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EMCLAIRE FINANCIAL CORP - Annual Report: 2019 (Form 10-K)

emcf20181231_10k.htm
 

 

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

(Mark One):

 

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

 

For the fiscal year ended: December 31, 2019

 

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: 000-18464

 

EMCLAIRE FINANCIAL CORP

(Exact name of registrant as specified in its charter)

 

Pennsylvania

25-1606091

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

   

612 Main Street, Emlenton, PA

16373

(Address of principal executive office)

(Zip Code)

 

Registrant’s telephone number: (844) 767-2311

 

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

 

Common Stock, par value $1.25 per share

EMCF

NASDAQ Capital Market (NASDAQ)

(Title of Class)

(Trading Symbol)

(Name of exchange on which registered)

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ☐ NO ☒.

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ☐ NO ☒.

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 month (or for such shorter period that the registrant was required to submit and post such files). YES ☒ NO ☐.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company (do not check if a smaller reporting company).

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 accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES ☐  NO ☒.

As of June 30, 2019, the aggregate value of the 2,242,764 shares of Common Stock of the Registrant issued and outstanding on such date, which excludes 455,948 shares held by the directors and officers of the Registrant as a group, was approximately $70.1 million. This figure is based on the last sales price of $31.26 per share of the Registrant’s Common Stock on June 30, 2019. The number of outstanding shares of common stock as of March 20, 2020, was 2,708,712.

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Proxy Statement for the 2020 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K.

 

 

 

EMCLAIRE FINANCIAL CORP

 

TABLE OF CONTENTS

 

PART I

 

 

 

Item 1.

Business

K-3

 

 

 

Item 1A.

Risk Factors

K-18

 

 

 

Item 1B.

Unresolved Staff Comments

K-18

 

 

 

Item 2.

Properties

K-18

 

 

 

Item 3.

Legal Proceedings

K-18

 

 

 

Item 4.

Mine Safety Disclosures

K-18

 

 

 

PART II

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

K-19

 

 

 

Item 6.

Selected Financial Data

K-19

 

 

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

K-19

 

 

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

K-29

 

 

 

Item 8.

Financial Statements and Supplementary Data

K-29

 

 

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

K-29

 

 

 

Item 9A.

Controls and Procedures

K-29

 

 

 

Item 9B.

Other Information

K-29

 

 

 

PART III

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

K-30

 

 

 

Item 11.

Executive Compensation

K-30

 

 

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

K-30

 

 

 

Item 13.

Certain Relationships and Related Transactions, and Director Independence

K-30

 

 

 

Item 14.

Principal Accountant Fees and Services

K-30

 

 

 

PART IV

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

K-30

 

 

 

SIGNATURES AND CERTIFICATIONS

K-32

 

 

Discussions of certain matters in this Form 10-K and other related year end documents may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), and as such, may involve risks and uncertainties. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations, are generally identifiable by the use of words or phrases such as “believe”, “plan”, “expect”, “intend”, “anticipate”, “estimate”, “project”, “forecast”, “may increase”, “may fluctuate”, “may improve” and similar expressions of future or conditional verbs such as “will”, “should”, “would”, and “could”. These forward-looking statements relate to, among other things, expectations of the business environment in which Emclaire Financial Corp operates, projections of future performance, potential future credit experience, perceived opportunities in the market and statements regarding the Corporation’s mission and vision. The Corporation’s actual results, performance and achievements may differ materially from the results, performance, and achievements expressed or implied in such forward-looking statements due to a wide range of factors. These factors include, but are not limited to, changes in interest rates, general economic conditions, the local economy, the demand for the Corporation’s products and services, accounting principles or guidelines, legislative and regulatory changes, monetary and fiscal policies of the U.S. Government, U.S. Treasury, and Federal Reserve, real estate markets, competition in the financial services industry, attracting and retaining key personnel, performance of new employees, regulatory actions, changes in and utilization of new technologies and other risks detailed in the Corporation’s reports filed with the Securities and Exchange Commission (SEC) from time to time. These factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. The Corporation does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

 

 

PART I

 

Item 1. Business

 

General

 

Emclaire Financial Corp (the Corporation) is a Pennsylvania corporation and financial holding company that provides a full range of retail and commercial financial products and services to customers in western Pennsylvania and northwestern West Virginia through its wholly owned subsidiary bank, The Farmers National Bank of Emlenton (the Bank).

 

The Bank was organized in 1900 as a national banking association and is a financial intermediary whose principal business consists of attracting deposits from the general public and investing such funds in real estate loans secured by liens on residential and commercial properties, consumer loans, commercial business loans, marketable securities and interest-earning deposits. The Bank currently operates through a network of 20 retail branch offices in Venango, Allegheny, Butler, Clarion, Clearfield, Crawford, Elk, Jefferson and Mercer counties, Pennsylvania and Hancock county, West Virginia. The Corporation and the Bank are headquartered in Emlenton, Pennsylvania.

 

The Bank is subject to examination and comprehensive regulation by the Office of the Comptroller of the Currency (OCC), which is the Bank’s chartering authority, and the Federal Deposit Insurance Corporation (FDIC), which insures customer deposits held by the Bank to the full extent provided by law. The Bank is a member of the Federal Reserve Bank of Cleveland (FRB) and the Federal Home Loan Bank of Pittsburgh (FHLB). The Corporation is a registered bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (BHCA), and a financial holding company under the Gramm-Leach Bliley Act of 1999 (GLBA) and is subject to the regulation and examination by the FRB.

 

On October 1, 2018, the Corporation completed the acquisition of Community First Bancorp, Inc. (CFB) and its subsidiary, Community First Bank, in accordance with the terms of the Agreement and Plan of Merger, dated as of May 25, 2018, in exchange for 419,173 shares of common stock valued at $15.6 million and $2.4 million in cash.  The Corporation also issued 420,593 shares of preferred stock valued at $4.2 million in exchange for similar preferred stock of Community First Bank.  The acquisition strengthened the Corporation's presence in existing markets and increased the Corporation's consolidated total assets, loans and deposits.

 

At December 31, 2019, the Corporation had $915.3 million in total assets, $85.9 million in stockholders’ equity, $695.3 million in net loans and $787.1 million in total deposits.

 

 

Lending Activities

 

General. The principal lending activities of the Corporation are the origination of residential mortgage, commercial mortgage, commercial business and consumer loans. The majority of the Corporation’s loans are originated in and secured by property within the Corporation’s primary market area.

 

One-to-Four Family Mortgage Loans. The Corporation offers first mortgage loans secured by one-to-four family residences located mainly in the Corporation’s primary lending area. One-to-four family mortgage loans amounted to 41.8% of the total loan portfolio at December 31, 2019. Typically such residences are single-family owner occupied units. The Corporation is an approved, qualified lender for the Federal Home Loan Mortgage Corporation (FHLMC) and the FHLB. As a result, the Corporation may sell loans to and service loans for the FHLMC and FHLB in market conditions and circumstances where this is advantageous in managing interest rate risk.

 

Home Equity Loans. The Corporation originates home equity loans secured by single-family residences. Home equity loans amounted to 13.9% of the total loan portfolio at December 31, 2019. These loans may be either a single advance fixed-rate loan with a term of up to 20 years or a variable rate revolving line of credit. These loans are made only on owner-occupied single-family residences.

 

Commercial Business and Commercial Real Estate Loans. Commercial lending constitutes a significant portion of the Corporation’s lending activities. Commercial business and commercial real estate loans amounted to 42.2% of the total loan portfolio at December 31, 2019. Commercial real estate loans generally consist of loans granted for commercial purposes secured by commercial or other nonresidential real estate. Commercial loans consist of secured and unsecured loans for such items as capital assets, inventory, operations and other commercial purposes.

 

Consumer Loans. Consumer loans generally consist of fixed-rate term loans for automobile purchases, home improvements not secured by real estate, capital and other personal expenditures. The Corporation also offers unsecured revolving personal lines of credit and overdraft protection. Consumer loans amounted to 2.1% of the total loan portfolio at December 31, 2019.

 

Loans to One Borrower. National banks are subject to limits on the amount of credit that they can extend to one borrower. Under current law, loans to one borrower are limited to an amount equal to 15% of unimpaired capital and surplus on an unsecured basis, and an additional amount equal to 10% of unimpaired capital and surplus if the loan is secured by readily marketable collateral. At December 31, 2019, the Bank’s loans to one borrower limit based upon 15% of unimpaired capital was $12.1 million. The Bank may grant credit to borrowers in excess of the legal lending limit as part of the Legal Lending Limit Pilot Program approved by the OCC which allows the Bank to exceed its legal lending limit within certain parameters. At December 31, 2019, the Bank’s largest single lending relationship had an outstanding balance of $8.3 million.

 

Loan Portfolio. The following table sets forth the composition and percentage of the Corporation’s loans receivable in dollar amounts and in percentages of the portfolio as of December 31:

 

   

2019

 

2018

 

2017

 

2016

 

2015

   

Dollar

         

Dollar

         

Dollar

         

Dollar

         

Dollar

       

(Dollar amounts in thousands)

 

Amount

 

%

 

Amount

 

%

 

Amount

 

%

 

Amount

 

%

 

Amount

 

%

Mortgage loans on real estate:

                                                                               

Residential mortgages

  $ 293,170       41.8 %   $ 295,405       41.3 %   $ 221,823       38.1 %   $ 198,167       38.0 %   $ 139,305       32.0 %

Home equity loans and lines of credit

    97,541       13.9 %     103,752       14.5 %     99,940       17.1 %     91,359       17.5 %     87,410       20.1 %

Commercial real estate

    229,951       32.7 %     238,734       33.4 %     193,068       33.1 %     166,994       32.1 %     129,691       29.8 %
                                                                                 

Total real estate loans

    620,662       88.4 %     637,891       89.2 %     514,831       88.3 %     456,520       87.6 %     356,406       81.9 %
                                                                                 

Other loans:

                                                                               

Commercial business

    66,603       9.5 %     66,009       9.2 %     58,941       10.1 %     57,788       11.1 %     71,948       16.5 %

Consumer

    14,639       2.1 %     11,272       1.6 %     9,589       1.6 %     6,672       1.3 %     6,742       1.6 %
                                                                                 

Total other loans

    81,242       11.6 %     77,281       10.8 %     68,530       11.7 %     64,460       12.4 %     78,690       18.1 %
                                                                                 

Total loans receivable

    701,904       100.0 %     715,172       100.0 %     583,361       100.0 %     520,980       100.0 %     435,096       100.0 %

Less:

                                                                               

Allowance for loan losses

    6,556               6,508               6,127               5,545               5,205          
                                                                                 

Net loans receivable

  $ 695,348             $ 708,664             $ 577,234             $ 515,435             $ 429,891          

 

 

The following table sets forth the final maturity of loans in the Corporation’s portfolio as of December 31, 2019. Demand loans having no stated schedule of repayment and no stated maturity are reported as due within one year.

 

(Dollar amounts in thousands)

 

Due in one year or less

 

Due from one to five years

 

Due from five to ten years

 

Due after ten years

 

Total

Residential mortgages

  $ 441     $ 3,741     $ 30,232     $ 258,756     $ 293,170  

Home equity loans and lines of credit

    749       10,042       18,940       67,810       97,541  

Commercial real estate

    826       34,327       64,432       130,366       229,951  

Commercial business

    2,935       20,698       8,823       34,147       66,603  

Consumer

    230       7,815       4,592       2,002       14,639  
                                         
    $ 5,181     $ 76,623     $ 127,019     $ 493,081     $ 701,904  

 

The following table sets forth the dollar amount of the Corporation’s fixed and adjustable rate loans with maturities greater than one year as of December 31, 2019:

 

   

Fixed

 

Adjustable

(Dollar amounts in thousands)

 

rates

 

rates

Residential mortgages

  $ 280,567     $ 12,162  

Home equity loans and lines of credit

    83,684       13,108  

Commercial real estate

    46,862       182,263  

Commercial business

    20,526       43,142  

Consumer

    12,629       1,780  
                 
    $ 444,268     $ 252,455  

 

Contractual maturities of loans do not reflect the actual term of the Corporation’s loan portfolio. The average life of mortgage loans is substantially less than their contractual terms because of loan prepayments and enforcement of due-on-sale clauses, which give the Corporation the right to declare a loan immediately payable in the event, among other things, that the borrower sells the real property subject to the mortgage. Scheduled principal amortization also reduces the average life of the loan portfolio. The average life of mortgage loans tends to increase when current market mortgage rates substantially exceed rates on existing mortgages and conversely, decrease when rates on existing mortgages substantially exceed current market interest rates.

