ENB Financial Corp 10-Q for FY2021 Q1
ENB Financial Corp (ENBP)
About this 10-Q
ENB Financial Corp filed this 10-Q on May 14, 2021, covering the quarter ended March 31, 2021 (FY2021 Q1).
Headline figures
Quarter ended March 31, 2021, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Net income
- $4.5M
- up 108.0% from net income of $2.17M a year earlier
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2021
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from________________________________ to ________________________________
ENB Financial Corp
(Exact name of registrant as specified in its charter)
| Pennsylvania | 000-53297 | 51-0661129 |
| (State or Other Jurisdiction of Incorporation) | (Commission File Number) | (IRS Employer Identification No) |
| 31 E. Main St., Ephrata, PA | 17522-0457 | |
| (Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code (717) 733-4181
Former name, former address, and former fiscal year, if changed since last report Not Applicable
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||
| None. | N/A | N/A |
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 ☒ 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 and post such files.)
Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See 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 | ☐ | |
| Non-accelerated filer | ☒ | Smaller reporting company | ☒ | |
| Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of May 1, 2021, the registrant had 5,566,566 shares of $0.10 (par) Common Stock outstanding.
1
ENB FINANCIAL CORP
March 31, 2021
2
ENB FINANCIAL CORP
Part I - Financial Information
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
| March 31, | December 31, | March 31, | ||||||||||
| 2021 | 2020 | 2020 | ||||||||||
| $ | $ | $ | ||||||||||
| ASSETS | ||||||||||||
| Cash and due from banks | 19,366 | 21,665 | 14,346 | |||||||||
| Interest-bearing deposits in other banks | 69,248 | 73,274 | 9,066 | |||||||||
| Total cash and cash equivalents | 88,614 | 94,939 | 23,412 | |||||||||
| Securities available for sale (at fair value) | 531,600 | 476,428 | 320,568 | |||||||||
| Equity securities (at fair value) | 7,217 | 7,105 | 6,640 | |||||||||
| Loans held for sale | 2,018 | 3,029 | 2,419 | |||||||||
| Loans (net of unearned income) | 841,934 | 823,370 | 764,120 | |||||||||
| Less: Allowance for credit losses | 12,690 | 12,327 | 9,803 | |||||||||
| Net loans | 829,244 | 811,043 | 754,317 | |||||||||
| Premises and equipment | 24,742 | 24,760 | 25,044 | |||||||||
| Regulatory stock | 6,160 | 6,107 | 7,222 | |||||||||
| Bank owned life insurance | 29,833 | 29,646 | 29,012 | |||||||||
| Other assets | 12,461 | 9,256 | 9,362 | |||||||||
| Total assets | 1,531,889 | 1,462,313 | 1,177,996 | |||||||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||||
| Liabilities: | ||||||||||||
| Deposits: | ||||||||||||
| Noninterest-bearing | 580,003 | 534,853 | 363,766 | |||||||||
| Interest-bearing | 745,384 | 717,958 | 619,086 | |||||||||
| Total deposits | 1,325,387 | 1,252,811 | 982,852 | |||||||||
| Short-term borrowings | — | — | 3,500 | |||||||||
| Long-term debt | 52,792 | 54,790 | 71,531 | |||||||||
| Subordinated debt | 19,620 | 19,601 | — | |||||||||
| Other liabilities | 5,269 | 4,895 | 3,607 | |||||||||
| Total liabilities | 1,403,068 | 1,332,097 | 1,061,490 | |||||||||
| Stockholders' equity: | ||||||||||||
| Common stock, par value $0.10 | ||||||||||||
| Shares: Authorized 24,000,000 | ||||||||||||
| Issued 5,739,114 and Outstanding 5,566,566 as of 3/31/21, | ||||||||||||
| 5,566,230 as of 12/31/20, and 5,598,501 as of 3/31/20 | 574 | 574 | 574 | |||||||||
| Capital surplus | 4,460 | 4,444 | 4,476 | |||||||||
| Retained earnings | 124,285 | 120,670 | 113,207 | |||||||||
| Accumulated other comprehensive income net of tax | 2,924 | 7,958 | 1,103 | |||||||||
| Less: Treasury stock cost on 172,548 shares as of 3/31/21, 172,884 as of 12/31/20, | ||||||||||||
| and 140,613 as of 3/31/20 | (3,422 | ) | (3,430 | ) | (2,854 | ) | ||||||
| Total stockholders' equity | 128,821 | 130,216 | 116,506 | |||||||||
| Total liabilities and stockholders' equity | 1,531,889 | 1,462,313 | 1,177,996 | |||||||||
See Notes to the Unaudited Consolidated Interim Financial Statements
3
ENB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
| Three Months ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| $ | $ | |||||||
| Interest and dividend income: | ||||||||
| Interest and fees on loans | 8,385 | 8,452 | ||||||
| Interest on securities available for sale | ||||||||
| Taxable | 1,079 | 1,221 | ||||||
| Tax-exempt | 952 | 566 | ||||||
| Interest on deposits at other banks | 22 | 60 | ||||||
| Dividend income | 92 | 188 | ||||||
| Total interest and dividend income | 10,530 | 10,487 | ||||||
| Interest expense: | ||||||||
| Interest on deposits | 314 | 809 | ||||||
| Interest on borrowings | 537 | 462 | ||||||
| Total interest expense | 851 | 1,271 | ||||||
| Net interest income | 9,679 | 9,216 | ||||||
| Provision for loan losses | 375 | 350 | ||||||
| Net interest income after provision for loan losses | 9,304 | 8,866 | ||||||
| Other income: | ||||||||
| Trust and investment services income | 670 | 622 | ||||||
| Service fees | 614 | 679 | ||||||
| Commissions | 864 | 686 | ||||||
| Gains on the sale of debt securities, net | 87 | 282 | ||||||
| Gains (losses) on equity securities, net | 248 | (230 | ) | |||||
| Gains on sale of mortgages | 1,930 | 541 | ||||||
| Earnings on bank-owned life insurance | 216 | 206 | ||||||
| Other income (loss) | 689 | (19 | ) | |||||
| Total other income | 5,318 | 2,767 | ||||||
| Operating expenses: | ||||||||
| Salaries and employee benefits | 5,699 | 5,696 | ||||||
| Occupancy | 683 | 591 | ||||||
| Equipment | 267 | 290 | ||||||
| Advertising & marketing | 190 | 274 | ||||||
| Computer software & data processing | 1,098 | 706 | ||||||
| Shares tax | 280 | 239 | ||||||
| Professional services | 439 | 623 | ||||||
| Other expense | 531 | 691 | ||||||
| Total operating expenses | 9,187 | 9,110 | ||||||
| Income before income taxes | 5,435 | 2,523 | ||||||
| Provision for federal income taxes | 931 | 358 | ||||||
| Net income | 4,504 | 2,165 | ||||||
| Earnings per share of common stock | 0.81 | 0.38 | ||||||
| Weighted average shares outstanding | 5,561,603 | 5,627,257 | ||||||
See Notes to the Unaudited Consolidated Interim Financial Statements
4
ENB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (UNAUDITED)
(DOLLARS IN THOUSANDS)
| Three Months ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| $ | $ | |||||||
| Net income | 4,504 | 2,165 | ||||||
| Other comprehensive loss, net of tax: | ||||||||
| Securities available for sale not other-than-temporarily impaired: | ||||||||
| Unrealized losses arising during the period | (6,282 | ) | (349 | ) | ||||
| Income tax effect | 1,317 | 75 | ||||||
| (4,965 | ) | (274 | ) | |||||
| Gains recognized in earnings | (87 | ) | (282 | ) | ||||
| Income tax effect | 18 | 59 | ||||||
| (69 | ) | (223 | ) | |||||
| Other comprehensive loss, net of tax | (5,034 | ) | (497 | ) | ||||
| Comprehensive (loss) income | (530 | ) | 1,668 | |||||
See Notes to the Unaudited Consolidated Interim Financial Statements
5
ENB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
| Accumulated | ||||||||||||||||||||||||
| Other | Total | |||||||||||||||||||||||
| Common | Capital | Retained | Comprehensive | Treasury | Stockholders' | |||||||||||||||||||
| Stock | Surplus | Earnings | Income (Loss) | Stock | Equity | |||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| Balances, December 31, 2019 | 574 | 4,482 | 111,944 | 1,600 | (1,912 | ) | 116,688 | |||||||||||||||||
| Net income | — | — | 2,165 | — | — | 2,165 | ||||||||||||||||||
| Other comprehensive loss net of tax | — | — | — | (497 | ) | — | (497 | ) | ||||||||||||||||
| Treasury stock purchased - 49,911 shares | — | — | — | — | (1,098 | ) | (1,098 | ) | ||||||||||||||||
| Treasury stock issued - 7,670 shares | — | (6 | ) | — | — | 156 | 150 | |||||||||||||||||
| Cash dividends paid, $0.16 per share | — | — | (902 | ) | — | — | (902 | ) | ||||||||||||||||
| Balances, March 31, 2020 | 574 | 4,476 | 113,207 | 1,103 | (2,854 | ) | 116,506 | |||||||||||||||||
| Balances, December 31, 2020 | 574 | 4,444 | 120,670 | 7,958 | (3,430 | ) | 130,216 | |||||||||||||||||
| Net income | — | — | 4,504 | — | — | 4,504 | ||||||||||||||||||
| Other comprehensive loss net of tax | — | — | — | (5,034 | ) | — | (5,034 | ) | ||||||||||||||||
| Treasury stock purchased - 7,600 shares | — | — | — | — | (149 | ) | (149 | ) | ||||||||||||||||
| Treasury stock issued - 7,936 shares | — | 16 | — | — | 157 | 173 | ||||||||||||||||||
| Cash dividends paid, $0.16 per share | — | — | (889 | ) | — | — | (889 | ) | ||||||||||||||||
| Balances, March 31, 2021 | 574 | 4,460 | 124,285 | 2,924 | (3,422 | ) | 128,821 | |||||||||||||||||
See Notes to the Unaudited Consolidated Interim Financial Statements
6
ENB FINANCIAL CORP
See Notes to the Unaudited Consolidated Interim Financial Statements
7
1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited consolidated interim financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and to general practices within the banking industry. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all significant adjustments considered necessary for fair presentation have been included. Certain items previously reported have been reclassified to conform to the current period’s reporting format. Such reclassifications did not affect net income or stockholders’ equity.
ENB Financial Corp (“the Corporation”) is the bank holding company for its wholly-owned subsidiary Ephrata National Bank (the “Bank”). This Form 10-Q, for the first quarter of 2021, is reporting on the results of operations and financial condition of ENB Financial Corp.
Operating results for the three months ended March 31, 2021, are not necessarily indicative of the results that may be expected for the year ending December 31, 2021. For further information, refer to the consolidated financial statements and footnotes thereto included in ENB Financial Corp’s Annual Report on Form 10-K for the year ended December 31, 2020.
Revenue from Contracts with Customers
The Company records revenue from contracts with customers in accordance with Accounting Standards Topic 606, Revenue from Contracts with Customers (Topic 606). Under Topic 606, the Corporation must identify contracts with customers, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when the Corporation satisfies a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods.
The Corporation’s primary sources of revenue are derived from interest and dividends earned on loans, investment securities, and other financial instruments that are not within the scope of Topic 606. The Corporation has evaluated the nature of its contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. The Corporation generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.
8
2. Securities Available for Sale
The amortized cost, gross unrealized gains and losses, and fair value of securities held at March 31, 2021,
and December 31, 2020, are as follows:
| Gross | Gross | |||||||||||||||
| (DOLLARS IN THOUSANDS) | Amortized | Unrealized | Unrealized | Fair | ||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| March 31, 2021 | ||||||||||||||||
| U.S. government agencies | 29,623 | 119 | (562 | ) | 29,180 | |||||||||||
| U.S. agency mortgage-backed securities | 67,875 | 1,194 | (486 | ) | 68,583 | |||||||||||
| U.S. agency collateralized mortgage obligations | 40,214 | 651 | (79 | ) | 40,786 | |||||||||||
| Asset-backed securities | 96,592 | 707 | (299 | ) | 97,000 | |||||||||||
| Corporate bonds | 66,376 | 841 | (73 | ) | 67,144 | |||||||||||
| Obligations of states and political subdivisions | 227,217 | 4,237 | (2,547 | ) | 228,907 | |||||||||||
| Total securities available for sale | 527,897 | 7,749 | (4,046 | ) | 531,600 | |||||||||||
| December 31, 2020 | ||||||||||||||||
| U.S. government agencies | 54,224 | 144 | (7 | ) | 54,361 | |||||||||||
| U.S. agency mortgage-backed securities | 69,777 | 1,441 | (166 | ) | 71,052 | |||||||||||
| U.S. agency collateralized mortgage obligations | 34,449 | 640 | (54 | ) | 35,035 | |||||||||||
| Asset-backed securities | 60,387 | 433 | (345 | ) | 60,475 | |||||||||||
| Corporate bonds | 60,387 | 1,348 | (12 | ) | 61,723 | |||||||||||
| Obligations of states and political subdivisions | 187,132 | 6,727 | (77 | ) | 193,782 | |||||||||||
| Total securities available for sale | 466,356 | 10,733 | (661 | ) | 476,428 | |||||||||||
The amortized cost and fair value of securities available for sale at March 31, 2021, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities due to certain call or prepayment provisions.
CONTRACTUAL MATURITY OF DEBT SECURITIES
(DOLLARS IN THOUSANDS)
| Amortized | ||||||||
| Cost | Fair Value | |||||||
| $ | $ | |||||||
| Due in one year or less | 39,983 | 40,532 | ||||||
| Due after one year through five years | 108,819 | 111,055 | ||||||
| Due after five years through ten years | 100,881 | 100,704 | ||||||
| Due after ten years | 278,214 | 279,309 | ||||||
| Total debt securities | 527,897 | 531,600 | ||||||
Securities available for sale with a par value of $86,896,000 and $86,849,000 at March 31, 2021, and December 31, 2020, respectively, were pledged or restricted for public funds, borrowings, or other purposes as required by law. The fair value of these pledged securities was $90,400,000 at March 31, 2021, and $91,666,000 at December 31, 2020.
9
Proceeds from active sales of securities available for sale, along with the associated gross realized gains and gross realized losses, are shown below. Realized gains and losses are computed on the basis of specific identification.
PROCEEDS FROM SALES OF SECURITIES AVAILABLE FOR SALE
(DOLLARS IN THOUSANDS)
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| $ | $ | |||||||
| Proceeds from sales | 50,341 | 27,409 | ||||||
| Gross realized gains | 141 | 297 | ||||||
| Gross realized losses | (54 | ) | (15 | ) | ||||
Management evaluates all of the Corporation’s securities for other-than-temporary impairment (OTTI) on a periodic basis. No securities in the portfolio had other-than-temporary impairment recorded in the first three months of 2021 or 2020.
Information pertaining to securities with gross unrealized losses at March 31, 2021, and December 31, 2020, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:
TEMPORARY IMPAIRMENTS OF SECURITIES
(DOLLARS IN THOUSANDS)
| Less than 12 months | More than 12 months | Total | ||||||||||||||||||||||
| Gross | Gross | Gross | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| As of March 31, 2021 | ||||||||||||||||||||||||
| U.S. government agencies | 23,848 | (562 | ) | — | — | 23,848 | (562 | ) | ||||||||||||||||
| U.S. agency mortgage-backed securities | 26,442 | (479 | ) | 588 | (7 | ) | 27,030 | (486 | ) | |||||||||||||||
| U.S. agency collateralized mortgage obligations | 8,038 | (63 | ) | 2,969 | (16 | ) | 11,007 | (79 | ) | |||||||||||||||
| Asset-backed securities | 36,047 | (179 | ) | 10,669 | (120 | ) | 46,716 | (299 | ) | |||||||||||||||
| Corporate bonds | 14,137 | (73 | ) | — | — | 14,137 | (73 | ) | ||||||||||||||||
| Obligations of states & political subdivisions | 105,959 | (2,547 | ) | — | — | 105,959 | (2,547 | ) | ||||||||||||||||
| Total temporarily impaired securities | 214,471 | (3,903 | ) | 14,226 | (143 | ) | 228,697 | (4,046 | ) | |||||||||||||||
| As of December 31, 2020 | ||||||||||||||||||||||||
| U.S. government agencies | 42,988 | (7 | ) | — | — | 42,988 | (7 | ) | ||||||||||||||||
| U.S. agency mortgage-backed securities | 15,995 | (157 | ) | 2,221 | (9 | ) | 18,216 | (166 | ) | |||||||||||||||
| U.S. agency collateralized mortgage obligations | 12,933 | (54 | ) | — | — | 12,933 | (54 | ) | ||||||||||||||||
| Asset-backed securities | 8,465 | (20 | ) | 18,080 | (325 | ) | 26,545 | (345 | ) | |||||||||||||||
| Corporate bonds | — | — | 3,016 | (12 | ) | 3,016 | (12 | ) | ||||||||||||||||
| Obligations of states & political subdivisions | 15,666 | (77 | ) | — | — | 15,666 | (77 | ) | ||||||||||||||||
| Total temporarily impaired securities | 96,047 | (315 | ) | 23,317 | (346 | ) | 119,364 | (661 | ) | |||||||||||||||
In the debt security portfolio there were 110 positions that were carrying unrealized losses as of March 31, 2021. There were no instruments considered to be other-than-temporarily impaired at March 31, 2021.
10
The Corporation evaluates fixed maturity positions for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic and market concerns warrant such evaluation. U.S. generally accepted accounting principles provide for the bifurcation of OTTI into two categories: (a) the amount of the total OTTI related to a decrease in cash flows expected to be collected from the debt security (the credit loss), which is recognized in earnings, and (b) the amount of total OTTI related to all other factors, which is recognized, net of taxes, as a component of accumulated other comprehensive income.
3. Equity Securities
The following table summarizes the amortized cost, gross unrealized gains and losses, and fair value of equity securities held at March 31, 2021 and December 31, 2020.
| Gross | Gross | |||||||||||||||
| (DOLLARS IN THOUSANDS) | Amortized | Unrealized | Unrealized | Fair | ||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| March 31, 2021 | ||||||||||||||||
| CRA-qualified mutual funds | 6,190 | — | — | 6,190 | ||||||||||||
| Bank stocks | 927 | 108 | (8 | ) | 1,027 | |||||||||||
| Total equity securities | 7,117 | 108 | (8 | ) | 7,217 | |||||||||||
| Gross | Gross | |||||||||||||||
| (DOLLARS IN THOUSANDS) | Amortized | Unrealized | Unrealized | Fair | ||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| December 31, 2020 | ||||||||||||||||
| CRA-qualified mutual funds | 6,176 | — | — | 6,176 | ||||||||||||
| Bank stocks | 982 | 53 | (106 | ) | 929 | |||||||||||
| Total equity securities | 7,158 | 53 | (106 | ) | 7,105 | |||||||||||
The following table presents the net gains and losses on the Corporation’s equity investments recognized in earnings during the three months ended March 31, 2021 and 2020, and the portion of unrealized gains and losses for the period that relates to equity investments held as of March 31, 2021 and 2020.
NET GAINS AND LOSSES ON EQUITY INVESTMENTS RECOGNIZED IN EARNINGS
(DOLLARS IN THOUSANDS)
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2021 | 2020 | |||||||
| $ | $ | |||||||
| Net gains (losses) recognized in equity securities during the period | 248 | (230 | ) | |||||
| Less: Net gains realized on the sale of equity securities during the period | 95 | — | ||||||
| Unrealized gains (losses) recognized in equity securities held at reporting date | 153 | (230 | ) | |||||
11
4. Loans and Allowance for Credit Losses
The following table presents the Corporation’s loan portfolio by category of loans as of March 31, 2021, and December 31, 2020:
LOAN PORTFOLIO
(DOLLARS IN THOUSANDS)
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| $ | $ | |||||||
| Commercial real estate | ||||||||
| Commercial mortgages | 144,939 | 142,698 | ||||||
| Agriculture mortgages | 178,070 | 176,005 | ||||||
| Construction | 21,317 | 23,441 | ||||||
| Total commercial real estate | 344,326 | 342,144 | ||||||
| Consumer real estate (a) | ||||||||
| 1-4 family residential mortgages | 265,127 | 263,569 | ||||||
| Home equity loans | 10,614 | 10,708 | ||||||
| Home equity lines of credit | 70,898 | 71,290 | ||||||
| Total consumer real estate | 346,639 | 345,567 | ||||||
| Commercial and industrial | ||||||||
| Commercial and industrial | 111,036 | 97,896 | ||||||
| Tax-free loans | 16,233 | 10,949 | ||||||
| Agriculture loans | 18,466 | 20,365 | ||||||
| Total commercial and industrial | 145,735 | 129,210 | ||||||
| Consumer | 4,827 | 5,155 | ||||||
| Gross loans prior to deferred fees | 841,527 | 822,076 | ||||||
| Deferred loan costs, net | 407 | 1,294 | ||||||
| Allowance for credit losses | (12,690 | ) | (12,327 | ) | ||||
| Total net loans | 829,244 | 811,043 | ||||||
| (a) | Real estate loans serviced for others, which are not included in the Consolidated Balance Sheets, totaled $253,527,000 and $235,437,000 as of March 31, 2021, and December 31, 2020, respectively. |
The largest movement within the Corporation’s loan portfolio since December 31, 2020 was the growth in the commercial and industrial loan sector, which experienced a $13.1 million, or 13.4% increase. This was a direct result of the Small Business Administration’s Paycheck Protection Program (PPP) established as part of the CARES Act passed in March 2020, to provide relief to small businesses from the impact of COVID-19. The Corporation began making these loans in early April 2020, but many of the original PPP loans had been forgiven as of December 31, 2020. Beginning in early 2021, another round of PPP funding was approved and the Corporation had again begun making loans under this program. The majority of these new loans have been written with a five-year term, however management expects the vast majority of these loans to be forgiven by the SBA, or paid off by the borrower, prior to maturity of the loan. As a result, management expects the commercial and industrial loan balances to decline by December 31, 2021 with further declines during 2022.
The Corporation grades commercial credits differently than consumer credits. The following tables represent all of the Corporation’s commercial credit exposures by internally assigned grades as of March 31, 2021 and December 31, 2020. The grading analysis estimates the capability of the borrower to repay the contractual obligations under the loan agreements as scheduled. The Corporation's internal commercial credit risk grading system is based on experiences with similarly graded loans.
12
The Corporation's internally assigned grades for commercial credits are as follows:
| · | Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. |
| · | Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem, if not corrected. |
| · | Substandard – loans that have a well-defined weakness based on objective evidence and characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. |
| · | Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances. |
| · | Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted. |
COMMERCIAL CREDIT EXPOSURE
CREDIT RISK PROFILE BY INTERNALLY ASSIGNED GRADE
(DOLLARS IN THOUSANDS)
| March 31, 2021 | Commercial Mortgages | Agriculture Mortgages | Construction | Commercial and Industrial | Tax-free Loans | Agriculture Loans | Total | |||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||
| Grade: | ||||||||||||||||||||||||||||
| Pass | 134,318 | 169,690 | 15,787 | 100,413 | 16,233 | 17,359 | 453,800 | |||||||||||||||||||||
| Special Mention | 5,437 | — | 5,530 | 6,540 | — | 85 | 17,592 | |||||||||||||||||||||
| Substandard | 5,184 | 8,380 | — | 4,083 | — | 1,022 | 18,669 | |||||||||||||||||||||
| Doubtful | — | — | — | — | — | — | — | |||||||||||||||||||||
| Loss | — | — | — | — | — | — | — | |||||||||||||||||||||
| Total | 144,939 | 178,070 | 21,317 | 111,036 | 16,233 | 18,466 | 490,061 | |||||||||||||||||||||
| December 31, 2020 | Commercial Mortgages | Agriculture Mortgages | Construction | Commercial and Industrial | Tax-free Loans | Agriculture Loans | Total | |||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||
| Grade: | ||||||||||||||||||||||||||||
| Pass | 133,853 | 166,102 | 21,142 | 87,767 | 10,949 | 18,586 | 438,399 | |||||||||||||||||||||
| Special Mention | 3,683 | 1,651 | 2,299 | 5,592 | — | 774 | 13,999 | |||||||||||||||||||||
| Substandard | 5,162 | 8,252 | — | 4,537 | — | 1,005 | 18,956 | |||||||||||||||||||||
| Doubtful | — | — | — | — | — | — | — | |||||||||||||||||||||
| Loss | — | — | — | — | — | — | — | |||||||||||||||||||||
| Total | 142,698 | 176,005 | 23,441 | 97,896 | 10,949 | 20,365 | 471,354 | |||||||||||||||||||||
Substandard loans decreased by $287,000, or 1.5%, while special mention loans have increased by $3,593,000, or 25.7%, from December 31, 2020 to March 31, 2021. Substandard loans decreased from $19.0 million to $18.7 million from December 31, 2020, to March 31, 2021 while special mention loans increased from $14.0 million to $17.6 million during this same period. The loan areas that experienced material changes in special mention were commercial mortgages and construction loans. Under commercial mortgages, one $1.5 million loan was transferred to special mention due to COVID-19 negatively impacting business operations. This was the primary reason for the increase in special mention loans as well as other smaller loan relationships that were downgraded during the first quarter of 2021.
