||%|
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. As rates increase, cash flows generally decrease as prepayments on the underlying mortgage loans decrease. As rates decrease, cash flows generally increase as prepayments increase due to increased refinance activity and other factors. In the table above, the entire balances and weighted-average rates for mortgage-backed securities and collateralized mortgage obligations are shown in one period.
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 securities, 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 letters of credit at December 31, 2018, and management does not expect the amount of purchases of bank premises and equipment to have a material, detrimental effect on the Corporation’s financial condition in 2019.
Gross loans outstanding (excluding mortgage loans held for sale) were $827,563,000 at December 31, 2018, up 1.5% from $815,713,000 at December 31, 2017. The total outstanding balances of residential mortgage segment loans at December 31, 2018 increased $9,520,000 (2.1%) as compared to December 31, 2017, and the total outstanding balances of commercial segment loans of $353,627,000 at December 31, 2018 was flat compared to December 31, 2017. Average total loans outstanding increased 5.3% in 2018 over 2017. Table VII shows the composition of the loan portfolio as of the end of the years 2014 through 2018. Over that period, the overall mix by segment has remained fairly constant, with residential mortgage loans of approximately 55% to 58% of the portfolio at each year-end, and commercial loans of 40% to 44% of the portfolio. Total loans outstanding were $197,018,000 (31.2%) higher at December 31, 2018 as compared to December 31, 2014.
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-K. Total participation loans outstanding amounted to $67,340,000 at December 31, 2018, up from $61,245,000 at December 31, 2017. At December 31, 2018, the balance of participation loans outstanding includes a total of $52,623,000 to businesses located outside of the Corporation’s market area, including $8,032,000 from participations in loans originated through the Corporation’s membership in a network that originates loans throughout the U.S. The Corporation’s participation loans originated through the network consist of loans to businesses that are larger than the Corporation’s typical commercial customer base. The loans originated through the network are considered “leveraged loans,” meaning the businesses typically have minimal tangible book equity and the extent of collateral available is limited, though at the time of origination the businesses have demonstrated strong cash flow performance in their recent histories. Total leveraged participation loans, including loans originated through the network and two loans originated through another lead institution, totaled $13,315,000 at December 31, 2018 and $15,328,000 at December 31, 2017.
Table VIII presents loan maturity data as of December 31, 2018. The interest rate simulation model used to prepare Table VIII classifies certain loans under different categories from the categories that appear in Table VII. Fixed-rate loans are shown in Table VIII based on their contractually scheduled principal repayments, and variable-rate loans are shown based on the date of the next change in rate. Table VIII shows that fixed-rate loans are approximately 36% of the loan portfolio. Of the 64% of the portfolio made up of variable-rate loans, a significant portion (71%) will re-price after more than one year. Variable-rate loans re-pricing after more than one year include residential and commercial real estate secured loans. The Corporation’s substantial investment in long-term, fixed-rate loans and variable-rate loans with extended periods until re-pricing is one of the concerns management attempts to address through interest rate risk management practices.
Short-term borrowings totaled $12,853,000 at December 31, 2018, down from $61,766,000 at December 31, 2017. Within this category, overnight borrowing from FHLB-Pittsburgh of $7,000,000 was down from $29,000,000 at December 31, 2017. In 2017, the Corporation paid off two higher-cost borrowings totaling $37,000,000, including an advance from FHLB-Pittsburgh of $10,000,000 with a rate of 3.81% in October and repurchase agreements totaling $27,000,000 with a rate of 3.595% in December. Repayment of these borrowings was funded by a series short-term advances from FHLB-Pittsburgh totaling $29,000,000, including advances maturing monthly from January through October 2018 with a weighted average interest rate of 1.69% and rates ranging from 1.23% to 1.89%.
Long-term borrowings of $35,915,000 at December 31, 2018 were up from the balance at December 31, 2017 of $9,189,000. As the short-term advances described above matured through 2018, they were renewed at FHLB Pittsburgh with long-term advances, generally with 13-month terms, utilizing the FHLB’s Community Lending Program (CLP). These advances have a weighted average rate of 2.40% with rates ranging from 1.83% to 2.77%.
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. 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 December 31, 2018, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $2,146,000, and the corresponding total outstanding balance of repurchased loans at December 31, 2017 was $1,805,000.
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. At December 31, 2017, outstanding balances of loans sold and serviced through the two programs totaled $169,725,000, including loans sold through the MPF Xtra program of $107,117,000 and loans sold through the Original Program of $62,608,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of December 31, 2018 and December 31, 2017.
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 December 31, 2018, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $4,157,000, and the Corporation has recorded a related allowance for credit losses in the amount of $328,000 which is included in “Accrued interest and other liabilities” in the accompanying consolidated balance sheets. At December 31, 2017, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $5,742,000, and the related allowance for credit losses was $260,000. The Corporation does not provide a credit enhancement for loans sold through the Xtra program.
TABLE VII - Five-year Summary of Loans by Type
(Dollars In Thousands)
|Residential mortgage loans - first liens||$||372,339||45.0||$||359,987||44.1||$||334,102||44.4||$||304,783||43.2||$||291,882||46.3|
|Residential mortgage loans - junior liens||25,450||3.1||25,325||3.1||23,706||3.2||21,146||3.0||21,166||3.4|
|Home equity lines of credit||34,319||4.1||35,758||4.4||38,057||5.1||39,040||5.5||36,629||5.8|
|1-4 Family residential construction||24,698||3.0||26,216||3.2||24,908||3.3||21,121||3.0||16,739||2.7|
|Total residential mortgage||456,806||55.2||447,286||54.8||420,773||56.0||386,090||54.8||366,416||58.1|
|Commercial loans secured by real estate||162,611||19.6||159,266||19.5||150,468||20.0||154,779||22.0||145,878||23.1|
|Commercial and industrial||91,856||11.1||88,276||10.8||83,854||11.2||75,196||10.7||50,157||8.0|
|Loans secured by farmland||7,146||0.9||7,255||0.9||7,294||1.0||7,019||1.0||7,916||1.3|
|Multi-family (5 or more) residential||7,180||0.9||7,713||0.9||7,896||1.1||9,188||1.3||8,917||1.4|
|Other commercial loans||13,950||1.7||10,986||1.3||11,475||1.5||12,152||1.7||13,334||2.1|
|Less: allowance for loan losses||(9,309||)||(8,856||)||(8,473||)||(7,889||)||(7,336||)|
TABLE VIII – LOAN MATURITY DISTRIBUTION
|As of December 31, 2018|
|Fixed-Rate Loans||Variable- or Adjustable-Rate Loans|
|1 Year||1-5||>5||1 Year||1-5||>5|
|or Less||Years||Years||Total||or Less||Years||Years||Total|
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 recorded as a reduction of the investment in loans. Notes 1 and 8 to the consolidated financial statements provide 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.
