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CNB FINANCIAL CORP/PA - Quarter Report: 2019 June (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019
or 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number 000-13396
CNB FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Pennsylvania
 
25-1450605
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
1 South Second Street
P.O. Box 42
Clearfield, Pennsylvania 16830
(Address of principal executive offices)
Registrant’s telephone number, including area code, (814) 765-9621
Securities registered pursuant to Section 12(b) of the Act:
 
 
 
 
 
Title of Class
 
Trading Symbol(s)
 
Name of each exchange on which registered
Common Stock, no par value
 
   CCNE
 
The NASDAQ Stock Market LLC
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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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
The number of shares outstanding of the issuer’s common stock as of August 5, 2019:
COMMON STOCK, NO PAR VALUE PER SHARE: 15,197,983 SHARES


Table of Contents

INDEX
PART I.
FINANCIAL INFORMATION
 
 
Page Number
 
 
 
 
 
1

 
 
2

 
 
3

 
 
4

 
 
5

 
 
6

 
 
27

 
 
39

 
 
40

 
PART II.
OTHER INFORMATION
 
 
41

 
 
41

 
 
41

 
 
41

 
 
41

 
 
41

 
 
42

 
 
43



Table of Contents

Forward-Looking Statements

The information below includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, with respect to the financial condition, liquidity, results of operations, and future performance of our business. These forward-looking statements are intended to be covered by the safe harbor for “forward-looking statements” provided by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that are not historical facts. Forward-looking statements include statements with respect to beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors (some of which are beyond our control). Forward-looking statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future conditional verbs such as “may,” “will,” “should,” “would” and “could.” Such known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from the statements, include, but are not limited to, (i) changes in general business, industry or economic conditions or competition; (ii) changes in any applicable law, rule, regulation, policy, guideline or practice governing or affecting financial holding companies and their subsidiaries or with respect to tax or accounting principles or otherwise; (iii) adverse changes or conditions in capital and financial markets; (iv) changes in interest rates; (v) higher than expected costs or other difficulties related to integration of combined or merged businesses; (vi) the inability to realize expected cost savings or achieve other anticipated benefits in connection with business combinations and other acquisitions; (vii) changes in the quality or composition of our loan and investment portfolios; (viii) adequacy of loan loss reserves; (ix) increased competition; (x) loss of certain key officers; (xi) deposit attrition; (xii) rapidly changing technology; (xiii) unanticipated regulatory or judicial proceedings and liabilities and other costs; (xiv) changes in the cost of funds, demand for loan products or demand for financial services; and (xv) other economic, competitive, governmental or technological factors affecting our operations, markets, products, services and prices. Such developments could have an adverse impact on our financial position and our results of operations.

The forward-looking statements contained herein are based upon management’s beliefs and assumptions. Any forward-looking statement made herein speaks only as of the date on which it is made. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.


Table of Contents

Part I Financial Information
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
Dollars in thousands, except share data
 
(unaudited) June 30, 2019
 
December 31, 2018
ASSETS
Cash and due from banks
$
33,926

 
$
43,327

Interest bearing deposits with other banks
4,004

 
2,236

Total cash and cash equivalents
37,930

 
45,563

Securities available for sale
533,970

 
516,863

Trading securities
8,904

 
7,786

Loans held for sale
2,032

 
367

Loans
2,627,269

 
2,479,348

Less: unearned discount
(4,911
)
 
(4,791
)
Less: allowance for loan losses
(21,437
)
 
(19,704
)
Net loans
2,600,921

 
2,454,853

FHLB, other equity, and restricted equity interests
24,501

 
24,508

Premises and equipment, net
51,785

 
49,920

Operating lease assets
17,082

 
0

Bank owned life insurance
57,130

 
56,443

Mortgage servicing rights
1,501

 
1,495

Goodwill
38,730

 
38,730

Core deposit intangible
396

 
727

Accrued interest receivable and other assets
26,092

 
24,266

Total Assets
$
3,400,974

 
$
3,221,521

LIABILITIES AND SHAREHOLDERS’ EQUITY
Non-interest bearing deposits
$
352,570

 
$
356,797

Interest bearing deposits
2,382,192

 
2,253,989

Total deposits
2,734,762

 
2,610,786

Short-term borrowings
52,907

 
0

FHLB and other long term borrowings
204,877

 
245,117

Subordinated debentures
70,620

 
70,620

Operating lease liabilities
17,862

 
0

Accrued interest payable and other liabilities
33,331

 
32,168

Total liabilities
3,114,359

 
2,958,691

Common stock, $0 par value; authorized 50,000,000 shares; issued 15,308,378 shares at June 30, 2019 and December 31, 2018
0

 
0

Additional paid in capital
97,414

 
97,602

Retained earnings
185,838

 
171,780

Treasury stock, at cost (110,395 shares at June 30, 2019 and 101,097 shares at December 31, 2018)
(2,735
)
 
(2,556
)
Accumulated other comprehensive income (loss)
6,098

 
(3,996
)
Total shareholders’ equity
286,615

 
262,830

Total Liabilities and Shareholders’ Equity
$
3,400,974

 
$
3,221,521

 
 
 
 
See Notes to Consolidated Financial Statements

1

Table of Contents

CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Dollars in thousands, except per share data
 
 
 
 
 
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2019
 
2018
 
2019
 
2018
INTEREST AND DIVIDEND INCOME:
 
 
 
 
 
 
 
Loans including fees
$
34,295

 
$
28,975

 
$
67,119

 
$
55,432

Securities:
 
 
 
 
 
 
 
Taxable
3,155

 
2,180

 
6,133

 
4,164

Tax-exempt
584

 
683

 
1,281

 
1,377

Dividends
248

 
261

 
502

 
513

Total interest and dividend income
38,282

 
32,099

 
75,035

 
61,486

INTEREST EXPENSE:
 
 
 
 
 
 
 
Deposits
7,201

 
3,687

 
13,788

 
6,611

Borrowed funds
1,292

 
1,604

 
2,702

 
3,092

Subordinated debentures (includes $14, $46, $20 and $105 accumulated other comprehensive income reclassification for change in fair value of interest rate swap agreements, respectively)
995

 
982

 
1,993

 
1,857

Total interest expense
9,488

 
6,273

 
18,483

 
11,560

NET INTEREST INCOME
28,794

 
25,826

 
56,552

 
49,926

PROVISION FOR LOAN LOSSES
1,788

 
1,905

 
3,094

 
3,536

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
27,006

 
23,921

 
53,458

 
46,390

NON-INTEREST INCOME:
 
 
 
 
 
 
 
Service charges on deposit accounts
1,569

 
1,271

 
3,050

 
2,518

Other service charges and fees
748

 
723

 
1,394

 
1,341

Wealth and asset management fees
1,202

 
1,090

 
2,244

 
2,120

Net realized gains on available-for-sale securities (includes $0, $0, $148 and $0 accumulated other comprehensive income reclassifications for net realized gains on available-for-sale securities, respectively)
0

 
0

 
148

 
0

Net realized and unrealized gains on trading securities
654

 
237

 
1,454

 
251

Mortgage banking
370

 
310

 
609

 
518

Bank owned life insurance
326

 
339

 
687

 
739

Card processing and interchange income
1,221

 
1,103

 
2,250

 
2,074

Other
702

 
533

 
1,109

 
796

Total non-interest income
6,792

 
5,606

 
12,945

 
10,357

NON-INTEREST EXPENSES:
 
 
 
 
 
 
 
Salaries and benefits
11,507

 
10,131

 
22,407

 
19,666

Net occupancy expense
2,695

 
2,634

 
5,561

 
5,130

Amortization of core deposit intangible
166

 
248

 
331

 
496

Data processing
1,437

 
1,147

 
2,622

 
2,221

State and local taxes
954

 
833

 
1,722

 
1,686

Legal, professional, and examination fees
570

 
550

 
1,123

 
1,058

Advertising
473

 
581

 
884

 
1,178

FDIC insurance premiums
373

 
378

 
795

 
676

Card processing and interchange expenses
684

 
638

 
1,431

 
1,372

Other
3,125

 
2,403

 
6,283

 
5,059

Total non-interest expenses
21,984

 
19,543

 
43,159

 
38,542

INCOME BEFORE INCOME TAXES
11,814

 
9,984

 
23,244

 
18,205

INCOME TAX EXPENSE (includes ($3), ($10), $27 and ($22) income tax expense from reclassification items, respectively)
2,047

 
1,543

 
4,004

 
2,667

NET INCOME
$
9,767

 
$
8,441

 
$
19,240

 
$
15,538

EARNINGS PER SHARE:
 
 
 
 
 
 
 
Basic
$
0.64

 
$
0.55

 
$
1.26

 
$
1.02

Diluted
$
0.64

 
$
0.55

 
$
1.26

 
$
1.02

DIVIDENDS PER SHARE:
 
 
 
 
 
 
 
Cash dividends per share
$
0.170

 
$
0.165

 
$
0.340

 
$
0.330

 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements

2

Table of Contents

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)
Dollars in thousands
 
 
 
 
 
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2019
 
2018
 
2019
 
2018
NET INCOME
$
9,767

 
$
8,441

 
$
19,240

 
$
15,538

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Net change in fair value of interest rate swap agreements designated as cash flow hedges:
 
 
 
 
 
 
 
Unrealized gain (loss) on interest rate swaps, net of tax of $46, $0, $72 and ($4), respectively
(173
)
 
1

 
(273
)
 
16

Reclassification adjustment for losses recognized in earnings, net of tax of ($3), ($10), ($4) and ($22), respectively
11

 
36

 
16

 
83

 
(162
)
 
37

 
(257
)
 
99

Net change in unrealized gains on securities available for sale:
 
 
 
 
 
 
 
Unrealized holding gains (losses) arising during the period, net of tax of ($1,433), $303, ($2,781) and $1,356, respectively
5,400

 
(1,140
)
 
10,468

 
(5,104
)
Reclassification adjustment for realized gains included in net income, net of tax of $0, 0$, $31 and $0, respectively
0

 
0

 
(117
)
 
0

 
5,400

 
(1,140
)
 
10,351

 
(5,104
)
Other comprehensive income (loss)
5,238

 
(1,103
)
 
10,094

 
(5,005
)
COMPREHENSIVE INCOME
$
15,005

 
$
7,338

 
$
29,334

 
$
10,533

 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements

3

Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Dollars in thousands
 
 
 
 
 
Six months ended June 30,
 
2019
 
2018
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
19,240

 
$
15,538

Adjustments to reconcile net income to net cash provided by operations:
 
 
 
Provision for loan losses
3,094

 
3,536

Depreciation and amortization of premises and equipment, operating leases assets, core deposit intangible, and mortgage servicing rights
2,848

 
2,464

Amortization and accretion of securities premiums and discounts, deferred loan fees and costs, net yield and credit mark on acquired loans, and unearned income
(341
)
 
38

Net realized gains on sales of available-for-sale securities
(148
)
 
0

Net realized and unrealized gains on trading securities
(1,454
)
 
(251
)
Proceeds from sale of trading securities
699

 
0

Purchase of trading securities
(363
)
 
(144
)
Gain on sale of loans
(401
)
 
(323
)
Net gains on dispositions of premises and equipment and foreclosed assets
(118
)
 
(217
)
Proceeds from sale of loans
17,330

 
10,084

Origination of loans held for sale
(18,594
)
 
(10,774
)
Income on bank owned life insurance
(687
)
 
(739
)
Stock-based compensation expense
867

 
949

Changes in:
 
 
 
Accrued interest receivable and other assets
(1,746
)
 
(4,378
)
Accrued interest payable, lease liabilities, and other liabilities
(1,611
)
 
2,153

NET CASH PROVIDED BY OPERATING ACTIVITIES
18,615

 
17,936

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Proceeds from maturities, prepayments and calls of available-for-sale securities
40,287

 
21,880

Proceeds from sales of available-for-sale securities
11,403

 
0

Purchase of available-for-sale securities
(55,987
)
 
(70,013
)
Loan origination and payments, net
(148,670
)
 
(189,994
)
Redemption (purchase) of FHLB, other equity, and restricted equity interests
7

 
(1,172
)
Purchase of premises and equipment
(3,900
)
 
(896
)
Proceeds from the sale of premises and equipment and foreclosed assets
385

 
538

NET CASH USED BY INVESTING ACTIVITIES
(156,475
)
 
(239,657
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Net change in:
 
 
 
Checking, money market and savings accounts
164,286

 
220,951

Certificates of deposit
(40,310
)
 
12,799

Purchase of treasury stock
(1,234
)
 
(454
)
Cash dividends paid
(5,182
)
 
(5,046
)
Repayment of long-term borrowings
(40,240
)
 
(15,131
)
Proceeds from long-term borrowings
0

 
50,000

Net change in short-term borrowings
52,907

 
(34,416
)
NET CASH PROVIDED BY FINANCING ACTIVITIES
130,227

 
228,703

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(7,633
)
 
6,982

CASH AND CASH EQUIVALENTS, Beginning
45,563

 
35,345

CASH AND CASH EQUIVALENTS, Ending
$
37,930

 
$
42,327

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
18,356

 
$
11,406

Income taxes
2,691

 
2,250

SUPPLEMENTAL NONCASH DISCLOSURES:
 
 
 
Transfers to other real estate owned
$
256

 
$
3

Grant of restricted stock awards from treasury stock
$
1,055

 
$
933



 
 
 
See Notes to Consolidated Financial Statements

4

Table of Contents

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (unaudited)
Dollars in thousands, except share and per share data
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Share-
holders’
Equity
Balance, April 1, 2019
$
97,139

 
$
178,662

 
$
(1,702
)
 
$
860

 
$
274,959

Net income
 
 
9,767

 
 
 
 
 
9,767

Other comprehensive income
 
 
 
 
 
 
5,238

 
5,238

Stock-based compensation expense
275

 
 
 
 
 
 
 
275

Purchase of treasury stock (40,000 shares)
 
 
 
 
(994
)
 
 
 
(994
)
Purchase of treasury stock for the purpose of tax withholding related to restricted stock award vesting (1,388 shares)
 
 
 
 
(39
)
 
 
 
(39
)
Cash dividends declared ($0.17 per share)
 
 
(2,591
)
 
 
 
 
 
(2,591
)
Balance, June 30, 2019
$
97,414

 
$
185,838

 
$
(2,735
)
 
$
6,098

 
$
286,615

 
 
 
 
 
 
 
 
 
 
Balance, April 1, 2018
$
96,786

 
$
152,872

 
$
(602
)
 
$
(4,245
)
 
$
244,811

Net income
 
 
8,441

 
 
 
 
 
8,441

Other comprehensive loss
 
 
 
 
 
 
(1,103
)
 
(1,103
)
Forfeiture of restricted stock award grants (130 shares)
1

 
 
 
(4
)
 
 
 
(3
)
Stock-based compensation expense
272

 
 
 
 
 
 
 
272

Purchase of treasury stock for the purpose of tax withholding related to restricted stock award vesting (79 shares)
 
 
 
 
(2
)
 
 
 
(2
)
Cash dividends declared ($0.165 per share)
 
 
(2,523
)
 
 
 
 
 
(2,523
)
Balance, June 30, 2018
$
97,059

 
$
158,790

 
$
(608
)
 
$
(5,348
)
 
$
249,893


 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Share-
holders’
Equity
Balance, January 1, 2019
$
97,602

 
$
171,780

 
$
(2,556
)
 
$
(3,996
)
 
$
262,830

Net income
 
 
19,240

 
 
 
 
 
19,240

Other comprehensive income
 
 
 
 
 
 
10,094

 
10,094

Restricted stock award grants (39,790 shares)
(1,055
)
 
 
 
1,055

 
 
 
0

Stock-based compensation expense
867

 
 
 
 
 
 
 
867

Purchase of treasury stock (40,000 shares)
 
 
 
 
(994
)
 
 
 
(994
)
Purchase of treasury stock for the purpose of tax withholding related to restricted stock award vesting (9,088 shares)
 
 
 
 
(240
)
 
 
 
(240
)
Cash dividends declared ($0.34 per share)
 
 
(5,182
)
 
 
 
 
 
(5,182
)
Balance, June 30, 2019
$
97,414

 
$
185,838

 
$
(2,735
)
 
$
6,098

 
$
286,615

 
 
 
 
 
 
 
 
 
 
Balance, January 1, 2018
$
97,042

 
$
148,298

 
$
(1,087
)
 
$
(343
)
 
$
243,910

Net income
 
 
15,538

 
 
 
 
 
15,538

Other comprehensive loss
 
 
 
 
 
 
(5,005
)
 
(5,005
)
Forfeiture of restricted stock award grants (130 shares)
1

 
 
 
(4
)
 
 
 
(3
)
Restricted stock award grants (37,708 shares)
(933
)
 
 
 
933

 
 
 
0

Stock-based compensation expense
949

 
 
 
 
 
 
 
949

Purchase of treasury stock (10,769 shares)
 
 
 
 
(286
)
 
 
 
(286
)
Purchase of treasury stock for the purpose of tax withholding related to restricted stock award vesting (6,119 shares)
 
 
 
 
(164
)
 
 
 
(164
)
Cash dividends declared ($0.33 per share)
 
 
(5,046
)
 
 
 
 
 
(5,046
)
Balance, June 30, 2018
$
97,059

 
$
158,790

 
$
(608
)
 
$
(5,348
)
 
$
249,893

 
 
 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements


5

Table of Contents

CNB FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
1.    BASIS OF PRESENTATION

The accompanying consolidated financial statements have been prepared pursuant to rules and regulations of the SEC and in compliance with accounting principles generally accepted in the United States of America (“GAAP”). Because this report is based on an interim period, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted.