 

Delinquencies and Classified Assets

 

Delinquent Loans and Other Real Estate Acquired Through Foreclosure (OREO). Typically, a loan is considered past due and a late charge is assessed when the borrower has not made a payment within 15 days from the payment due date. When a borrower fails to make a required payment on a loan, the Corporation attempts to cure the deficiency by contacting the borrower. The initial contact with the borrower is made shortly after the 17th day following the due date for which a payment was not received. In most cases, delinquencies are cured promptly.

 

If the delinquency exceeds 60 days, the Corporation works with the borrower to set up a satisfactory repayment schedule. Typically, loans are considered nonaccruing upon reaching 90 days delinquent unless the credit is well secured and in the process of collection, although the Corporation may be receiving partial payments of interest and partial repayments of principal on such loans. When a loan is placed in nonaccrual status, previously accrued but unpaid interest is deducted from interest income. The Corporation institutes foreclosure action on secured loans only if all other remedies have been exhausted. If an action to foreclose is instituted and the loan is not reinstated or paid in full, the property is sold at a judicial or trustee’s sale at which the Corporation may be the buyer.

 

Real estate properties acquired through, or in lieu of, foreclosure are to be sold and are initially recorded at fair value at the date of foreclosure less costs to sell, thereby establishing a new cost basis. After foreclosure, management periodically performs valuations and the real estate is carried at the lower of carrying amount or fair value less the cost to sell the property. Changes in the valuation allowance are included in the loss on foreclosed real estate. The Corporation generally attempts to sell its OREO properties as soon as practical upon receipt of clear title.

 

As of December 31, 2019, the Corporation’s nonperforming assets were $3.2 million, or 0.34% of the Corporation’s total assets, compared to $3.7 million, or 0.42% of the Corporation’s total assets, at December 31, 2018. Nonperforming assets at December 31, 2019 included nonperforming loans and OREO of $2.9 million and $249,000, respectively. Included in nonaccrual loans at December 31, 2019 were five loans totaling $409,000 considered to be troubled debt restructurings (TDRs).

 

 

Classified Assets. Regulations applicable to insured institutions require the classification of problem assets as “substandard,” “doubtful,” or “loss” depending upon the existence of certain characteristics as discussed below. A category designated “special mention” must also be maintained for assets currently not requiring the above classifications but having potential weakness or risk characteristics that could result in future problems. An asset is classified as substandard if not adequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. A substandard asset is characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all the weaknesses inherent in those classified as substandard and these weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable or improbable. Assets classified as loss are considered uncollectible and of such little value that their continuance as assets is not warranted.

 

The Corporation’s classification of assets policy requires the establishment of valuation allowances for loan losses in an amount deemed prudent by management. Valuation allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities. When the Corporation classifies a problem asset as a loss, the portion of the asset deemed uncollectible is charged off immediately.

 

The Corporation regularly reviews the problem loans and other assets in its portfolio to determine whether any require classification in accordance with the Corporation’s policy and applicable regulations. As of December 31, 2019, the Corporation’s classified and criticized assets amounted to $17.0 million or 1.9% of total assets, with $5.6 million identified as special mention and $11.5 million classified as substandard.

 

Included in classified and criticized assets at December 31, 2019 are three large loan relationships exhibiting credit deterioration that may impact the ability of the borrowers to comply with their present loan repayment terms on a timely basis.  These relationships are located in western Pennsylvania throughout the greater Pittsburgh area.

 

The first relationship, with an outstanding balance of $3.1 million at December 31, 2019, consists of two commercial mortgages which primarily refinanced third-party debt obligations.  The debt obligations are secured by a hotel along with all related furniture, fixtures and equipment as well as two undeveloped parcels of land.  The hotel is operational; however, cash flow was adversely impacted by elevated operating expenses.  That said, results continue to evidence improvement in operating performance.  The loans are well supported by guarantors who have significant net worth positions and the ability to support the operations of the hotel, as needed.  At December 31, 2019, the loans were performing and classified as special mention. Ultimately, due to the estimated value of the collateral and the willingness and ability of the guarantors to support the loans, the Corporation does not currently expect to incur a loss on this loan.

 

The second relationship, with an outstanding balance of $2.1 million at December 31, 2019, consists of one commercial mortgage which primarily refinanced third-party debt obligations and is primarily secured with all buildings and improvements of a university campus.  The subject loan represents a portion of a participated credit facility led by a third-party financial institution.  A decline in student enrollment has resulted in a corresponding decline in financial performance of the university.  The university maintains satisfactory capital structure ratios and is undergoing efforts to increase enrollment and reduce operating expenditures. At December 31, 2019, the loan was performing and classified as special mention.  Ultimately, due to the estimated value of the university campus and ancillary collateral, the Corporation does not currently expect to incur a loss on this loan.

 

The third relationship, with an outstanding balance of $1.4 million at December 31, 2019, consists of one commercial mortgage which primarily refinanced third-party debt obligations and is primarily secured with all buildings and improvements of a technical college.  The subject loan represents a portion of a participated credit facility led by a third-party financial institution.  A decline in student enrollment has resulted in a corresponding decline in financial performance of the college.  That said, results continue to evidence improvement in operating performance.  At December 31, 2019, the loan was performing and classified as substandard.  Ultimately, due to the estimated value of the college campus and ancillary collateral, the Corporation does not currently expect to incur a loss on this loan.

 

 

 

 

The following table sets forth information regarding the Corporation’s nonperforming assets as of December 31:

 

(Dollar amounts in thousands)

 

2019

 

2018

 

2017

 

2016

 

2015

Nonperforming loans

  $ 2,907     $ 3,028     $ 3,693     $ 3,323     $ 3,069  
                                         

Total as a percentage of gross loans

    0.41 %     0.42 %     0.63 %     0.64 %     0.71 %
                                         

Repossessions

          13                    

Real estate acquired through foreclosure

    249       701       492       291       160  

Total as a percentage of total assets

    0.03 %     0.08 %     0.07 %     0.04 %     0.03 %
                                         

Total nonperforming assets

  $ 3,156     $ 3,742     $ 4,185     $ 3,614     $ 3,229  
                                         

Total nonperforming assets as a percentage of total assets

    0.34 %     0.42 %     0.56 %     0.52 %     0.54 %
                                         

Allowance for loan losses as a percentage of nonperforming loans

    225.52 %     214.93 %     165.91 %     166.87 %     169.60 %

 

Allowance for Loan Losses. Management establishes allowances for estimated losses on loans based upon its evaluation of the pertinent factors underlying the types and quality of loans; historical loss experience based on volume and types of loans; trend in portfolio volume and composition; level and trend of nonperforming assets; detailed analysis of individual loans for which full collectability may not be assured; determination of the existence and realizable value of the collateral and guarantees securing such loans and the current economic conditions affecting the collectability of loans in the portfolio. The Corporation analyzes its loan portfolio at least quarterly for valuation purposes and to determine the adequacy of its allowance for loan losses. Based upon the factors discussed above, management believes that the Corporation’s allowance for loan losses as of December 31, 2019 of $6.6 million was adequate to cover probable incurred losses in the portfolio at such time.

 

The following table sets forth an analysis of the allowance for losses on loans receivable for the years ended December 31: 

 

(Dollar amounts in thousands)

 

2019

 

2018

 

2017

 

2016

 

2015

Balance at beginning of period

  $ 6,508     $ 6,127     $ 5,545     $ 5,205     $ 5,224  
                                         

Provision for loan losses

    715       1,280       903       464       381  
                                         

Charge-offs:

                                       

Residential mortgages

    (227 )     (71 )     (40 )     (101 )     (79 )

Home equity loans and lines of credit

    (61 )     (155 )     (114 )     (118 )     (221 )

Commercial real estate

    (242 )     (484 )     (127 )     (18 )     (35 )
Commercial business     (250 )           (14 )     (11 )     (182 )

Consumer loans

    (133 )     (279 )     (71 )     (48 )     (50 )
      (913 )     (989 )     (366 )     (296 )     (567 )

Recoveries:

                                       

Residential mortgages

    40       3                    

Home equity loans and lines of credit

    6       14       23       3       30  

Commercial real estate

    134       48       8       158       88  

Commercial business

          1       2             31  

Consumer loans

    66       24       12       11       18  
      246       90       45       172       167  
                                         

Net charge-offs

    (667 )     (899 )     (321 )     (124 )     (400 )
                                         

Balance at end of period

  $ 6,556     $ 6,508     $ 6,127     $ 5,545     $ 5,205  
                                         

Ratio of net charge-offs to average loans outstanding

    0.09 %     0.14 %     0.06 %     0.03 %     0.10 %
                                         

Ratio of allowance to total loans at end of period

    0.93 %     0.91 %     1.05 %     1.06 %     1.20 %
                                         

 

 

The following table provides a breakdown of the allowance for loan losses by major loan category for the years ended December 31:

 

(Dollar amounts in thousands)

 

2019

 

2018

 

2017

 

2016

 

2015

Loan Categories:

  Dollar Amount   Percent of total loans   Dollar Amount   Percent of total loans   Dollar Amount  

Percent of total loans

  Dollar Amount  

Percent of total loans

  Dollar Amount  

Percent of total loans

Residential mortgages

  $ 2,309       41.8 %   $ 2,198       41.3 %   $ 2,090       38.1 %   $ 1,846       32.0 %   $ 1,429       27.8 %

Home equity loans and lines of credit

    626       13.9 %     648       14.5 %     646       17.1 %     633       20.1 %     586       23.2 %

Commercial real estate

    2,898       32.7 %     3,106       33.4 %     2,753       33.1 %     2,314       29.8 %     2,185       28.8 %

Commercial business

    636       9.5 %     500       9.2 %     585       10.1 %     700       16.5 %     960       18.2 %

Consumer loans

    87       2.1 %     56       1.6 %     53       1.6 %     52       1.6 %     45       2.0 %
                                                                                 
    $ 6,556       100.0 %   $ 6,508       100.0 %   $ 6,127       100.0 %   $ 5,545       100.0 %   $ 5,205       100.0 %
                                                                                 

 

Investment Activities

 

General. The Corporation maintains an investment portfolio of securities such as U.S. government agencies, mortgage-backed securities, collateralized mortgage obligations, municipal and equity securities.

 

Investment decisions are made within policy guidelines as established by the Board of Directors. This policy is aimed at maintaining a diversified investment portfolio, which complements the overall asset/liability and liquidity objectives of the Corporation, while limiting the related credit risk to an acceptable level.

 

The following table sets forth certain information regarding the fair value, weighted average yields and contractual maturities of the Corporation’s securities as of December 31, 2019:

 

(Dollar amounts in thousands)

 

Due in 1 year or less

 

Due from 1 to 3 years

 

Due from 3 to 5 years

 

Due from 5 to 10 years

 

Due after 10 years

 

No scheduled maturity

 

Total

U.S. government sponsored entities and agencies

  $     $ 5,063     $ 2,014     $     $     $     $ 7,077  

U.S. agency mortgage-backed securities: residential

                      2,821       38,254             41,075  

U.S. agency collateralized mortgage obligations: residential

                      3,221       29,616             32,837  

Corporate securities

                      9,153       2,169             11,322  

State and political subdivision

    265       849       2,196       4,695       19,791             27,796  

Equity securities

                                  19       19  
                                                         

Estimated fair value

  $ 265     $ 5,912     $ 4,210     $ 19,890     $ 89,830     $ 19     $ 120,126  
                                                         

Weighted average yield (1)

    2.43 %     1.67 %     2.73 %     3.74 %     2.73 %     0.00 %     2.84 %

(1) Taxable equivalent adjustments have been made in calculating yields on state and political subdivision securities.

 

 

The following table sets forth the fair value of the Corporation’s investment securities as of December 31:

 

(Dollar amounts in thousands)

 

2019

 

2018

 

2017

U.S. Treasury

  $     $ 4,445     $ 4,472  

U.S. government sponsored entities and agencies

    7,077       16,783       13,926  

U.S. agency mortgage-backed securities: residential

    41,075       27,176       20,758  

U.S. agency collateralized mortgage obligations: residential

    32,837       18,664       21,924  

Corporate securities

    27,796       22,732       9,030  

State and political subdivision

    11,322       7,918       29,240  

Equity securities

    19       7       1,817  
    $ 120,126     $ 97,725     $ 101,167  

 

For additional information regarding the Corporation’s investment portfolio see “Note 2 – Securities” to the consolidated financial statements on page F-14.

 

Sources of Funds

 

General. Deposits are the primary source of the Corporation’s funds for lending and investing activities. Secondary sources of funds are derived from loan repayments, investment maturities and borrowed funds. Loan repayments can be considered a relatively stable funding source, while deposit activity is greatly influenced by interest rates and general market conditions. The Corporation also has access to funds through other various sources. For additional information about the Corporation’s sources of funds, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity” in Item 7.