13
For consumer loans, the Corporation evaluates credit quality based on whether the loan is considered performing or non-performing. Non-performing loans consist of those loans greater than 90 days delinquent and nonaccrual loans. The following tables present the balances of consumer loans by classes of the loan portfolio based on payment performance as of March 31, 2021 and December 31, 2020:
CONSUMER CREDIT EXPOSURE
CREDIT RISK PROFILE BY PAYMENT PERFORMANCE
(DOLLARS IN THOUSANDS)
| March 31, 2021 | 1-4 Family Residential Mortgages | Home Equity Loans | Home Equity Lines of Credit | Consumer | Total | |||||||||||||||
| Payment performance: | $ | $ | $ | $ | $ | |||||||||||||||
| Performing | 264,943 | 10,614 | 70,898 | 4,814 | 351,269 | |||||||||||||||
| Non-performing | 184 | — | — | 13 | 197 | |||||||||||||||
| Total | 265,127 | 10,614 | 70,898 | 4,827 | 351,466 | |||||||||||||||
| December 31, 2020 | 1-4 Family Residential Mortgages | Home Equity Loans | Home Equity Lines of Credit | Consumer | Total | |||||||||||||||
| Payment performance: | $ | $ | $ | $ | $ | |||||||||||||||
| Performing | 262,185 | 10,708 | 71,267 | 5,141 | 349,301 | |||||||||||||||
| Non-performing | 1,384 | — | 23 | 14 | 1,421 | |||||||||||||||
| Total | 263,569 | 10,708 | 71,290 | 5,155 | 350,722 | |||||||||||||||
14
The following tables present an age analysis of the Corporation’s past due loans, segregated by loan portfolio class, as of March 31, 2021 and December 31, 2020:
AGING OF LOANS RECEIVABLE
(DOLLARS IN THOUSANDS)
| Loans | ||||||||||||||||||||||||||||
| Greater | Receivable > | |||||||||||||||||||||||||||
| 30-59 Days | 60-89 Days | than 90 | Total Past | Total Loans | 90 Days and | |||||||||||||||||||||||
| March 31, 2021 | Past Due | Past Due | Days | Due | Current | Receivable | Accruing | |||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||||||||||
| Commercial mortgages | — | — | 192 | 192 | 144,747 | 144,939 | — | |||||||||||||||||||||
| Agriculture mortgages | 245 | — | — | 245 | 177,825 | 178,070 | — | |||||||||||||||||||||
| Construction | — | — | — | — | 21,317 | 21,317 | — | |||||||||||||||||||||
| Consumer real estate | ||||||||||||||||||||||||||||
| 1-4 family residential mortgages | 1,351 | 174 | 184 | 1,709 | 263,418 | 265,127 | 139 | |||||||||||||||||||||
| Home equity loans | — | — | — | — | 10,614 | 10,614 | — | |||||||||||||||||||||
| Home equity lines of credit | — | — | — | — | 70,898 | 70,898 | — | |||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||||||
| Commercial and industrial | 14 | — | 444 | 458 | 110,578 | 111,036 | — | |||||||||||||||||||||
| Tax-free loans | — | — | — | — | 16,233 | 16,233 | — | |||||||||||||||||||||
| Agriculture loans | 6 | — | — | 6 | 18,460 | 18,466 | — | |||||||||||||||||||||
| Consumer | 8 | 1 | 13 | 22 | 4,805 | 4,827 | 13 | |||||||||||||||||||||
| Total | 1,624 | 175 | 833 | 2,632 | 838,895 | 841,527 | 152 | |||||||||||||||||||||
AGING OF LOANS RECEIVABLE
(DOLLARS IN THOUSANDS)
| Loans | ||||||||||||||||||||||||||||
| Greater | Receivable > | |||||||||||||||||||||||||||
| 30-59 Days | 60-89 Days | than 90 | Total Past | Total Loans | 90 Days and | |||||||||||||||||||||||
| December 31, 2020 | Past Due | Past Due | Days | Due | Current | Receivable | Accruing | |||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||||||||||
| Commercial mortgages | — | — | 208 | 208 | 142,490 | 142,698 | — | |||||||||||||||||||||
| Agriculture mortgages | — | — | — | — | 176,005 | 176,005 | — | |||||||||||||||||||||
| Construction | — | — | — | — | 23,441 | 23,441 | — | |||||||||||||||||||||
| Consumer real estate | ||||||||||||||||||||||||||||
| 1-4 family residential mortgages | 618 | — | 1,384 | 2,002 | 261,567 | 263,569 | 1,336 | |||||||||||||||||||||
| Home equity loans | 1 | — | — | 1 | 10,707 | 10,708 | — | |||||||||||||||||||||
| Home equity lines of credit | — | — | 23 | 23 | 71,267 | 71,290 | 23 | |||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||||||
| Commercial and industrial | — | — | 469 | 469 | 97,427 | 97,896 | — | |||||||||||||||||||||
| Tax-free loans | — | — | — | — | 10,949 | 10,949 | — | |||||||||||||||||||||
| Agriculture loans | 42 | — | — | 42 | 20,323 | 20,365 | — | |||||||||||||||||||||
| Consumer | 23 | 3 | 14 | 40 | 5,115 | 5,155 | 14 | |||||||||||||||||||||
| Total | 684 | 3 | 2,098 | 2,785 | 819,291 | 822,076 | 1,373 | |||||||||||||||||||||
15
The following table presents nonaccrual loans by classes of the loan portfolio as of March 31, 2021 and December 31, 2020:
NONACCRUAL LOANS BY LOAN CLASS
(DOLLARS IN THOUSANDS)
| March 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| $ | $ | |||||||
| Commercial real estate | ||||||||
| Commercial mortgages | 192 | 208 | ||||||
| Agriculture mortgages | — | — | ||||||
| Construction | — | — | ||||||
| Consumer real estate | ||||||||
| 1-4 family residential mortgages | 45 | 48 | ||||||
| Home equity loans | — | — | ||||||
| Home equity lines of credit | — | — | ||||||
| Commercial and industrial | ||||||||
| Commercial and industrial | 444 | 469 | ||||||
| Tax-free loans | — | — | ||||||
| Agriculture loans | — | — | ||||||
| Consumer | — | — | ||||||
| Total | 681 | 725 | ||||||
As of March 31, 2021 and December 31, 2020, all of the Corporation’s commercial loans on nonaccrual status were also considered impaired. Information with respect to impaired loans for the three months ended March 31, 2021 and March 31, 2020, is as follows:
IMPAIRED LOANS
(DOLLARS IN THOUSANDS)
| Three Months Ended March 31, | ||||||||
| 2021 | 2020 | |||||||
| $ | $ | |||||||
| Average recorded balance of impaired loans | 5,739 | 3,937 | ||||||
| Interest income recognized on impaired loans | 66 | 35 | ||||||
No loan modifications were made during the first quarter of 2021 that would be considered a troubled debt restructuring (TDR). There was one loan modification made during the third quarter of 2020 that would be considered a TDR. One $3.6 million loan was restructured to provide relief to the commercial borrower by reducing the interest rate, providing a six-month interest only period, and extending the amortization period by an additional nine years. In addition to this TDR, deferments of principal related to the impact of COVID-19 did occur beginning in late March 2020, however these modifications are not considered a TDR under the revised COVID-19 regulatory guidance. There was one loan modification that occurred during the first quarter of 2019, constituting a TDR. A modification of the payment terms to a loan customer are considered a TDR if a concession was made to a borrower that is experiencing financial difficulty. A concession is generally defined as more favorable payment or credit terms granted to a borrower in an effort to improve the likelihood of the lender collecting principal in its entirety. Concessions usually are in the form of interest only for a period of time, or a lower interest rate offered in an effort to enable the borrower to continue to make normally scheduled payments. Included in the impaired loan portfolio are three loans to unrelated borrowers that are being reported as TDRs. The balance of these three TDR loans was $5,018,000 as of March 31, 2021. None of these TDR loans are non-accrual.
16
The following tables summarize information regarding impaired loans by loan portfolio class as of March 31, 2021 and December 31, 2020, and for the three months ended March 31, 2021, and the twelve months ended December 31, 2020:
| IMPAIRED LOAN ANALYSIS | ||||||||||||||||||||
| (DOLLARS IN THOUSANDS) | ||||||||||||||||||||
| March 31, 2021 | Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | |||||||||||||||
| $ | $ | $ | $ | $ | ||||||||||||||||
| With no related allowance recorded: | ||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||
| Commercial mortgages | 238 | 274 | — | 253 | 8 | |||||||||||||||
| Agriculture mortgages | 796 | 796 | — | 802 | 10 | |||||||||||||||
| Construction | — | — | — | — | — | |||||||||||||||
| Total commercial real estate | 1,034 | 1,070 | — | 1,055 | 18 | |||||||||||||||
| Commercial and industrial | ||||||||||||||||||||
| Commercial and industrial | 444 | 484 | — | 455 | 6 | |||||||||||||||
| Tax-free loans | — | — | — | — | — | |||||||||||||||
| Agriculture loans | — | — | — | — | — | |||||||||||||||
| Total commercial and industrial | 444 | 484 | — | 455 | 6 | |||||||||||||||
| Total with no related allowance | 1,478 | 1,554 | — | 1,510 | 24 | |||||||||||||||
| With an allowance recorded: | ||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||
| Commercial mortgages | 3,570 | 3,570 | 1,099 | 3,578 | 42 | |||||||||||||||
| Agriculture mortgages | 651 | 651 | 14 | 651 | — | |||||||||||||||
| Construction | — | — | — | — | — | |||||||||||||||
| Total commercial real estate | 4,221 | 4,221 | 1,113 | 4,229 | 42 | |||||||||||||||
| Commercial and industrial | ||||||||||||||||||||
| Commercial and industrial | — | — | — | — | — | |||||||||||||||
| Tax-free loans | — | — | — | — | — | |||||||||||||||
| Agriculture loans | — | — | — | — | — | |||||||||||||||
| Total commercial and industrial | — | — | — | — | — | |||||||||||||||
| Total with a related allowance | 4,221 | 4,221 | 1,113 | 4,229 | 42 | |||||||||||||||
| Total by loan class: | ||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||
| Commercial mortgages | 3,808 | 3,844 | 1,099 | 3,831 | 50 | |||||||||||||||
| Agriculture mortgages | 1,447 | 1,447 | 14 | 1,453 | 10 | |||||||||||||||
| Construction | — | — | — | — | — | |||||||||||||||
| Total commercial real estate | 5,255 | 5,291 | 1,113 | 5,284 | 60 | |||||||||||||||
| Commercial and industrial | ||||||||||||||||||||
| Commercial and industrial | 444 | 484 | — | 455 | 6 | |||||||||||||||
| Tax-free loans | — | — | — | — | — | |||||||||||||||
| Agriculture loans | — | — | — | — | — | |||||||||||||||
| Total commercial and industrial | 444 | 484 | — | 455 | 6 | |||||||||||||||
| Total | 5,699 | 5,775 | 1,113 | 5,739 | 66 | |||||||||||||||
17
| IMPAIRED LOAN ANALYSIS | ||||||||||||||||||||
| (DOLLARS IN THOUSANDS) | ||||||||||||||||||||
| December 31, 2020 | Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | |||||||||||||||
| $ | $ | $ | $ | $ | ||||||||||||||||
| With no related allowance recorded: | ||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||
| Commercial mortgages | 256 | 318 | — | 798 | — | |||||||||||||||
| Agriculture mortgages | 806 | 835 | — | 1,170 | 46 | |||||||||||||||
| Construction | — | — | — | — | — | |||||||||||||||
| Total commercial real estate | 1,062 | 1,153 | — | 1,968 | 46 | |||||||||||||||
| Commercial and industrial | ||||||||||||||||||||
| Commercial and industrial | 469 | 504 | — | 513 | 23 | |||||||||||||||
| Tax-free loans | — | — | — | — | — | |||||||||||||||
| Agriculture loans | — | — | — | — | — | |||||||||||||||
| Total commercial and industrial | 469 | 504 | — | 513 | 23 | |||||||||||||||
| Total with no related allowance | 1,531 | 1,657 | — | 2,481 | 69 | |||||||||||||||
| With an allowance recorded: | ||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||
| Commercial mortgages | 3,581 | 3,581 | 1,110 | 1,468 | 57 | |||||||||||||||
| Agriculture mortgages | 651 | 651 | 21 | 679 | 34 | |||||||||||||||
| Construction | — | — | — | — | — | |||||||||||||||
| Total commercial real estate | 4,232 | 4,232 | 1,131 | 2,147 | 91 | |||||||||||||||
| Commercial and industrial | ||||||||||||||||||||
| Commercial and industrial | — | — | — | — | — | |||||||||||||||
| Tax-free loans | — | — | — | — | — | |||||||||||||||
| Agriculture loans | — | — | — | — | — | |||||||||||||||
| Total commercial and industrial | — | — | — | — | — | |||||||||||||||
| Total with a related allowance | 4,232 | 4,232 | 1,131 | 2,147 | 91 | |||||||||||||||
| Total by loan class: | ||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||
| Commercial mortgages | 3,837 | 3,899 | 1,110 | 2,266 | 57 | |||||||||||||||
| Agriculture mortgages | 1,457 | 1,486 | 21 | 1,849 | 80 | |||||||||||||||
| Construction | — | — | — | — | — | |||||||||||||||
| Total commercial real estate | 5,294 | 5,385 | 1,131 | 4,115 | 137 | |||||||||||||||
| Commercial and industrial | ||||||||||||||||||||
| Commercial and industrial | 469 | 504 | — | 513 | 23 | |||||||||||||||
| Tax-free loans | — | — | — | — | — | |||||||||||||||
| Agriculture loans | — | — | — | — | — | |||||||||||||||
| Total commercial and industrial | 469 | 504 | — | 513 | 23 | |||||||||||||||
| Total | 5,763 | 5,889 | 1,131 | 4,628 | 160 | |||||||||||||||
18
The following table details activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2021:
ALLOWANCE FOR CREDIT LOSSES
(DOLLARS IN THOUSANDS)
| Commercial Real Estate | Consumer Real Estate | Commercial and Industrial | Consumer | Unallocated | Total | |||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||
| Beginning balance - December 31, 2020 | 6,329 | 3,449 | 1,972 | 52 | 525 | 12,327 | ||||||||||||||||||
| Charge-offs | — | — | — | (14 | ) | — | (14 | ) | ||||||||||||||||
| Recoveries | — | — | 1 | 1 | — | 2 | ||||||||||||||||||
| Provision | 173 | (41 | ) | (15 | ) | 20 | 238 | 375 | ||||||||||||||||
| Balance - March 31, 2021 | 6,502 | 3,408 | 1,958 | 59 | 763 | 12,690 | ||||||||||||||||||
During the three months ended March 31, 2021, management charged off $14,000 in loans while recovering $2,000 and added $375,000 to the provision. The unallocated portion of the allowance increased from 4.3% of total reserves as of December 31, 2020, to 6.0% as of March 31, 2021. Management monitors the unallocated portion of the allowance with a desire to maintain it at approximately 5% over the long term, with a requirement of it not to exceed 10%.
During the three months ended March 31, 2021, net provision expense was recorded for the commercial real estate sector as well as the consumer sector with credit provisions recorded for the consumer real estate and commercial and industrial sectors. The higher provision in the commercial real estate sector was due to growth in this portfolio of loans since December 31, 2020, as well as an increase in the qualitative factor related to the trends in the nature and volume of this sector. There were minimal charge-offs and recoveries recorded during the three months ended March 31, 2021, so the provision expense was primarily related to an increase in loan balances as well as slightly higher unallocated portion of the allowance.
As of March 31, 2021, the Corporation’s total delinquencies were 0.31%, a decline from 0.34% at December 31, 2020. The Corporation’s total delinquencies continue to compare favorably to the national uniform bank performance group, which was at 1.31% as of December 31, 2020.
Outside of the above measurements and indicators, management continues to utilize nine qualitative factors to continually refine the potential credit risks across the Corporation’s various loan types. In addition, the loan portfolio is sectored out into nine different categories to evaluate these qualitative factors. A total score of the qualitative factors for each loan sector is calculated to utilize in the allowance for loan loss calculation. The agricultural dairy sector carries the highest level of qualitative factors due to the long-term weakness in milk prices. While the dairy market has improved recently, COVID-19 initially caused a sharp decline in milk prices.
19
The following table details activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2020:
ALLOWANCE FOR CREDIT LOSSES
(DOLLARS IN THOUSANDS)
| Commercial Real Estate | Consumer Real Estate | Commercial and Industrial | Consumer | Unallocated | Total | |||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||
| Beginning balance - December 31, 2019 | 4,319 | 2,855 | 1,784 | 41 | 448 | 9,447 | ||||||||||||||||||
| Charge-offs | — | — | — | (6 | ) | — | (6 | ) | ||||||||||||||||
| Recoveries | 11 | — | 1 | — | — | 12 | ||||||||||||||||||
| Provision | 252 | 296 | 171 | 21 | (390 | ) | 350 | |||||||||||||||||
| Balance - March 31, 2020 | 4,582 | 3,151 | 1,956 | 56 | 58 | 9,803 | ||||||||||||||||||
During the three months ended March 31, 2020, management charged off $6,000 in loans while recovering $12,000 and added $350,000 to the provision. The unallocated portion of the allowance decreased from 4.7% of total reserves as of December 31, 2019, to 0.6% as of March 31, 2020.
During the three months ended March 31, 2020, net provision expense was recorded for all sectors. The higher provision was primarily caused by increasing the qualitative factors across all industry lines to various degrees as a result of the impact from COVID-19. A qualitative factor was increased for business loans specifically related to the special federal governmental lending programs developed as a result of COVID-19. There were minimal charge-offs and recoveries recorded during the three months ended March 31, 2020, so the provision expense was primarily related to this change in economic conditions and potential for credit declines moving forward. The total amount of substandard loans at the end of the first quarter of 2020 was slightly higher resulting in slightly more provision expense.
As of March 31, 2020, the Corporation’s total delinquencies were 0.67%, a decline from 0.91% at December 31, 2019.
The Corporation reduced one qualitative factor for residential mortgages in the first quarter of 2020; this factor had been increased in the fourth quarter of 2019 because of higher delinquency. However, mortgage loan delinquency declined in the first quarter of 2020. Delinquency among agriculture loans, excluding loans to dairy farmers, has continued to increase, and ended at 2.32% at March 31, 2020. A total of six agriculture loans were delinquent at this time.
20
The following tables present the balance in the allowance for credit losses and the recorded investment in loans receivable by portfolio segment based on impairment method as of March 31, 2021 and December 31, 2020:
ALLOWANCE FOR CREDIT LOSSES AND RECORDED INVESTMENT IN LOANS RECEIVABLE
(DOLLARS IN THOUSANDS)
| As of March 31, 2021: | Commercial Real Estate | Consumer Real Estate | Commercial and Industrial | Consumer | Unallocated | Total | ||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||
| Ending balance: individually evaluated | ||||||||||||||||||||||||
| for impairment | 1,113 | — | — | — | — | 1,113 | ||||||||||||||||||
| Ending balance: collectively evaluated | ||||||||||||||||||||||||
| for impairment | 5,389 | 3,408 | 1,958 | 59 | 763 | 11,577 | ||||||||||||||||||
| Loans receivable: | ||||||||||||||||||||||||
| Ending balance | 344,326 | 346,639 | 145,735 | 4,827 | 841,527 | |||||||||||||||||||
| Ending balance: individually evaluated | ||||||||||||||||||||||||
| for impairment | 5,255 | — | 444 | — | 5,699 | |||||||||||||||||||
| Ending balance: collectively evaluated | ||||||||||||||||||||||||
| for impairment | 339,071 | 346,639 | 145,291 | 4,827 | 835,828 | |||||||||||||||||||
| As of December 31, 2020: | Commercial Real Estate | Consumer Real Estate | Commercial and Industrial | Consumer | Unallocated | Total | ||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||
| Ending balance: individually evaluated | ||||||||||||||||||||||||
| for impairment | 1,131 | — | — | — | — | 1,131 | ||||||||||||||||||
| Ending balance: collectively evaluated | ||||||||||||||||||||||||
| for impairment | 5,198 | 3,449 | 1,972 | 52 | 525 | 11,196 | ||||||||||||||||||
| Loans receivable: | ||||||||||||||||||||||||
| Ending balance | 342,144 | 345,567 | 129,210 | 5,155 | 822,076 | |||||||||||||||||||
| Ending balance: individually evaluated | ||||||||||||||||||||||||
| for impairment | 5,294 | — | 469 | — | 5,763 | |||||||||||||||||||
| Ending balance: collectively evaluated | ||||||||||||||||||||||||
| for impairment | 336,850 | 345,567 | 128,741 | 5,155 | 816,313 | |||||||||||||||||||
5. Fair Value Presentation
U.S. generally accepted accounting principles establish a hierarchal disclosure framework associated with the level of observable pricing utilized in measuring assets and liabilities at fair value. The three broad levels defined by the hierarchy are as follows:
| Level I: | Quoted prices are available in active markets for identical assets or liabilities as of the reported date. |
| Level II: | Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed. |
| Level III: | Assets and liabilities that have little to no observable pricing as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation. |
21
The following tables provide the fair market value for assets required to be measured and reported at fair value on a recurring basis on the Consolidated Balance Sheets as of March 31, 2021, and December 31, 2020, by level within the fair value hierarchy. As required by U.S. generally accepted accounting principles, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
ASSETS MEASURED ON A RECURRING BASIS
(DOLLARS IN THOUSANDS)
| March 31, 2021 | ||||||||||||||||
| Level I | Level II | Level III | Total | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| U.S. government agencies | — | 29,180 | — | 29,180 | ||||||||||||
| U.S. agency mortgage-backed securities | — | 68,583 | — | 68,583 | ||||||||||||
| U.S. agency collateralized mortgage obligations | — | 40,786 | — | 40,786 | ||||||||||||
| Asset-backed securities | — | 97,000 | — | 97,000 | ||||||||||||
| Corporate bonds | — | 67,144 | — | 67,144 | ||||||||||||
| Obligations of states & political subdivisions | — | 228,907 | — | 228,907 | ||||||||||||
| Equity securities | 7,217 | — | — | 7,217 | ||||||||||||
| Total securities | 7,217 | 531,600 | — | 538,817 | ||||||||||||
On March 31, 2021, the Corporation held no securities valued using level III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable, but not necessarily quotes on identical securities traded in active markets on a daily basis. The Corporation’s CRA fund investments and bank stocks are fair valued utilizing level I inputs because the funds have their own quoted prices in an active market. As of March 31, 2021, the CRA fund investments had a $6,190,000 book and fair market value and the bank stock portfolio had a book value of $927,000, and fair market value of $1,027,000.
Financial instruments are considered level III when their values are determined using pricing models, discounted cash flow methodologies, or similar techniques, and at least one significant model assumption or input is unobservable. In addition to these unobservable inputs, the valuation models for level III financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Level III financial instruments also include those for which the determination of fair value requires significant management judgment or estimation.
ASSETS MEASURED ON A RECURRING BASIS
(DOLLARS IN THOUSANDS)
| December 31, 2020 | ||||||||||||||||
| Level I | Level II | Level III | Total | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| U.S. government agencies | — | 54,361 | — | 54,361 | ||||||||||||
| U.S. agency mortgage-backed securities | — | 71,052 | — | 71,052 | ||||||||||||
| U.S. agency collateralized mortgage obligations | — | 35,035 | — | 35,035 | ||||||||||||
| Asset-backed securities | — | 60,475 | — | 60,475 | ||||||||||||
| Corporate bonds | — | 61,723 | — | 61,723 | ||||||||||||
| Obligations of states & political subdivisions | — | 193,782 | — | 193,782 | ||||||||||||
| Equity securities | 7,105 | — | — | 7,105 | ||||||||||||
| Total securities | 7,105 | 476,428 | — | 483,533 | ||||||||||||
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On December 31, 2020, the Corporation held no securities valued using level III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable but not necessarily quotes on identical securities traded in active markets on a daily basis. The Corporation’s CRA fund investments and bank stocks are fair valued utilizing level I inputs because the funds have their own quoted prices in an active market. As of December 31, 2020, the CRA fund investments had a $6,176,000 book and market value and the bank stocks had a book value of $982,000 and a market value of $929,000.
The following tables provide the fair value for each class of assets required to be measured and reported at fair value on a nonrecurring basis on the Consolidated Balance Sheets as of March 31, 2021 and December 31, 2020, by level within the fair value hierarchy:
ASSETS MEASURED ON A NONRECURRING BASIS
(Dollars in Thousands)
| March 31, 2021 | ||||||||||||||||
| Level I | Level II | Level III | Total | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| Assets: | ||||||||||||||||
| Impaired Loans | $ | — | $ | — | $ | 4,586 | $ | 4,586 | ||||||||
| Total | $ | — | $ | — | $ | 4,586 | $ | 4,586 | ||||||||
| December 31, 2020 | ||||||||||||||||
| Level I | Level II | Level III | Total | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| Assets: | ||||||||||||||||
| Impaired Loans | $ | — | $ | — | $ | 4,632 | $ | 4,632 | ||||||||
| Total | $ | — | $ | — | $ | 4,632 | $ | 4,632 | ||||||||
The Corporation had a total of $5,699,000 of impaired loans as of March 31, 2021, with $1,113,000 of specific allocation against these loans and $5,763,000 of impaired loans as of December 31, 2020, with $1,131,000 of specific allocation against these loans. The value of impaired loans is generally determined through independent appraisals of the underlying collateral.
The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis for which the Corporation has utilized level III inputs to determine fair value:
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| QUANTITATIVE INFORMATION ABOUT LEVEL III FAIR VALUE MEASUREMENTS | |||||
| (DOLLARS IN THOUSANDS) | |||||
| March 31, 2021 | |||||
| Fair Value | Valuation | Unobservable | Range | ||
| Estimate | Techniques | Input | (Weighted Avg) | ||
| Impaired loans | 4,586 | Appraisal of | Appraisal | -20% (-20%) | |
| collateral (1) | adjustments (2) | ||||
| Liquidation | -10% (-10%) | ||||
| expenses (2) | |||||
| December 31, 2020 | |||||
| Fair Value | Valuation | Unobservable | Range | ||
| Estimate | Techniques | Input | (Weighted Avg) | ||
| Impaired loans | 4,632 | Appraisal of | Appraisal | -20% (-20%) | |
| collateral (1) | adjustments (2) | ||||
| Liquidation | -10% (-10%) | ||||
| expenses (2) | |||||
(1) Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level III inputs which are not identifiable.
(2) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.