In the opinion of management of the registrant, the accompanying consolidated financial statements as of June 30, 2019 and for the three and six month periods ended June 30, 2019 and 2018 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations for the periods presented. The financial performance reported for CNB Financial Corporation (the “Corporation”) for the three and six month period ended June 30, 2019 is not necessarily indicative of the results to be expected for the full year. This information should be read in conjunction with the Corporation’s Annual Report on Form 10-K for the period ended December 31, 2018 (the “2018 Form 10-K”). All dollar amounts are stated in thousands, except share and per share data and other amounts as indicated. Certain prior period amounts have been reclassified to conform to the current period presentation.

2.    STOCK COMPENSATION

The Corporation has a stock incentive plan, which is administered by a committee of the Board of Directors and which permits the Corporation to provide various types of stock-based compensation to its key employees, directors, and/or consultants, including time-based and performance-based shares of restricted stock. The Corporation previously maintained the CNB Financial Corporation 2009 Stock Incentive Plan, which terminated in accordance with its terms on February 10, 2019, and currently maintains the CNB Financial Corporation 2019 Omnibus Incentive Plan (the "2019 Stock Incentive Plan"), which was approved by the Corporation’s shareholders and became effective on April 16, 2019. 

For key employees, the vesting of time-based restricted stock is one-third, one-fourth, or one-fifth of the granted restricted shares per year, beginning one year after the grant date, with 100% vesting on the third, fourth or fifth anniversary of the grant date, respectively. Prior to 2018, for non-employee directors, the vesting schedule was one-third of the granted restricted shares per year, beginning one year after the grant date, with 100% vested on the third anniversary of the grant date. Beginning in 2018, stock compensation received by non-employee directors vests immediately. At June 30, 2019, there was no unrecognized compensation cost related to stock-based compensation awarded under this plan and, except for the time-based and performance-based restricted stock awards disclosed below and in previous filings, no other stock-based compensation was granted during the three or six month periods ended June 30, 2019 and 2018.
In addition to the time-based restricted stock disclosed above, the Corporation’s Board of Directors grants performance-based restricted stock awards (“PBRSAs”) to key employees. The number of PBRSAs will depend on certain performance conditions and are also subject to service-based vesting. In 2019, awards with a maximum of 16,681 shares in aggregate were granted to key employees. In 2018, awards with a maximum of 15,657 shares in aggregate were granted to key employees. In 2017, an award with a maximum of 7,109 shares was granted to a key employee.
Compensation expense for the restricted stock awards is recognized over the requisite service period noted above based on the fair value of the shares at the date of grant. Nonvested restricted stock awards are recorded as a reduction of additional paid-in-capital in shareholders’ equity until earned. Compensation expense resulting from time-based, performance-based and director restricted stock awards was $275 and $867 for the three and six months ended June 30, 2019 and $272 and $949 for the three and six months ended June 30, 2018. There was $911 and $775 of total unrecognized compensation cost related to unvested restricted stock awards, as of June 30, 2019 and December 31, 2018, respectively. The total income tax benefit related to the recognized compensation cost of vested restricted stock awards was $58 and $182 for the three and six months ended June 30, 2019 and $57 and $199 for the three and six months ended June 30, 2018, respectively.

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Table of Contents

A summary of changes in time-based nonvested restricted stock awards for the three months ended June 30, 2019 follows:
 
Shares
 
Per Share Weighted Average Grant Date Fair Value
Nonvested at beginning of period
67,769

 
$
24.79

Vested
(3,611
)
 
23.42

Nonvested at end of period
64,158

 
$
24.87


A summary of changes in time-based nonvested restricted stock awards for the six months ended June 30, 2019 follows:
 
Shares
 
Per Share Weighted Average Grant Date Fair Value
Nonvested at beginning of period
75,889

 
$
23.20

Granted
25,940

 
25.27

Vested
(37,671
)
 
21.76

Nonvested at end of period
64,158

 
$
24.87



The above table excludes 13,850 shares in restricted stock awards that were granted at a weighted average fair value of $25.27 and immediately vested. Compensation expense resulting from the immediately vested shares was $0 and $350 for the three and six months ended June 30, 2019 and is included in the previously disclosed $275 and $867 above, respectively.

The fair value of shares vested was $101 and $1,328 during the three and six months ended June 30, 2019 and $9 and $1,471 for the three and six months ended June 30, 2018.

3.    FAIR VALUE

Fair Value Measurement

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. A fair value hierarchy has also been established which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The following three levels of inputs are used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair values of most trading securities and securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

The Corporation’s derivative instruments are interest rate swaps that are similar to those that trade in liquid markets. As such, significant fair value inputs can generally be verified and do not typically involve significant management judgments (Level 2 inputs).

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals prepared by third-parties. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Management also adjusts appraised values based on the length of time that has passed since the appraisal date and other factors. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

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Table of Contents

Assets and liabilities measured at fair value on a recurring basis are as follows at June 30, 2019 and December 31, 2018:
 
 

 
Fair Value Measurements at June 30, 2019 Using:
 
 
 
 
Quoted Prices in Active Markets for Identical Assets
 
Significant Other Observable Inputs
 
Significant Unobservable Inputs
Description
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Securities Available For Sale:
 
 
 
 
 
 
 
U.S. Government sponsored entities
$
140,727

 
$
0

 
$
140,727

 
$
0

States and political subdivisions
119,454

 
0

 
119,454

 
0

Residential and multi-family mortgage
233,064

 
0

 
233,064

 
0

Corporate notes and bonds
11,889

 
0

 
11,889

 
0

Pooled SBA
27,876

 
0

 
27,876

 
0

Other
960

 
960

 
0

 
0

Total Securities Available For Sale
$
533,970

 
$
960

 
$
533,010

 
$
0

Interest Rate swaps
$
1,802

 
$
0

 
$
1,802

 
$
0

Trading Securities:
 
 
 
 
 
 
 
Corporate equity securities
$
7,155

 
$
7,155

 
$
0

 
$
0

Mutual funds
916

 
916

 
0

 
0

Certificates of deposit
179

 
179

 
0

 
0

Corporate notes and bonds
603

 
603

 
0

 
0

U.S. Government sponsored entities
51

 
0

 
51

 
0

Total Trading Securities
$
8,904

 
$
8,853

 
$
51

 
$
0

Liabilities:
 
 
 
 
 
 
 
Interest rate swaps
$
(2,328
)
 
$
0

 
$
(2,328
)
 
$
0

 
 
 
 
 
 
 
 
 
 
 
Fair Value Measurements at December 31, 2018 Using:
 
 
 
Quoted Prices in Active Markets for Identical Assets
 
Significant Other Observable Inputs
 
Significant Unobservable Inputs
Description
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Securities Available For Sale:
 
 
 
 
 
 
 
U.S. Government sponsored entities
$
132,694

 
$
0

 
$
132,694

 
$
0

States and political subdivisions
136,031

 
0

 
136,031

 
0

Residential and multi-family mortgage
206,053

 
0

 
206,053

 
0

Corporate notes and bonds
11,777

 
0

 
11,777

 
0

Pooled SBA
29,374

 
0

 
29,374

 
0

Other
934

 
934

 
0

 
0

Total Securities Available For Sale
$
516,863

 
$
934

 
$
515,929

 
$
0

Interest Rate swaps
$
485

 
$
0

 
$
485

 
$
0

Trading Securities:
 
 
 
 
 
 
 
Corporate equity securities
$
5,828

 
$
5,828

 
$
0

 
$
0

Mutual funds
1,058

 
1,058

 
0

 
0

Certificates of deposit
268

 
268

 
0

 
0

Corporate notes and bonds
581

 
581

 
0

 
0

U.S. Government sponsored entities
51

 
0

 
51

 
0

Total Trading Securities
$
7,786

 
$
7,735

 
$
51

 
$
0

Liabilities:
 
 
 
 
 
 
 
Interest rate swaps
$
(686
)
 
$
0

 
$
(686
)
 
$
0








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Table of Contents

Assets and liabilities measured at fair value on a non-recurring basis are as follows at June 30, 2019 and December 31, 2018:
 
 
 
Fair Value Measurements at June 30, 2019 Using:
 
 
 
Quoted Prices in
Active Markets 
for
Identical Assets
 
Significant Other
Observable Inputs
 
Significant
Unobservable
Inputs
Description
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Impaired loans:
 
 
 
 
 
 
 
Commercial, industrial, and agricultural
$
631

 
0

 
0

 
$
631

Commercial mortgages
$
933

 
0

 
0

 
$
933

 
 
 
 
 
 
 
 
 
 
 
Fair Value Measurements at December 31, 2018 Using
 
 
 
Quoted Prices in
 
 
 
Significant
 
 
 
Active Markets 
for
 
Significant Other
 
Unobservable
 
 
 
Identical Assets
 
Observable Inputs
 
Inputs
Description
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Impaired loans:
 
 
 
 
 
 
 
Commercial, industrial, and agricultural
$
2,055

 
0

 
0

 
$
2,055

Commercial mortgages
$
679

 
0

 
0

 
$
679



The estimated fair values of impaired collateral dependent loans, such as commercial or residential mortgages, are determined primarily through third-party appraisals. When a collateral dependent loan, such as a commercial or residential mortgage loan, becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal, and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral and a further reduction for estimated costs to sell the property is applied, which results in an amount that is considered to be the estimated fair value. If a loan becomes impaired and the appraisal of related loan collateral is outdated, management applies an appropriate adjustment factor based on its experience with current valuations of similar collateral in determining the loan’s estimated fair value and resulting allowance for loan losses. Third-party appraisals are not customarily obtained in respect of unimpaired loans, unless in management’s view changes in circumstances warrant obtaining an updated appraisal.
The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at June 30, 2019:
 
Fair
value
 
Valuation Technique
 
Unobservable Inputs
 
Range
(Weighted Average)
Impaired loans – commercial, industrial, and agricultural
$631
 
Valuation of third party appraisal on underlying collateral
 
Loss severity rates
 
48%-61% (58%)
Impaired loans – commercial mortgages
$933
 
Valuation of third party appraisal on underlying collateral
 
Loss severity rates
 
0-100% (66%)
The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2018:
 
Fair
value
 
Valuation Technique
 
Unobservable Inputs
 
Range
(Weighted Average)
Impaired loans – commercial, industrial, and agricultural
$2,055
 
Valuation of third party appraisal on underlying collateral
 
Loss severity rates
 
20%-60% (34%)
Impaired loans – commercial mortgages
$679
 
Valuation of third party appraisal on underlying collateral
 
Loss severity rates
 
15%-39% (33%)


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Table of Contents

Fair Value of Financial Instruments
The following table presents the carrying amount and fair value of financial instruments at June 30, 2019:
 
Carrying
 
Fair Value Measurement Using:
 
Total
 
Amount
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
37,930

 
$
37,930

 
$
0

 
$
0

 
$
37,930

Securities available for sale
533,970

 
960

 
533,010

 
0

 
533,970

Trading securities
8,904

 
8,853

 
51

 
0

 
8,904

Loans held for sale
2,032

 
0

 
2,037

 
0

 
2,037

Net loans
2,600,921

 
0

 
0

 
2,578,210

 
2,578,210

FHLB and other restricted interests
24,501

 
n/a

 
n/a

 
n/a

 
n/a

Interest rate swaps
1,802

 
0

 
1,802

 
0

 
1,802

Accrued interest receivable
12,020

 
6

 
3,310

 
8,704

 
12,020

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits
$
(2,734,762
)
 
$
(2,379,635
)
 
$
(355,750
)
 
$
0

 
$
(2,735,385
)
FHLB and other borrowings
(257,784
)
 
0

 
(260,361
)
 
0

 
(260,361
)
Subordinated debentures
(70,620
)
 
0

 
(64,791
)
 
0

 
(64,791
)
Interest rate swaps
(2,328
)
 
0

 
(2,328
)
 
0

 
(2,328
)
Accrued interest payable
(990
)
 
0

 
(990
)
 
0

 
(990
)
The following table presents the carrying amount and fair value of financial instruments at December 31, 2018:
 
Carrying
 
Fair Value Measurement Using:
 
Total
 
Amount
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
45,563

 
$
45,563

 
$
0

 
$
0

 
$
45,563

Securities available for sale
516,863

 
934

 
515,929

 
0

 
516,863

Trading securities
7,786

 
7,735

 
51

 
0

 
7,786

Loans held for sale
367

 
0

 
368

 
0

 
368

Net loans
2,454,853

 
0

 
0

 
2,433,417

 
2,433,417

FHLB and other restricted interests
24,508

 
n/a

 
n/a

 
n/a

 
n/a

Interest rate swaps
485

 
0

 
485

 
0

 
485

Accrued interest receivable
10,843

 
6

 
3,368

 
7,469

 
10,843

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits
$
(2,610,786
)
 
$
(2,215,349
)
 
$
(397,370
)
 
$
0

 
$
(2,612,719
)
FHLB and other borrowings
(245,117
)
 
0

 
(242,592
)
 
0

 
(242,592
)
Subordinated debentures
(70,620
)
 
0

 
(65,794
)
 
0

 
(65,794
)
Interest rate swaps
(686
)
 
0

 
(686
)
 
0

 
(686
)
Accrued interest payable
(863
)
 
0

 
(863
)
 
0

 
(863
)


In accordance with our adoption of Accounting Standards Update ("ASU") 2016-01 in 2018, the methods utilized to measure the fair value of financial instruments at June 30, 2019 and December 31, 2018 represent an approximation of exit price; however, an actual exit price may differ.