The allowance for loan losses was $9,309,000 at December 31, 2018, up from $8,856,000 at December 31, 2017. Table X shows total specific allowances on impaired loans increased $326,000 to $1,605,000 at December 31, 2018 from $1,279,000 at December 31, 2017. A significant portion of the total specific allowances on impaired loans is related to two commercial loan relationships. The largest individual loan balance for which a specific allowance has been recorded is a real estate secured commercial loan with an outstanding balance of $2,515,000 and a specific allowance of $781,000 at December 31, 2018, down from an outstanding balance of $2,641,000 and a specific allowance of $919,000 at December 31, 2017. At December 31, 2018, the Corporation recorded a specific allowance of $584,000 related to commercial participation loans to one borrower that were identified as impaired in the fourth quarter 2018. The allowance for these loans was determined based on comparison of the Corporation’s total outstanding exposure to the estimated, discounted value of the borrower’s equipment, inventory and accounts receivable. At December 31, 2018, the outstanding balance of these loans totaled $1,265,000.
Table X also shows that the collectively determined portion of the allowance increased $127,000 across all loan classes. This increase was primarily due to loan growth in 2018 with stable aggregate net charge-off experience and minor changes to the qualitative factors used in the allowance calculation.
The provision for loan losses by segment for 2018 and 2017 is as follows:
The provision for loan losses is further detailed as follows:
|Residential mortgage segment|
|Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs||$||144||$||300|
|Increase (decrease) in collectively determined portion of the allowance attributable to:|
|Changes in historical loss experience factors||(65||)||(53||)|
|Changes in qualitative factors||0||(229||)|
|Total provision for loan losses -|
|Residential mortgage segment||$||173||$||251|
|Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs||$||180||$||611|
|Increase (decrease) in collectively determined portion of the allowance attributable to:|
|Changes in historical loss experience factors||(21||)||(268||)|
|Changes in qualitative factors||0||(210||)|
|Total provision for loan losses -|
|Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs||$||133||$||112|
|Increase (decrease) in collectively determined portion of the allowance attributable to:|
|Changes in historical loss experience factors||34||14|
|Changes in qualitative factors||1||(6||)|
|Total provision for loan losses -|
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.
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 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).
The Corporation’s overall net charge-off experience improved in 2018, consistent with the reductions in the provision for both the Residential mortgage and Commercial segments. While total (gross) charge-offs of $497,000 in 2018 were up from $479,000 in 2017, total recoveries of $366,000 in 2018 exceeded the 2017 total of $61,000. In 2018, the Corporation recorded a recovery of $311,000 on a commercial participation loan for which a charge-off of $595,000 had been recorded in 2016. Table XII shows the average rate of net charge-offs as a percentage of loans was 0.02% in 2018, with an annual average over the five-year period ended December 31, 2018 of 0.09%, and annual average rates ranging from a high of 0.29% in 2014 to the low of 0.02% in 2018.
Table XI 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 1.94% at December 31, 2018, down from 2.10% at December 31, 2017. Nonperforming assets as a percentage of total assets was 1.37% at December 31, 2018, also down from 1.47% at December 31, 2017. Table XI presents data at the end of each of the years ended December 31, 2014 through 2018. For the range of dates presented in Table XI, total nonperforming loans as a percentage of loans has ranged from a low of 1.94% at December 31, 2018 to a high of 2.45% at December 31, 2014, and total nonperforming assets as a percentage of assets has ranged from a low of 1.31% at December 31, 2015 to a high of 1.47% at December 31, 2017.
Total impaired loans of $9,774,000 at December 31, 2018 are up $263,000 from the corresponding amount at December 31, 2017 of $9,511,000, while foreclosed assets held for sale increased $105,000 to a balance of $1,703,000 at December 31, 2018. In the second quarter 2018, the Corporation acquired two properties that had secured a commercial loan, recording the acquisition at an estimated fair value of $2,293,000 with no gain or loss recognized. In the third quarter 2018, the Corporation recorded a loss of $53,000 based on an updated estimate of costs to sell the properties, resulting in an adjustment in their carrying value to $2,240,000 at September 30, 2018. In October 2018, one of the two commercial properties referred to above was sold for $711,000, with no gain or loss recognized.
Total nonperforming assets of $17,722,000 at December 31, 2018 are down $1,004,000 from the corresponding amount at December 31, 2017. The total amount of nonperforming assets exceeds the amount of total impaired loans because the nonperforming category includes, in addition to impaired loans, foreclosed assets held for sale and loans 90 days or more past due or in nonaccrual status with outstanding balances lower than the minimum amounts that are individually evaluated for impairment. A summary of changes in the components of nonperforming assets at December 31, 2018 as compared to December 31, 2017 is as follows:
|·||Nonaccrual loans totaled $13,113,000 at December 31, 2018, down from $13,404,000 at December 31, 2017. The net decrease in nonaccrual loans included the effect of a decrease in total residential mortgage loans in nonaccrual status of $467,000 to $4,556,000 at December 31, 2018.|
|·||Total loans past due 90 days or more and still accruing interest amounted to $2,906,000 at December 31, 2018, a decrease of $818,000 from $3,724,000 at December 31, 2017. At December 31, 2018, total residential mortgage loans that were more than 90 days past due but deemed to be well secured and in the process of collection amounted to $2,003,000, down from $2,648,000 at December 31, 2017. The Corporation reviews the status of loans past due 90 days or more each quarter to determine if it is appropriate to continue to accrue interest and has determined the loans included in this category are well secured and that ultimate collection of all principal and interest is probable.|
|·||Foreclosed assets held for sale consisted of real estate, and totaled $1,703,000 at December 31, 2018, an increase of $105,000 from $1,598,000 at December 31, 2017. At December 31, 2018, the Corporation held 6 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. At December 31, 2017, the Corporation held 16 such properties for sale, with total carrying values of $721,000 related to residential real estate, $632,000 of land and $245,000 related to commercial real estate. The Corporation evaluates the carrying values of foreclosed assets each quarter based on the most recent market activity or appraisals for each property.|
Over the period 2014-2018, each period includes a few large commercial relationships that have required significant monitoring and workout efforts. As a result, a limited number of relationships may significantly impact the total amount of allowance required on impaired loans, and may significantly impact the amount of total charge-offs reported in any one period.
Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of December 31, 2018. Management continues to closely monitor its commercial loan relationships for possible credit losses, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.
Tables IX through XII present historical data related to the allowance for loan losses.
TABLE IX - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
|Years Ended December 31,|
|(Dollars in Thousands)||2018||2017||2016||2015||2014|
|Balance, beginning of year||$||8,856||$||8,473||$||7,889||$||7,336||$||8,663|
|Provision for loan losses||584||801||1,221||845||476|
|Balance, end of period||$||9,309||$||8,856||$||8,473||$||7,889||$||7,336|
|Net charge-offs as a % of average loans||0.02||%||0.05||%||0.09||%||0.04||%||0.29||%|
TABLE X - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES
|As of December 31,|
|ASC 310 - Impaired loans||$||1,605||$||1,279||$||674||$||820||$||769|
|ASC 450 - Collective segments:|
TABLE XI - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS
AND TROUBLED DEBT RESTRUCTURINGS (TDRs)
(Dollars in Thousands)
|As of December 31,|
|Impaired loans with a valuation allowance||$||4,851||$||4,100||$||3,372||$||1,933||$||3,241|
|Impaired loans without a valuation allowance||4,923||5,411||7,488||8,041||9,075|
|Total impaired loans||$||9,774||$||9,511||$||10,860||$||9,974||$||12,316|
|Total loans past due 30-89 days and still accruing||$||7,142||$||9,449||$||7,735||$||7,057||$||7,121|
|Total nonaccrual loans||$||13,113||$||13,404||$||8,736||$||11,517||$||12,610|
|Total loans past due 90 days or more and still accruing||2,906||3,724||6,838||3,229||2,843|
|Total nonperforming loans||16,019||17,128||15,574||14,746||15,453|
|Foreclosed assets held for sale (real estate)||1,703||1,598||2,180||1,260||1,189|
|Total nonperforming assets||$||17,722||$||18,726||$||17,754||$||16,006||$||16,642|
|Loans subject to troubled debt restructurings (TDRs):|
|Total nonperforming loans as a % of loans||1.94||%||2.10||%||2.07||%||2.09||%||2.45||%|
|Total nonperforming assets as a % of assets||1.37||%||1.47||%||1.43||%||1.31||%||1.34||%|
|Allowance for loan losses as a % of total loans||1.12||%||1.09||%||1.13||%||1.12||%||1.16||%|
|Allowance for loan losses as a % of nonperforming loans||58.11||%||51.70||%||54.40||%||53.50||%||47.47||%|
TABLE XII - FIVE-YEAR HISTORY OF LOAN LOSSES
(Dollars in Thousands)
|Average gross loans||$||822,346||$||780,640||$||723,076||$||657,727||$||627,753||$||722,308|
|Year-end gross loans||827,563||815,713||751,835||704,880||630,545||$||746,107|
|Year-end allowance for loan losses||9,309||8,856||8,473||7,889||7,336||$||8,373|
|Year-end nonaccrual loans||13,113||13,404||8,736||11,517||12,610||$||11,876|
|Year-end loans 90 days or more past due and still accruing||2,906||3,724||6,838||3,229||2,843||3,908|
|Provision for loan losses||584||801||1,221||845||476||785|
|Earnings coverage of charge-offs||210||x||56||x||37||x||85||x||14||x||38||x|
|Allowance coverage of charge-offs||71||x||21||x||13||x||27||x||4||x||13||x|
|Net charge-offs as a % of provision for loan losses||22.43||%||52.18||%||52.17||%||34.56||%||378.78||%||83.57||%|
|Net charge-offs as a % of average gross loans||0.02||%||0.05||%||0.09||%||0.04||%||0.29||%||0.09||%|
|Income before income taxes on a fully taxable equivalent basis||27,564||23,350||23,861||24,710||25,784||25,054|
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The Corporation’s significant fixed and determinable contractual obligations as of December 31, 2018 include repayment obligations related to time deposits and borrowed funds. Information related to maturities of time deposits is provided in Note 11 to the consolidated financial statements. Information related to maturities of borrowed funds is provided in Note 12 to the consolidated financial statements.
The Corporation’s operating lease and other commitments at December 31, 2018 are immaterial. As described in more detail in Note 2 to the Consolidated Financial Statements, Accounting Standards Update 2016-02, Leases (Topic 842) changes current U.S. GAAP by requiring that lease assets and liabilities arising from operating leases be recognized on the balance sheet. In July 2018, the FASB issued ASU 2018-10 and ASU 2018-11, Codification Improvements to Topic 842, Leases, amending various aspects of Topic 842. Topic 842 will become effective for the Corporation for annual and interim periods beginning in the first quarter 2019. The Corporation estimates that the adoption of ASU 2016-02 will result in the recognition of right-of-use assets and lease liabilities for operating leases of approximately $1,200,000 on its Consolidated Balance Sheets, with no material impact to its Consolidated Statements of Income. The Corporation’s significant off-balance sheet arrangements include commitments to extend credit and standby letters of credit. Off-balance sheet arrangements are described in Note 16 to the consolidated financial statements.
As described in more detail in the “Financial Condition” section of Management’s Discussion and Analysis, the Corporation sells residential mortgage loans for which 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. At December 31, 2018, outstanding balances of such loans sold totaled $171,742,000.