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The following table provides the carrying amount for each class of assets and liabilities and the fair value for certain financial instruments that are not required to be measured or reported at fair value on the Consolidated Balance Sheets as of March 31, 2021 and December 31, 2020:
FINANCIAL INSTRUMENTS NOT REQUIRED TO BE MEASURED OR REPORTED AT FAIR VALUE
(DOLLARS IN THOUSANDS)
| March 31, 2021 | ||||||||||||||||||||
| Quoted Prices in | ||||||||||||||||||||
| Active Markets | Significant Other | Significant | ||||||||||||||||||
| for Identical | Observable | Unobservable | ||||||||||||||||||
| Carrying | Assets | Inputs | Inputs | |||||||||||||||||
| Amount | Fair Value | (Level 1) | (Level II) | (Level III) | ||||||||||||||||
| $ | $ | $ | $ | $ | ||||||||||||||||
| Financial Assets: | ||||||||||||||||||||
| Cash and cash equivalents | 88,614 | 88,614 | 88,614 | — | — | |||||||||||||||
| Regulatory stock | 6,160 | 6,160 | 6,160 | — | — | |||||||||||||||
| Loans held for sale | 2,018 | 2,018 | 2,018 | — | — | |||||||||||||||
| Loans, net of allowance | 829,244 | 844,405 | — | — | 844,405 | |||||||||||||||
| Mortgage servicing assets | 1,314 | 1,779 | — | — | 1,779 | |||||||||||||||
| Accrued interest receivable | 5,111 | 5,111 | 5,111 | — | — | |||||||||||||||
| Bank owned life insurance | 29,833 | 29,833 | 29,833 | — | — | |||||||||||||||
| Financial Liabilities: | ||||||||||||||||||||
| Demand deposits | 580,003 | 580,003 | 580,003 | — | — | |||||||||||||||
| Interest-bearing demand deposits | 46,509 | 46,509 | 46,509 | — | — | |||||||||||||||
| NOW accounts | 125,101 | 125,101 | 125,101 | — | — | |||||||||||||||
| Money market deposit accounts | 151,297 | 151,297 | 151,297 | — | — | |||||||||||||||
| Savings accounts | 303,324 | 303,324 | 303,324 | — | — | |||||||||||||||
| Time deposits | 119,153 | 120,299 | — | — | 120,299 | |||||||||||||||
| Total deposits | 1,325,387 | 1,326,533 | 1,206,234 | — | 120,299 | |||||||||||||||
| Long-term debt | 52,792 | 50,452 | — | — | 50,452 | |||||||||||||||
| Subordinated debt | 19,620 | 19,157 | — | — | 19,157 | |||||||||||||||
| Accrued interest payable | 496 | 496 | 496 | — | — | |||||||||||||||
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FINANCIAL INSTRUMENTS NOT REQUIRED TO BE MEASURED OR REPORTED AT FAIR VALUE
(DOLLARS IN THOUSANDS)
| December 31, 2020 | ||||||||||||||||||||
| Quoted Prices in | ||||||||||||||||||||
| Active Markets | Significant Other | Significant | ||||||||||||||||||
| for Identical | Observable | Unobservable | ||||||||||||||||||
| Carrying | Assets | Inputs | Inputs | |||||||||||||||||
| Amount | Fair Value | (Level 1) | (Level II) | (Level III) | ||||||||||||||||
| $ | $ | $ | $ | $ | ||||||||||||||||
| Financial Assets: | ||||||||||||||||||||
| Cash and cash equivalents | 94,939 | 94,939 | 94,939 | — | — | |||||||||||||||
| Regulatory stock | 6,107 | 6,107 | 6,107 | — | — | |||||||||||||||
| Loans held for sale | 3,029 | 3,029 | 3,029 | — | — | |||||||||||||||
| Loans, net of allowance | 811,043 | 829,902 | — | — | 829,902 | |||||||||||||||
| Mortgage servicing assets | 1,076 | 1,083 | — | — | 1,083 | |||||||||||||||
| Accrued interest receivable | 4,546 | 4,546 | 4,546 | — | — | |||||||||||||||
| Bank owned life insurance | 29,646 | 29,646 | 29,646 | — | — | |||||||||||||||
| Financial Liabilities: | ||||||||||||||||||||
| Demand deposits | 534,853 | 534,853 | 534,853 | — | — | |||||||||||||||
| Interest-bearing demand deposits | 47,092 | 47,092 | 47,092 | — | — | |||||||||||||||
| NOW accounts | 137,279 | 137,279 | 137,279 | — | — | |||||||||||||||
| Money market deposit accounts | 140,113 | 140,113 | 140,113 | — | — | |||||||||||||||
| Savings accounts | 274,386 | 274,386 | 274,386 | — | — | |||||||||||||||
| Time deposits | 119,088 | 121,470 | — | — | 121,470 | |||||||||||||||
| Total deposits | 1,252,811 | 1,255,193 | 1,133,723 | — | 121,470 | |||||||||||||||
| Long-term debt | 54,790 | 51,800 | — | — | 51,800 | |||||||||||||||
| Subordinated debt | 19,601 | 19,601 | — | — | 19,601 | |||||||||||||||
| Accrued interest payable | 320 | 320 | 320 | — | — | |||||||||||||||
7. Commitments and Contingent Liabilities
In order to meet the financing needs of its customers in the normal course of business, the Corporation makes various commitments that are not reflected in the accompanying consolidated financial statements. These commitments include firm commitments to extend credit, unused lines of credit, and open letters of credit. As of March 31, 2021, firm loan commitments were $95.5 million, unused lines of credit were $334.0 million, and open letters of credit were $9.7 million. The total of these commitments was $439.2 million, which represents the Corporation’s exposure to credit loss in the event of nonperformance by its customers with respect to these financial instruments. The actual credit losses that may arise from these commitments are expected to compare favorably with the Corporation’s loan loss experience on its loan portfolio taken as a whole. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for balance sheet financial instruments.
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8. Accumulated Other Comprehensive Income (Loss)
The activity in accumulated other comprehensive income (loss) for the three months ended March 31, 2021 and 2020
is as follows:
ACCUMULATED OTHER COMPREHENSIVE INCOME (1) (2)
(DOLLARS IN THOUSANDS)
| Unrealized | ||||
| Gains (Losses) | ||||
| on Securities | ||||
| Available-for-Sale | ||||
| $ | ||||
| Balance at December 31, 2020 | 7,958 | |||
| Other comprehensive loss before reclassifications | (4,965 | ) | ||
| Amount reclassified from accumulated other comprehensive income (loss) | (69 | ) | ||
| Period change | (5,034 | ) | ||
| Balance at March 31, 2021 | 2,924 | |||
| Balance at December 31, 2019 | 1,600 | |||
| Other comprehensive loss before reclassifications | (274 | ) | ||
| Amount reclassified from accumulated other comprehensive income (loss) | (223 | ) | ||
| Period change | (497 | ) | ||
| Balance at March 31, 2020 | 1,103 | |||
(1) All amounts are net of tax. Related income tax expense or benefit is calculated using a Federal income tax rate of 21%.
(2) Amounts in parentheses indicate debits.
DETAILS ABOUT ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) COMPONENTS (1)
(DOLLARS IN THOUSANDS)
| Amount Reclassified from | ||||||||||
| Accumulated Other Comprehensive | ||||||||||
| Income (Loss) | ||||||||||
| For the Three Months | ||||||||||
| Ended March 31, | ||||||||||
| 2021 | 2020 | Affected Line Item in the | ||||||||
| $ | $ | Consolidated Statements of Income | ||||||||
| Securities available-for-sale: | ||||||||||
| Net securities gains, | 87 | 282 | Gains on the sale of | |||||||
| reclassified into earnings | debt securities, net | |||||||||
| Related income tax expense | (18 | ) | (59 | ) | Provision for federal income taxes | |||||
| Net effect on accumulated other comprehensive | ||||||||||
| income (loss) for the period | 69 | 223 | ||||||||
9. Leases
A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. The Corporation accounts for all lease agreements in accordance with ASC Topic 842. For the Corporation, Topic 842 primarily affected the accounting treatment for operating lease agreements in which the Corporation is the lessee.
All of these leases in which the Corporation is the lessee are comprised of real estate property for branches and office space with terms extending through 2026. All of the Corporation’s leases are classified as operating leases, and therefore, were previously not recognized on the Corporation’s Consolidated Balance Sheets. In accordance with Topic 842, operating lease agreements are required to be recognized on the Consolidated Balance Sheets as a right-of use (“ROU”) asset and a corresponding lease liability.
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The following table represents the Consolidated Balance Sheet classification of the Corporation’s ROU assets and lease liabilities.
| Lease Consolidated Balance Sheets Classification | ||||||||||
| (Dollars in Thousands) | Classification | March 31, 2021 | December 31, 2020 | |||||||
| Lease Right-of-Use Assets | ||||||||||
| Operating lease right-of use assets | Other Assets | $ | 683 | 728 | ||||||
| Lease Liabilities | ||||||||||
| Operating lease liabilties | Other Liabilities | $ | 695 | 740 | ||||||
The calculated amount of the ROU assets and lease liabilities in the table above are impacted by the length of the lease term and the discount rate used to determine the present value of the minimum lease payments. The Corporation’s lease agreements often include one or more options to renew at the Corporation’s discretion. If at lease inception, the Corporation considers the exercising of a renewal option to be reasonably certain, the Corporation will include the extended term in the calculation of the ROU asset and lease liability. Regarding the discount rate, Topic 842 requires the use of the rate implicit in the lease whenever this rate is readily determinable. As the rate is rarely determinable, the Corporation utilizes its incremental borrowing rate at lease inception, on a collateralized basis, over a similar term. For operating leases existing prior to January 1, 2019, the rate for the remaining lease term as of January 1, 2019 was used.
| March 31, 2021 | December 31, 2020 | |||||||
| Weighted-average remaining lease term | ||||||||
| Operating leases | 4.2 years | 4.4 years | ||||||
| Weighted-average discount rate | ||||||||
| Operating leases | 3.11% | 3.11% | ||||||
The following table represents lease costs and other lease information. As the Corporation elected, for all classes of underlying assets, not to separate lease and non-lease components and instead to account for them as a single lease component, the variable lease cost primarily represents variable payments such as common area maintenance and utilities.
Future minimum payments for operating leases with initial or remaining terms of one year or more as of March 31, 2021 were as follows:
| Lease Payment Schedule | ||||
| (Dollars in Thousands) | Operating Leases | |||
| Twelve Months Ended: | ||||
| March 31, 2022 | $ | 206 | ||
| March 31, 2023 | 155 | |||
| March 31, 2024 | 154 | |||
| March 31, 2025 | 155 | |||
| March 31, 2026 | 61 | |||
| Thereafter | 12 | |||
| Total Future Minimum Lease Payments | 743 | |||
| Amounts Representing Interests | (48 | ) | ||
| Present Value of Net Future Minimum Lease Payments | $ | 695 | ||
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10. Risks and Uncertainties
COVID-19 Update
The following table provides information with respect to our commercial loans by type at March 31, 2021.
At Risk
| (Dollars in Thousands) | # | $ | $ | % | ||||||||||||
| Number | Total | Principal | of Total | |||||||||||||
| of | Loan | Balance | Loan | |||||||||||||
| Loan Type | Loans | Exposure | of Loans | Balance | ||||||||||||
| Lessors of Nonresidential Buildings | 162 | 80,435 | 72,980 | 8.67% | ||||||||||||
| Lessors of Residential Buildings | 207 | 42,041 | 37,301 | 4.43% | ||||||||||||
| Specialized Freight | 29 | 16,441 | 12,090 | 1.44% | ||||||||||||
| Residential Remodelers | 94 | 10,533 | 3,916 | 0.47% | ||||||||||||
| New Single Family Housing Construction | 50 | 8,190 | 3,721 | 0.44% | ||||||||||||
| Passenger Car Leasing | 154 | 9,749 | 9,730 | 1.16% | ||||||||||||
| Hotels | 13 | 7,436 | 6,512 | 0.77% | ||||||||||||
| Religious Organizations | 34 | 7,468 | 6,368 | 0.76% | ||||||||||||
| Car Washes | 7 | 6,345 | 6,184 | 0.73% | ||||||||||||
| Concrete & Structural Contrators | 21 | 5,522 | 3,647 | 0.43% | ||||||||||||
| Other | 67 | 14,991 | 8,122 | 0.96% | ||||||||||||
| Totals | 838 | 209,151 | 170,571 | 20.23% | ||||||||||||
The Corporation has a diversified commercial loan portfolio that is consistent with the diversified economies of Lancaster, Lebanon and Berks Counties in Pennsylvania, the Corporation’s market area. The above chart is focused on loan types that are commonly known to be at risk or negatively impacted by the COVID-19 pandemic and its effects. The Corporation’s largest exposure to at risk loan types are loans on leased commercial property and loans on residential investment properties. The Corporation has a relatively low exposure to the hospitality industry, including restaurants. Single loan type exposures falling under the other category do not exceed 0.5% of total loans and include loan types such as site preparation contractors, fuel dealers, and recreational centers. The above levels of exposure to these at risk loan types have not had significant movements from 2020 to 2021. Management does not expect any significant movements in these exposures going forward.
Paycheck Protection Program (PPP)
The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, was signed into law on March 27, 2020, providing over $2 trillion in economic relief to individuals and businesses impacted by the COVID-19 pandemic. The CARES Act authorized the Small Business Administration (SBA) to temporarily guarantee loans under a new 7(a) loan program called the Paycheck Protection Program (PPP). As a qualified SBA lender, the Corporation was authorized to originate PPP loans.
In terms of qualifying for a PPP loan, an eligible business could apply for a PPP loan up to the greater of: (1) 2.5 times its average monthly payroll costs; or (2) $10 million. The PPP loans have the following terms: (a) an interest rate of 1.0%, (b) a two-year or five-year loan term to maturity; and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA will guarantee 100% of the PPP loans made to eligible borrowers. The entire principal amount of the PPP loan, including any accrued interest, is eligible to be reduced by the amount of loan forgiveness available under the PPP, provided the employee and compensation levels of the business are maintained and 60% of the loan proceeds are used for payroll expenses, with the remaining 40% of the loan proceeds used for other qualifying expenses such as utilities.
In the initial CARES Act, $349 billion of funds were made available for PPP loans. This amount was fully exhausted prior to the end of April. Congress then passed an additional allocation of funds for the PPP loans, allowing a second round of applications to begin. The Corporation generated PPP loans under this initial plan in the amount of approximately $78 million. In the first quarter of 2021, the SBA made another round of PPP funding available and the Corporation made additional loans to qualifying small businesses. Additionally, some of the original PPP loans became eligible for forgiveness. As a result of the forgiveness of some of the original PPP loans and the initiation of additional PPP loans, the total balance of PPP loans at March 31, 2021, was $58.1 million. Management’s focus has been to serve the customers and market area that the Corporation serves.
29
In accordance with the SBA terms and conditions on these PPP loans, as of March 31, 2021, the Corporation received approximately $5.1 million in fees associated with the processing of these loans. All fee income is being deferred over the expected life of each PPP loan. The initial batch of the PPP loans carried a stated maturity of two years. In later batches of PPP loans the maturity can be five years, however the majority of the Corporation’s PPP loans carry a two-year maturity. When a PPP loan is paid off or forgiven, the remaining fee amount is taken into income. The Corporation expects there to be few loans that are on the books until the stated maturity dates.
COVID-19 Loan Forbearance Programs
As of March 31, 2021, over 330 of the Corporation’s customers had requested payment deferrals, or payments of interest only, on loans originally totaling over $65 million at the time of deferment. These loans now have a current balance of $52.0 million, or 6.2% of the total loan portfolio as of March 31, 2021. The current balance of these loans was $54.6 million as of December 31, 2020. In accordance with interagency guidance issued in March 2020, these short-term deferrals are not considered troubled debt restructurings (TDRs) unless the borrower was previously experiencing financial difficulty. In addition, the risk-rating on COVID-19 modified loans did not change, and these loans will not be considered past due until after the deferral period is over and scheduled payments resume. The credit quality of these loans will be reevaluated after the deferral period ends.
Of the $52.0 million of current loan balances with payments being deferred, $41.7 million, or 80.3%, were in the form of commercial or agricultural loan deferments, with the vast majority of these commercial loan deferrals. The remaining loan deferments consisted of $10.1 million of residential mortgage deferrals and $162,000 of consumer loan deferrals. The vast majority of the COVID-19 loan payment deferrals were for a 90-day period. As of March 31, 2021 the Corporation had eight commercial loans remaining on deferment totaling $4.6 million. It is expected that all of these loans will return to normal payments during the second quarter of 2021.
As of March 31, 2021, the Corporation’s delinquent and non-performing levels were not yet materially impacted by the weaker economic conditions brought on by COVID-19. However, the Corporation did experience a sharp increase in the amount of impaired loans during the second half of 2020. Impaired loans grew from $3.9 million as of March 31, 2020 to $5.7 million as of March 31, 2021, a $1.8 million increase. This increase was solely due to a $3.6 million loan to one commercial borrower being classified as both impaired and a troubled debt restructuring. This borrower continues to perform according to restructured terms. Partially offsetting this additional impaired loan, other impaired loans paid off or paid down resulting in the lower level of increase.
Due to the severity and length of this economic interruption, management does anticipate that the levels of delinquencies and non-performing loans could rise in 2021. The significance of the credit deterioration will depend on the length of time local business operations are curtailed, or limited, and the amount of time it takes for consumer confidence to rebuild and engage into increased purchasing activities. Management has already significantly increased the Corporation’s provision for loan losses in 2020, as qualitative factors have been increased based on predicted prolonged economic weakness, which is expected to impact more and more borrowers.
11. Recently Issued Accounting Standards
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should 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 allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. With certain exceptions, transition to the new requirements will be through a cumulative-effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies, to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. We expect to recognize a one-time cumulative-effect adjustment to the allowance for credit losses as of the beginning of the first reporting period in which the new standard is effective but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements.
30
In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments ‒ Credit Losses, which, in addition to addressing other matters, ASU 2018-19 clarifies that receivables arising from operating leases are not within the scope of Subtopic 326-20. The effective date and transition requirements for ASU 2018-19 are the same as those in ASU 2016-13. This Update is not expected to have a significant impact on the Corporation’s financial statements.
In May 2019, the FASB issued ASU 2019-05, Financial Instruments – Credit Losses, Topic 326, which allows entities to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost upon adoption of the new credit losses standard. To be eligible for the transition election, the existing financial asset must otherwise be both within the scope of the new credit losses standard and eligible for the applying the fair value option in ASC 825-10.3. The election must be applied on an instrument-by-instrument basis and is not available for either available-for-sale or held-to-maturity debt securities. For entities that elect the fair value option, the difference between the carrying amount and the fair value of the financial asset would be recognized through a cumulative-effect adjustment to opening retained earnings as of the date an entity adopted ASU 2016-13. Changes in fair value of that financial asset would subsequently be reported in current earnings. For entities that have not yet adopted ASU 2016-13, the effective dates and transition requirements are the same as those in ASU 2016-13. For entities that have adopted ASU 2016-13, ASU 2019-05 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted once ASU 2016-13 has been adopted On October 16, 2019, the FASB voted to defer the effective date for ASC 326, Financial Instruments – Credit Losses, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. The final ASU is expected to be issued in mid-November. This Update is not expected to have a significant impact on the Corporation’s financial statements.
In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, to clarify its new credit impairment guidance in ASC 326, based on implementation issues raised by stakeholders. This Update clarified, among other things, that expected recoveries are to be included in the allowance for credit losses for these financial assets; an accounting policy election can be made to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions instead of the prepayment assumptions applicable immediately prior to the restructuring event; and extends the practical expedient to exclude accrued interest receivable from all additional relevant disclosures involving amortized cost basis. The effective dates in this Update are the same as those applicable for ASU 2019-10. The Corporation qualifies as a smaller reporting company and does not expect to early adopt these ASUs.
In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments. This ASU was issued to improve and clarify various financial instruments topics, including the current expected credit losses (CECL) standard issued in 2016. The ASU includes seven issues that describe the areas of improvement and the related amendments to GAAP; they are intended to make the standards easier to understand and apply and to eliminate inconsistencies, and they are narrow in scope and are not expected to significantly change practice for most entities. Among its provisions, the ASU clarifies that all entities, other than public business entities that elected the fair value option, are required to provide certain fair value disclosures under ASC 825, Financial Instruments, in both interim and annual financial statements. It also clarifies that the contractual term of a net investment in a lease under Topic 842 should be the contractual term used to measure expected credit losses under Topic 326. Amendments related to ASU 2019-04 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is not permitted before an entity’s adoption of ASU 2016-01. Amendments related to ASU 2016-13 for entities that have not yet adopted that guidance are effective upon adoption of the amendments in ASU 2016-13. Early adoption is not permitted before an entity’s adoption of ASU 2016-13. Amendments related to ASU 2016-13 for entities that have adopted that guidance are effective for fiscal years beginning after December 15, 2019, including interim periods within those years. Other amendments are effective upon issuance of this ASU. The Corporation is currently evaluating the impact the adoption of the standard will have on the Corporation’s financial position or results of operations.
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In January 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, March 2020, to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls reference rate reform, if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. The amendments in this ASU are effective for all entities upon issuance through December 31, 2022. It is too early to predict whether a new rate index replacement and the adoption of the ASU will have a material impact on the Corporation’s financial statements.
In August 2020, the FASB issued ASU 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40), which simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts on an entity’s own equity. This ASU removes from U.S. GAAP the separation models for (1) convertible debt with a cash conversion feature and (2) convertible instruments with a beneficial conversion feature. As a result, entities will not separately present in equity an embedded conversion feature in such debt. Instead, they will account for a convertible debt instrument wholly as debt, and for convertible preferred stock wholly as preferred stock (i.e., as a single unit of account), unless (1) a convertible instrument contains features that require bifurcation as a derivative under ASC 815 or (2) a convertible debt instrument was issued at a substantial premium. This ASU requires entities to provide expanded disclosures about the terms and features of convertible instruments, how the instruments have been reported in the entity’s financial statements, and information about events, conditions, and circumstances that can affect how to assess the amount or timing of an entity’s future cash flows related to those instruments. The amendments in this ASU are effective for public business entities that are not smaller reporting companies, for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. For all other entities, this ASU is effective for fiscal years beginning after December 15, 2023, and interim periods within those fiscal years. The guidance may be early adopted for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. This Update is not expected to have a significant impact on the Corporation’s financial statements.
In October 2020, the FASB issued ASU 2020-08, Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable Fees and Other Costs, which clarifies that, for each reporting period, an entity should reevaluate whether a callable debt security is within the scope of ASC 310-20-35-33. For public business entities, ASU 2020-08 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early application is not permitted. For all other entities, ASU 2020-08 is effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. This Update is not expected to have a significant impact on the Corporation’s financial statements.
In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848), which provides optional temporary guidance for entities transitioning away from the London Interbank Offered Rate (LIBOR) and other interbank offered rates (IBORs) to new references rates so that derivatives affected by the discounting transition are explicitly eligible for certain optional expedients and exceptions within Topic 848. ASU 2021-01 clarifies that the derivatives affected by the discounting transition are explicitly eligible for certain optional expedients and exceptions in Topic 848. ASU 2021-01 is effective immediately for all entities. Entities may elect to apply the amendments on a full retrospective basis as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or on a prospective basis to new modifications from any date within an interim period that includes or is subsequent to the date of the issuance of a final update, up to the date that financial statements are available to be issued. The amendments in this update do not apply to contract modifications made, as well as new hedging relationships entered into, after December 31, 2022, and to existing hedging relationships evaluated for effectiveness for periods after December 31, 2022, except for certain hedging relationships existing as of December 31, 2022, that apply certain optional expedients in which the accounting effects are recorded through the end of the hedging relationship. This Update is not expected to have a significant impact on the Corporation’s financial statements.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis represents management’s view of the financial condition and results of operations of the Corporation. This discussion and analysis should be read in conjunction with the consolidated financial statements and other financial schedules included in this quarterly report, and in conjunction with the 2020 Annual Report to Shareholders of the Corporation. The financial condition and results of operations presented are not indicative of future performance.
Forward-Looking Statements
The U.S. Private Securities Litigation Reform Act of 1995 provides safe harbor in regards to the inclusion of forward-looking statements in this document and documents incorporated by reference. Forward-looking statements pertain to possible or assumed future results that are made using current information. These forward-looking statements are generally identified when terms such as: “believe,” “estimate,” “anticipate,” “expect,” “project,” “forecast,” and other similar wordings are used. The readers of this report should take into consideration that these forward-looking statements represent management’s expectations as to future forecasts of financial performance, or the likelihood that certain events will or will not occur. Due to the very nature of estimates or predications, these forward-looking statements should not be construed to be indicative of actual future results. Additionally, management may change estimates of future performance, or the likelihood of future events, as additional information is obtained. This document may also address targets, guidelines, or strategic goals that management is striving to reach but may not be indicative of actual results.
Readers should note that many factors affect this forward-looking information, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference into this document. These factors include, but are not limited to, the following:
| · | National and local economic conditions |
| · | Effects of economic conditions particularly with regard to the negative impact of severe, wide-ranging and continuing disruptions caused by the spread of coronavirus (COVID-19) and government and business responses thereto, specifically the effect on loan customers to repay loans |
| · | Health of the housing market |
| · | Real estate valuations and its impact on the loan portfolio |
| · | Interest rate and monetary policies of the Federal Reserve Board |
| · | Volatility of the securities markets including the valuation of securities |
| · | Future actions or inactions of the United States government, including a failure to increase the government debt limit, a prolonged shutdown of the federal government, increase in taxes or regulations, or increasing debt balances |
| · | Political changes and their impact on new laws and regulations |
| · | Competitive forces |
| · | Impact of mergers and acquisition activity in the local market and the effects thereof |
| · | Potential impact from continually evolving cybersecurity and other technological risks and attacks, including additional costs, reputational damage, regulatory penalties, and financial losses |
| · | Changes in customer behavior impacting deposit levels and loan demand |
| · | Changes in accounting principles, policies, or guidelines as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board, and other accounting standards setters |
| · | Ineffective business strategy due to current or future market and competitive conditions |
| · | Management’s ability to manage credit risk, liquidity risk, interest rate risk, and fair value risk |
| · | Operation, legal, and reputation risk |
| · | Results of the regulatory examination and supervision process |
| · | The impact of new laws and regulations |
| · | Possible changes to the capital and liquidity requirements and other regulatory pronouncements, regulations and rules |
| · | Large scale global disruptions such as pandemics, terrorism, trade wars, and armed conflict. |
| · | Local disruptions due to flooding, severe weather, or other natural disasters |
| · | The risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful |
| · | Business and competitive disruptions caused by new market and industry entrants |
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Readers should be aware if any of the above factors change significantly, the statements regarding future performance could also change materially. The safe harbor provision provides that the Corporation is not required to publicly update or revise forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should review any changes in risk factors in documents filed by the Corporation periodically with the Securities and Exchange Commission, including Item 1A of Part II of this Quarterly Report on Form 10-Q, Annual Reports on Form 10-K, and Current Reports on Form 8-K.
Results of Operations
Overview
The first quarter of 2021 was positively impacted by a number of items resulting in very strong financial results. The COVID-19 pandemic continues to impact customer behavior and balance sheet growth, but there has not been significant negative impacts on earnings or credit. Customers have adapted to changes in behavior and the Corporation continues to seek ways to manage the structure of the balance sheet to ensure positive financial results now and in future time periods.
The Corporation recorded net income of $4,504,000 for the three-month period ended March 31, 2021, a $2,339,000, or 108.0% increase, from the $2,165,000 earned during the same period in 2020. The earnings per share, basic and diluted, were $0.81 for the three months ended March 31, 2021, compared to $0.38 for the same period in 2020, a 113.2% increase. The increase in the Corporation’s 2021 earnings was caused primarily by growth in gains on mortgages sold, other income, and net interest income.