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Table of Contents

4.    SECURITIES
Securities available for sale at June 30, 2019 and December 31, 2018 are as follows:
 
June 30, 2019
 
December 31, 2018
 
Amortized
 
Unrealized
 
Fair
 
Amortized
 
Unrealized
 
Fair
 
Cost
 
Gains
 
Losses
 
Value
 
Cost
 
Gains
 
Losses
 
Value
U.S. Gov’t sponsored entities
$
138,235

 
$
2,633

 
$
(141
)
 
$
140,727

 
$
134,010

 
$
254

 
$
(1,570
)
 
$
132,694

State & political subdivisions
116,140

 
3,387

 
(73
)
 
119,454

 
134,662

 
1,942

 
(573
)
 
136,031

Residential & multi-family mortgage
229,925

 
4,086

 
(947
)
 
233,064

 
209,126

 
500

 
(3,573
)
 
206,053

Corporate notes & bonds
12,352

 
16

 
(479
)
 
11,889

 
12,356

 
22

 
(601
)
 
11,777

Pooled SBA
27,671

 
373

 
(168
)
 
27,876

 
30,163

 
135

 
(924
)
 
29,374

Other
1,020

 
0

 
(60
)
 
960

 
1,020

 
0

 
(86
)
 
934

Total
$
525,343

 
$
10,495

 
$
(1,868
)
 
$
533,970

 
$
521,337

 
$
2,853

 
$
(7,327
)
 
$
516,863



At June 30, 2019 and December 31, 2018, there were no holdings of securities of any one issuer, other than the U.S. Government sponsored entities, in an amount greater than 10% of shareholders’ equity. The Corporation’s residential and multi-family mortgage securities are issued by government sponsored entities.
Trading securities at June 30, 2019 and December 31, 2018 are as follows:
 
June 30, 2019
 
December 31, 2018
Corporate equity securities
$
7,155

 
$
5,828

Mutual funds
916

 
1,058

Certificates of deposit
179

 
268

Corporate notes and bonds
603

 
581

U.S. Government sponsored entities
51

 
51

Total
$
8,904

 
$
7,786


Securities with unrealized losses at June 30, 2019 and December 31, 2018, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:
June 30, 2019
 
Less than 12 Months
 
12 Months or More
 
Total
Description of Securities
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
U.S. Gov’t sponsored entities
$
0

 
$
0

 
$
35,941

 
$
(141
)
 
$
35,941

 
$
(141
)
State & political subdivisions
870

 
0

 
732

 
(73
)
 
1,602

 
(73
)
Residential & multi-family mortgage
8,001

 
(57
)
 
51,298

 
(890
)
 
59,299

 
(947
)
Corporate notes & bonds
0

 
0

 
9,522

 
(479
)
 
9,522

 
(479
)
Pooled SBA
0

 
0

 
13,975

 
(168
)
 
13,975

 
(168
)
Other
0

 
0

 
960

 
(60
)
 
960

 
(60
)
 
$
8,871

 
$
(57
)
 
$
112,428

 
$
(1,811
)
 
$
121,299

 
$
(1,868
)

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Table of Contents


December 31, 2018
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
U.S. Gov’t sponsored entities
$
14,786

 
$
(41
)
 
$
70,676

 
$
(1,529
)
 
$
85,462

 
$
(1,570
)
State & political subdivisions
13,834

 
(62
)
 
21,080

 
(511
)
 
34,914

 
(573
)
Residential & multi-family mortgage
69,015

 
(656
)
 
87,286

 
(2,917
)
 
156,301

 
(3,573
)
Corporate notes & bonds
0

 
0

 
9,759

 
(601
)
 
9,759

 
(601
)
Pooled SBA
760

 
(7
)
 
20,795

 
(917
)
 
21,555

 
(924
)
Other
0

 
0

 
934

 
(86
)
 
934

 
(86
)
 
$
98,395

 
$
(766
)
 
$
210,530

 
$
(6,561
)
 
$
308,925

 
$
(7,327
)

The Corporation evaluates securities for other-than-temporary impairment on a quarterly basis, or more frequently when economic or market conditions warrant such an evaluation.

At June 30, 2019 and December 31, 2018, management performed an assessment for possible other-than-temporary impairment of the Corporation’s debt securities, relying on information obtained from various sources, including publicly available financial data, ratings by external agencies, brokers and other sources. Based on the results of the assessment, management believes impairment of these debt securities at June 30, 2019 and December 31, 2018 to be temporary.
For the securities that comprise corporate notes and bonds and the securities that are issued by state and political subdivisions, management monitors publicly available financial information, such as filings with the Securities and Exchange Commission, in order to evaluate the securities for other-than-temporary impairment. For financial institution issuers, management monitors information from quarterly “call” report filings that are used to generate Uniform Bank Performance Reports. All other securities that were in an unrealized loss position at the balance sheet date were reviewed by management, and issuer-specific documents were reviewed as appropriate given the following considerations. When reviewing securities for other-than-temporary impairment, management considers the financial condition and near-term prospects of the issuer and whether downgrades by bond rating agencies have occurred. Management also considers the length of time and extent to which fair value has been less than cost, and whether management does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery.
As of June 30, 2019 and December 31, 2018, management concluded that the securities described in the previous paragraph were not other-than-temporarily impaired for the following reasons:
 
There is no indication of any significant deterioration of the creditworthiness of the institutions that issued the securities.
All contractual interest payments on the securities have been received as scheduled, and no information has come to management’s attention through the processes previously described which would lead to a conclusion that future contractual payments will not be timely received.
The Corporation does not intend to sell and it is not more likely than not that it will be required to sell the securities in an unrealized loss position before recovery of its amortized cost basis.
On June 30, 2019 and December 31, 2018, securities carried at $261,059 and $290,717, respectively, were pledged to secure public deposits and for other purposes as provided by law.
Information pertaining to security sales on available for sale securities is as follows:
 
Proceeds
 
Gross
Gains
 
Gross
Losses
Three months ended June 30, 2019
$
0

 
$
0

 
$
0

Three months ended June 30, 2018
$
0

 
$
0

 
$
0

Six months ended June 30, 2019
$
11,403

 
$
152

 
$
4

Six months ended June 30, 2018
$
0

 
$
0

 
$
0


The tax provision related to these net realized gains was $0 and $31 during the three and six months ended June 30, 2019.

12

Table of Contents

The following is a schedule of the contractual maturity of securities available for sale at June 30, 2019:
 
Amortized
Cost
 
Fair
Value
1 year or less
$
76,122

 
$
75,987

1 year – 5 years
113,884

 
115,445

5 years – 10 years
71,326

 
75,086

After 10 years
5,395

 
5,552

 
266,727

 
272,070

Residential and multi-family mortgage
229,925

 
233,064

Pooled SBA
27,671

 
27,876

Other
1,020

 
960

Total debt securities
$
525,343

 
$
533,970



Mortgage and asset backed securities and pooled SBA securities are not due at a single date; periodic payments are received based on the payment patterns of the underlying collateral.

5.    LOANS
Total net loans at June 30, 2019 and December 31, 2018 are summarized as follows:
 
June 30, 2019
 
December 31, 2018
Commercial, industrial, and agricultural
$
993,629

 
$
916,297

Commercial mortgages
750,334

 
697,776

Residential real estate
786,354

 
771,309

Consumer
89,331

 
86,035

Credit cards
7,284

 
7,623

Overdrafts
337

 
308

Less: unearned discount
(4,911
)
 
(4,791
)
allowance for loan losses
(21,437
)
 
(19,704
)
Loans, net
$
2,600,921

 
$
2,454,853


At June 30, 2019 and December 31, 2018, net unamortized loan fees of $3,374 and $3,175, respectively, have been included in the carrying value of loans.

The Corporation’s outstanding loans and related unfunded commitments are primarily concentrated within central and northwest Pennsylvania, central and northeast Ohio, and western New York. The Bank attempts to limit concentrations within specific industries by utilizing dollar limitations to single industries or customers, and by entering into participation agreements with third parties. Collateral requirements are established based on management’s assessment of the customer. The Corporation maintains lending policies to control the quality of the loan portfolio. These policies delegate the authority to extend loans under specific guidelines and underwriting standards. These policies are prepared by the Corporation’s management and reviewed and ratified annually by the Corporation’s Board of Directors.

Pursuant to the Corporation’s lending policies, management considers a variety of factors when determining whether to extend credit to a customer, including loan-to-value ratios, FICO scores, quality of the borrower’s financial statements, and the ability to obtain personal guarantees.
Commercial, industrial, and agricultural loans comprised 38% and 37% of the Corporation’s total loan portfolio at June 30, 2019 and December 31, 2018, respectively. Commercial mortgage loans comprised 29% and 28% of the Corporation’s total loan portfolio at June 30, 2019 and December 31, 2018, respectively. Management assigns a risk rating to all commercial loans at loan origination. The loan-to-value policy guidelines for commercial, industrial, and agricultural loans are generally a maximum of 80% of the value of business equipment, a maximum of 75% of the value of accounts receivable, and a maximum of 60% of the value of business inventory at loan origination. The loan-to-value policy guideline for commercial mortgage loans is generally a maximum of 85% of the appraised value of the real estate.
Residential real estate loans comprised 30% and 31% of the Corporation’s total loan portfolio at June 30, 2019 and December 31, 2018, respectively. The loan-to-value policy guidelines for residential real estate loans vary depending on the collateral position and the specific type of loan. Higher loan-to-value terms may be approved with the appropriate private mortgage insurance coverage.

13

Table of Contents

The Corporation also originates and prices loans for sale into the secondary market. Loans so originated are classified as loans held for sale and are excluded from residential real estate loans reported above. The rationale for these sales is to mitigate interest rate risk associated with holding lower rate, long-term residential mortgages in the loan portfolio and to generate fee revenue from sales and servicing the loan. The Corporation also offers a variety of unsecured and secured consumer loan and credit card products which represented less than 4% of the total loan portfolio at both June 30, 2019 and December 31, 2018. Terms and collateral requirements vary depending on the size and nature of the loan.
Transactions in the allowance for loan losses for the three months ended June 30, 2019 were as follows:
 
Commercial,Industrial, 
and Agricultural
 
Commercial
Mortgages
 
Residential
Real
Estate
 
Consumer
 
Credit
Cards
 
Overdrafts
 
Total
Allowance for loan losses, April 1, 2019
$
7,787

 
$
8,846

 
$
1,383

 
$
2,040

 
$
105

 
$
185

 
$
20,346

Charge-offs
0

 
0

 
(146
)
 
(513
)
 
(26
)
 
(88
)
 
(773
)
Recoveries
4

 
16

 
2

 
28

 
1

 
25

 
76

Provision (benefit) for loan losses
317

 
676

 
164

 
586

 
7

 
38

 
1,788

Allowance for loan losses, June 30, 2019
$
8,108

 
$
9,538

 
$
1,403

 
$
2,141

 
$
87

 
$
160

 
$
21,437

Transactions in the allowance for loan losses for the six months ended June 30, 2019 were as follows:
 
Commercial,Industrial, 
and Agricultural
 
Commercial
Mortgages
 
Residential
Real
Estate
 
Consumer
 
Credit
Cards
 
Overdrafts
 
Total
Allowance for loan losses, January 1, 2019
$
7,341

 
$
7,490

 
$
2,156

 
$
2,377

 
$
103

 
$
237

 
$
19,704

Charge-offs
0

 
(2
)
 
(244
)
 
(1,062
)
 
(52
)
 
(216
)
 
(1,576
)
Recoveries
8

 
1

 
67

 
74

 
6

 
59

 
215

Provision (benefit) for loan losses
759

 
2,049

 
(576
)
 
752

 
30

 
80

 
3,094

Allowance for loan losses, June 30, 2019
$
8,108

 
$
9,538

 
$
1,403

 
$
2,141

 
$
87

 
$
160

 
$
21,437

Transactions in the allowance for loan losses for the three months ended June 30, 2018 were as follows:
 
Commercial, Industrial, 
and
Agricultural
 
Commercial
Mortgages
 
Residential
Real
Estate
 
Consumer
 
Credit
Cards
 
Overdrafts
 
Total
Allowance for loan losses, April 1, 2018
$
6,282

 
$
10,020

 
$
2,052

 
$
2,065

 
$
123

 
$
214

 
$
20,756

Charge-offs
0

 
0

 
(77
)
 
(551
)
 
(26
)
 
(56
)
 
(710
)
Recoveries
94

 
0

 
9

 
35

 
17

 
16

 
171

Provision (benefit) for loan losses
767

 
595

 
(84
)
 
607

 
(13
)
 
33

 
1,905

Allowance for loan losses, June 30, 2018
$
7,143

 
$
10,615

 
$
1,900

 
$
2,156

 
$
101

 
$
207

 
$
22,122


Transactions in the allowance for loan losses for the six months ended June 30, 2018 were as follows:
 
Commercial, Industrial, 
and
Agricultural
 
Commercial
Mortgages
 
Residential
Real
Estate
 
Consumer
 
Credit
Cards
 
Overdrafts
 
Total
Allowance for loan losses, January 1, 2018
$
6,160

 
$
9,007

 
$
2,033

 
$
2,179

 
$
120

 
$
194

 
$
19,693

Charge-offs
(31
)
 
0

 
(77
)
 
(1,141
)
 
(45
)
 
(142
)
 
(1,436
)
Recoveries
162

 
0

 
12

 
84

 
24

 
47

 
329

Provision (benefit) for loan losses
852

 
1,608

 
(68
)
 
1,034

 
2

 
108

 
3,536

Allowance for loan losses, June 30, 2018
$
7,143

 
$
10,615

 
$
1,900

 
$
2,156

 
$
101

 
$
207

 
$
22,122




14

Table of Contents

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and is based on the Corporation’s impairment method as of June 30, 2019 and December 31, 2018. The recorded investment in loans excludes accrued interest and unearned discounts due to their insignificance.

