Embassy Bancorp, Inc. - Quarter Report: 2020 September (Form 10-Q)

emyb-20200930x10q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2020 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 000-53528


Embassy Bancorp, Inc.
(Exact name of registrant as specified in its charter)

Pennsylvania	26-3339011
(State of incorporation)	(I.R.S. Employer Identification No.)

One Hundred Gateway Drive, Suite 100 Bethlehem, PA	18017
(Address of principal executive offices)	(Zip Code)

(610) 882-8800
(Registrant’s Telephone Number)

Securities registered pursuant to Section 12(b) of the Act: None.

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 filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.


Large Accelerated Filer ¨	Accelerated Filer 
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 or the Exchange Act.) Yes ¨ No x

Indicate the number of shares outstanding of each of the registrant’s classes of common equity, as of the latest practicable date:


COMMON STOCK
Number of shares outstanding as of November 2, 2020	($1.00 Par Value)	7,474,621
	(Title Class)	(Outstanding Shares)

Embassy Bancorp, Inc.

Table of Contents


Part I – Financial Information	3

Item 1 – Financial Statements
Consolidated Balance Sheets (Unaudited)	3
Consolidated Statements of Income (Unaudited)	4
Consolidated Statements of Comprehensive Income (Unaudited)	5
Consolidated Statements of Stockholders’ Equity (Unaudited)	6
Consolidated Statements of Cash Flows (Unaudited)	8
Notes to Consolidated Financial Statements (Unaudited)	9

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations	29

Item 3 – Quantitative and Qualitative Disclosures About Market Risk	42

Item 4 – Controls and Procedures	42

Part II - Other Information	44

Item 1 - Legal Proceedings	44

Item 1A - Risk Factors	44

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds	44

Item 3 - Defaults Upon Senior Securities	44

Item 4 – Mine Safety Disclosures	44

Item 5 - Other Information	44

Item 6 - Exhibits	45

‎

Embassy Bancorp, Inc.

Part I – Financial Information

Item 1 – Financial Statements

Consolidated Balance Sheets (Current Period Unaudited)



	September 30,		December 31,
ASSETS	2020		2019

	(In Thousands, Except Share Data)
Cash and due from banks	$	14,823	$	5,825
Interest bearing demand deposits with banks		70,876		33,161
Federal funds sold		1,000		1,000
Cash and Cash Equivalents		86,699		39,986
Securities available for sale		121,646		90,829
Restricted investment in bank stock		1,330		1,478
Loans receivable, net of allowance for loan losses of $9,718 in 2020; $8,022 in 2019		1,048,885		1,006,117
Paycheck Protection Program loans receivable		67,020		-
Premises and equipment, net of accumulated depreciation		3,030		2,123
Bank owned life insurance		20,813		20,259
Accrued interest receivable		3,236		2,048
Other assets		12,270		13,279
Total Assets	$	1,364,929	$	1,176,119
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Non-interest bearing	$	261,088	$	171,815
Interest bearing		888,362		860,153
Total Deposits		1,149,450		1,031,968
Securities sold under agreements to repurchase		11,181		7,208
Short-term borrowings		-		18,067
Long-term borrowings		14,651		-
Paycheck Protection Program Liquidity Facility borrowings		62,039		-
Accrued interest payable		1,670		3,281
Other liabilities		17,600		15,980
Total Liabilities		1,256,591		1,076,504
Stockholders' Equity:
Common stock, $1 par value; authorized 20,000,000 shares;
2020 issued 7,579,668 shares; outstanding 7,474,621 shares;
2019 issued 7,543,524 shares; outstanding 7,478,477 shares;		7,580		7,544
Surplus		26,178		25,937
Retained earnings		73,348		65,794
Accumulated other comprehensive income		2,952		1,340
Treasury stock, at cost: 105,047 and 65,047 shares at September 30, 2020 and
December 31, 2019, respectively		(1,720)		(1,000)
Total Stockholders' Equity		108,338		99,615
Total Liabilities and Stockholders' Equity	$	1,364,929	$	1,176,119

See notes to consolidated financial statements.

‎

Embassy Bancorp, Inc.

Consolidated Statements of Income (Unaudited)



	Three Months Ended September 30,				Nine Months Ended September 30,

	2020		2019		2020			2019

	(In Thousands, Except Per Share Data)
INTEREST INCOME
Loans, including fees	$	10,196	$	9,995	$	30,460	$	29,463
Paycheck Protection Program loans, including fees		420		-		658		-
Securities, taxable		339		446		1,074		1,207
Securities, non-taxable		210		216		617		758
Short-term investments, including federal funds sold		26		209		129		523
Total Interest Income		11,191		10,866		32,938		31,951
INTEREST EXPENSE
Deposits		1,350		2,421		4,939		6,634
Securities sold under agreements to repurchase and federal
funds purchased		2		17		15		62
Short-term borrowings		-		-		51		273
Long-term borrowings		28		-		63		-
Paycheck Protection Program Liquidity Facility borrowings		54		-		78		-
Total Interest Expense		1,434		2,438		5,146		6,969
Net Interest Income		9,757		8,428		27,792		24,982
PROVISION FOR LOAN LOSSES		700		120		1,670		345
Net Interest Income after ‎ Provision for Loan Losses		9,057		8,308		26,122		24,637
OTHER NON-INTEREST INCOME
Merchant and credit card processing fees		47		85		167		259
Debit card interchange fees		182		166		460		451
Other service fees		116		132		300		373
Bank owned life insurance		257		120		554		464
Gain on sale of securities, net		-		-		128		-
Gain on sale of other real estate owned		-		-		-		45
Gain on sale of loans		-		-		59		-
Total Other Non-Interest Income		602		503		1,668		1,592
OTHER NON-INTEREST EXPENSES
Salaries and employee benefits		2,726		2,586		8,234		7,850
Occupancy and equipment		821		865		2,474		2,546
Data processing		654		598		1,913		1,739
Merchant and credit card processing		5		(3)		48		63
Advertising and promotion		261		396		831		1,271
Professional fees		192		206		638		594
FDIC insurance		119		(3)		267		199
Loan & real estate		73		61		192		148
Charitable contributions		194		192		666		661
Other		402		409		1,214		1,324
Total Other Non-Interest Expenses		5,447		5,307		16,477		16,395

Income Before Income Taxes		4,212		3,504		11,313		9,834
INCOME TAX EXPENSE		788		675		2,115		1,839
Net Income	$	3,424	$	2,829	$	9,198	$	7,995

BASIC EARNINGS PER SHARE	$	0.46	$	0.38	$	1.23	$	1.07

DILUTED EARNINGS PER SHARE	$	0.46	$	0.38	$	1.22	$	1.06

DIVIDENDS PER SHARE	$	0.22	$	0.20	$	0.22	$	0.20

See notes to consolidated financial statements
‎

Embassy Bancorp, Inc.

Consolidated Statements of Comprehensive Income (Unaudited)



	Three Months Ended September 30,
	2020			2019

		(In Thousands)
Net Income	$		3,424	$		2,829
Change in Accumulated Other Comprehensive (Loss) Income:
Unrealized holding (loss) gain on securities available for sale		(48)			194
Less: reclassification adjustment for realized gains		-			-
		(48)			194
Income tax effect		10			(41)
Net unrealized (loss) gain		(38)			153
Other comprehensive (loss) income, net of tax			(38)			153
Comprehensive Income	$		3,386	$		2,982



	Nine Months Ended September 30,
	2020			2019

		(In Thousands)

Net Income	$		9,198	$		7,995
Change in Accumulated Other Comprehensive Income:
Unrealized holding gain on securities available for sale		2,168			3,240
Less: reclassification adjustment for realized gains		(128)			-
		2,040			3,240
Income tax effect		(428)			(680)
Net unrealized gain		1,612			2,560
Other comprehensive income, net of tax			1,612			2,560
Comprehensive Income	$		10,810	$		10,555

See notes to consolidated financial statements.

Embassy Bancorp, Inc.

Consolidated Statements of Stockholders’ Equity (Unaudited)


	Nine Months Ended September 30, 2020
	Common Stock		Surplus		Retained Earnings		Accumulated Other Comprehensive Income		Treasury Stock		Total

	(In Thousands, Except Share Data)
BALANCE - DECEMBER 31, 2019	$	7,544	$	25,937	$	65,794	$	1,340	$	(1,000)	$	99,615
Net income		-		-		2,457		-		-		2,457
Other comprehensive income, net of tax		-		-		-		1,425		-		1,425
Common stock grants to directors, ‎ 12,757 shares		13		135		-		-		-		148
Common stock grants to officers, 19,453 shares
and compensation expense recognized on
stock grants, net of unearned compensation
expense of $639		19		25		-		-		-		44
Shares issued under employee stock purchase
plan, 1,289 shares		1		13		-		-		-		14
Purchase of treasury stock, 40,000 shares ‎ at $18.00 per share		-		-		-		-		(720)		(720)
BALANCE - MARCH 31, 2020	$	7,577	$	26,110	$	68,251	$	2,765	$	(1,720)	$	102,983

Net income		-		-		3,317		-		-		3,317
Other comprehensive income, net of tax		-		-		-		225		-		225
Dividend declared, $0.22 per share		-		-		(1,644)		-		-		(1,644)
Compensation expense recognized on
stock grants, net of unearned compensation
expense of $641		-		(3)		-		-		-		(3)
Shares issued under employee stock purchase
plan, 1,038 shares		1		12		-		-		-		13
BALANCE - JUNE 30, 2020	$	7,578	$	26,119	$	69,924	$	2,990	$	(1,720)	$	104,891

Net income		-		-		3,424		-		-		3,424
Other comprehensive loss, net of tax		-		-		-		(38)		-		(38)
Compensation expense recognized on
stock grants, net of unearned compensation
expense of $600		-		41		-		-		-		41
Shares issued under employee stock purchase
plan, 1,607 shares		2		18		-		-		-		20
BALANCE - SEPTEMBER 30, 2020	$	7,580	$	26,178	$	73,348	$	2,952	$	(1,720)	$	108,338

‎

Embassy Bancorp, Inc.

Consolidated Statements of Stockholders’ Equity (Unaudited)


	Nine Months Ended September 30, 2019
	Common Stock		Surplus		Retained Earnings		Accumulated Other Comprehensive (Loss) Income		Treasury Stock		Total

	(In Thousands, Except Share Data)
BALANCE - DECEMBER 31, 2018	$	7,530	$	25,532	$	56,410	$	(1,247)	$	(1,000)	$	87,225
Net income		-		-		2,552		-		-		2,552
Other comprehensive income, net of tax		-		-		-		1,598		-		1,598
Compensation expense recognized on ‎ stock options		-		1		-		-		-		1
Common stock grants to directors, ‎ 10,799 shares		10		151		-		-		-		161
Compensation expense recognized on
stock grants, net of unearned compensation
expense of $608		-		51		-		-		-		51
Shares issued under employee stock purchase
plan, 894 shares		1		13		-		-		-		14
BALANCE - MARCH 31, 2019	$	7,541	$	25,748	$	58,962	$	351	$	(1,000)	$	91,602

Net income		-		-		2,614		-		-		2,614
Other comprehensive income, net of tax		-		-		-		809		-		809
Dividend declared, $0.20 per share		-		-		(1,495)		-		-		(1,495)
Compensation expense recognized on ‎ stock options		-		1		-		-		-		1
Compensation expense recognized on
stock grants, net of unearned compensation
expense of $558		-		50		-		-		-		50
Shares issued under employee stock purchase
plan, 712 shares		1		10		-		-		-		11
BALANCE - JUNE 30, 2019	$	7,542	$	25,809	$	60,081	$	1,160	$	(1,000)	$	93,592

Net income		-		-		2,829		-		-		2,829
Other comprehensive income, net of tax		-		-		-		153		-		153
Compensation expense recognized on ‎ stock options		-		1		-		-		-		1
Compensation expense recognized on
stock grants, net of unearned compensation
expense of $507		-		51		-		-		-		51
Shares issued under employee stock purchase
plan, 888 shares		1		13		-		-		-		14
BALANCE - SEPTEMBER 30, 2019	$	7,543	$	25,874	$	62,910	$	1,313	$	(1,000)	$	96,640

See notes to consolidated financial statements.

Embassy Bancorp, Inc.