 

Deposits. The Corporation offers a wide variety of deposit account products to both consumer and commercial deposit customers, including time deposits, noninterest bearing and interest bearing demand deposit accounts, savings deposits and money market accounts.

 

Deposit products are promoted in periodic newspaper, radio and other forms of advertisements, along with notices provided in customer account statements. The Corporation’s marketing strategy is based on its reputation as a community bank that provides quality products and personalized customer service.

 

The Corporation sets interest rates on its interest bearing deposit products that are competitive with rates offered by other financial institutions in its market area. Management reviews interest rates on deposits weekly and considers a number of factors, including: (1) the Corporation’s internal cost of funds; (2) rates offered by competing financial institutions; (3) investing and lending opportunities; and (4) the Corporation’s liquidity position.

 

The following table summarizes the Corporation’s deposits as of December 31: 

 

(Dollar amounts in thousands)

 

2019

 

2018

   

Weighted

                 

Weighted

               

Type of accounts

 

average rate

 

Amount

 

Percent

 

average rate

 

Amount

 

Percent

Non-interest bearing deposits

        $ 148,842       18.9 %         $ 148,893       19.5 %

Interest bearing demand deposits

    0.76 %     420,515       53.4 %     0.52 %     391,054       51.4 %

Time deposits

    2.17 %     217,767       27.7 %     1.84 %     221,599       29.1 %

Total

    1.01 %   $ 787,124       100.0 %     0.80 %   $ 761,546       100.0 %

 

The following table sets forth maturities of the Corporation’s time deposits of $100,000 or more at December 31, 2019 by time remaining to maturity: 

 

(Dollar amounts in thousands)

 

Amount

 

Three months or less

  $ 10,082  

Over three months to six months

    15,230  

Over six months to twelve months

    14,805  

Over twelve months

    89,113  
    $ 129,230  

 

 

Borrowings. Borrowings may be used to compensate for reductions in deposit inflows or net deposit outflows, or to support lending and investment activities. These borrowings include FHLB advances, federal funds, repurchase agreements, advances from the Federal Reserve Discount Window and lines of credit at the Bank and the Corporation with other correspondent banks. The following table summarizes information with respect to borrowings at or for the years ending December 31: 

 

(Dollar amounts in thousands)

 

2019

 

2018

Ending balance

  $ 28,550     $ 45,350  

Average balance

    36,508       24,250  

Maximum balance

    60,050       57,675  

Average rate

    2.73 %     2.73 %

 

For additional information regarding the Corporation’s deposit base and borrowed funds, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Deposits and Borrowed Funds” in Item 7 and “Note 8 – Deposits” on page F-23 and “Note 9 – Borrowed Funds” on page F-24 to the consolidated financial statements.

 

Subsidiary Activity

 

The Corporation has one wholly owned subsidiary, the Bank. Emclaire Settlement Services, LLC, a former subsidiary of the Corporation ceased operations and was dissolved during 2019, provided real estate settlement services to the Bank and other customers. As of December 31, 2019, the Bank had no subsidiaries.

 

Personnel

 

At December 31, 2019, the Corporation had 162 full time equivalent employees, compared to 164 at December 31, 2018. There is no collective bargaining agreement between the Corporation and its employees, and the Corporation believes its relationship with its employees is satisfactory.

 

Competition

 

The Corporation competes for loans, deposits and customers with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions and other nonbank financial service providers.

 

Supervision and Regulation

 

General. Bank holding companies and banks are extensively regulated under both federal and state law. Set forth below is a summary description of certain provisions of certain laws that relate to the regulation of the Corporation and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.

 

The Corporation. The Corporation is a registered bank holding company and subject to regulation and examination by the FRB under the BHCA. The Corporation is required to file periodic reports with the FRB and such additional information as the FRB may require. The Bank Holding Company rating system emphasizes risk management and evaluation of the potential impact of non-depository entities on safety and soundness.

 

The FRB may require the Corporation to terminate an activity or terminate control of or liquidate or divest certain subsidiaries, affiliates or investments when the FRB believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The FRB also has the authority to regulate provisions of certain bank holding company debt, including the authority to impose interest rate ceilings and reserve requirements on such debt. Under certain circumstances, the Corporation must file written notice and obtain FRB approval prior to purchasing or redeeming its equity securities.

 

The Corporation is required to obtain prior FRB approval for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Prior FRB approval is also required for the merger or consolidation of the Corporation and another bank holding company.

 

The BHCA generally prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or furnishing services to its subsidiaries. However, subject to the prior FRB approval, a bank holding company may engage in any, or acquire shares of companies engaged in, activities that the FRB deems to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

 

 

The BHCA also authorizes bank holding companies to engage in securities, insurance and other activities that are financial in nature or incidental to a financial activity. In order to undertake these activities, a bank holding company must become a financial holding company by submitting to the appropriate FRB a declaration that the company elects to be a financial holding company and a certification that all of the depository institutions controlled by the company are well capitalized and well managed. The Corporation submitted a declaration of election to become a financial holding company with the FRB which became effective in March 2007. Federal legislation also directed federal regulators to require depository institution holding companies to serve as a source of strength for their depository institution subsidiaries.

 

Under FRB regulations, the Corporation is required to serve as a source of financial and managerial strength to the Bank and may not conduct operations in an unsafe or unsound manner. In addition, it is the FRB’s policy that a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of FRB regulations or both.

 

The Corporation is also a bank holding company within the meaning of the Pennsylvania Banking Code. As such, the Corporation and its subsidiaries are subject to examination by, and may be required to file reports with, the Pennsylvania Department of Banking and Securities.

 

The Corporation’s securities are registered with the SEC under the Exchange Act. As such, the Corporation is subject to the information, proxy solicitation, insider trading, corporate governance, and other requirements and restrictions of the Exchange Act. The public may obtain all forms and information filed with the SEC through its website http://www.sec.gov.

 

In December 2013, federal regulators adopted final rules to implement the provisions of the Dodd Frank Act commonly referred to as the Volcker Rule and established July 21, 2015 as the end of the conformance period. The regulations contain prohibitions and restrictions on the ability of financial institutions, holding companies and their affiliates to engage in proprietary trading and to hold certain interests in, or to have certain relationships with, various types of investment funds, including hedge funds and private equity funds. Recently promulgated Federal regulations exclude from the Volcker Rule restrictions community banks with $10 billion or less in total consolidated assets and total trading assets and liabilities of 5% or less of total consolidated assets.  The Corporation qualifies for the exclusion from the Volcker Rule restrictions.

 

The Bank. As a national banking association, the Bank is subject to primary supervision, examination and regulation by the OCC. The Bank is also subject to regulations of the FDIC as administrator of the Deposit Insurance Fund (DIF) and the FRB. If, as a result of an examination of the Bank, the OCC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of the Bank’s operations are unsatisfactory or that the Bank is violating or has violated any law or regulation, various remedies are available to the OCC. Such remedies include the power to enjoin “unsafe or unsound practices,” to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the Bank’s growth, to assess civil monetary penalties, and to remove officers and directors. The FDIC has similar enforcement authority, in addition to its authority to terminate the Bank’s deposit insurance in the absence of action by the OCC and upon a finding that the Bank is operating in an unsafe or unsound condition, is engaging in unsafe or unsound activities, or that the Bank’s conduct poses a risk to the deposit insurance fund or may prejudice the interest of its depositors.

 

A national bank may have a financial subsidiary engaged in any activity authorized for national banks directly or certain permissible activities. Generally, a financial subsidiary is permitted to engage in activities that are “financial in nature” or incidental thereto, even though they are not permissible for the national bank itself. The definition of “financial in nature” includes, among other items, underwriting, dealing in or making a market in securities, including, for example, distributing shares of mutual funds. The subsidiary may not, however, engage as principal in underwriting insurance, issue annuities or engage in real estate development or investment or merchant banking.

 

The Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 established a comprehensive framework to modernize and reform the oversight of public company auditing, improve the quality and transparency of financial reporting by those companies and strengthen the independence of auditors. Among other things, the legislation (i) created a public company accounting oversight board that is empowered to set auditing, quality control and ethics standards, to inspect registered public accounting firms, to conduct investigations and to take disciplinary actions, subject to SEC oversight and review; (ii) strengthened auditor independence from corporate management by limiting the scope of consulting services that auditors can offer their public company audit clients; (iii) heightened the responsibility of public company directors and senior managers for the quality of the financial reporting and disclosure made by their companies; (iv) adopted a number of provisions to deter wrongdoing by corporate management; (v) imposed a number of new corporate disclosure requirements; (vi) adopted provisions which generally seek to limit and expose to public view possible conflicts of interest affecting securities analysis; and (vii) imposed a range of new criminal penalties for fraud and other wrongful acts and extended the period during which certain types of lawsuits can be brought against a company or its insiders.

 

 

2010 Regulatory Reform. On July 21, 2010, the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 was signed into law. The goals of the Dodd Frank Act included restoring public confidence in the financial system following the financial crisis, preventing another financial crisis and permitting regulators to identify shortfalls in the system before another financial crisis can occur. The Dodd Frank Act is also intended to promote a fundamental restructuring of federal banking regulation by taking a systemic view of regulation rather than focusing on regulation of individual financial institutions.

 

Many of the provisions in the Dodd Frank Act require that regulatory agencies draft implementing regulations. Implementation of the Dodd Frank Act has had and will continue to have a broad impact on the financial services industry by introducing significant regulatory and compliance changes including, among other things: (i) changing the assessment base for federal deposit insurance from the amount of insured deposits to average consolidated total assets less average tangible equity, eliminating the ceiling and increasing the size of the floor of the DIF and offsetting the impact of the increase in the minimum floor on institutions with less than $10 billion in assets; (ii) making permanent the $250,000 limit for federal deposit insurance and increasing the cash limit of Securities Investor Protection Corporation protection to $250,000; (iii) eliminating the requirement that the FDIC pay dividends from the DIF when the reserve ratio is between 1.35% and 1.50%, but continuing the FDIC’s authority to declare dividends when the reserve ratio at the end of a calendar year is at least 1.50%; however, the FDIC is granted sole discretion in determining whether to suspend or limit the declaration or payment of dividends; (iv) repealing the federal prohibition on payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts; (v) implementing certain corporate governance revisions that apply to all public companies, including regulations that require publicly traded companies to give shareholders a non-binding advisory vote to approve executive compensation, commonly referred to as a “say-on-pay” vote and an advisory role on so-called “golden parachute” payments in connection with approvals of mergers and acquisitions; new director independence requirements and considerations to be taken into account by compensation committees and their advisers relating to executive compensation; additional executive compensation disclosures; and a requirement that companies adopt a policy providing for the recovery of executive compensation in the event of a restatement of its financial statements, commonly referred to as a “clawback” policy; (vi) centralizing responsibility for consumer financial protection by creating a new independent federal agency, the Consumer Financial Protection Bureau (CFPB) responsible for implementing federal consumer protection laws to be applicable to all depository institutions; (vii) imposing new requirements for mortgage lending, including new minimum underwriting standards, limitations on prepayment penalties and imposition of new mandated disclosures to mortgage borrowers; (viii) imposing new limits on affiliate transactions and causing derivative transactions to be subject to lending limits and other restrictions including adoption of the “Volcker Rule” regulating transactions in derivative securities; (ix) limiting debit card interchange fees that financial institutions with $10 billion or more in assets are permitted to charge their customers; and (x) implementing regulations to incentivize and protect individuals, commonly referred to as whistleblowers to report violations of federal securities laws.

 

Many aspects of the Dodd Frank Act continue to be subject to rulemaking and will take effect over several additional years, making it difficult to anticipate the overall financial impact on us or across the industry. The changes resulting from the Dodd Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. The legislation enacted in 2018 and summarized below may reduce some of the burdens associated with the implementation of the Dodd Frank Act, but the actual impact is impossible to predict with any certainty.

 

2018 Regulatory Reform. In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the Act), was enacted to modify or remove certain financial reform rules and regulations, including some of those implemented under the Dodd Frank Act. While the Act maintains most of the regulatory structure established by the Dodd Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and for large banks with assets of more than $50 billion. Many of these changes could result in meaningful regulatory relief for community banks such as the Bank.

 

The Act, among other matters, expands the definition of qualified mortgages which may be held by a financial institution and simplifies the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “Community Bank Leverage Ratio” of between 8 and 10 percent to replace the leverage and risk-based regulatory capital ratios. The Act also expands the category of holding companies that may rely on the “Small Bank Holding Company and Savings and Loan Holding Company Policy Statement” by raising the maximum amount of assets a qualifying holding company may have from $1 billion to $3 billion. This expansion also excludes such holding companies from the minimum capital requirements of the Dodd Frank Act. In addition, the Act includes regulatory relief for community banks regarding regulatory examination cycles, call reports, the Volcker Rule (proprietary trading prohibitions), mortgage disclosures and risk weights for certain high-risk commercial real estate loans.