June 30, 2019
 
Commercial, Industrial, 
and
Agricultural
 
Commercial
Mortgages
 
Residential
Real
Estate
 
Consumer
 
Credit
Cards
 
Overdrafts
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending allowance balance attributable to loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
222

 
$
664

 
$
0

 
$
0

 
$
0

 
$
0

 
$
886

Collectively evaluated for impairment
7,795

 
4,154

 
1,403

 
2,141

 
87

 
160

 
15,740

Acquired with deteriorated credit quality
0

 
0

 
0

 
0

 
0

 
0

 
0

Modified in a troubled debt restructuring
91

 
4,720

 
0

 
0

 
0

 
0

 
4,811

Total ending allowance balance
$
8,108

 
$
9,538

 
$
1,403

 
$
2,141

 
$
87

 
$
160

 
$
21,437

Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
1,666

 
$
1,435

 
$
472

 
$
0

 
$
0

 
$
0

 
$
3,573

Collectively evaluated for impairment
988,617

 
738,828

 
785,882

 
89,331

 
7,284

 
337

 
2,610,279

Acquired with deteriorated credit quality
0

 
545

 
0

 
0

 
0

 
0

 
545

Modified in a troubled debt restructuring
3,346

 
9,526

 
0

 
0

 
0

 
0

 
12,872

Total ending loans balance
$
993,629

 
$
750,334

 
$
786,354

 
$
89,331

 
$
7,284

 
$
337

 
$
2,627,269


December 31, 2018
 
Commercial, Industrial, 
and
Agricultural
 
Commercial
Mortgages
 
Residential
Real
Estate
 
Consumer
 
Credit
Cards
 
Overdrafts
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending allowance balance attributable to loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
54

 
$
4

 
$
100

 
$
0

 
$
0

 
$
10

 
$
168

Collectively evaluated for impairment
7,183

 
3,036

 
2,056

 
2,377

 
103

 
227

 
14,982

Acquired with deteriorated credit quality
0

 
0

 
0

 
0

 
0

 
0

 
0

Modified in a troubled debt restructuring
104

 
4,450

 
0

 
0

 
0

 
0

 
4,554

Total ending allowance balance
$
7,341

 
$
7,490

 
$
2,156

 
$
2,377

 
$
103

 
$
237

 
$
19,704

Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
1,334

 
1,446

 
502

 
0

 
0

 
10

 
$
3,292

Collectively evaluated for impairment
910,386

 
685,714

 
770,807

 
86,035

 
7,623

 
298

 
2,460,863

Acquired with deteriorated credit quality
0

 
567

 
0

 
0

 
0

 
0

 
567

Modified in a troubled debt restructuring
4,577

 
10,049

 
0

 
0

 
0

 
0

 
14,626

Total ending loans balance
$
916,297

 
697,776

 
771,309

 
86,035

 
7,623

 
308

 
$
2,479,348


15

Table of Contents

The following tables present information related to loans individually evaluated for impairment, including loans modified in troubled debt restructurings, by portfolio segment as of June 30, 2019 and December 31, 2018 and for the three and six months ended June 30, 2019 and 2018:
June 30, 2019
 
Unpaid Principal
Balance
 
Recorded
Investment
 
Allowance for Loan
Losses Allocated
With an allowance recorded:
 
 
 
 
 
Commercial, industrial, and agricultural
$
2,829

 
$
1,268

 
$
313

Commercial mortgage
8,179

 
7,790

 
5,384

Residential real estate
0

 
0

 
0

With no related allowance recorded:
 
 
 
 
 
Commercial, industrial, and agricultural
4,493

 
3,744

 
0

Commercial mortgage
4,084

 
3,171

 
0

Residential real estate
492

 
472

 
0

Total
$
20,077

 
$
16,445

 
$
5,697

December 31, 2018
 
Unpaid Principal
Balance
 
Recorded
Investment
 
Allowance for Loan
Losses Allocated
With an allowance recorded:
 
 
 
 
 
Commercial, industrial, and agricultural
$
3,053

 
$
3,037

 
$
158

Commercial mortgage
10,799

 
6,709

 
4,454

Residential real estate
502

 
502

 
100

Overdrafts
10

 
10

 
10

With no related allowance recorded:
 
 
 
 
 
Commercial, industrial, and agricultural
3,684

 
2,874

 
0

Commercial mortgage
5,659

 
4,786

 
0

Residential real estate
0

 
0

 
0

Overdrafts
0

 
0

 
0

Total
$
23,707

 
$
17,918

 
$
4,722


The unpaid principal balance of impaired loans includes the Corporation’s recorded investment in the loan and amounts that have been charged off.
 
Three months ended June 30, 2019
 
Three months ended June 30, 2018
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Cash Basis
Interest
Recognized
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Cash Basis
Interest
Recognized
With an allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
Commercial, industrial, and agricultural
$
1,273

 
$
27

 
$
27

 
$
3,838

 
$
21

 
$
21

Commercial mortgage
7,807

 
46

 
46

 
8,738

 
56

 
56

Residential real estate
0

 
0

 
0

 
0

 
0

 
0

With no related allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
Commercial, industrial, and agricultural
3,811

 
32

 
32

 
5,326

 
45

 
45

Commercial mortgage
3,257

 
20

 
20

 
5,490

 
33

 
33

Residential real estate
485

 
4

 
4

 
0

 
0

 
0

Total
$
16,633

 
$
129

 
$
129

 
$
23,392

 
$
155

 
$
155


16

Table of Contents

 
Six months ended June 30, 2019
 
Six months ended June 30, 2018
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Cash Basis
Interest
Recognized
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Cash Basis
Interest
Recognized
With an allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
Commercial, industrial, and agricultural
$
1,861

 
$
65

 
$
65

 
$
3,197

 
$
43

 
$
43

Commercial mortgage
7,441

 
86

 
86

 
9,069

 
74

 
74

Residential real estate
0

 
0

 
0

 
0

 
0

 
0

With no related allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
Commercial, industrial, and agricultural
3,499

 
86

 
86

 
5,045

 
91

 
91

Commercial mortgage
3,767

 
38

 
38

 
4,463

 
46

 
46

Residential real estate
490

 
11

 
11

 
0

 
0

 
0

Total
$
17,058

 
$
286

 
$
286

 
$
21,774

 
$
254

 
$
254


The following table presents the recorded investment in nonaccrual loans and loans past due over 90 days still accruing interest by class of loans as of June 30, 2019 and December 31, 2018:
 
June 30, 2019
 
December 31, 2018
 
Nonaccrual
 
Past Due
Over 90 Days
Still on Accrual
 
Nonaccrual
 
Past Due
Over 90 Days
Still on Accrual
Commercial, industrial, and agricultural
$
3,263

 
$
248

 
$
2,076

 
$
487

Commercial mortgages
6,219

 
0

 
6,329

 
53

Residential real estate
4,824

 
195

 
5,187

 
299

Consumer
554

 

 
670

 
43

Credit cards
0

 
21

 
0

 
5

Total
$
14,860

 
$
464

 
$
14,262

 
$
887



Nonaccrual loans and loans past due over 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
The following table presents the aging of the recorded investment in past due loans as of June 30, 2019 and December 31, 2018 by class of loans.
June 30, 2019
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Greater Than
89 Days
Past Due
 
Total
Past Due
 
Loans Not
Past Due
 
Total
Commercial, industrial, and agricultural
$
3,221

 
$
2,607

 
$
2,983

 
$
8,811

 
$
984,818

 
$
993,629

Commercial mortgages
904

 
5,283

 
4,111

 
10,298

 
740,036

 
750,334

Residential real estate
3,704

 
774

 
2,757

 
7,235

 
779,119

 
786,354

Consumer
460

 
153

 
284

 
897

 
88,434

 
89,331

Credit cards
105

 
5

 
21

 
131

 
7,153

 
7,284

Overdrafts
0

 
0

 
0

 
0

 
337

 
337

Total
$
8,394

 
$
8,822

 
$
10,156

 
$
27,372

 
$
2,599,897

 
$
2,627,269



17

Table of Contents

December 31, 2018
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
Greater Than
89 Days
Past Due
 
Total
Past Due
 
Loans Not
Past Due
 
Total
Commercial, industrial, and agricultural
$
2,339

 
$
9

 
$
2,264

 
$
4,612

 
$
911,685

 
$
916,297

Commercial mortgages
758

 
3,055

 
283

 
4,096

 
693,680

 
697,776

Residential real estate
3,982

 
1,257

 
3,988

 
9,227

 
762,082

 
771,309

Consumer
470

 
282

 
363

 
1,115

 
84,920

 
86,035

Credit cards
59

 
15

 
5

 
79

 
7,544

 
7,623

Overdrafts
0

 
0

 
0

 
0

 
308

 
308

Total
$
7,608

 
$
4,618

 
$
6,903

 
$
19,129

 
$
2,460,219

 
$
2,479,348


Troubled Debt Restructurings
The terms of certain loans have been modified as troubled debt restructurings. The modification of the terms of such loans included either or both of the following: a reduction of the stated interest rate of the loan or an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk.
The following table presents the number of loans, loan balances, and specific reserves for loans that have been restructured in a troubled debt restructuring as of June 30, 2019 and December 31, 2018.
 
June 30, 2019
 
December 31, 2018
 
Number of
Loans
 
Loan
Balance
 
Specific
Reserve
 
Number of
Loans
 
Loan
Balance
 
Specific
Reserve
Commercial, industrial, and agricultural
10

 
$
3,346

 
$
91

 
10

 
$
4,577

 
$
104

Commercial mortgages
15

 
9,526

 
4,720

 
15

 
10,049

 
4,450

Residential real estate
0

 
0

 
0

 
0

 
0

 
0

Consumer
0

 
0

 
0

 
0

 
0

 
0

Credit cards
0

 
0

 
0

 
0

 
0

 
0

Total
25

 
$
12,872

 
$
4,811

 
25

 
$
14,626

 
$
4,554


There were no loans modified as troubled debt restructurings during the three and six months ended June 30, 2019 and four loans modified as troubled debt restructurings during the three and six months ended June 30, 2018.
 
Three and six months ended June 30, 2018
 
Number of
Loans
 
Pre-Modification Outstanding Recorded Investment
 
Post-Modification Outstanding Recorded Investment
Commercial, industrial, and agricultural
0

 
$
0

 
$
0

Commercial mortgages
4

 
1,091

 
1,091

Residential real estate
0

 
0

 
0

Consumer
0

 
0

 
0

Credit cards
0

 
0

 
0

Total
4

 
$
1,091

 
$
1,091


A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. There were no loans modified as troubled debt restructurings for which there was a payment default within a twelve-month cycle following the modification during the period ended June 30, 2019 and June 30, 2018. There were no principal balances were forgiven in connection with the loan restructurings.

In order to determine whether a borrower is experiencing financial difficulty, the Corporation evaluates the probability that the borrower will default on any of its debt payments in the foreseeable future without a loan modification. This evaluation is performed using the Corporation’s internal underwriting policies. The Corporation has no further loan commitments to customers whose loans are classified as a troubled debt restructuring.

Generally, nonperforming troubled debt restructurings are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

18

Table of Contents

Credit Quality Indicators

The Corporation classifies commercial, industrial, and agricultural loans and commercial mortgage loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors.

The Corporation uses the following definitions for risk ratings:

Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Corporation’s credit position at some future date.

Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are 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 those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not rated as special mention, substandard, or doubtful are considered to be pass rated loans. All loans included in the following tables have been assigned a risk rating within 12 months of the balance sheet date. 
June 30, 2019
 
Pass
 
Special
Mention
 
Substandard
 
Doubtful
 
Total
Commercial, industrial, and agricultural
$
952,065

 
$
23,169

 
$
18,395

 
$
0

 
$
993,629

Commercial mortgages
730,455

 
8,935

 
10,944

 
0

 
750,334

Total
$
1,682,520

 
$
32,104

 
$
29,339

 
$
0

 
$
1,743,963

December 31, 2018
 
Pass
 
Special
Mention
 
Substandard
 
Doubtful
 
Total
Commercial, industrial, and agricultural
$
890,360

 
$
10,484

 
$
15,453

 
$
0

 
$
916,297

Commercial mortgages
684,806

 
3,236

 
9,734

 
0

 
697,776

Total
$
1,575,166

 
$
13,720

 
$
25,187

 
$
0

 
$
1,614,073


The Corporation considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential real estate, consumer, and credit card loan classes, the Corporation also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in residential, consumer, and credit card loans based on payment activity as of June 30, 2019 and December 31, 2018:
 
June 30, 2019
 
December 31, 2018
 
Residential
Real Estate
 
Consumer
 
Credit
Cards
 
Residential
Real Estate
 
Consumer
 
Credit
Cards
Performing
$
781,335

 
$
88,777

 
$
7,263

 
$
765,823

 
$
85,322

 
$
7,618

Nonperforming
5,019

 
554

 
21

 
5,486

 
713

 
5

Total
$
786,354

 
$
89,331

 
$
7,284

 
$
771,309

 
$
86,035

 
$
7,623


The Corporation’s portfolio of residential real estate and consumer loans maintained within Holiday Financial Services Corporation (“Holiday”) are considered to be subprime loans. Holiday is a subsidiary that offers small balance unsecured and secured loans primarily collateralized by automobiles and equipment, to borrowers with higher risk characteristics than are typical in the Bank’s consumer loan portfolio.

19

Table of Contents

Holiday’s loan portfolio is summarized as follows at June 30, 2019 and December 31, 2018:
 
6/30/2019
 
12/31/2018
Consumer
$
26,898

 
$
26,568

Less: unearned discount
(4,911
)
 
(4,791
)
Total
$
21,987

 
$
21,777



6. DEPOSITS
Total deposits at June 30, 2019 and December 31, 2018 are summarized as follows:
 
6/30/2019
 
12/31/2018
 
Percentage
Change
Checking, non-interest bearing
$
352,570

 
$
356,797

 
(1.2
)%
Checking, interest bearing
597,558

 
600,046

 
(0.4
)%
Savings accounts
1,429,507

 
1,258,506

 
13.6
 %
Certificates of deposit
355,127

 
395,437

 
(10.2
)%
 
$
2,734,762

 
$
2,610,786

 
4.7
 %


7.    EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income, excluding net earnings allocated to participating securities, by the weighted average number of shares outstanding during the applicable period, excluding outstanding participating securities. Diluted earnings per share is computed using the weighted average number of shares determined for the basic computation plus the dilutive effect of potential common shares issuable under certain stock compensation plans. For the three and six months ended June 30, 2019 and 2018, there were no outstanding stock options to include in the diluted earnings per share calculations and the impact of performance based shares was immaterial.
Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and are included in the computation of earnings per share pursuant to the two-class method. The Corporation has determined that its outstanding unvested stock awards are participating securities.
The computation of basic and diluted earnings per share is shown below:
 
Three months ended June 30,
 
Six months ended June 30,
 
2019
 
2018
 
2019
 
2018
Basic earnings per common share computation:
 
 
 
 
 
 
 
Net income per consolidated statements of income
$
9,767

 
$
8,441

 
$
19,240

 
$
15,538

Net earnings allocated to participating securities
(40
)
 
(39
)
 
(78
)
 
(73
)
Net earnings allocated to common stock
$
9,727

 
$
8,402

 
$
19,162

 
$
15,465

Distributed earnings allocated to common stock
$
2,580

 
$
2,510

 
$
5,160

 
$
5,019

Undistributed earnings allocated to common stock
7,147

 
5,892

 
14,002

 
10,446

Net earnings allocated to common stock
$
9,727

 
$
8,402

 
$
19,162

 
$
15,465

Weighted average common shares outstanding, including shares considered participating securities
15,230

 
15,286

 
15,230

 
15,279

Less: Average participating securities
(62
)
 
(69
)
 
(62
)
 
(70
)
Weighted average shares
15,168

 
15,217

 
15,168

 
15,209

Basic earnings per common share
$
0.64

 
$
0.55

 
$
1.26

 
$
1.02

Diluted earnings per common share computation:
 
 
 
 
 
 
 
Net earnings allocated to common stock
$
9,727

 
$
8,402

 
$
19,162

 
$
15,465

Weighted average common shares outstanding for basic earnings per common share
15,168

 
15,217

 
15,168

 
15,209

Add: Dilutive effects of assumed exercises of stock options
0

 
0

 
0

 
0

Weighted average shares and dilutive potential common shares
15,168

 
15,217

 
15,168

 
15,209

Diluted earnings per common share
$
0.64

 
$
0.55

 
$
1.26

 
$
1.02




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8.    DERIVATIVE INSTRUMENTS

On September 7, 2018, the Corporation executed an interest rate swap agreement with a 5-year term and an effective date of September 15, 2018 in order to hedge cash flows associated with $10 million of a subordinated note that was issued by the Corporation during 2007 and elected cash flow hedge accounting for the agreement. The Corporation’s objective in using this derivative is to add stability to interest expense and to manage its exposure to interest rate risk. The interest rate swap involves the receipt of variable-rate amounts in exchange for fixed-rate payments from September 15, 2018 to September 15, 2023 without the exchange of the underlying notional amount. At June 30, 2019, the variable rate on the subordinated debt was 3.96% (LIBOR plus 155 basis points) and the Corporation was paying 4.53% (2.98% fixed rate plus 155 basis points).