Consolidated Statements of Cash Flows (Unaudited)



	Nine Months Ended September 30,
	2020		2019

	(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	9,198	$	7,995
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1,670		345
Amortization of deferred loan costs		208		190
Accretion of deferred Paycheck Protection Program loan fees		(372)		-
Depreciation		567		620
Net amortization of investment security premiums and discounts		341		117
Stock compensation expense		230		316
Net realized gain on sale of other real estate owned		-		(45)
Income on bank owned life insurance		(554)		(464)
Net realized gain on sale of securities available for sale		(128)		-
Loans originated for sale		(689)		-
Proceeds from sale of loans		748		-
Net realized gain on sale of loans		(59)		-
(Increase) decrease in accrued interest receivable		(1,188)		143
Decrease in other assets		581		796
(Decrease) increase in accrued interest payable		(1,611)		1,123
Increase (decrease) in other liabilities		855		(172)
Net Cash Provided by Operating Activities		9,797		10,964
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale		(83,121)		(20,429)
Maturities, calls and principal repayments of securities available for sale		50,873		18,408
Proceeds from sales of securities available for sale		4,023		-
Net increase in loans		(44,646)		(29,584)
Net increase in Paycheck Protection Program loans		(66,648)		-
Net redemption of restricted investment in bank stock		148		2,039
Proceeds from sale of other real estate owned		-		180
Purchases of premises and equipment		(1,474)		(514)
Net Cash Used in Investing Activities		(140,845)		(29,900)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits		117,482		103,518
Net increase (decrease) in securities sold under agreements to repurchase		3,973		(8,736)
Proceeds from Employee Stock Purchase Plan		47		39
Decrease in short-term borrowed funds		(18,067)		(53,995)
Proceeds from long-term borrowed funds		14,651		-
Proceeds from Paycheck Protection Program Liquidity Facility borrowed funds		62,039		-
Purchase of treasury stock		(720)		-
Dividends paid		(1,644)		(1,495)
Net Cash Provided by Financing Activities		177,761		39,331
Net Increase in Cash and Cash Equivalents		46,713		20,395
CASH AND CASH EQUIVALENTS - BEGINNING		39,986		27,576
CASH AND CASH EQUIVALENTS - ENDING	$	86,699	$	47,971

SUPPLEMENTARY CASH FLOWS INFORMATION
Interest paid	$	6,757	$	5,846
Income taxes paid	$	2,242	$	1,859

Non-cash Investing and Financing Activities:

Right of use assets obtained in exchange for new operating lease liabilities	$	181	$	-
Unsettled trades to purchase securities	$	(765)	$	-
Recognition of operating lease right of use assets	$	-	$	10,908
Recognition of operating lease liabilities	$	-	$	11,014

See notes to consolidated financial statements.

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

Note 1 – Basis of Presentation

Embassy Bancorp, Inc. (the “Company”) is a Pennsylvania corporation organized in 2008 and registered as a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Company was formed for purposes of acquiring Embassy Bank For The Lehigh Valley (the “Bank”) in connection with the reorganization of the Bank into a bank holding company structure, which was consummated on November 11, 2008. Accordingly, the Company owns all of the capital stock of the Bank, giving the organization more flexibility in meeting its capital needs as the Company continues to grow. Embassy Holdings, LLC (the “LLC”) is a wholly-owned subsidiary of the Bank organized to engage in the holding of property acquired by the Bank in satisfaction of debts previously contracted. As such, the consolidated financial statements contained herein include the accounts of the Company, the Bank and the LLC. All significant intercompany transactions and balances have been eliminated.

The Bank, which is the Company’s principal operating subsidiary, was originally incorporated as a Pennsylvania bank on May 11, 2001 and opened its doors on November 6, 2001. It was formed by a group of local business persons and professionals with significant prior experience in community banking in the Lehigh Valley area of Pennsylvania, the Bank’s primary market area.

The accompanying unaudited financial statements have been prepared in accordance with United States of America generally accepted accounting principles (“US GAAP”) for interim financial information and in accordance with instructions for Form 10-Q and Rule 10-01 of the Securities and Exchange Commission Regulation S-X. Accordingly, they do not include all of the information and footnotes required by US GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020.

The consolidated financial statements presented in this report should be read in conjunction with the audited consolidated financial statements and the accompanying notes for the year ended December 31, 2019, included in the Company’s Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 11, 2020.

The Company has evaluated subsequent events for potential recognition and/or disclosure through the date the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q were issued. Subsequent to September 30, 2020, on October 21, 2020, the Company purchased an additional $4.0 million in bank owned life insurance.

Certain amounts in the 2019 consolidated financial statements may have been reclassified to conform to 2020 presentation. These reclassifications had no effect on 2019 net income.

Note 2 - Summary of Significant Accounting Policies

The significant accounting policies of the Company as applied in the interim financial statements presented herein are substantially the same as those followed on an annual basis as presented in the Company’s Form 10-K for the year ended December 31, 2019.

Note 3 – COVID-19

On March 11, 2020, the World Health Organization declared the outbreak of a novel coronavirus (“COVID-19”) as a global pandemic and on March 13, 2020 the United States government declared COVID-19 as a national emergency. The continuing effects of COVID-19 could adversely impact a broad range of industries in which the Company’s customers operate and impair their ability to fulfill their financial obligations to the Company. The economic effects of COVID-19 may adversely affect the Company’s financial condition and results of operations, though such potential impact is unknown at this time.

‎

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

For the nine months ended September 30, 2020, the Company provided certain borrowers affected in a variety of ways by COVID-19 with payment accommodations that facilitate their ability to work through the immediate impact of the virus. Payment accommodations were in the form of short-term principal and/or interest deferrals. These payment accommodations were made in accordance with Section 4013 of the Coronavirus Aid, Relief and Economic Security (“CARES”) Act and the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus. Section 4013 of the CARES Act, enacted on March 27, 2020, provides that, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States under the National Emergencies Act terminates, the Company may elect to suspend GAAP for loan modifications related to the pandemic that would otherwise be categorized as troubled debt restructurings and suspend any determination of a loan modified as a result of the effects of the pandemic as being a troubled debt restructuring, including impairment for accounting purposes. Interest income is continuing to be recognized during the accommodation period. The following table presents COVID-19 payment accommodations based on loan type and amount at September 30, 2020:


	Number of Loans	Loan Amount
		(In Thousands)
Commercial real estate	143	$	131,391
Commercial	49		8,816
Residential real estate	77		15,011
Consumer	2		33
Total	271	$	155,251

Included in the totals above are two hundred thirty-four (234) loans totaling $113.5 million in which the payment accommodation period has ended and the loan payments have resumed under their original contractual terms. Also included in the totals above are four (4) loans totaling $246 thousand that are in their first short-term payment accommodation period, thirty-one (31) loans totaling $41.5 million that are in their second short-term payment accommodation period and two (2) loans totaling $82 thousand that are in their third short-term payment accommodation period.

At October 28, 2020, the Company had two hundred sixty-four (264) Section 4013 loans totaling $153.7 million. Included in these totals are two hundred forty-two (242) loans totaling $133.3 million in which the payment accommodation period has ended and the loan payments have resumed under their original contractual terms. Also included in the totals are six (6) loans totaling $394 thousand that are in their first short-term payment accommodation period, eleven (11) loans totaling $4.0 million that are in their second short-term payment accommodation period and five (5) loans totaling $15.9 million that are in their third short-term payment accommodation period. Between September 30, 2020 and October 28, 2020, there were nine (9) Section 4013 loans totaling $1.3 million that were repaid in full and two (2) new Section 4013 loans added totaling $148 thousand.

As part of the CARES Act, the Company was approved to be a Paycheck Protection Program (“PPP”) lender. The Company had not previously been an approved Small Business Administration (“SBA”) 7(a) lender. The Company began accepting applications from qualified borrowers on April 3, 2020. As of September 30, 2020, the Company had a total of five hundred fifty (550) PPP loans with a receivable balance of $67.0 million, net of $1.6 million of unearned origination fees and costs. As of November 3, 2020, the Company has received forgiveness payments on PPP loans of $2.0 million from the SBA and has an additional $5.5 million of PPP loan forgiveness applications submitted to the SBA awaiting decision on forgiveness.

These PPP loans are 100% guaranteed by the SBA, have a two year or up to five year maturity and an interest rate of 1% throughout the term of the loan, with payments deferred over the first six months following the date of disbursement of the loan. The SBA may forgive the PPP loans if certain conditions are met by the borrower, including using at least 60% of the proceeds for payroll costs. The SBA also provides the Company with a processing fee for each loan, with the amount of such fee pre-determined by the SBA dependent upon the size of each loan. At September 30, 2020, the Company has recorded gross deferred PPP loan fees of $2.2 million, which will be recognized through interest income over the life of the related PPP loans. Because of the 100% SBA guarantee, the Company has determined that no allowance for loan losses is required on the PPP loans. All PPP loans have a pass rating and none are past due under their contractual terms.

‎

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

In April 2020, the Company applied and was approved by the Federal Reserve Board for both the ability to borrow under its Paycheck Protection Program Liquidity Facility (“PPPLF”), as well as its Discount Window. The PPPLF provides term funding to depository institutions that originate loans to small businesses under the PPP. PPP loans that are pledged to secure PPPLF extensions of credit are excluded from leverage ratio calculations. The components of long-term borrowings with the PPPLF at September 30, 2020 were as follows:


	September 30, 2020
	(Dollars in Thousands)
Maturity Date	Interest Rate		Outstanding
April 2022	0.35%	$	38,701
May 2022	0.35%		23,338
Total PPPLF Outstanding Borrowings		$	62,039

The Company’s allowance for loan losses increased $1.7 million to $9.7 million at September 30, 2020 compared to $8.0 million at December 31, 2019. At September 30, 2020 and December 31, 2019, the allowance for loan losses represented 0.92% and 0.79%, respectively, of loans receivable (not including PPP loans which are 100% guaranteed by the SBA). During the first three quarters of 2020, the Company adjusted the allowance for loan losses’ economic risk factor and loan modifications risk factor methodologies to incorporate the current economic implications, unemployment rate and number of loan modifications from the COVID-19 pandemic, leading to the increase in the allowance for loan losses as a percentage of total loans. In determining its allowance for loan loss level at September 30, 2020, the Company considered the health and composition of its loan portfolio going into and through the COVID-19 pandemic. The Company’s nonperforming loans to total loans receivable, excluding PPP loans receivable, was 0.28% at September 30, 2020, up from 0.26% at December 31, 2019. The Company had no charge-offs for the three and nine months ended September 30, 2020 and for the year ended December 31, 2019. At September 30, 2020, approximately 95% of the Company’s loan portfolio is collateralized by real estate. Less than 6% of the Company’s loan portfolio is to borrowers in the more particularly hard-hit industries (including the travel and hotel industry, the full-service and limited-service restaurant industries, and the assisted living facilities industry) and the Company has no international exposure. The Company was not required to adopt the Current Expected Credit Losses (“CECL”) Financial Accounting Standards Board (“FASB “) accounting standard in 2020, as this guidance will not be effective for the Company until 2023.

In response to the COVID-19 outbreak, the Federal Reserve Board in mid-March 2020 has reduced by 150 basis points the benchmark federal funds rate to a target range of 0% to 0.25%, and the yields on 10 and 30 year Treasury notes have declined to historic lows. Less than 10% of the Company’s loan portfolio is scheduled to mature or reprice within the next year. As a result of the decline in the Federal Reserve Board’s target federal funds rate and yields on Treasury notes, the Company’s future net interest margin and spread may be further reduced.

‎

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

Note 4 – Securities Available For Sale

At September 30, 2020 and December 31, 2019, respectively, the amortized cost and approximate fair values of securities available-for-sale were as follows:



			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value

	(In Thousands)
September 30, 2020:
U.S. Treasury securities	$	19,997	$	1	$	-	$	19,998
U.S. Government agency obligations		13,529		3		-		13,532
Municipal bonds		36,570		1,735		-		38,305
U.S. Government Sponsored Enterprise (GSE) - ‎ Mortgage-backed securities - commercial		513		37		-		550
U.S. Government Sponsored Enterprise (GSE) - ‎ Mortgage-backed securities - residential		47,300		1,961		-		49,261
Total	$	117,909	$	3,737	$	-	$	121,646

December 31, 2019:
Municipal bonds	$	25,586	$	863	$	(5)	$	26,444
U.S. Government Sponsored Enterprise (GSE) - ‎ Mortgage-backed securities - residential		63,546		877		(38)		64,385
Total	$	89,132	$	1,740	$	(43)	$	90,829

The amortized cost and fair value of securities as of September 30, 2020, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without any penalties.



		Amortized		Fair
		Cost		Value

	(In Thousands)
Due in one year or less	$	34,681	$	34,687
Due after one year through five years		1,675		1,685
Due after five years through ten years		5,899		6,120
Due after ten years		27,841		29,343
		70,096		71,835
U.S. Government Sponsored Enterprise (GSE) - Mortgage-backed securities - commercial		513		550
U.S. Government Sponsored Enterprise (GSE) - Mortgage-backed securities - residential		47,300		49,261
Total	$	117,909	$	121,646

There were no sales of securities for the three months ended September 30, 2020 and for the three and nine months ended September 30, 2019. Gross gains of $128 thousand were realized on sales of securities for the nine months ended September 30, 2020. There were no gross losses on the sales of securities for the nine months ended September 30, 2020.

Securities with a carrying value of $92.6 million and $74.0 million at September 30, 2020 and December 31, 2019, respectively, were subject to agreements to repurchase, pledged to secure public deposits, or pledged for other purposes required or permitted by law.

‎

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

The Company had no securities in an unrealized loss position at September 30, 2020. The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2019:



		Less Than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

December 31, 2019:	(In Thousands)
Municipal bonds	$	1,295	$	(5)	$	-	$	-	$	1,295	$	(5)
U.S. Government Sponsored Enterprise
(GSE) - Mortgage -backed securities -
residential		4,701		(1)		8,528		(37)		13,229		(38)
Total Temporarily Impaired Securities	$	5,996	$	(6)	$	8,528	$	(37)	$	14,524	$	(43)

The Company had no securities in an unrealized loss position at September 30, 2020 and five (5) securities in an unrealized loss position at December 31, 2019. The unrealized losses were due to market interest rate fluctuations. Management believes that the unrealized loss only represented temporary impairment of the securities.