 

It is difficult at this time to predict when or how any new standards under the Act will ultimately be applied to us or what specific impact the Act and the implementing rules and regulations will have on community banks.

 

 

Anti-Money Laundering. All financial institutions, including national banks, are subject to federal laws that are designed to prevent the use of the U.S. financial system to fund terrorist activities. Financial institutions operating in the United States must develop anti-money laundering compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such compliance programs are intended to supplement compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control Regulations. The Bank has established policies and procedures to ensure compliance with these provisions.

 

Privacy. Federal banking rules limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. Pursuant to these rules, financial institutions must provide (i) initial notices to customers about their privacy policies, describing conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates; (ii) annual notices of their privacy policies to current customers and (iii) a reasonable method for customers to “opt out” of disclosures to nonaffiliated third parties. These privacy provisions affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. The Corporation’s privacy policies have been implemented in accordance with the law.

 

Dividends and Other Transfers of Funds. Dividends from the Bank constitute the principal source of income to the Corporation. The Corporation is a legal entity separate and distinct from the Bank. The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends to the Corporation. In addition, the Bank’s regulators have the authority to prohibit the Bank from paying dividends, depending upon the Bank’s financial condition, if such payment is deemed to constitute an unsafe or unsound practice.

 

Limitations on Transactions with Affiliates. Transactions between national banks and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a national bank includes any company or entity which controls the national bank or that is controlled by a company that controls the national bank. In a holding company context, the holding company of a national bank (such as the Corporation) and any companies which are controlled by such holding company are affiliates of the national bank. Generally, Section 23A limits the extent to which the national bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such bank’s capital stock and surplus, and contains an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus. Section 23B applies to “covered transactions” as well as certain other transactions and requires that all transactions be on terms substantially the same, or at least as favorable, to the national bank as those provided to a non-affiliate. The term “covered transaction” includes the making of loans to, purchase of assets from and issuance of a guarantee to an affiliate and similar transactions. Section 23B transactions also include the provision of services and the sale of assets by a national bank to an affiliate.

 

In addition, Sections 22(g) and (h) of the Federal Reserve Act place restrictions on loans to executive officers, directors and principal shareholders of the national bank and its affiliates. Under Section 22(h), loans to a director, an executive officer and to a greater than 10% shareholder of a national bank, and certain affiliated interests of either, may not exceed, together with all other outstanding loans to such person and affiliated interests, the national bank’s loans to one borrower limit (generally equal to 15% of the bank’s unimpaired capital and surplus). Section 22(h) also requires that loans to directors, executive officers and principal shareholders be made on terms substantially the same as offered in comparable transactions to other persons unless the loans are made pursuant to a benefit or compensation program that (i) is widely available to employees of the bank and (ii) does not give preference to any director, executive officer or principal shareholder, or certain affiliated interests of either, over other employees of the national bank. Section 22(h) also requires prior board approval for certain loans. In addition, the aggregate amount of extensions of credit by a national bank to all insiders cannot exceed the bank’s unimpaired capital and surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers. The Bank currently is subject to Sections 22(g) and (h) of the Federal Reserve Act and at December 31, 2019, was in compliance with the above restrictions.

 

Loans to One Borrower Limitations. With certain limited exceptions, the maximum amount that a national bank may lend to any borrower (including certain related entities of the borrower) at one time may not exceed 15% of the unimpaired capital and surplus of the institution, plus an additional 10% of unimpaired capital and surplus for loans fully secured by readily marketable collateral. At December 31, 2019, the Bank’s loans-to-one-borrower limit was $12.1 million based upon the 15% of unimpaired capital and surplus measurement. The Bank may grant credit to borrowers in excess of the legal lending limit as part of the Legal Lending Limit Pilot Program approved by the OCC which allows the Bank to exceed its legal lending limit within certain parameters. At December 31, 2019, the Bank’s largest single lending relationship had an outstanding balance of $8.3 million.

 

Capital Standards. The Bank is required to comply with applicable capital adequacy standards established by the federal banking agencies. Beginning on January 1, 2015, the Bank became subject to a new comprehensive capital framework for U.S. banking organizations. In July 2013, the Federal Reserve Board, FDIC and OCC adopted a final rule that implements the Basel III changes to the international regulatory capital framework. The Basel III rules include requirements contemplated by the Dodd Frank Act as well as certain standards initially adopted by the Basel Committee on Banking Supervision in December 2010.

 

 

Effective January 1, 2020, qualifying community banking organizations may elect to comply with a greater than 9% community bank leverage ratio (the "CBLR") requirement in lieu of the currently applicable requirements for calculating and reporting risk-based capital ratios.  The CBLR is equal to Tier 1 capital divided by average total consolidated assets.  In order to qualify for the CBLR election, a community bank must (i) have a leverage capital ratio greater than 9 percent, (ii) have less that $10 billion in average total consolidated assets, (iii) not exceed certain levels of off-balance sheet exposure and trading assets plus trading liabilities and (iv) not be an advanced approaches banking organization.  A community bank that meets the above qualifications and elects to utilize the CBLR is considered to have satisfied the risk-based and leverage capital requirements in the generally applicable capital rules and is also considered to be "well capitalized" under the prompt corrective action rules.

 

Unless a community bank qualifies for, and elects to comply with, the CBLR beginning on January 1, 2020, national banks are required to maintain the Basel III minimum levels of regulatory capital described below. The Basel III rules include risk-based and leverage capital ratio requirements that refine the definition of what constitutes “capital” for purposes of calculating those ratios. The minimum capital level requirements are (i) a common equity Tier 1 risk-based capital ratio of 4.5%; (ii) a Tier 1 risk-based capital ratio of 6% (increased from 4%); (iii) a total risk-based capital ratio of 8% (unchanged from previous rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. Common equity Tier 1 capital consists of retained earnings and common stock instruments, subject to certain adjustments.

 

The Basel III rules also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum risk-based capital requirements. The conversation buffer was fully phased in as of January 1, 2019 and results in the following minimum ratios: (i) a common equity Tier 1 risk-based capital ratio of 7.0%, (ii) a Tier 1 risk-based capital ratio of 8.5% and (iii) a total risk-based capital ratio of 10.5%. An institution is subject to limitations on certain activities including payment of dividends, share repurchases and discretionary bonuses to executive officers if its capital level is below the buffer amount.

 

The Basel III rules also revise the prompt corrective action framework, which is designed to place restrictions on insured depository institutions if their capital levels do not meet certain thresholds. These revisions were effective January 1, 2015. The prompt corrective action rules were modified to include a common equity Tier 1 capital component and to increase certain other capital requirements for the various thresholds. Under the proposed prompt corrective action rules, insured depository institutions are required to meet the following capital levels in order to qualify as “well capitalized”: (i) a new common equity Tier 1 risk-based capital ratio of 6.5%; (ii) a Tier 1 risk-based capital ratio of 8% (increased from 6%); (iii) a total risk-based capital ratio of 10% (unchanged from previous rules); and (iv) a Tier 1 leverage ratio of 5% (unchanged from previous rules).

 

The Basel III rules set forth certain changes in the methods of calculating risk-weighted assets, which in turn affect the calculation of risk based ratios. Under the Basel III rules, higher or more sensitive risk weights are assigned to various categories of assets including certain credit facilities that finance the acquisition, development or construction of real property, certain exposures of credits that are 90 days past due or on nonaccrual, foreign exposures and certain corporate exposures. In addition, Basel III rules include (i) alternate standards of credit worthiness consistent with the Dodd Frank Act; (ii) greater recognition of collateral guarantees and (iii) revised capital treatment for derivatives and repo-style transactions.

 

In addition, the final rule includes certain exemptions to address concerns about the regulatory burden on community banks. Banking organizations with less than $15 billion in consolidated assets as of December 31, 2009 are permitted to include in Tier 1 capital trust preferred securities and cumulative perpetual preferred stock issued and included in Tier 1 capital prior to May 19, 2010 on a permanent basis without any phase out. Community banks were required to make this election by their March 31, 2015 quarterly filings with the appropriate federal regulator to opt-out of the requirement to include most accumulated other comprehensive income (AOCI) components in the calculation of Common equity Tier 1 capital and in effect retain the AOCI treatment under the current capital rules. The Bank made in its March 31, 2015 quarterly filing a one-time permanent election to continue to exclude accumulated other comprehensive income from capital. If it would not have made this election, unrealized gains and losses would have been included in the calculation of its regulatory capital.

 

The Basel III rules generally became effective beginning January 1, 2015; however, certain calculations under the Basel III rules have phase-in periods. In 2015, the Board of Governors of the Federal Reserve System amended its Small Bank Holding Company Policy Statement by increasing the policy’s consolidated assets threshold from $500 million to $1 billion and the 2018 legislation summarized above increased that asset threshold to $3 billion. The primary benefit of being deemed a "small bank holding company" is the exemption from the requirement to maintain consolidated regulatory capital ratios; instead, regulatory capital ratios only apply at the subsidiary bank level.

 

 

The following table sets forth certain information concerning regulatory capital ratios of the Bank as of the dates presented. The capital adequacy ratios disclosed below are exclusive of the capital conservation buffer.

 

(Dollar amounts in thousands)

 

December 31, 2019

   

December 31, 2018

 
   

Amount

   

Ratio

   

Amount

   

Ratio

 

Total capital to risk-weighted assets:

                               

Actual

  $ 80,418       13.74 %   $ 76,344       12.93 %

For capital adequacy purposes

    46,836       8.00 %     47,252       8.00 %

To be well capitalized

    58,544       10.00 %     59,065       10.00 %

Tier 1 capital to risk-weighted assets:

                               

Actual

  $ 73,862       12.62 %   $ 69,836       11.82 %

For capital adequacy purposes

    35,127       6.00 %     35,439       6.00 %

To be well capitalized

    46,836       8.00 %     47,252       8.00 %

Common Equity Tier 1 capital to risk-weighted assets:

                               

Actual

  $ 73,862       12.62 %   $ 69,836       11.82 %

For capital adequacy purposes

    26,345       4.50 %     26,579       4.50 %

To be well capitalized

    38,054       6.50 %     38,393       6.50 %

Tier 1 capital to average assets:

                               

Actual

  $ 73,862       8.17 %   $ 69,836       7.95 %

For capital adequacy purposes

    36,146       4.00 %     35,126       4.00 %

To be well capitalized

    45,182       5.00 %     43,908       5.00 %

 

Prompt Corrective Action and Other Enforcement Mechanisms. Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve the problems of insured depository institutions, including but not limited to those institutions that fall below one or more prescribed minimum capital ratios. Each federal banking agency has promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At December 31, 2019, the Bank exceeded the required ratios for classification as “well capitalized.”

 

An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat a significantly undercapitalized institution as critically undercapitalized.

 

In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation, or any condition imposed in writing by the agency or any written agreement with the agency. Finally, pursuant to an interagency agreement, the FDIC can examine any institution that has a substandard regulatory examination score or is considered undercapitalized – without the permission of the institution’s primary regulator.

 

Safety and Soundness Standards. The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: (i) internal controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) asset growth, (v) earnings, and (vi) compensation, fees and benefits. In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and earnings standards. These guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. Under these standards, an insured depository institution should: (i) conduct periodic asset quality reviews to identify problem assets, (ii) estimate the inherent losses in problem assets and establish reserves that are sufficient to absorb estimated losses, (iii) compare problem asset totals to capital, (iv) take appropriate corrective action to resolve problem assets, (v) consider the size and potential risks of material asset concentrations, and (vi) provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk. These guidelines also set forth standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves.

 

 

Insurance of Accounts. Deposit accounts are currently insured by the DIF generally up to a maximum of $250,000 per separately insured depositor. As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, insured institutions. It also may prohibit any insured institution from engaging in any activity determined by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against insured institutions.

 

The Dodd Frank Act raised the minimum reserve ratio of the DIF from 1.15% to 1.35% and required the FDIC to offset the effect of this increase on insured institutions with assets of less than $10 billion (small institutions). In March 2016, the FDIC adopted a rule to accomplish this by imposing a surcharge on larger institutions commencing when the reserve ratio reaches 1.15% and ending when it reaches 1.35%. The reserve ratio reached 1.15% effective as of June 30, 2016 and exceeded 1.35% effective as of September 30, 2018. Small institutions receive credits for the portion of their regular assessments that contributed to growth in the reserve ratio between 1.15% and 1.35%. The credits apply to reduce regular assessments by 2 basis points for quarters when the reserve ratio is at least 1.38%.