The gains from the sale of mortgages were $1,930,000 for the three months ended March 31, 2021, compared to gains of $541,000 for the first quarter of 2020, an increase of $1,389,000, or 256.7%. The volume of mortgages sold was higher during the first three months of 2021 compared to the same period in the prior year. This volume has been driven by low market rates, which has caused an increase in refinancing activity over the course of the past year. Additionally, margins received on sold mortgages have been at higher levels supporting this higher level of gains. Gains on securities in total increased by $283,000, or 544.2%, for the three months ended March 31, 2021, compared to the same period in the prior year primarly driven by gains on equity securities sold as well as unrealized gains on equity securities recorded in income due to the increased market values of bank stocks as of March 31, 2021. Outside of mortgage and security gains, other non-interest income increased by $879,000, or 40.4% for the first quarter of 2021, due to many positive trends such as higher trust income, higher commissions on debit card interchange fees, and lower mortgage servicing asset amortization.
The Corporation’s NII increased by $463,000, or 5.0%, for the three months ended March 31, 2021, compared to the same period in 2020. The increase in NII primarily resulted from an increase in interest on securities available for sale of $244,000, or 13.7%, for the three-month period ended March 31, 2021, as well as a decrease in interest expense on deposits and borrowings of $420,000, or 33.0%. The low interest rate environment has caused a rapid decline in asset yield, but also a decline in the cost of funds, which has resulted in these much lower levels of interest expense.
The financial services industry uses two primary performance measurements to gauge performance: return on average assets (ROA) and return on average equity (ROE). ROA measures how efficiently a bank generates income based on the amount of assets or size of a company. ROE measures the efficiency of a company in generating income based on the amount of equity or capital utilized. The latter measurement typically receives more attention from shareholders. The ROA and ROE increased for the quarter-to-date period ended March 31, 2021, compared to the same period in the prior year, due to much higher earnings in the first quarter of 2021 compared to 2020.
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| Key Ratios | Three Months Ended | |||
| March 31, | ||||
| 2021 | 2020 | |||
| Return on Average Assets | 1.24% | 0.74% | ||
| Return on Average Equity | 14.03% | 7.42% | ||
The results of the Corporation’s operations are best explained by addressing, in further detail, the five major sections of the income statement, which are as follows:
| · | Net interest income |
| · | Provision for loan losses |
| · | Other income |
| · | Operating expenses |
| · | Provision for income taxes |
The following discussion analyzes each of these five components.
Net Interest Income
NII represents the largest portion of the Corporation’s operating income. In the first three months of 2021, NII generated 64.5% of the Corporation’s revenue stream, which consists of net interest income and non-interest income, compared to 76.9% in the first three months of 2020. This significant decrease is a result of much higher levels of non-interest income primarily driven by mortgage gains in the first quarter of 2021 which made up 12.9% of the Corporation’s revenue stream, compared to only 4.5% in the first quarter of 2020. However, the overall performance of the Corporation is highly dependent on the changes in net interest income since it comprises such a significant portion of operating income.
The following table shows a summary analysis of net interest income on a fully taxable equivalent (FTE) basis. For analytical purposes and throughout this discussion, yields, rates, and measurements such as NII, net interest spread, and net yield on interest earning assets are presented on an FTE basis. The FTE net interest income shown in both tables below will exceed the NII reported on the consolidated statements of income, which is not shown on an FTE basis. The amount of FTE adjustment totaled $268,000 for the three months ended March 31, 2021, compared to $166,000 for the same period in 2020.
NET INTEREST INCOME
(DOLLARS IN THOUSANDS)
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2021 | 2020 | |||||||
| $ | $ | |||||||
| Total interest income | 10,530 | 10,487 | ||||||
| Total interest expense | 851 | 1,271 | ||||||
| Net interest income | 9,679 | 9,216 | ||||||
| Tax equivalent adjustment | 268 | 166 | ||||||
| Net interest income (fully taxable equivalent) | 9,947 | 9,382 | ||||||
NII is the difference between interest income earned on assets and interest expense incurred on liabilities. Accordingly, two factors affect net interest income:
| · | The rates earned on interest earning assets and paid on interest bearing liabilities |
| · | The average balance of interest earning assets and interest bearing liabilities |
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The Federal funds rate, the Prime rate, the shape of the U.S. Treasury curve, and other wholesale funding curves, all affect NII. The Federal Reserve controls the Federal funds rate, which is one of a number of tools available to the Federal Reserve to conduct monetary policy. The Federal funds rate, and guidance on when the rate might be changed, is often the focal point of discussion regarding the direction of interest rates. During 2020, the Federal funds rate was decreased by 150 basis points in March taking the rate to 0.25% by March 31, 2020. With the declines in the Federal funds rate, the U.S. Treasury yield curve became flatter. Long-term rates like the ten-year U.S. Treasury were 232 basis points under the 3.25% Prime rate as of December 31, 2020. Long-term Treasury rates remained low throughout 2020, and with the decreases in the Federal Reserve short-term rates, the yield curve remained essentially flat throughout the year. Management had not anticipated the Fed rate decreases in the first quarter of 2020. During the first quarter of 2021, longer-term U.S. Treasury rates did increase adding some slope to the yield curve. The ten-year Treasury rate was 1.74% as of March 31, 2021, which was 151 basis points under the Prime rate. This Treasury rate movement makes it a little easier to get asset yield on the longer end of the curve, but yields are still compressed compared to years prior to 2020, making increasing asset yield much more difficult, which adds strain to NII and NIM.
The Prime rate is generally used by commercial banks to extend variable rate loans to business and commercial customers. For many years, the Prime rate has been set at 300 basis points, or 3.00% higher, than the Federal funds rate and typically moves when the Federal funds rate changes. As such, the Prime rate decreased to 3.25% in March of 2020 after the 150 basis point Fed rate decline. The Corporation’s Prime-based loans generally reprice a day after the Federal Reserve rate movement.
As a result of a larger balance sheet in the first quarter of 2021, even with much lower asset yields, the Corporation’s NII on a tax equivalent basis increased while the Corporation’s margin decreased to 2.86% for the quarter, compared to 3.41% in the first quarter of 2020. Loan yields were lower in the first quarter of 2021 due to the 150 basis point Fed rate decline during the first quarter of 2020. The Corporation’s NII for the three months ended March 31, 2021 increased over the same period in 2020, by $565,000, or 6.0%. Management’s asset liability sensitivity measurements continue to show a benefit to both margin and NII given Federal Reserve rate increases. Actual results over the past two years have confirmed the asset sensitivity of the Corporation’s balance sheet. However, in a down-rate environment, the margin and NII would suffer unless balance sheet growth is enough to offset lower asset yields.
Security yields will generally fluctuate more rapidly than loan yields based on changes to the U.S. Treasury rates and yield curve. With lower Treasury rates in 2020, security reinvestment had generally been occurring at lower yield levels. With slightly higher Treasury rates in the first quarter of 2021, security yields have increased slightly, but still remain compressed compared to years prior to 2020.
The Corporation’s loan portfolio yield has decreased from the prior years’ period as the variable rate portion of the loan portfolio repriced lower with each Federal Reserve rate movement and some fixed rate borrowers requested loan modifications to reset their rates lower in the current record low market rate environment. The vast majority of the Corporation’s commercial Prime-based loans were priced at the Prime rate, which was 4.75% to start 2020, and then 4.25% as of March 4, 2020, and 3.25% as of March 16, 2020 through March 31, 2021. The pricing for the most typical five-year fixed rate commercial loans is currently in line with the Prime rate. With the significant 2020 Federal Reserve rate reductions, adding variable rate loans to the portfolio means they will be priced at very low rates to start but can reprice lower if the Federal Reserve lowers rates any further and would reprice higher if the Federal Reserve would increase rates. There are elements of the Corporation’s Prime-based commercial loans priced above the Prime rate based on the level of credit risk of the borrower. Management does price a portion of consumer variable rate loans above the Prime rate, which also helps to improve loan yield. Both commercial and consumer Prime-based pricing continues to be influenced by local competition.
Mid-term and long-term interest rates on average were higher in the first quarter of 2021 compared to the first quarter of 2020. The average rate of the 10-year U.S. Treasury was 1.34% in the first quarter of 2021 compared to 1.37% in the first quarter of 2020, and it stood at 1.74% on March 31, 2021, compared to 0.70% on March 31, 2020. The slope of the yield curve has been compressed throughout 2020 and 2021 with a little more slope in the first quarter of 2021. As of December 31, 2020, the 10-year U.S. Treasury rate was only 68 basis points higher than the Fed funds rate and as of March 31, 2021, it was 149 basis points higher than the Fed funds rate. The slope of the yield curve has fluctuated many times in the past two years with the 10-year U.S. Treasury yield as high as 1.88% in the first quarter of 2020 and 1.74% in the first quarter of 2021, and as low as 0.54% in the first quarter of 2020, and 0.93% in the first quarter of 2021.
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The Corporation’s overall cost of funds, including non-interest bearing funds, remained stable through the first quarter of 2021 between 19 and 21 basis points. Management expects the cost of funds will decline slightly and then stabilize throughout 2021 as limited deposits reprice to lower rates. Core deposit interest rates were reduced nine times throughout 2020 and time deposit rates have also decreased resulting in maturing time deposits repricing at lower levels or moving into core deposit products. Management does not anticipate significant deposit rate movements in 2021 as deposits are now priced at very low rates. Typically, financial institutions will make small systematic moves on core interest bearing accounts while making larger rate movements in the pricing of new or reissued time deposits. The Corporation’s costs on borrowings included $50,000 of prepayment penalties recorded on FHLB long-term advances paid off early during the first quarter of 2021, accelerating the interest expense, but achieving savings in future time periods. While the average balance of borrowings was lower in the first quarter of 2021 than the first quarter of 2020, the interest expense was higher, as the new $20 million sub debt issue beginning on December 30, 2020, carried a higher rate of interest than FHLB long-term advances that were paid off. As a result, the total cost of borrowings increased from the first quarter of 2020 to the first quarter of 2021 by $75,000.
The following table provides an analysis of year-to-date changes in net interest income by distinguishing what changes were a result of average balance increases or decreases and what changes were a result of interest rate increases or decreases.
RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME
(TAXABLE EQUIVALENT BASIS, DOLLARS IN THOUSANDS)
| Three Months Ended March 31, | Three Months Ended March 31, | |||||||||||||||||||||||
| 2021 vs. 2020 | 2020 vs. 2019 | |||||||||||||||||||||||
| Increase (Decrease) | Increase (Decrease) | |||||||||||||||||||||||
| Due To Change In | Due To Change In | |||||||||||||||||||||||
| Net | Net | |||||||||||||||||||||||
| Average | Interest | Increase | Average | Interest | Increase | |||||||||||||||||||
| Balances | Rates | (Decrease) | Balances | Rates | (Decrease) | |||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| INTEREST INCOME | ||||||||||||||||||||||||
| Interest on deposits at other banks | 48 | (86 | ) | (38 | ) | 25 | (12 | ) | 13 | |||||||||||||||
| Securities available for sale: | ||||||||||||||||||||||||
| Taxable | 399 | (552 | ) | (153 | ) | 116 | (179 | ) | (63 | ) | ||||||||||||||
| Tax-exempt | 606 | (117 | ) | 489 | (66 | ) | (35 | ) | (101 | ) | ||||||||||||||
| Total securities | 1,005 | (669 | ) | 336 | 50 | (214 | ) | (164 | ) | |||||||||||||||
| Loans | 837 | (912 | ) | (75 | ) | 622 | (202 | ) | 420 | |||||||||||||||
| Regulatory stock | (24 | ) | (54 | ) | (78 | ) | 19 | 1 | 20 | |||||||||||||||
| Total interest income | 1,866 | (1,721 | ) | 145 | 716 | (427 | ) | 289 | ||||||||||||||||
| INTEREST EXPENSE | ||||||||||||||||||||||||
| Deposits: | ||||||||||||||||||||||||
| Demand deposits | 55 | (322 | ) | (267 | ) | 28 | (152 | ) | (124 | ) | ||||||||||||||
| Savings deposits | 6 | (15 | ) | (9 | ) | 2 | (4 | ) | (2 | ) | ||||||||||||||
| Time deposits | (47 | ) | (172 | ) | (219 | ) | (5 | ) | 116 | 111 | ||||||||||||||
| Total deposits | 14 | (509 | ) | (495 | ) | 25 | (40 | ) | (15 | ) | ||||||||||||||
| Borrowings: | ||||||||||||||||||||||||
| Total borrowings | (41 | ) | 116 | 75 | 57 | 50 | 107 | |||||||||||||||||
| Total interest expense | (27 | ) | (393 | ) | (420 | ) | 82 | 10 | 92 | |||||||||||||||
| NET INTEREST INCOME | 1,893 | (1,328 | ) | 565 | 634 | (437 | ) | 197 | ||||||||||||||||
During the first three months of 2021, the Corporation’s NII on an FTE basis increased by $565,000, or 6.0%, over the same period in 2020. Total interest income on an FTE basis for the three months ended March 31, 2021, increased $145,000, or 1.4%, from 2020, while interest expense decreased $420,000, or 33.0%, for the three months ended March 31, 2021, compared to the same period in 2020. The FTE interest income from the securities portfolio increased by $336,000, or 17.2%, while loan interest income decreased $75,000, or 0.9%. During the first three months of 2021, additional loan volume caused by loan growth added $837,000 to net interest income, but the lower yields caused a $912,000 decrease, resulting in a total decrease of $75,000. Higher balances in the securities portfolio caused an increase of $1,005,000 in NII, while lower yields on securities caused a $669,000 decrease, resulting in a net increase of $336,000.
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The average balance of interest bearing liabilities increased by 15.4% during the three months ended March 31, 2021, compared to the prior year driven by growth in deposit balances. The lower cost on deposit accounts resulted in a decrease in interest expense. Lower rates on all deposit types caused a $509,000 decrease in interest expense while higher balances of demand and savings deposits caused an increase in expense of $14,000 resulting in a total decrease of $495,000.
Out of all the Corporation’s deposit types, interest-bearing demand deposits reprice the most rapidly, as nearly all accounts are immediately affected by rate changes. Time deposit balances decreased resulting in a $47,000 reduction to expense, and time deposits repricing to lower interest rates decreased interest expense by $172,000, causing a net total decrease of $219,000 in time deposit interest expense. Even with the low rate environment, the Corporation was successful in increasing balances of other deposit types.
The average balance of outstanding borrowings decreased by 9.4% from the prior year, due to early payoff of FHLB advances that occurred during 2020 and the first quarter of 2021. This resulted in a decrease in interest expense of $41,000. Although interest rates were lower in the first three months of 2021 compared to the prior year, the Corporation incurred interest prepayment penalites of $50,000 to pay off a long-term FHLB advance. The Corporation also issued subordinated debt at the end of 2020, which was at a higher interest rate than the FHLB advances. These two events increased interest expense by $116,000. The combination of lower overall levels of borrowings at a materially higher weighted average interest rate caused an increase in interest expense of $75,000 on total borrowings. The sub debt issue was pursued because of the benefit of being treated as Tier 1 capital at the bank level and Tier II capital at the bank holding company level.
The following table shows a more detailed analysis of net interest income on an FTE basis with all the major elements of the Corporation’s balance sheet, which consists of interest earning and non-interest earning assets and interest bearing and non-interest bearing liabilities. Additionally, the analysis provides the net interest spread and the net yield on interest earning assets. The net interest spread is the difference between the yield on interest earning assets and the interest rate paid on interest bearing liabilities. The net interest spread has the deficiency of not giving credit for the non-interest bearing funds and capital used to fund a portion of the total interest earning assets. For this reason, management emphasizes the net yield on interest earning assets, also referred to as the NIM. The NIM is calculated by dividing net interest income on an FTE basis into total average interest earning assets. The NIM is generally the benchmark used by analysts to measure how efficiently a bank generates NII.
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COMPARATIVE AVERAGE BALANCE SHEETS AND NET INTEREST INCOME
(DOLLARS IN THOUSANDS)
| For the Three Months Ended March 31, | ||||||||||||||||||||||||
| 2021 | 2020 | |||||||||||||||||||||||
| (c) | (c) | |||||||||||||||||||||||
| Average | Annualized | Average | Annualized | |||||||||||||||||||||
| Balance | Interest | Yield/Rate | Balance | Interest | Yield/Rate | |||||||||||||||||||
| $ | $ | % | $ | $ | % | |||||||||||||||||||
| ASSETS | ||||||||||||||||||||||||
| Interest earning assets: | ||||||||||||||||||||||||
| Federal funds sold and interest | ||||||||||||||||||||||||
| on deposits at other banks | 57,975 | 22 | 0.15 | 18,860 | 60 | 1.29 | ||||||||||||||||||
| Securities available for sale: | ||||||||||||||||||||||||
| Taxable | 318,921 | 1,104 | 1.38 | 229,149 | 1,256 | 2.19 | ||||||||||||||||||
| Tax-exempt | 172,768 | 1,189 | 2.75 | 86,695 | 701 | 3.23 | ||||||||||||||||||
| Total securities (d) | 491,689 | 2,293 | 1.87 | 315,844 | 1,957 | 2.48 | ||||||||||||||||||
| Loans (a) | 838,954 | 8,416 | 4.03 | 759,998 | 8,491 | 4.48 | ||||||||||||||||||
| Regulatory stock | 6,033 | 67 | 4.45 | 7,468 | 145 | 7.77 | ||||||||||||||||||
| Total interest earning assets | 1,394,651 | 10,798 | 3.11 | 1,102,170 | 10,653 | 3.87 | ||||||||||||||||||
| Non-interest earning assets (d) | 79,897 | 72,386 | ||||||||||||||||||||||
| Total assets | 1,474,548 | 1,174,556 | ||||||||||||||||||||||
| LIABILITIES & | ||||||||||||||||||||||||
| STOCKHOLDERS' EQUITY | ||||||||||||||||||||||||
| Interest bearing liabilities: | ||||||||||||||||||||||||
| Demand deposits | 324,277 | 38 | 0.05 | 265,771 | 305 | 0.46 | ||||||||||||||||||
| Savings deposits | 286,793 | 14 | 0.02 | 215,889 | 23 | 0.04 | ||||||||||||||||||
| Time deposits | 119,309 | 262 | 0.89 | 133,706 | 481 | 1.45 | ||||||||||||||||||
| Borrowed funds | 74,411 | 537 | 2.93 | 82,118 | 462 | 2.26 | ||||||||||||||||||
| Total interest bearing liabilities | 804,790 | 851 | 0.43 | 697,484 | 1,271 | 0.73 | ||||||||||||||||||
| Non-interest bearing liabilities: | ||||||||||||||||||||||||
| Demand deposits | 534,503 | 355,778 | ||||||||||||||||||||||
| Other | 5,028 | 3,896 | ||||||||||||||||||||||
| Total liabilities | 1,344,321 | 1,057,158 | ||||||||||||||||||||||
| Stockholders' equity | 130,227 | 117,398 | ||||||||||||||||||||||
| Total liabilities & stockholders' equity | 1,474,548 | 1,174,556 | ||||||||||||||||||||||
| Net interest income (FTE) | 9,947 | 9,382 | ||||||||||||||||||||||
| Net interest spread (b) | 2.68 | 3.14 | ||||||||||||||||||||||
| Effect of non-interest | ||||||||||||||||||||||||
| bearing deposits | 0.18 | 0.27 | ||||||||||||||||||||||
| Net yield on interest earning assets (c) | 2.86 | 3.41 | ||||||||||||||||||||||
(a) Includes balances of nonaccrual loans and the recognition of any related interest income. The quarter-to-date average balances include net deferred loan costs of $1,199,000 as of March,31 2021, and $1,982,000 as of March 31, 2020. Such fees and costs recognized through income and included in the interest amounts totaled $338,000 in 2021, and ($35,000) in 2020.
(b) Net interest spread is the arithmetic difference between the yield on interest earning assets and the rate paid on interest bearing liabilities.
(c) Net yield, also referred to as net interest margin, is computed by dividing net interest income (FTE) by total interest earning assets.
(d) Securities recorded at amortized cost. Unrealized holding gains and losses are included in non-interest earning assets.
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The Corporation’s interest income increased primarily due to increased interest income on securities, but the increase in income was the result of growth in the securities portfolio, not an increase in asset yield, resulting in a lower NIM of 2.86% for the first quarter of 2021, compared to 3.41% for the first quarter of 2020. The yield earned on assets decreased by 76 basis points during the three months ended March 31, 2021, while the rate paid on liabilities decreased by 30 basis points when comparing both years. This resulted in a 46 basis point decrease in interest spread, and the effect of non-interest bearing deposits decreased by nine basis points during the three months ended March 31, 2021, compared to the prior year, resulting in the decrease in NIM of 55 basis points. Management anticipates a levelling out of NIM during the remainder of 2021 as Treasury rates have increased a little assisting with achieving higher yields in the securities portfolio and loan yields will benefit some by the remainder of the PPP fees that are accretive to loan interest income as PPP loans pay off or are forgiven. Loan yields decreased in the first three months of 2021 compared to the prior year primarily as a result of the 150 basis points of Prime decline in the first quarter of 2020 that did not fully impact the loan yields until the second quarter of 2020. Growth in the loan portfolio will help to offset a declining asset yield moving through 2021. The Corporation’s loan yield decreased 45 basis points in the first three months of 2021 compared to the first three months of 2020. Loan interest income decreased $75,000, or 0.9%, for this time period as a result of the decline in yields.
Loan pricing was challenging in the first quarter of 2021 as a result of the very low rate environment and competition resulting in fixed-rate loans being priced at very low levels and variable-rate loans priced at the Prime rate or below. The Prime rate decreased by 1.50% in March of 2020 to 3.25%, which is now comparable to the typical rate of a five-year fixed-rate loan. The commercial or business fixed rates do increase with longer fixed terms or lower credit quality. In terms of the variable rate pricing, nearly all variable rate loans offered are Prime-based. Management is able to price loan customers with higher levels of credit risk at Prime plus pricing, such as Prime plus 0.75%, which amounted to 4.00% at March 31, 2021, still a relatively low rate. However, only a small minority of the loans in the commercial and agricultural portfolios are at these higher rates due to the strong credit quality of the Corporation’s borrowers and market competition. Competition in the immediate market area has been pricing select shorter-term fixed-rate commercial and agricultural lending rates below 3.25% for the strongest loan credits.
Tax equivalent yields on the Corporation’s securities decreased by 61 basis points for the three months ended March 31, 2021, compared to 2020. The Corporation’s securities portfolio consists of approximately 75% fixed income debt instruments and 25% variable rate product as of March 31, 2021. The Corporation’s taxable securities experienced an 81 basis-point decrease in yield for the three months ended March 31, 2021, compared to 2020. Security reinvestment in 2021 has been occurring at slightly higher rates due to the increase in U.S. Treasury rates, but reinvestment throughout the majority of 2020 was at much lower yields. The sharp growth in the investment portfolio during a period of very low rates also contributed to the decline in average security yield. This large amount of new investment was caused by the significant influx of deposits, which caused excess liquidity. The sharpest growth in the securities portfolio occurred in the fourth quarter of 2020 and the first quarter of 2021. In addition to these negative influences, the Corporation’s U.S. agency mortgage-backed securities and collateralized mortgage obligations experience faster principal prepayments as market rates decrease, causing the amortization of premium to increase, effectively decreasing the yield.
The yield on tax-exempt securities decreased by 48 basis points in the first quarter of 2021 compared to 2020. For the Corporation, these bonds consist entirely of tax-free municipal bonds. While the tax-exempt yields on municipal bonds declined with the tax rate change at the end of 2017, yields became more attractive again during 2020 and 2021. Management began investing in more of these bonds in 2020 as yields stood out and provided better returns than other sectors of the portfolio.
The interest rate paid on deposits decreased for the three months ended March 31, 2021, from the same period in 2020. Management follows a disciplined pricing strategy on core deposit products that are not rate sensitive, meaning that the balances do not fluctuate significantly when interest rates change. Rates on interest-bearing checking accounts and money market accounts were decreased in 2020, resulting in a decrease in the cost of funds on these accounts of 41 basis points. Savings account rates were also decreased during 2020 resulting in a two basis point reduction in the cost of funds associated with these accounts. Additionally, the cost of funds on time deposits decreased by 56 basis points during the first quarter of 2021 compared to the same period in the prior year. Typically, the Corporation sees increases in core deposit products during periods when consumers are not confident in the stock market or economic conditions deteriorate. During these periods, there is a “flight to safety” to federally insured deposits. This trend occurred again in early 2020 as the federal, state and local governmental bodies began rapidly instituting social distancing measures in an effort to control the spread of the coronavirus. These measures had an immediate signicant negative impact to the economy, which also resulted in the Federal Reserve quickly dropping interest rates back to historic lows. This in turn resulted in market interest rates declining again to historic lows, with the Corporation reducing offering rates on deposit products. As the rate difference between time deposits and core deposits narrowed, many customers chose to transfer funds from maturing time deposits into checking and savings accounts.
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The Corporation’s average deposits increased $293.7 million, or 30.2%, with all types of interest-bearing deposits increasing $115.0 million, or 18.7%, while non-interest bearing demand deposits increased $178.7 million, or 50.2%. In the current rate environment, with short-term rates low and with small rate differences for longer-term deposits, the consumer generally elected to stay short and maintain funds in accessible deposit instruments. In addition to the consumer staying liquid with their available funds, there has been a general trend of funds flowing from time deposit accounts into non-interest checking, NOW, and savings accounts. The average balance of time deposits declined during the first three months of 2021 compared to 2020, but the other areas of NOW, MMDA, and savings grew sufficiently enough to compensate for the decline in time deposits, causing total interest bearing funds to increase significantly. Time deposit balances had been growing throughout 2018 and 2019 due to the odd-month CD promotions available at those times, but with the recent sharp decline in rates, time deposits declined throughout 2020 and management expects these time deposit balances to decrease throughout the remainder of 2021 as a result of customers electing to allow maturing time deposit balances to roll off and hold them in a liquid account until there is some sign of rate increases.
Interest expense on deposits decreased by $495,000, or 61.2%, for the three months ended March 31, 2021, compared to the same period in 2020. Demand and savings deposits reprice in their entirety whenever the offering rates are changed, so with each successive rate drop in 2020, these deposits repriced lower. Interest rates on interest checking and money market accounts were decreased nine times in 2020. For the three months ended March 31, 2021, the average balances of interest bearing demand deposits increased by $58.5 million, or 22.0%, over the same period in 2020, while the average balance of savings accounts increased by $70.9 million, or 32.8%.