Note 5 – Restricted Investment in Bank Stock

Restricted investments in bank stock consist of FHLBank of Pittsburgh (“FHLB”) stock and Atlantic Community Bankers Bank (“ACBB”) stock. The restricted stocks are carried at cost. Federal law requires a member institution of the FHLB to hold stock of its district FHLB according to a predetermined formula. The Bank had FHLB stock at a carrying value of $1.3 million as of September 30, 2020 and $1.4 million as of December 31, 2019. The Bank had ACBB stock at a carrying value of $40 thousand at September 30, 2020 and December 31, 2019.

Management evaluates the FHLB and ACBB restricted stock for impairment. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the issuer as compared to the capital stock amount for the issuer and the length of time this situation has persisted, (2) commitments by the issuer to make payments required by law or regulation and the level of such payments in relation to the operating performance of the issuer, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the issuer.

Based upon its evaluation of the foregoing criteria, management believes no impairment charge is necessary related to the FHLB or ACBB stock as of September 30, 2020.

Note 6 – Loans and Credit Quality

On May 1, 2020, the Company sold its entire $689 thousand commercial credit card loan portfolio to an unrelated third party for a gain of $59 thousand. These loans were classified as held for sale at March 31, 2020 prior to the May 1, 2020 sale.

The Company has presented PPP loans of $67.0 million separately from loans receivable on the Consolidated Balance Sheet. As described in Note 3, PPP loans are 100% SBA guaranteed and the Company has determined that no allowance for loan losses is required on PPP loans. All PPP loans are risk rated as pass. PPP loans are not included in the following composition and credit quality tables.

‎

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

The following table presents the composition of loans receivable at September 30, 2020 and December 31, 2019, respectively:



	September 30, 2020			December 31, 2019
			Percentage of			Percentage of
	Balance		total Loans	Balance		total Loans

		(Dollars in Thousands)

Commercial real estate	$	449,268	42.46%	$	427,987	42.24%
Commercial construction		11,297	1.07%		12,622	1.25%
Commercial		44,902	4.24%		53,747	5.30%
Residential real estate		551,960	52.16%		518,150	51.13%
Consumer		712	0.07%		820	0.08%
Total loans		1,058,139	100.00%		1,013,326	100.00%
Unearned origination fees		464			813
Allowance for loan losses		(9,718)			(8,022)
Net Loans	$	1,048,885		$	1,006,117

The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention (potential weaknesses), substandard (well defined weaknesses) and doubtful (full collection unlikely) within the Company's internal risk rating system as of September 30, 2020 and December 31, 2019, respectively:



	Pass		Special Mention		Substandard		Doubtful		Total

September 30, 2020		(In Thousands)
Commercial real estate	$	447,828	$	-	$	1,440	$	-	$	449,268
Commercial construction		10,982		-		315		-		11,297
Commercial		44,820		82		-		-		44,902
Residential real estate		550,897		518		545		-		551,960
Consumer		712		-		-		-		712
Total	$	1,055,239	$	600	$	2,300	$	-	$	1,058,139

December 31, 2019
Commercial real estate	$	426,526	$	-	$	1,461	$	-	$	427,987
Commercial construction		12,307		-		315		-		12,622
Commercial		53,656		91		-		-		53,747
Residential real estate		517,281		719		150		-		518,150
Consumer		820		-		-		-		820
Total	$	1,010,590	$	810	$	1,926	$	-	$	1,013,326

At September 30, 2020 and December 31, 2019 the Company had no foreclosed assets or recorded investment in consumer mortgage loans collateralized by residential real estate in the process of foreclosure.

‎

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

The following table summarizes information in regards to impaired loans by loan portfolio class as of September 30, 2020 and December 31, 2019, respectively:


	September 30, 2020						December 31, 2019
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
	(In Thousands)
With no related allowance recorded:
Commercial real estate	$	862	$	1,102			$	1,626	$	1,890
Commercial construction		315		315				315		315
Commercial		-		-				-		-
Residential real estate		914		984				530		786
Consumer		-		-				-		-
With an allowance recorded:
Commercial real estate	$	700	$	700	$	25	$	-	$	-	$	-
Commercial construction		-		-		-		-		-		-
Commercial		231		231		25		234		234		27
Residential real estate		611		611		127		816		816		175
Consumer		-		-		-		-		-		-
Total:
Commercial real estate	$	1,562	$	1,802	$	25	$	1,626	$	1,890	$	-
Commercial construction		315		315		-		315		315		-
Commercial		231		231		25		234		234		27
Residential real estate		1,525		1,595		127		1,346		1,602		175
Consumer		-		-		-		-		-		-
	$	3,633	$	3,943	$	177	$	3,521	$	4,041	$	202

‎

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

The following tables summarize information regarding the average recorded investment and interest income recognized on impaired loans by loan portfolio for the three and nine months ended September 30, 2020 and 2019, respectively:


	Three Months Ended September 30,
	2020				2019
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(In Thousands)
With no related allowance recorded:
Commercial real estate	$	870	$	13	$	1,702	$	17
Commercial construction		315		3		315		3
Commercial		-		-		-		-
Residential real estate		920		7		667		3
Consumer		-		-		-		-
With an allowance recorded:
Commercial real estate	$	700	$	5	$	-	$	-
Commercial construction		-		-		-		-
Commercial		232		2		237		1
Residential real estate		614		5		828		7
Consumer		1		-		-		-
Total:
Commercial real estate	$	1,570	$	18	$	1,702	$	17
Commercial construction		315		3		315		3
Commercial		232		2		237		1
Residential real estate		1,534		12		1,495		10
Consumer		1		-		-		-
	$	3,652	$	35	$	3,749	$	31


	Nine Months Ended September 30,
	2020				2019
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(In Thousands)
With no related allowance recorded:
Commercial real estate	$	1,063	$	37	$	1,713	$	51
Commercial construction		315		8		315		9
Commercial		-		-		-		-
Residential real estate		769		23		684		8
Consumer		-		-		-		-
With an allowance recorded:
Commercial real estate	$	525	$	16	$	-	$	-
Commercial construction		-		-		-		-
Commercial		233		7		238		6
Residential real estate		667		16		835		22
Consumer		1		-		-		-
Total:
Commercial real estate	$	1,588	$	53	$	1,713	$	51
Commercial construction		315		8		315		9
Commercial		233		7		238		6
Residential real estate		1,436		39		1,519		30
Consumer		1		-		-		-
	$	3,573	$	107	$	3,785	$	96

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

The following table presents non-accrual loans by classes of the loan portfolio:



	September 30, 2020		December 31, 2019

	(In Thousands)
Commercial real estate	$	-	$	-
Commercial construction		-		-
Commercial		-		-
Residential real estate		236		18
Consumer		-		-
Total	$	236	$	18

The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the past due status as of September 30, 2020 and December 31, 2019, respectively:


					Greater								Loan
					than								Receivables >
	30-59 Days		60-89 Days		90 Days		Total				Total Loan		90 Days and
	Past Due		Past Due		Past Due		Past Due		Current		Receivables		Accruing

September 30, 2020	(In Thousands)
Commercial real estate	$	-	$	-	$	117	$	117	$	449,151	$	449,268	$	117
Commercial construction		-		-		-		-		11,297		11,297		-
Commercial		309		135		-		444		44,458		44,902		-
Residential real estate		1,125		1,800		-		2,925		549,035		551,960		-
Consumer		-		-		-		-		712		712		-
Total	$	1,434	$	1,935	$	117	$	3,486	$	1,054,653	$	1,058,139	$	117

December 31, 2019
Commercial real estate	$	-	$	-	$	-	$	-	$	427,987	$	427,987	$	-
Commercial construction		-		-		-		-		12,622		12,622		-
Commercial		-		-		-		-		53,747		53,747		-
Residential real estate		951		-		-		951		517,199		518,150		-
Consumer		-		-		-		-		820		820		-
Total	$	951	$	-	$	-	$	951	$	1,012,375	$	1,013,326	$	-

‎

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

The following tables detail the activity in the allowance for loan losses for the three and nine months ended September 30, 2020 and 2019:



	Commercial Real Estate		Commercial Construction		Commercial		Residential Real Estate		Consumer		Unallocated		Total

Allowance for loan losses	(In Thousands)
Three Months Ending September 30, 2020
Beginning Balance - June 30, 2020	$	3,574	$	113	$	762	$	3,618	$	16	$	934	$	9,017
Charge-offs		-		-		-		-		-		-		-
Recoveries		-		-		-		1		-		-		1
Provisions		743		25		33		183		(1)		(283)		700
Ending Balance - September 30, 2020	$	4,317	$	138	$	795	$	3,802	$	15	$	651	$	9,718

Nine Months Ending September 30, 2020
Beginning Balance - December 31, 2019	$	3,221	$	121	$	770	$	3,488	$	19	$	403	$	8,022
Charge-offs		-		-		-		-		-		-		-
Recoveries		24		-		-		2		-		-		26
Provisions		1,072		17		25		312		(4)		248		1,670
Ending Balance - September 30, 2020	$	4,317	$	138	$	795	$	3,802	$	15	$	651	$	9,718

Three Months Ending September 30, 2019
Beginning Balance - June 30, 2019	$	3,220	$	105	$	643	$	3,265	$	24	$	384	$	7,641
Charge-offs		-		-		-		-		-		-		-
Recoveries		-		-		-		1		-		-		1
Provisions		(66)		(18)		74		145		(9)		(6)		120
Ending Balance - September 30, 2019	$	3,154	$	87	$	717	$	3,411	$	15	$	378	$	7,762

Nine Months Ending September 30, 2019
Beginning Balance - December 31, 2018	$	3,248	$	94	$	574	$	3,179	$	19	$	298	$	7,412
Charge-offs		-		-		-		-		-		-		-
Recoveries		-		-		4		1		-		-		5
Provisions		(94)		(7)		139		231		(4)		80		345
Ending Balance - September 30, 2019	$	3,154	$	87	$	717	$	3,411	$	15	$	378	$	7,762

‎

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

The following tables represent the allocation for loan losses and the related loan portfolio disaggregated based on impairment methodology at September 30, 2020 and December 31, 2019:



	Commercial Real Estate		Commercial Construction		Commercial		Residential Real Estate		Consumer		Unallocated		Total

	(In Thousands)
September 30, 2020
Allowance for Loan Losses
Ending Balance	$	4,317	$	138	$	795	$	3,802	$	15	$	651	$	9,718
Ending balance: individually evaluated for impairment	$	25	$	-	$	25	$	127	$	-	$	-	$	177
Ending balance: collectively evaluated for impairment	$	4,292	$	138	$	770	$	3,675	$	15	$	651	$	9,541

Loans receivables:
Ending balance	$	449,268	$	11,297	$	44,902	$	551,960	$	712			$	1,058,139
Ending balance: individually evaluated for impairment	$	1,562	$	315	$	231	$	1,525	$	-			$	3,633
Ending balance: collectively evaluated for impairment	$	447,706	$	10,982	$	44,671	$	550,435	$	712			$	1,054,506

December 31, 2019
Allowance for Loan Losses
Ending Balance	$	3,221	$	121	$	770	$	3,488	$	19	$	403	$	8,022
Ending balance: individually evaluated for impairment	$	-	$	-	$	27	$	175	$	-	$	-	$	202
Ending balance: collectively evaluated for impairment	$	3,221	$	121	$	743	$	3,313	$	19	$	403	$	7,820

Loans receivables:
Ending balance	$	427,987	$	12,622	$	53,747	$	518,150	$	820			$	1,013,326
Ending balance: individually evaluated for impairment	$	1,626	$	315	$	234	$	1,346	$	-			$	3,521
Ending balance: collectively evaluated for impairment	$	426,361	$	12,307	$	53,513	$	516,804	$	820			$	1,009,805

Troubled Debt Restructurings

The Company may grant a concession or modification for economic or legal reasons related to a borrower’s financial condition that it would not otherwise consider, resulting in a modified loan which is then identified as a troubled debt restructuring (“TDR”). The Company may modify loans through rate reductions, extensions to maturity, interest only payments, or payment modifications to better coincide the timing of payments due under the modified terms with the expected timing of cash flows from the borrowers’ operations. Loan modifications are intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. TDRs are considered impaired loans for purposes of calculating the Company’s allowance for loan losses. Payment accommodations completed since the COVID-19 outbreak are reported in accordance with Section 4013 of the CARES Act and the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus are described in Note 3.

The Company identifies loans for potential restructure primarily through direct communication with the borrower and the evaluation of the borrower’s financial statements, revenue projections, tax returns, and credit reports. Even if the borrower is not presently in default, management will consider the likelihood that cash flow shortages, adverse economic conditions, and negative trends may result in a payment default in the near future.