 

Effective July 1, 2016, the FDIC adopted changes that eliminated its risk-based premium system. Under the new premium system, the FDIC assesses deposit insurance premiums on the assessment base of a depository institution, which is its average total assets reduced by the amount of its average tangible equity. For a small institution (one with assets of less than $10 billion) that has been federally insured for at least five years, effective July 1, 2016, the initial base assessment rate ranges from 3 to 30 basis points, based on the institution’s CAMELS composite and component ratings and certain financial ratios; its leverage ratio; its ratio of net income before taxes to total assets; its ratio of nonperforming loans and leases to gross assets; its ratio of other real estate owned to gross assets; its brokered deposits ratio (excluding reciprocal deposits if the institution is well capitalized and has a CAMELS composite rating of 1 or 2); its one year asset growth ratio (which penalizes growth adjusted for mergers in excess of 10%); and its loan mix index (which penalizes higher risk loans based on historical industry charge off rates).  The initial base assessment rate is subject to downward adjustment (not below 1.5%) based on the ratio of unsecured debt the institution has issued to its assessment base, and to upward adjustment (which can cause the rate to exceed 30 basis points) based on its holdings of unsecured debt issued by other insured institutions. Institutions with assets of $10 billion or more are assessed using a scorecard method.

 

In addition, all FDIC insured institutions were required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. The first Financing Corporation bonds matured in 2019.

 

Under the Federal Deposit Insurance Act, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule order or condition imposed by the FDIC.

 

Interstate Banking and Branching. Banks have the ability, subject to certain state restrictions, to acquire, by acquisition or merger, branches outside its home state. In addition, federal legislation permits a bank headquartered in Pennsylvania to enter another state through de novo branching (as compared to an acquisition) if under the state law in the state which the proposed branch is to be located a state-chartered institution would be permitted to establish the branch. Interstate branches are subject to certain laws of the states in which they are located. Competition may increase further as banks branch across state lines and enter new markets.

 

Consumer Protection Laws and Regulations. The bank regulatory agencies are focusing greater attention on compliance with consumer protection laws and their implementing regulations. Examination and enforcement have become more intense in nature, and insured institutions have been advised to carefully monitor compliance with such laws and regulations. The Bank is subject to many federal consumer protection statutes and regulations, some of which are discussed below.

 

The Community Reinvestment Act (CRA) is intended to encourage insured depository institutions, while operating safely and soundly, to help meet the credit needs of their communities. The CRA specifically directs the federal regulatory agencies, in examining insured depository institutions, to assess a bank’s record of helping meet the credit needs of its entire community, including low- and moderate-income neighborhoods, in a manner consistent with safe and sound banking practices. CRA regulations (i) establish the definition of “Intermediate Small Bank” as an institution with total assets of $250 million to $1 billion, without regard to any holding company; and (ii) take into account abusive lending practices by a bank or its affiliates in determining a bank’s CRA rating. The CRA further requires the agencies to take a financial institution’s record of meeting its community credit needs into account when evaluating applications for, among other things, domestic branches, mergers or acquisitions, or holding company formations. The agencies use the CRA assessment factors in order to provide a rating to the financial institution. The ratings range from a high of “outstanding” to a low of “substantial noncompliance.” In its last examination for CRA compliance, as of January 15, 2019, the Bank was rated “satisfactory.”

 

 

The Fair Credit Reporting Act (FCRA), as amended by the Fair and Accurate Credit Transactions Act of 2003 (FACTA), requires financial firms to help deter identity theft, including developing appropriate fraud response programs, and give consumers more control of their credit data. It also reauthorizes a federal ban on state laws that interfere with corporate credit granting and marketing practices. In connection with the FACTA, financial institution regulatory agencies proposed rules that would prohibit an institution from using certain information about a consumer it received from an affiliate to make a solicitation to the consumer, unless the consumer has been notified and given a chance to opt out of such solicitations. A consumer’s election to opt out would be applicable for at least five years.

 

The Federal Trade Commission (FTC), the federal bank regulatory agencies and the National Credit Union Administration (NCUA) have issued regulations (the Red Flag Rules) requiring financial institutions and creditors to develop and implement written identity theft prevention programs as part of the FACTA. The programs must provide for the identification, detection and response to patterns, practices or specific activities – known as red flags – that could indicate identity theft. These red flags may include unusual account activity, fraud alerts on a consumer report or attempted use of suspicious account application documents. The program must also describe appropriate responses that would prevent and mitigate the crime and detail a plan to update the program. The program must be managed by the Board of Directors or senior employees of the institution or creditor, include appropriate staff training and provide oversight of any service providers.

 

The Check Clearing for the 21st Century Act (Check 21) facilitates check truncation and electronic check exchange by authorizing a new negotiable instrument called a “substitute check,” which is the legal equivalent of an original check. Check 21 does not require banks to create substitute checks or accept checks electronically; however, it does require banks to accept a legally equivalent substitute check in place of an original.

 

The Equal Credit Opportunity Act (ECOA) generally prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act.

 

The Truth in Lending Act (TILA) is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As a result of the TILA, all creditors must use the same credit terminology to express rates and payments, including the annual percentage rate, the finance charge, the amount financed, the total of payments and the payment schedule, among other things.

 

The Fair Housing Act (FHA) regulates many practices, including making it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap or familial status. A number of lending practices have been found by the courts to be, or may be considered, illegal under the FHA, including some that are not specifically mentioned in the FHA itself.

 

The Home Mortgage Disclosure Act (HMDA) grew out of public concern over credit shortages in certain urban neighborhoods and provides public information that will help show whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. The HMDA also includes a “fair lending” aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes.

 

The term “predatory lending,” much like the terms “safety and soundness” and “unfair and deceptive practices,” is far-reaching and covers a potentially broad range of behavior. As such, it does not lend itself to a concise or a comprehensive definition. Generally speaking, predatory lending involves at least one, and perhaps all three, of the following elements (i) making unaffordable loans based on the assets of the borrower rather than on the borrower’s ability to repay an obligation (“asset-based lending”); (ii) inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced (“loan flipping”); and (iii) engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrower.

 

FRB regulations aimed at curbing such lending significantly widened the pool of high-cost home-secured loans covered by the Home Ownership and Equity Protection Act of 1994, a federal law that requires extra disclosures and consumer protections to borrowers. Lenders that violate the rules face cancellation of loans and penalties equal to the finance charges paid.

 

OCC guidelines require national banks and their operating subsidiaries to comply with certain standards when making or purchasing loans to avoid predatory or abusive residential mortgage lending practices. Failure to comply with the guidelines could be deemed an unsafe and unsound or unfair or deceptive practice, subjecting the bank to supervisory enforcement actions.

 

 

Finally, the Real Estate Settlement Procedures Act (RESPA) requires lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements. Also, RESPA prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts. Penalties under the above laws may include fines, reimbursements and other penalties. Due to heightened regulatory concern related to compliance with the CRA, FACTA, TILA, FHA, ECOA, HMDA and RESPA generally, the Bank may incur additional compliance costs or be required to expend additional funds for investments in its local community.

 

Federal Home Loan Bank System. The Bank is a member of the FHLB. Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB makes available loans or advances to its members in compliance with the policies and procedures established by the Board of Directors of the individual FHLB. As an FHLB member, the Bank is required to own a certain amount of capital stock in the FHLB. At December 31, 2019, the Bank was in compliance with the stock requirements.

 

Federal Reserve System. The FRB requires all depository institutions to maintain noninterest bearing reserves at specified levels against their transaction accounts (primarily checking) and non-personal time deposits. At December 31, 2019, the Bank was in compliance with these requirements.

 

Item 1A. Risk Factors

 

Not required as the Corporation is a smaller reporting company.

 

Item 1B. Unresolved Staff Comments

 

None.

 

Item 2. Properties

 

The Corporation owns no real property but utilizes the main office of the Bank, which is owned by the Bank. The Corporation’s and the Bank’s executive offices are located at 612 Main Street, Emlenton, Pennsylvania. The Corporation pays no rent or other form of consideration for the use of this facility.

 

The Bank owns and leases numerous other premises for use in conducting business activities. The Bank considers these facilities owned or occupied under lease to be adequate. For additional information regarding the Bank’s properties, see “Note 5 - Premises and Equipment” to the consolidated financial statements on page F-21.

 

Item 3. Legal Proceedings

 

Neither the Bank nor the Corporation is involved in any material legal proceedings. The Bank, from time to time, is party to litigation that arises in the ordinary course of business, such as claims to enforce liens, claims involving the origination and servicing of loans, and other issues related to the business of the Bank. In the opinion of management, the resolution of any such issues would not have a material adverse impact on the financial position, results of operation, or liquidity of the Bank or the Corporation.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

 

PART II

 

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market, Holder and Dividend Information

 

Emclaire Financial Corp common stock is traded on NASDAQ Capital Market (NASDAQ) under the symbol “EMCF”. The listed market makers for the Corporation’s common stock include:

 

Boenning and Scattergood, Inc.

Janney Montgomery Scott LLC

Raymond James & Associates, Inc.

4 Tower Bridge

1717 Arch Street

550 West Washington Boulevard

200 Barr Harbor Drive, Suite 300

Philadelphia, PA  19103

Suite 1050

West Conshohocken, PA  19428-2979

Telephone:  (215) 665-6000

Chicago, IL  60661

Telephone:  (800) 883-1212

 

Telephone:  (312) 869-3800

 

The Corporation has traditionally paid regular quarterly cash dividends. Future dividends will be determined by the Board of Directors after giving consideration to the Corporation’s financial condition, results of operations, tax status, industry standards, economic conditions, regulatory requirements and other factors.

 

The following table sets forth the high and low sale and quarter-end closing market prices of our common stock for the last two years as reported by the Nasdaq Capital Market as well as cash dividends paid for the quarterly periods presented.

 

   

Market Price

 

Cash

   

High

 

Low

 

Close

 

Dividend

2019:

                               

Fourth quarter

  $ 34.00     $ 29.92     $ 32.53     $ 0.29  

Third quarter

    37.00       30.42       32.90       0.29  

Second quarter

    34.50       29.83       34.50       0.29  

First quarter

    32.35       29.34       30.80       0.29  
                                 

2018:

                               

Fourth quarter

  $ 36.70     $ 29.90     $ 30.34     $ 0.28  

Third quarter

    38.60       34.07       37.30       0.28  

Second quarter

    35.06       31.05       34.30       0.28  

First quarter

    33.60       29.72       33.41       0.28  

 

As of March 2, 2020, there were approximately 728 stockholders of record and 2,708,712 shares of common stock entitled to vote, receive dividends and considered outstanding for financial reporting purposes. The number of stockholders of record does not include the number of persons or entities who hold their stock in nominee or “street” name.

 

Common stockholders may have dividends reinvested to purchase additional shares through the Corporation’s dividend reinvestment plan. Participants may also make optional cash purchases of common stock through this plan. To obtain a plan document and authorization card to participate in the plan, please call 888-509-4619.

 

Purchases of Equity Securities

 

The Corporation did not repurchase any of its equity securities in the year ended December 31, 2019.

 

Item 6. Selected Financial Data

 

Not required as the Corporation is a smaller reporting company.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis represents a review of the Corporation’s consolidated financial condition and results of operations for the years ended December 31, 2019 and 2018. This review should be read in conjunction with the consolidated financial statements beginning on page F-3.

 

 

Overview

 

The Corporation reported consolidated net income available to common stockholders of $7.8 million, or $2.86 per diluted common share, for 2019, compared to $4.1 million, or $1.72 per diluted common share, for 2018. Net income available to common stockholders was impacted by the following:

 

 

Net interest income increased $2.5 million, or 9.7%, to $28.1 million for the year ended December 31, 2019 from $25.6 million for 2018. This increase primarily related to an increase in interest income of $5.2 million, or 16.7%, partially offset by an increase in interest expense of $2.7 million, or 50.0%. Driving the increase in interest income was a $78.9 million increase in the average balance of loans. The increase in interest expense was driven by increases in the Corporation's average balance of interest-bearing deposits and borrowed funds of $61.1 million and $12.3 million, respectively. The increases in the Corporation's interest-earning assets and interest-bearing liabilities includes the impact of the Community First Bancorp, Inc. (CFB) acquisition in October 2018, which added $111.6 million in loans and $106.1 million in deposits at the time of the acquisition.

 

 

Noninterest income increased $183,000, or 4.3%, to $4.4 million for the year ended December 31, 2019 from $4.2 million in 2018 due to increases in earnings on bank-owned life insurance, fees and service charges, gains on the sale of loans and gains on the sale of securities of $165,000, $126,000, $95,000 and $87,000, respectively, partially offset by a decrease in other noninterest income of $290,000.  This decrease in other noninterest income was due to a $540,000 gain recorded in the fourth quarter of 2018 related to the retirement of 18,000 shares of CFB stock the Corporation owned at the time of the acquisition.