In order to hedge cash flows associated with $10 million of the subordinated note discussed above, on May 3, 2011, the Corporation executed an interest rate swap agreement with a 5-year term and an effective date of September 15, 2013 that expired in September 2018. The Corporation’s objective in using this derivative was to add stability to interest expense and to manage its exposure to interest rate risk. The interest rate swap involved the receipt of variable-rate amounts in exchange for fixed-rate payments from September 15, 2013 to September 15, 2018 without exchange of the underlying notional amount.
As of June 30, 2019 and December 31, 2018, no derivatives were designated as fair value hedges or hedges of net investments in foreign operations. Additionally, the Corporation does not use derivatives for trading or speculative purposes and currently does not have any derivatives that are not designated as hedges.
The following tables provide information about the amounts and locations of activity related to the interest rate swaps designated as cash flow hedges within the Corporation’s consolidated balance sheet and statement of income as of June 30, 2019 and December 31, 2018 and for the three and six months ended June 30, 2019 and 2018:
 
 
 
Fair value as of
 
Balance Sheet
Location
 
June 30, 2019
 
December 31, 2018
Interest rate contracts
Accrued interest and
other liabilities
 
$
(526
)
 
$
(201
)

For the Three Months
Ended June 30, 2019
(a)
 
(b)
 
(c)
 
(d)
 
(e)
Interest rate contracts
$
(162
)
 
Interest expense –
subordinated debentures
 
$
(14
)
 
Other
income
 
$
0

For the Six Months
Ended June 30, 2019
(a)
 
(b)
 
(c)
 
(d)
 
(e)
Interest rate contracts
$
(257
)
 
Interest expense –
subordinated debentures
 
$
(20
)
 
Other
income
 
$
0

For the Three Months
Ended June 30, 2018
(a)
 
(b)
 
(c)
 
(d)
 
(e)
Interest rate contracts
$
37

 
Interest expense –
subordinated debentures
 
$
(46
)
 
Other
income
 
$
0

For the Six Months
Ended June 30, 2018
(a)
 
(b)
 
(c)
 
(d)
 
(e)
Interest rate contracts
$
99

 
Interest expense –
subordinated debentures
 
$
(105
)
 
Other
income
 
$
0

 
(a)
Amount of Gain or (Loss) Recognized in Other Comprehensive Loss on Derivative (Effective Portion), net of tax
(b)
Location of Gain or (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion)
(c)
Amount of Gain or (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion)
(d)
Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
(e)
Amount of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
Amounts reported in accumulated other comprehensive loss related to the interest rate swap will be reclassified to interest expense as interest payments are made on the subordinated debentures. Such amounts reclassified from accumulated other comprehensive loss to interest expense in the next twelve months are expected to be $58.

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As of June 30, 2019 and December 31, 2018, a cash collateral balance in the amount of $600 and $200, respectively, was maintained with a counterparty to the interest rate swaps. These balances are included in interest bearing deposits with other banks on the consolidated balance sheet.

The Corporation entered into certain interest rate swap contracts that are not designated as hedging instruments. These derivative contracts relate to transactions in which the Corporation enters into an interest rate swap with a customer while at the same time entering into an offsetting interest rate swap with another financial institution. In connection with each swap transaction, the Corporation agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. Concurrently, the Corporation agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the Corporation’s customers to effectively convert a variable rate loan to a fixed rate. Because the Corporation acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts offset each other and do not impact the Corporation’s results of operations.
The Corporation pledged cash collateral to another financial institution with a balance $1,850 as of June 30, 2019 and $750 as of December 31, 2018. This balance is included in interest bearing deposits with other banks on the consolidated balance sheets. The Corporation may require its customers to post cash or securities as collateral on its program of back-to-back swaps depending upon the specific facts and circumstances surrounding each loan and individual swap. In addition, certain language is included in the International Swaps and Derivatives Association agreement and loan documents where, in default situations, the Corporation is permitted to access collateral supporting the loan relationship to recover any losses suffered on the derivative asset or liability. The Corporation may be required to post additional collateral to swap counterparties in the future in proportion to potential increases in unrealized loss positions.
The following table provides information about the amounts and locations of activity related to the back-to-back interest rate swaps within the Corporation’s consolidated balance sheet as of June 30, 2019 and December 31, 2018:
 
Notional
Amount
 
Weighted
Average
Maturity
(in years)
 
Weighted
Average
Fixed Rate
 
Weighted Average
Variable Rate
 
Fair
Value
 
 
June 30, 2019
 
 
 
 
 
 
 
 
 
 
 
3rd Party interest rate swaps
$
35,956

 
8.2
 
4.13
%
 
1 month LIBOR + 2.27%
 
$
1,802

 
(a) 
Customer interest rate swaps
(35,956
)
 
8.2
 
4.13
%
 
1 month LIBOR + 2.27%
 
(1,802
)
 
(b) 
December 31, 2018
 
 
 
 
 
 
 
 
 
 
 
3rd Party interest rate swaps
$
23,152

 
7.2
 
3.85
%
 
1 month LIBOR + 2.24%
 
$
485

 
(a) 
Customer interest rate swaps
(23,152
)
 
7.2
 
3.85
%
 
1 month LIBOR + 2.24
 
(485
)
 
(b) 
(a)
Reported in accrued interest receivable and other assets within the consolidated balance sheets
(b)
Reported in accrued interest payable and other liabilities within the consolidated balance sheets

9.    REVENUE FROM CONTRACTS WITH CUSTOMERS

All of the Corporation's revenue from contracts with customers in the scope of ASC 606 is recognized within non-interest income. The following table presents the Corporation's non-interest income by revenue stream and reportable segment for the three and six months ended June 30, 2019 and 2018. Items outside the scope of ASC 606 are noted as such.
 
Three months ended June 30,
 
Six months ended June 30,
 
2019
 
2018
 
2019
 
2018
Non-interest Income
 
 
 
 
 
 
 
Service charges on deposit accounts
$
1,569

 
$
1,271

 
$
3,050

 
$
2,518

Wealth and asset management fees
1,202

 
1,090

 
2,244

 
2,120

Mortgage banking (1)
370

 
310

 
609

 
518

Card processing and interchange income
1,221

 
1,103

 
2,250

 
2,074

Net gains (losses) on sales of securities (1)
0

 
0

 
148

 
0

Other income
2,430

 
1,832

 
4,644

 
3,127

Total non-interest income
$
6,792

 
$
5,606

 
$
12,945

 
$
10,357

(1) Not within scope of ASU 2014-9


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Management determined that the primary sources of revenue emanating from interest and dividend income on loans and investment securities along with non-interest revenue resulting from security gains, loan servicing, gains on the sale of loans, commitment fees, fees from financial guarantees, certain credit card fees and gains (losses) on sale of other real estate owned not financed by the Corporation, are not within the scope of ASU 2014-9. As a result, no changes were made during the period related to these sources of revenue, which comprised 89.5% and 89.8% of the total revenue of the Corporation for the three and six months ended June 30, 2019 and 88.9% and 88.8% for the three and six months ended June 30, 2018, respectively.

The types of non-interest income within the scope of the standard that are material to the consolidated financial statements are services charges on deposit accounts, wealth and asset management fee income, card processing and interchange income, and other income.

Service charges on deposit accounts: The Corporation earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed, as that is the point in time the Corporation fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Corporation satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Services charges on deposits are withdrawn from the customer’s account balance.

Wealth and asset management fees: The Corporation earns wealth and asset management fees from its contracts with trust and brokerage customers to manage assets for investment, and/or to transact on their accounts. These fees are primarily earned over time as the Corporation provides the contracted monthly or quarterly services and are generally assessed based on a tiered scale of the market value of assets under management at month end. Fees for these services are billed to customers on a monthly or quarterly basis and are recorded as revenue at the end of the period for which the wealth and asset management services have been performed. Other performance obligations, such as the delivery of account statements to customers, are generally considered immaterial to the overall transaction price.

Card processing and interchange income: The Corporation earns interchange fees from check card and credit card transactions conducted through the Visa payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.

Other income: The Corporation's other income includes sources such as bank owned life insurance, certain service fees, gains (losses) on sales of fixed assets, and gains (losses) on sale of other real estate owned. The service fees are recognized in the same manner as the service charges mentioned above. While gains on the sale of other real estate owned are generally within the scope of ASU 2014-9, the Corporation does not finance the sale of transactions and as such there is no change in revenue recognition.

10.    LEASES

As of January 1, 2019, the Corporation adopted certain accounting standard updates related to accounting for leases (Topic 842 - Leases), primarily ASU 2016-02 and subsequent updates. This guidance requires a lessee to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model. The Corporation adopted the provisions of ASU 2016-02 on January 1, 2019, and elected several practical expedients made available by the FASB. Specifically, the Corporation elected the transition practical expedient to not recast comparative periods upon the adoption of the new guidance. In addition, the Corporation elected to apply certain practical adoption expedients provided under the updates whereby we did not reassess (1) whether any expired or existing contracts are or contain leases, (2) the lease classification for any expired or existing leases and (3) initial direct costs for any existing leases. As a result, the Corporation recognized approximately $12.5 million of right of use assets, approximately $800 thousand in prepaid rent, and $13.3 million of related lease liabilities as of January 1, 2019.


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Table of Contents

Operating lease assets represent our right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease assets and liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental borrowing rate at the lease commencement date. Operating lease cost, which is comprised of amortization of the operating lease asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded in net occupancy expense in the consolidated statements of income.

The Corporation leases certain full-serve branch offices, land and equipment. Leases with an initial term of twelve months or less are not recorded on the balance sheet. Most leases include one or more options to renew and the exercise of the lease renewal options are at the Corporation's sole discretion. Certain lease agreements of the Corporation include rental payments adjusted periodically for changes in the consumer price index.

Leases
 
Classification
 
June 30, 2019
Assets:
 
 
 
 
Operating lease assets
 
Operating lease assets
 
$
17,082

Finance lease assets
 
Premises and equipment, net (1)
 
536

Total leased assets
 
 
 
$
17,618

 
 
 
 
 
Liabilities:
 
 
 
 
Operating lease liabilities
 
Operating lease liabilities
 
$
17,862

Finance lease liabilities
 
Accrued interest payable and other liabilities
 
666

Total leased liabilities
 
 
 
$
18,528

(1) Finance lease assets are recorded net of accumulated amortization of $680 as of June 30, 2019.
The components of the Corporation's net lease expense for the three and six months ended June 30, 2019 were as follows:
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
Lease Cost
 
Classification
 
2019
 
2019
Operating lease cost
 
Net occupancy expense
 
$
400

 
$
805

Variable lease cost
 
Net occupancy expense
 
15

 
49

Finance lease cost:
 
 
 
 
 
 
Amortization of leased assets
 
Net occupancy expense
 
18

 
36

Interest on lease liabilities
 
Interest expense - borrowed funds
 
8

 
16

Sublease income (1)
 
Net occupancy expense
 
(20
)
 
(41
)
Net lease cost
 
 
 
$
421

 
$
865

(1) Sublease income excludes rental income from owned properties.

The following table sets forth future minimum rental payments under noncancelable leases with terms in excess of one year as of June 30, 2019:
Maturity of Lease Liabilities as of June 30, 2019
 
Operating Leases (1)
 
Finance Leases
 
Total
2019
 
$
678

 
$
52

 
$
730

2020
 
1,430

 
105

 
1,535

2021
 
1,483

 
105

 
1,588

2022
 
1,537

 
105

 
1,642

2023
 
1,458

 
105

 
1,563

After 2023
 
17,938

 
315

 
18,253

Total lease payments
 
24,524

 
787

 
25,311

Less: Interest
 
6,662

 
121

 
6,783

Present value of lease liabilities
 
$
17,862

 
$
666

 
$
18,528

(1) Operating lease payments include payments related to options to extend lease terms that are reasonably certain of being exercised and exclude $3,173 of legally binding minimum lease payments for leases signed, but not yet commenced.


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Table of Contents

Other information related to the Corporation's lease liabilities as of the six months ended June 30, 2019 was as follows:
Lease Term and Discount Rate
 
June 30, 2019
Weighted-average remaining lease term (years)
 
 
Operating leases
 
17.1

Finance leases
 
7.5

 
 
 
Weighted-average discount rate
 
 
Operating leases
 
3.61
%
Finance leases
 
4.54
%

Other Information
 
June 30, 2019
Cash paid for amounts included in the measurement of lease liabilities
 
 
Operating cash flows from operating leases
 
$
409

Leased assets obtained in exchange from new operating lease liabilities
 
17,586



11.    CONTINGENCY

On March 28, 2018, the Corporation received a notice of assessment from the Pennsylvania Department of Revenue that reported a sales tax assessment amount of $824 plus interest and penalties of $339 resulting in a total assessed balance of $1,163. The notice of assessment covers the period from January 1, 2013 through July 31, 2016. The Corporation has evaluated the specific items on which sales tax has been assessed in conjunction with its legal counsel and has determined that it is probable that the Corporation has some liability based on a review of the Pennsylvania tax laws that apply to the assessed items. The Corporation’s reasonable estimate of this liability as of June 30, 2019 is $246, of which $96 was accrued and previously reported in state and local tax expense in the consolidated statement of income during the year ended December 31, 2018. The remaining balance that has not been accrued relates primarily to sales tax assessments associated with data processing and banking equipment maintenance, which the Corporation’s management and legal counsel have concluded were improperly assessed based on current Pennsylvania sales tax law. The Corporation appealed the notice of assessment to the Pennsylvania Board of Appeals and the appeal was denied. The Corporation is in the process of appealing the assessment to the Pennsylvania Board of Finance and Revenue. The ultimate resolution of this matter, which may take in excess of one year, could result in an additional expense up to the total amount assessed.

12.    RECENT ACCOUNTING PRONOUNCEMENTS

In June 2016, the FASB issued an update (ASU 2016-13, Financial Instruments – Credit Losses) which will require recognition of an entity’s current estimate of all expected credit losses for assets measured at amortized cost. The amendments in ASU 2016-13 eliminate the probable initial recognition threshold in current GAAP. In addition, the amendments in ASU 2016-13 broaden the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually, such as loans. The update will be effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted for interim and annual reporting periods beginning after December 15, 2018. In November 2018, the FASB issued ASU 2018-19, "Codification Improvements to Topic 326, Financial Instruments – Credit Losses."  The amendment clarifies that receivables arising from operating leases are not within the scope of Subtopic 326-20 and should be accounted for in accordance with Topic 842, "Leases." In April 2019, ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments,” was issued to address certain codification improvements and to provide certain accounting policy electives related to accrued interest as well as disclosure related to credit losses, among other things. In May 2019, ASU 2019-05, “Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief,” was issued to provide transition relief in connection with the adoption of ASU 2016-03 whereby entities would have the option to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost basis. The Corporation has formed a committee comprised of individuals from different disciplines, including credit administration, finance, loan servicing and information technology, to evaluate the requirements of the new standard and the impact it will have on current processes. Management continues to work through their implementation plan, including refinement of model assumptions, parallel testing, documentation of processes and internal controls and policy development with the assistance of a third-party. The new guidance is expected to be heavily influenced by an assessment of the composition, characteristics and credit quality of the Corporation's loan and investment securities portfolio, as well as the economic conditions in effect at the adoption date. The impact to the financial statements is yet to be determined.