‎

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

The following table presents TDR’s outstanding:



	Accrual Loans		Non-Accrual Loans		Total Modifications

September 30, 2020	(In Thousands)
Commercial real estate	$	1,135	$	-	$	1,135
Commercial construction		260		-		260
Commercial		231		-		231
Residential real estate		954		16		970
Consumer		-		-		-
	$	2,580	$	16	$	2,596

December 31, 2019
Commercial real estate	$	1,188	$	-	$	1,188
Commercial construction		260		-		260
Commercial		233		-		233
Residential real estate		982		18		1,000
Consumer		-		-		-
	$	2,663	$	18	$	2,681

As of September 30, 2020, no available commitments were outstanding on TDRs.

There were no newly restructured loans that occurred during the three and nine months ended September 30, 2020 and 2019.

There were no loans that were modified and classified as a TDR within the prior twelve months that experienced a payment default (loans ninety days or more past due) during the three and nine months ended September 30, 2020 and 2019.

Note 7 – Deposits

The components of deposits at September 30, 2020 and December 31, 2019 are as follows:


	September 30,		December 31,
	2020		2019
	(In Thousands)

Demand, non-interest bearing	$	261,088	$	171,815
Demand, NOW and money market, interest bearing		179,342		180,869
Savings		497,086		425,284
Time, $250 and over		83,984		92,517
Time, other		127,950		161,483
Total deposits	$	1,149,450	$	1,031,968

At September 30, 2020, the scheduled maturities of time deposits are as follows (in thousands):


2020 (remainder of the year)	$	49,451
2021		114,979
2022		16,620
2023		25,602
2024		4,187
2025		1,095
	$	211,934

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

Note 8 – Short-term and Long-term Borrowings

Securities sold under agreements to repurchase, federal funds purchased and FHLB short term advances generally represent overnight or less than twelve month borrowings. Long term advances from the FHLB are for periods of twelve months or more and are generally less than sixty months. The Bank has an agreement with the FHLB, which allows for borrowings up to a percentage of qualifying assets. At September 30, 2020, the Bank had a maximum borrowing capacity for short-term and long-term advances of approximately $684.5 million. This borrowing capacity with the FHLB includes a line of credit of $150.0 million. There were no short-term FHLB advances outstanding as of September 30, 2020 and $18.1 million in short-term FHLB advances outstanding as of December 31, 2019. There were $14.7 million in long-term FHLB advances outstanding as of September 30, 2020 and none outstanding at December 31, 2019. All FHLB borrowings are secured by qualifying assets of the Bank.

The components of long-term borrowings with the FHLB at September 30, 2020 were as follows:


	September 30, 2020
	(Dollars in Thousands)
Maturity Date	Interest Rate		Outstanding
March 2022	0.79%	$	10,000
March 2022	0.64%		2,663
March 2022	0.61%		1,988
Total FHLB Outstanding Borrowings		$	14,651

The Bank has a federal funds line of credit with the ACBB of $10.0 million, of which none was outstanding at September 30, 2020 and December 31, 2019. Advances from this line are unsecured.

As described in Note 3, the Bank has long-term PPPLF borrowings through the Federal Reserve Bank of Philadelphia of $62.0 million, at an interest rate of 0.35%, as of September 30, 2020 and none as of December 31, 2019. All PPPLF borrowings are secured by PPP loans.

Note 9 – Stock Incentive Plan and Employee Stock Purchase Plan

Stock Incentive Plan:

At the Company’s annual meeting on June 20, 2019, the shareholders approved the amendment and restatement of the Embassy Bancorp, Inc. 2010 Stock Incentive Plan (the “SIP”), which was originally adopted by the Company’s shareholders effective June 16, 2010, to replenish the number of shares of common stock available for issuance under the SIP and extend the term of the SIP for another ten (10) years. The SIP authorizes the Board of Directors, or a committee authorized by the Board of Directors, to award a stock based incentive to (i) designated officers (including officers who are directors) and other designated employees at the Company and its subsidiaries, and (ii) non-employee members of the Board of Directors and advisors and consultants to the Company and its subsidiaries. The SIP provides for stock based incentives in the form of incentive stock options as provided in Section 422 of the Internal Revenue Code of 1986, non-qualified stock options, stock appreciation rights, restricted stock and deferred stock awards. The term of the option, the amount of time for the option to vest after grant, if any, and other terms and limitations will be determined at the time of grant. Options granted under the SIP may not have an exercise period that is more than ten years from the time the option is granted. The maximum number of shares of common stock authorized for issuance under the SIP increased from 500,000 to 756,356 (in order to replenish the shares that were previously issued). The SIP provides for appropriate adjustments in the number and kind of shares available for grant or subject to outstanding awards under the SIP to avoid dilution in the event of a merger, stock splits, stock dividends or other changes in the capitalization of the Company. The SIP expires on June 20, 2029. At September 30, 2020, there were 467,790 shares available for issuance under the SIP.

The Company grants shares of restricted stock, under the SIP, to certain members of its Board of Directors as compensation for their services, in accordance with the Company’s Non-employee Directors Compensation program adopted in October 2010. The Company also grants restricted stock to certain officers under individual agreements with these officers. Some of these restricted stock awards vest immediately, while the remainder vest over the service period of three years to nine years. Management recognizes compensation expense for the fair value of the restricted stock awards on a straight-line basis over the requisite service period. Since inception of the plan and through the period ended September 30, 2020, there have been 172,323 awards granted. There were no awards granted during the three months ended September 30, 2020 and 2019. During the nine months ended September 30, 2020 and 2019 there were

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

32,210 and 10,799 awards granted, respectively. During the three and nine months ended September 30, 2020, the Company recognized $41 thousand and $82 thousand in compensation expense for restricted stock awards, respectively. During the three and nine months ended September 30, 2019, the Company recognized compensation expense of $51 thousand and $152 thousand, respectively.

The Company has granted stock options to purchase shares of stock to certain executive officers under individual agreements and/or in accordance with their respective employment agreements. There was no stock compensation expense related to these options for the three and nine months ended September 30, 2020 and $1 thousand and $3 thousand in stock compensation expense for the three and nine months ended September 30, 2019, respectively.

Employee Stock Purchase Plan:

On January 1, 2017, the Company implemented the Embassy Bancorp, Inc. Employee Stock Purchase Plan (“ESPP”), which was approved by the Company’s shareholders at the annual meeting held on June 16, 2016. Under the ESPP, each employee of the Company and its subsidiaries who is employed on an offering date and customarily is scheduled to work at least twenty (20) hours per week and more than five (5) months in a calendar year is eligible to participate. The purchase price for shares purchased under the ESPP shall initially equal 95% of the fair market value of such shares on the date of purchase. The purchase price may be adjusted from time to time by the Board of Directors; provided, however, that the discount to fair market value shall not exceed 15%. The Company has authorized 350,000 shares of its common stock for the ESPP, of which 14,156 shares have been issued as of September 30, 2020. The Company recognized discount expense in relation to the ESPP of $1 thousand and $2 thousand for the three and nine months ended September 30, 2020 and 2019, respectively.

Note 10 – Other Comprehensive (Loss) Income

US GAAP requires that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

The components of other comprehensive (loss) income both before tax and net of tax are as follows:



	Three Months Ended September 30,
	2020						2019

	(In Thousands)

	Before		Tax		Net of		Before		Tax		Net of
	Tax		Effect		Tax		Tax		Effect		Tax
Change in accumulated other comprehensive (loss) income:
Unrealized holding (losses) gains on securities ‎ available for sale	$	(48)	$	10	$	(38)	$	194	$	(41)	$	153
Reclassification adjustments for gains on securities ‎ transactions included in net income (A),(B)		-		-		-		-		-		-
Total other comprehensive (loss) income	$	(48)	$	10	$	(38)	$	194	$	(41)	$	153



	Nine Months Ended September 30,
	2020						2019

	(In Thousands)

	Before		Tax		Net of		Before		Tax		Net of
	Tax		Effect		Tax		Tax		Effect		Tax
Change in accumulated other comprehensive income:
Unrealized holding gains on securities ‎ available for sale	$	2,168	$	(455)	$	1,713	$	3,240	$	(680)	$	2,560
Reclassification adjustments for gains on securities ‎ transactions included in net income (A),(B)		(128)		27		(101)		-		-		-
Total other comprehensive income	$	2,040	$	(428)	$	1,612	$	3,240	$	(680)	$	2,560

A.Realized gains on securities transactions included in gain on sales of securities, net, in the accompanying Consolidated Statements of Income.

B.Tax effect included in income tax expense in the accompanying Consolidated Statements of Income.

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

There were no realized gains on securities available for sale for the three months ended September 30, 2020 and 2019. A summary of the realized gains on securities available for sale for the nine months ended September 30, 2020 and 2019, net of tax, is as follows:


	Nine Months Ended
	September 30,
		2020		2019

		(In Thousands)
Securities available for sale:
Realized gains on securities transactions	$	(128)	$	-
Income taxes		27		-
Net of tax	$	(101)	$	-

A summary of the accumulated other comprehensive income net of tax, is as follows:



	Securities
	Available
	for Sale
Three Months Ended September 30, 2020 and 2019	(In Thousands)
Balance June 30, 2020	$	2,990
Other comprehensive loss before reclassifications		(38)
Amounts reclassified from accumulated other ‎ comprehensive income		-
Net other comprehensive loss during the period		(38)
Balance September 30, 2020	$	2,952

Balance June 30, 2019	$	1,160
Other comprehensive income before reclassifications		153
Amounts reclassified from accumulated other ‎ comprehensive income		-
Net other comprehensive income during the period		153
Balance September 30, 2019	$	1,313


Nine Months Ended September 30, 2020 and 2019
Balance January 1, 2020	$	1,340
Other comprehensive income before reclassifications		1,713
Amounts reclassified from accumulated other ‎ comprehensive income		(101)
Net other comprehensive income during the period		1,612
Balance September 30, 2020	$	2,952

Balance January 1, 2019	$	(1,247)
Other comprehensive income before reclassifications		2,560
Amounts reclassified from accumulated other ‎ comprehensive income		-
Net other comprehensive income during the period		2,560
Balance September 30, 2019	$	1,313

‎

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

Note 11 – Basic and Diluted Earnings per Share

Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period, as adjusted for stock dividends and splits. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustments to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019
	(Dollars In Thousands, Except Share and Per Share Data)
Net income	$	3,424	$	2,829	$	9,198	$	7,995

Weighted average shares outstanding		7,473,032		7,476,936		7,463,002		7,474,400
Dilutive effect of potential common shares, stock options		45,964		62,051		45,963		61,979
Diluted weighted average common shares outstanding		7,518,996		7,538,987		7,508,965		7,536,379

Basic earnings per share	$	0.46	$	0.38	$	1.23	$	1.07
Diluted earnings per share	$	0.46	$	0.38	$	1.22	$	1.06

Stock options of 4,227 were not considered in computing diluted earnings per common share for the three and nine months ended September 30, 2020 because to do so would have been anti-dilutive. There were no stock options not considered in computing diluted earnings per common share for the three and nine months ended September 30, 2019.

Note 12 – Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

Fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

US GAAP establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:

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

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

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

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy utilized at September 30, 2020 and December 31, 2019, respectively, are as follows:


		(Level 1)		(Level 2)
		Quoted		Significant		(Level 3)
		Prices in Active		Other		Significant
		Markets for		Observable		Unobservable
Description	Identical Assets		Inputs		Inputs		Total

		(In Thousands)
U.S. Treasury securities	$	-	$	19,998	$	-	$	19,998
U.S. Government agency obligations		-		13,532		-		13,532
Municipal bonds		-		38,305		-		38,305
U.S. Government Sponsored Enterprise (GSE) -
Mortgage-backed securities - commercial		-		550		-		550
U.S. Government Sponsored Enterprise (GSE) -
Mortgage-backed securities - residential		-		49,261		-		49,261
September 30, 2020 Securities available for sale	$	-	$	121,646	$	-	$	121,646

Municipal bonds	$	-	$	26,444	$	-	$	26,444
U.S. Government Sponsored Enterprise (GSE) -
Mortgage-backed securities - residential		-		64,385		-		64,385
December 31, 2019 Securities available for sale	$	-	$	90,829	$	-	$	90,829

The fair value of securities available for sale are determined by matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted prices. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the security’s terms and conditions, among other things.

For financial assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2020 and December 31, 2019, respectively, are as follows:


		(Level 1)		(Level 2)
		Quoted		Significant		(Level 3)
		Prices in Active		Other		Significant
		Markets for		Observable		Unobservable
Description	Identical Assets		Inputs		Inputs		Total
		(In Thousands)
September 30, 2020 Impaired loans	$	-	$	-	$	1,365	$	1,365
December 31, 2019 Impaired loans	$	-	$	-	$	848	$	848

Impaired loans are those that are accounted for under existing FASB guidance, in which the Bank has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. Fair values may also include qualitative adjustments by management based on economic conditions and liquidation expenses. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

At September 30, 2020, of the impaired loans having an aggregate balance of $3.6 million, $2.1 million did not require a valuation allowance because the value of the collateral, including estimated selling costs, securing the loan was determined to meet or exceed

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

the balance owed on the loan. Of the remaining $1.5 million in impaired loans, an aggregate valuation allowance of $177 thousand was required to reflect what was determined to be a shortfall in the value of the collateral as compared to the balance on such loans.