 

 

 

Noninterest expense decreased $1.5 million, or 6.5%, to $22.1 million for the year ended December 31, 2019 from $23.7 million for 2018. This decrease was primarily related to decreases in acquisition costs, FDIC insurance expense, intangible asset amortization expense and professional fees of $3.6 million, $260,000, $90,000 and $41,000, respectively.  These decreases were partially offset by increases in compensation and employee benefits, other noninterest expense and premises and equipment expense of $1.4 million, $819,000 and $208,000, respectively.

 

 

Changes in Financial Condition

 

Total assets increased $16.4 million, or 1.8%, to $915.3 million at December 31, 2019 from $898.9 million at December 31, 2018. This increase primarily related to increases in securities, cash and cash equivalents and interest earning time deposits of $22.4 million, $4.0 million and $3.0 million, respectively, partially offset by a $13.3 million decrease in net loans receivable. Liabilities increased $10.6 million, or 1.3%, to $829.4 million at December 31, 2019 from $818.9 million at December 31, 2018 due to a $25.6 million increase in customer deposits partially offset by a $16.8 million decrease in borrowed funds.

 

Cash and cash equivalents. Cash and cash equivalents increased $4.0 million, or 36.8%, to $15.0 million at December 31, 2019 from $11.0 million at December 31, 2018. This increase primarily resulted from an increase in customer deposits and a decrease in loans, partially offset by a decrease in borrowed funds.

 

Interest earning time deposits. Interest earning time deposits increased $3.0 million, or 43.9%, to $9.7 million at December 31, 2019 from $6.7 million at December 31, 2018.  This increase resulted from the purchase of certificates of deposits with other financial institutions totaling $5.5 million, partially offset by maturities totaling $2.5 million during the year.

Securities. Securities increased $22.4 million, or 22.9%, to $120.1 million at December 31, 2019 from $97.7 million at December 31, 2018. This increase primarily resulted from investment security purchases totaling $76.1 million, partially offset by sales, maturities and repayments totaling $55.4 million during the year.

Loans receivable. Net loans receivable decreased $13.3 million, or 1.9%, to $695.3 million at December 31, 2019 from $708.7 million at December 31, 2018. The decrease was driven by decreases in the Corporation’s commercial mortgage, home equity and residential mortgage portfolios of $8.8 million, $6.2 million and $2.2 million, respectively, partially offset by increases in the consumer and commercial business portfolios of $3.4 million and $594,000, respectively. Loans acquired from CFB totaled $111.6 million at the time of the acquisition in October 2018 and $83.3 million at December 31, 2019.

 

 

Nonperforming assets. Nonperforming assets include nonaccrual loans, loans 90 days past due and still accruing, repossessions and real estate owned. Nonperforming assets were $3.2 million, or 0.34% of total assets, at December 31, 2019 compared to $3.7 million, or 0.42% of total assets, at December 31, 2018. Nonperforming assets consisted of nonperforming loans and real estate owned of $2.9 million and $249,000, respectively, at December 31, 2019 and $3.0 million and $701,000, respectively, at December 31, 2018. At December 31, 2019, nonperforming loans consisted primarily of residential mortgage, home equity and commercial mortgage loans.

 

Federal bank stocks. Federal bank stocks were comprised of FHLB stock and FRB stock of $4.0 million and $1.8 million, respectively, at December 31, 2019. These stocks are purchased and redeemed at par as directed by the federal banks and levels maintained are based primarily on borrowing and other correspondent relationships between the Corporation and the federal banks.

 

Bank-owned life insurance (BOLI). The Corporation maintains single premium life insurance policies on certain current and former officers and employees of the Bank. In addition to providing life insurance coverage, whereby the Bank as well as the officers and employees receive life insurance benefits, the appreciation of the cash surrender value of the BOLI will serve to offset and finance existing and future employee benefit costs. Increases in this account are typically associated with an increase in the cash surrender value of the policies, partially offset by certain administrative expenses.  BOLI increased $406,000, or 2.7%, to $15.3 million at December 31, 2019 from $14.9 million at December 31, 2018.

 

Premises and equipment. Premises and equipment increased $130,000 to $19.0 million at December 31, 2019 from $18.9 million at December 31, 2018. The overall increase in premises and equipment during the year was due to capital expenditures of $1.8 million, partially offset by depreciation and amortization of $1.4 million.

 

Goodwill. Goodwill increased $12,000 to $19.5 million at December 31, 2019 from $19.4 million at December 31, 2018. During 2019, the Corporation finalized the accounting for the acquisition of CFB and recorded a small adjustment to the $9.2 million of goodwill. Goodwill represents the excess of the total purchase price paid for the acquisition over the fair value of the identifiable assets acquired, net of the fair value of the liabilities assumed. Goodwill is evaluated for impairment at least annually and more frequently if events and circumstances indicate that the asset might be impaired. Management evaluated goodwill and concluded that no impairment existed at December 31, 2019.

 

Core deposit intangible. The core deposit intangible was $1.2 million at December 31, 2019, compared to $1.4 million at December 31, 2018. During 2018, the Corporation recorded a core deposit intangible of $1.2 million related to the CFB acquisition. The core deposit intangible also includes amounts associated with the assumption of deposits in the 2017 Northern Hancock Bank and Trust Co. (NHB) acquisition and the 2016 United American Savings Bank (UASB) acquisition. This asset represents the long-term value of the core deposits acquired. In each instance, the fair value was determined using a third-party valuation expert specializing in estimating fair values of core deposit intangibles. The fair value was derived using an industry standard present value methodology. All-in costs and runoff balances by year were discounted by comparable term FHLB advance rates, used as an alternative cost of funds measure. This intangible asset amortizes over a weighted average estimated life of the related deposits. The core deposit intangible asset is not estimated to have a significant residual value. The Corporation recorded $176,000 and $266,000 of intangible amortization in 2019 and 2018, respectively.

 

Deposits. Total deposits increased $25.6 million, or 3.4%, to $787.1 million at December 31, 2019 from $761.5 million at December 31, 2018. Interest bearing deposits increased $25.6 million, or 4.2%. Deposits assumed from CFB totaled $106.1 million at the time of the acquisition in October 2018 and $65.8 million at December 31, 2019.

 

Borrowed funds. Borrowed funds decreased $16.8 million, or 37.0%, to $28.6 million at December 31, 2019 from $45.4 million at December 31, 2018. Borrowed funds at December 31, 2019 consisted of short-term borrowings of $2.1 million and long-term borrowings of $26.5 million. Short-term borrowed funds at December 31, 2019 consisted of an outstanding balance of $2.1 million on a line of credit with a correspondent bank at 5.00%. Long-term borrowed funds consisted of five $5.0 million FHLB term advances totaling $25.0 million, maturing between 2020 and 2023 and having fixed interest rates between 1.97% and 2.85%.  In addition, the Corporation had $1.5 million outstanding on a term advance with a correspondent bank at a fixed rate of 4.75%. Long-term advances are utilized primarily to fund loan growth and short-term advances are utilized primarily to compensate for the normal deposit fluctuations.

 

Stockholders’ equity. Stockholders’ equity increased $5.9 million, or 7.3%, to $85.9 million at December 31, 2019 from $80.0 million at December 31, 2018. The increase was primarily due to net income of $8.0 million and an increase of $1.0 million in accumulated other comprehensive income, partially offset by common stock and preferred dividends paid of $3.1 million and $182,000, respectively.

 

 

Changes in Results of Operations

 

The Corporation reported net income before preferred stock dividends of $8.0 million and $4.2 million in 2019 and 2018, respectively. The following “Average Balance Sheet and Yield/Rate Analysis” and “Analysis of Changes in Net Interest Income” tables should be utilized in conjunction with the discussion of the interest income and interest expense components of net interest income.

 

Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include nonaccrual loans and exclude the allowance for loan losses and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt loans and securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis. The information is based on average daily balances during the periods presented.

 

(Dollar amounts in thousands)

 

Year ended December 31,

 
   

2019

   

2018

 
   

Average

           

Yield/

   

Average

           

Yield/

 
   

Balance

   

Interest

   

Rate

   

Balance

   

Interest

   

Rate

 

Interest-earning assets:

                                               

Loans, taxable

  $ 679,607     $ 31,824       4.68 %   $ 601,188     $ 27,393       4.56 %

Loans, tax exempt

    20,736       812       3.92 %     20,281       752       3.71 %

Total loans receivable

    700,343       32,636       4.66 %     621,469       28,145       4.53 %

Securities, taxable

    87,544       2,258       2.58 %     73,872       1,792       2.43 %

Securities, tax exempt

    16,995       457       2.69 %     24,485       647       2.64 %

Total securities

    104,539       2,715       2.60 %     98,357       2,439       2.48 %

Interest-earning deposits with banks

    31,905       566       1.77 %     19,220       284       1.48 %

Federal bank stocks

    5,858       419       7.15 %     4,633       298       6.43 %

Total interest-earning cash equivalents

    37,763       985       2.61 %     23,853       582       2.44 %

Total interest-earning assets

    842,645       36,336       4.31 %     743,679       31,166       4.19 %

Cash and due from banks

    3,333                       2,968                  

Other noninterest-earning assets

    62,572                       50,316                  

Total Assets

  $ 908,550                     $ 796,963                  

Interest-bearing liabilities:

                                               

Interest-bearing demand deposits

  $ 401,564     $ 2,630       0.65 %   $ 380,753     $ 1,901       0.50 %

Time deposits

    223,222       4,457       2.00 %     182,931       2,823       1.54 %

Total interest-bearing deposits

    624,786       7,087       1.13 %     563,684       4,724       0.84 %

Borrowed funds, short-term

    4,663       183       3.93 %     5,660       209       3.70 %

Borrowed funds, long-term

    31,845       813       2.55 %     18,590       453       2.43 %

Total borrowed funds

    36,508       996       2.73 %     24,250       662       2.73 %

Total interest-bearing liabilities

    661,294       8,083       1.22 %     587,934       5,386       0.92 %

Noninterest-bearing demand deposits

    149,744                   133,936              

Funding and cost of funds

    811,038       8,083       1.00 %     721,870       5,386       0.75 %

Other noninterest-bearing liabilities

    13,761                       10,889                  

Total Liabilities

    824,799                       732,759                  

Stockholders' Equity

    83,751                       64,204                  

Total Liabilities and Stockholders' Equity

  $ 908,550                     $ 796,963                  

Net interest income

          $ 28,253                     $ 25,780          
                                                 

Interest rate spread (difference between weighted average rate on interest-earning assets and interest-bearing liabilities)

                    3.09 %                     3.27 %
                                                 

Net interest margin (net interest income as a percentage of average interest-earning assets)

                    3.35 %                     3.47 %

 

Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Corporation’s interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior year volume), changes in volume (changes in volume multiplied by prior year rate) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on loans and securities reflect the changes in interest income on a fully tax equivalent basis.

 

(Dollar amounts in thousands)

 

Year ended December 31,

 
   

2019 versus 2018

 
   

Increase (Decrease) due to

 
   

Volume

   

Rate

   

Total

 

Interest income:

                       

Loans

  $ 3,656     $ 835     $ 4,491  

Securities

    157       119       276  

Interest-earning deposits with banks

    216       66       282  

Federal bank stocks

    85       36       121  

Total interest-earning assets

    4,114       1,056       5,170  
                         

Interest expense:

                       

Interest-bearing deposits

    555       1,808       2,363  

Borrowed funds, short-term

    (39 )     13       (26 )

Borrowed funds, long-term

    338       22       360  

Total interest-bearing liabilities

    854       1,843       2,697  

Net interest income

  $ 3,260     $ (787 )   $ 2,473  

 

2019 Results Compared to 2018 Results

 

The Corporation reported net income available to common stockholders of $7.8 million and $4.1 million for 2019 and 2018, respectively. The $3.7 million, or 88.6%, increase in net income was attributed to increases in net interest income and noninterest income of $2.5 million and $183,000, respectively, and decreases in noninterest expense and the provision for loan losses of $1.5 million and $565,000, respectively, partially offset by increases in the provision for income taxes and preferred dividends of $1.0 million and $91,000, respectively. Returns on average equity and assets were 9.50% and 0.88%, respectively, for 2019, compared to 6.56% and 0.53%, respectively, for 2018.

 

Net interest income. The primary source of the Corporation’s revenue is net interest income. Net interest income is the difference between interest income on earning assets, such as loans and securities, and interest expense on liabilities, such as deposits and borrowed funds, used to fund the earning assets. Net interest income is impacted by the volume and composition of interest-earning assets and interest-bearing liabilities, and changes in the level of interest rates. Tax equivalent net interest income increased $2.5 million to $28.3 million for 2019, compared to $25.8 million for 2018. This increase in net interest income can be attributed to an increase in tax equivalent interest income of $5.2 million, partially offset by an increase in interest expense of $2.7 million.