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Table of Contents

In August 2018, the FASB issued ASU 2018-14, "Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans." ASU 2018-14 amends ASC 715-20, "Compensation - Retirement Benefits - Defined Benefit Plans - General." The amended guidance modifies the disclosure requirements for employers that sponsor defined benefit pension or other post-retirement plans by removing and adding certain disclosures for these plans. The eliminated disclosures include (a) the amounts in accumulated Other Comprehensive Income ("OCI") expected to be recognized in net periodic benefit costs over the next fiscal year, and (b) the effects of a one percentage point change in assumed health care cost trend rates on the net periodic benefit costs and the benefit obligation for post-retirement health care benefits. Additional disclosures include descriptions of significant gains and losses affecting the benefit obligation for the period. The update will be effective for annual reporting periods beginning after December 15, 2020, with early adoption permitted for annual reporting periods beginning after December 15, 2019. Management is currently evaluating the impact of the adoption of ASU 2018-14 on the Corporation’s footnote disclosures included in the financial statements.

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” ASU 2018-13 modifies disclosure requirements on fair value measurements based on the concepts in the Concepts Statement, including the consideration of costs and benefits. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The update will be effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted for interim and annual reporting periods beginning after December 15, 2018. Management is currently evaluating the impact of the adoption of ASU 2018-13 on the Corporation’s footnote disclosures included in the financial statements.

In March 2019, the FASB issued an amendment (ASU 2019-01, Leases (Topic 842) Codification Improvements) which provides clarifications to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing essential information about leasing transactions. Specifically, ASU 2019-01 (i) allows the fair value of the underlying asset reported by lessors that are not manufacturers or dealers to continue to be its cost and not fair value as measured under the fair value definition, (ii) allows for the cash flows received for sales-type and direct financing leases to continue to be presented as results from investing, and (iii) clarifies that entities do not have to disclose the effect of the lease standard on adoption year interim amounts. The amendment will be effective for annual reporting periods beginning after December 15, 2019. Management does not expect the adoption of ASU 2019-01 will have any material impact on the Corporation’s financial statements.


26

Table of Contents

ITEM 2
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

The following discussion and analysis of the consolidated financial statements of the Corporation is presented to provide insight into management’s assessment of financial results. The Corporation’s subsidiary, CNB Bank (the “Bank”), provides financial services to individuals and businesses primarily within its primary market area of the Pennsylvania counties of Blair, Cambria, Cameron, Centre, Clearfield, Crawford, Elk, Indiana, Jefferson, and McKean. As ERIEBANK, a division of the Bank, the Bank operates in the Pennsylvania counties of Crawford, Erie, and Warren and the Ohio counties of Ashtabula and Lake. As FCBank, a division of the Bank, the Bank operates in the Ohio counties of Crawford, Richland, Ashland, Wayne, Marion, Morrow, Knox, Delaware, and Franklin. As Bank on Buffalo, a division of the Bank, the Bank operates in Erie and Niagara counties, New York. The Bank is subject to regulation, supervision and examination by the Pennsylvania State Department of Banking as well as the Federal Deposit Insurance Corporation.

In addition to the Bank, the Corporation has four other subsidiaries. CNB Securities Corporation is incorporated in Delaware and currently maintains investments in debt and equity securities. CNB Risk Management, Inc. is a Delaware-based captive insurance company which insures against certain risks unique to the operations of the Corporation and its subsidiaries and for which insurance may not be currently available or economically feasible in today's insurance marketplace. CNB Insurance Agency, incorporated in Pennsylvania, provides for the sale of nonproprietary annuities and other insurance products. Holiday Financial Services Corporation (“Holiday”), incorporated in Pennsylvania, offers small balance secured and unsecured loans, primarily collateralized by automobiles and equipment, to borrowers with higher risk characteristics. The financial condition and results of operations of the Corporation and its consolidated subsidiaries are not necessarily indicative of future performance.

When we use the terms “we”, “us” and “our”, we mean CNB Financial Corporation and its subsidiaries. Management’s discussion and analysis should be read in conjunction with the Corporation’s consolidated financial statements and related notes.

The following discussion should be read in conjunction with the Corporation’s Consolidated Financial Statements and Notes thereto, for the year ended December 31, 2018, included in its 2018 Form 10-K, and in conjunction with the Consolidated Financial Statements and Notes thereto included in Item 1 of this report. Operating results for the three and six months ended June 30, 2019 are not necessarily indicative of the results for the full year ending December 31, 2019, or any future period. The average balances, average yields, return on average assets, return on average equity, net interest margin and total net loan charge-offs to average loans annualized return calculations were refined. Prior periods were adjusted to be comparative to the current period. The impact of the change was immaterial.

GENERAL OVERVIEW

Management looks to return on average equity, earnings per share, asset quality, and other metrics to measure the performance of the Corporation. The interest rate environment will continue to play an important role in the future earnings of the Corporation. In order to address the flattening yield curve and highly competitive environment, the Corporation has remained focused on disciplined loan pricing to sustain a strong net interest margin.

Non-interest costs are expected to increase with the growth of the Corporation; however, management’s growth strategies are also expected to result in an increase in earning assets as well as enhanced non-interest income, which is expected to more than offset increases in non-interest expenses in 2019 and beyond. While past results are not an indication of future earnings, management believes the Corporation is well positioned to sustain core earnings during 2019. Although the Corporation's discussion regarding its financial performance distinguishes between certain markets and Private Banking, it does not meet the criteria for discrete segment reporting of its operating results. Management's conclusion was based on the limited level of financial information available to segregate operating results, coupled with the fact that no operating results are available for the Corporation's Chief Operating Decision Maker (CODM) to review on a regular basis. All dollar amounts are stated in thousands, except share and per share data and other amounts as indicated.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents totaled $37.9 million at June 30, 2019 compared to $45.6 million at December 31, 2018. Cash and cash equivalents fluctuate based on the timing and amount of liquidity events that occur in the normal course of business.


27

Table of Contents

Management believes the liquidity needs of the Corporation are satisfied by the current balance of cash and cash equivalents, customer deposits, Federal Home Loan Bank ("FHLB") financing, and the portions of the securities and loan portfolios that mature within one year. The Corporation expects that these sources of funds will enable it to meet cash obligations and off-balance sheet commitments as they come due.

SECURITIES

Securities available for sale and trading securities totaled $542.9 million and $524.6 million at June 30, 2019 and December 31, 2018, respectively. The Corporation’s objective is to maintain the securities portfolio at a size that ranges between 15% and 20% of total assets in order to appropriately balance the earnings and liquidity provided by the portfolio.  As of June 30, 2019 and December 31, 2018, the securities portfolio as a percentage of total assets was 16.0% and 16.3%, respectively. Note 4 to the consolidated financial statements  provides more detail concerning the composition of the Corporation’s securities portfolio and the process for evaluating securities for other-than-temporary impairment.

The Corporation generally buys into the market over time and does not attempt to “time” its transactions. In doing this, the highs and lows of the market are averaged into the portfolio and the overall effect of different rate environments is minimized.

The Corporation monitors the earnings performance and the effectiveness of the liquidity of the securities portfolio on a regular basis through meetings of the Asset/Liability Committee of the Corporation’s Board of Directors (the “ALCO”). The ALCO also reviews and manages interest rate risk for the Corporation. Through active balance sheet management and analysis of the securities portfolio, a sufficient level of liquidity is maintained to satisfy depositor requirements and various credit needs of our customers.

LOANS

Corporation's total loan portfolio, net of unearned, reached $2.6 billion as of June 30, 2019, resulting in an increase of $148 million, or 12.0%, on an annualized basis during the first six months of 2019. Over the same time period, this increase was driven by commercial and industrial loans, which increased $77.3 million, or 17.0%, on an annualized basis, while commercial real estate loans contributed an increase of $52.6 million, or 15.2%, on an annualized basis. Loan growth during the first six months of 2019 was attributable to Private Banking and our Buffalo market, which increased $21.1 million, or 23.2% (annualized), and $61.0 million, or 47.6% (annualized), respectively. Lending efforts consist principally of commercial and retail lending, which includes single family residential mortgages and other consumer loans. The Corporation views commercial lending as its competitive advantage and continues to focus on this area by hiring and retaining experienced loan officers and supporting them with robust credit analysis. The Corporation expects continued strong loan demand through the remainder of 2019.

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is established by provisions for losses in the loan portfolio as well as overdrafts in deposit accounts. These provisions are charged against current income. Loans and overdrafts deemed not collectible are charged off against the allowance while any subsequent collections are recorded as recoveries and increase the allowance. The provision for loan losses reflects the amount deemed appropriate by management to establish an adequate reserve for probable incurred losses. Management’s judgment is based on the evaluation of individual loans, the overall risk characteristics of various portfolio segments, past experience with losses, the impact of economic conditions on borrowers and other relevant factors.


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The following table below presents activity within the allowance account for the specified periods:
 
Six months ending
June 30, 2019
 
Year ending
December 31, 2018
 
Six months ending
June 30, 2018
Balance at beginning of period
$
19,704

 
$
19,693

 
$
19,693

Charge-offs:
 
 
 
 
 
Commercial, industrial, and agricultural
0

 
(253
)
 
(31
)
Commercial mortgages
(2
)
 
(3,337
)
 
0

Residential real estate
(244
)
 
(315
)
 
(77
)
Consumer
(1,062
)
 
(2,279
)
 
(1,141
)
Credit cards
(52
)
 
(90
)
 
(45
)
Overdrafts
(216
)
 
(319
)
 
(142
)
 
(1,576
)
 
(6,593
)
 
(1,436
)
Recoveries:
 
 
 
 
 
Commercial, industrial, and agricultural
8

 
171

 
162

Commercial mortgages
1

 
30

 
0

Residential real estate
67

 
67

 
12

Consumer
74

 
141

 
84

Credit cards
6

 
33

 
24

Overdraft deposit accounts
59

 
90

 
47

 
215

 
532

 
329

Net charge-offs
(1,361
)
 
(6,061
)
 
(1,107
)
Provision for loan losses
3,094

 
6,072

 
3,536

Balance at end of period
$
21,437

 
$
19,704

 
$
22,122

Loans, net of unearned
$
2,622,358

 
$
2,474,557

 
$
2,335,292

Allowance to net loans
0.82
%
 
0.80
%
 
0.95
%
Net charge-offs to average loans (annualized)
0.11
%
 
0.26
%
 
0.10
%
Nonperforming assets
$
15,764

 
$
15,567

 
$
23,451

Nonperforming % of total assets
0.46
%
 
0.48
%
 
0.78
%

The adequacy of the allowance for loan losses is subject to a formal analysis by the Credit Administration and Finance Departments of the Corporation. As part of the formal analysis, delinquencies and losses are monitored monthly. The loan portfolio is divided into several categories in order to better analyze the entire pool. First is a selection of classified loans that is given a specific reserve. The remaining loans are pooled, by category, into the following segments:

Reviewed
 
Commercial, industrial, and agricultural
Commercial mortgages

Homogeneous
 
Residential real estate
Consumer
Credit cards
Overdrafts

The reviewed loan pools above are further segregated into four categories of risk: pass rated, special mention, substandard, and doubtful. Historical loss factors are calculated for each pool, excluding overdrafts, based on the previous eight quarters of experience. The homogeneous loan pools are evaluated by analyzing the historical loss factors from the most recent eight quarter ends.


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Table of Contents

The historical loss factors for both the reviewed and homogeneous loan pools are further adjusted based on the following six qualitative factors:
 
Levels of and trends in delinquencies, non-accrual loans, and classified loans;
Trends in volume and terms of loans;
Effects of any changes in lending policies and procedures;
Experience and ability of management;
National and local economic trends and conditions; and
Concentrations of credit.

The methodology described above was developed based upon the experience of the Corporation’s management team, guidance from the regulatory agencies, expertise of a third-party loan review provider and discussions with peers. The resulting factors are applied to the loan pool balances in order to estimate the probable risk of loss within each loan pool. Prudent business practices dictate that the level of the allowance for loan losses, as well as corresponding charges to the provision for loan losses, should be commensurate with identified areas of risk within the loan portfolio and the attendant risks inherent therein. The quality of the credit risk management function and the overall administration of this vital segment of the Corporation’s assets are critical to the ongoing success of the Corporation.

The analysis also considers numerous historical and other factors to analyze the adequacy of the allowance for loan losses and charges against the provision for loan losses. Management pays special attention to a section of the analysis that compares and plots the actual level of the allowance for loan losses against the aggregate amount of loans adversely classified in order to compute the estimated probable losses associated with those loans. By noting the “spread” at that time, as well as for prior periods, management can evaluate the current adequacy of the allowance as well as evaluate any developing trends. The volume and composition of the Corporation’s loan portfolio continue to reflect growth in commercial credits, most significantly in commercial and industrial loans and commercial real estate loans.

As mentioned in the “Loans” section of this analysis, management considers commercial lending to be a competitive advantage and continues to focus on this area as part of its strategic growth initiatives. However, management also recognizes and considers the fact that risk is more pronounced in these types of credits and is, to a greater degree than with other loans, driven by the economic environment in which the debtor’s business operates.

In the first six months of 2019, one commercial real estate loan that was impaired at year end 2018 experienced further deterioration, resulting in an additional provision for loan losses of $664 thousand. As of June 30, 2019, the outstanding principal balance of the loan, net of the reserve recorded on this loan, is $771 thousand. The allowance for loans collectively evaluated for impairment was 0.60% at June 30, 2019, compared to 0.64% at June 30, 2018. This decrease was due to organic growth the loan portfolio, coupled with a continued strong credit quality risk profile and lower historical loss levels.

Management believes that the allowance for loan losses is reasonable and adequate to absorb probable incurred losses in its portfolio at June 30, 2019.

DEPOSITS

The Corporation considers deposits to be its primary source of funding growth in assets. At June 30, 2019, total deposits of $2.7 billion reflected an increase of $124 million, or 9.6%, on an annualized basis, during the first six months of 2019. Growth in deposits was driven by targeted customer acquisition strategies aimed at core deposits that, over time, tend to be a more stable source of funding. As a result of our customer acquisition strategies, during the first six month of 2019 Private Banking contributed to an increase in total deposits of $47.0 million, or 25.8%, on an annualized basis, while the deposit portfolio in our Buffalo market grew $102 million, or 81.7%, on an annualized basis.

OTHER FUNDING SOURCES

The Corporation also considers other funding sources, such as short-term borrowings and term debt when evaluating funding needs. During the first six months of 2019, short-term borrowings from the FHLB increased to $52.9 million, from zero at December 31, 2018, as a supplemental funding source for the Corporation.

Periodically, the Corporation utilizes borrowings from the FHLB and other lenders as a supplemental strategy to meet funding obligations or match fund certain assets. As part of the Corporation's liquidity management, management plans to continue to maintain a robust level of short-term and long-term borrowing capacity as an available funding source.


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Table of Contents

SHAREHOLDERS’ EQUITY AND CAPITAL RATIOS AND METRICS

The Corporation’s capital continued to provide a source of strength for its growth. Total shareholders’ equity was $286.6 million at June 30, 2019, reflecting an increase of $23.8 million, or 9.0%, from $262.8 million at December 31, 2018. In the first six months of 2019, the Corporation earned $19.2 million and declared dividends of $5.2 million, resulting in a dividend payout ratio of 26.9% of net income. In addition, during the first six months of 2019, accumulated OCI increased $10.1 million, partially offset by an increase of $179 thousand in treasury stock as a result of 40,000 shares repurchased.

The Corporation has complied with the standards of capital adequacy mandated by government regulations. Bank regulators have established “risk-based” capital requirements designed to measure capital adequacy. Risk-based capital ratios reflect the relative risks of various assets banks hold in their portfolios. A weight category of 0% (lowest risk assets), 20%, 50%, 100% or 150% (highest risk assets), is assigned to each asset on the balance sheet.