Real estate properties acquired through, or in lieu of, foreclosure are to be sold and are carried at fair value less estimated cost to sell. Fair value is based upon independent market prices or appraised value of the property. These assets would be included in Level 3 fair value based upon the lowest level of input that is significant to the fair value measurement. At both September 30, 2020 and December 31, 2019, the Company had no real estate properties acquired through, or in lieu of, foreclosure.

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



	Quantitative Information about Level 3 Fair Value Measurements
Description	Fair Value ‎Estimate		Valuation Techniques	Unobservable Input	Range ‎(Weighted Average)

		(Dollars In Thousands)
September 30, 2020:
Impaired loans	$	1,365	Appraisal of collateral and	Appraisal adjustments (1)	0% to -25% (-15.1%)
			pending agreement of sale	Liquidation expenses (2)	0% to -10.0% (-8.5%)
December 31, 2019:
Impaired loans	$	848	Appraisal of collateral	Appraisal adjustments (1)	0% to -25% (-25%)
				Liquidation expenses (2)	0% to -7.5% (-7.5%)

1.Appraisals may be adjusted by management for qualitative factors including economic conditions and the age of the appraisal. The range and weighted average of appraisal adjustments are presented as a percent of the appraisal.

2.Appraisals and pending agreements of sale are adjusted by management for liquidation expenses. The range and weighted average of liquidation expense adjustments are presented as a percent of the appraisal or pending agreement of sale.

‎

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

The estimated fair values of the Company’s financial instruments were as follows at September 30, 2020 and December 31, 2019:



						(Level 1)
						Quoted		(Level 2)
						Prices in		Significant		(Level 3)
						Active		Other		Significant
		Carrying		Fair Value		Markets for		Observable		Unobservable
		Amount		Estimate		Identical Assets		Inputs		Inputs

	(In Thousands)
September 30, 2020:
Financial assets:
Cash and cash equivalents	$	86,699	$	86,699	$	86,699	$	-	$	-
Securities available-for-sale		121,646		121,646		-		121,646		-
Loans receivable, net of allowance		1,048,885		1,168,911		-		-		1,168,911
Paycheck Protection Program loans receivable		67,020		67,558		-		-		67,558
Restricted investments in bank stock		1,330		1,330		-		1,330		-
Accrued interest receivable		3,236		3,236		-		3,236		-
Financial liabilities:
Deposits		1,149,450		1,152,953		-		1,152,953		-
Securities sold under agreements to
repurchase and federal funds purchased		11,181		11,181		-		11,181		-
Long-term borrowings		14,651		14,708		-		-		14,708
Paycheck Protection Program Liquidity Facility		62,039		62,144		-		-		62,144
Accrued interest payable		1,670		1,670		-		1,670		-
Off-balance sheet financial instruments:
Commitments to grant loans		-		-		-		-		-
Unfunded commitments under lines of credit		-		-		-		-		-
Standby letters of credit		-		-		-		-		-

December 31, 2019:
Financial assets:
Cash and cash equivalents	$	39,986	$	39,986	$	39,986	$	-	$	-
Securities available-for-sale		90,829		90,829		-		90,829		-
Loans receivable, net of allowance		1,006,117		1,013,093		-		-		1,013,093
Restricted investments in bank stock		1,478		1,478		-		1,478		-
Accrued interest receivable		2,048		2,048		-		2,048		-
Financial liabilities:
Deposits		1,031,968		1,033,786		-		1,033,786		-
Securities sold under agreements to
repurchase and federal funds purchased		7,208		7,208		-		7,208		-
Short-term borrowings		18,067		18,067		-		18,067		-
Accrued interest payable		3,281		3,281		-		3,281		-
Off-balance sheet financial instruments:
Commitments to grant loans		-		-		-		-		-
Unfunded commitments under lines of credit		-		-		-		-		-
Standby letters of credit		-		-		-		-		-

Note 13 – Future Accounting Standards

In June 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-13, “Financial Instruments - Credit Losses”. ASU 2016-13 requires entities to report “expected” credit losses on financial instruments and other commitments to extend credit rather than the current “incurred loss” model. These expected credit losses for financial assets held at the reporting date are to be based on historical experience, current conditions, and reasonable and supportable forecasts. This ASU will also require enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as

Embassy Bancorp, Inc.

Notes to Consolidated Financial Statements (Unaudited)

well as the credit quality and underwriting standards of an entity’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In November 2019, the FASB issued an update to defer the implementation date for smaller reporting companies from 2020 to 2023. The Company currently qualifies as a smaller reporting company under SEC Regulation S-K and, therefore, the guidance is effective for the Company in 2023. The Company has not yet determined the impact this standard will have on its consolidated financial statements or results of operations.

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion and analysis provides an overview of the financial condition and results of operations of Embassy Bancorp, Inc. (the “Company”) as of September 30, 2020 and for the three and nine months ended September 30, 2020 and 2019, respectively. This discussion should be read in conjunction with the preceding consolidated financial statements and related footnotes, as well as with the audited consolidated financial statements and the accompanying notes for the year ended December 31, 2019 included in the Company’s Form 10-K filed with the Securities and Exchange Commission. Current performance does not guarantee and may not be indicative of similar performance in the future.

Critical Accounting Policies

Disclosure of the Company’s significant accounting policies is included in Note 1 to the consolidated financial statements included in the Company’s Form 10-K for the year ended December 31, 2019. Some of these policies are particularly sensitive, requiring significant judgments, estimates and assumptions to be made by management, most particularly in connection with determining the provision for loan losses and the appropriate level of the allowance for loan losses and the valuation of deferred tax assets. Additional information is contained in this Form 10-Q under the paragraphs titled “Provision for Loan Losses,” “Credit Risk and Loan Quality,” and “Income Taxes” contained on the following pages.

Caution About Forward-looking Statements

This report contains forward-looking statements, including statements of goals, intentions, and expectations as to future trends, plans, events or results of Company operations and policies and regarding general economic conditions. 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. These statements are based upon current and anticipated economic conditions, nationally and in the Company’s market, interest rates and interest rate policy, competitive factors and other conditions that, by their nature, are not susceptible to accurate forecast, and are subject to significant uncertainty.

Such forward-looking statements can be identified by the use of forward-looking terminology such as “believes”, “expects”, “may”, “intends”, “will”, “should”, “anticipates”, or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy.

No assurance can be given that the future results covered by forward-looking statements will be achieved. Such statements are subject to risks, uncertainties, and other factors that could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could impact the Company’s operating results include, but are not limited to, (i) the effects of changing economic conditions in the Company’s market areas and nationally, (ii) credit risks of commercial, real estate, consumer and other lending activities, (iii) significant changes in interest rates, (iv) changes in federal and state banking laws and regulations which could impact the Company’s operations, (v) changes in accounting policies or procedures as may be required by FASB or regulatory agencies, (vi) risks and uncertainties related to the COVID-19 pandemic and resulting governmental and societal responses, and (vii) other external developments which could materially affect the Company’s business and operations, as well as the risks described in the Company’s Form 10-K for the year ended December 31, 2019 and subsequent filings with the SEC.

OVERVIEW

The Company is a Pennsylvania corporation organized in 2008 and registered as a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Company was formed for purposes of acquiring Embassy Bank For The Lehigh Valley (the “Bank”) in connection with the reorganization of the Bank into a bank holding company structure, which was consummated on November 11, 2008. Accordingly, the Company owns all of the capital stock of the Bank, giving the organization more flexibility in meeting its capital needs as the Company continues to grow. Embassy Holdings, LLC (the “LLC”) is a wholly-owned subsidiary of the Bank organized to engage in the holding of property acquired by the Bank in satisfaction of debts previously contracted. As such, the consolidated financial statements contained herein include the accounts of the Company, the Bank and the LLC.

The Bank, which is the Company’s primary operating subsidiary, was originally incorporated as a Pennsylvania bank on May 11, 2001 and opened its doors on November 6, 2001. It was formed by a group of local business persons and professionals with significant prior experience in community banking in the Lehigh Valley area of Pennsylvania, the Bank’s primary market area, for the purpose of providing a local community bank to serve Lehigh and Northampton Counties in Pennsylvania.

Since its inception, the Board’s philosophy has been that, by running the Bank with a view toward the long term, only good things will happen for the Bank’s customers, team members, shareholders and the Lehigh Valley community.

At September 30, 2020, the Company continued to be in a strong financial and operational condition. The Bank’s September 30, 2020 capital ratios exceeded the amounts required to be considered “well capitalized” as defined in applicable banking regulations. The Company’s ratio of non-performing loans to total loans (not including PPP loans) at September 30, 2020 was 0.28% and the ratio of non-performing assets to total assets was 0.21%. Management believes the Company is well prepared for the ongoing economic and social consequences of the COVID-19 global pandemic.

The Company’s assets increased $188.8 million from $1.18 billion at December 31, 2019 to $1.36 billion at September 30, 2020. The increase was due to an increase in cash and cash equivalents of $46.7 million, an increase of $30.8 million in securities available for sale, an increase of $42.8 million in net loans receivable (not including PPP loans) and new PPP loans of $67.0 million. The growth in cash and cash equivalents, securities available for sale, and net loans receivable was primarily funded by deposits, while the PPP loan growth was primarily funded with PPPLF borrowings of $62.0 million. The Company's deposits grew $117.5 million from $1.03 billion at December 31, 2019 to $1.15 billion at September 30, 2020. The overall deposit growth was due to a highly effective relationship building, sales and marketing effort, which served to further increase the Company’s overall presence in the market it serves, along with deposit relationships developed as a result of cross-marketing efforts to its loan and other non-depository banking service customers. The Bank also continues to capitalize on opportunities created by recent merger announcements, name changes, and competitive branch hour adjustments and/or closures in the Company’s market area, attracting customers looking to relocate to a local, reputable community bank.

Net loans receivable (not including PPP loans) increased by $42.8 million from $1.01 billion at December 31, 2019 to $1.05 billion at September 30, 2020. Before the onset of the COVID-19 pandemic the market continued to be very competitive and the Company is committed to maintaining a high-quality portfolio that returns a reasonable market rate. While the past and current economic and competitive conditions in the marketplace have created more competition for loans to credit-worthy customers, the Company continues to expand its market presence and continues to focus on developing a reputation as being a market leader in both commercial and consumer/mortgage lending. Management believes that this combination of relationship building, cross marketing and responsible underwriting will translate into continued long-term growth of a portfolio of quality loans and core deposit relationships, although there can be no assurance of this. The Company continues to monitor interest rate exposure of its interest-bearing assets and liabilities and believes that it is well positioned for any anticipated future market rate adjustments.

Net income for the three months ended September 30, 2020 was $3.4 million compared to net income for the three months ended September 30, 2019 of $2.8 million, an increase of $595 thousand, or 21.0%. Basic and diluted earnings per share increased to $0.46 for the three months ended September 30, 2020, as compared to $0.38 for the three months ended September 30, 2019. The difference in net income for the three months ended September 30, 2020 and September 30, 2019 resulted, in part, from an increase in net interest income, an increase in bank owned life insurance income, a decrease in advertising and promotion expense, and a decrease in occupancy and equipment expense; offset by an increase in the provision for loan losses, an increase in salaries and benefits expense, an increase in data processing expense, and an increase in FDIC insurance expense. The increase in the provision for loan losses for the three months ended September 30, 2020 was primarily a result of continued provisioning in accordance with the allowance for loan loss methodology due to the COVID-19 pandemic, and to a lesser extent, ongoing loan growth.

Net income for the nine months ended September 30, 2020 was $9.2 million compared to net income for the nine months ended September 30, 2019 of $8.0 million, an increase of $1.2 million, or 15.0%. Basic and diluted earnings per share increased to $1.23 and $1.22, respectively, for the nine months ended September 30, 2020, as compared to $1.07 and $1.06, respectively, for the nine months ended September 30, 2019. The difference in net income for the nine months ended September 30, 2020 and September 30, 2019 resulted, in part, from an increase in net interest income, an increase in bank owned life insurance income, gain on the sale of securities, gain on the sale of loans, a decrease in advertising and promotion expense, and a decrease in occupancy and equipment expense; offset by an increase in the provision for loan losses, a decrease in credit card processing fees and other service fees, no gains on the sale of real estate owned, an increase in salaries and benefits expense, an increase in data processing expense, and an increase in FDIC insurance expense. The increase in the provision for loan losses for the nine months ended September 30, 2020 was primarily a result of continued provisioning in accordance with the allowance for loan loss methodology due to the COVID-19 pandemic and, to a lesser extent, ongoing loan growth.

RESULTS OF OPERATIONS

Net Interest Income

Generally, changes in net interest income are measured by net interest rate spread and net interest margin. Interest rate spread is the mathematical difference between the average interest earned on earning assets and interest paid on interest bearing liabilities. Interest margin represents the net interest yield on earning assets. The interest margin gives a reader a better indication of asset earning results when compared to peer groups or industry standards.