Time deposits reprice over time according to their maturity schedule. This enables management to both reduce and increase rates slowly over time. During the three months ended March 31, 2021, time deposit balances decreased compared to balances at March 31, 2020. The decrease can be attributed to the low rates paid on time deposits, which has caused the differential between time deposit rates and rates on non-maturity deposits to be minimal. As a result, customers have elected to keep more of their funds in non-maturity deposits and less funds in time deposits. Because time deposits are the most expensive deposit product for the Corporation and the largest dollar expense from a funding standpoint, the reduction in time deposits, along with the increases in interest-bearing checking, savings, and non-interest bearing checking, has allowed the Corporation to achieve a more balanced deposit funding position and maintain a lower cost of funds. The Corporation’s interest expense on time deposits decreased by $220,000, or 45.6%, for the first three months of 2021, compared to the same period in 2020. Management anticipates the interest expense on time deposits and annualized rate paid will decline throughout the remainder of 2021 as these higher-priced time deposits mature and reprice at lower levels or convert to non-maturity deposits.
The Corporation’s average rate on borrowed funds increased by 67 basis points from the first quarter of 2020 to the first quarter of 2021, as an FHLB borrowing was paid off early during the first quarter of 2021 accelerating $50,000 of interest expense. In addition, the Corporation’s subordinated debt issued on December 30, 2020, is included in this total borrowed funds amount and is at a rate of 4.00% for 5 years, so the increase in rate paid on borrowed funds is a direct result of this as well.
The Corporation historically uses both short-term and long-term borrowings to supplement liquidity generated by deposit growth. Average short-term advances of only $77,000 were utilized in the three months ended March 31, 2021, while average short-term advances of $1,806,000 were utilized in the three months ended March 31, 2020. Management has used FHLB long-term borrowings as part of an asset liability strategy to lengthen liabilities rather than as a source of liquidity. Average total long-term FHLB borrowings decreased by $25,589,000, or 31.9%, for the three months ended March 31, 2021, compared to the same period in 2020. The average balance of subordinated debt increased by $19,610,000, as subordinated debt was issued at the end of 2020 as a vehicle to support capital growth for the Corporation. This growth in debt balances contributed to an increase in interest expense for the three months ended March 31, 2021, compared to the same period in the prior year. Interest expense on borrowed funds increased $76,000, or 16.5%, for the three-month period when comparing 2021 to 2020, driven higher by $50,000 of FHLB interest prepayment penalties on the early payoff of an advance as well as $200,000 of interest expense accrued on subordinated debt. Despite these increases, interest expense in total was held to a low level due to the prepayment of many FHLB advances in 2020 which accelerated the interest expense to the prior year and will result in savings in 2021 and future years.
For the three months ended March 31, 2021, the net interest spread decreased by 46 basis points to 2.68%, compared to 3.14% for the three months ended March 31, 2020. The effect of non-interest bearing funds decreased to 18 basis points from 27 basis points for the three months ended March 31, 2021. The effect of non-interest bearing funds refers to the benefit gained from deposits on which the Corporation does not pay interest. As rates go higher, the benefit of non-interest bearing deposits increases because there is more difference between non-interest bearing funds and interest bearing liabilities. For example, if an interest checking account with $10,000 earns 1%, the benefit for $10,000 of non-interest bearing deposits is equivalent to $100; but if the interest-checking rate is increased to 1.50%, then the benefit of the non-interest bearing funds is $150. This assumes dollar-for-dollar replacement, which is not realistic, but demonstrates the way the higher cost of funds affects the benefit to non-interest bearing deposits.
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The Asset Liability Committee (ALCO) carefully monitors the NIM because it indicates trends in net interest income, the Corporation’s largest source of revenue. For more information on the plans and strategies in place to protect the NIM and moderate the impact of rising rates, refer to Item 7A: Quantitative and Qualitative Disclosures about Market Risk.
Provision for Loan Losses
The allowance for credit losses (ACL) provides for losses inherent in the loan portfolio as determined by a quarterly analysis and calculation of various factors related to the loan portfolio. The amount of the provision reflects the adjustment management determines necessary to ensure the ACL is adequate to cover any losses inherent in the loan portfolio. The Corporation recorded a provision expense of $375,000 for the three months ended March 31, 2021, compared to $350,000 for the three months ended March 31, 2020. The analysis of the ACL takes into consideration, among other things, the following factors:
| · | levels and trends in delinquencies, nonaccruals, charge-offs and recoveries, |
| · | trends within the loan portfolio, |
| · | changes in lending policies and procedures, |
| · | experience of lending personnel and management oversight, |
| · | national and local economic trends, |
| · | concentrations of credit, |
| · | external factors such as legal and regulatory requirements, |
| · | changes in the quality of loan review and board oversight, and |
| · | changes in the value of underlying collateral. |
As of March 31, 2021, total delinquencies represented 0.31% of total loans, compared to 0.67% as of March 31, 2020. These ratios are very low compared to local and national peer groups. The vast majority of the Corporation’s loan customers have remained steadfast in making their loan payments and avoiding delinquency, even during challenging economic conditions. The delinquency ratios speak to the long-term health, conservative nature, and, importantly, the character of the Corporation’s customers and lending practices. Classified loans are primarily determined by loan-to-value and debt-to-income ratios. The level of classified loans has decreased from March 31, 2020, to March 31, 2021, from 20.7% of regulatory capital to 14.7% of regulatory capital. The delinquency and classified loan information is utilized in the quarterly ACL calculation, which directly affects the provision expense. A sharp increase or decrease in delinquencies and/or classified loans during the quarter would be cause for management to increase or decrease the provision expense. The level of actual charge-offs relative to the amount of recoveries can also have a significant impact on the provision. Management had minimal charge-offs and recoveries in the first three months of 2021.
Generally, management will evaluate and adjust, if necessary, the provision expense each quarter based upon completion of the quarterly ACL calculation. Future provision amounts will generally depend on the amount of loan growth achieved versus levels of delinquent, non-performing, and classified loans, as well as charge-offs and recoveries.
In addition to the above, provision expense is impacted by three major components that are all included in the quarterly calculation of the ACL. First, specific allocations are made for any loans where management has determined an exposure that needs to be provided for. These specific allocations are reviewed each quarter to determine if adjustments need to be made. It is common for specific allocations to be reduced as additional principal payments are made, so while some specific allocations are being added, others are being reduced. Second, management provides for estimated losses on pools of similar loans based on historical loss experience. Finally, management utilizes qualitative factors every quarter to adjust historical loss experience to take into consideration the current trends in loan volume, delinquencies, charge-offs, changes in lending practices, and the quality of the Corporation’s underwriting, credit analysis, lending staff, and Board oversight. National and local economic trends and conditions are also helpful to determine the amount of loan loss allowance the Corporation should be carrying on the various types of loans. Management evaluates and adjusts, if necessary, the qualitative factors on a quarterly basis.
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In the first three months of 2021, qualitative factors were adjusted by management based on current internal information regarding trends in the nature and volume of the loan portfolio and delinquency. An increase in qualitative factors was made across one loan pool related to trends in the nature and volume of the loan portfolio. This factor was increased by 5 basis points since December 31, 2020. Other factors remained unchanged in the first three months of 2021.
Management also monitors the allowance as a percentage of total loans. The percentage of the allowance to total loans has increased since March 31, 2020, and remains higher than the Bank’s national peer group from the Uniform Bank Performance Reports. As of March 31, 2021, the allowance as a percentage of total loans was 1.51%, up from 1.28% at March 31, 2020, and 1.50% at December 31, 2020. Management continues to evaluate the ACL in relation to the size of the loan portfolio and changes to the segments within the loan portfolio and their associated credit risk. Management believes the ACL is adequate to provide for future loan losses based on the current portfolio and the current economic environment. More detail is provided under Allowance for Credit Losses in the Financial Condition section that follows.
Other Income
Other income for the first quarter of 2021 was $5,318,000, an increase of $2,551,000, or 92.2%, compared to the $2,767,000 earned during the first quarter of 2020. The following table details the categories that comprise other income. As illustrated in the tables below the primary contributor to the increase was the gains on the sales of mortgages.
OTHER INCOME
(DOLLARS IN THOUSANDS)
| Three Months Ended March 31, | Increase (Decrease) | |||||||||||||||
| 2021 | 2020 | |||||||||||||||
| $ | $ | $ | % | |||||||||||||
| Trust and investment services | 670 | 622 | 48 | 7.7 | ||||||||||||
| Service charges on deposit accounts | 248 | 315 | (67 | ) | (21.3 | ) | ||||||||||
| Other service charges and fees | 366 | 364 | 2 | 0.5 | ||||||||||||
| Commissions | 864 | 686 | 178 | 25.9 | ||||||||||||
| Gains on securities transactions, net | 87 | 282 | (195 | ) | (69.1 | ) | ||||||||||
| Gains (losses) on equity securities, net | 248 | (230 | ) | 478 | >100% | |||||||||||
| Gains on sale of mortgages | 1,930 | 541 | 1,389 | 256.7 | ||||||||||||
| Earnings on bank owned life insurance | 216 | 206 | 10 | 4.9 | ||||||||||||
| Other miscellaneous income (loss) | 689 | (19 | ) | 708 | >100% | |||||||||||
| Total other income | 5,318 | 2,767 | 2,551 | 92.2 | ||||||||||||
Trust and investment services income increased $48,000, or 7.7%, for the three months ended March 31, 2021, compared to the same period last year. This revenue consists of income from traditional trust services and income from alternative investment services provided through a third party. In the first quarter of 2021, traditional trust income increased by $61,000, or 16.1%, while income from alternative investments decreased by $13,000, or 5.2%, compared to the first quarter of 2020. The decline in income from the investment services area can be attributed to less new business, which was impacted by COVID-19 and the branch lobby closures during 2020. Management would expect activity to increase again going into the remainder of 2021. The trust and investment services area continues to be an area of strategic focus for the Corporation. Management believes there continues to be great need for retirement, estate, small business succession planning, and personal investment services in the Corporation’s service area. Management also sees these services as being a necessary part of a comprehensive line of financial solutions across the organization.
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Service charges on deposit accounts decreased by $67,000, or 21.3%, for the three months ended March 31, 2021, compared to the same period in 2020. The decrease is primarily due to a decrease in overdraft fees that were lower by $72,000, or 27.3%, for the three months ended March 31, 2021, compared to the same period in 2020. This decline can be primarily attributed to the current economic environment, which has necessitated changes in customer behaviors. Various other fee income categories increased or decreased to lesser degrees making up the remainder of the variance compared to the prior year.
Commissions increased by $178,000, or 25.9%, for the three months ended March 31, 2021, compared to the same period in 2020. This increase was primarily caused by an increase in debit card interchange income of $164,000, or 28.4%. The interchange income is a direct result of the volume of debit card transactions processed and this income is increasing as customers utilize electronic payments more.
For the three months ended March 31, 2021, $87,000 of gains on securities transactions were recorded, compared to gains of $282,000 for the same period in 2020. Gains or losses on securities transactions fluctuate based on market opportunities to take gains and reposition the securities portfolio to improve long-term earnings, or as part of management’s asset liability goals to improve liquidity or reduce interest rate risk or fair value risk. The gains or losses recorded by the Corporation depend heavily on market pricing and the volume of security sales. Generally, the lower U.S. Treasury yields go, the more management will be motivated to pursue taking gains from the sale of securities. However, these market opportunities are evaluated subject to the Corporation’s other asset liability measurements and goals. The yield curve in the first three months of 2021 provided fewer opportunities to take gains out of the portfolio than during the first three months of 2020.
Gains on equity securities amounted to $248,000 during the first three months of 2021, comared to a loss of $230,000 in the prior year. This represents an increase in income of $478,000 for the first quarter of 2021 compared to the first quarter of 2020. Gains or losses on equity securities are impacted by actual sales of securities as well as changes in the market value of these securities since market value gains and losses are recorded through income. In the first three months of 2021, $95,000 of gains were recorded on the sale of bank stocks and $153,000 was recorded as an unrealized gain due to the increase in market value of the bank stock portfolio. During the first three months of 2020, unrealized losses of $230,000 were recorded due to the decline in bank stock prices as the COVID-19 pandemic began and negatively impacted the market.
Gains on the sale of mortgages were $1,930,000 for the three-month period ended March 31, 2021, compared to $541,000 for the same period in 2020, a $1,389,000, or 256.7% increase. Mortgage activity was significantly higher in the first three months of 2021 compared to the prior year as a result of historically low interest rates and a surge in mortgage refinancing activity. Even with market rates increasing slightly in the first quarter of 2021, refinance activity continued at record levels. Management currently anticipates that gains throughout the remainder of 2021 may decrease slightly compared to the prior year, due to the increase in market rates that will likely result in a slowdown of mortgage activity, as well as lower margins received on mortgages sold.
For the three months ended March 31, 2021, earnings on bank-owned life insurance (BOLI) increased by $10,000, or 4.9%, compared to the same period in 2020. The amount of BOLI income is generally dependent upon the actual return of the policies, the insurance cost components, and any benefits paid upon death that exceed the policy’s cash surrender value. Increases in cash surrender value are a function of the return of the policy net of all expenses.
The miscellaneous income category increased by $708,000, for the three months ended March 31, 2021, compared to the same period in 2020. The quarterly increase can be primarily attributed to net mortgage servicing income, which increased by $263,000 in 2021 compared to 2020 due to much lower levels of mortgage servicing asset amortization in 2021. The slightly higher interest rate environment resulted in this lower level of amortization. Other miscellaneous income categories increased as well making up the remainder of the variance in this category.
Operating Expenses
Operating expenses for the first quarter of 2021 were $9,187,000, an increase of $77,000, or 0.8%, compared to the $9,110,000 for the first quarter of 2020. The following table provides details of the Corporation’s operating expenses for the three-month period ended March 31, 2021, compared to the same period in 2020.
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OPERATING EXPENSES
(DOLLARS IN THOUSANDS)
| Three Months Ended March 31, | ||||||||||||||||
| 2021 | 2020 | Increase (Decrease) | ||||||||||||||
| $ | $ | $ | % | |||||||||||||
| Salaries and employee benefits | 5,699 | 5,696 | 3 | 0.1 | ||||||||||||
| Occupancy expenses | 683 | 591 | 92 | 15.6 | ||||||||||||
| Equipment expenses | 267 | 290 | (23 | ) | (7.9 | ) | ||||||||||
| Advertising & marketing expenses | 190 | 274 | (84 | ) | (30.7 | ) | ||||||||||
| Computer software & data processing expenses | 1,098 | 706 | 392 | 55.5 | ||||||||||||
| Bank shares tax | 280 | 239 | 41 | 17.2 | ||||||||||||
| Professional services | 439 | 623 | (184 | ) | (29.5 | ) | ||||||||||
| Other operating expenses | 531 | 691 | (160 | ) | (23.2 | ) | ||||||||||
| Total Operating Expenses | 9,187 | 9,110 | 77 | 0.8 | ||||||||||||
Salaries and employee benefits are the largest category of operating expenses. In general, they comprise approximately 62% of the Corporation’s total operating expenses. For the three months ended March 31, 2021, salaries and benefit costs remained nearly the same as 2020. This has resulted in better operational efficiency as the Corporation’s total assets have grown dramatically since the prior year, but salaries and benefit costs have remained static resulting in overall improvements in efficiency.
Occupancy expenses consist of the following:
| · | Depreciation of bank buildings |
| · | Real estate taxes and property insurance |
| · | Building lease expense |
| · | Utilities |
| · | Building repair and maintenance |
Occupancy expenses increased by $92,000, or 15.6% for the three months ended March 31, 2021, compared to the same period in the prior year. Snow removal costs alone increased by $43,000, or 300.6%, and utilities costs increased by $20,000, or 10.9%, for the first quarter of 2021, compared to the same period in the prior year. In addition, building repair and maintenance costs increased $16,000, or 44.9% for the same time period. Other occupancy costs increased or decreased by smaller amounts making up the remainder of the variance in this category.
Equipment expenses decreased by $23,000, or 7.9%, for the three months ended March 31, 2021, compared to the same period in the prior year. The decrease in this category is primarily related to depreciation on existing furniture and equipment which decreased by $28,000, or 15.0%. This decline can be attributed to depreciation streams ending on furniture and equipment purchased in prior years with new purchases of furniture and equipment only partially offsetting this decline.
Advertising and marketing expenses decreased by $84,000, or 30.7%, for the three months ended March 31, 2021, compared to the same period in 2020. These expenses can be further broken down into two categories, marketing expenses and public relations. The marketing expenses decreased by $60,000, or 34.9%, for the quarter-to-date period ended March 31, 2021, compared to the same period in the prior year. Public relations expenses decreased by $24,000, or 23.9%, for the three months ended March 31, 2021, compared to the same period in 2020. Marketing expenses support the overall business strategies of the Corporation; therefore, the timing of these expenses is highly dependent upon the execution of those strategies.
Computer software and data processing expenses increased by $392,000, or 55.5%, for the first quarter of 2021 compared to 2020. Software-related expenses were up by $336,000, or 81.3%, as a result of purchasess of new software platforms to support the strategic initiatives of the Corporation as well as higher amortization on software purchased in the prior year. Software expenses are likely to continue to increase in 2021, but the actual increase will be dependent on how quickly new software platforms are identified, analyzed, approved and placed into service. Data processing fees were up $56,000, or 19.1%, for the three months ended March 31, 2021, compared to the same period in 2020.
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Bank shares tax expense was $280,000 for the first quarter of 2021, an increase of $41,000, or 17.2%, from the first quarter of 2020. Two main factors determine the amount of bank shares tax: the ending value of shareholders’ equity and the ending value of tax-exempt U.S. obligations. The shares tax calculation uses a period-end balance of shareholders’ equity and a tax rate of 0.95%. The increase in 2021 can be primarily attributed to the Corporation’s growing value of shareholders’ equity.
Professional services expense decreased by $184,000, or 29.5%, for the three-month periods ended March 31, 2021, compared to the same period in 2020. These services include accounting and auditing fees, legal fees, and fees for other third-party services. These fees were elevated in the first quarter of 2020 due to implementation expenses related to a consumer loan platform. Several other professional services expenses increased or decreased slightly making up the remainder of the variance.
Other operating expenses decreased by $160,000, or 23.2%, for the three-month period ended March 31, 2021, compared to the same period in 2020. Contributing to this decrease, fraud-related charges-offs decreased by $88,000, operating supplies decreased by $44,000, or 43.8%, loan-related expenses decreased by $35,000, or 35.8%, and travel costs decreased by $34,000, or 74.1%. Partially offsetting these decreases, FDIC insurance costs increased by $86,000 for the three months ended March 31, 2021, compared to the first quarter of the prior year. Several other operating expense categories increased or decreased by smaller amounts making up the remainder of this variance.
Income Taxes
For the three months ended March 31, 2021, the Corporation recorded Federal income tax expense of $931,000, compared to $358,000 for the three months ended March 31, 2020. The effective tax rate for the Corporation was 17.1% for the three months ended March 31, 2021, and 14.2% for the three months ended March 31, 2020. Certain items of income are not subject to Federal income tax, such as tax-exempt interest income on loans and securities, and BOLI income; therefore, the effective income tax rate for the Corporation is lower than the stated tax rate. The effective tax rate is calculated by dividing the Corporation’s provision for Federal income taxes on the Consolidated Statements of Income by the income before income taxes for the applicable period.
The Corporation’s effective tax rate has historically been maintained at low levels primarily due to a relatively high level of tax-free municipal bonds held in the securities portfolio. The fluctuation of the effective tax rate will occur as a result of total tax-free revenue as a percentage of total revenue.
The Corporation is also subject to Pennsylvania Corporate Net Income Tax; however, the Corporation’s Holding Company has very limited taxable corporate net income activities. The Corporation’s wholly owned subsidiary, Ephrata National Bank, is subject to Pennsylvania Bank Shares Tax. Like Federal Corporate income tax, the Pennsylvania Bank Shares Tax is a significant expense for the Corporation, amounting to $280,000 in the first three months of 2021 compared to $239,000 in 2020. The Bank Shares Tax expense appears on the Corporation’s Consolidated Statements of Income, under operating expenses.
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Financial Condition
Investment Securities
The Corporation classifies all of its debt securities as available for sale and reports the portfolio at fair value. As of March 31, 2021, the Corporation had $538.8 million of securities available for sale, which accounted for 35.2% of assets, compared to 33.1% as of December 31, 2020, and 27.8% as of March 31, 2020. Based on ending balances, the securities portfolio increased 64.7% from March 31, 2020, and 11.4% from December 31, 2020.
The debt securities portfolio was showing a net unrealized gain of $3,703,000 as of March 31, 2021, compared to an unrealized gain of $10,072,000 as of December 31, 2020, and an unrealized gain of $1,396,000 as of March 31, 2020. The valuation of the Corporation’s securities portfolio, predominately debt securities, is impacted by both the U.S. Treasury rates and the perceived forward direction of interest rates. The 10-year U.S. Treasury yield was 0.70% as of March 31, 2020, 0.93% as of December 31, 2020, and 1.74% as of March 31, 2021. The lower Treasury rates have caused an increase in market valuation, which has resulted in the unrealized gains recorded at March 31, 2021, December 31, 2020, and March 31, 2020. Gains were lower as of March 31, 2021, compared to the end of 2020 due to the increase in Treasury rates experienced in the first quarter of 2021. Additionally, with the Federal Reserve’s sudden overnight rate decreases in March of 2020, the variable rate portion of the Corporation’s security portfolio lost market value due to the market’s recognition that these instruments would yield materially less going forward which resulted in the lower levels of unrealized gains at March 31, 2020.
The table below summarizes the Corporation’s amortized cost, unrealized gain or loss position, and fair value for each sector of the securities portfolio for the periods ended March 31, 2021, December 31, 2020, and March 31, 2020.
AMORTIZED COST AND FAIR VALUE OF SECURITIES HELD
(DOLLARS IN THOUSANDS)
| Net | ||||||||||||
| Amortized | Unrealized | Fair | ||||||||||
| Cost | Gains (Losses) | Value | ||||||||||
| $ | $ | $ | ||||||||||
| March 31, 2021 | ||||||||||||
| U.S. government agencies | 29,623 | (443 | ) | 29,180 | ||||||||
| U.S. agency mortgage-backed securities | 67,875 | 708 | 68,583 | |||||||||
| U.S. agency collateralized mortgage obligations | 40,214 | 572 | 40,786 | |||||||||
| Asset-backed securities | 96,592 | 408 | 97,000 | |||||||||
| Corporate bonds | 66,376 | 768 | 67,144 | |||||||||
| Obligations of states and political subdivisions | 227,217 | 1,690 | 228,907 | |||||||||
| Total debt securities, available for sale | 527,897 | 3,703 | 531,600 | |||||||||
| Equity securities | 7,117 | 100 | 7,217 | |||||||||
| Total securities | 535,014 | 3,803 | 538,817 | |||||||||
| December 31, 2020 | ||||||||||||
| U.S. government agencies | 54,224 | 137 | 54,361 | |||||||||
| U.S. agency mortgage-backed securities | 69,777 | 1,275 | 71,052 | |||||||||
| U.S. agency collateralized mortgage obligations | 34,449 | 586 | 35,035 | |||||||||
| Asset-backed securities | 60,387 | 88 | 60,475 | |||||||||
| Corporate bonds | 60,387 | 1,336 | 61,723 | |||||||||
| Obligations of states and political subdivisions | 187,132 | 6,650 | 193,782 | |||||||||
| Total debt securities | 466,356 | 10,072 | 476,428 | |||||||||
| Equity securities | 7,158 | (53 | ) | 7,105 | ||||||||
| Total securities | 473,514 | 10,019 | 483,533 | |||||||||
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| Net | ||||||||||||
| Amortized | Unrealized | Fair | ||||||||||
| Cost | Gains (Losses) | Value | ||||||||||
| $ | $ | $ | ||||||||||
| March 31, 2020 | ||||||||||||
| U.S. government agencies | 10,378 | 150 | 10,528 | |||||||||
| U.S. agency mortgage-backed securities | 60,464 | 1,052 | 61,516 | |||||||||
| U.S. agency collateralized mortgage obligations | 55,834 | 787 | 56,621 | |||||||||
| Asset-backed securities | 28,969 | (1,854 | ) | 27,115 | ||||||||
| Corporate bonds | 64,429 | (1,623 | ) | 62,806 | ||||||||
| Obligations of states and political subdivisions | 99,098 | 2,884 | 101,982 | |||||||||
| Total debt securities | 319,172 | 1,396 | 320,568 | |||||||||
| Equity securities | 6,847 | (207 | ) | 6,640 | ||||||||
| Total securities available for sale | 326,019 | 1,189 | 327,208 | |||||||||
Interest rate changes and the perceived forward direction of interest rates generally have a close relationship to the valuation of the Corporation’s fixed income securities portfolio. There are also a number of other market factors that impact bond prices. During the second half of 2019, the Federal Reserve decreased short-term rates three times for a total of 75 basis points, and during the first quarter of 2020, the Federal Reserve decreased short-term rates two times for a total of 150 basis points. Market conditions in the first quarter of 2020 were very unpredictable and fast changing due to the start of COVID-19 and the declaration of a global pandemic on March 11, 2020. The Fed’s reduction of interest rates was in response to this pandemic and caused short-term and long-term Treasury rates to decline at a rapid pace to reach all-time lows. During the first quarter of 2021, rates on the longer end of the yield curve did increase causing slight declines in the unrealized gains on the investment portfolio. The COVID-19 pandemic continues to have significant impacts on rates and the economy and management believes this will continue throughout 2021, but the absolute value and direction of Treasury rates could fluctuate as the pandemic recovery reaches new levels. Beyond interest rate movements, there are also a number of other factors that influence bond pricing including regulatory changes, financial performance of issuers, changes to credit rating of insurers of bonds, changes in market perception of certain classes of securities, and many more. Management monitors the changes in interest rates and other market influences to assist in management of the securities portfolio.
Any material increase in market interest rates would have a negative impact on the market value of the Corporation’s fixed income debt securities. As of March 31, 2021, approximately 75% of the Corporation’s debt securities were fixed rate securities with the other 25% variable rate. The variable rate instruments generally experience very little impact to valuation based on a change in rates because they trade on a spread over overnight rates such as LIBOR. However, with the Federal Reserve drastically reducing the Federal Funds rate by 1.50% in March of 2020 to 0.25%, caused the market to view floating rate bonds differently, as the new effective yields on those securities would be significantly reduced upon the next rate reset. Whereas fixed rate securities without call options could maintain their effective yield in a new bond market with sharply lower yields. Therefore, the valuation of the fixed rate securities held up better when the securities portfolio was valued for March 31, 2020. Since that time, the pricing of variable rate instruments has become more rational and most bonds have experienced an increase in unrealized gain since March of 2020. Generally the longer the bond and the longer the call protection, the better the bond did in terms of valuation. The municipal bond sector is the largest of the portfolio and, as a result, management will closely monitor the 10-year U.S. Treasury yield due to its impact on these securities. The other sectors of the portfolio have shorter lives and duration and would be more influenced by the 2-year and 5-year U.S. Treasury rates. The change in value of unrealized gains and losses for the remainder of 2021 will be impacted by movements in U.S. Treasury rates and could increase and decrease throughout the remainder of the year as Treasury rates fluctuate.