Also, for loans sold under the MPF Original program, the Corporation provides a credit enhancement. At December 31, 2018, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $4,157,000, and the Corporation has recorded a related allowance for credit losses in the amount of $328,000 which is included in “Accrued interest and other liabilities” in the accompanying consolidated balance sheets.
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 December 31, 2018, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $11,857,000.
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 securities with a carrying value of $15,710,000 at December 31, 2018.
The Corporation’s outstanding, available, and total credit facilities at December 31, 2018 and 2017 are as follows:
|Dec. 31,||Dec. 31,||Dec. 31,||Dec. 31,||Dec. 31,||Dec. 31,|
|Federal Home Loan Bank of Pittsburgh||$||42,915||$||67,189||$||318,699||$||295,441||$||361,614||$||362,630|
|Federal Reserve Bank Discount Window||0||0||15,262||15,877||15,262||15,877|
|Other correspondent banks||0||0||45,000||45,000||45,000||45,000|
|Total credit facilities||$||42,915||$||67,189||$||378,961||$||356,318||$||421,876||$||423,507|
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. At December 31, 2017, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $29,000,000, short-term borrowings of $29,000,000 and long-term borrowings with a total amount of $9,189,000. Additional information regarding borrowed funds is included in Note 12 to the 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. At December 31, 2018, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $196,522,000.
Management believes the Corporation is well-positioned to meet its short-term and long-term obligations.
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 December 31, 2018; however, C&N Bank remains subject to regulatory capital requirements administered by the federal banking agencies.
Details concerning capital ratios at December 31, 2018 and December 31, 2017 are presented in Note 18 to the consolidated financial statements. Management believes, as of December 31, 2018, that C&N Bank meets all capital adequacy requirements to which it is subject and maintains a capital conservation buffer (described in more detail in Note 18) 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 Note 18, the Corporation’s and C&N Bank’s capital ratios at December 31, 2018 and December 31, 2017 exceed the Corporation’s Board policy threshold levels.
Management expects C&N Bank to maintain capital levels that exceed the regulatory standards for well-capitalized institutions and the applicable capital conservation buffer, including the impact of the pending merger discussed in Note 22 to the audited, consolidated financial statements, 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. In addition, the Corporation and C&N Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities. These restrictions are described in Note 18 to the consolidated financial statements. 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 sufficient 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). Generally, the new rule implemented higher minimum capital requirements, revised the definition of regulatory capital components and related calculations, added a new common equity tier 1 capital ratio, implemented a new capital conservation buffer, increased the risk weighting for past due loans and provided a transition period for several aspects of the new rule.
The current (new) capital rule provides that, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization 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 and is added to the minimum required risk-based capital ratios (as defined) for common equity tier 1 capital, tier 1 capital and total capital. The minimum capital conservation buffer to avoid limitations on capital distributions was 1.875% in 2018 and increased to 2.5%, effective January 1, 2019.
As fully phased in, a banking organization with a buffer greater than 2.5% 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. The new rule also prohibits a banking organization 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||%|
At December 31, 2018, C&N Bank’s Capital Conservation Buffer (also determined based on the minimum total capital ratio) was 13.75%.
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 ($4,307,000) at December 31, 2018 and ($1,566,000) at December 31, 2017. 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 7 to the consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale debt securities for other-than-temporary impairment at December 31, 2018.
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 (Loss) related to defined benefit plans, net of deferred income tax, was $137,000 at December 31, 2018 and $59,000 at December 31, 2017.
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 securities and changes in underfunded or overfunded defined benefit plans.
Comprehensive Income totaled $19,627,000 in 2018 as compared to $12,825,000 in 2017. In 2018, Comprehensive Income included: (1) Net Income of $22,013,000, which was $8,579,000 higher than in 2017; (2) Other Comprehensive Loss from unrealized losses on available-for-sale securities, net of deferred income tax, of ($2,452,000) as compared to Other Comprehensive Loss of ($617,000) in 2017; and (3) Other Comprehensive Income from defined benefit plans of $66,000 in 2018 as compared to Other Comprehensive Income of $8,000 in 2017. Fluctuations in interest rates significantly affected fair values of available-for-sale securities in 2018 and 2017, and accordingly had an effect on Other Comprehensive (Loss) in each year.
The Corporation is significantly affected by the Federal Reserve Board’s efforts to control inflation through changes in short-term interest rates. Since September 2007, the Federal Reserve has maintained the federal funds target rate at very low levels by historical standards. Further, throughout the period of low interest rates, the Federal Reserve has injected massive amounts of liquidity into the nation’s monetary system through a variety of programs. Since late 2015, the Federal Reserve has begun to move its federal funds target rate higher, in an effort to re-establish a more normalized level by historical standards, with nine separate 0.25% increases from December 2015 through December 2018, resulting in the current range of 2.25% to 2.50%. The Federal Open Market Committee (FOMC) has noted in its most recent statement that while the labor market continues to strengthen, and economic activity has been rising at a solid rate, inflation remains subdued, measured through 2017 and 2018 at levels at or just below the FOMC’s 2% longer run objective. The FOMC continues to view sustained expansion of economic activity and strong labor market conditions with inflation remaining near their 2% objective as the most likely outcome. Based on this, the FOMC has indicated they will be patient with future rate adjustments to the target rate to continue to support these trends.
Although management cannot predict future changes in the rates of inflation, management monitors the impact of economic trends, including any indicators of inflationary pressures, in managing interest rate and other financial risks.
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 December 31, 2018. 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.
The Corporation continues to analyze the changes implemented by the Act.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 2 to the consolidated financial statements for a description of recent accounting pronouncements and their recent or potential future effects on the Corporation’s financial statements.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Data)
|December 31,||December 31,|
|Cash and due from banks:|
|Total cash and due from banks||37,487||40,244|
|Available-for-sale debt securities, at fair value||363,273||355,937|
|Marketable equity security||950||971|
|Loans held for sale||213||765|
|Allowance for loan losses||(9,309||)||(8,856||)|
|Bank-owned life insurance||19,035||20,083|
|Accrued interest receivable||3,968||4,048|
|Bank premises and equipment, net||14,592||15,432|
|Foreclosed assets held for sale||1,703||1,598|
|Deferred tax asset, net||4,110||3,289|
|Intangible assets - Goodwill and core deposit intangibles||11,951||11,954|
|Accrued interest and other liabilities||10,985||9,112|
|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 $1.00 per share; authorized 20,000,000 shares; issued 12,655,171; outstanding 12,319,330 at December 31, 2018 and 12,214,525 December 31, 2017||12,655||12,655|
|Treasury stock, at cost; 335,841 shares at December 31, 2018 and 440,646 shares at December 31, 2017||(6,362||)||(8,348||)|
|Accumulated other comprehensive loss||(4,170||)||(1,507||)|
|TOTAL STOCKHOLDERS' EQUITY||197,368||188,443|
|TOTAL LIABILITIES & STOCKHOLDERS' EQUITY||$||1,290,893||$||1,276,959|
The accompanying notes are an integral part of the consolidated financial statements.