The Company determines interest rate spread and margin on both a US GAAP and tax equivalent basis. The use of tax equivalent basis in determining interest rate spread and margin is considered a non-US GAAP measure. The Company believes use of this

measure provides meaningful information to the reader of the consolidated financial statements when comparing taxable and non-taxable assets. However, it is supplemental to US GAAP which is used to prepare the Company’s consolidated financial statements and should not be read in isolation or relied upon as a substitute for US GAAP measures. In addition, the non-US GAAP measure may not be comparable to non-US GAAP measures reported by other companies. The tax rate used to calculate the tax equivalent adjustments was 21% for 2020 and 2019.

Total interest income for the three months ended September 30, 2020 increased $325 thousand to $11.2 million, as compared to $10.9 million for the three months ended September 30, 2019. Average earning assets were $1.31 billion for the three months ended September 30, 2020 as compared to $1.11 billion for the three months ended September 30, 2019. The tax equivalent yield on average earning assets was 3.42% for the third quarter of 2020 compared to 3.92% for the third quarter of 2019.

Total interest expense for the three months ended September 30, 2020 decreased $1.0 million to $1.4 million, as compared to $2.4 million for the three months ended September 30, 2019. Average interest bearing liabilities were $977.6 million for the three months ended September 30, 2020 as compared to $865.2 million for the three months ended September 30, 2019. The yield on average interest bearing liabilities was 0.58% and 1.12% for the third quarter of 2020 and 2019.

Net interest income for the three months ended September 30, 2020 was $9.8 million compared to $8.4 million for the three months ended September 30, 2019. The improvement in net interest income is primarily the result of a decrease in the balance and rates of certificates of deposit and a decrease in the rates of interest bearing demand deposits, NOW, money market, savings, securities sold under agreement to repurchase and other borrowings. Also contributing to the improvement in net interest income for the three months ended September 30, 2020 was an increase in the balances of taxable loans, taxable and non-taxable investments and interest bearing deposits with banks, and interest income from PPP loans. The improvements were offset, in part, by a decrease in the rates of taxable and non-taxable loans, taxable and non-taxable investments, fed funds sold and interest bearing deposits with banks, an increase in the balance of interest bearing demand deposits, NOW, money markets, savings, securities sold under agreement to repurchase, FHLB long-term borrowings, and interest expense from PPPLF borrowings. The Company’s net interest margin decreased to 2.96% on a US GAAP basis and 2.98% on a non-US GAAP basis for the three months ended September 30, 2020, as compared to 3.02% on a US GAAP basis and 3.05% on a non-US GAAP basis for the three months ended September 30, 2019.

In response to the COVID-19 outbreak, the Federal Reserve Board in mid-March 2020 reduced by 150 basis points the benchmark fed funds rate to a target range of 0% to 0.25%, and the yields on 10 and 30 year Treasury notes have declined to historic lows. Less than 10% of the Company’s loan portfolio is scheduled to mature or reprice within the next year. As a result of the decline in the Federal Reserve Board’s target federal funds rate and yields on Treasury notes, the Company’s future net interest margin and spread may be further reduced. The Company’s net interest margin was also affected by the PPP loans, which bear interest at a rate of 1.0%, and PPPLF borrowings added during the year. The net interest margin on a non-US GAAP basis excluding PPP loans and PPP interest income and PPPLF borrowings interest expense for the three months ended September 30, 2020 was 3.02%.

Total interest income for the nine months ended September 30, 2020 increased $987 thousand to $32.9 million, as compared to $32.0 million for the nine months ended September 30, 2019. Average earning assets were $1.23 billion for the nine months ended September 30, 2020 as compared to $1.09 billion for the nine months ended September 30, 2019. The tax equivalent yield on average earning assets was 3.60% for the nine months ended September 30, 2020 compared to 3.96% for the nine months ended September 30, 2019, respectively.

Total interest expense for the nine months ended September 30, 2020 decreased $1.8 million to $5.1 million, as compared to $7.0 million for the nine months ended September 30, 2019. Average interest bearing liabilities were $930.2 million for the nine months ended September 30, 2020 as compared to $859.4 million for the nine months ended September 30, 2019. The yield on average interest bearing liabilities was 0.74% and 1.08% for the nine months ended September 30, 2020 and 2019, respectively.

Net interest income for the nine months ended September 30, 2020 was $27.8 million compared to $25.0 million for the nine months ended September 30, 2019. The improvement in net interest income for the nine months ended September 30, 2020 is primarily the result of a decrease in the balance and rates of certificates of deposit, securities sold under agreement to repurchase, and FHLB short-term borrowings, and a decrease in the rates of interest bearing demand deposits, NOW, money market, and savings accounts. Also contributing to the improvement in net interest income for the nine months ended September 30, 2020 was an increase in the balances of taxable loans, taxable investments and interest bearing deposits with banks, and interest income from PPP loans. The improvements were offset, in part, by a decrease in the rates of taxable and non-taxable loans, taxable and non-taxable investments, fed funds sold and interest bearing deposits with banks, an increase in the balance of interest bearing demand deposits, NOW and money markets, savings and FHLB long-term borrowings, and interest expense from PPPLF borrowings. The Company’s net interest margin decreased to 3.02% on a US GAAP basis and 3.04% on a non-US GAAP basis for the nine months ended September 30, 2020, as compared to 3.07% on a US GAAP basis and 3.11% on a non-US GAAP basis for the nine months ended September 30, 2019. As a result of the decline in the Federal Reserve Board’s target federal funds rate and yields on Treasury notes, the Company’s future net interest margin and spread may be further reduced. The Company’s net interest margin was also affected by the PPP loans, which bear interest at a rate of 1.0%, and PPPLF borrowings added during the period. The net interest margin on a non-US GAAP basis

excluding PPP loans and PPP interest income and PPPLF borrowings interest expense for the nine months ended September 30, 2020 was 3.07%.

‎

The table below sets forth average balances and corresponding yields for the corresponding periods ended September 30, 2020 and 2019, respectively:

Distribution of Assets, Liabilities and Stockholders’ Equity:

Interest Rates and Interest Differential (quarter to date)


	Three Months Ended September 30,
	2020					2019
					Tax					Tax
	Average				Equivalent	Average				Equivalent
	Balance			Interest	Yield	Balance			Interest	Yield

		(Dollars In Thousands)
ASSETS
Loans - taxable (2)	$	1,038,531	$	10,146	3.89%	$	964,990	$	9,933	4.08%
Loans - Paycheck Protection Program		66,327		420	2.52%		-		-	0.00%
Loans - non-taxable (1)		6,523		50	3.86%		7,863		62	3.96%
Investment securities - taxable		104,162		339	1.29%		68,867		446	2.57%
Investment securities - non-taxable (1)		29,767		210	3.55%		27,659		216	3.92%
Federal funds sold		1,000		-	0.00%		1,000		6	2.20%
Interest bearing deposits with banks		63,705		26	0.16%		35,494		203	2.27%
TOTAL INTEREST EARNING ASSETS		1,310,015		11,191	3.42%		1,105,873		10,866	3.92%
Less allowance for loan losses		(9,256)					(7,669)
Other assets		54,364					50,575
TOTAL ASSETS	$	1,355,123				$	1,148,779

LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing demand deposits, ‎ NOW and money market	$	185,460	$	39	0.08%	$	169,208	$	341	0.80%
Savings		483,656		352	0.29%		425,802		542	0.51%
Certificates of deposit		220,048		959	1.73%		260,554		1,538	2.34%
Securities sold under agreements to repurchase ‎and other borrowings		26,357		30	0.45%		9,666		17	0.70%
Paycheck Protection Program Liquidity
Facility borrowings		62,039		54	0.35%		-		-	0.00%
TOTAL INTEREST BEARING LIABILITIES		977,560		1,434	0.58%		865,230		2,438	1.12%

Non-interest bearing demand deposits		249,902					166,829
Other liabilities		20,257					20,958
Stockholders' equity		107,404					95,762
TOTAL LIABILITIES AND ‎STOCKHOLDERS' EQUITY	$	1,355,123				$	1,148,779

Net interest income			$	9,757				$	8,428
Tax equivalent adjustments
Loans				13					16
Investments				56					57
Total tax equivalent adjustments				69					73
Net interest income on a tax equivalent basis			$	9,826				$	8,501
Net interest spread (US GAAP basis)					2.81%					2.78%
Net interest margin (US GAAP basis)					2.96%					3.02%
Net interest spread (non-US GAAP basis) (3)					2.84%					2.80%
Net interest margin (non-US GAAP basis) (3)					2.98%					3.05%

(1)Yields on tax exempt assets have been calculated on a fully tax equivalent basis at a tax rate of 21% as of September 30, 2020 and 2019, respectively.

(2)The average balance of taxable loans includes loans in which interest is no longer accruing.

(3)Non-US GAAP net interest spread and net interest margin calculated on a fully tax equivalent basis at a tax rate of 21% as of September 30, 2020 and 2019, respectively.

Distribution of Assets, Liabilities and Stockholders’ Equity:

Interest Rates and Interest Differential (year to date)


		Nine Months Ended September 30,

	2020						2019

					Tax					Tax
	Average				Equivalent	Average				Equivalent
	Balance		Interest		Yield	Balance		Interest		Yield

		(Dollars In Thousands)
ASSETS
Loans - taxable (2)	$	1,027,335	$	30,300	3.94%	$	960,776	$	29,278	4.07%
Loans - Paycheck Protection Program		36,521		658	2.41%		-		-	0.00%
Loans - non-taxable (1)		6,988		160	3.87%		7,919		185	3.95%
Investment securities - taxable		82,130		1,074	1.75%		60,623		1,207	2.66%
Investment securities - non-taxable (1)		27,041		617	3.86%		30,698		758	4.18%
Federal funds sold		845		2	0.25%		745		13	2.30%
Interest bearing deposits with banks		48,101		127	0.35%		25,446		510	2.68%
TOTAL INTEREST EARNING ASSETS		1,228,961		32,938	3.60%		1,086,207		31,951	3.96%
Less allowance for loan losses		(8,631)					(7,571)
Other assets		52,899					51,258
TOTAL ASSETS	$	1,273,229				$	1,129,894

LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing demand deposits,
NOW and money market	$	186,543	$	404	0.29%	$	152,763	$	722	0.63%
Savings		455,227		1,138	0.33%		432,522		1,683	0.52%
Certificates of deposit		233,831		3,397	1.94%		249,084		4,229	2.27%
Securities sold under agreements to repurchase ‎and other borrowings		24,877		129	0.69%		25,007		335	1.79%
Paycheck Protection Program Liquidity
Facility borrowings		29,749		78	0.35%		-		-	0.00%
TOTAL INTEREST BEARING LIABILITIES		930,227		5,146	0.74%		859,376		6,969	1.08%

Non-interest bearing demand deposits		218,948					158,188
Other liabilities		19,449					19,481
Stockholders' equity		104,605					92,849
TOTAL LIABILITIES AND ‎STOCKHOLDERS' EQUITY	$	1,273,229				$	1,129,894

Net interest income			$	27,792				$	24,982
Tax equivalent adjustments
Loans				43					49
Investments				164					201
Total tax equivalent adjustments				207					250
Net interest income on a tax equivalent basis			$	27,999				$	25,232
Net interest spread (US GAAP basis)					2.84%					2.85%
Net interest margin (US GAAP basis)					3.02%					3.07%
Net interest spread (non-US GAAP basis) (3)					2.86%					2.88%
Net interest margin (non-US GAAP basis) (3)					3.04%					3.11%

(1)Yields on tax exempt assets have been calculated on a fully tax equivalent basis at a tax rate of 21% as of September 30, 2020 and 2019, respectively.

(2)The average balance of taxable loans includes loans in which interest is no longer accruing.

(3)Non-US GAAP net interest spread and net interest margin calculated on a fully tax equivalent basis at a tax rate of 21% as of September 30, 2020 and 2019, respectively.

The table below demonstrates the relative impact on net interest income of changes in the volume of interest-earning assets and interest-bearing liabilities and changes in rates earned and paid by the Company on such assets and liabilities:


	Three Months Ended									Nine Months Ended
	September 30, 2020								September 30, 2020
	compared to September 30, 2019									compared to September 30, 2019
	(In Thousands)
			Due to change in:								Due to change in:
	Total						# of		Total						# of
	Change		Volume		Rate		Days		Change		Volume		Rate		Days

Interest-earning assets:
Loans - taxable	$	213	$	757	$	(516)	$	(28)	$	1,022	$	2,028	$	(1,034)	$	28
Loans - Paycheck Protection Program		420		420		-		-		658		658		-		-
Loans - non-taxable		(12)		(11)		(1)		-		(25)		(21)		(4)		-
Investment securities - taxable		(107)		229		(335)		(1)		(133)		429		(562)		-
Investment securities - non-taxable		(6)		16		(22)		-		(141)		(90)		(52)		1
Federal funds sold		(6)		-		(6)		-		(11)		1		(12)		-
Interest bearing deposits with banks		(177)		161		(338)		-		(383)		454		(837)		-
Total net change in income on
interest-earning assets		325		1,572		(1,218)		(29)		987		3,459		(2,501)		29

Interest-bearing liabilities:
Interest bearing demand deposits,
NOW and money market		(302)		33		(335)		-		(318)		159		(478)		1
Savings		(190)		74		(263)		(1)		(545)		88		(634)		1
Certificates of deposit		(579)		(239)		(337)		(3)		(832)		(259)		(576)		3
Total deposits		(1,071)		(132)		(935)		(4)		(1,695)		(12)		(1,688)		5
Securities sold under agreements to
repurchase and other borrowings		13		29		(16)		-		(206)		(1)		(205)		-
Paycheck Protection Program
Liquidity Facility borrowings		54		54		-		-		78		78		-		-
Total net change in expense on
interest-bearing liabilities		(1,004)		(49)		(951)		(4)		(1,823)		65		(1,893)		5
Change in net interest income	$	1,329	$	1,621	$	(267)	$	(25)	$	2,810	$	3,394	$	(608)	$	24

Provision for Loan Losses

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

The allowance for loan losses is maintained at a level management considers to be adequate to provide for losses that can be reasonably anticipated. Management’s periodic evaluation of the adequacy of the allowance is based on known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant change.

