Company Quick10K Filing
Quick10K
First Keystone
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$26.50 6 $153
10-Q 2019-06-30 Quarter: 2019-06-30
10-Q 2019-03-31 Quarter: 2019-03-31
10-K 2018-12-31 Annual: 2018-12-31
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
10-Q 2015-09-30 Quarter: 2015-09-30
10-Q 2015-06-30 Quarter: 2015-06-30
10-Q 2015-03-31 Quarter: 2015-03-31
10-K 2014-12-31 Annual: 2014-12-31
10-Q 2014-09-30 Quarter: 2014-09-30
10-Q 2014-06-30 Quarter: 2014-06-30
10-Q 2014-03-31 Quarter: 2014-03-31
10-K 2013-12-31 Annual: 2013-12-31
8-K 2019-10-30 Earnings, Exhibits
8-K 2019-08-28 Other Events, Exhibits
8-K 2019-07-31 Earnings, Exhibits
8-K 2019-05-29 Other Events, Exhibits
8-K 2019-05-09 Shareholder Vote, Regulation FD, Exhibits
8-K 2019-04-30 Earnings, Exhibits
8-K 2019-02-27 Other Events, Exhibits
8-K 2019-02-26 Officers
8-K 2019-01-31 Earnings, Exhibits
8-K 2018-11-30 Other Events, Exhibits
8-K 2018-10-31 Earnings, Exhibits
8-K 2018-10-24 Officers
8-K 2018-09-25 Officers, Exhibits
8-K 2018-08-28 Amend Bylaw, Exhibits
8-K 2018-08-28 Other Events, Exhibits
8-K 2018-07-31 Earnings, Exhibits
8-K 2018-05-10 Shareholder Vote, Regulation FD, Exhibits
8-K 2018-05-01 Earnings, Exhibits
8-K 2018-04-24 Officers, Exhibits
8-K 2018-03-15 Accountant, Exhibits
8-K 2018-01-31 Earnings, Exhibits
HDP Hortonworks 1,636
GLTC Geltech Solutions 32
NODC Nodechain 9
PWVI Powerverde 3
LOGQ Logicquest Technology 0
SNDL Sundial Growers 0
CNL Clecoorate Holdings 0
MSCD Morgan Stanley Smith Barney Charter Aspect 0
BBLG Bone Biologics 0
INTB Intelligent Buying 0
FKYS 2019-06-30
Part I - Financial Information
Item 1. Financial Statements
Note 1 ― Basis of Presentation and Accounting Policies
Note 2 ― Recent Accounting Standards Updates (&Ldquo;Asu&Rdquo;)
Note 3 &Mdash; Securities
Note 4 &Mdash; Loans and Allowance for Loan Losses
Note 5 &Mdash; Deposits
Note 6 &Mdash; Borrowings
Note 7 &Mdash; Commitments and Contingencies
Note 8 &Mdash; Financial Instruments with Off-Balance Sheet Risk and Concentrations of Credit Risk
Note 9 &Mdash; Fair Value Measurements
Note 10 &Mdash; Revenue Recognition
Note 11 &Mdash; Earnings per Share
Item 2. First Keystone Corporation Management's Discussion and Analysis of Financial Condition and Results of Operation
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II - Other Information
Item 1.Legal Proceedings
Item 1A.Risk Factors
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.Defaults Upon Senior Securities
Item 4.Mine Safety Disclosures
Item 5.Other Information
Item 6.Exhibits and Reports on Form 8-K
EX-31.1 tv526055_ex31-1.htm
EX-31.2 tv526055_ex31-2.htm
EX-32.1 tv526055_ex32-1.htm
EX-32.2 tv526055_ex32-2.htm

First Keystone Earnings 2019-06-30

FKYS 10Q Quarterly Report

Balance SheetIncome StatementCash Flow

10-Q 1 tv526055_10q.htm FORM 10-Q

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10Q

 

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

 

For the quarterly period ended June 30, 2019

 

or

 

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

 

For the transition period from ________ to ________

 

Commission File Number: 000-21344

 

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

 

Pennsylvania   23-2249083
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)

 

111 West Front Street, Berwick, PA   18603
(Address of principal executive offices)   (Zip Code)

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.          Yes   x       No   ¨

 

Indicate by check mark whether the registrant has submitted electronically 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 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 7(a)(2)(B) of the Exchange Act. ¨

 

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

 

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

 

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

 

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

Common Stock, $2 Par Value, 5,789,843 shares as of August 5, 2019.

 

 

 

 

 

 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

(Dollars in thousands, except share and per share data)  June 30,   December 31, 
   2019   2018 
ASSETS          
Cash and due from banks  $7,465   $9,822 
Interest-bearing deposits in other banks   2,182    1,128 
Total cash and cash equivalents   9,647    10,950 
Time deposits with other banks   1,482    1,482 
Debt securities available-for-sale, at fair value   305,578    316,054 
Marketable equity securities, at fair value   1,671    1,560 
Restricted investment in bank stocks   6,474    8,681 
Loans   611,414    606,027 
Loans held for sale   667    365 
Allowance for loan losses   (6,772)   (6,745)
Net loans   605,309    599,647 
Premises and equipment, net   19,736    19,946 
Operating lease right-of-use assets   1,530     
Accrued interest receivable   3,934    4,041 
Cash surrender value of bank owned life insurance   23,272    22,963 
Investments in low-income housing partnerships   2,004    2,096 
Goodwill   19,133    19,133 
Foreclosed assets held for resale   895    1,163 
Deferred income taxes       1,469 
Other assets   3,147    2,815 
TOTAL ASSETS  $1,003,812   $1,012,000 
LIABILITIES          
Deposits:          
Non-interest bearing  $135,976   $126,361 
Interest bearing   570,749    545,192 
Total deposits   706,725    671,553 
Short-term borrowings   120,151    174,445 
Long-term borrowings   45,000    45,000 
Operating lease liabilities   1,639     
Accrued interest payable   739    785 
Deferred income taxes   425     
Other liabilities   3,426    3,461 
TOTAL LIABILITIES   878,105    895,244 
STOCKHOLDERS’ EQUITY          
Preferred stock, par value $2.00 per share; authorized 1,000,000 shares as of June 30, 2019 and December 31, 2018; issued 0 as of June 30, 2019 and December 31, 2018        
Common stock, par value $2.00 per share; authorized 20,000,000 shares as of June 30, 2019 and December 31, 2018; issued 6,021,455 as of June 30, 2019 and 5,996,322 as of December 31, 2018; outstanding 5,789,843 as of June 30, 2019 and 5,764,710 as of December 31, 2018   12,043    11,993 
Surplus   37,801    37,255 
Retained earnings   77,454    75,798 
Accumulated other comprehensive income (loss)   4,118    (2,581)
Treasury stock, at cost, 231,612 shares as of June 30, 2019 and December 31, 2018   (5,709)   (5,709)
TOTAL STOCKHOLDERS’ EQUITY   125,707    116,756 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $1,003,812   $1,012,000 

 

See accompanying notes to consolidated financial statements.

 

 2 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

THREE AND SIX MONTHS ENDED JUNE 30, 2019 AND 2018

(Unaudited)

 

(Dollars in thousands, except per share data)  Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2019   2018   2019   2018 
INTEREST INCOME                    
Interest and fees on loans  $7,196   $6,274   $14,270   $12,219 
Interest and dividend income on securities:                    
Taxable   1,303    1,162    2,521    2,202 
Tax-exempt   829    1,170    1,847    2,369 
Dividends   11    10    22    21 
Dividend income on restricted investment in bank stocks   125    112    309    180 
Interest on interest-bearing deposits in other banks   15    9    24    17 
Total interest income   9,479    8,737    18,993    17,008 
INTEREST EXPENSE                    
Interest on deposits   1,596    1,293    2,974    2,565 
Interest on short-term borrowings   794    400    1,909    574 
Interest on long-term borrowings   207    291    407    626 
Total interest expense   2,597    1,984    5,290    3,765 
Net interest income   6,882    6,753    13,703    13,243 
Provision for loan losses   46        138    50 
Net interest income after provision for loan losses   6,836    6,753    13,565    13,193 
NON-INTEREST INCOME                    
Trust department   264    223    525    458 
Service charges and fees   533    532    1,047    989 
Bank owned life insurance income   154    154    309    297 
ATM fees and debit card income   419    399    796    756 
Gains on sales of mortgage loans   75    38    115    67 
Net securities gains   92    54    195    37 
Other   79    70    136    125 
Total non-interest income   1,616    1,470    3,123    2,729 
NON-INTEREST EXPENSE                    
Salaries and employee benefits   2,953    2,957    6,085    5,993 
Occupancy, net   432    427    896    899 
Furniture and equipment   150    152    290    292 
Computer expense   299    240    579    493 
Professional services   208    309    478    532 
Pennsylvania shares tax   192    200    384    399 
FDIC insurance   72    75    137    156 
ATM and debit card fees   221    192    432    367 
Data processing fees   305    266    572    533 
Foreclosed assets held for resale expense   5    7    43    75 
Advertising   160    129    313    210 
Other   658    722    1,301    1,622 
Total non-interest expense   5,655    5,676    11,510    11,571 
Income before income tax expense   2,797    2,547    5,178    4,351 
Income tax expense   267    71    405    98 
NET INCOME  $2,530   $2,476   $4,773   $4,253 
PER SHARE DATA                    
Net income per share:                    
Basic  $0.44   $0.43   $0.83   $0.74 
Diluted   0.44    0.43    0.83    0.74 
Dividends per share   0.27    0.27    0.54    0.54 

 

See accompanying notes to consolidated financial statements.