The Corporation’s effective duration increased in the first quarter of 2021 to 3.5, from 2.7 at December 31, 2020. Effective duration is a measurement of the length of the securities portfolio with a higher level indicating more length and more exposure to an increase in interest rates. The securities portfolio base case effective duration was 2.2 as of March 31, 2020. Duration is expected to remain stable or increase slightly throughout the remainder of 2021. The Corporation increased effective duration by purchasing longer asset backed and municipal securities in the first quarter of 2021. Additionally, with increasing rates, pass-through structures of MBS and CMO instruments typically lengthen in duration as principal payments decrease.
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Management’s actions to maintain reasonable effective duration of the securities portfolio are part of a broader asset liability plan to continually work to mitigate future interest rate risk and fair value risk to the Corporation. Part of that strategy is to retain higher levels of cash and cash equivalents to increase liquidity and provide an immediate hedge against higher interest rates and fair value risk. However, despite taking actions to mitigate the Corporation’s future risk, these risks are inherent to the banking model. Unrealized gains and losses on securities will vary significantly according to market forces. Management’s focus will continue to be on the long-term performance of these securities. While management has and will continue to take gains from the portfolio when opportunities exist, the broader securities strategy remains to buy and hold debt securities until maturity. Because market interest rates were declining rapidly in 2020, there was some opportunity to realize gains from the sales of securities. As a result, gains from the sales of debt securities were higher in the first quarter of 2020 than the first quarter of 2021.
The Corporation typically invests excess liquidity into securities, primarily fixed-income bonds. The securities portfolio provides interest and dividend income to supplement the interest income on loans. Additionally, the securities portfolio assists in the management of both liquidity risk and interest rate risk. In order to provide maximum flexibility for management of liquidity and interest rate risk, the securities portfolio is classified as available for sale and reported at fair value. Management adjusts the value of all the Corporation’s securities on a monthly basis to fair market value as determined in accordance with U.S. generally accepted accounting principles. Management has the ability and intent to hold all debt securities until maturity, and does not generally record impairment on bonds that are currently valued below book value. In addition to the fixed and variable rate bonds, the Corporation’s equity holdings consist of a small CRA-qualified mutual fund with a book and fair market value of $6.2 million. The CRA fund is a Small Business Association (SBA) variable rate fund with a stable dollar price. The Corporation also has a small portfolio of bank stocks with a book value of $927,000 and fair market value of $1,027,000 as of March 31, 2021. The fair value of the bank stocks was significantly impacted by the COVID-19 pandemic and the drastic devaluation of bank stocks during 2020 but has rebounded as of March 31, 2021, and is responsible for the large increase in gains on equity securities reported as of March 31, 2021.
All securities and bonds are evaluated for impairment on a quarterly basis. Should any impairment occur, management would write down the security to a fair market value in accordance with U.S. generally accepted accounting principles, with the amount of the write down recorded as a loss on securities.
Each quarter, management sets portfolio allocation guidelines and adjusts the security portfolio strategy generally based on the following factors:
| · | ALCO positions as to liquidity, credit risk, interest rate risk, and fair value risk |
| · | Growth of the loan portfolio |
| · | Slope of the U.S. Treasury curve |
| · | Relative performance of the various instruments, including spread to U.S. Treasuries |
| · | Duration and average length of the portfolio |
| · | Volatility of the portfolio |
| · | Direction of interest rates |
| · | Economic factors impacting debt securities |
The investment policy of the Corporation imposes guidelines to ensure diversification within the portfolio. The diversity specifications provide opportunities to shorten or lengthen duration, maximize yield, and mitigate credit risk. The composition of the securities portfolio based on fair market value is shown in the following table.
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SECURITIES PORTFOLIO
(DOLLARS IN THOUSANDS)
| Period Ending | ||||||||||||||||||||||||
| March 31, 2021 | December 31, 2020 | March 31, 2020 | ||||||||||||||||||||||
| $ | % | $ | % | $ | % | |||||||||||||||||||
| U.S. government agencies | 29,180 | 5.4 | 54,361 | 11.2 | 10,528 | 3.2 | ||||||||||||||||||
| U.S. agency mortgage-backed securities | 68,583 | 12.7 | 71,052 | 14.7 | 61,516 | 18.8 | ||||||||||||||||||
| U.S. agency collateralized mortgage obligations | 40,786 | 7.6 | 35,035 | 7.2 | 56,621 | 17.3 | ||||||||||||||||||
| Asset-backed securities | 97,000 | 18.0 | 60,475 | 12.5 | 27,115 | 8.3 | ||||||||||||||||||
| Corporate debt securities | 67,144 | 12.5 | 61,723 | 12.8 | 62,806 | 19.2 | ||||||||||||||||||
| Obligations of states and political subdivisions | 228,907 | 42.5 | 193,782 | 40.1 | 101,982 | 31.2 | ||||||||||||||||||
| Total debt securities, available for sale | 531,600 | 98.7 | 476,428 | 98.5 | 320,568 | 98.0 | ||||||||||||||||||
| Marketable equity securities | 7,217 | 1.3 | 7,105 | 1.5 | 6,640 | 2.0 | ||||||||||||||||||
| Total securities | 538,817 | 100.0 | 483,533 | 100.0 | 327,208 | 100.0 | ||||||||||||||||||
The largest movements within the securities portfolio were shaped by market factors, such as:
| · | slope of the U.S. Treasury curve and projected forward rates |
| · | interest spread versus U.S. Treasury rates on the various securities |
| · | pricing of the instruments, including supply and demand for the product |
| · | structure of the instruments, including duration and average life |
| · | portfolio weightings versus policy guidelines |
| · | prepayment speeds on mortgage-backed securities and collateralized mortgage obligations |
| · | credit risk of each instrument and risk-based capital considerations |
| · | Federal income tax considerations with regard to obligations of tax-free states and political subdivisions. |
The Corporation’s U.S. government agency sector decreased by $25.2 million, or 46.3%, since December 31, 2020, with the weighting decreased from 11.2% of the portfolio to 5.4%. Management had purchased $35.5 million of short-term discount notes at the end of 2020 to offset the Corporation’s shares tax expense. These bonds were sold in the first quarter of 2021 and are responsible for the decline in this category. In the past, management’s goal was to maintain agency securities at approximately 10% of the securities portfolio. In the current rate environment, management is comfortable maintaining agencies below this level. In the past, this sector was important in maintaining adequate risk weightings of the portfolio and to ensure sufficient U.S. government securities for pledging purposes, as was utilizing both mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs) to do the same. Instead, Management has increased the allocations of both asset-backed securities (ABS) and obligations of states and political subdivisions (municipals) since March 31, 2020.
The Corporation’s ABS and municipal sectors have increased significantly since March 31, 2020, with ABS increasing $69.9 million, or 257.7%, and municipals increasing $126.9 million, or 124.5%. ABS securities are floating rate student loan pools which are instruments that will perform well in a rates-up environment and offset the interest rate risk of the longer fixed-rate municipal bonds. These securities provide a variable rate return materially above the overnight Federal funds rate in a safe investment with a risk rating very similar to that of U.S. Agency bonds. The asset-backed securities generally provide monthly principal and interest payments to complement the Corporation’s ongoing cash flows. With liquidity and cash levels remaining high, management views the ABS sector as a safe, higher yielding option than cash with the qualities of cash in a rates-up environment.
Obligations of states and political subdivisions, or municipal bonds, are tax-free and taxable securities that generally provide the highest yield in the securities portfolio. They also carry the longest duration on average of any instrument in the securities portfolio. Municipal tax-equivalent yields generally start well above other taxable bonds. These instruments also experience significant fair market value gains and losses when interest rates decrease and increase. Municipal securities were purchased throughout 2020 and the first quarter of 2021 due to market conditions that led to favorable yields on some instruments. The Corporation also began purchasing some taxable municipal securities that added to the value of this sector. Municipal bonds represented 42.5% of the securities portfolio as of March 31, 2021, compared to 31.2% as of March 31, 2020. The Corporation’s investment policy limits municipal holdings to 150% of Tier 2 capital. As of March 31, 2021, municipal holdings amounted to 153% of Tier 2 capital, slightly above this limit. The Corporation plans to sell some municipal bonds to be back within policy guidelines by June 30, 2021.
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The Corporation’s U.S. agency MBS and CMO sectors have fluctuated since March 31, 2020, with MBS increasing $7.1 million, or 11.5%, and CMOs decreasing $15.8 million, or 28.0%. These two security types both consist of mortgage instruments that pay monthly interest and principal, however the behavior of the two types vary according to the structure of the mortgage pool or CMO instrument. Management desires to maintain a substantial amount of MBS and CMOs in order to assist in adding to and maintaining a stable five-year ladder of cash flows, which is important in providing stable liquidity and interest rate risk positions. Unlike the typical U.S. agency paper, corporate bonds, and obligations of states and political subdivisions, which only pay principal at final maturity, the U.S. agency MBS and CMO securities pay contractual monthly principal and interest, but are also subject to additional prepayment of principal. The combined effect of all of these instruments paying monthly principal and interest provides the Corporation with a reasonably stable base cash flow of approximately $2.5 - $3.0 million per month. Cash flows coming off of MBS and CMOs do slow down and speed up as interest rates increase or decrease, which has an impact on the portfolio’s length and yield. As interest rates decline, prepayment of principal on securities increases, the duration of the security shortens, and the yield declines as more amortization is required on premium bonds. When interest rates increase, the opposite of this occurs. Despite the fluctuations that occur in terms of monthly cash flow as a result of changing prepayment speeds, the monthly cash flow generated by U.S. agency MBS and CMO securities is reasonably stable and as a group is material, and helps to soften or smooth out the Corporation’s total monthly cash flow from all securities.
As of March 31, 2021, the fair value of the Corporation’s corporate bonds increased by $4.3 million, or 6.9%, from balances at March 31, 2020. Like any security, corporate bonds have both positive and negative qualities and management must evaluate these securities on a risk versus reward basis. Corporate bonds add diversity to the portfolio and provide strong yields for short maturities; however, by their very nature, corporate bonds carry a high level of credit risk should the entity experience financial difficulties. Management stands to possibly lose the entire principal amount if the entity that issued the corporate paper fails. As a result of the higher level of credit risk taken by purchasing a corporate bond, management has in place procedures to closely analyze the financial health of the company as well as policy guidelines. The guidelines include both maximum investment by issuer and minimal credit ratings that must be met in order for management to purchase a corporate bond. Financial analysis is conducted prior to every corporate bond purchase with ongoing monitoring performed on all securities held.
By policy, management is to identify and recommend whether to hold or sell securities with credit ratings that have fallen below minimum policy credit ratings required at the time of purchase, or below investment grade. Management monitors the security ratings on a monthly basis and reviews quarterly with the Board of Directors. Management, with Board approval, determines whether it is in the Corporation’s best interest to continue to hold any security that has fallen below policy guidelines or below investment grade based on the expectation of recovery of market value or improved performance. At this time management has elected, and the Board has approved, holding all securities that have fallen below initial policy guidelines. As of March 31, 2021, no securities have fallen below investment grade.
As of March 31, 2021, two of the 35 corporate securities held by the Corporation showed an unrealized holding loss. These securities with unrealized holding losses were valued at 99.7% of book value. The Corporation’s investment policy requires that corporate bonds have a minimum credit rating of A3 by Moody’s or A- by S&P or Fitch at the time of purchase, or an average or composite rating of A-. As of March 31, 2021, all but one of the corporate bonds had at least one A3 or A- rating by one of the two predominate credit rating services, Moody’s and S&P. One corporate bond had a total book value of $2.0 million, and did not have an A3 or A- rating as of March 31, 2021. The bond was rated Moody’s Baa1 and S&P BBB+, which are two levels above the minimum required to be considered investment grade. Management conducts ongoing monitoring of this security and has chosen to continue to hold the bond with Board approval. In addition, there are fifteen corporate bond instruments that have split ratings with the highest rating within the Corporation’s initial purchase policy guidelines and the lower rating outside of management guidelines, but all are still investment grade. The fifteen bonds have a book value of $24.4 million with a $391,000 unrealized gain as of March 31, 2021. Management conducts ongoing monitoring of these bonds with the Board approving holding these securities on a quarterly basis. In addition, the Corporation purchased $1,000,000 of a 4% subordinated debt note in the fourth quarter of 2020 and $750,000 of a $3.5% subordinated debt note in the first quarter of 2021, both of which are unrated. These are considered corporate bonds as they each are subordinated debt of a domestic community bank but are unrated because they are not a typical corporate issuance. Currently, there are no indications that any of these bonds would discontinue contractual payments.
The Corporation’s investment policy requires that municipal bonds not carrying any insurance coverage have a minimum credit rating of A3 by Moody’s or A- by S&P or Fitch at the time of purchase. As of March 31, 2021, one municipal bond with a par value of $500,000 was unrated, and no other municipal bonds carried a credit rating under these levels.
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Management utilizes several municipal surveillance reports and engages an independent non-brokerage service third party to perform enhanced municipal credit evaluation. Management will typically sell municipal securities if negative trends in financial performance are found and/or ratings have declined to levels deemed unacceptable. As a result of the above monitoring and actions taken to proactively sell weaker municipal credits, the Corporation’s entire municipal bond portfolio consists of investment grade credits.
The entire securities portfolio is reviewed monthly for credit risk and evaluated quarterly for possible impairment. The Corporation’s municipal and corporate bonds present the largest credit risk and highest likelihood for any possible impairment. Due to the ability for corporate credit situations to change rapidly and ongoing nationwide concerns of pension obligations impacting municipalities, management continues to closely monitor all corporate and municipal securities.
Loans
Net loans outstanding increased by 9.9%, to $829.2 million at March 31, 2021, from $754.3 million at March 31, 2020. Net loans increased by 2.2%, an annualized rate of 9.0%, from $811.0 million at December 31, 2020. The following table shows the composition of the loan portfolio as of March 31, 2021, December 31, 2020, and March 31, 2020.
LOANS BY MAJOR CATEGORY
(DOLLARS IN THOUSANDS)
| March 31 | December 31, | March 31 | ||||||||||||||||||||||
| 2021 | 2020 | 2020 | ||||||||||||||||||||||
| $ | % | $ | % | $ | % | |||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||||||
| Commercial mortgages | 144,939 | 17.2 | 142,698 | 17.4 | 120,080 | 15.8 | ||||||||||||||||||
| Agriculture mortgages | 178,070 | 21.2 | 176,005 | 21.4 | 177,368 | 23.2 | ||||||||||||||||||
| Construction | 21,317 | 2.5 | 23,441 | 2.9 | 18,778 | 2.5 | ||||||||||||||||||
| Total commercial real estate | 344,326 | 40.9 | 342,144 | 41.7 | 316,226 | 41.5 | ||||||||||||||||||
| Consumer real estate (a) | ||||||||||||||||||||||||
| 1-4 family residential mortgages | 265,127 | 31.5 | 263,569 | 32.0 | 259,937 | 34.1 | ||||||||||||||||||
| Home equity loans | 10,614 | 1.3 | 10,708 | 1.3 | 10,741 | 1.4 | ||||||||||||||||||
| Home equity lines of credit | 70,898 | 8.4 | 71,290 | 8.7 | 68,633 | 9.0 | ||||||||||||||||||
| Total consumer real estate | 346,639 | 41.2 | 345,567 | 42.0 | 339,311 | 44.5 | ||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||
| Commercial and industrial | 111,036 | 13.2 | 97,896 | 11.9 | 63,670 | 8.4 | ||||||||||||||||||
| Tax-free loans | 16,233 | 1.9 | 10,949 | 1.3 | 16,582 | 2.2 | ||||||||||||||||||
| Agriculture loans | 18,466 | 2.2 | 20,365 | 2.5 | 20,733 | 2.7 | ||||||||||||||||||
| Total commercial and industrial | 145,735 | 17.3 | 129,210 | 15.7 | 100,985 | 13.3 | ||||||||||||||||||
| Consumer | 4,827 | 0.6 | 5,155 | 0.6 | 5,557 | 0.7 | ||||||||||||||||||
| Total loans | 841,527 | 100.0 | 822,076 | 100.0 | 762,079 | 100.0 | ||||||||||||||||||
| Less: | ||||||||||||||||||||||||
| Deferred loan fees (costs), net | (407 | ) | (1,294 | ) | (2,041 | ) | ||||||||||||||||||
| Allowance for credit losses | 12,690 | 12,327 | 9,803 | |||||||||||||||||||||
| Total net loans | 829,244 | 811,043 | 754,317 | |||||||||||||||||||||
| (a) | Residential real estate loans do not include mortgage loans serviced for others which totaled $253,527,000 as of March 31, 2021, $235,437,000 as of December 31, 2020, and $162,246,000 as of March 31, 2020. |
There was significant growth in the loan portfolio since March 31, 2020, and moderate growth since December 31, 2020. Most major loan categories showed an increase in balances from both time periods. Loan growth was significant in 2020 and continued with moderate growth in the first three months of 2021, primarily due to the PPP loans which were put on the books beginning in the second quarter of 2020 and continued into the first quarter of 2021.
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The consumer residential real estate category represents the largest group of loans for the Corporation. The consumer residential real estate category of total loans increased from $339.3 million on March 31, 2020, to $346.6 million on March 31, 2021, a 2.2% increase. This category includes closed-end fixed rate or adjustable-rate residential real estate loans secured by 1-4 family residential properties, including first and junior liens, and floating rate home equity loans. The 1-4 family residential mortgages account for the vast majority of residential real estate loans with fixed and floating home equity loans making up the remainder. Historically, the entire consumer residential real estate component of the loan portfolio has averaged close to 40% of total loans. As of March 31, 2020, this percentage was 44.5%, and as of March 31, 2021, it decreased to 41.2%. Management expects the consumer residential real estate category to increase throughout the remainder of 2021 due to a continued effort to increase mortgage volume, and the strategic decision to keep some shorter-term mortgages on the books as opposed to selling them on the secondary market. Although economic conditions for consumers have deteriorated with the COVID-19 pandemic, increased unemployment, and decreased consumer spending, the mortgage market continues to remain relatively strong as consumers refinance existing debt to lower rates. Market conditions have been changing rapidly throughout the first quarter of 2021 and the rest of the year is unpredictable, but management would expect mortgage volume to continue at fairly high levels from a historic perspective.
The first lien 1-4 family mortgages increased by $5.2 million, or 2.0%, from March 31, 2020, to March 31, 2021. These first lien 1-4 family loans made up 76.6% of the residential real estate total as of March 31, 2020, and 76.5% as of March 31, 2021. The vast majority of the first lien 1-4 family closed end loans consist of single family personal first lien residential mortgages and home equity loans, with the remainder consisting of 1-4 family residential non-owner-occupied mortgages. In the first quarter of 2021, mortgage production increased 3% over the previous quarter and was up 76% over the first quarter of 2020. Purchase money origination constituted 55% of the Corporation’s mortgage originations for the quarter, with construction-only and construction-permanent loans making up 51% of that mix. With continued heavy refinance activity, the percentage of mortgage originations going in the Corporation’s held for investment mortgage portfolio declined quarter-over-quarter, with more customers opting for held-for-sale fixed rate products. In the first quarter of 2021, 47% of all mortgage originations were held in the mortgage portfolio, 46% of which were adjustable rate mortgages. As of March 31, 2021, ARM balances were $124.7 million, representing 47.0% of the 1-4 family residential loan portfolio of the Corporation. The ARM product is beneficial to the Corporation as it limits the interest rate risk to a much shorter time period. Low rates continued to drive overall strong production volume and the gains on the sale of mortgages increased by 25% quarter-over-quarter.
As of March 31, 2021, the remainder of the residential real estate loans consisted of $10.6 million of fixed rate junior lien home equity loans, and $70.9 million of variable rate home equity lines of credit (HELOCs). This compares to $10.7 million of fixed rate junior lien home equity loans, and $68.6 million of HELOCs as of March 31, 2020. Therefore, combined, these two types of home equity loans increased from $79.3 million to $81.5 million, an increase of 2.8%. The majority of borrowers have been choosing variable rate HELOC loans in the historically low rate environment. With no sign of the Federal Reserve moving to increase rates, management expects HELOC activity to increase with customers choosing variable rate product over fixed rate product until rates begin to increase again.
Commercial real estate makes up 40.9% of total loans as of March 31, 2021, compared to 41.5% of total loans as of March 31, 2020. Within the commercial real estate segment, the increase has primarily been in commercial mortgages, with agriculture mortgages and construction loans remaining fairly stable. Agricultural mortgages increased marginally, by $0.7 million, or 0.4%, from $177.4 million as of March 31, 2020, to $178.1 million as of March 31, 2021. Dairy lending remains constrained with milk prices at three-year lows and it does not appear pricing will improve materially in the immediate future. There have been overcapacity issues resulting in some consolidation of the area’s larger milk producers. Several dairy farmers have left the industry or are in the process of doing so. While dairy remains the largest agricultural loan concentration, management believes dairy loans will decline as a percentage of total agricultural loans with other non-dairy agricultural areas growing. Currently, management is experiencing more growth in specialty crops and other areas outside of dairy like poultry and layers. Management anticipates that agricultural mortgages may increase through the remainder of 2021 as the economy stabilizes and more farmers move forward with capital improvements or expansion of current operations.
Commercial mortgages increased $24.9 million, or 20.7%, from balances at March 31, 2020. Commercial mortgages as a percentage of the total loan portfolio increased to 17.2% as of March 31, 2021, compared to 15.8% at March 31, 2020. New loan production in this segment is currently outpacing normal principal payments, pay downs, and payoffs. Commercial real estate loans have shown solid growth as a number of businesses move ahead on commercial projects. Management expects commercial real estate loans to remain stable as a percentage of the Corporation’s loans for the remainder of 2021.
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The Corporation’s commercial construction loan balances increased by $2.5 million, or 13.5%, from March 31, 2020 to March 31, 2021. Management was experiencing some demand for smaller residential builds like construction on existing lots but no new large scale projects. Commercial construction loans were 2.5% of the total loan portfolio as of March 31, 2020 and 2021.
The other area of commercial lending is non-real estate secured commercial lending, referred to as commercial and industrial lending. Commercial and industrial loans not secured by real estate accounted for 17.3% of total loans as of March 31, 2021, compared to 13.3% as of March 31, 2020. In scope, the commercial and industrial loan sector, at 17.3% of total loans, is significantly smaller than the commercial real estate sector at 40.9% of total loans. This is consistent with management’s credit preference for obtaining real estate collateral when making commercial loans. The balance of total commercial and industrial loans increased from $101.0 million at March 31, 2020, to $145.7 million at March 31, 2021, a 44.3% increase. This category of loans generally includes unsecured lines of credit, truck, equipment, and receivable and inventory loans, in addition to tax-free loans to municipalities. The balance at March 31, 2021, also includes the PPP loans, which has declined rapidly as these loans are forgiven by the SBA after businesses prove they used the funds for qualified expenses. Management anticipates that these loans will experience a significant decline in the remainder of 2021.
The Corporation provides credit to many small and medium-sized businesses. Much of this credit is in the form of Prime-based lines of credit to local businesses where the line may not be secured by real estate, but is based on the health of the borrower with other security interests on accounts receivable, inventory, equipment, or through personal guarantees. Commercial and industrial loans, including PPP loans, increased to $111.0 million at March 31, 2021, a $47.3 million, or 74.3% increase, from the $63.7 million at March 31, 2020. This increase was driven solely by the generation of PPP loans during the second and third quarters of 2020 and then again during the first quarter of 2021. The outstanding PPP loan balances were impacted by the forgiveness of some of the first round of PPP loans during the fourth quarter of 2020 and the first quarter of 2021, but new loan generation during the first quarter of 2021 offset some of the forgiven balances. The tax-free loans declined by $0.3 million, or 2.1%, from balances at March 31, 2020, and the commercial and industrial agricultural loans declined by $2.3 million, or 10.9%.
The consumer loan portfolio decreased to $4.8 million at March 31, 2021, from $5.6 million at March 31, 2020. Consumer loans made up 0.6% of total loans on March 31 2021, and 0.7% on March 31, 2020. The long-term trend over the past decade has seen homeowners turning to the equity in their homes to finance cars and education rather than traditional consumer loans that are generally unsecured. Slightly higher demand for unsecured credit is being outpaced by principal payments on existing loans resulting in the decrease in balances. Management anticipates that the Corporation’s level of consumer loans will likely remain stable as a percentage of the portfolio, as the need for additional unsecured credit is generally offset by those borrowers wishing to reduce debt levels and move away from the higher cost of unsecured financing relative to other forms of real estate secured financing.
Non-Performing Assets
Non-performing assets include:
| · | Nonaccrual loans |
| · | Loans past due 90 days or more and still accruing |
| · | Non-performing troubled debt restructurings |
| · | Other real estate owned |
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NON-PERFORMING ASSETS
(DOLLARS IN THOUSANDS)
| March 31, | December 31, | March 31, | ||||||||||
| 2021 | 2020 | 2020 | ||||||||||
| $ | $ | $ | ||||||||||
| Nonaccrual loans | 681 | 725 | 1,953 | |||||||||
| Loans past due 90 days or more and still accruing | 152 | 1,373 | 146 | |||||||||
| Troubled debt restructurings, non-performing | — | — | 1,117 | |||||||||
| Total non-performing loans | 833 | 2,098 | 3,216 | |||||||||
| Other real estate owned | — | — | — | |||||||||
| Total non-performing assets | 833 | 2,098 | 3,216 | |||||||||
| Non-performing assets to net loans | 0.10% | 0.25% | 0.43% | |||||||||
The total balance of non-performing assets decreased by $2.4 million, or 74.1%, and $1.3 million, or 60.3%, from balances at March 31, 2020 and December 31, 2020, respectively. The decrease from the prior periods was primarily due to lower levels of loans past due 90 days or more as well as a decrease in non-performing troubled debt restructurings (TDRs). There were no non-performing TDR loans as of March 31, 2021 or December 31, 2020. A TDR is a loan where management has granted a concession to the borrower from the original terms. A concession is generally granted in order to improve the financial position of the borrower and improve the likelihood of full collection by the lender. There were two non-performing TDRs as of March 31, 2020; an agriculture mortgage with a balance of $677,000 which had cash flow difficulties and a modification in payment terms; and a $439,000 real estate secured loan with a payment modification to allow annual interest and principal payments. Non-accrual loans decreased, by $1.3 million, or 65.1%, since March 31, 2020, and loans past due 90 days or more and still accruing were up slightly from the prior year period, and down more significantly, by $1.2 million, or 89.0% since December 31, 2020. The $1.3 million of non-accrual reduction that occurred between March 31, 2020 and December 31, 2020 was due to two commercial borrowers paying off their loans during the remainder of 2020. One commercial borrower with three non-accrual loans totaling over $1.0 million paid them off in the second quarter of 2020, while another commercial borrower with a $92,000 non-accrual loan was paid off in December 2020.