The allowance consists of general, specific, qualitative and unallocated components. The general component covers non-classified loans and classified loans not considered impaired, and is based on historical loss experience adjusted for qualitative factors. The specific component relates to loans that are classified as impaired and/or restructured. For loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. An allowance for loan losses is not maintained on loans designated as held for sale.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and/or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral-dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and home equity loans for impairment disclosures, unless such loans are the subject of a restructuring agreement or there is a possible loss expected.

For the three months ended September 30, 2020, the provision for loan losses was $700 thousand, as compared to $120 thousand for the same period ended September 30, 2019. In the three months ended September 30, 2020 and September 30, 2019 there were no charge-offs and $1 thousand in recoveries. For the nine months ended September 30, 2020, the provision for loan losses was $1.7 million, as compared to $345 thousand for the same period ended September 30, 2019. In the nine months ended September 30, 2020, there were no charge-offs and $26 thousand in recoveries, as compared to no charge-offs and $5 thousand in recoveries for the nine months ended September 30, 2019. The provision for loan losses is a function of the allowance for loan loss methodology that the Bank uses to determine the appropriate level of the allowance for inherent loan losses after net charge-offs have been deducted. During the first three quarters of 2020, the Bank adjusted the economic risk factor and loan modifications risk factor methodologies to incorporate the current economic implications, unemployment rate and amount of loan modifications due to the COVID-19 pandemic. See further discussion following in the “Credit Risk and Loan Quality” section of the Bank’s considerations of its September 30, 2020 allowance for loan loss levels. The allowance for loan losses is $9.7 million as of September 30, 2020, which is 0.92% of outstanding loans receivable (not including PPP loans), compared to $7.8 million or 0.79% of outstanding loans as of September 30, 2019. At December 31, 2019, the allowance for loan losses was $8.0 million, which represented 0.79% of total outstanding loans. Based principally on economic conditions, asset quality, and loan-loss experience, including that of comparable institutions in the Bank’s market area, the allowance is believed to be adequate to absorb any losses inherent in the portfolio. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate, or that material increases will not be necessary should the quality of the loans deteriorate. The Bank has not participated in any sub-prime lending activity.

‎

The activity in the allowance for loan losses is shown in the following table, as well as period end loans receivable and the allowance for loan losses as a percent of the total loans receivable portfolio:



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019

	(In Thousands)
Loans receivable at end of period	$	1,058,139	$	985,946	$	1,058,139	$	985,946
Allowance for loan losses:
Balance, beginning	$	9,017	$	7,641	$	8,022	$	7,412
Provision for loan losses		700		120		1,670		345
Loans charged off:
Commercial real estate		-		-		-		-
Commercial construction		-		-		-		-
Commercial		-		-		-		-
Residential real estate		-		-		-		-
Consumer		-		-		-		-
Total loans charged off		-		-		-		-
Recoveries of loans previously charged off:
Commercial real estate		-		-		24		-
Commercial construction		-		-		-		-
Commercial		-		-		-		4
Residential real estate		1		1		2		1
Consumer		-		-		-		-
Total recoveries		1		1		26		5
Net charge offs		1		1		26		5
Balance at end of period	$	9,718	$	7,762	$	9,718	$	7,762
Allowance for loan losses to loans receivable at end of period		0.92%		0.79%		0.92%		0.79%

Non-interest Income

Total non-interest income was $602 thousand for the three months ended September 30, 2020 compared to $503 thousand for the same period in 2019. The increase is attributable to an increase in bank owned life insurance of $137 thousand and a $16 thousand increase in debit card interchange fees; offset by a decrease of $38 thousand in merchant processing and credit card processing fees due, in part, to less credit card activity due to the credit card portfolio being sold in the second quarter of 2020, and a decrease of $16 thousand in other service fees. The increase in the bank owned life insurance was driven by the effect market conditions had on underlying life insurance assets, particularly the separate account life insurance assets.

Total non-interest income was $1.7 million for the nine months ended September 30, 2020 compared to $1.6 million for the same period in 2019. The increase is attributable to an increase in bank owned life insurance of $90 thousand, the gain on the sale of securities of $128 thousand and the gain on the sale of loans of $59 thousand; offset by a decrease of $92 thousand in merchant processing and credit card processing fees due, in part, to less merchant processing activity resulting from the COVID-19 pandemic and less credit card activity due to the credit card portfolio being sold in the second quarter of 2020, a decrease in other service fees of $73 thousand in part due to the Company waiving overdraft fees during part of the second quarter due to the COVID-19 pandemic, and the gain on the sale of real estate owned of $45 thousand during the nine months ended September 30, 2019. The increase in the bank owned life insurance was driven by the effect market conditions had on underlying life insurance assets, particularly the separate account life insurance assets.

Non-interest Expense

Non-interest expenses increased by $140 thousand from $5.3 million for the three months ended September 30, 2019 to $5.4 million for the same period ended September 30, 2020. The increase in non-interest expenses is primarily due to an increase of $140 thousand in salaries and employee benefits in part due to a 4.3% increase in full-time equivalent employees from ninety-two (92) at September 30, 2019 to ninety-six (96) at September 30, 2020 as a result of continued growth, annual increases in salaries and benefits, and increase in health insurance cost; offset by an increase in deferred compensation costs associated with loan originations. Additional increases in non-interest expenses are attributable to an increase of $122 thousand in FDIC insurance due to FDIC credits applied in the third quarter of 2019, and an increase of $56 thousand in data processing due primarily to e-commerce and the expanding customer base. These increases in non-interest expenses were offset by a decrease of $44 thousand in occupancy and equipment due to fewer leasehold improvements, a decrease of $135 thousand in advertising and promotions from shifts in marketing strategies and less

promotional items resulting in part from the COVID-19 pandemic, and a decrease of $7 thousand in other expenses due to less employee and customer expenses primarily due to restrictions from the COVID-19 pandemic and less fraud losses.

Non-interest expenses increased by $82 thousand from $16.4 million for the nine months ended September 30, 2019 to $16.5 million for the same period ended September 30, 2020. The increase in non-interest expenses is primarily due to an increase of $384 thousand in salaries and employee benefits, in part, due to a 4.3% increase in full-time equivalent employees from ninety-two (92) at September 30, 2019 to ninety-six (96) at September 30, 2020 as a result of continued growth, annual increases in salaries and benefits, and increase in health insurance cost; offset by an increase in deferred compensation costs primarily associated with PPP loan originations. Additional increases in non-interest expenses are attributable to an increase of $68 thousand in FDIC insurance due to FDIC credits applied in the third quarter of 2019 offset by the remaining FDIC assessment credits applied in the first quarter of 2020, an increase of $174 thousand in data processing due primarily to e-commerce and the expanding customer base, an increase of $44 thousand in professional fees primarily due to an increase in auditing and consulting costs, and an increase of $44 thousand in loan and real estate expenses. These increases in non-interest expenses were offset by a decrease of $72 thousand in occupancy and equipment due, in part, to fewer leasehold improvements, a decrease of $440 thousand in advertising and promotions from shifts in marketing strategies and less promotional items resulting in part from the COVID-19 pandemic, and a decrease of $110 thousand in other expenses in part due to less operating expenses, less fraud losses, and less employee, customer and shareholder expenses primarily due to restrictions from the COVID-19 pandemic.

A breakdown of other expenses can be found in the Consolidated Statements of Income.

Income Taxes

The provision for income taxes for the three months ended September 30, 2020 totaled $788 thousand, or 18.7% of income before taxes. The provision for income taxes for the three months ended September 30, 2019 totaled $675 thousand, or 19.3% of income before taxes. The decrease in the tax rate is primarily the result of the increase in income on bank owned life insurance; offset by the change in the mix of taxable and tax free loans and investments. The provision for income taxes for the nine months ended September 30, 2020 totaled $2.1 million, or 18.7% of income before taxes, compared to income taxes for the nine months ended September 30, 2019 totaling $1.8 million, or 18.7% of income before taxes.

FINANCIAL CONDITION

Securities

The Bank’s securities portfolio continues to be classified, in its entirety, as “available for sale.” Management believes that a portfolio classification of available for sale allows complete flexibility in the investment portfolio. Using this classification, the Bank intends to hold these securities for an indefinite amount of time, but not necessarily to maturity. Such securities are carried at fair value with unrealized gains or losses reported as a separate component of stockholders’ equity. The portfolio is structured to provide maximum return on investments while providing a consistent source of liquidity and meeting strict risk standards. Investment securities consist primarily of mortgage-backed securities issued by FHLMC or FNMA, taxable and non-taxable municipal bonds, government agency bonds, and Treasury securities. The Bank holds no high-risk securities or derivatives as of September 30, 2020. The Bank has not made any investments in non-U.S. government agency mortgage backed securities or sub-prime loans.

Total securities at September 30, 2020 were $121.6 million compared to $90.8 million at December 31, 2019. The increase in the investment portfolio resulted from the purchase of three (3) mortgage-backed securities and eight (8) taxable municipal bonds, nine (9) tax-free municipal bonds, two (2) government agency bonds and three (3) Treasury securities totaling $83.9 million, and an increase in unrealized gains of $2.0 million; offset by principal pay downs on mortgage-backed securities, calls of eleven (11) non-taxable municipal bonds, the maturity of one (1) government agency bond, and maturity of one (1) Treasury security totaling $50.9 million and the sale of one (1) mortgage backed security totaling $4.0 million, including a realized gain of $128 thousand. The carrying value of the securities portfolio as of September 30, 2020 includes a net unrealized gain of $3.7 million, which is recorded as accumulated other comprehensive income in stockholders’ equity net of income tax effect. This compares to a net unrealized gain of $1.7 million at December 31, 2019. The current unrealized gain position of the securities portfolio is due to changes in market interest rates since purchase. No securities are deemed to be other than temporarily impaired.

Loans

On May 1, 2020, the Company sold its entire $689 thousand commercial credit card loan portfolio to an unrelated third party for a gain of $59 thousand. These commercial credit cards were unsecured. The Company does not anticipate originating and selling commercial credits cards in the future.

The loan portfolio comprises a major component of the Bank’s earning assets. All of the Bank’s loans are to domestic borrowers. Total net loans receivable (not including PPP loans) at September 30, 2020 increased $42.8 million to $1.05 billion from $1.01 billion December 31, 2019. The gross loan-to-deposit ratio (not including PPP loans) decreased from 98% at December 31, 2019 to 92% at

September 30, 2020. The Bank’s loan portfolio at September 30, 2020 was comprised of residential real estate and consumer loans of $552.7 million, an increase of $33.7 million from December 31, 2019, and commercial loans of $505.5 million, an increase of $11.1 million from December 31, 2019. The Bank has not originated, nor does it intend to originate, sub-prime mortgage loans. As described in Note 3 to the consolidated financial statements, the Bank is participating in the SBA PPP program to support the needs of its small business clients. PPP loans receivable at September 30, 2020 were $67.0 million. Including PPP loans receivable, the gross loan-to-deposit ratio was 98%.

Payment accommodations related to COVID-19 assistance were in the form of short-term (six months or less) principal and/or interest deferrals and the loans were considered current at the time of the accommodation. These payment accommodations were done in accordance with Section 4013 of the Coronavirus Aid, Relief and Economic Security (“CARES”) Act and the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus and the Company will not be categorizing these modifications as troubled debt restructurings. Through September 30, 2020, the Company had provided payment accommodations on two hundred seventy-one (271) loans with balances of $155.3 million. Included in these totals are two hundred thirty-four (234) loans totaling $113.5 million in which the payment accommodation period has ended and the loan payments have resumed under their original contractual terms. Also included in the totals are four (4) loans totaling $246 thousand that are in their first short-term payment accommodation period, thirty-one (31) loans totaling $41.5 million that are in their second short-term payment accommodation period and two (2) loans totaling $82 thousand that are in their third short-term payment accommodation period.