 

 3 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

THREE AND SIX MONTHS ENDED JUNE 30, 2019 AND 2018

(Unaudited)

 

(Dollars in thousands)  Three Months Ended 
   June 30, 
   2019   2018 
Net Income  $2,530   $2,476 
           
Other comprehensive income (loss):          
Unrealized net holding gains (losses) on debt securities available-for-sale arising during the period, net of income taxes of $812 and $(174), respectively   3,057    (656)
           
Less reclassification adjustment for net realized gains included in net income, net of income taxes of $(0) and $(0), respectively (a) (b)        
           
Total other comprehensive income (loss)   3,057    (656)
           
Total Comprehensive Income  $5,587   $1,820 

 

 

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

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

 

(Dollars in thousands)  Six Months Ended 
   June 30, 
   2019   2018 
Net Income  $4,773   $4,253 
           
Other comprehensive income (loss):          
Unrealized net holding gains (losses) on debt securities available-for-sale arising during the period, net of income taxes of $1,798 and $(1,373), respectively   6,766    (5,166)
           
Less reclassification adjustment for net realized gains included in net income, net of income taxes of $(18) and $(3), respectively (a) (b)   (67)   (13)
           
Total other comprehensive income (loss)   6,699    (5,179)
           
Total Comprehensive Income (Loss)  $11,472   $(926)

 

 

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

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

 

See accompanying notes to consolidated financial statements.

 

 4 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

SIX MONTHS ENDED JUNE 30, 2019 AND 2018

(Unaudited)

 

(Dollars in thousands, except per share data)                  Accumulated         
                   Other       Total 
   Common Stock       Retained   Comprehensive   Treasury   Stockholders’ 
   Shares   Amount   Surplus   Earnings   Income (Loss)   Stock   Equity 
                             
Balance at January 1, 2019   5,996,322   $11,993   $37,255   $75,798   $(2,581)  $(5,709)  $116,756 
Net Income                  4,773              4,773 
Other comprehensive income, net of taxes                       6,699         6,699 
Issuance of common stock under dividend reinvestment plan   25,133    50    546                   596 
Dividends - $0.54 per share                  (3,117)             (3,117)
Balance at June 30, 2019   6,021,455   $12,043   $37,801   $77,454   $4,118   $(5,709)  $125,707 
                                    
Balance at January 1, 2018   5,950,951   $11,902   $36,193   $72,507   $1,826   $(5,709)  $116,719 
Net Income                  4,253              4,253 
Other comprehensive loss, net of taxes                       (5,179)        (5,179)
Issuance of common stock under dividend reinvestment plan   22,763    45    564                   609 
Impact of adoption of Accounting standards1                  274    (274)         
Dividends - $0.54 per share                  (3,091)             (3,091)
Balance at June 30, 2018   5,973,714   $11,947   $36,757   $73,943   $(3,627)  $(5,709)  $113,311 

 

 

1Represents the impact of adopting Accounting Standard Updates (“ASU”) 2018-02 and ASU 2016-01 effective January 1, 2018.

 

See accompanying notes to consolidated financial statements.

 

 5 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30, 2019 AND 2018

(Unaudited)

 

(Dollars in thousands)  2019   2018 
OPERATING ACTIVITIES          
Net income  $4,773   $4,253 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   138    50 
Depreciation and amortization   518    533 
Net premium amortization on securities   1,398    1,742 
Deferred income tax expense   113    128 
Gains on sales of mortgage loans   (115)   (67)
Proceeds from sales of mortgage loans originated for resale   3,768    3,722 
Originations of mortgage loans originated for resale   (3,960)   (4,715)
Net securities gains   (195)   (37)
Net losses on sales of foreclosed real estate held for resale, including write-downs   20    23 
Decrease in accrued interest receivable   107    58 
Earnings on investment in bank owned life insurance   (309)   (297)
Net losses (gains) on disposals of premises and equipment   4    (17)
Increase in other assets   (1,862)   (95)
Amortization of investment in real estate ventures   177    347 
(Decrease) increase in accrued interest payable   (46)   190 
Increase in other liabilities   1,583    89 
NET CASH PROVIDED BY OPERATING ACTIVITIES   6,112    5,907 
INVESTING ACTIVITIES          
Proceeds from sales of debt securities available-for-sale   32,374    14,038 
Proceeds from maturities and redemptions of debt securities available-for-sale   11,185    11,874 
Purchases of debt securities available-for-sale   (25,917)   (24,178)
Net change in restricted investment in bank stocks   2,207    (2,521)
Net increase in loans   (5,450)   (25,058)
Purchases of premises and equipment   (334)   (200)
Purchase of investment in real estate venture   (85)    
Proceeds from sales of foreclosed assets held for resale   248    114 
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES   14,228    (25,931)
FINANCING ACTIVITIES          
Net increase (decrease) in deposits   35,172    (53,112)
Net (decrease) increase in short-term borrowings   (54,294)   86,716 
Proceeds from long-term borrowings   10,000     
Repayment of long-term borrowings   (10,000)   (10,000)
Common stock issued   596    609 
Dividends paid   (3,117)   (3,091)
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES   (21,643)   21,122 
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS   (1,303)   1,098 
CASH AND CASH EQUIVALENTS, BEGINNING   10,950    8,739 
CASH AND CASH EQUIVALENTS, ENDING  $9,647   $9,837 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION          
Interest paid  $5,336   $3,575 
Income taxes paid   263    233 
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES          
Loans transferred to foreclosed assets held for resale       142 
Lease liabilities arising from obtaining operating lease right-of-use assets   121     

 

See accompanying notes to consolidated financial statements.

 

 6 

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1 ― BASIS OF PRESENTATION AND ACCOUNTING POLICIES

 

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

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included. Operating results for the three and six month periods ended June 30, 2019, are not necessarily indicative of the results for the year ending December 31, 2019. For further information, refer to the consolidated financial statements and notes thereto included in First Keystone Corporation’s Annual Report on Form 10-K for the year ended December 31, 2018.

 

The Corporation has evaluated events and transactions occurring subsequent to the consolidated balance sheet date of June 30, 2019 for items that should potentially be recognized or disclosed in these consolidated financial statements. The evaluation was conducted through the date these consolidated financial statements were issued.

 

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

 

Recently adopted ASUs:

 

On January 1, 2019, the Corporation adopted ASU 2016-02, Leases (Topic 842), and all subsequent amendments to the ASU, which required that lease assets and liabilities arising from operating leases be recognized on the balance sheet. The Corporation also elected to adopt the transition relief provisions from ASU 2018-11, Leases (Topic 842) –Targeted Improvements, and recorded the impact of adoption as of January 1, 2019, without restating any prior-year amounts or disclosures. Adoption of ASU 2016-02 resulted in the recognition of right-of-use assets and lease liabilities for operating leases of $1,465,000 and $1,556,000, respectively, on its consolidated balance sheet as of January 1, 2019, with no adjustment to stockholders’ equity and no material impact to its consolidated statements of income. As of June 30, 2019, the Corporation has recorded right-of-use assets and lease liabilities for operating leases of $1,530,000 and $1,639,000, respectively, on its consolidated balance sheet.

 

In March 2017, the Financial Accounting Standards Board (“FASB”) issued ASU 2017-08, Receivables- Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities held at a premium, and requires that the premiums be amortized to the earliest call date. ASU 2017-08 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. The Corporation was already accounting for callable debt securities in this manner, and the adoption of this standard had no material impact on the consolidated financial statements and related disclosures.

 

 7 

 

 

Pending ASUs:

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU No. 2016-13 requires financial assets measured at amortized cost to be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. ASU No. 2016-13 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2019. Early adoption is permitted for annual and interim periods beginning after December 15, 2018. In July 2019, the FASB authorized the authoring of an exposure draft which proposes delaying the effective date for smaller reporting companies to fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. While the Corporation is currently evaluating the provisions of ASU 2016-13 to determine the potential impact of the new standard will have on the Corporation’s consolidated financial statements, it has taken steps to prepare for the implementation when it becomes effective, such as: forming an internal committee, gathering pertinent data, consulting with outside professionals, subscribing to a new software system, and running existing and new methodologies concurrently through the period of implementation.

 

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

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) – Disclosure Framework – Changes to Disclosure Requirements for Fair Value Measurement. The amendments in this Update removed required disclosures regarding as follows: 1. The amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, 2. The policy for timing of transfers between levels, 3. The valuation processes for Level 3 fair value measurements, and 4. The Update modified the disclosure requirements on fair value measurements in Topic 820: 1. The changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and 2. The range and weighted average significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information (such as the median or arithmetic average) in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The amendments in this Update are effective for all entities for fiscal years, and interim periods within those fiscal years beginning after December 15, 2019. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this Update and delay adoption of the additional disclosures until their effective date. The Corporation will be assessing the impact that this guidance will have on its consolidated financial statements and related disclosures.

 

NOTE 3SECURITIES

 

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

 

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

 

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

 

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

 

The amortized cost, related estimated fair value, and unrealized gains and losses for debt securities classified as “Available-For-Sale” were as follows at June 30, 2019 and December 31, 2018:

 

   Debt Securities Available-for-Sale 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
June 30, 2019:                    
U.S. Treasury securities  $5,332   $7   $   $5,339 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed   82,988    529    (453)   83,064 
Other   20,093    23    (64)   20,052 
Other mortgage backed debt securities   6,534    14    (52)   6,496 
Obligations of state and political subdivisions   144,440    5,487    (95)   149,832 
Asset backed securities   13,845    96    (29)   13,912 
Corporate debt securities   27,134    198    (449)   26,883 
Total  $300,366   $6,354   $(1,142)  $305,578 

 

   Debt Securities Available-for-Sale 
(Dollars in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
December 31, 2018:                    
U.S. Treasury securities  $5,307   $   $(12)  $5,295 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed   66,300    105    (1,529)   64,876 
Other   18,706    21    (484)   18,243 
Other mortgage backed debt securities   4,767        (18)   4,749 
Obligations of state and political subdivisions   182,621    1,678    (2,021)   182,278 
Asset backed securities   14,323    47        14,370 
Corporate debt securities   27,297    24    (1,078)   26,243 
Total  $319,321   $1,875   $(5,142)  $316,054 

 

Securities Available-for-Sale with an aggregate fair value of $154,149,000 at June 30, 2019 and $149,993,000 at December 31, 2018, were pledged to secure public funds, trust funds, securities sold under agreements to repurchase, debtor in possession funds and the Federal Discount Window aggregating $99,610,000 at June 30, 2019 and $112,528,000 at December 31, 2018.