Consolidated Statements of Income
(In Thousands Except Per Share Data)
|Years Ended December 31,|
|Interest and fees on loans:|
|Interest on mortgages held for sale||14||25|
|Interest on balances with depository institutions||415||190|
|Income from available-for-sale debt securities:|
|Dividends on marketable equity security||22||21|
|Total interest and dividend income||50,328||45,863|
|Interest on deposits||3,702||2,403|
|Interest on short-term borrowings||366||213|
|Interest on long-term borrowings||557||1,299|
|Total interest expense||4,625||3,915|
|Net interest income||45,703||41,948|
|Provision for loan losses||584||801|
|Net interest income after provision for loan losses||45,119||41,147|
|Trust and financial management revenue||5,838||5,399|
|Insurance commissions, fees and premiums||105||115|
|Service charges on deposit accounts||5,171||4,560|
|Service charges and fees||343||345|
|Interchange revenue from debit card transactions||2,546||2,221|
|Net gains from sale of loans||682||818|
|Loan servicing fees, net||347||244|
|Increase in cash surrender value of life insurance||394||379|
|Other noninterest income||2,153||1,275|
|Gain on restricted equity security||2,321||0|
|Realized (losses) gains on available-for-sale debt securities, net||(288||)||257|
|Total noninterest income||20,630||16,410|
|Salaries and wages||17,191||15,806|
|Pensions and other employee benefits||5,259||5,348|
|Occupancy expense, net||2,497||2,340|
|Furniture and equipment expense||1,196||1,299|
|Data processing expenses||2,750||2,406|
|Automated teller machine and interchange expense||1,304||1,284|
|Pennsylvania shares tax||1,318||1,329|
|Other noninterest expense||5,377||4,988|
|Total noninterest expense||39,486||36,967|
|Income before income tax provision||26,263||20,590|
|Income tax provision||4,250||7,156|
|EARNINGS PER COMMON SHARE - BASIC||$||1.79||$||1.10|
|EARNINGS PER COMMON SHARE - DILUTED||$||1.79||$||1.10|
The accompanying notes are an integral part of consolidated financial statements.
Consolidated Statements of Comprehensive Income
|Years Ended December 31,|
|Unrealized losses on available-for-sale securities:|
|Unrealized holding losses on available-for-sale securities||(3,392||)||(691||)|
|Reclassification adjustment for losses (gains) realized in income||288||(257||)|
|Other comprehensive loss on available-for-sale securities||(3,104||)||(948||)|
|Unfunded pension and postretirement obligations:|
|Changes from plan amendments and actuarial gains and losses included in accumulated other comprehensive gain||101||36|
|Amortization of prior service cost and net actuarial loss included in net periodic benefit cost||(17||)||(24||)|
|Other comprehensive gain on unfunded retirement obligations||84||12|
|Other comprehensive loss before income tax||(3,020||)||(936||)|
|Income tax related to other comprehensive loss||634||327|
|Net other comprehensive loss||(2,386||)||(609||)|
The accompanying notes are an integral part of the consolidated financial statements.
Consolidated Statements of Changes in Stockholders' Equity
(In Thousands Except Share and Per Share Data)
|Balance, January 1, 2017||12,655,171||541,943||$||12,655||$||71,730||$||112,790||$||(898||)||$||(10,269||)||$||186,008|
|Other comprehensive loss, net||(609||)||(609||)|
|Cash dividends declared on common stock, $1.04 per share||(12,616||)||(12,616||)|
|Shares issued for dividend reinvestment plan||(63,066||)||276||1,195||1,471|
|Shares issued from treasury and redeemed related to exercise of stock options||(11,780||)||(100||)||227||127|
|Restricted stock granted||(30,782||)||(583||)||583||0|
|Forfeiture of restricted stock||4,406||85||(85||)||0|
|Stock-based compensation expense||627||627|
|Other stock-based expense||(75||)||1||1|
|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|
|Other comprehensive loss, net||(2,386||)||(2,386||)|
|Cash dividends declared on common stock, $1.08 per share||(13,255||)||(13,255||)|
|Shares issued for dividend reinvestment plan||(59,330||)||385||1,124||1,509|
|Shares issued from treasury and redeemed related to exercise of stock options||(18,862||)||(166||)||355||189|
|Restricted stock granted||(34,552||)||(655||)||655||0|
|Forfeiture of restricted stock||7,939||148||(148||)||0|
|Stock-based compensation expense||855||855|
|Balance, December 31, 2018||12,655,171||335,841||$||12,655||$||72,602||$||122,643||$||(4,170||)||$||(6,362||)||$||197,368|
|(a)||As described in more detail in the Recent Accounting Pronouncements - Adopted section of Note 2, 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 2, 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 2, 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 the consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
|Years Ended December 31,|
|CASH FLOWS FROM OPERATING ACTIVITIES:|
|Adjustments to reconcile net income to net cash provided by operating activities:|
|Provision for loan losses||584||801|
|Realized losses (gains) on available-for-sale securities, net||288||(257||)|
|Unrealized loss on marketable equity security||21||0|
|Gain on restricted equity security||(2,321||)||0|
|Depreciation and amortization expense||1,754||1,639|
|Accretion and amortization on securities, net||1,044||1,157|
|Increase in cash surrender value of life insurance||(394||)||(379||)|
|Stock-based compensation and other expense||855||628|
|Deferred income taxes||(187||)||2,155|
|Decrease in fair value of servicing rights||83||168|
|Gains on sales of loans, net||(682||)||(818||)|
|Origination of loans held for sale||(21,014||)||(25,129||)|
|Proceeds from sales of loans held for sale||22,060||25,119|
|Increase in accrued interest receivable and other assets||(413||)||(595||)|
|Increase in accrued interest payable and other liabilities||1,957||1,312|
|Net Cash Provided by Operating Activities||25,892||19,374|
|CASH FLOWS FROM INVESTING ACTIVITIES:|
|Proceeds from maturities of certificates of deposit||2,280||348|
|Purchase of certificates of deposit||(3,700||)||(100||)|
|Proceeds from sales of available-for-sale securities||25,860||24,118|
|Proceeds from calls and maturities of available-for-sale securities||52,383||63,679|
|Purchase of available-for-sale securities||(90,015||)||(51,476||)|
|Redemption of Federal Home Loan Bank of Pittsburgh stock||6,145||7,288|
|Purchase of Federal Home Loan Bank of Pittsburgh stock||(5,301||)||(9,418||)|
|Net increase in loans||(14,492||)||(65,225||)|
|Proceeds from sale of restricted equity security||2,321||0|