 

Interest income. Tax equivalent interest income increased $5.2 million, or 16.6%, to $36.3 million for 2019, compared to $31.2 million for 2018. This increase can be attributed to increases in interest earned on loans, deposits with banks and securities and dividends received on federal bank stocks of $4.5 million, $282,000, $276,000 and $121,000, respectively.

 

Tax equivalent interest earned on loans receivable increased $4.5 million, or 16.0%, to $32.6 million for 2019, compared to $28.1 million for 2018. The average balance of loans increased $78.9 million, or 12.7%, generating $3.7 million of additional interest income on loans. In addition, the average yield on loans increased 13 basis points to 4.66% for 2019, versus 4.53% for 2018 causing an $835,000 increase in interest income.

 

Interest earned on interest-earning deposits with banks increased $282,000, or 99.3%, to $566,000 for 2019, compared to $284,000 for 2018. The average balance of these accounts increased $12.7 million, or 66.0%, causing a $216,000 increase in interest income.  In addition, the average yield on interest-earning deposits increased 29 basis points to 1.77% for 2019, versus 1.48% for 2018 causing a $66,000 increase in interest income.

 

Tax equivalent interest earned on securities increased $276,000, or 11.3%, to $2.7 million for 2019, compared to $2.4 million for 2018. The average balance of securities increased $6.2 million, or 6.3%, generating $157,000 of additional income. The average yield on securities increased 12 basis points to 2.60% for 2019 versus 2.48% for 2018 causing a $119,000 increase in interest income.

 

Interest earned on federal bank stocks increased $121,000, or 40.6%, to $419,000 for 2019, compared to $298,000 for 2018. The average balance of federal bank stocks increased $1.2 million, or 26.4%, resulting in $85,000 of additional income.  Also, the average yield on federal bank stocks increased 72 basis points to 7.15% for 2019 versus 6.43% for 2018 causing a $36,000 increase in interest income.

 

 

 

 

Interest expense. Interest expense increased $2.7 million, or 50.1%, to $8.1 million for 2019, compared to $5.4 million for 2018. This increase can be attributed to increases in interest expense on interest-bearing deposits and borrowed funds of $2.4 million and $334,000, respectively.


Interest expense on deposits increased $2.4 million, or 50.0%, to $7.1 million for 2019, compared to $4.7 million for 2018.  The average rate on interest-bearing deposits increased by 29 basis points to 1.13% for 2019 versus 0.84% for 2018 causing a $1.8 million increase in interest expense. In addition, the average balance of interest-bearing deposits increased $61.1 million, or 10.8%, causing a $555,000 increase in interest expense.

Interest expense on borrowed funds increased $334,000, or 50.5%, to $996,000 for 2019, compared to $662,000 for 2018. The average balance of borrowed funds increased $12.3 million, or 50.5%, to $36.5 million for 2019, compared to $24.3 million for 2018 causing a $299,000 decrease in interest expense.

Provision for loan losses. The Corporation records provisions for loan losses to maintain a level of total allowance for loan losses that management believes, to the best of its knowledge, covers all probable incurred losses estimable at each reporting date. Management considers historical loss experience, the present and prospective financial condition of borrowers, current conditions (particularly as they relate to markets where the Corporation originates loans), the status of nonperforming assets, the estimated underlying value of the collateral and other factors related to the collectability of the loan portfolio.

 

Nonperforming loans decreased $121,000, or 4.0%, to $2.9 million at December 31, 2019 from $3.0 million at December 31, 2018. The decrease in nonperforming loans was primarily related to a decrease of $470,000 in loans past due more than 90 days and still accruing, partially offset by an increase of $350,000 in non-accrual loans.  The increase in non-accrual loans was primarily from changes in the commercial real estate loan portfolio.

 

The provision for loan losses decreased $565,000, or 44.1%, to $715,000 for 2019 from $1.3 million for 2018. The Corporation’s allowance for loan losses amounted to $6.6 million, or 0.93% of the Corporation’s total loan portfolio at December 31, 2019 compared to $6.5 million or 0.91% of total loans at December 31, 2018. The allowance for loan losses, as a percentage of nonperforming loans at December 31, 2019 and 2018, was 225.5% and 214.9%, respectively. The allocation of the allowance for loan losses related to residential mortgage loans and commercial business loans increased during the year  primarily as a result of an increase in net charge-offs associated with these portfolios.  The allocation related to consumer loans increased primarily as a result of growth in the loan portfolios, while the allocation related to commercial real estate loans and home equity loans decreased as a result of reductions in the amount of net charge-offs and portfolio balance decreases. At December 31, 2019, there was no provision for loan losses allocated to loans acquired from UASB, NHB or CFB.

 

Noninterest income. Noninterest income includes revenue that is related to services rendered and activities conducted in the financial services industry, including fees on depository accounts, general transaction and service fees, title premiums, security and loan sale gains and losses, and earnings on BOLI. Noninterest income increased $183,000, or 4.4%, to $4.4 million in 2019 from $4.2 million in 2018. The increase in noninterest income is due to increases in earnings on BOLI, fees and service charges, gains on the sale of loans and gains on the sale of securities of $165,000, $126,000, $95,000 and $87,000, respectively, partially offset by a decrease in other income of $290,000.  The decrease in other income was due to a $540,000 gain recorded in the fourth quarter of 2018 related to the retirement of 18,000 shares of CFB stock the Corporation owned at the time of the acquisition.

 

Noninterest expense. Noninterest expense decreased $1.5 million, or 6.5%, to $22.1 million for 2019, compared to $23.7 million for 2018. This decrease was primarily related to decreases in acquisition costs, FDIC insurance expense, intangible asset amortization expense and professional fees of $3.6 million, $260,000, $90,000 and $41,000, respectively.  These decreases were partially offset by increases in compensation and employee benefits, other noninterest expense and premises and equipment expense of $1.4 million, $819,000 and $208,000, respectively.

 

Acquisition costs decreased $3.6 million in 2019. Acquisition costs of $3.6 million were incurred in 2018 related to the acquisition of CFB and included employee non-compete and severance costs, professional fees, system conversion costs, contract termination fees, legal fees, accounting and auditing fees and other costs of $1.5 million, $531,000, $481,000, $427,000, $330,000, $50,000 and $228,000, respectively. 

 

 

FDIC insurance expense decreased $260,000, or 48.8%, to $273,000 for 2019, compared to $533,000 for 2018.  This decrease was primarily related to $215,000 in Small Bank Assessment credits received by the Bank and utilized in the third and fourth quarters of 2019.

 

Compensation and employee benefits expense increased $1.4 million, or 13.7%, to $11.7 million for 2019, compared to $10.3 million for 2018. This increase primarily related to normal wage and salary increases, increases in insurance and retirement benefits, as well as costs associated with the full-year operation of the three branch offices acquired from CFB in 2018.

 

Other noninterest expense increased $819,000, or 17.0%, to $5.6 million for 2019, compared to $4.8 million for 2018.  This increase primarily related to increases in processing and telecommunications expenses of $464,000 and $153,000, respectively, related to outsourcing core systems processing, as well as costs associated with the full-year operation of the acquired branch offices.

 

Premises and equipment expense increased $208,000, or 6.6%, to $3.4 million for 2019, compared to $3.2 million for 2018. This increase primarily related to expenses associated with the full-year operation of the acquired branch offices.

 

The provision for income taxes increased $1.0 million to $1.7 million for 2019, compared to $633,000 million for 2018 primarily due to the increase in net income available to common stockholders.

 

Market Risk Management

 

Market risk for the Corporation consists primarily of interest rate risk exposure and liquidity risk. The Corporation is not subject to currency exchange risk or commodity price risk, and has no trading portfolio, and therefore, is not subject to any trading risk. In addition, the Corporation does not participate in hedging transactions such as interest rate swaps and caps. Changes in interest rates will impact both income and expense recorded and also the market value of long-term interest-earning assets.

 

The primary objective of the Corporation’s asset liability management function is to maximize the Corporation’s net interest income while simultaneously maintaining an acceptable level of interest rate risk given the Corporation’s operating environment, capital and liquidity requirements, balance sheet mix, performance objectives and overall business focus. One of the primary measures of the exposure of the Corporation’s earnings to interest rate risk is the timing difference between the repricing or maturity of interest-earning assets and the repricing or maturity of its interest-bearing liabilities.

 

The Corporation’s Board of Directors has established a Finance Committee, consisting of five outside directors, the President and Chief Executive Officer (CEO), Treasurer and Chief Financial Officer (CFO) and Chief Operating Officer (COO), to monitor market risk, including primarily interest rate risk. This committee, which meets at least quarterly, generally establishes and monitors the investment, interest rate risk and asset liability management policies of the Corporation.

 

In order to minimize the potential for adverse affects of material and prolonged changes in interest rates on the Corporation’s results of operations, the Corporation’s management team has implemented and continues to monitor asset liability management policies to better match the maturities and repricing terms of the Corporation’s interest-earning assets and interest-bearing liabilities. Such policies have consisted primarily of (i) originating adjustable-rate mortgage loans; (ii) originating short-term secured commercial loans with the rate on the loan tied to the prime rate or reset features in which the rate changes at determined intervals; (iii) emphasizing investment in shorter-term (expected duration of five years or less) investment securities; (iv) selling longer-term (30-year) fixed-rate residential mortgage loans in the secondary market; (v) maintaining a high level of liquid assets (including securities classified as available for sale) that can be readily reinvested in higher yielding investments should interest rates rise; (vi) emphasizing the retention of lower cost savings accounts and other core deposits; and (vii) lengthening liabilities and locking in lower borrowing rates with longer terms whenever possible.

 

Interest Rate Sensitivity Gap Analysis

 

The implementation of asset and liability initiatives and strategies and compliance with related policies, combined with other external factors such as demand for the Corporation’s products and economic and interest rate environments in general, has resulted in the Corporation maintaining a one-year cumulative interest rate sensitivity gap within internal policy limits of between a positive and negative 15% of total assets. The one-year interest rate sensitivity gap is identified as the difference between the Corporation’s interest-earning assets that are scheduled to mature or reprice within one year and its interest-bearing liabilities that are scheduled to mature or reprice within one year.

 

The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities, and is considered negative when the amount of interest rate-sensitive liabilities exceeds the amount of interest rate-sensitive assets. Generally, during a period of rising interest rates, a negative gap would adversely affect net interest income while a positive gap would result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would result in an increase in net interest income and a positive gap would adversely affect net interest income. The closer to zero, or more neutral, that gap is maintained, generally, the lesser the impact of market interest rate changes on net interest income.

 

 

Based on certain assumptions derived from the Corporation’s historical experience, at December 31, 2019, the Corporation’s interest-earning assets maturing or repricing within one year totaled $280.2 million while the Corporation’s interest-bearing liabilities maturing or repricing within one year totaled $193.6 million, providing an excess of interest-earning assets over interest-bearing liabilities of $86.6 million or 9.5% of total assets. At December 31, 2019, the percentage of the Corporation’s assets to liabilities maturing or repricing within one year was 144.7%.

 

The following table presents the amounts of interest-earning assets and interest-bearing liabilities outstanding as of December 31, 2019 which are expected to mature, prepay or reprice in each of the future time periods presented:

 

(Dollar amounts in thousands)

 

Six months or less

 

Six months to one year

 

One to three years

 

Three to four years

 

Over four years

 

Total

Total interest-earning assets

  $ 188,771     $ 91,433     $ 254,854     $ 68,860     $ 238,772     $ 842,690  
                                                 

Total interest-bearing liabilities

    101,559       92,013       290,598       75,817       105,344       665,331  
                                                 

Interest rate sensitivity gap

  $ 87,212     $ (580 )   $ (35,744 )   $ (6,957 )   $ 133,428     $ 177,359  
                                                 

Cumulative rate sensitivity gap

  $ 87,212     $ 86,632     $ 50,888     $ 43,931     $ 177,359          
                                                 

Ratio of gap during the period to total interest earning assets

    10.35 %     (0.07 %)     (4.24 %)     (0.83 %)     15.83 %        
                                                 

Ratio of cumulative gap to total interest earning assets

    10.35 %     10.28 %     6.04 %     5.21 %     21.05 %        
                                                 

 

Although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. The ability of many borrowers to service their debt may decrease in the event of an interest rate increase.

 

Interest Rate Sensitivity Simulation Analysis

 

The Corporation also utilizes income simulation modeling in measuring its interest rate risk and managing its interest rate sensitivity. The Finance Committee of the Board of Directors believes that simulation modeling enables the Corporation to more accurately evaluate and manage the possible effects on net interest income due to the exposure to changing market interest rates and different loan and security prepayment and deposit decay assumptions under various interest rate scenarios.