 

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The amortized cost and estimated fair value of debt securities, by contractual maturity, are shown below at June 30, 2019. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

(Dollars in thousands)  June 30, 2019 
   Debt Securities Available-For-Sale 
       U.S. Government    Other   Obligations         
       Corporations &   Mortgage   of State   Asset   Corporate 
   U.S. Treasury   Agencies   Backed Debt   & Political   Backed   Debt 
   Securities   Obligations1   Securities1   Subdivisions   Securities   Securities 
Within 1 Year:                              
Amortized cost  $5,332   $   $   $1,001   $   $ 
Fair value   5,339            1,001         
                               
1 - 5 Years:                              
Amortized cost       16,722        21,676        27,134 
Fair value       16,743        22,057        26,883 
                               
5 - 10 Years:                              
Amortized cost       33,895        30,837    10,037     
Fair value       33,823        31,620    10,070     
                               
After 10 Years:                              
Amortized cost       52,464    6,534    90,926    3,808     
Fair value       52,550    6,496    95,154    3,842     
                               
Total:                              
Amortized cost  $5,332   $103,081   $6,534   $144,440   $13,845   $27,134 
Fair value   5,339    103,116    6,496    149,832    13,912    26,883 

 

 

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

 

There were no aggregate securities with a single issuer (excluding the U.S. Government and U.S. Government Agencies and Corporations) which exceeded ten percent of consolidated stockholders’ equity at June 30, 2019. The quality rating of the obligations of state and political subdivisions are generally investment grade, as rated by Moody’s, Standard and Poor’s or Fitch. The typical exceptions are local issues which are not rated, but are secured by the full faith and credit obligations of the communities that issued these securities.

 

There were no sales of investments in Available-for-Sale debt securities for the three months ended June 30, 2019 or 2018. There were no impairment losses realized on Available-for-Sale debt securities during the three months ended June 30, 2019 or 2018.

 

Proceeds from sales of investments in Available-for-Sale debt securities for the six months ended June 30, 2019 and 2018 were $32,374,000 and $14,038,000, respectively. Gross gains realized on these sales were $187,000 and $50,000, respectively. Gross losses realized on these sales were $102,000 and $34,000, respectively. There were no impairment losses realized on Available-for-Sale debt securities during the six months ended June 30, 2019 or 2018.

 

At June 30, 2019 and December 31, 2018, the Corporation had $1,671,000 and $1,560,000, respectively, in equity securities recorded at fair value. Prior to January 1, 2018, equity securities were stated at fair value with unrealized gains and losses reported as a separate component of AOCI, net of tax. At December 31, 2017, net unrealized gains net of tax of $634,000 had been recognized in AOCI. On January 1, 2018, these unrealized gains and losses were reclassified out of AOCI and into retained earnings with subsequent changes in fair value being recognized in net income. The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the six months ended June 30, 2019 and 2018:

 

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(Dollars in thousands)  Six months ended   Six months ended 
   June 30, 2019   June 30, 2018 
Net gains recognized during the period on equity securities  $110   $21 
Less: Net gains and (losses) recognized during the period on equity securities sold during the period        
Unrealized gains recognized during the reporting period on equity securities still held at the reporting date  $110   $21 

 

There were no proceeds from sales of investments in Held-to-Maturity debt securities during the first six months of 2019 or 2018. Therefore, there were no gains or losses realized during these periods.

 

In July 2019, the opportunity arose in the market for the Bank to facilitate a favorable trade strategy to sell bonds with a tax equivalent yield spread close to the US Treasury yield, therefore, enabling the future redeployment of capital into higher performing bonds. As part of this strategy, the Bank sold approximately $39,000,000 of bonds with a gross gain of $718,000 and a gross loss of $47,000 for a net gain of $671,000. The Bank has currently reinvested $6,774,000 of the proceeds from this strategy and will continue to reinvest during the third quarter of 2019.

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Securities classified as Available-for-Sale or Held-to-Maturity are generally evaluated for OTTI under FASB ASC 320, Investments - Debt and Equity Securities. In determining OTTI under the FASB ASC 320 model, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

 

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

 

The Corporation and its investment advisors monitor the entire portfolio monthly with particular attention given to securities in a continuous loss position of at least ten percent for over twelve months. Based on the factors described above, management did not consider any securities to be other-than-temporarily impaired at June 30, 2019 or December 31, 2018.

 

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In accordance with disclosures required by FASB ASC 320-10-50, Investments – Debt and Equity Securities, the summary below shows the gross unrealized losses and fair value of the Corporation’s debt securities. Totals are aggregated by investment category where individual securities have been in a continuous loss position for less than 12 months or 12 months or more as of June 30, 2019 and December 31, 2018:

 

June 30, 2019

 

(Dollars in thousands)  Less Than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Loss   Value   Loss   Value   Loss 
Debt Securities Available-for-Sale:                              
U.S. Treasury securities  $   $   $   $   $   $ 
Obligations of U.S. Government Corporations and Agencies:                              
Mortgage-backed   9,006    (56)   39,828    (397)   48,834    (453)
Other   3,276    (17)   6,579    (47)   9,855    (64)
Other mortgage backed debt securities   2,458    (52)           2,458    (52)
Obligations of state and political subdivisions           5,284    (95)   5,284    (95)
Asset backed securities   4,984    (29)           4,984    (29)
Corporate debt securities   3,469    (31)   9,332    (418)   12,801    (449)
Total  $23,193   $(185)  $61,023   $(957)  $84,216   $(1,142)

 

December 31, 2018

 

(Dollars in thousands)  Less Than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Loss   Value   Loss   Value   Loss 
Debt Securities Available-for-Sale:                              
U.S. Treasury securities  $5,295   $(12)  $   $   $5,295   $(12)
Obligations of U.S. Government Corporations and Agencies:                              
Mortgage-backed   3,690    (17)   55,443    (1,512)   59,133    (1,529)
Other   7,553    (66)   7,067    (418)   14,620    (484)
Other mortgage backed debt securities   4,749    (18)           4,749    (18)
Obligations of state and political subdivisions   14,453    (75)   66,583    (1,946)   81,036    (2,021)
Asset backed securities                        
Corporate debt securities   1,823    (29)   19,477    (1,049)   21,300    (1,078)
Total  $37,563   $(217)  $148,570   $(4,925)  $186,133   $(5,142)

 

The Corporation invests in various forms of agency debt including mortgage-backed securities and callable debt. The mortgage-backed securities are issued by FHLMC (“Federal Home Loan Mortgage Corporation”), FNMA (“Federal National Mortgage Association”) or GNMA (“Government National Mortgage Association”). The municipal securities consist of general obligations and revenue bonds. The fair market value of the above securities is influenced by market interest rates, prepayment speeds on mortgage securities, bid-offer spreads in the market place and credit premiums for various types of agency debt. These factors change continuously and therefore the market value of these securities may be higher or lower than the Corporation’s carrying value at any measurement date. Management does not believe any of their 7 debt securities with a less than one year unrealized loss position, or any of their 32 debt securities with a one year or greater unrealized loss position as of June 30, 2019, represent an other-than-temporary impairment, as the unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities.

 

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NOTE 4LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans

 

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

 

Residential mortgage loans held for sale are carried at the lower of cost or market on an aggregate basis determined by independent pricing from appropriate federal or state agency investors. These loans are sold without recourse. Loans held for sale amounted to $667,000 and $365,000 at June 30, 2019 and December 31, 2018, respectively.

 

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

 

Commercial and Industrial Lending

 

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

 

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

 

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

 

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

 

Commercial Real Estate Lending

 

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

 

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

 

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

 

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Residential Real Estate Lending (Including Home Equity)

 

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

 

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

 

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

 

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

 

Consumer Lending

 

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

 

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

 

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

 

Delinquent Loans

 

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

 

Commercial and Industrial and Commercial Real Estate loans are charged off in whole or in part when they become sufficiently delinquent based upon the terms of the underlying loan contract and when a collateral deficiency exists. Because all or part of the contractual cash flows are not expected to be collected, the loan is considered to be impaired, and the Bank estimates the impairment based on its analysis of the cash flows or collateral estimated at fair value less cost to sell.

 

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

 

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

 

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

 

Allowance for Loan Losses

 

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

 

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

 

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

 

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

 

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

 

A reserve for unfunded lending commitments is provided for possible credit losses on off-balance sheet credit exposures. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and, if necessary, is recorded in other liabilities on the consolidated balance sheets. As of June 30, 2019 and December 31, 2018, the amount of the reserve for unfunded lending commitments was $93,000 and $117,000, respectively.

 

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

 

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

 

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

 

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

 

Loans modified in a troubled debt restructuring are considered impaired and may or may not be placed on non-accrual status until the Bank determines the future collection of principal and interest is reasonably assured, which generally requires that the borrower demonstrates a period of performance according to the restructured terms of six months.

 

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

 

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

 

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

 

 16 

 

 

Risk grade characteristics are as follows:

 

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

 

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

 

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

 

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

 

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

 

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

 

Risk Grade 8 − SUBSTANDARD (Non-Pass Category)

 

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

 

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

 

Risk Grade 9 − DOUBTFUL (Non-Pass Category)

 

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

 

 17 

 

 

The following table presents the classes of the loan portfolio summarized by risk rating as of June 30, 2019 and December 31, 2018:

 

(Dollars in thousands)  Commercial and
Industrial
   Commercial Real Estate 
   June 30,   December 31,   June 30,   December 31, 
   2019   2018   2019   2018 
Grade:                    
1-6   Pass  $80,277   $90,835   $349,942   $329,126 
7      Special Mention   4    6    949    5,249 
8      Substandard   1,099    1,219    12,760    13,403 
9      Doubtful                
Add (deduct):  Unearned discount and                
   Net deferred loan fees and costs   173    160    739    698 
Total loans  $81,553   $92,220   $364,390   $348,476 

 

   Residential Real Estate
Including Home Equity
   Consumer 
   June 30,   December 31,   June 30,   December 31, 
   2019   2018   2019   2018 
Grade:                
1-6   Pass  $159,227   $158,755   $5,643   $5,854 
7      Special Mention   119    121    21    1 
8      Substandard   1,112    941    25    9 
9      Doubtful                
Add (deduct):  Unearned discount and                
   Net deferred loan fees and costs   (96)   (76)   87    91 
Total loans  $160,362   $159,741   $5,776   $5,955 

 

   Total Loans 
   June 30,   December 31, 
   2019   2018 
Grade:          
1-6   Pass  $595,089   $584,570 
7      Special Mention   1,093    5,377 
8      Substandard   14,996    15,572 
9      Doubtful        
Add (deduct):  Unearned discount and        
  Net deferred loan fees and costs   903    873 
Total loans  $612,081   $606,392 

 

Commercial and Industrial and Commercial Real Estate include loans categorized as tax-free in the amounts of $19,468,000 and $2,086,000 at June 30, 2019 and $24,161,000 and $2,164,000 at December 31, 2018. Loans held for sale amounted to $667,000 at June 30, 2019 and $365,000 at December 31, 2018.