The Corporation’s capital ratios, book value per share and tangible book value per share as of June 30, 2019 and December 31, 2018 are as follows:
 
June 30, 2019
 
December 31, 2018
Total risk-based capital ratio
13.00
%
 
13.21
%
Tier 1 capital ratio
10.23
%
 
10.33
%
Common equity tier 1 ratio
9.45
%
 
9.50
%
Leverage ratio
8.00
%
 
7.87
%
Tangible common equity/tangible assets (1)
7.36
%
 
7.02
%
Book value per share
$
18.86

 
$
17.28

Tangible book value per share (1)
$
16.28

 
$
14.69

 
(1)
Tangible common equity, tangible assets and tangible book value per share are non-GAAP financial measures calculated using GAAP amounts. Tangible common equity is calculated by excluding the balance of goodwill and other intangible assets from the calculation of stockholders’ equity. Tangible assets is calculated by excluding the balance of goodwill and other intangible assets from the calculation of total assets. Tangible book value per share is calculated by dividing tangible common equity by the number of shares outstanding. The Corporation believes that these non-GAAP financial measures provide information to investors that is useful in understanding its financial condition. Because not all companies use the same calculation of tangible common equity and tangible assets, this presentation may not be comparable to other similarly titled measures calculated by other companies. A reconciliation of these non-GAAP financial measures is provided below.

 
June 30, 2019
 
December 31, 2018
Shareholders’ equity
$
286,615

 
$
262,830

Less goodwill
38,730

 
38,730

Less core deposit intangible
396

 
727

Tangible common equity
$
247,489

 
$
223,373

Total assets
$
3,400,974

 
$
3,221,521

Less goodwill
38,730

 
38,730

Less core deposit intangible
396

 
727

Tangible assets
$
3,361,848

 
$
3,182,064

Ending shares outstanding
15,197,983

 
15,207,281

Tangible book value per share
$
16.28

 
$
14.69

Tangible common equity/tangible assets
7.36
%
 
7.02
%

LIQUIDITY

Liquidity measures an organization’s ability to meet its cash obligations as they come due. The consolidated statements of cash flows included in the accompanying financial statements provide analysis of the Corporation’s cash and cash equivalents and the sources and uses of cash. Additionally, the portion of the loan portfolio that matures within one year and securities with maturities within one year in the investment portfolio are considered part of the Corporation’s liquid assets. Liquidity is monitored by both management and the Board’s ALCO, which establishes and monitors ranges of acceptable liquidity. Management believes that the Corporation’s current liquidity position is acceptable.


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Table of Contents

OFF-BALANCE SHEET ACTIVITIES

Some financial instruments, such as loan commitments, credit lines, risk participation agreements, letters of credit, and overdraft protection, are issued to meet customer financing needs. These financial instruments are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The credit policies used for evaluating loans are the same as the policies used to make such commitments, including obtaining collateral at exercise of the commitment.

The contractual amount of financial instruments with off balance sheet risk was as follows at June 30, 2019 and December 31, 2018:
 
June 30, 2019
 
December 31, 2018
 
Fixed Rate
 
Variable Rate
 
Fixed Rate
 
Variable Rate
Commitments to make loans
$
42,370

 
$
192,131

 
$
46,265

 
$
191,803

Unused lines of credit
13,562

 
430,159

 
14,390

 
429,456

Standby letters of credit
12,705

 
1,073

 
14,831

 
1,479


The fixed rate loan commitments at June 30, 2019 have interest rates ranging from 2.45% to 18.00% and maturities ranging from ten months to 35 years. The fixed rate loan commitments at December 31, 2018 have interest rates ranging from 2.45% to 18.00% and maturities ranging from one year to 35 years.

The Corporation makes investments in limited partnerships, including certain small business investment corporations and low income housing partnerships. As of June 30, 2019 and December 31, 2018, unfunded capital commitments totaled $3,322 and $3,905, respectively, for the small business investment corporations and $1,252 and $1,434, respectively, for the low income housing partnerships. At June 30, 2019 and December 31, 2018, capital contributions to the small business investment corporations were $7,178 and $6,595, respectively, and capital contributions to the low income housing partnerships were $4,748 and $4,566, respectively.

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Table of Contents

CONSOLIDATED YIELD COMPARISONS
AVERAGE BALANCES AND NET INTEREST MARGIN FOR THE THREE MONTHS ENDED JUNE 30, 2019 AND 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2019
 
June 30, 2018
 
 
Average
Balance
 
Annual
Rate
 
Interest
Inc./Exp.
 
Average
Balance
 
Annual
Rate
 
Interest
Inc./Exp.
ASSETS:
 
 
 
 
 
 
 
 
 
 
 
 
Securities:
 
 
 
 
 
 
 
 
 
 
 
 
Taxable (1)
 
$
435,180

 
2.91
%
 
$
3,155

 
$
332,683

 
2.58
%
 
$
2,180

Tax-Exempt (1,2)
 
84,267

 
3.44
%
 
705

 
95,907

 
3.52
%
 
833

Equity Securities (1,2)
 
17,860

 
6.15
%
 
274

 
20,122

 
6.00
%
 
301

Total securities
 
537,307

 
3.10
%
 
4,134

 
448,712

 
2.93
%
 
3,314

Loans:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial (2)
 
969,330

 
5.37
%
 
12,980

 
792,980

 
4.94
%
 
9,775

Mortgage (2)
 
1,505,532

 
5.07
%
 
19,032

 
1,430,327

 
4.85
%
 
17,279

Consumer
 
90,957

 
11.03
%
 
2,501

 
83,911

 
10.02
%
 
2,096

Total loans (3)
 
2,565,819

 
5.39
%
 
34,513

 
2,307,218

 
5.07
%
 
29,150

Total earning assets
 
3,103,126

 
5.00
%
 
$
38,647

 
2,755,930

 
4.72
%
 
$
32,464

Non interest-bearing assets:
 
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
 
43,941

 
 
 
 
 
32,351

 
 
 
 
Premises and equipment
 
68,086

 
 
 
 
 
50,106

 
 
 
 
Other assets
 
136,782

 
 
 
 
 
132,664

 
 
 
 
Allowance for loan losses
 
(20,566
)
 
 
 
 
 
(21,233
)
 
 
 
 
Total non interest-bearing assets
 
228,243

 
 
 
 
 
193,888

 
 
 
 
TOTAL ASSETS
 
$
3,331,369

 
 
 
 
 
$
2,949,818

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY:
 
 
 
 
 
 
 
 
 
 
 
 
Demand—interest-bearing
 
$
586,111

 
0.43
%
 
$
622

 
$
590,575

 
0.37
%
 
$
539

Savings
 
1,401,924

 
1.37
%
 
4,804

 
1,007,013

 
0.72
%
 
1,801

Time
 
350,594

 
2.03
%
 
1,775

 
377,915

 
1.43
%
 
1,347

Total interest-bearing deposits
 
2,338,629

 
1.24
%
 
7,201

 
1,975,503

 
0.75
%
 
3,687

Short-term borrowings
 
4,899

 
3.19
%
 
39

 
53,708

 
1.98
%
 
265

Long-term borrowings
 
236,742

 
2.12
%
 
1,253

 
260,927

 
2.06
%
 
1,339

Subordinated debentures
 
70,620

 
5.65
%
 
995

 
70,620

 
5.58
%
 
982

Total interest-bearing liabilities
 
2,650,890

 
1.44
%
 
$
9,488

 
2,360,758

 
1.07
%
 
$
6,273

Demand—non interest-bearing
 
355,058

 
 
 
 
 
313,400

 
 
 
 
Other liabilities
 
46,518

 
 
 
 
 
28,291

 
 
 
 
Total liabilities
 
3,052,466

 
 
 
 
 
2,702,449

 
 
 
 
Shareholders’ equity
 
278,903

 
 
 
 
 
247,369

 
 
 
 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
3,331,369

 
 
 
 
 
$
2,891,824

 
 
 
 
Interest income/Earning assets
 
 
 
5.00
%
 
$
38,647

 
 
 
4.72
%
 
$
32,464

Interest expense/Interest-bearing liabilities
 
 
 
1.44
%
 
9,488

 
 
 
1.07
%
 
6,273

Net interest spread
 
 
 
3.56
%
 
$
29,159

 
 
 
3.65
%
 
$
26,191

Interest income/Earning assets
 
 
 
5.00
%
 
38,647

 
 
 
4.72
%
 
32,464

Interest expense/Earning assets
 
 
 
1.23
%
 
9,488

 
 
 
0.91
%
 
6,273

Net interest margin
 
 
 
3.77
%
 
$
29,159

 
 
 
3.81
%
 
$
26,191

 
(1)
Includes unamortized discounts and premiums. Average balance is computed using the amortized cost of securities. The average yield has been computed using the historical amortized cost average balance for available for sale securities.
(2)
Average yields are stated on a fully taxable equivalent basis.
(3)
Average outstanding includes the average balance outstanding of all non-accrual loans. Loans consist of the average of total loans less average unearned income. The amount of loan fees included in the interest income on loans is not material.

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Table of Contents

CONSOLIDATED YIELD COMPARISONS
AVERAGE BALANCES AND NET INTEREST MARGIN FOR THE SIX MONTHS ENDED JUNE 30, 2019 AND 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2019
 
June 30, 2018
 
 
Average
Balance
 
Annual
Rate
 
Interest
Inc./Exp.
 
Average
Balance
 
Annual
Rate
 
Interest
Inc./Exp.
ASSETS:
 
 
 
 
 
 
 
 
 
 
 
 
Securities:
 
 
 
 
 
 
 
 
 
 
 
 
Taxable (1)
 
$
424,788

 
2.90
%
 
$
6,133

 
$
325,103

 
2.55
%
 
$
4,164

Tax-Exempt (1,2)
 
91,388

 
3.48
%
 
1,546

 
96,870

 
3.56
%
 
1,683

Equity Securities (1,2)
 
18,228

 
6.13
%
 
554

 
19,937

 
6.00
%
 
593

Total securities
 
534,404

 
3.11
%
 
8,233

 
441,910

 
2.92
%
 
6,440

Loans:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial (2)
 
951,175

 
5.38
%
 
25,365

 
781,040

 
4.78
%
 
18,507

Mortgage (2)
 
1,493,604

 
5.04
%
 
37,295

 
1,394,064

 
4.80
%
 
33,180

Consumer
 
89,966

 
10.97
%
 
4,896

 
83,168

 
9.93
%
 
4,095

Total loans (3)
 
2,534,745

 
5.37
%
 
67,556

 
2,258,272

 
4.98
%
 
55,782

Total earning assets
 
3,069,149

 
4.98
%
 
$
75,789

 
2,700,182

 
4.64
%
 
$
62,222

Non interest-bearing assets:
 
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
 
36,994

 
 
 
 
 
28,653

 
 
 
 
Premises and equipment
 
67,237

 
 
 
 
 
50,347

 
 
 
 
Other assets
 
136,406

 
 
 
 
 
131,160

 
 
 
 
Allowance for loan losses
 
(20,218
)
 
 
 
 
 
(20,599
)
 
 
 
 
Total non interest-bearing assets
 
220,419

 
 
 
 
 
189,561

 
 
 
 
TOTAL ASSETS
 
$
3,289,568

 
 
 
 
 
$
2,889,743

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY:
 
 
 
 
 
 
 
 
 
 
 
 
Demand—interest-bearing
 
$
572,632

 
0.42
%
 
$
1,204

 
$
577,719

 
0.37
%
 
$
1,062

Savings
 
1,364,118

 
1.34
%
 
9,094

 
961,240

 
0.62
%
 
2,972

Time
 
360,055

 
1.95
%
 
3,490

 
378,398

 
1.37
%
 
2,577

Total interest-bearing deposits
 
2,296,805

 
1.21
%
 
13,788

 
1,917,357

 
0.70
%
 
6,611

Short-term borrowings
 
12,637

 
3.00
%
 
188

 
64,630

 
1.80
%
 
576

Long-term borrowings
 
239,455

 
2.12
%
 
2,514

 
250,141

 
2.03
%
 
2,516

Subordinated debentures
 
70,620

 
5.69
%
 
1,993

 
70,620

 
5.30
%
 
1,857

Total interest-bearing liabilities
 
2,619,517

 
1.42
%
 
$
18,483

 
2,302,748

 
1.01
%
 
$
11,560

Demand—non interest-bearing
 
350,399

 
 
 
 
 
313,028

 
 
 
 
Other liabilities
 
46,460

 
 
 
 
 
28,365

 
 
 
 
Total liabilities
 
3,016,376

 
 
 
 
 
2,644,141

 
 
 
 
Shareholders’ equity
 
273,192

 
 
 
 
 
245,602

 
 
 
 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
3,289,568

 
 
 
 
 
$
2,891,824

 
 
 
 
Interest income/Earning assets
 
 
 
4.98
%
 
$
75,789

 
 
 
4.64
%
 
$
62,222

Interest expense/Interest-bearing liabilities
 
 
 
1.42
%
 
18,483

 
 
 
1.01
%
 
11,560

Net interest spread
 
 
 
3.56
%
 
$
57,306

 
 
 
3.63
%
 
$
50,662

Interest income/Earning assets
 
 
 
4.98
%
 
75,789

 
 
 
4.64
%
 
62,222

Interest expense/Earning assets
 
 
 
1.21
%
 
18,483

 
 
 
0.86
%
 
11,560

Net interest margin
 
 
 
3.77
%
 
$
57,306

 
 
 
3.78
%
 
$
50,662

 
(1)
Includes unamortized discounts and premiums. Average balance is computed using the amortized cost of securities. The average yield has been computed using the historical amortized cost average balance for available for sale securities.
(2)
Average yields are stated on a fully taxable equivalent basis.
(3)
Average outstanding includes the average balance outstanding of all non-accrual loans. Loans consist of the average of total loans less average unearned income. The amount of loan fees included in the interest income on loans is not material.



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Table of Contents

RESULTS OF OPERATIONS
Three Months Ended June 30, 2019 and 2018

OVERVIEW OF THE INCOME STATEMENT

The Corporation had net income of $9.8 million, or $0.64 per diluted share, in the second quarter of 2019, compared to $8.4 million, or $0.55 per diluted share, in the second quarter of 2018, reflecting increases of $1.3 million, or 15.7%, and $0.09 per diluted share, or 16.4%. The increases in earnings and earnings per diluted share are the result of a continued strong financial performance driven by organic growth. Total revenue (comprised of net interest income plus non-interest income) of $35.6 million for the three months ended June 30, 2019 increased $4.2 million, or 13.2%, from the comparable period in 2018, while total non-interest expense of $22.0 million for the second quarter of 2019 increased $2.4 million, or 12.5%, from the second quarter of 2018. Provision expense of $1.8 million for the second quarter of 2019 decreased $117 thousand, or 6.1%, from the same period in 2018.

The return on average assets and the return on average equity for the second quarter of 2019 were 1.18% and 14.05%, respectively, increasing from 1.15% and 13.69%, respectively, for the second quarter of 2018. Similarly, efficiency ratio of 61.06% for the second quarter of 2019 improved six basis points from 61.12% for the comparable period in 2018. The Corporation’s financial performance ratios continued to reflect a focus on profitability, based on organic growth in its diversified markets, coupled with efficient management of expenses and strong credit quality.