|Proceeds from bank owned life insurance||1,442||0|
|Purchase of premises and equipment||(1,167||)||(1,697||)|
|Proceeds from sale of foreclosed assets||2,418||1,387|
|Net Cash Used in Investing Activities||(21,648||)||(30,905||)|
|CASH FLOWS FROM FINANCING ACTIVITIES:|
|Net increase in deposits||25,323||24,606|
|Net (decrease) increase in short-term borrowings||(48,913||)||35,591|
|Proceeds from long-term borrowings||33,000||8,000|
|Repayments of long-term borrowings||(6,274||)||(37,265||)|
|Sale of treasury stock||189||127|
|Common dividends paid||(11,746||)||(11,145||)|
|Net Cash (Used in) Provided by Financing Activities||(8,421||)||19,914|
|(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS||(4,177||)||8,383|
|CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR||37,004||28,621|
|CASH AND CASH EQUIVALENTS, END OF YEAR||$||32,827||$||37,004|
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:|
|Assets acquired through foreclosure of real estate loans||$||2,520||$||940|
|Income taxes paid||$||4,277||$||4,913|
The accompanying notes are an integral part of the consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION - 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”), as well as C&N Bank’s wholly-owned subsidiary, C&N Financial Services Corporation. In December 2018, C&N Bank established a new entity, Northern Tier Holding LLC, for the purpose of acquiring, holding and disposing of real property acquired by the Bank. C&N Bank is the sole member of Northern Tier Holding LLC. All material intercompany balances and transactions have been eliminated in consolidation.
NATURE OF OPERATIONS - The Corporation is primarily engaged in providing a full range of banking and mortgage services to individual and corporate customers in North Central Pennsylvania and Southern New York State. Lending products include mortgage loans, commercial loans and consumer loans, as well as specialized instruments such as commercial letters-of-credit. Deposit products include various types of checking accounts, passbook and statement savings, money market accounts, interest checking accounts, Individual Retirement Accounts and certificates of deposit. The Corporation also offers non-insured “RepoSweep” accounts.
The Corporation provides Trust and Financial Management services, including administration of trusts and estates, retirement plans, and other employee benefit plans, and investment management services. The Corporation offers a variety of personal and commercial insurance products through C&N Financial Services Corporation. C&N Financial Services Corporation also offers mutual funds, annuities, educational savings accounts and other investment products through registered agents.
Management has determined that the Corporation has one reportable segment, “Community Banking.” All of the Corporation’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Corporation supports the others.
The Corporation is subject to competition from other financial institutions. It is also subject to regulation by certain federal and state agencies and undergoes periodic examination by those regulatory authorities. As a consequence, the Corporation’s business is particularly susceptible to being affected by future federal and state legislation and regulations.
USE OF ESTIMATES - The financial information is presented in accordance with generally accepted accounting principles and general practice for financial institutions in the United States of America (“U.S. GAAP”). In preparing financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements. In addition, these estimates and assumptions affect revenues and expenses in the financial statements and as such, actual results could differ from those estimates.
Material estimates that are particularly susceptible to change include: (1) the allowance for loan losses, (2) fair values of debt securities based on estimates from independent valuation services or from brokers, (3) assessment of impaired securities to determine whether or not the securities are other-than-temporarily impaired, (4) valuation of deferred tax assets and (5) valuation of obligations from defined benefit plans.
INVESTMENT SECURITIES - Investment securities are accounted for as follows:
Available-for-sale debt securities - includes debt securities not classified as held-to-maturity or trading. Such securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported separately through accumulated other comprehensive income (loss), net of tax. Premiums on non-amortizing available-for-sale debt securities are amortized using the level yield method to the earliest call date, while discounts on non-amortizing securities are amortized to the maturity date. Premiums and discounts on amortizing securities (mortgage-backed securities) are amortized using the level yield method over the remaining contractual life of the securities, adjusted for actual prepayments. Realized gains and losses on sales of available-for-sale securities are computed on the basis of specific identification of the adjusted cost of each security. Securities within the available-for-sale portfolio may be used as part of the Corporation’s asset and liability management strategy and may be sold in response to changes in interest rate risk, prepayment risk or other factors.
Other-than-temporary impairment – Credit-related declines in the fair value of available-for-sale debt securities that are deemed to be other-than-temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment (OTTI) losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value, and (4) whether the Corporation intends to sell the security or if it is more likely than not that the Corporation will be required to sell the security before the recovery of its amortized cost basis. The credit-related impairment is recognized in earnings and is the difference between a security’s amortized cost basis and the present value of expected future cash flows discounted at the security’s effective interest rate. For debt securities classified as held-to-maturity, if any, the amount of noncredit-related impairment is recognized in other comprehensive income and accreted over the remaining life of the debt security as an increase in the carrying value of the security.
Marketable equity security – the marketable equity security is carried at fair value with unrealized gains and losses included in other noninterest income in the consolidated statements of income.