 

 18 

 

 

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

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the three month period ended June 30, 2019:                              
Allowance for Loan Losses:                              
Beginning balance  $732   $3,865   $1,641   $110   $414   $6,762 
Charge-offs           (28)   (10)       (38)
Recoveries               2        2 
Provision   (89)   34    28    9    64    46 
Ending Balance  $643   $3,899   $1,641   $111   $478   $6,772 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the six month period ended June 30, 2019:                        
Allowance for Loan Losses:                              
Beginning balance  $724   $3,700   $1,650   $117   $554   $6,745 
Charge-offs       (64)   (28)   (25)       (117)
Recoveries   1        2    3        6 
Provision   (82)   263    17    16    (76)   138 
Ending Balance  $643   $3,899   $1,641   $111   $478   $6,772 
Ending balance: individually evaluated for impairment  $   $   $3   $   $   $3 
Ending balance: collectively evaluated for impairment  $643   $3,899   $1,638   $111   $478   $6,769 
                               
Loans Receivable:                              
Ending Balance  $81,553   $364,390   $160,362   $5,776   $   $612,081 
Ending balance: individually evaluated for impairment  $1,105   $11,333   $834   $   $   $13,272 
Ending balance: collectively evaluated for impairment  $80,448   $353,057   $159,528   $5,776   $   $598,809 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the three month period ended June 30, 2018:                        
Allowance for Loan Losses:                              
Beginning balance  $1,017   $4,528   $1,672   $95   $67   $7,379 
Charge-offs   (8)   (343)   (77)   (8)       (436)
Recoveries               3        3 
Provision   (102)   (205)   93    15    199     
Ending Balance  $907   $3,980   $1,688   $105   $266   $6,946 

 

 19 

 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the six month period ended June 30, 2018:                        
Allowance for Loan Losses:                              
Beginning balance  $949   $4,067   $1,656   $111   $704   $7,487 
Charge-offs   (8)   (460)   (106)   (21)       (595)
Recoveries   1            3        4 
Provision   (35)   373    138    12    (438)   50 
Ending Balance  $907   $3,980   $1,688   $105   $266   $6,946 
Ending balance: individually evaluated for impairment  $   $4   $19   $   $   $23 
Ending balance: collectively evaluated for impairment  $907   $3,976   $1,669   $105   $266   $6,923 
                               
Loans Receivable:                              
Ending Balance  $100,469   $316,066   $162,480   $5,809   $   $584,824 
Ending balance: individually evaluated for impairment  $1,175   $11,192   $962   $   $   $13,329 
Ending balance: collectively evaluated for impairment  $99,294   $304,874   $161,518   $5,809   $   $571,495 

 

(Dollars in thousands)  Commercial   Commercial   Residential             
   and Industrial   Real Estate   Real Estate   Consumer   Unallocated   Total 
As of and for the year ended December 31, 2018                        
Allowance for Loan Losses:                              
Beginning balance  $949   $4,067   $1,656   $111   $704   $7,487 
Charge-offs   (18)   (783)   (181)   (57)       (1,039)
Recoveries   31    60        6        97 
Provision   (238)   356    175    57    (150)   200 
Ending Balance  $724   $3,700   $1,650   $117   $554   $6,745 
Ending balance: individually evaluated for impairment  $   $1   $   $   $   $1 
Ending balance: collectively evaluated for impairment  $724   $3,699   $1,650   $117   $554   $6,744 
                               
Loans Receivable:                              
Ending Balance  $92,220   $348,476   $159,741   $5,955   $   $606,392 
Ending balance: individually evaluated for impairment  $1,126   $15,890   $577   $   $   $17,593 
Ending balance: collectively evaluated for impairment  $91,094   $332,586   $159,164   $5,955   $   $588,799 

 

Of the $895,000 in foreclosed assets held for resale at June 30, 2019, $39,000 was represented by land and $856,000 was represented by commercial real estate. Of the $1,163,000 in foreclosed assets held for resale at December 31, 2018, $268,000 was represented by residential real estate, $39,000 was represented by land, and $856,000 was represented by commercial real estate. At June 30, 2019 and December 31, 2018, all foreclosed assets were held as the result of obtaining physical possession. Consumer mortgage loans secured by residential real estate for which the Bank has entered into formal foreclosure proceedings but for which physical possession of the property has yet to be obtained amounted to $671,000 at June 30, 2019 and $718,000 at December 31, 2018. These balances were not included in foreclosed assets held for resale at June 30, 2019 or December 31, 2018.

 

From time to time, the Bank may agree to modify the contractual terms of a borrower’s loan. In cases where the modifications represent a concession to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring (“TDR”).

 

 20 

 

 

The outstanding recorded investment of TDRs as of June 30, 2019 and December 31, 2018 was $8,917,000 and $13,777,000, respectively. The decrease in TDRs at June 30, 2019 as compared to December 31, 2018 is mainly attributable to one large loan to a real estate developer specializing in commercial office space that carried a value of $4,296,000 and was modified as a TDR during the fourth quarter of 2018; the loan was subsequently paid off during the six months ended June 30, 2019. There were no unfunded commitments on TDRs at June 30, 2019 and December 31, 2018.

 

During the three months ended June 30, 2019, no loans were modified as TDRs as compared to the same period in 2018, when five loans with a combined post modification balance of $890,000 were modified as TDRs. The loan modifications for the three months ended June 30, 2018 consisted of one interest rate modification and four payment modifications.

 

During the six months ended June 30, 2019, no loans were modified as TDRs as compared to the same period in 2018, when eight loans with a combined post modification balance of $1,053,000 were classified as TDRs. The loan modifications for the six months ended June 30, 2018 consisted of one interest rate modification, one term modification, and six payment modifications.

 

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

 

(Dollars in thousands)  June 30,   December 31, 
   2019   2018 
Non-accrual TDRs  $113   $80 
Accruing TDRs   8,804    13,697 
Total  $8,917   $13,777 

 

At June 30, 2019, six Commercial Real Estate loans classified as TDRs with a combined recorded investment of $486,000 and one Commercial and Industrial loan classified as a TDR with a recorded investment of $4,000 were not in compliance with the terms of their restructure, compared to June 30, 2018 when eight Commercial Real Estate loans classified as TDRs with a combined recorded investment of $570,000 were not in compliance with the terms of their restructure.

 

During the three months ended June 30, 2019, no loans that were modified as TDRs during the preceding twelve months had experienced payment defaults, compared to the three months ended June 30, 2018 when two Commercial Real Estate loans with a combined outstanding recorded investment of $47,000 that were modified as TDRs during the preceding twelve months had experienced payment defaults. During the six months ended June 30, 2019, no loans that were modified as TDRs during the preceding twelve months had experienced payment defaults, compared to the six months ended June 30, 2018 when two Commercial Real Estate loans with a combined outstanding recorded investment of $47,000 that were modified as TDRs during the preceding twelve months had experienced payment defaults.

 

The following table presents information regarding the loan modifications categorized as TDRs during the three and six months ended June 30, 2018. No loans were modified as TDRs during the three or six months ended June 30, 2019.

 

(Dollars in thousands)  Three Months Ended June 30, 2018 
       Pre-Modification   Post-Modification     
   Number   Outstanding Recorded   Outstanding Recorded   Recorded 
   of Contracts   Investment   Investment   Investment 
Commercial and Industrial   3   $751   $751   $751 
Commercial Real Estate   2    133    139    138 
Total   5   $884   $890   $889 

 

(Dollars in thousands)  Six Months Ended June 30, 2018 
       Pre-Modification   Post-Modification     
   Number   Outstanding Recorded   Outstanding Recorded   Recorded 
   of Contracts   Investment   Investment   Investment 
Commercial and Industrial   3   $751   $751   $751 
Commercial Real Estate   5    285    302    294 
Total   8   $1,036   $1,053   $1,045 

 

 21 

 

 

The following table provides detail regarding the types of loan modifications made for loans categorized as TDRs during the three and six months ended June 30, 2018 with the total number of each type of modification performed. No loans were modified as TDRs during the three or six months ended June 30, 2019.

 

   Three Months Ended June 30, 2018   Six Months Ended June 30, 2018 
   Rate   Term   Payment   Number   Rate   Term   Payment   Number 
   Modification   Modification   Modification   Modified   Modification   Modification   Modification   Modified 
Commercial and Industrial           3    3            3    3 
Commercial Real Estate   1        1    2    1    1    3    5 
Total   1        4    5    1    1    6    8 

 

The recorded investment, unpaid principal balance, and the related allowance of the Corporation’s impaired loans are summarized below at June 30, 2019 and December 31, 2018.