NET INTEREST MARGIN

Net interest margin on a fully tax equivalent basis was 3.77% and 3.81% for the quarters ended June 30, 2019 and 2018, respectively. The yield on earning assets increased 28 basis points to 45.00% for the quarter ended June 30, 2019 from 4.72% for the quarter ended June 30, 2018. The cost of interest-bearing liabilities increased 37 basis points to 1.44% for the quarter ended June 30, 2019  from 1.07% for the quarter ended June 30, 2018. The decrease of four basis points in net interest margin was a net result of the successful execution on our focus to attract and retain core customers, as a primary source of funding of organic loan growth.

PROVISION FOR LOAN LOSSES

During the quarter ended June 30, 2019, the Corporation recorded a provision for loan losses of $1.8 million, as compared to a provision for loan losses of $1.9 million for the quarter ended June 30, 2018. Net chargeoffs in the second quarter of 2019 were $697 thousand, compared to net chargeoffs of $539 thousand in the second quarter of 2018. Net chargeoffs of the Bank totaled $245 thousand and $94 thousand during the quarters ended June 30, 2019 and 2018, or 0.04% and 0.02%, respectively, of average Bank loans. Holiday recorded net chargeoffs totaling $452 thousand and $445 thousand during the quarters ended June 30, 2019 and 2018, respectively.

Management believes the provision for loan losses was appropriate and the allowance for loan losses is adequate to absorb probable incurred losses in our portfolio as of June 30, 2019.

NON-INTEREST INCOME

There were no net realized gains on available-for-sale securities during the quarter ended June 30, 2019. Net realized and unrealized gains on trading securities were $654 thousand during the quarter ended June 30, 2019, compared to $237 thousand during the quarter ended June 30, 2018 as a result of a $463 thousand gain on sale of a restricted equity security (Visa Class B stock).

The Corporation had received 2,905 shares for Visa Class B stock pursuant to Visa's 2007 initial public offering. The carrying value of the shares was zero, which represented the Corporation's cost basis. Class B shares are subject to restrictions on transfer, essentially limiting their transferability to other owners of Class B shares. In the second quarter of 2019, the Corporation sold all of its Visa Class B stock.

Excluding the effects of securities transactions discussed above, non-interest income was $6.1 million for the quarter ended June 30, 2019, compared to $5.4 million for the quarter ended June 30, 2018, reflecting an increase of $769 thousand, or 14.3%.
This increase was driven primarily from organic deposit growth, resulting in service charges in deposit accounts increasing $298 thousand, or 23.4%, in the second quarter of 2019 compared to the second quarter of 2018. Finally, other non-interest income increased $169 thousand, or 31.7% in the second quarter of 2019 compared to the second quarter of 2018, due to a net increase in various categories.


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NON-INTEREST EXPENSES

Total non-interest expenses were $22.0 million and $19.5 million for the quarters ended June 30, 2019 and 2018, respectively. Salaries and benefits expense increased $1.4 million, or 13.6%, during the quarter ended June 30, 2019 compared to the quarter ended June 30, 2018, primarily as a result of the expansion of staffing levels in several areas, including business development, risk management and customer service personnel. The remainder of the increase in non-interest expenses was primarily a result the Corporation's continued growth and the servicing of a larger customer base. Total households serviced at June 30, 2019 were 66,251, compared to 61,354 households at June 30, 2018, an increase of 8.0% resulting from our core deposit growth strategies in Private Banking and the Buffalo market, further enhancing their value contributions to the Corporation. The ratio of non-interest expenses to average assets was 2.65% and 2.66% during the quarters ended June 30, 2019 and 2018, respectively. Going forward, we intend to continue to invest in risk management and customer service resources to support the Corporation’s growth.

INCOME TAX EXPENSE

Income tax expense was $2.0 million during the three months ended June 30, 2019 and $1.5 million during the three months ended June 30, 2018, resulting in effective tax rates of 17.3% and 15.5%, respectively. The increase in the effective tax rate is primarily attributable to the Corporation’s growth being generated by taxable activities. The effective rates for the periods differed from the federal statutory rate of 21.0% at June 30, 2019 and 2018 principally as a result of tax exempt income from securities and loans, as well as earnings from bank owned life insurance.

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RESULTS OF OPERATIONS
Six Months Ended June 30, 2019 and 2018

OVERVIEW OF THE INCOME STATEMENT

The Corporation had net income of $19.2 million, or $1.26 per diluted share, for the six months ended June 30, 2019, compared to $15.5 million, or $1.02 per diluted share, for the comparable period in 2018, reflecting increases of $3.7 million, or 23.8%, and $0.24 per diluted share, or 23.5%, respectively. The increase in earnings and earnings per diluted share are the result of a continued strong financial performance driven by organic growth. Total revenue of $69.5 million for the six months ended June 30, 2019 increased $9.2 million, or 15.3%, from the comparable period in 2018, while total non-interest expense of $43.2 million for the first six months of 2019 increased $4.6 million, or 12.0%, from the second quarter of 2018. Provision for loan losses of $3.1 million for the first six months of 2019 decreased $442 thousand, or 12.5%, from the comparable period in 2018.

The return on average assets and the return on average equity for the six months ended June 30, 2019 were 1.18% and 14.20%, respectively, increasing from 1.08% and 12.76%, respectively, for the six months ended June 30, 2018. The efficiency ratio of 61.59% for the first six months of 2019 improved 71 basis points from 62.30% for the first six months of 2018.

NET INTEREST MARGIN

Net interest margin on a fully tax equivalent basis was 3.77% and 3.78% for the six months ended June 30, 2019 and 2018, respectively. The yield on earning assets increased 34 basis points to 4.98% for the six months ended June 30, 2019, from 4.64% for the six months ended June 30, 2018. The cost of interest-bearing liabilities increased 41 basis points to 1.42% for the six months ended June 30, 2019 from 1.01% for the six months ended June 30, 2018.

PROVISION FOR LOAN LOSSES

During the six months ended June 30, 2019, the Corporation recorded a provision for loan losses of $3.1 million, as compared to a provision for loan losses of $3.5 million for the six months ended June 30, 2018. Net chargeoffs in the first six months of 2019 were $1.4 million, compared to net chargeoffs of $1.1 million in the first six months of 2018. Net chargeoffs of the Bank totaled $475 thousand and $139 thousand during the six months ended June 30, 2019 and 2018, or 0.04% and 0.01%, respectively, of average Bank loans. Holiday recorded net chargeoffs totaling $886 thousand and $968 thousand during the six months ended June 30, 2019 and 2018, respectively.

Management believes the provision for loan losses was appropriate and the allowance for loan losses is adequate to absorb probable incurred losses in our portfolio as of June 30, 2019.

NON-INTEREST INCOME

Net realized gains on available-for-sale securities were $148 thousand and zero during the six months ended June 30, 2019 and 2018, respectively. Net realized and unrealized gains on trading securities were $1.5 million during the six months ended June 30, 2019, compared to $251 thousand during the six months ended June 30, 2018, as a result of improvements in equity markets and a $463 thousand gain on sale of a restricted equity security (Visa Class B stock).

The Corporation had received 2,905 shares for Visa Class B stock pursuant to Visa's 2007 initial public offering. The carrying value of the shares was zero, which represented the Corporation's cost basis. Class B shares are subject to restrictions on transfer, essentially limiting their transferability to other owners of Class B shares. In the second quarter of 2019, the Corporation sold all of its Visa Class B stock.

Excluding the effects of securities transactions, non-interest income was $11.3 million for the six months ended June 30, 2019, compared to $10.1 million for the six months ended June 30, 2018.

As a result of its organic deposit growth, the Corporation experienced an increase in service charges in deposit accounts of $532 thousand, or 21.1%, in the first six months of 2019 compared to the first six months of 2018. Finally, other non-interest income increased $313 thousand, or 39.3% in the first six months of 2019 compared to the first six months of 2018 due to fluctuations in various fee income categories within other non-interest income.





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NON-INTEREST EXPENSES

Total non-interest expenses were $43.2 million and $38.5 million for the six months ended June 30, 2019 and 2018, respectively. Salaries and benefits expense increased $2.7 million, or 13.9%, during the six months ended June 30, 2019 compared to the six months ended June 30, 2018, primarily as a result of the expansion of staffing levels in several areas, including business development, risk management and customer service personnel. The remainder of the increase in non-interest expenses was primarily a result the Corporation's continued growth and the servicing of a larger customer base. Total households serviced at June 30, 2019 were 66,251, compared to 61,354 households at June 30, 2018, an increase of 8.0%. The ratio of non-interest expenses to average assets was 2.65% and 2.69% during the six months ended June 30, 2019 and 2018, respectively.

INCOME TAX EXPENSE

Income tax expense was $4.0 million during the six months ended June 30, 2019 and $2.7 million during the six months ended June 30, 2018, resulting in effective tax rates of 17.2% and 14.6%, respectively. The increase in the effective tax rate is primarily attributable to the Corporation’s growth being generated by taxable activities. The effective rates for the periods differed from the federal statutory rate of 21.0% at June 30, 2019 and 2018 principally as a result of tax exempt income from securities and loans, as well as earnings from bank owned life insurance.

CRITICAL ACCOUNTING POLICIES

The Corporation’s accounting and reporting policies are in accordance with GAAP and conform to general practices within the financial services industry. Accounting and reporting practices for the allowance for loan losses and fair value of securities are deemed critical since they involve the use of estimates and require significant management judgments. In addition, the fair value of assets acquired and liabilities assumed in connection with business combinations, including the associated goodwill that was recorded, required the use of material estimates. Application of assumptions different than those used by management could result in material changes in the Corporation’s financial position or results of operations. Note 1 (Summary of Significant Accounting Policies), Note 2 (Business Combination and Branch Sale), Note 4 (Securities) and Note 5 (Loans) of the Corporation’s 2018 Form 10-K provide additional detail with regard to the Corporation’s accounting for the allowance for loan losses, the fair value of securities, business combinations and loans. There have been no significant changes in the application of accounting policies since December 31, 2018.


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ITEM 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a financial institution, the Corporation’s primary source of market risk is interest rate risk, which is the exposure to fluctuations in the Corporation’s future earnings resulting from changes in interest rates. This exposure is correlated to the repricing characteristics of the Corporation’s portfolio of assets and liabilities. Each asset or liability reprices either at maturity or during the life of the instrument.

The principal purpose of asset/liability management is to maximize current and future net interest income within acceptable levels of interest rate risk while satisfying liquidity and capital requirements. Net interest income is enhanced by increasing the net interest margin and the growth in earning assets. As a result, the primary goal of interest rate risk management is to maintain a balance between risk and reward such that net interest income is maximized while risk is maintained at an acceptable level.

The Corporation uses an asset-liability management model to measure the effect of interest rate changes on its net interest income. The Corporation’s management also reviews asset-liability maturity gap and repricing analyses regularly. The Corporation does not always attempt to achieve a precise match between interest sensitive assets and liabilities because it believes that an actively managed amount of interest rate risk is inherent and appropriate in the management of the Corporation’s profitability.

Asset-liability modeling techniques and simulation involve assumptions and estimates that inherently cannot be measured with precision. Key assumptions in these analyses include maturity and repricing characteristics of assets and liabilities, prepayments on amortizing assets, non-maturing deposit sensitivity, and loan and deposit pricing. These assumptions are inherently uncertain due to the timing, magnitude, and frequency of rate changes and changes in market conditions and management strategies, among other factors. However, the analyses are useful in quantifying risk and provide a relative gauge of the Corporation’s interest rate risk position over time.

Management reviews interest rate risk on a quarterly basis and reports to the ALCO. This review includes earnings shock scenarios whereby interest rates are immediately increased and decreased by 100, 200, 300 and 400 basis points. These scenarios, detailed in the table below, indicate that there would not be a significant variance in net interest income over a one-year period due to interest rate changes; however, actual results could vary significantly. At June 30, 2019, all interest rate risk levels according to the model were within the tolerance limits of ALCO-approved policy. In addition, the table does not take into consideration changes that management would make to realign its assets and liabilities in the event of an unexpected changing interest rate environment. Due to the current low interest rate environment, the 300 and 400 basis point declining interest rate scenarios have been excluded from the table.
March 31, 2019
Change in
Basis Points
 
% Change in Net
Interest Income
400
 
8.9%
300
 
6.6%
200
 
4.8%
100
 
4.3%
(100)
 
(4.8)%
(200)
 
(6.6)%

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ITEM 4

CONTROLS AND PROCEDURES

The Corporation’s management, under the supervision of and with the participation of the Corporation’s Principal Executive Officer and Principal Financial Officer, has carried out an evaluation of the design and effectiveness of the Corporation’s disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934 as of the end of the period covered by this report. Based upon that evaluation, management, including the Principal Executive Officer and Principal Financial Officer, have concluded that, as of the end of such period, the Corporation’s disclosure controls and procedures are effective to provide reasonable assurance that all material information required to be disclosed in reports the Corporation files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms

There was no significant change in the Corporation’s internal control over financial reporting that occurred during the quarter ended June 30, 2019 that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.


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PART II
OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

There are no pending legal proceedings to which the Corporation or any of its subsidiaries is a party, or of which any of their properties is the subject, except ordinary routine proceedings which are incidental to the business.

ITEM 1A. RISK FACTORS

There have been no material changes to the risk factors disclosed in Part I, Item IA of the 2018 Form 10-K.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table provides information with respect to any purchase of shares of the Corporation’s common stock made by or on behalf of the Corporation for the three months ended June 30, 2019.
Period
Total Number of Shares Purchased
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Number (or approximate dollar value) of Shares that May Yet Be Purchased Under the Plans or Programs (1)
April 1 – 30, 2019
0

 
$
0

 
0

 
289,731

May 1 – 31, 2019
0

 
0

 
0

 
289,731

June 1 – 30, 2019
40,000

 
24.80

 
40,000

 
249,731

 
(1)
The Corporation’s stock repurchase program, which was announced on November 12, 2014, authorizes the repurchase of up to 500,000 shares of common stock. The program will remain in effect until fully utilized or until modified, suspended or terminated. As of June 30, 2019, there were 249,731 shares remaining in the program.

Additionally, during the quarter ended June 30, 2019, certain employees surrendered shares of common stock owned by them to satisfy their statutory minimum U.S. federal and state tax obligations associated with the vesting of shares of restricted common stock issued under the 2019 Stock Incentive Plan.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.
ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.
ITEM 5. OTHER INFORMATION

None.

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ITEM 6. EXHIBITS
Exhibit No.
  
Description
 
 
3.1
  
 
 
3.2
  
 
 
 
10.1
 
 
 
31.1
  
 
 
31.2
  
 
 
32.1
  
 
 
32.2
  
 
 
101.INS
  
XBRL Instance Document
 
 
101.SCH
  
XBRL Taxonomy Extension Schema Document
 
 
101.CAL
  
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF
  
XBRL Taxonomy Extension Definitions Linkbase Document
 
 
101.LAB
  
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE
  
XBRL Taxonomy Extension Presentation Linkbase Document

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
 
CNB FINANCIAL CORPORATION
 
 
 
 
 
 
(Registrant)
 
 
 
 
DATE: August 8, 2019
 
 
 
 
 
/s/ Joseph B. Bower, Jr.
 
 
 
 
 
 
Joseph B. Bower, Jr.
 
 
 
 
 
 
President and Chief Executive Officer
 
 
 
 
 
 
(Principal Executive Officer)
 
 
 
 
DATE: August 8, 2019
 
 
 
 
 
/s/ Tito L. Lima
 
 
 
 
 
 
Tito L. Lima
 
 
 
 
 
 
Treasurer
 
 
 
 
 
 
(Principal Financial and Accounting Officer)


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