Management continues to monitor delinquency trends and the level of non-performing loans closely. At this time, management believes that the potential for material losses related to non-performing loans is decreasing with the level of delinquencies and non-performing loans lower than what was experienced throughout 2020.
There was no other real estate owned (OREO) as of March 31, 2021, December 31, 2020, or March 31, 2020.
Allowance for Credit Losses
The allowance for credit losses is established to cover any losses inherent in the loan portfolio. Management reviews the adequacy of the allowance each quarter based upon a detailed analysis and calculation of the allowance for credit losses. This calculation is based upon a systematic methodology for determining the allowance for credit losses in accordance with generally accepted accounting principles. The calculation includes estimates and is based upon losses inherent in the loan portfolio. The allowance calculation includes specific provisions for under-performing loans and general allocations to cover anticipated losses on all loan types based on historical losses. The calculation is also influenced by nine qualitative factors that are adjusted on a quarterly basis as needed. Based on the quarterly credit loss calculation, management will adjust the allowance for credit losses through the provision as necessary. Changes to the allowance for credit losses during the year are primarily affected by five main factors:
| · | Historical loan losses |
| · | Qualitative factor adjustments including levels of delinquent and non-performing loans |
| · | Growth trends of the loan portfolio |
| · | Recovery of loans previously charged off |
| · | Provision for loan losses |
Strong credit and collateral policies have been instrumental in producing a favorable history of loan losses for the Corporation. The Allowance for Credit Losses table below shows the activity in the allowance for credit losses for the three-month periods ended March 31, 2021 and March 31, 2020. At the bottom of the table, two benchmark percentages are shown. The first is net charge-offs as a percentage of average loans outstanding for the year. The second is the total allowance for credit losses as a percentage of total loans.
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ALLOWANCE FOR CREDIT LOSSES
(DOLLARS IN THOUSANDS)
| Three Months Ended | ||||||||
| March 31 | ||||||||
| 2021 | 2020 | |||||||
| $ | $ | |||||||
| Balance at January 1, | 12,327 | 9,447 | ||||||
| Loans charged off: | ||||||||
| Real estate | — | — | ||||||
| Commercial and industrial | — | — | ||||||
| Consumer | 14 | 6 | ||||||
| Total charged off | 14 | 6 | ||||||
| Recoveries of loans previously charged off: | ||||||||
| Real estate | — | (11 | ) | |||||
| Commercial and industrial | (1 | ) | (1 | ) | ||||
| Consumer | (1 | ) | — | |||||
| Total recovered | (2 | ) | (12 | ) | ||||
| Net loans charged off (recovered) | 12 | (6 | ) | |||||
| Provision charged to operating expense | 375 | 350 | ||||||
| Balance at March 31, | 12,690 | 9,803 | ||||||
| Net charge-offs as a % of average total loans outstanding | 0.00% | 0.00% | ||||||
| Allowance at end of period as a % of total loans | 1.51% | 1.28% | ||||||
Charge-offs for the three months ended March 31, 2021, were $14,000, compared to $6,000 for the same period in 2020. Management typically charges off unsecured debt over 90 days delinquent with little likelihood of recovery. In the first three months of 2021 and 2020, the Corporation charged off several smaller amounts related to consumer loans. Recoveries were also low in the first three months of 2020 and 2021 with only total recoveries of $2,000 in the first quarter of 2021 and $12,000 in the first quarter of 2020.
The allowance as a percentage of total loans represents the portion of the total loan portfolio for which an allowance has been provided. Management regularly reviews the overall risk profile of the loan portfolio and the impact that current economic trends have on the Corporation’s loans. The financial industry typically evaluates the quality of loans on a scale with “unclassified” representing healthy loans, “special mention” being the first indication of credit concern, and several successive classified ratings indicating further credit declines of “substandard,” “doubtful,” and, ultimately, “loss.”
The Corporation’s level of classified loans was $21.9 million on March 31, 2021, compared to $25.8 million on March 31, 2020. Total classified loans increased during 2020 but then decreased by December 31, 2020, and into the first quarter of 2021. Having more loans in a classified status could result in a larger allowance as higher amounts of projected historical losses and qualitative factors are attached to these loans. In addition to this impact, management performs a specific allocation test on these classified loans. There was $1.1 million of specifically allocated allowance against the classified loans as of March 31, 2021, $1.1 million of specific allocation as of December 31, 2020, and $114,000 of specific allocation as of March 31, 2020. The higher specific allocation at March 31, 2021 and December 31, 2020, is related to a customer with ongoing business concerns. Typically, as the classified loan balances fluctuate, the associated specific allowance applied to them fluctuates, resulting in a lower or higher required allowance.
The net charge-offs as a percentage of average total loans outstanding indicates the percentage of the Corporation’s total loan portfolio that has been charged off during the period, after reducing charge-offs by recoveries. The Corporation continues to experience low net charge-off percentages due to strong credit practices. Management continually monitors delinquencies, classified loans, and non-performing loans closely in regard to how they may impact charge-offs in the future. The actual charge-offs have been running at low levels, and management expects this to continue through the remainder of 2021. Management practices are in place to reduce the number and severity of losses. In regard to severely delinquent loans, management attempts to improve the Corporation’s collateral or credit position and, in the case of a loan workout, intervene to minimize additional charge-offs.
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The allowance as a percentage of total loans was 1.51% as of March 31, 2021, 1.50% as of December 31, 2020, and 1.28% as of March 31, 2020. Management anticipates that the allowance percentage will remain fairly stable during the remainder of 2021, as the allowance balance is increased with additional provision expense to account for loan growth throughout the year. It is typical for the allowance for credit losses to contain a small amount of excess reserves. Over the long term, management targets and excess reserve at approximately 5% knowing that the reserve can fluctuate. The excess reserve stood at 6.0% as of March 31, 2021. Management would anticipate that this unallocated portion of the allowance will decrease throughout the remainder of 2021.
Premises and Equipment
Premises and equipment, net of accumulated depreciation, decreased by $0.3 million, or 1.2%, to $24.7 million as of March 31, 2021, from $25.0 million as of March 31, 2020. As of March 31, 2021, $335,000 was classified as construction in process compared to $239,000 as of March 31, 2020. Fixed assets declined as a result of depreciation outpacing new purchases in 2021.
Regulatory Stock
The Corporation owns multiple forms of regulatory stock that is required in order to be a member of the Federal Reserve Bank (FRB) and members of banks such as the Federal Home Loan Bank (FHLB) and Atlantic Community Bankers Bank (ACBB). The Corporation’s $6.2 million of regulatory stock holdings as of March 31, 2021, consisted of $5.6 million of FHLB of Pittsburgh stock, $531,000 of FRB stock, and $37,000 of Atlantic Community Bancshares, Inc. stock, the Bank Holding Company of ACBB. All of these stocks are valued at a stable dollar price, which is the price used to purchase or liquidate shares; therefore, the investment is carried at book value and there is no fair market value adjustment.
The Corporation’s investment in FHLB stock is required for membership in the organization. The amount of stock required is dependent upon the relative size of outstanding FHLB borrowings and mortgage activity. Excess stock is typically repurchased from the Corporation at par if the borrowings decline to a predetermined level. The Corporation’s FHLB stock position was $5.6 million on March 31, 2021, $5.9 million on December 31, 2020, and $7.0 million on March 31, 2020, with no excess capital stock position. Any future stock repurchases would be the result of lower borrowing balances. Stock repurchases by the FHLB occur every quarter.
The 2021 first quarter dividend declaration made on FHLB stock by FHLB of Pittsburgh was at a 5.75% annualized yield on activity stock and 2.50% annualized yield on membership stock. Most of the Corporation’s dividend is based on the activity stock, which is based on the amount of borrowings and mortgage activity with FHLB.
Deposits
The Corporation’s total ending deposits at March 31, 2021, increased by $72.6 million, or 5.8%, and by $342.5 million, or 34.9%, from December 31, 2020, and March 31, 2020, respectively. Customer deposits are the Corporation’s primary source of funding for loans and securities. In the past few years, the economic concerns and volatility of the equity markets continued to lead customers to banks for safe places to invest money, despite historically low interest rates. The mix of the Corporation’s deposit categories has changed moderately since March 31, 2020, with the changes being a $216.2 million, or 59.4% increase in non-interest bearing demand deposit accounts, an $18.0 million, or 63.3% increase in interest bearing demand balances, a $29.5 million, or 30.9% increase in NOW balances, a $10.5 million, or 7.5% increase in money market account balances, an $81.1 million, or 36.5% increase in savings account balances, and a $12.8 million, or 9.7% decrease in time deposit balances.
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The growth across most categories of core deposit accounts is a direct result of the PPP funding, government stimulus payments, and the change in customer’s spending habits during the uncertain economic conditions brought on by COVID-19. Due to limited safe investment options outside of banks, the Corporation saw customers bring deposit funds back to regular core checking and savings accounts in an effort to provide safety and financial flexibility. With the decrease in rates that occurred during 2020, customer deposits increased with few options in the market to earn a higher return. Customers view demand deposit, money market and savings accounts as the safest, most convenient place to maintain funds for maximum flexibility. Management believes deposit balances may continue to increase, but at a slower pace, through the remainder of 2021.
The Deposits by Major Classification table, shown below, provides the balances of each category for March 31, 2021, December 31, 2020, and March 31, 2020.
DEPOSITS BY MAJOR CLASSIFICATION
(DOLLARS IN THOUSANDS)
| March 31, | December 31, | March 31, | ||||||||||
| 2021 | 2020 | 2020 | ||||||||||
| $ | $ | $ | ||||||||||
| Non-interest bearing demand | 580,003 | 534,853 | 363,766 | |||||||||
| Interest bearing demand | 46,509 | 47,092 | 28,479 | |||||||||
| NOW accounts | 125,101 | 137,279 | 95,604 | |||||||||
| Money market deposit accounts | 151,297 | 140,113 | 140,781 | |||||||||
| Savings accounts | 303,324 | 274,386 | 222,241 | |||||||||
| Time deposits | 119,153 | 119,088 | 131,981 | |||||||||
| Total deposits | 1,325,387 | 1,252,811 | 982,852 | |||||||||
The growth and mix of deposits is often driven by several factors including:
| · | Convenience and service provided |
| · | Current rates paid on deposits relative to competitor rates |
| · | Level of and perceived direction of interest rates |
| · | Financial condition and perceived safety of the institution |
| · | Possible risks associated with other investment opportunities |
| · | Level of fees on deposit products |
The Corporation has been a stable presence in the local market area that has experienced several large bank mergers over the past several years. Three new convenient locations were added since 2016, significantly expanding the Corporation’s footprint, with a presence in three counties with a total of thirteen branch locations. The Corporation has a history of offering competitive interest rates and fair and understandable service fees because of a strong commitment to the customers and the communities that it serves. Management has always priced products and services in a manner that makes them affordable for all customers. This in turn creates a high degree of customer loyalty and a stable deposit base. Additionally, as financial institutions have come under increased scrutiny from both regulators and customers, the Corporation has maintained an outstanding reputation. Management believes the Corporation’s deposit base has benefited as a result of a growing desire by customers to seek a longstanding, reliable financial institution as a partner to meet their financial needs.
Time deposits are typically a more rate-sensitive product, making them a source of funding that is prone to balance variations depending on the interest rate environment and how the Corporation’s time deposit rates compare with the local market rates. Time deposits fluctuate as consumers search for the best rates in the market, with less allegiance to any particular financial institution. As of March 31, 2021, time deposit balances had decreased $12.8 million, or 9.7%, from March 31, 2020, and increased slightly from December 31, 2020. The Corporation has experienced a slow and steady shift in deposit trends over the past five years as customers have moved money from time deposits into core checking and savings accounts. With the Federal Reserve rate decreases in 2020, there is minimal differences between shorter term CD rates and interest bearing non-maturity deposits, influencing customers to accumulate their funds in a liquid account that can be accessed at any time. This has resulted in declining time deposit balances and more significant growth in the core deposit areas.
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Borrowings
Total borrowings were $72.4 million, $74.4 million, and $75.0 million as of March 31, 2021, December 31, 2020, and March 31, 2020, respectively. Of these amounts, $3.5 million reflect short-term funds as of March 31, 2020, with no short-term funds outstanding as of March 31, 2021 and December 31, 2020. Short-term funds are used for immediate liquidity needs and are not typically part of an ongoing liquidity or interest rate risk strategy; therefore, they fluctuate more rapidly. When short-term funds are used, they are purchased through correspondent and member bank relationships as overnight borrowings or through the FHLB for terms less than one year.
Total long-term borrowings, borrowings initiated for terms longer than one year, were $52.8 million as of March 31, 2021, $54.8 million as of December 31, 2020, and $71.5 million as of March 31, 2020. The long-term borrowings for the Corporation were made up entirely of FHLB long-term advances at March 31, 2021, December 31, 2020, and March 31, 2020. FHLB advances are used as a secondary source of funding and to mitigate interest rate risk. These long-term funding instruments are typically a more effective funding instrument in terms of selecting the exact amount, rate, and term of funding rather than trying to source the same through deposits. In this manner, management can efficiently meet known liquidity and interest rate risk needs. The decrease in FHLB borrowings since March 31, 2020, can be attributed to management taking advantage of declining rates by prepaying FHLB advances and incurring penalties in order to save on interest expense in future years.
In order to limit the Corporation’s exposure and reliance to a single funding source, the Corporation’s Asset Liability Policy sets a goal of maintaining the amount of borrowings from the FHLB to 15% of asset size. As of March 31, 2021, the Corporation was significantly under this policy guideline at 6.4% of asset size with $52.8 million of total FHLB borrowings. The Corporation also has a policy that limits total borrowings from all sources to 150% of the Corporation’s capital. As of March 31, 2021, the Corporation was significantly under this policy guideline at 56.2% of capital with $72.4 million total borrowings from all sources. The Corporation has maintained FHLB borrowings and total borrowings well within these policy guidelines throughout all of 2020 and through the first three months of 2021.
The Corporation continues to be well under the FHLB maximum borrowing capacity (MBC), which is currently $449.3 million. The Corporation’s two internal policy limits mentioned above are far more restrictive than the FHLB MBC, which is calculated and set quarterly by FHLB.
In addition to the long-term advances funded through the FHLB, on December 30, 2020, the Corporation completed the sale of a subordinated debt note offering. The Corporation sold $20.0 million of subordinated debt notes with a maturity date of December 30, 2030. These notes are non-callable for 5 years and carry a fixed interest rate of 4% per year for 5 years and then convert to a floating rate for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The notes are structured to qualify as Tier 2 capital for the Corporation and any funds it invests in the Bank qualify as Tier 1 capital at the Bank. As of March 31, 2021, $15.0 million of funds were invested in the Bank. The Corporation paid an issuance fee of 2% of the total issue that will be amortized to the call date on a pro-rata basis.
Stockholders’ Equity
Federal regulatory authorities require banks to meet minimum capital levels. The Corporation, as well as the Bank, as the solely owned subsidiary of the Corporation, maintains capital ratios well above those minimum levels. The risk-weighted capital ratios are calculated by dividing capital by total risk-weighted assets. Regulatory guidelines determine the risk-weighted assets by assigning assets to specific risk-weighted categories. The calculation of tier I capital to risk-weighted average assets does not include an add-back to capital for the amount of the allowance for credit losses, thereby making this ratio lower than the total capital to risk-weighted assets ratio.
The following tables reflect the capital ratios for the Corporation and Bank compared to the regulatory capital requirements.
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| REGULATORY CAPITAL RATIOS: | |||||||
| Regulatory Requirements | |||||||
| Adequately | Well | ||||||
| As of March 31, 2021 | Capital Ratios | Capitalized | Capitalized | ||||
| Total Capital to Risk-Weighted Assets | |||||||
| Consolidated | 16.8% | 8.0% | 10.0% | ||||
| Bank | 16.2% | 8.0% | 10.0% | ||||
| Tier 1 Capital to Risk-Weighted Assets | |||||||
| Consolidated | 13.4% | 6.0% | 8.0% | ||||
| Bank | 14.9% | 6.0% | 8.0% | ||||
| Common Equity Tier 1 Capital to Risk-Weighted Assets | |||||||
| Consolidated | 13.4% | 4.5% | 6.5% | ||||
| Bank | 14.9% | 4.5% | 6.5% | ||||
| Tier 1 Capital to Average Assets | |||||||
| Consolidated | 8.6% | 4.0% | 5.0% | ||||
| Bank | 9.5% | 4.0% | 5.0% | ||||
| As of December 31, 2020 | |||||||
| Total Capital to Risk-Weighted Assets | |||||||
| Consolidated | 16.1% | 8.0% | 10.0% | ||||
| Bank | 15.3% | 8.0% | 10.0% | ||||
| Tier I Capital to Risk-Weighted Assets | |||||||
| Consolidated | 12.8% | 6.0% | 8.0% | ||||
| Bank | 14.0% | 6.0% | 8.0% | ||||
| Common Equity Tier I Capital to Risk-Weighted Assets | |||||||
| Consolidated | 12.8% | 4.5% | 6.5% | ||||
| Bank | 14.0% | 4.5% | 6.5% | ||||
| Tier I Capital to Average Assets | |||||||
| Consolidated | 9.0% | 4.0% | 5.0% | ||||
| Bank | 9.8% | 4.0% | 5.0% | ||||
| As of March 31, 2020 | |||||||
| Total Capital to Risk-Weighted Assets | |||||||
| Consolidated | 14.3% | 8.0% | 10.0% | ||||
| Bank | 14.2% | 8.0% | 10.0% | ||||
| Tier 1 Capital to Risk-Weighted Assets | |||||||
| Consolidated | 13.1% | 6.0% | 8.0% | ||||
| Bank | 13.0% | 6.0% | 8.0% | ||||
| Common Equity Tier 1 Capital to Risk-Weighted Assets | |||||||
| Consolidated | 13.1% | 4.5% | 6.5% | ||||
| Bank | 13.0% | 4.5% | 6.5% | ||||
| Tier 1 Capital to Average Assets | |||||||
| Consolidated | 9.9% | 4.0% | 5.0% | ||||
| Bank | 9.8% | 4.0% | 5.0% | ||||
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On December 30, 2020, the Corporation issued $20 million of subordinated debt in order to support capital levels which had declined due to the sharp balance sheet growth that had occurred during 2020. The $20 million of subordinated debt qualifies as Tier 2 capital at the Holding Company level. Amounts of the subordinated debt can be transferred to the Bank where it qualifies as Tier 1 Capital. As of March 31, 2021, $15.0 million of this subordinated debt funding was transferred down to the Bank to rebuild the Bank’s capital levels. As of March 31, 2021 the Bank’s Tier 1 Leverage Ratio stood at 9.5% while the Corporation’s Tier 1 Leverage Ratio was 8.6%. The Bank’s Tier 1 Leverage Ratio policy range is 9.0% to 12.0% while the Corporation’s Tier 1 Leverage Ratio policy range is 8.0% - 12.0%. Tier 1 Capital levels at the Corporation level were not impacted by the subordinated debt issue since subordinated debt only qualifies as Tier 2 Capital at the Corporate level. As such, in terms of the Corporation’s regulatory capital ratios, only the Total Capital to Risk-Weighted Assets ratio was enhanced as a result of the $20 million subordinated debt issue. Most of the marked improvement in capital ratios occurred at the Bank level.
Dividends play a vital role in the management of capital levels of the Corporation. Management seeks a balance between maintaining a sufficient cushion of excess capital above regulatory limits versus the payment of dividends to the shareholders as a direct return of their investment. Due to a constant stream of stable earnings, the payment of a dividend is needed to maintain capital at acceptable levels in order to provide an adequate return of equity to the shareholders.
The Corporation’s dividends per share for the three months ended March 31, 2021, were $0.16, the same as the dividend paid out in the first three months of 2020. Dividends are paid from current earnings and available retained earnings. The Corporation’s current capital plan calls for management to maintain tier I capital to average assets between 8.0% and 12.0%. As a secondary measurement, the capital plan also targets a long-term dividend payout ratio in the range of 30% to 45%. This ratio will vary according to income, but over the long term, the Corporation’s goal is to maintain and target a payout ratio within this range. For the three months ended March 31, 2021, the payout ratio was 19.8%. This dividend payout ratio is low as a result of the higher earnings in the first quarter of 2021, some of which are non-recurring. Management currently anticipates that the payout ratio will return to more normal levels as 2021 progresses. Management’s goal is to maintain all regulatory capital ratios at current levels. Future dividend payout ratios are dependent on the future level of earnings and other factors that impact the level of capital.
The amount of unrealized gain or loss on the securities portfolio is reflected, net of tax, as an adjustment to capital, as required by U.S. generally accepted accounting principles. This is recorded as accumulated other comprehensive income or loss in the capital section of the consolidated balance sheet. An unrealized gain increases capital, while an unrealized loss reduces capital. This requirement takes the position that, if the Corporation liquidated the securities portfolio at the end of each period, the current unrealized gain or loss on the securities portfolio would directly impact the Corporation’s capital. As of March 31, 2021, the Corporation showed an unrealized gain, net of tax, of $2,924,000, compared to an unrealized gain of $7,958,000 at December 31, 2020, and an unrealized gain of $1,103,000 as of March 31, 2020. These unrealized gains, net of tax are excluded from capital when calculating the tier I capital to average assets numbers above. The amount of unrealized gain or loss on the securities portfolio, shown net of tax, as an adjustment to capital, does not include any actual impairment taken on securities, which is shown as a reduction to income on the Corporation’s Consolidated Statements of Income. No impairment was recorded in the three months ended March 31, 2021, or in the same prior year period. The changes in unrealized gains and losses are due to normal changes in market valuations of the Corporation’s securities as a result of interest rate movements.
Off-Balance Sheet Arrangements
In the normal course of business, the Corporation typically has off-balance sheet arrangements related to loan funding commitments. These arrangements may impact the Corporation’s financial condition and liquidity if they were to be exercised within a short period of time. As discussed in the following liquidity section, the Corporation has in place sufficient liquidity alternatives to meet these obligations. The following table presents information on the commitments by the Corporation as of March 31, 2021.
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OFF-BALANCE SHEET ARRANGEMENTS
(DOLLARS IN THOUSANDS)
| March 31, | ||||
| 2021 | ||||
| $ | ||||
| Commitments to extend credit: | ||||
| Revolving home equity | 133,009 | |||
| Construction loans | 2,634 | |||
| Real estate loans | 123,820 | |||
| Business loans | 163,725 | |||
| Consumer loans | 1,273 | |||
| Other | 5,064 | |||
| Standby letters of credit | 9,696 | |||
| Total | 439,221 | |||
Significant Legislation
Dodd-Frank Wall Street Reform and Consumer Protection Act
In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was signed into law. Dodd-Frank is intended to affect a fundamental restructuring of federal banking regulation. Among other things, Dodd-Frank creates a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms. Dodd-Frank additionally creates a new independent federal regulator to administer federal consumer protection laws. Dodd-Frank is expected to have a significant impact on the Corporation’s business operations as its provisions take effect. It is difficult to predict at this time what specific cumulative impact Dodd-Frank and the yet-to-be-written implementing rules and regulations will have on community banks. However, it is expected that, at a minimum, they will increase the Corporation’s operating and compliance costs and could increase interest expense. Among the provisions that have already or are likely to affect the Corporation are the following:
Holding Company Capital Requirements
Dodd-Frank requires the Federal Reserve to apply consolidated capital requirements to bank holding companies that are no less stringent than those currently applied to depository institutions. Under these standards, trust preferred securities will be excluded from tier I capital unless such securities were issued prior to May 19, 2010, by a bank holding company with less than $15 billion in assets. Dodd-Frank additionally requires that bank regulators issue countercyclical capital requirements so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, are consistent with safety and soundness.
Deposit Insurance
Dodd-Frank permanently increased the maximum deposit insurance amount for banks, savings institutions, and credit unions to $250,000 per depositor. Additionally, on February 7, 2011, the Board of Directors of the FDIC approved a final rule based on the Dodd-Frank Act that revises the assessment base from one based on domestic deposits to one based on assets. This change, which was effective in April 2011, saved the Corporation a significant amount of FDIC insurance premiums from the significantly higher FDIC insurance premiums placed into effect after the financial crisis.
Corporate Governance
Dodd-Frank requires publicly traded companies to give stockholders a non-binding vote on executive compensation at least every three years, a non-binding vote regarding the frequency of the vote on executive compensation at least every six years, and a non-binding vote on “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. The SEC has finalized the rules implementing these requirements which took effect on January 21, 2011. The Corporation was exempt from these requirements until January 21, 2013, due to its status as a smaller reporting company. Additionally, Dodd-Frank directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the company is publicly traded. Dodd-Frank also gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.
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Limits on Interchange Fees
Dodd-Frank amended the Electronic Fund Transfer Act to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.
Consumer Financial Protection Bureau
Dodd-Frank created the Consumer Financial Protection Bureau (CFPB), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy Provisions of the Gramm-Leach-Bliley Act, and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive, or abusive practices in connection with the offering of consumer financial products. Dodd-Frank authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, Dodd-Frank will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. Dodd-Frank permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
Prohibition Against Charter Conversions of Troubled Institutions
Dodd-Frank prohibits a depository institution from converting from a state to federal charter or vice versa while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days. The notice must include a plan to address the significant supervisory matter. The converting institution must also file a copy of the conversion application with its current federal regulator which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating thereto.
Interstate Branching
Dodd-Frank authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks will be able to enter new markets more freely.