 

(Dollars in thousands)  June 30, 2019   December 31, 2018 
       Unpaid           Unpaid     
   Recorded   Principal   Related   Recorded   Principal   Related 
   Investment   Balance   Allowance   Investment   Balance   Allowance 
With no related allowance recorded:                              
Commercial and Industrial  $1,105   $1,105   $   $1,126   $1,126   $ 
Commercial Real Estate   11,333    14,350        15,807    20,107     
Residential Real Estate   778    840        577    619     
                               
With an allowance recorded:                              
Commercial and Industrial                        
Commercial Real Estate               83    83    1 
Residential Real Estate   56    62    3             
Total  $13,272   $16,357   $3   $17,593   $21,935   $1 
                               
Total consists of:                              
Commercial and Industrial  $1,105   $1,105   $   $1,126   $1,126   $ 
Commercial Real Estate  $11,333   $14,350   $   $15,890   $20,190   $1 
Residential Real Estate  $834   $902   $3   $577   $619   $ 

 

 

At June 30, 2019 and December 31, 2018, $8,917,000 and $13,777,000 of loans classified as TDRs were included in impaired loans with a total allocated allowance of $0 and $1,000, respectively. The recorded investment represents the loan balance reflected on the consolidated balance sheets net of any charge-offs. The unpaid balance is equal to the gross amount due on the loan.

 

 22 

 

 

The average recorded investment and interest income recognized for the Corporation’s impaired loans are summarized below for the three and six months ended June 30, 2019 and 2018.

 

(Dollars in thousands)  For the Three Months Ended   For the Three Months Ended 
   June 30, 2019   June 30, 2018 
   Average   Interest   Average   Interest 
   Recorded   Income   Recorded   Income 
   Investment   Recognized   Investment   Recognized 
With no related allowance recorded:                    
Commercial and Industrial  $1,111   $13   $1,180   $5 
Commercial Real Estate   11,856    102    11,530    105 
Residential Real Estate   447    4    898    1 
                     
With an allowance recorded:                    
Commercial and Industrial                
Commercial Real Estate           51    1 
Residential Real Estate   56        185     
Total  $13,470   $119   $13,844   $112 
                     
Total consists of:                    
Commercial and Industrial  $1,111   $13   $1,180   $5 
Commercial Real Estate  $11,856   $102   $11,581   $106 
Residential Real Estate  $503   $4   $1,083   $1 

 

 

Of the $119,000 and $112,000 in interest income recognized on impaired loans for the three months ended June 30, 2019 and 2018, respectively, $5,000 and $0 in interest income was recognized with respect to non-accrual loans.

 

(Dollars in thousands)  For the Six Months Ended   For the Six Months Ended 
   June 30, 2019   June 30, 2018 
   Average   Interest   Average   Interest 
   Recorded   Income   Recorded   Income 
   Investment   Recognized   Investment   Recognized 
With no related allowance recorded:                    
Commercial and Industrial  $1,116   $27   $1,188   $9 
Commercial Real Estate   13,700    252    10,478    206 
Residential Real Estate   444    5    914    2 
                     
With an allowance recorded:                    
Commercial and Industrial                
Commercial Real Estate   51    1    1,179    1 
Residential Real Estate   28        127     
Total  $15,339   $285   $13,886   $218 
                     
Total consists of:                    
Commercial and Industrial  $1,116   $27   $1,188   $9 
Commercial Real Estate  $13,751   $253   $11,657   $207 
Residential Real Estate  $472   $5   $1,041   $2 

 

 

Of the $285,000 and $218,000 in interest income recognized on impaired loans for the six months ended June 30, 2019 and 2018, respectively, $5,000 and $0 in interest income was recognized with respect to non-accrual loans.

 

 23 

 

 

Total non-performing assets (which includes loans receivable on non-accrual status, foreclosed assets held for resale and loans past-due 90 days or more and still accruing interest) as of June 30, 2019 and December 31, 2018 were as follows:

 

(Dollars in thousands)  June 30,   December 31, 
   2019   2018 
Commercial Real Estate  $3,715   $3,402 
Residential Real Estate   753    494 
Total non-accrual loans   4,468    3,896 
Foreclosed assets held for resale   895    1,163 
Loans past-due 90 days or more and still accruing interest       228 
Total non-performing assets  $5,363   $5,287 

 

The following tables present the classes of the loan portfolio summarized by past-due status at June 30, 2019 and December 31, 2018:

 

(Dollars in thousands)                          90 Days 
                           Or Greater 
                           Past Due 
           90 Days               and Still 
   30-59 Days   60-89 Days   or Greater   Total       Total   Accruing 
   Past Due   Past Due   Past Due   Past Due   Current   Loans   Interest 
June 30, 2019:                                   
Commercial and Industrial  $4   $   $   $4   $81,549   $81,553   $ 
Commercial Real Estate   1,130    88    3,619    4,837    359,553    364,390     
Residential Real Estate   1,355    232    753    2,340    158,022    160,362     
Consumer   24            24    5,752    5,776     
Total  $2,513   $320   $4,372   $7,205   $604,876   $612,081   $ 

 

(Dollars in thousands)                          90 Days 
                           Or Greater 
                           Past Due 
           90 Days               and Still 
   30-59 Days   60-89 Days   or Greater   Total       Total   Accruing 
   Past Due   Past Due   Past Due   Past Due   Current   Loans   Interest 
December 31, 2018:                                   
Commercial and Industrial  $16   $30   $   $46   $92,174   $92,220   $ 
Commercial Real Estate   1,990    630    3,477    6,097    342,379    348,476    145 
Residential Real Estate   1,519    228    456    2,203    157,538    159,741    83 
Consumer   12            12    5,943    5,955     
Total  $3,537   $888   $3,933   $8,358   $598,034   $606,392   $228 

 

At June 30, 2019 and December 31, 2018, commitments to lend additional funds with respect to impaired loans consisted of one irrevocable letter of credit totaling $1,249,000 that was associated with a loan to a developer of a residential sub-division.

 

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NOTE 5 — DEPOSITS

 

Major classifications of deposits at June 30, 2019 and December 31, 2018 consisted of:

 

(Dollars in thousands)  June 30,   December 31, 
   2019   2018 
Non-interest bearing demand  $135,976   $126,361 
Interest bearing demand   174,960    180,328 
Savings   180,392    167,572 
Time certificates of deposits less than $250,000   193,495    172,550 
Time certificates of deposits $250,000 or greater   20,316    23,597 
Other time deposits   1,586    1,145 
Total deposits  $706,725   $671,553 

 

Total Deposits increased $35,172,000 to $706,725,000 as of June 30, 2019 due to increases in non-interest bearing, savings deposits, and time deposits. These increases were due to the Corporation accepting $20,000,000 in brokered CD’s in the second quarter of 2019 and normal deposit fluctuations during the six months ended June 30, 2019.

 

NOTE 6BORROWINGS

 

Short-Term Borrowings

 

Short-term borrowings include federal funds purchased, securities sold under agreements to repurchase, the Federal Discount Window, and Federal Home Loan Bank (“FHLB”) advances, which generally represent overnight or less than 30-day borrowings. Short-term borrowings and weighted–average interest rates at June 30, 2019 and December 31, 2018 are as follows:

 

(Dollars in thousands)  June 30, 2019   December 31, 2018 
       Average       Average 
   Amount   Rate   Amount   Rate 
Federal funds purchased  $       $    2.19%
Securities sold under agreements to repurchase   13,982    0.97%   12,957    0.56%
Federal Discount Window               2.19%
Federal Home Loan Bank   106,169    2.70%   161,488    2.28%
Total  $120,151    2.53%  $174,445    2.04%

 

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

 

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

 

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

 

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

 

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The following table presents the short-term borrowings subject to an enforceable master netting arrangement or repurchase agreements as of June 30, 2019 and December 31, 2018.

 

(Dollars in thousands)      Gross  Net Amounts             
       Amounts  of Liabilities             
       Offset  Presented             
   Gross   in the  in the             
   Amounts of   Consolidated  Consolidated       Cash     
   Recognized   Balance  Balance   Financial   Collateral   Net 
   Liabilities   Sheet  Sheet   Instruments   Pledge   Amount 
June 30, 2019                            
Repurchase agreements (a)  $13,982   $   $13,982   $(13,982)  $   $ 
                             
December 31, 2018                            
Repurchase agreements (a)  $12,957   $   $12,957   $(12,957)  $   $ 

 

 

(a) As of June 30, 2019 and December 31, 2018, the fair value of securities pledged in connection with repurchase agreements was $20,251,000 and $16,970,000, respectively.

 

The following table presents the remaining contractual maturity of the master netting arrangement or repurchase agreements as of June 30, 2019:

 

(Dollars in thousands)  Remaining Contractual Maturity of the Agreements 
   Overnight          Greater     
   and   Up to  30 -90   than     
   Continuous   30 days  Days   90 Days   Total 
June 30, 2019:                       
Repurchase agreements and repurchase-to-maturity transactions:                       
U.S. Treasury and/or agency securities  $13,982 $   $   $   $13,982 
Total  $13,982 $   $   $   $13,982 

 

Long-Term Borrowings

 

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

 

NOTE 7COMMITMENTS AND CONTINGENCIES

 

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

 

The Corporation’s banking subsidiary currently leases three branch banking facilities and one parcel of land under operating leases. At June 30, 2019, right-of-use assets and lease liabilities were recorded related to these operating leases totaling $1,530,000 and $1,639,000, respectively. Further options to extend or terminate the lease are not applicable for any of the four leases. No significant assumptions or judgements were made in determining whether a contract contained a lease or in the consideration of lease versus non-lease components. None of the leases contained an implicit rate; therefore, our incremental borrowing rate was used for each of the leases.

 

The Bank recognized total operating lease costs for the six months ended June 30, 2019 of $96,000. Cash payments totaled $77,000.

 

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The following table displays the weighted-average term and discount rates for operating leases outstanding as of June 30, 2019.