Credit Risk and Loan Quality

The allowance for loan losses increased $1.7 million to $9.7 million at September 30, 2020 compared to $8.0 million at December 31, 2019. At September 30, 2020 and December 31, 2019, the allowance for loan losses represented 0.92% and 0.79%, respectively, of total loans receivable (not including PPP loans which are guaranteed by the SBA). In the first three quarters of 2020, the Bank adjusted the economic risk factor and loan modifications risk factor methodologies to incorporate the current economic implications, unemployment rate and amount of loan modifications due to the COVID-19 pandemic, leading to the increase in the allowance for loan losses as a percentage of total loans. In determining its allowance for loan loss level at September 30, 2020, the Bank considered the health and composition of its loan portfolio going into and during the COVID-19 pandemic. The Bank’s nonperforming loans to total loans receivable (not including PPP loans) was 0.28% at September 30, 2020, down from 0.29% at September 30, 2019 and up slightly from 0.26% at December 31, 2019. The Bank had no charge-offs for the three and nine months ended September 30, 2020 and for the year ended December 31, 2019. At September 30, 2020, approximately 95% of the Bank’s loan portfolio is collateralized by real estate. Less than 6% of the Bank’s loan portfolio is to borrowers in the more particularly hard-hit industries (including the travel and hotel industry, the full-service and limited-service restaurant industries, and the assisted living facilities industry) and the Bank has no direct international exposure. The Bank was not required to adopt the Current Expected Credit Losses (“CECL”) FASB accounting standard in 2020, as this guidance will not be effective for the Bank until 2023. Based upon current economic conditions, the composition of the loan portfolio, the perceived credit risk in the portfolio and loan-loss experience of the Bank and comparable institutions in the Bank’s market area, management feels the allowance is adequate to absorb reasonably anticipated losses. The Bank will continue to evaluate the allowance for loan losses as new information becomes available.

At September 30, 2020, December 31, 2019, and September 30, 2019 aggregate balances on non-performing loans are included in the following table. Troubled debt restructurings, included in the following table, represent loans where the Company, for economic or legal reasons related to the debtor’s financial difficulties, has granted a concession to the debtor that it would not otherwise consider. There were no loans that were modified and classified as a TDR within the prior twelve months that experienced a payment default (loans ninety or more days past due) for the three and nine months ended September 30, 2020.

‎

The details for non-performing loans are included in the following table:



		September 30,		December 31,		September 30,
		2020		2019		2019

	(In Thousands)
Non-accrual - commercial	$	-	$	-	$	-
Non-accrual - consumer		236		18		19
Restructured loans, accruing interest and less than 90 days past due		2,580		2,663		2,858
Loans past due 90 or more days, accruing interest		117		-		-
Total nonperforming loans		2,933		2,681		2,877
Foreclosed assets		-		-		-
Total nonperforming assets	$	2,933	$	2,681	$	2,877
Nonperforming loans to total loans receivable at period-end		0.28%		0.26%		0.29%
Nonperforming assets to total assets		0.21%		0.23%		0.25%

The $117 thousand loan that was past due more than 90 days and still accruing interest was subsequently paid off in October 2020.

Premises and Equipment

Company premises and equipment, net of accumulated depreciation, increased $907 thousand from December 31, 2019 to September 30, 2020. This increase is due to purchases offset by depreciation on existing premises and equipment. The increase in purchases was primarily due to the ongoing construction of the new Macungie branch, which is tentatively expected to open in November 2020.

Deposits

Total deposits at September 30, 2020 increased $117.5 million to $1.15 billion from $1.03 billion at December 31, 2019. The increase in the Company’s deposits was due to an increase of $87.7 million in demand, NOW and money market deposits and a $71.8 million increase in savings deposits; offset by a decrease of $42.1 million in time deposits. The growth in total deposits was due to organic growth of new and existing customers. The shift out of time deposits was primarily due to promotions rolling off into lower yielding deposits due to the current rate environment. The funds were primarily used to fund new loan growth and purchase securities.

Liquidity

Liquidity represents the Company’s ability to meet the demands required for the funding of loans and to meet depositors’ requirements for use of their funds. The Company’s sources of liquidity are cash balances, due from banks, and federal funds sold. Cash and cash equivalents were $86.7 million at September 30, 2020, compared to $40.0 million at December 31, 2019.

Additional asset liquidity sources include principal and interest payments from the investment security and loan portfolios. Long-term liquidity needs may be met by selling unpledged securities available for sale, selling or participating loans, or raising additional capital. At September 30, 2020, the Company had $121.6 million of available for sale securities. Securities with carrying values of approximately $92.6 million and $74.0 at September 30, 2020 and December 31, 2019, respectively, were pledged as collateral to secure securities sold under agreements to repurchase, public deposits, and for other purposes required or permitted by law.

At September 30, 2020, the Bank had a maximum borrowing capacity for short-term and long-term advances of approximately $684.5 million. This borrowing capacity with the FHLB includes a line of credit of $150.0 million. There were no short-term FHLB advances outstanding as of September 30, 2020 and $18.1 million in short-term FHLB advances outstanding as of December 31, 2019. There were $14.7 million in long-term FHLB advances outstanding as of September 30, 2020 and none outstanding at December 31, 2019. All FHLB borrowings are secured by qualifying assets of the Bank. The increase in long-term FHLB advances corresponds with some of the run-off of the certificates of deposit described above.

The Bank has a federal funds line of credit with the ACBB of $10.0 million, of which none was outstanding at September 30, 2020 and December 31, 2019. Advances from this line are unsecured.

As described in Note 3, the Bank has long-term PPPLF borrowings through the Federal Reserve Bank of Philadelphia of $62.0 million as of September 30, 2020. All PPPLF borrowings are secured by PPP loans. The PPPLF provides term funding to depository institutions that originate loans to small businesses under the PPP. PPP loans that are pledged to secure PPPLF extensions of credit are excluded from leverage ratio calculations.

The Company has no investment in or financial relationship with any unconsolidated entities that are reasonably likely to have a material effect on liquidity or capital resources.

Off-Balance Sheet Arrangements

The Company’s consolidated financial statements do not reflect various off-balance sheet arrangements that are made in the normal course of business, which may involve some liquidity risk. These off-balance sheet arrangements consist of unfunded loans and commitments, as well as lines of credit made under the same standards as on-balance sheet instruments. These unused commitments totaled $135.0 million at September 30, 2020. At September 30, 2020 the Company had letters of credit outstanding of $4.6 million. Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Company. Management is of the opinion that the Company’s liquidity is sufficient to meet its anticipated needs. Management will continue to evaluate the Company’s liquidity position for changes caused by the COVID-19 pandemic.

Capital Resources and Adequacy

Total stockholders’ equity was $108.3 million as of September 30, 2020, representing a net increase of $8.7 million from December 31, 2019. The increase in capital was primarily the result of the net income of $9.2 million, an increase of $1.6 million in unrealized gains on available for sale securities, and an increase in surplus of $241 thousand due to stock grants and employee stock purchases with compensation expense, offset by dividends paid of $1.6 million and a treasury stock purchase of $720 thousand.

The Company and the Bank are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain actions by regulators that could have a material effect on the consolidated financial statements.

The regulations require that banks maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined in the regulations), and Tier I capital to average assets (as defined in the regulations). As of September 30, 2020, the Bank met the minimum requirements. In addition, the Bank’s capital ratios exceeded the amounts required to be considered “well capitalized” as defined in the regulations.

The following table provides a comparison of the Bank’s risk-based capital ratios and leverage ratios:



Consolidated Bank

	September 30, 2020			December 31, 2019

	(Dollars In Thousands)
Tier I, common stockholders' equity	$	105,307		$	98,230
Tier II, allowable portion of allowance for loan losses		9,718			8,022
Total capital	$	115,025		$	106,252

Common equity tier 1 capital ratio		11.9	%		12.0	%
Tier I risk based capital ratio		11.9	%		12.0	%
Total risk based capital ratio		13.0	%		13.0	%
Tier I leverage ratio		8.1	%		8.4	%

Note: Unrealized gains and losses on securities available for sale are excluded from regulatory capital components of risk-based capital and leverage ratios.

In addition to the risk-based capital guidelines, the federal banking regulators established minimum leverage ratio (Tier 1 capital to total assets) guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of 3% for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a leverage ratio of at least 4%.

The capital ratios to be considered “well capitalized” under the new capital rules are: common equity of 6.5%, Tier 1 leverage of 5%, Tier 1 risk-based capital of 8%, and Total Risk-Based capital of 10%.

The Company qualifies as a small bank holding company and is not subject to the Federal Reserve’s consolidated capital rules, although an institution that so qualifies may continue to file reports that include such capital amounts and ratios. The Company has elected to continue to report those amounts and ratios.

‎

The following table provides the Company’s risk-based capital ratios and leverage ratios:



Consolidated Corporation

	September 30, 2020			December 31, 2019

	(Dollars In Thousands)
Tier I, common stockholders' equity	$	105,386		$	98,275
Tier II, allowable portion of allowance for loan losses		9,718			8,022
Total capital	$	115,104		$	106,297

Common equity tier 1 capital ratio		11.9	%		12.0	%
Tier I risk based capital ratio		11.9	%		12.0	%
Total risk based capital ratio		13.0	%		13.0	%
Tier I leverage ratio		8.1	%		8.4	%

Note: Unrealized gains on securities available for sale are excluded from regulatory capital components of risk-based capital and leverage ratios.

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

The Company’s primary source of market risk is interest rate risk. A principal objective of the Company’s asset/liability management policy is to minimize the Company’s exposure to changes in interest rates by an ongoing review of the maturity and repricing of interest earning assets and interest bearing liabilities. The Asset Liability Committee (ALCO), included as part of the Board of Directors meetings, oversees this review, which establishes policies to control interest rate sensitivity. Interest rate sensitivity is the volatility of a company’s earnings resulting from a movement in market interest rates. The Company monitors rate sensitivity in order to reduce vulnerability to interest rate fluctuations while maintaining adequate capital levels and acceptable levels of liquidity. The Company’s asset/liability management policy, monthly and quarterly financial reports, along with simulation modeling, supplies management with guidelines to evaluate and manage rate sensitivity.

Based on a twelve-month forecast of the balance sheet, the following table sets forth the Company’s interest rate risk profile at September 30, 2020. For income simulation purposes, personal and business savings accounts reprice every three months, personal and business NOW accounts reprice every four months and personal and business money market accounts reprice every two months. The impact on net interest income, illustrated in the following table, would vary if different assumptions were used or if actual experience differs from that indicated by the assumptions.



	Change in Interest Rates		Percentage Change in Net Interest Income

	Down 100 basis points		-1.9%
	Down 200 basis points		-4.5%

	Up 100 basis points		1.1%
	Up 200 basis points		2.0%

Item 4 – Controls and Procedures

The term “disclosure controls and procedures” is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”). This term refers to the controls and procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods. Our Chief Executive Officer and our Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2020, and they have concluded that, as of this date, our disclosure controls and procedures were effective at ensuring that required information will be disclosed on a timely basis in our reports filed under the Exchange Act.

There were no significant changes to our internal controls over financial reporting or in the other factors that could significantly affect our internal controls over financial reporting during the quarter ended September 30, 2020, including any corrective actions with regard to significant deficiencies and material weakness.

‎

Part II - Other Information

Item 1 - Legal Proceedings

The Company and the Bank are an occasional party to legal actions arising in the ordinary course of its business. In the opinion of management, the Company has adequate legal defenses and/or insurance coverage respecting any and each of these actions and does not believe that they will materially affect the Company’s operations or financial position.

Item 1A - Risk Factors

In addition to the other information set forth in this Quarterly Report, you should carefully consider the factors discussed in “Risk Factors” included within the 2019 Form 10-K and our subsequent filings with the SEC. There are no material changes from such risk factors. Such risks are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently believe to be immaterial also may materially adversely affect our business, financial condition and/or operating results. See “Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Caution About Forward-looking Statements.”

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3 - Defaults Upon Senior Securities

None.

Item 4 – Mine Safety Disclosures

None.

Item 5 - Other Information

None.

‎

Item 6 - Exhibits



	Exhibit
	Number		Description
	3.1		Articles of Incorporation as amended (conformed) (Incorporated by reference to Exhibit 3.1 of Registrant's
			Form 10-Q filed on August 12, 2016).
	3.2		Amended and Restated By-Laws (conformed) (Incorporated by reference to Exhibit 3.2 of Registrant's
			Form 10-Q filed on August 12, 2016).
	31.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a).
	31.2		Certification of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a).
	32		Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 1350
			of the Sarbanes-Oxley Act of 2002.
	101.1		Interactive Data Files (XBRL)

No.	Description
101.INS	XBRL Instance Document.*
101.SCH	XBRL Taxonomy Extension Schema Document.
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB	XBRL Taxonomy Extension Label Linkbase Document.
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document.
101.DEF	XBRL Taxonomy Extension Definitions Linkbase Document.
104	Cover Page Interactive Data File (formatted as inline XBRL
	and contained in Exhibit 101)

* This instance document does not appear in the interactive data file because its XBRL tags are embedded within the inline XBRL.

‎

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.


		EMBASSY BANCORP, INC.
		(Registrant)

Dated: November 6, 2020	By:	/s/ David M. Lobach, Jr.
		David M. Lobach, Jr.
		President and Chief Executive Officer


Dated: November 6, 2020	By:	/s/ Judith A. Hunsicker
		Judith A. Hunsicker
		First Executive Officer,
		Chief Operating Officer, Secretary and
		Chief Financial Officer