Limits on Interstate Acquisitions and Mergers
Dodd-Frank precludes a bank holding company from engaging in an interstate acquisition – the acquisition of a bank outside its home state – unless the bank holding company is both well capitalized and well managed. Furthermore, a bank may not engage in an interstate merger with another bank headquartered in another state unless the surviving institution will be well capitalized and well managed. The previous standard in both cases was adequately capitalized and adequately managed.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
As a financial institution, the Corporation is subject to three primary risks:
| · | Credit risk |
| · | Liquidity risk |
| · | Interest rate risk |
The Board of Directors has established an Asset Liability Management Committee (ALCO) to measure, monitor, and manage these primary market risks. The Asset Liability Policy has instituted guidelines for all of these primary risks, as well as other financial performance measurements with target ranges. The Asset Liability goals and guidelines are consistent with the Strategic Plan goals related to financial performance.
Credit Risk
For discussion on credit risk refer to the sections in Item 2. Management’s Discussion and Analysis, on securities, non-performing assets, and allowance for credit losses.
Liquidity Risk
Liquidity refers to having an adequate supply of cash available to meet business needs. Financial institutions must ensure that there is adequate liquidity to meet a variety of funding needs, at a minimal cost. Minimal cost is an important component of liquidity. If a financial institution is required to take significant action to obtain funding, and is forced to utilize an expensive source, it has not properly planned for its liquidity needs. Funding new loans and covering deposit withdrawals are the primary liquidity needs of the Corporation. The Corporation uses a variety of funding sources to meet liquidity needs, such as:
| · | Deposits |
| · | Loan repayments |
| · | Maturities and sales of securities |
| · | Borrowings from correspondent and member banks |
| · | Current earnings |
As noted in the discussion on deposits, customers have historically provided the Corporation with a reliable and steadily increasing source of funds liquidity. The Corporation also has in place relationships with other banking institutions for the purpose of buying and selling Federal funds. The lines of credit with these institutions provide immediate sources of additional liquidity. The Corporation currently has unsecured lines of credit totaling $32 million. This does not include amounts available from member banks such as the Federal Reserve Discount Window or the FHLB of Pittsburgh.
Management uses a cumulative maturity gap analysis to measure the amount of assets maturing within various periods versus liabilities maturing in those same periods. A gap ratio of 100% represents an equal amount of assets and liabilities maturing in the same stated period. Management monitors six-month, one-year, three-year, and five-year cumulative gaps to assist in determining liquidity risk. As of March 31, 2021, all maturity gap ratios were higher than corporate policy guidelines, due to a larger amount of loans and securities now maturing in less than five years, influenced very directly by the PPP loans that will mature in the next one to five years. The six-month gap ratio was 321.1%, compared to an upper policy guideline of 155%; the one-year gap ratio was 238.8%, compared to an upper policy guideline of 140%; the three-year gap ratio was 202.4%, compared to an upper guideline of 125%; and the five-year gap ratio was 178.6%, compared to an upper policy guideline of 115%. The results show asset sensitivity. In a rising interest rate cycle higher gap ratios would be more beneficial to the Corporation. However, in a declining rate environment, being asset sensitive is unfavorable. Even though the Corporation shows asset sensitivity above policy guidelines for the longer-term gap measurements, it is likely we would be back in a rising rate environment for those longer three and five-year periods and having asset sensitivity would be beneficial in that case. The current asset sensitivity of the Corporation’s balance sheet does negatively impact performance in the current rates-down interest rate scenario as there are more assets repricing to lower rates than liabilities. This asset sensitivity will be beneficial in the next rates-up cycle. Management will continue to monitor and manage the length of the balance sheet in order to sustain reasonable asset yields in a declining rate environment, while still positioning for a likely rising rate environment out in the future.
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Gap ratios have been increasing for the Corporation throughout 2020 and 2021. The Corporation’s assets are moderately long, but the length of the securities portfolio and the loan portfolio is more than offset by the length of the Corporation’s core deposit liabilities in conjunction with holding high levels of cash and cash equivalents. Beyond the non-maturity deposits, management is able to utilize the length of wholesale funding instruments to offset the declining length of the CD portfolio. Management believes that the Federal Reserve rate decreases early in 2020 will negatively impact net interest income for the remainder of 2021 as assets continue to reprice to lower levels. However, some savings can be achieved through deposits, primarily the CD portfolio, as the maturing CDs reprice to significantly lower levels.
The size and length of the Corporation’s core deposit liabilities provide the most extension in terms of lengthening the liabilities on the balance sheet. The length of the core deposits is significantly longer than the Corporation’s longest term time deposits and wholesale borrowings. The mix of the Corporation’s liabilities alone would be sufficient to offset the Corporation’s longer assets and to maintain gap ratios within management’s guidelines.
Management desires to show reductions to the cost of funds and improve the loan-to-deposit ratio and does have a large securities portfolio to draw liquidity from in the event deposit growth slows or reverses. With gap ratios that are already sufficiently high, management can put more of the available cash to work earning higher returns than overnight funds earn.
Management may desire to have higher gap ratios when factoring in future loan growth or other funding changes to the balance sheet. Management has been actively working to increase the Corporation’s loan-to-deposit ratio. As the loan-to-deposit ratio increases and more loans go on to the Corporation’s balance sheet, the asset mix will generally lengthen and the gap ratios will decline. However, in 2020 and 2021, the Corporation’s deposits have experienced very strong growth attributable to the very low interest rates and a desire by consumers to safeguard more cash during uncertain times. This has caused the loan-to-deposit ratio to decline during 2020 and 2021 even with moderate loan growth. As of March 31, 2021, the loan-to-deposit ratio was 63.5%, compared to 65.7%, at December 31, 2020, and 77.7% at March 31, 2020.
Management’s desired gap levels will also change due to the direction of interest rates. In March 2020, the Federal Reserve cut the overnight interest rate by 150 basis points at two separate special Federal Reserve Board meetings. Cash and other short term assets were directly impacted by this change in overnight rates. If the Corporation’s liquid assets cannot be deployed into higher yielding longer term assets, then management will reduce the amount of cash and short-term assets to reduce the exposure to future decreases in the overnight rate. Management believes the overnight Federal funds rate will not decline further in 2021, but the economic environment is unpredictable and future rate changes will be dependent on the national and global economic conditions.
The risk of liabilities repricing at higher interest rates is low in the present environment as the Corporation does not foresee the need to raise deposit interest rates any time in the near future. A number of the Corporation’s maturing time deposits have already repriced to lower rates due to the rapid rate declines during March of 2020. However, a large portion of the Corporation’s deposits are core deposits with little repricing expected to occur in the near future. The Corporation’s maturing time deposits and borrowings are generally repricing to lower interest rates and will continue to do so throughout 2021. The Corporation’s average cost of funds was 21 basis points as of March 31, 2021, which is low from an historic perspective. The Corporation’s average cost of funds was 20 basis points as of December 31, 2020, and 49 basis points as of March 31, 2020. This cost of funds will likely remain around the current level throughout the remainder of 2021. The average cost of funds includes the benefit of non-interest bearing demand deposit accounts.
Deposits had not been very rate sensitive for a number of years as a result of the limited desirable rates available to the deposit customers. The Corporation had experienced a steady growth in both non-interest bearing and interest bearing funds during this last prolonged and historically low interest rate cycle, but in 2018 and through 2019, deposit growth had been slower than in prior years. With the Federal Reserve rate declines in the first quarter of 2020, deposit growth has once again been strong with customers choosing to keep their funds in banks as opposed to investing in other instruments that are more susceptible to market fluctuations. Additionally, with the government aid direct deposits and checks sent out in 2020 and 2021, the Corporation has experienced significant deposit growth throughout the latter part of 2020 and the first quarter of 2021.
The performance of the equity markets also has a bearing on how much of the current deposits will remain at the Corporation. It is management’s observation that since the financial crisis, an element of the Corporation’s deposit customers has been reluctant to redeploy funds presently at banks back into the equity market. This became even more apparent with the COVID-19 pandemic and the volatility in the equity markets caused by this event. Investors have grown weary of the fluctuations in the equity markets. In 2019, the equity markets had very strong gains, which did not adversely impact the Corporation’s deposit growth. In March 2020, with the outbreak of COVID-19, the equity markets recorded their biggest decline in recent history with the market down between 30% and 35% after huge sell-offs. The equity market has since recovered and has steadily grown to new historic highs, well ahead of the expected continued COVID-19 recovery. But the previous history of unprecedented equity declines following a fueled bull market is causing many customers to keep a large percentage of their excess funds in banks which has caused the increase in the Corporation’s deposits through 2020 and the first quarter of 2021.
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The Corporation’s net interest margin is down from levels in the previous quarter and previous year. Management’s future asset liability decisions will be dependent upon improvements in asset yield as well as the expected timing of further short-term rate increases or decreases. Management expects that the gap ratios will remain above the established guidelines throughout the remainder of 2021.
It is important to stress that the gap ratios are a static measurement of the Corporation’s asset liability position. It is only one of many asset liability analysis tools management utilizes to measure, monitor, and manage both liquidity and interest rate risk. The deficiencies with the gap analysis are that it makes no provision for changes to the balance sheet out into the future and would not factor in changes that management would very likely make to mitigate future interest rate risk.
In addition to the cumulative maturity gap analysis discussed above, management utilizes a number of liquidity measurements that management believes has advantages over and gives better clarity to the Corporation’s present and projected liquidity than the static gap analysis offers.
The Corporation analyzes the following additional liquidity measurements in an effort to monitor and mitigate liquidity risk:
| · | Core Deposit Ratio – Core deposits as a percentage of assets |
| · | Funding Concentration Analysis – Alternative funding sources outside of core deposits as a percentage of assets |
| · | Short-term Funds Availability – Readily available short-term funds as a percentage of assets |
| · | Securities Portfolio Liquidity – Cash flows maturing in one year or less as a percentage of assets and securities |
| · | Readily Available Unencumbered Securities and Cash – Unencumbered securities as a percentage of the securities portfolio and as a percentage of total assets |
| · | Borrowing Limits – Internal borrowing limits in terms of both FHLB and total borrowings |
| · | Three, Six, and Twelve-month Projected Sources and Uses of Funds – Projection of future liquidity positions |
These measurements are designed to prevent undue reliance on outside sources of funding and to ensure a steady stream of liquidity is available should events occur that would cause a sudden decrease in deposits or large increase in loans or both, which would in turn draw significantly from the Corporation’s available liquidity sources. As of March 31, 2021, the Corporation was within guidelines for all of the above measurements
The Corporation’s liquidity measurements are tracked and reported quarterly by management to both observe trends and ensure the measurements stay within desired ranges. Management is confident that a sufficient amount of internal and external liquidity exists to provide for significant unanticipated liquidity needs.
Interest Rate Risk
Interest rate risk is measured using two analytical tools:
| · | Changes in net interest income |
| · | Changes in net portfolio value |
Financial modeling is used to forecast net interest income and earnings, as well as net portfolio value, also referred to as fair value. The modeling is generally conducted under seven different interest rate scenarios. The scenarios consist of a projection of net interest income if rates remain flat, increase 100, 200, or 300 basis points, or decrease 25, 50, or 75 basis points. Currently, the flat-rate scenario seems more likely for the remainder of 2021, with the Federal funds rate at 0.25% as of March 31, 2021. The rates-down scenarios are much less likely now with the Federal Reserve rate cuts that already occurred in 2020. For that reason, management believes it appropriate to model rates down 25, 50, and 75 basis points to most adequately cover all the reasonably possible declining rate scenarios that the Corporation could face, while continuing to model rates up scenarios of 100, 200, and 300 basis points. While management had previously turned its focus to rates-down scenarios, with each Federal Reserve rate reduction, the ability to further reduce interest rates diminishes and the exposure to higher interest rates increases. The overnight Federal funds rate and the current U.S. Treasury rates are presently at low historical levels. Because of this historical perspective, if management would take a neutral position in terms of the direction of forward interest rates, there is clearly more long term risk of rates going up than down. So while in the near term it is likely we may see no Federal Reserve rate increases or decreases, management remains guarded about the impact of higher interest rates and continues to prepare for rate increases on a larger scale than decreases.
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The results obtained through the use of forecasting models are based on a variety of factors. Both the net interest income and fair value forecasts make use of the maturity and repricing schedules to determine the changes to the balance sheet over the course of time. Additionally, there are many assumptions that factor into the results. These assumptions include, but are not limited to, the following:
| · | Projected forward interest rates |
| · | Slope of the U.S. Treasury curve |
| · | Spreads available on securities over the U.S. Treasury curve |
| · | Prepayment speeds on loans held and mortgage-backed securities |
| · | Anticipated calls on securities with call options |
| · | Deposit and loan balance fluctuations |
| · | Competitive pressures affecting loan and deposit rates |
| · | Economic conditions |
| · | Consumer reaction to interest rate changes |
For the interest rate sensitivity analysis and net portfolio value analysis discussed below, results are based on a static balance sheet reflecting no projected growth from balances as of March 31, 2021. While it is unlikely that the balance sheet will not grow at all, management considers a static analysis to be the most conservative and most accurate means to evaluate fair value and future interest rate risk. The static balance sheet approach is used to reduce the number of variables in calculating the model’s accuracy in predicting future net interest income. It is appropriate to pull out various balance sheet growth scenarios which could be utilized to compensate for a declining margin. By testing the model using a base model assuming no growth, this variable is eliminated and management can focus on predicted net interest income based on the current existing balance sheet. Management does run additional scenarios with expected growth rates through the asset liability model to most accurately predict future financial performance. This is done separately and apart from the static balance sheet approach discussed above to test fair value and future interest rate risk.
As a result of the many assumptions, this information should not be relied upon to predict future results. Additionally, both of the analyses discussed below do not consider any action that management could take to minimize or offset the negative effect of changes in interest rates. These tools are used to assist management in identifying possible areas of risk in order to address them before a greater risk is posed. Personnel perform an in-depth annual validation and a quarterly review of the settings and assumptions used in the model to ensure reliability of the forecast results. In addition to the annual validation review, management also engages a third party every three years to obtain a complete external review of the model. That review was completed in the third quarter of 2020. The purpose was to conduct a comprehensive evaluation of the model input, assumptions, and output and this study concluded that the model is managed appropriately and generating acceptable results. Back testing of the model to actual results is performed quarterly to ensure the validity of the assumptions in the model. The internal and external validations as well as the back testing indicate that the model assumptions are reliable.
Changes in Net Interest Income
The change in net interest income measures the amount of net interest income fluctuation that would be experienced over one year, assuming interest rates change immediately and remain the same for one year. This is considered to be a short-term view of interest rate risk. The analysis of changes in net interest income due to changes in interest rates is commonly referred to as interest rate sensitivity. The Corporation’s interest rate sensitivity analysis indicates that if interest rates were to go up immediately, the Corporation would realize more net interest income. This is due to the ability of the Corporation to immediately achieve higher interest earnings on interest-earning assets while having the ability to limit the amount of increase in interest-bearing liabilities based on the timing of deposit rate changes. This results in an increase in net interest income in the rising rate scenarios, but a decline in net interest income in the declining rate scenarios.
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The first quarter 2021 analysis projects net interest income expected in the seven rate scenarios over a one-year time horizon. As of March 31, 2021, the Corporation was within guidelines for the maximum amount of net interest income change in all rate scenarios. All up-rate scenarios show a positive impact to net interest income. The increase in net interest income in the up-rate scenarios is largely due to the increase in variable rate loans and the recent purchases of variable rate securities and the cash balances held on the Corporation’s balance sheet. On the liability side, when interest rates do increase, it is typical for management to react more slowly in increasing deposit rates. Loans that are Prime-based will increase by the full amount of the market rate movement while deposit rates will only increase at a fraction of the market rate increase. Additionally, deposit rates may level off more when market rates increase by 200 or 300 basis points where variable loan rates will still increase by the same amount as the Prime rate. With the Federal Reserve acting to decrease interest rates by 225 basis points over five meetings held since June 30, 2019, the Corporation has had more exposure to all maturing fixed-rate loans and securities. These assets have been maturing and repricing to lower market rates, while most of the Corporation’s interest-bearing deposits could not be repriced any lower. This would result in a decline in net interest income in any down-rate scenario.
For the rates-up 100 basis point scenario, net interest income increases by 1.3% compared to the rates unchanged scenario. The higher interest rates go, the greater the likelihood that the proportionality of the Corporation’s deposit rate changes decreases as a percentage of the Federal Reserve’s action. For the rates-up 200 and 300 basis point scenarios, net interest income increases by 1.9% and 2.7%, respectively, compared to the rates unchanged scenario. Management’s maximum permitted net interest income declines by policy are -5%, -10%, and -15%, for the rates-up 100, 200, and 300 basis point scenarios, respectively.
The positive impact of higher rates is primarily due to the favorable impact of all of the Corporation’s variable rate loans repricing by the full amount of the Federal rate change, assisted by the Corporation’s relatively high interest earning cash balances and that component of the loans and securities portfolios that reprice in less than one year. This more than offsets the increase in interest expense caused by repricing deposits, where they are only repricing by a fraction of the rate change. The Corporation’s short term borrowings do price up faster than deposits, generally equivalent to the U.S. Treasury market. However, as of March 31, 2021, the Corporation had no overnight or short term borrowings but had $52.8 million of long-term fixed-rate advances. Additionally, total borrowings only make up approximately 3.8% of the total funding provided by deposits and borrowings. The more aggressive rates-up scenarios also benefit from known historical experience of deposit rate increases lagging and a slowing in the pace of the actual rate increase as interest rates continue to rise. This allows management the ability to benefit from higher rates by controlling the amount of the interest rate increases on large amounts of liabilities that could reprice.
As of March 31, 2021, in the down scenarios of -25, -50, and -75 basis points, net interest income decreases by 0.6%, 1.8%, and 3.0%, respectively, compared to policy guidelines of -1.25%, -2.5% and -3.75%. Management does not expect the Corporation’s exposure to interest rate changes to increase or change significantly during the remainder of 2021.
The assumptions and analysis of interest rate risk are based on historical experience during varied economic cycles. Management believes these assumptions to be appropriate; however, actual results could vary significantly. Management uses this analysis to identify trends in interest rate sensitivity and determine if action is necessary to mitigate asset liability risk.
Changes in Net Portfolio Value
The change in net portfolio value is considered a tool to measure long-term interest rate risk. The analysis measures the exposure of the balance sheet to valuation changes due to changes in interest rates. The calculation of net portfolio value discounts future cash flows to the present value based on current market rates. The change in net portfolio value estimates the gain or loss in value that would occur on market sensitive instruments given an interest rate increase or decrease in the same seven scenarios mentioned above. As of March 31, 2021, the Corporation was within guidelines for all up-rate scenarios and out of policy guidelines for the down-rate scenarios. The Corporation shows a very favorable benefit to net portfolio value in the rising rate scenarios, due primarily to the very low market rates and the elevated amount of core deposits on the Corporation’s balance sheet as of March 31, 2021. The non-interest bearing demand deposit accounts and low-interest bearing checking, NOW, and money market accounts provide more benefit to the Corporation when interest rates are higher and the difference between the overnight funding costs compared to the average interest bearing core deposit rates are greater. As interest rates increase, the discount rate used to value the Corporation’s interest bearing accounts increases, causing a lower net present value for these interest-bearing deposits. This improves the modeling of the Corporation’s fair value risk to higher interest rates as the liability amounts decrease causing a higher net portfolio value of the Corporation’s balance sheet. However, as interest rates decrease, the discount rate used to value the Corporation’s interest bearing accounts decreases, causing a higher net present value for these interest-bearing deposits.
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The results as of March 31, 2021, indicate that the Corporation’s net portfolio value would experience valuation gains of 10.6%, 14.9%, and 14.9% in the rates-up 100, 200, and 300 basis point scenarios. Management’s maximum permitted declines in net portfolio value by policy are -5% for rates-up 100 basis points, graduating up to -15% for rates-up 300 basis points. A valuation loss would indicate that the value of the Corporation’s assets is declining at a faster pace than the decrease in the value of the Corporation’s liabilities. The analysis does show a valuation loss in the down 25, 50, and 75 basis point scenarios of -6.4%, -14.7%, and -23.3%, respectively, compared to policy guidelines of -3.75%, -7.5%, and -11.25%. The Corporation’s expected valuation loss was outside of guidelines for all down-rate scenarios. With the significant declines in the overnight and Prime rate since 2019, the Corporation’s exposure to valuation changes based on lower rates has also changed materially. Management does not anticipate any further Federal Reserve rate reductions as another 0.25% move down would cause the Federal funds rate range to be in negative territory at -0.25% to 0.00%. The Federal Reserve has signaled that their preferred course of action would be to use other tools available to support the economy before resorting to a further rate reduction. Management also does not anticipate that market interest rates decline materially from the present levels. Currently the two-year U.S. Treasury yield has been around 0.16%. This has been the case for much of 2020 and 2021. While interest rates are unlikely to materially decline, the behavior of the Corporation’s deposits will continue to have an impact on the Corporation’s net portfolio value. With the recent rapid increase in the Corporation’s core deposits, management is guarded against further valuation declines in the rates-down interest rate scenarios throughout the remainder of 2021, even though the likelihood of lower interest rates is remote.
The weakness with the net portfolio value analysis is that it assumes liquidation of the Corporation rather than as a going concern. For that reason, it is considered a secondary measurement of interest rate risk to “Changes in Net Interest Income” discussed above. However, the net portfolio value analysis is a more important tool to measure the impact of interest rate changes to capital. In the current regulatory climate, the focus is on ensuring adequate asset liability modeling is being done to project the impact of very large interest rate increases on capital. The asset liability modeling currently in place measures the impact of such a rate change on the valuation of the Corporation’s loans, securities, deposits, and borrowings, and the resulting impact to capital. Management continues to analyze additional scenario testing to model “worst case” scenarios to adequately plan for the possible severe impact of such events.
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Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
Management carried out an evaluation, under the supervision and with the participation of the Chief Executive Officer and Treasurer (Principal Financial Officer), of the effectiveness of the design and the operation of the Corporation’s disclosure controls and procedures (as such term as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2021, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer along with the Treasurer (Principal Financial Officer) concluded that the Corporation’s disclosure controls and procedures as of March 31, 2021, are effective to ensure that information required to be disclosed in the reports that the company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.
(b) Changes in Internal Controls.
There have been no changes in the Corporation’s internal controls over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
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March 31, 2021
Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position or results of operations of the Corporation or its subsidiaries taken as a whole. There are no proceedings pending other than ordinary routine litigation incident to the business of the Corporation. In addition, no material proceedings are pending, are known to be threatened, or contemplated against the Corporation by governmental authorities.
The Corporation continually monitors the risks related to the Corporation’s business, other events, the Corporation’s Common Stock, and the Corporation’s industry. Management has not identified any new risk factors since the December 31, 2020 Form 10-K filing.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Purchases
The following table details the Corporation’s purchase of its own common stock during the three months ended March 31, 2021.
| Issuer Purchase of Equity Securites | ||||||||||||||||
| Total Number of | Maximum Number | |||||||||||||||
| Total Number | Average | Shares Purchased | of Shares that May | |||||||||||||
| of Shares | Price Paid | as Part of Publicly | Yet be Purchased | |||||||||||||
| Period | Purchased | Per Share | Announced Plans * | Under the Plan * | ||||||||||||
| January 2021 | — | — | — | 190,000 | ||||||||||||
| February 2021 | 7,600 | 19.53 | 7,600 | 182,400 | ||||||||||||
| March 2021 | — | — | — | 182,400 | ||||||||||||
| Total | 7,600 | |||||||||||||||
* On October 21, 2020, the Board of Directors of the Corporation approved a plan to repurchase, in open market and privately negotiated transactions, up to 200,000 shares of its outstanding common stock. The first purchase of common stock under this plan occurred on October 28, 2020. By March 31, 2021, a total of 17,600 shares were repurchased at a total cost of $335,000 for an average cost per share of $19.03.
Item 3. Defaults Upon Senior Securities – Nothing to Report
Item 4. Mine Safety Disclosures – Not Applicable
Item 5. Other Information – Nothing to Report
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Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| ENB Financial Corp | ||
| (Registrant) | ||
| Dated: May 14, 2021 | By: | /s/ Jeffrey S. Stauffer |
| Jeffrey S. Stauffer | ||
| Chairman of the Board | ||
| Chief Executive Officer and President | ||
| Principal Executive Officer | ||
| Dated: May 14, 2021 | By: | /s/ Scott E. Lied |
| Scott E. Lied, CPA | ||
| Treasurer | ||
| Principal Financial Officer | ||
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Exhibit 31.1
CERTIFICATION
I, Jeffrey S. Stauffer, certify that:
| 1. | I have reviewed this quarterly report on Form 10-Q of ENB Financial Corp; |
| 2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| 4. | The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
| (a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| (b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
| (c) | Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| (d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
| 5. | The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): |
| (a) | All significant deficiencies, and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and |
| (b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. |
| Date: May 14, 2021 | By: | /s/ Jeffrey S. Stauffer |
| Jeffrey S. Stauffer | ||
| Chairman of the Board | ||
| Chief Executive Officer and President | ||
| Principal Executive Officer |
74
ENB FINANCIAL CORP
Exhibit 31.2
CERTIFICATION
I, Scott E. Lied, certify that:
| 1. | I have reviewed this quarterly report on Form 10-Q of ENB Financial Corp; |
| 2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| 4. | The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
| (a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| (b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
| (c) | Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| (d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
| 5. | The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): |
| (a) | All significant deficiencies, and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and |
| (b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. |
| Date: May 14, 2021 | By: | /s/ Scott E. Lied |
| Scott E. Lied, CPA | ||
| Treasurer | ||
| Principal Financial Officer |
75
ENB FINANCIAL CORP
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADDED BY
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report on Form 10-Q of ENB Financial Corp (the "Corporation") for the period ended March 31, 2021, as filed with the Securities and Exchange Commission (the "Report"), I, Jeffrey S. Stauffer, Chief Executive Officer and President, of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002, that:
| 1. | The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
| 2. | To my knowledge, the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation as of and for the period covered by the Report. |
| Date: May 14, 2021 | By: | /s/ Jeffrey S. Stauffer |
| Jeffrey S. Stauffer | ||
| Chairman of the Board | ||
| Chief Executive Officer and President | ||
| Principal Executive Officer |
76
ENB FINANCIAL CORP
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADDED BY
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report on Form 10-Q of ENB Financial Corp (the "Corporation") for the period ended March 31, 2021, as filed with the Securities and Exchange Commission (the "Report"), I, Scott E. Lied, Treasurer of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002, that:
| 1. | The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
| 2. | To my knowledge, the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation as of and for the period covered by the Report. |
| Date: May 14, 2021 | By: | /s/ Scott E. Lied |
| Scott E. Lied, CPA | ||
| Treasurer | ||
| Principal Financial Officer |
77