 

   Operating 
Weighted-average term (years)   26.06 
Weighted-average discount rate   3.85%

 

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

 

(Dollars in thousands)   June 30, 
   2019 
Minimum lease payments due:     
Within one year  $131 
After one but within two years   113 
After two but within three years   102 
After three but within four years   68 
After four but within five years   68 
After five years   2,360 
Total undiscounted cash flows   2,842 
Discount on cash flows   (1,203)
Total lease liability  $1,639 

 

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

 

Financial Instruments with Off-Balance Sheet Risk

 

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

 

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

 

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

 

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

 

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The contract or notional amounts at June 30, 2019 and December 31, 2018 were as follows:

 

(Dollars in thousands)  June 30, 2019   December 31, 2018 
Financial instruments whose contract amounts represent credit risk:          
Commitments to extend credit  $103,402   $107,126 
Financial standby letters of credit  $339   $331 
Performance standby letters of credit  $3,113   $3,107 

 

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

 

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

 

Financial Instruments with Concentrations of Credit Risk

 

The Corporation originates primarily commercial and residential real estate loans to customers in northeastern Pennsylvania. The ability of the majority of the Corporation’s customers to honor their contractual loan obligations is dependent on the economy and real estate market in this area. At June 30, 2019, the Corporation had $524,752,000 in loans secured by real estate, which represented 85.7% of total loans. The real estate loan portfolio is largely secured by lessors of residential buildings and dwellings, lessors of non-residential buildings, and lessors of hotels/motels. As of June 30, 2019 and December 31, 2018, management is of the opinion that there were no concentrations exceeding 10% of total loans with regard to loans to borrowers who were engaged in similar activities that were similarly impacted by economic or other conditions.

 

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

 

NOTE 9FAIR VALUE MEASUREMENTS

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Financial Assets Measured at Fair Value on a Recurring Basis

 

At June 30, 2019 and December 31, 2018, securities measured at fair value on a recurring basis and the valuation methods used are as follows:

 

(Dollars in thousands)  Level 1   Level 2   Level 3   Total 
June 30, 2019                    
Debt Securities Available-for-Sale:                    
U.S. Treasury securities  $   $5,339   $   $5,339 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgage-backed       83,064        83,064 
Other       20,052        20,052 
Other mortgage backed debt securities       6,496        6,496 
Obligations of state and political subdivisions       149,832        149,832 
Asset backed securities       13,912        13,912 
Corporate debt securities       26,883        26,883 
Total debt securities available-for-sale       305,578        305,578 
Marketable equity securities   1,671            1,671 
Total recurring fair value measurements  $1,671   $305,578   $   $307,249 

 

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(Dollars in thousands)  Level 1   Level 2   Level 3   Total 
December 31, 2018                
Available-for-Sale Debt Securities:                    
U.S. Treasury securities  $   $5,295   $   $5,295 
Obligations of U.S. Government Corporations and Agencies:                    
Mortgaged-backed       64,876        64,876 
Other       18,243        18,243 
Other mortgage backed debt securities       4,749        4,749 
Obligations of state and political subdivisions       182,278        182,278 
Asset backed securities       14,370        14,370 
Corporate debt securities       26,243        26,243 
Total debt securities available-for-sale       316,054        316,054 
Marketable equity securities   1,560            1,560 
Total  $1,560   $316,054   $   $317,614 

 

The estimated fair values of equity securities classified as Level 1 are derived from quoted market prices in active markets; these assets consist mainly of stocks held in other banks. The estimated fair values of all debt securities classified as Level 2 are obtained from nationally-recognized third-party pricing agencies. The estimated fair values are derived primarily from cash flow models, which include assumptions for interest rates, credit losses, and prepayment speeds. The significant inputs utilized in the cash flow models are based on market data obtained from sources independent of the Corporation (observable inputs), and are therefore classified as Level 2 within the fair value hierarchy. The Corporation does not have any Level 3 inputs for securities. There were no transfers between Level 1 and Level 2 during 2019 or 2018.

 

Financial Assets Measured at Fair Value on a Nonrecurring Basis

 

At June 30, 2019 and December 31, 2018, impaired loans measured at fair value on a nonrecurring basis and the valuation methods used are as follows:

 

                 
(Dollars in thousands)  Level 1   Level 2   Level 3   Total 
Assets at June 30, 2019                
Impaired loans:                
Commercial Real Estate  $   $   $6,222   $6,222 
Residential Real Estate          189    189 
Total impaired loans  $   $   $6,411   $6,411 

 

(Dollars in thousands)  Level 1   Level 2   Level 3   Total 
Assets at December 31, 2018                
Impaired loans:                    
Commercial Real Estate  $   $   $6,400   $6,400 
Residential Real Estate           81    81 
Total impaired loans  $   $   $6,481   $6,481 

 

The Bank’s impaired loan valuation procedure for any loans greater than $250,000 requires an appraisal to be obtained and reviewed annually at year end. A quarterly collateral evaluation is performed which may include a site visit, property pictures and discussions with realtors and other similar business professionals to ascertain current values. For impaired loans less than $250,000 upon classification and annually at year end, the Bank completes a Certificate of Inspection, which includes an onsite inspection, insured values, tax assessed values, recent sales comparisons and a review of the previous evaluations. These assets are included as Level 3 fair values, based upon the lowest level that is significant to the fair value measurements. The fair value consists of the impaired loan balances less the valuation allowance and/or charge-offs. There were no transfers between valuation levels in 2019 and 2018.

 

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Nonfinancial Assets Measured at Fair Value on a Nonrecurring Basis

 

At June 30, 2019 and December 31, 2018, foreclosed assets held for resale measured at fair value on a nonrecurring basis and the valuation methods used are as follows:

 

(Dollars in thousands)  Level 1   Level 2   Level 3   Total 
Assets at June 30, 2019                
Foreclosed assets held for resale:                    
Commercial Real Estate  $   $   $856   $856 
Residential Real Estate                
Total foreclosed assets held for resale  $   $   $856   $856 

 

 (Dollars in thousands)  Level 1   Level 2   Level 3   Total 
Assets at December 31, 2018                    
Foreclosed assets held for resale:                    
Commercial Real Estate  $   $   $856   $856 
Residential Real Estate                
Total foreclosed assets held for resale  $   $   $856   $856 

 

The Bank’s foreclosed asset valuation procedure requires an appraisal, which considers the sales prices of similar properties in the proximate vicinity, to be completed periodically with the exception of those cases which the Bank has obtained a sales agreement. These assets are included as Level 3 fair values, based upon the lowest level that is significant to the fair value measurements. There were no transfers between valuation levels in 2019 and 2018.

 

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

 

(Dollars in thousands)  Quantitative Information about Level 3 Fair Value Measurements 
   Fair Value            Weighted 
   Estimate   Valuation Technique  Unobservable Input  Range  Average 
June 30, 2019                   
Impaired loans  $3,388   Appraisal of collateral1,3  Appraisal adjustments2  (15%) – (73%)   (18%) 
Impaired loans  $3,023   Discounted cash flow  Discount rate  (7%) – (7%)   (7%) 
Foreclosed assets held for resale  $856   Appraisal of collateral1,3  Appraisal adjustments2  (16%) – (35%)   (18%) 
                    
December 31, 2018                   
Impaired loans  $3,346   Appraisal of collateral1,3  Appraisal adjustments2  (15%) – (82%)   (18%) 
Impaired loans  $3,135   Discounted cash flow  Discount rate  (6%) – (7%)   (7%) 
Foreclosed assets held for resale  $856   Appraisal of collateral1,3  Appraisal adjustments2  (16%) – (35%)   (18%) 

 

 

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

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

3Includes qualitative adjustments by management and estimated liquidation expenses.

 

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Fair Value of Financial Instruments

 

(Dollars in thousands)  Carrying   Fair Value Measurements at June 30, 2019 
   Amount   Level 1   Level 2   Level 3   Total 
FINANCIAL ASSETS:                         
Cash and due from banks  $7,465   $7,465   $   $   $7,465 
Interest-bearing deposits in other banks   2,182        2,182        2,182 
Time deposits with other banks   1,482        1,482        1,482 
Restricted investment in bank stocks   6,474        6,474        6,474 
Net loans   605,309            615,054    615,054 
Mortgage servicing rights   288            288    288 
Accrued interest receivable   3,934        3,934        3,934 
                          
FINANCIAL LIABILITIES:                         
Demand, savings and other deposits   491,328        491,328        491,328 
Time deposits   215,397        215,416        215,416 
Short-term borrowings   120,151        120,187        120,187 
Long-term borrowings   45,000        45,815        45,815 
Accrued interest payable   739        739        739 
                          
OFF-BALANCE SHEET FINANCIAL  INSTRUMENTS                    
                          
(Dollars in thousands)  Carrying   Fair Value Measurements at December 31, 2018 
   Amount   Level 1   Level 2   Level 3   Total 
FINANCIAL ASSETS:                         
Cash and due from banks  $9,822   $9,822   $   $   $9,822 
Interest-bearing deposits in other banks   1,128        1,128        1,128 
Time deposits with other banks   1,482        1,469        1,469 
Restricted investment in bank stocks   8,681        8,681        8,681 
Net loans   599,647            597,548    597,548 
Mortgage servicing rights   316            316    316 
Accrued interest receivable   4,041        4,041        4,041 
                          
FINANCIAL LIABILITIES:                         
Demand, savings and other deposits   474,261        474,261        474,261 
Time deposits   197,292        195,136        195,136 
Short-term borrowings   174,445        174,491        174,491 
Long-term borrowings   45,000        45,077        45,077 
Accrued interest payable   785        785        785 
                          
OFF-BALANCE SHEET FINANCIAL  INSTRUMENTS                    

 

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NOTE 10REVENUE RECOGNITION

 

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

 

Deposits related fees and service charges

 

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

 

Wealth/Asset/Trust Management Fees

 

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

 

Assets held in a fiduciary capacity by the Trust Department are not assets of the Corporation and, therefore, are not included in our consolidated financial statements. Wealth management fees, which are contractually agreed with each customer, are earned each month and recognized on a cash basis based on average fair value of the trust assets under management. The services provided under such a contract are considered a single performance obligation under ASC 606 because they embody a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer. Wealth management fees charged by the Trust Department follow a tiered structure based on the type and size of the assets under management. Wealth management fees are included within non-interest income in the consolidated statements of income. As of June 30, 2019 and December 31, 2018, the fair value of trust assets under management was $107,282,000 and $105,917,000, respectively. The costs of acquiring asset management customers are incremental and recognized within non-interest expense in the consolidated statements of income.

 

Interchange Fees and Surcharges

 

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

 

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NOTE 11EARNINGS PER SHARE

 

Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Corporation. Potential common shares that may be issued by the Corporation relate solely to outstanding stock options and are determined using the treasury stock method. The following table sets forth the computation of basic and diluted earnings per share.