Restricted equity securities - Restricted equity securities consist primarily of Federal Home Loan Bank of Pittsburgh stock, and are carried at cost and evaluated for impairment. Holdings of restricted equity securities are included in Other Assets in the consolidated balance sheets, and dividends received on restricted securities are included in Other Income in the consolidated statements of income.
LOANS HELD FOR SALE - Mortgage loans held for sale are reported at the lower of cost or market, determined in the aggregate.
LOANS RECEIVABLE - Loans receivable which management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at unpaid principal balances, less the allowance for loan losses and net deferred loan fees. Interest income is accrued on the unpaid principal balance. Loan origination and commitment fees, as well as certain direct origination costs, are deferred and amortized as a yield adjustment over the lives of the related loans using the interest method.
The loans receivable portfolio is segmented into residential mortgage, commercial and consumer loans. The residential mortgage segment includes the following classes: first and junior lien residential mortgages, home equity lines of credit and residential construction loans. The most significant classes of commercial loans are commercial loans secured by real estate, non-real estate secured commercial and industrial loans, loans to political subdivisions, commercial construction, and loans secured by farmland.
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 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.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the collection of all, or part, of the principal balance is highly unlikely. Non-residential consumer loans are generally charged off no later than when they are 120 days past due on a contractual basis, or earlier in the event of bankruptcy or if there is an amount deemed uncollectible.
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 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. In the process of evaluating the loan portfolio, management also considers the Corporation’s exposure to losses from unfunded loan commitments. As of December 31, 2018 and 2017, management determined that no allowance for credit losses related to unfunded loan commitments was required.
The allowance consists primarily of two major components – (1) a specific component based on a detailed assessment of certain larger loan relationships, mainly commercial purpose, determined on a loan-by-loan basis; and (2) a general component for the remainder of the portfolio 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.
The specific component relates to loans that are classified as impaired based on a detailed assessment of certain larger loan relationships evaluated by a management committee referred to as the Watch List Committee. Specific loan relationships are identified for evaluation based on the related credit risk rating. For individual loans classified as impaired, an allowance is established when the collateral value less estimated selling costs, present value of discounted cash flows or observable market price of the impaired loan is lower than the carrying value of that loan.
The general component covers pools of loans by loan class 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 loans are subject to a restructuring agreement. The pools of loans for each loan segment are evaluated for loss exposure based upon average historical net charge-off rates, adjusted for qualitative factors. 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. Qualitative risk factors (described in the following paragraph) are evaluated for the impact on each of the three distinct 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. Any adjustments to the factors are supported by a narrative documentation of changes in conditions accompanying the allowance for loan losses calculation.
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. Further, the residential mortgage segment is significantly affected by the values of residential real estate that provide collateral for the loans. The majority of the Corporation’s commercial segment loans (approximately 53% at December 31, 2018) are secured by real estate, and accordingly, the Corporation’s risk for the commercial segment is significantly affected by commercial real estate values. The consumer segment includes a wide mix of loans for different purposes, primarily secured loans, including loans secured by motor vehicles, manufactured housing and other types of collateral.
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.
For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. 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 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.
Loans whose terms are modified are classified as troubled debt restructurings if the Corporation grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve reductions in required payments, an extension of a loan’s stated maturity date or a temporary reduction in interest rate. Loans classified as troubled debt restructurings are designated as impaired. Nonaccrual troubled debt restructurings may be restored to accrual status if the ultimate collectability of principal and interest payments under the modified terms is not in doubt, and there has been a period (generally, for at least six consecutive months) of satisfactory payment performance by the borrower either immediately before or after the restructuring.
BANK PREMISES AND EQUIPMENT - Bank premises and equipment are stated at cost less accumulated depreciation. Repair and maintenance expenditures which extend the useful lives of assets are capitalized, and other repair and maintenance expenditures are expensed as incurred. Depreciation expense is computed using the straight-line method.
IMPAIRMENT OF LONG-LIVED ASSETS - The Corporation reviews long-lived assets, such as premises and equipment and intangibles, for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. These changes in circumstances may include a significant decrease in the market value of an asset or the manner in which an asset is used. If there is an indication the carrying value of an asset may not be recoverable, future undiscounted cash flows expected to result from use of the asset are estimated. If the sum of the expected cash flows is less than the carrying value of the asset, a loss is recognized for the difference between the carrying value and fair market value of the asset.
FORECLOSED ASSETS HELD FOR SALE - Foreclosed assets held for sale consist of real estate acquired by foreclosure and are initially recorded at fair value, less estimated selling costs.
GOODWILL AND CORE DEPOSIT INTANGIBLE ASSETS - Goodwill represents the excess of the cost of acquisitions over the fair value of the net assets acquired. Goodwill is tested at least annually for impairment, or more often if events or circumstances indicate there may be impairment. Core deposit intangibles are being amortized over periods of time that represent the expected lives using a method of amortization that reflects the pattern of economic benefit. Core deposit intangibles are subject to impairment testing whenever events or changes in circumstances indicate their carrying amounts may not be recoverable.
SERVICING RIGHTS - The estimated fair value of servicing rights related to mortgage loans sold and serviced by the Corporation is recorded as an asset upon the sale of such loans. The valuation of servicing rights is adjusted quarterly, with changes in fair value included in Loan Servicing Fees, Net, in the consolidated statements of income. Significant inputs to the valuation include expected net servicing income to be received, the expected life of the underlying loans and the discount rate. The servicing rights asset is included in Other Assets in the consolidated balance sheets.
INCOME TAXES - Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases given the provisions of the enacted tax laws. Deferred tax assets are reduced, if necessary, by the amount of such benefits that are not expected to be realized based upon available evidence. Tax benefits from investments in limited partnerships that have qualified for federal low-income tax credits are recognized as a reduction in the provision for income tax over the term of the investment using the effective yield method. The Corporation includes income tax penalties in the provision for income tax. The Corporation has no accrued interest related to unrecognized tax benefits.
STOCK COMPENSATION PLANS - The Corporation’s stock-based compensation policy applies to all forms of stock-based compensation including stock options and restricted stock units. All stock-based compensation is accounted for under the fair value method as required by U.S. GAAP. The expense associated with stock-based compensation is recognized over the vesting period of each individual arrangement.
The fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option valuation model. The fair value of restricted stock is based on the current market price on the date of grant.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS - In the ordinary course of business, the Corporation has entered into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable.
CASH FLOWS - The Corporation utilizes the net reporting of cash receipts and cash payments for certain deposit and lending activities. Cash equivalents include federal funds sold and all cash and amounts due from depository institutions and interest-bearing deposits in other banks with original maturities of three months or less.
TRUST ASSETS AND INCOME - Assets held by the Corporation in a fiduciary or agency capacity for its customers are not included in the financial statements since such items are not assets of the Corporation. Trust income is recorded on a cash basis, which is not materially different from the accrual basis.
2. 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 foreseeable future.
Recent Accounting Pronouncements - Adopted
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. New disclosures required by the ASU have been included in Note 21.
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 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).
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 6.|
Recently Issued But Not Yet Effective Accounting Pronouncements
ASU 2016-02, Leases (Topic 842) changes GAAP by requiring that lease assets and liabilities arising from operating leases be recognized on the balance sheet. In July 2018, the FASB issued ASU 2018-10 and ASU 2018-11, Codification Improvements to Topic 842, Leases, amending various aspects of Topic 842. Among other things, ASU 2018-11 provides for an optional transition method under which comparative periods presented in the financial statements will continue to be in accordance with Topic 840, Leases, and a practical expedient to not separate non-lease components from the associated lease component. Topic 842 would not significantly change the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee from current U.S. GAAP. For leases with a term of 12 months or less, a lessee would be permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and liabilities. Topic 842 will become effective for the Corporation for annual and interim periods beginning in the first quarter 2019. The Corporation has elected to adopt this pronouncement using the optional transition method under ASU 2018-11 as of January 1, 2019 and estimates that the adoption will result in recognition of right-of-use assets and lease liabilities for operating leases of approximately $1,200,000 on its Consolidated Balance Sheets, with no expected adjustment to stockholders’ equity and no material impact to its consolidated statements of income.
ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), 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 amendments in ASU 2016-13 will be effective for the Corporation beginning in the first quarter 2020. Earlier adoption is permitted beginning in the first quarter 2019; however, the Corporation does not plan to early adopt the ASU. The Corporation has formed a cross functional management team and is working with an outside vendor assessing alternative loss estimation methodologies and the Corporation’s data and system needs in order to evaluate the impact that adoption of this standard will have on the Corporation’s financial condition and results of operations. The Corporation will record the effect of implementing this ASU through a cumulative-effect adjustment through retained earnings as of the beginning of the reporting period in which Topic 326 is effective.
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.
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.
3. 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 (loss) income. The components of other comprehensive (loss) income, and the related tax effects, are as follows:
|Unrealized losses on available-for-sale securities:|
|Unrealized holding losses on available-for-sale securities||$||(3,392||)||$||712||$||(2,680||)|
|Reclassification adjustment for losses realized in income||288||(60||)||228|
|Other comprehensive loss on available-for-sale securities||(3,104||)||652||(2,452||)|
|Unfunded pension and postretirement obligations:|
|Changes from plan amendments and actuarial gains and losses included in other comprehensive income||101||(21||)||80|
|Amortization of prior service cost and net actuarial loss included in net periodic benefit cost||(17||)||3||(14||)|
|Other comprehensive income on unfunded retirement obligations||84||(18||)||66|
|Total other comprehensive loss||$||(3,020||)||$||634||$||(2,386||)|
|Unrealized losses on available-for-sale securities:|
|Unrealized holding losses on available-for-sale securities||$||(691||)||$||242||$||(449||)|
|Reclassification adjustment for (gains) realized in income||(257||)||89||(168||)|
|Other comprehensive loss on available-for-sale securities||(948||)||331||(617||)|
|Unfunded pension and postretirement obligations:|
|Changes from plan amendments and actuarial gains and losses included in other comprehensive income||36||(12||)||24|
|Amortization of prior service cost and net actuarial loss included in net periodic benefit cost||(24||)||8||(16||)|
|Other comprehensive income on unfunded retirement obligations||12||(4||)||8|
|Total other comprehensive loss||$||(936||)||$||327||$||(609||)|
Changes in the components of accumulated other comprehensive (loss) income, included in stockholders’ equity, are as follows:
|(In Thousands)||on Securities||Obligations||Loss|
|Balance, beginning of period||$||(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 year ended December 31, 2018||(2,452||)||66||(2,386||)|
|Balance, end of period||$||(4,307||)||$||137||$||(4,170||)|
|Balance, beginning of period||$||(949||)||$||51||$||(898||)|
|Other comprehensive (loss) income during year ended December 31, 2017||(617||)||8||(609||)|
|Balance, end of period||$||(1,566||)||$||59||$||(1,507||)|
Items reclassified out of each component of accumulated other comprehensive (loss) income are as follows:
For the Year Ended December 31, 2018
|Details about Accumulated Other||Accumulated Other||Affected Line Item in the Consolidated|
|Comprehensive Loss Components||Comprehensive Loss||Statements of Income|
|Unrealized gains and losses on available-for-sale securities||$||288||Realized losses on available-for-sale debt securities, net|
|(60||)||Income tax provision|
|228||Net of tax|
|Amortization of defined benefit pension and postretirement items:|
|Prior service cost||(30||)||Other noninterest expense|
|Actuarial loss||13||Other noninterest expense|
|(17||)||Total before tax|
|3||Income tax provision|
|(14||)||Net of tax|
|Total reclassifications for the period||$||214|
For the Year Ended December 31, 2017
|Details about Accumulated Other||Accumulated Other||Affected Line Item in the Consolidated|
|Comprehensive Loss Components||Comprehensive Loss||Statements of Income|
|Unrealized gains and losses on available-for-sale securities||$||(257||)||Realized gains on available-for-sale debt securities, net|
|89||Income tax provision|
|(168||)||Net of tax|
|Amortization of defined benefit pension and postretirement items:|
|Prior service cost||(31||)||Other noninterest expense|
|Actuarial loss||7||Other noninterest expense|
|(24||)||Total before tax|
|8||Income tax provision|
|(16||)||Net of tax|
|Total reclassifications for the period||$||(184||)|
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.