 

(In thousands, except earnings per share)  Three Months Ended 
   June 30, 
   2019   2018 
Net income  $2,530   $2,476 
Weighted-average common shares outstanding   5,777    5,732 
Basic earnings per share  $0.44   $0.43 
           
Weighted-average common shares outstanding   5,777    5,732 
Common stock equivalents due to effect of stock options        
Total weighted-average common shares and equivalents   5,777    5,732 
Diluted earnings per share  $0.44   $0.43 

 

(In thousands, except earnings per share)  Six Months Ended 
   June 30, 
   2019   2018 
Net income  $4,773   $4,253 
Weighted-average common shares outstanding   5,771    5,726 
Basic earnings per share  $0.83   $0.74 
           
Weighted-average common shares outstanding   5,771    5,726 
Common stock equivalents due to effect of stock options        
Total weighted-average common shares and equivalents   5,771    5,726 
Diluted earnings per share  $0.83   $0.74 

 

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

 

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

 

CRITICAL ACCOUNTING ESTIMATES

 

The Corporation has chosen accounting policies that it believes are appropriate to accurately and fairly report its operating results and financial position, and the Corporation applies those accounting policies in a consistent manner. The Significant Accounting Policies are summarized in Note 1 to the consolidated financial statements included in the 2018 Annual Report on Form 10-K. There have been no changes to the Critical Accounting Estimates since the Corporation filed its Annual Report on Form 10-K for the year ended December 31, 2018.

 

RESULTS OF OPERATIONS

 

Quarter ended June 30, 2019 compared to quarter ended June 30, 2018

 

First Keystone Corporation realized earnings for the second quarter of 2019 of $2,530,000, an increase of $54,000, or 2.2% from the second quarter of 2018. The increase in net income for the three months ended June 30, 2019 was primarily due to an increase in interest income and fees on loans, an increase in net securities gains and trust department income, and a decrease in professional services expense.

 

On a per share basis, for the three months ended June 30, 2019, net income was $0.44 versus $0.43 for the same three month period of 2018. Cash dividends amounted to $0.27 per share for the three months ended June 30, 2019 and 2018.

 

NET INTEREST INCOME

 

The major source of operating income for the Corporation is net interest income, defined as interest income less interest expense. In the three months ended June 30, 2019, interest income amounted to $9,479,000, an increase of $742,000 or 8.5% from the three months ended June 30, 2018, while interest expense amounted to $2,597,000 in the three months ended June 30, 2019, an increase of $613,000 or 30.9% from the three months ended June 30, 2018. As a result, net interest income increased $129,000 or 1.9% to $6,882,000 from $6,753,000 for the same period in 2018.

 

The Corporation’s net interest margin for the three months ended June 30, 2019 was 3.19% compared to 3.20% for same period in 2018. The decrease in net interest margin was a result of an increase in short-term borrowing costs.

 

PROVISION FOR LOAN LOSSES

 

The provision for loan losses for the three months ended June 30, 2019 and June 30, 2018 was $46,000 and $0, respectively. The increase in the provision for loan losses resulted from the Corporation’s analysis of the current loan portfolio, including historic losses, past-due trends, current economic conditions, and other relevant factors. Charge-off and recovery activity in the allowance for loan losses resulted in net charge-offs of $36,000 and $433,000 for the three months ended June 30, 2019 and 2018, respectively. See Allowance for Loan Losses on page 41 for further discussion.

 

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NON-INTEREST INCOME

 

Total non-interest income was $1,616,000 for the three months ended June 30, 2019, as compared to $1,470,000 for the same period in 2018, an increase of $146,000, or 9.9%. The increase was the result of more trust department income, higher average gains on sales of individual mortgage loans, and an increase in net securities gains in the three months ended June 30, 2019 as compared to the same period in 2018. Trust department income increased $41,000 or 18.4% to $264,000 for the three months ended June 30, 2019 as compared to the same period in 2018. ATM fees and debit card income increased $20,000 or 5.0% to $419,000 for the three months ended June 30, 2019. Gains on sales of mortgage loans increased $37,000 or 97.4% due to higher average gains on individual mortgage loan sales. Net securities gains increased $38,000 to $92,000 for the three months ended June 30, 2019 as compared to the three months ended June 30, 2018. The increase was due to an increase in net gains recognized on owned marketable equity securities in the second quarter of 2019 as compared to the second quarter of 2018.

 

NON-INTEREST EXPENSE

 

Total non-interest expense was $5,655,000 for the three months ended June 30, 2019, as compared to $5,676,000 for the three months ended June 30, 2018. Non-interest expense decreased $21,000 or 0.4%.

 

Expenses associated with employees (salaries and employee benefits) continue to be the largest category of non-interest expense. Salaries and benefits amounted to $2,953,000 or 52.2% of total non-interest expense for the three months ended June 30, 2019, as compared to $2,957,000 or 52.1% for the same three months of 2018.

 

Net occupancy, furniture and equipment, and computer expense amounted to $881,000 for the three months ended June 30, 2019, an increase of $62,000 or 7.6%. Professional services decreased $101,000 or 32.7% to $208,000 as of June 30, 2019. The decrease in the second quarter of 2018 was due to a combination of higher engagement fees relating to income generation consulting and higher legal fees relating to the resignation of an executive officer of the Bank. Pennsylvania shares tax expense amounted to $192,000 for the three months ended June 30, 2019, a decrease of $8,000 or 4.0% as compared to the same three months in 2018.

 

FDIC insurance expense decreased $3,000 or 4.0% for the three months ended June 30, 2019. FDIC insurance expense varies with changes in net asset size, risk ratings, and FDIC derived assessment rates. ATM and debit card fees expense amounted to $221,000 for the three months ended June 30, 2019, an increase of $29,000 or 15.1% as compared to the same three months of 2018. The increase was due to an increase in client card usage causing higher electronic funds transfer fees. Data processing expenses amounted to $305,000 for the three months ended June 30, 2019, an increase of $39,000 or 14.7% as compared to the same three months of 2018. The increase was due to pricing increases from our main third party data processor and an increase in trust department tax form processing fees during the second quarter of 2019. Foreclosed assets held for resale expense decreased $2,000 in the second quarter of 2019 as compared to the second quarter of 2018. Advertising expense increased $31,000 or 24.0% during the three months ended June 30, 2019. This increase was due to more media advertising employed in the second quarter of 2019 including additional newspaper advertising and an increase in promotional community sponsorships during the three months ended June 30, 2019 as compared to the same three months of 2018.

 

Other non-interest expense amounted to $658,000 for the three months ended June 30, 2019, a decrease of $64,000 or 8.9% as compared to the three months ended June 30, 2018. The decrease was due to a decrease in loan collections expense resulting from a right of setoff taken from a customer’s account to cover various expenses paid by the Bank and a decrease in the provision for unfunded commitments due to lower commercial real estate balances requiring a reserve.

 

INCOME TAXES

 

Income tax expense amounted to $267,000 for the three months ended June 30, 2019, as compared to $71,000 for the three months ended June 30, 2018, an increase of $196,000. The effective total income tax rate was 9.5% for the second quarter of 2019 as compared to 2.8% for the second quarter of 2018. The increase in the effective tax rate was mainly due to a net decrease in tax-exempt income from investments in and loans to state and local units of government. The Corporation recognized $101,000 of tax credits from low-income housing partnerships in the second quarter of 2019.

 

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Six months ended June 30, 2019 compared to six months ended June 30, 2018

 

First Keystone Corporation realized earnings for the first six months of 2019 of $4,773,000, an increase of $520,000, or 12.2% from the same period in 2018. The increase in net income for the six months ended June 30, 2019 was primarily due to an increase in interest income and fees on loans, an increase in net securities gains, and a decrease in other non-interest expense.

 

On a per share basis, net income was $0.83 for the six months ended June 30, 2019 versus $0.74 for the same six month period of 2018. Cash dividends amounted to $0.54 per share for the six months ended June 30, 2019 and 2018.

 

NET INTEREST INCOME

 

The major source of operating income for the Corporation is net interest income, defined as interest income less interest expense. For the six months ended June 30, 2019, interest income amounted to $18,993,000, an increase of $1,985,000 or 11.7% from the six months ended June 30, 2018, while interest expense amounted to $5,290,000 in the six months ended June 30, 2019, an increase of $1,525,000 or 40.5% from the six months ended June 30, 2018. As a result, net interest income increased $460,000 or 3.5% to $13,703,000 from $13,243,000 for the same period in 2018.

 

The Corporation’s net interest margin for the six months ended June 30, 2019 was 3.17% compared to 3.16% for same period in 2018. The increase in net interest margin was a result of an increase in yield on the loan portfolio.

 

PROVISION FOR LOAN LOSSES

 

The provision for loan losses for the six months ended June 30, 2019 and June 30, 2018 was $138,000 and $50,000, respectively. The increase in the provision for loan losses resulted from the Corporation’s analysis of the current loan portfolio, including historic losses, past-due trends, current economic conditions, and other relevant factors. Charge-off and recovery activity in the allowance for loan losses resulted in net charge-offs of $111,000 and $591,000 for the six months ended June 30, 2019 and 2018, respectively. See Allowance for Loan Losses on page 41 for further discussion.

 

NON-INTEREST INCOME

 

Total non-interest income was $3,123,000 for the six months ended June 30, 2019, as compared to $2,729,000 for the same period in 2018, an increase of $394,000, or 14.4%. The increase was mainly the result of higher net securities gains, higher trust department income and higher service charges and fees income. ATM fees and debit card income increased $40,000 or 5.3% to $796,000 for the six months ended June 30, 2019. Service charges and fee income increased $58,000 or 5.9%. Gains on sales of mortgage loans increased $48,000 or 71.6% due to higher average gains on individual mortgage loan sales. Trust department income increased $67,000 or 14.6% to $525,000 for the six months ended June 30, 2019 as compared to the same period in 2018. Net securities gains increased $158,000 to $195,000 for the six months ended June 30, 2019 as compared to the six months ended June 30, 2018. The increase was due to more net gains taken on sales of available-for-sale debt securities as a result of a strategic decrease in securities to fund loan growth, and an increase in net gains recognized on owned marketable equity securities in the first half of 2019 as compared to the same period of 2018.

 

NON-INTEREST EXPENSE

 

Total non-interest expense was $11,510,000 for the six months ended June 30, 2019, as compared to $11,571,000 for the six months ended June 30, 2018. Non-interest expense decreased $61,000 or 0.5%.

 

Expenses associated with employees (salaries and employee benefits) continue to be the largest category of non-interest expense. Salaries and benefits amounted to $6,085,000 or 52.9% of total non-interest expense for the six months ended June 30, 2019, as compared to $5,993,000 or 51.8% for the same six months of 2018. The increase was mainly due to higher profit sharing expenses, increased commissions paid to sales staff, and additional employee training costs in 2019. In the prior year there was a large reversal of a retirement benefit as the result of the resignation of an executive officer of the Bank in the second quarter of 2018.

 

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Net occupancy, furniture and equipment, and computer expense amounted to $1,765,000 for the six months ended June 30, 2019, an increase of $81,000 or 4.8%. This increase was mainly due to increases in software maintenance costs in the first six months of 2019 as compared to the same period in 2018. Professional services decreased $54,000 or 10.2% to $478,000 as of June 30, 2019. The decrease was due to higher engagement fees related to income generation consulting and higher legal fees relating to the resignation of an executive officer of the bank in the second quarter of 2018. Pennsylvania shares tax expense amounted to $384,000 for the six months ended June 30, 2019, a decrease of $15,000 or 3.8% as compared to the same six months in 2018.

 

FDIC insurance expense decreased $19,000 or 12.2% for the six months ended June 30, 2019. FDIC insurance expense varies with changes in net asset size, risk ratings, and FDIC derived assessment rates. ATM and debit card fees expense amounted to $432,000 for the six months ended June 30, 2019, an increase of $65,000 or 17.7% as compared to the same six months of 2018. The increase was due to an increase in client card usage causing higher electronic funds transfer fees. Data processing expenses amounted to $572,000 for the six months ended June 30, 2019, an increase of $39,000 or 7.3% as compared to the six months ended June 30, 2018. The increase was due to pricing increases from our main third party data processor and an increase in trust department tax form processing fees during the second quarter of 2019. Foreclosed assets held for resale expense decreased $32,000 in the first half of 2019. There were additional expenses incurred on foreclosed property purchases in the first half of 2018 along with less general expenses on foreclosed assets in 2019 due to fewer properties owned and maintained. Advertising expense increased $103,000 or 49.0% during the six months ended June 30, 2019. This increase was due to a more aggressive advertising approach in the first half of 2019 including an increase in newspaper and billboard advertising and an increase in promotional community sponsorships during the six months ended June 30, 2019 as compared to the same six months of 2018.

 

Other non-interest expense amounted to $1,301,000 for the six months ended June 30, 2019, a decrease of $321,000 or 19.8% as compared to the six months ended June 30, 2018. The decrease was due to a decrease in amortization costs on one of the Corporation’s low income housing investment properties and a decrease in the provision for unfunded commitments due to lower commercial real estate balances requiring a reserve.

 

INCOME TAXES

 

Income tax expense amounted to $405,000 for the six months ended June 30, 2019, as compared to $98,000 for the six months ended June 30, 2018, an increase of $307,000. The effective total income tax rate was 7.8% for the first half of 2019 as compared to 2.3% for the first half of 2018. The increase in the effective tax rate was mainly due to a net decrease in tax-exempt income from investments in and loans to state and local units of government. The Corporation recognized $202,000 of tax credits from low-income housing partnerships in the first half of 2019.

 

FINANCIAL CONDITION

 

SUMMARY

 

Total assets decreased to $1,003,812,000 as of June 30, 2019, a decrease of $8,188,000 from year-end 2018. Total assets as of December 31, 2018 amounted to $1,012,000,000.

 

Total debt securities available-for-sale decreased $10,476,000 or 3.3% to $305,578,000 as of June 30, 2019 from December 31, 2018.

 

Total loans increased $5,689,000 or 0.9% to $612,081,000 as of June 30, 2019 from December 31, 2018. Loan demand grew in the six months ended June 30, 2019 as the Bank has realized an increase in loan originations, primarily in the commercial real estate portfolio.

 

Total deposits increased $35,172,000 or 5.2% to $706,725,000 as of June 30, 2019 from December 31, 2018.

 

The Corporation continues to maintain and manage its asset growth. The Corporation’s strong equity capital position provides an opportunity to further leverage its asset growth. Total borrowings decreased in the first six months of 2019 by $54,294,000 to $165,151,000 from $219,445,000 as of December 31, 2018. Borrowings decreased mainly due to increased deposit balances and increased cash provided by investment activity.

 

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Total stockholders’ equity increased to $125,707,000 at June 30, 2019, an increase of $8,951,000 or 7.7% from December 31, 2018 due to an increase in accumulated other comprehensive income and retained earnings.

 

SEGMENT REPORTING

 

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

 

EARNING ASSETS

 

Earning assets are defined as those assets that produce interest income. By maintaining a healthy asset utilization rate, i.e., the volume of earning assets as a percentage of total assets, the Corporation maximizes income. The earning asset ratio (average interest earning assets divided by average total assets) equaled 92.4% at June 30, 2019 and 92.5% at June 30, 2018. This indicates that the management of earning assets is a priority and non-earning assets, primarily cash and due from banks, fixed assets and other assets, are maintained at minimal levels. The primary earning assets are loans and investment securities.

 

Our primary earning asset, total loans, increased to $612,081,000 as of June 30, 2019, up $5,689,000, or 0.9% since year-end 2018. The loan portfolio continues to be well diversified. Non-performing assets increased since year-end 2018, and overall asset quality has remained consistent. Total non-performing assets were $5,363,000 as of June 30, 2019, an increase of $76,000, or 1.4% from $5,287,000 reported in non-performing assets as of December 31, 2018. Total allowance for loan losses to total non-performing assets was 126.27% as of June 30, 2019 and 127.58% at December 31, 2018.

 

In addition to loans, another primary earning asset is our overall investment portfolio, which decreased in size from December 31, 2018 to June 30, 2019. Debt securities available-for-sale amounted to $305,578,000 as of June 30, 2019, a decrease of $10,476,000 from year-end 2018.

 

Interest-bearing deposits in other banks increased as of June 30, 2019, to $2,182,000 from $1,128,000 at year-end 2018. Time deposits with other banks were $1,482,000 at June 30, 2019 and December 31, 2018.

 

LOANS

 

Total loans increased to $612,081,000 as of June 30, 2019 as compared to $606,392,000 as of December 31, 2018. The table on page 18 provides data relating to the composition of the Corporation’s loan portfolio on the dates indicated. Total loans increased by $5,689,000 or 0.9%.

 

Steady demand for borrowing by businesses accounted for the 0.9% increase in the loan portfolio from December 31, 2018 to June 30, 2019. The Commercial and Industrial portfolio decreased $10,667,000 to $81,553,000 as of June 30, 2019, as compared to $92,220,000 at December 31, 2018. The decrease in the Commercial and Industrial portfolio (which includes tax-free Commercial and Industrial loans) was attributed to new loan originations totaling $4,609,000 offset by a $2,783,000 decrease in utilization of existing Commercial and Industrial lines of credit and loan payoffs of $8,858,000, as well as regular principal payments and other typical fluctuations and activity in the Commercial and Industrial portfolio. The Commercial Real Estate portfolio (which includes tax-free Commercial Real Estate loans) increased $15,914,000 to $364,390,000 at June 30, 2019, as compared to $348,476,000 at December 31, 2018. The increase was mainly the result of $33,436,000 in new loan originations and a $3,064,000 increase in utilization of existing Commercial Real Estate lines of credit, offset by $15,866,000 in loan payoffs in addition to regular principal payments and other typical amortizations in the Commercial Real Estate portfolio. Residential Real Estate loans increased $621,000 to $160,362,000 at June 30, 2019, as compared to $159,741,000 at December 31, 2018. The increase was the result of $8,960,000 in new loan originations offset by loan payoffs of $6,972,000, net loans sold of $246,000 and regular principal payments. Net loans sold in the Residential Real Estate portfolio for the six months ended June 30, 2019 consisted of total loans sold in the six months ended June 30, 2019 of $3,653,000, offset with loans opened and sold in the same quarter during the first two quarters of 2019 which amounted to $3,407,000. The Corporation continues to originate and sell certain long-term fixed rate residential mortgage loans which conform to secondary market requirements. The Corporation derives ongoing income from the servicing of mortgages sold in the secondary market. The Corporation continues its efforts to lend to creditworthy borrowers.

 

Management believes that the loan portfolio is well diversified. The total commercial portfolio was $445,943,000 at June 30, 2019. Of total loans, $364,390,000 or 59.5% were secured by commercial real estate, primarily lessors of residential buildings and dwellings and lessors of non-residential buildings. The Corporation continues to monitor these portfolios.

 

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The largest relationship is comprised of a group of related entities (operating companies and real estate holding companies) engaged in the business of owning and operating various income-producing properties, predominantly student housing rentals, in central Pennsylvania. At June 30, 2019, the relationship had outstanding balances and unused commitments totaling $11,191,000, which consisted of $10,941,000 in commercial term debt and one line of credit with an available balance of $250,000. The loans are secured by commercial real estate and the assignment of rents and leases.

 

The second largest relationship is comprised of various real estate entities with a mutual owner who is a related party of the bank and began real estate investment and development activities in 1989. The individual owns a diverse mix of real estate entities which specialize in construction/development projects (which include VA clinics), leasing of commercial office space, and rental of multi-tenant residential units. The relationship had outstanding loan balances and unused commitments of $11,154,000 at June 30, 2019. This relationship is comprised of $10,029,000 in term debt and three lines of credit totaling $1,125,000. The relationship is well secured by first lien mortgages on income producing commercial and residential real estate and assignment of governmental leases.

 

The third largest relationship consists of an electrical contractor that has serviced eastern and northeastern Pennsylvania for over forty years, as well as a related real estate holding company. The guarantor is also a partner in a separate real estate development company that specializes in the renovation and conversion of o