 

As with gap analysis and earnings simulation modeling, assumptions about the timing and variability of cash flows are critical in net portfolio equity valuation analysis. Particularly important are the assumptions driving mortgage prepayments and the assumptions about expected attrition of the core deposit portfolios. These assumptions are based on the Corporation’s historical experience.

 

The Corporation has established the following guidelines for assessing interest rate risk:

 

Net interest income simulation. Given a 200 basis point immediate increase or decrease in market interest rates, net interest income may not change by more than 15% for a one-year period.

 

Economic value of equity simulation. Economic value of equity is the present value of the Corporation’s existing assets less the present value of the Corporation’s existing liabilities. Given a 200 basis point immediate and permanent increase or decrease in market interest rates, economic value of equity may not correspondingly decrease or increase by more than 20%.

 

These guidelines take into consideration the current interest rate environment, the Corporation’s financial asset and financial liability product mix and characteristics and liquidity sources among other factors. Given the current rate environment, a drop in short-term market interest rates of 200 basis points immediately or over a one-year horizon would seem unlikely. This should be considered in evaluating modeling results outlined in the table below.

 

 

The following table presents the simulated impact of a 100 basis point or 200 basis point upward or downward shift of market interest rates on net interest income for the years ended December 31, 2019 and 2018, respectively. This analysis was done assuming that the interest-earning asset and interest-bearing liability levels at December 31, 2019 remained constant. The impact of the market rate movements on net interest income was developed by simulating the effects of rates changing immediately for a one-year period from the December 31, 2019 levels for net interest income.

 

   

Increase

 

Decrease

   

+100 BP

 

+200 BP

 

-100 BP

 

-200 BP

2019 Net interest income - increase (decrease)

    1.87 %     2.06 %     (1.83 %)     (5.28 %)
                                 

2018 Net interest income - increase (decrease)

    0.26 %     0.30 %     (0.15 %)     (3.98 %)

 

The expected increase in 2018 and 2019 net interest income in the rising rate scenarios shown in the table above resulted from the Corporation having an excess of immediately repricing interest-earning assets over immediately repricing interest-bearing liabilities.

 

Impact of Inflation and Changing Prices

 

The consolidated financial statements of the Corporation and related notes presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) which require the measurement of financial condition and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.

 

Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services since such prices are affected by inflation to a larger degree than interest rates. In the current interest rate environment, liquidity and the maturity structure of the Corporation’s assets and liabilities are critical to the maintenance of acceptable performance levels.

 

Capital Resources

 

Total stockholders’ equity increased $5.9 million, or 7.3%, to $85.9 million at December 31, 2019 from $80.0 million at December 31, 2018.  Net income available to common stockholders of $7.8 million in 2019 represented a increase in earnings of $3.7 million, or 88.6%, compared to 2018. The Corporation’s capital to assets ratio increased to 9.4% at December 31, 2019 from 8.9% at December 31, 2018.

 

While continuing to sustain a strong capital position, dividends on common stock increased to $3.1 million in 2019 from $2.7 million in 2018. In addition, stockholders have taken part in the Corporation’s dividend reinvestment plan introduced during 2003 with 38% of registered shareholder accounts active in the plan at December 31, 2019. Dividend reinvestment is achieved through the purchase of common shares on the secondary market.

 

Capital adequacy is intended to enhance the Corporation’s ability to support growth while protecting the interest of stockholders and depositors and to ensure that capital ratios are in compliance with regulatory minimum requirements. Regulatory agencies have developed certain capital ratio requirements that are used to assist them in monitoring the safety and soundness of financial institutions. At December 31, 2019, the Bank was in excess of all regulatory capital requirements. See Note 10 on page F-25 to the Corporation’s consolidated financial statements attached hereto.

 

Liquidity

 

The Corporation’s primary sources of funds generally have been deposits obtained through the offices of the Bank, borrowings from the FHLB, and amortization and prepayments of outstanding loans and maturing securities. During 2019, the Corporation used its sources of funds primarily to purchase additional securities and increase interest-earning deposits. As of December 31, 2019, the Corporation had outstanding loan commitments, including undisbursed loans and amounts available under credit lines, totaling $122.5 million, and standby letters of credit totaling $548,000, net of cash collateral maintained by the Bank. The Bank has established policies to monitor and manage liquidity levels to ensure the Bank’s ability to meet demands for customer withdrawals and the repayment of borrowings.

 

At December 31, 2019, time deposits amounted to $217.8 million, or 27.7%, of the Corporation’s total consolidated deposits, including approximately $67.9 million scheduled to mature within the next year. Management believes that the Corporation has adequate resources to fund all of its commitments, that all of its commitments will be funded as required by related maturity dates and that, based upon past experience and current pricing policies, it can adjust the rates of time deposits to retain a substantial portion of maturing liabilities.

 

 

Aside from liquidity available from customer deposits or through sales and maturities of securities, the Corporation and the Bank have alternative sources of funds. These sources include a line of credit for the Corporation with a correspondent bank, the Bank’s line of credit and term borrowing capacity from the FHLB and, to a more limited extent, through the sale of loans. At December 31, 2019, the Bank’s borrowing capacity with the FHLB, net of funds borrowed and irrevocable standby letters of credit issued to secure certain deposit accounts, was $252.0 million.

 

The Corporation pays a regular quarterly cash dividend. The Corporation paid dividends of $0.29 and $0.28 per common share for each of the four quarters of 2019 and 2018, respectively. On February 21, 2020, the Corporation declared a quarterly dividend of $0.30 per common share payable on March 20, 2020 to shareholders of record on March 2, 2020. The determination of future dividends on the Corporation’s common stock will depend on conditions existing at that time with consideration given to the Corporation’s earnings, capital and liquidity needs, among other factors.

 

Management is not aware of any conditions, including any regulatory recommendations or requirements, which would adversely impact its liquidity or its ability to meet funding needs in the ordinary course of business.

 

Critical Accounting Policies

 

The Corporation’s consolidated financial statements are prepared in accordance with GAAP and follow general practices within the industry in which it operates. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates or judgments. Certain policies inherently have a greater reliance on the use of estimates, and as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates or judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily though the use of internal cash flow modeling techniques.

 

The most significant accounting policies followed by the Corporation are presented in Note 1 to the consolidated financial statements beginning on page F-8. These policies, along with the disclosures presented in the other financial statement notes, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management has identified the following as critical accounting policies:

 

Allowance for loan losses. The Corporation considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than other significant accounting policies. The balance in the allowance for loan losses is determined based on management’s review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions and other pertinent factors, including management’s assumptions as to future delinquencies, recoveries and losses. All of these factors may be susceptible to significant change. Among the many factors affecting the allowance for loan losses, some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all of the potential factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from management’s estimates, additional provisions for loan losses may be required that would adversely impact the Corporation’s financial condition or earnings in future periods.

 

Other-than-temporary impairment. Management evaluates debt securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic, market or other concerns warrant such evaluation. Consideration is given to: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions and (4) whether the Corporation has the intent to sell the security or more likely than not will be required to sell the security before its anticipated recovery.

 

 

Goodwill and intangible assets. Goodwill represents the excess cost over fair value of assets acquired in a business combination. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values. Goodwill is subject to ongoing periodic impairment tests based on the fair value of the reporting unit compared to its carrying amount, including goodwill. Impairment exists when a reporting unit’s carrying amount exceeds its fair value. At November 30, 2019, the required annual impairment test of goodwill was performed and no impairment existed as of the valuation date. If for any future period it is determined that there has been impairment in the carrying value of our goodwill balances, the Corporation will record a charge to earnings, which could have a material adverse effect on net income, but not risk based capital ratios.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

Information required by this item is included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.

 

Item 8. Financial Statements and Supplementary Data

 

Information required by this item is included beginning on page F-1.

 

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

Not applicable.

 

Item 9A. Controls and Procedures

 

The Corporation maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Corporation’s management, including its CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” in Rule 13a-15(e).

 

As of December 31, 2019, the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s CEO and CFO, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures. Based on the foregoing, the Corporation’s CEO and CFO concluded that the Corporation’s disclosure controls and procedures were effective.

 

During the fourth quarter of fiscal year 2019, there has been no change made in the Corporation’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

 

There have been no significant changes in the Corporation’s internal controls or in other factors that could significantly affect the internal controls subsequent to the date the Corporation completed its valuation.

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Corporation. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

 

Management’s Report on Internal Control Over Financial Reporting

 

Management completed an assessment of the Corporation’s internal control over financial reporting as of December 31, 2019. This assessment was based on criteria for evaluating internal control over financial reporting established in the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that the Corporation’s internal control over financial reporting was effective as of December 31, 2019.

 

Item 9B. Other Information

 

None.

 

 

PART III

 

Item 10. Directors, Executive Officers and Corporate Governance

 

The information required by this item is incorporated herein by reference to the sections captioned “Principal Beneficial Owners of the Corporation’s Common Stock”, “Section 16(a) Beneficial Ownership Reporting Compliance” and “Information With Respect to Nominees For Director, Continuing Director and Executive Officers” in the Corporation’s definitive proxy statement for the Corporation’s Annual Meeting of Stockholders to be held on April 22, 2020 (the Proxy Statement).

 

The Corporation maintains a Code of Personal and Business Conduct and Ethics (the Code) that applies to all employees, including the CEO and the CFO. A copy of the Code has previously been filed with the SEC and is posted on our website at www.emclairefinancial.com. Any waiver of the Code with respect to the CEO and the CFO will be publicly disclosed in accordance with applicable regulations.

 

Item 11. Executive Compensation

 

The information required by this item is incorporated herein by reference to the section captioned “Executive Compensation” in the Proxy Statement.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

The information required by this item is incorporated herein by reference to the section captioned “Principal Beneficial Owners of the Corporation’s Common Stock” in the Proxy Statement.

 

Equity Compensation Plan Information. The following table provides certain information as of December 31, 2019 with respect to shares of common stock that may be issued under our 2014 Stock Incentive Plan, which was approved by shareholders in April 2014.

 

Plan Category

 

Number of securities to be issued upon exercise of outstanding options

 

Weighted-average exercise price of outstanding options

 

Number of securities remaining available for issuance under equity compensation plans (excluding securities reflected in the first column) (1)

Equity compensation plans approved by security holders

        $       108,266  
                         

Equity compensation plans not approved by security holders

                 
                         

Total

        $       108,266  

 

(1) The 2014 Stock Incentive Plan provides for the grant of options to purchase up to 88,433 shares of common stock and for grants of up to 88,433 shares of restricted common stock of which no options and 68,600 shares of restricted stock have been granted at December 31, 2019.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

 

The information required by this item is incorporated herein by reference to the sections captioned “Information With Respect to Nominees For Director, Continuing Directors and Executive Officers” and “Executive Compensation” in the Proxy Statement.

 

Item 14. Principal Accountant Fees and Services

 

The information required by this item is incorporated herein by reference to the section captioned “Relationship With Independent Registered Public Accounting Firm” in the Proxy Statement.

 

PART IV

 

Item 15. Exhibits and Financial Statement Schedules

 

(a)(1)-(2)

Financial Statements and Schedules:

 

(i) The financial statements required in response to this item are incorporated by reference from Item 8 of this report.

 

(b)

Exhibits are either attached as part of this Report or incorporated herein by reference.

 

 

3.1

 

Amended and Restated Articles of Incorporation of Emclaire Financial Corp (1)

3.2

 

Bylaws of Emclaire Financial Corp (2)

4.1

 

Specimen Common Stock Certificate of Emclaire Financial Corp (3)

4.2   Description of Emclaire Common Stock

10.1

 

Amended and Restated Employment Agreement between Emclaire Financial Corp, The Farmers National Bank of Emlenton and William C. Marsh, dated as of November 18, 2015 (4)*

10.2

 

Amended and Restated Change in Control Agreement between Emclaire Financial Corp, The Farmers National Bank of Emlenton and Jennifer A. Roxbury, dated as of November 18, 2015*

10.3

 

Amended and Restated Change in Control Agreement between Emclaire Financial Corp, The Farmers National Bank of Emlenton and Amanda L. Engles, dated as of November 15, 2017 (5)*

10.4

 

Amended and Restated Change in Control Agreement between Emclaire Financial Corp, The Farmers National Bank of Emlenton and Robert A. Vernick dated November 18, 2015*

10.5

 

Amended and Restated Supplemental Executive Retirement Plan Agreement between The Farmers National Bank of Emlenton and William C. Marsh, dated as of November 18, 2015 (4)*

10.6

 

Amended and Restated Supplemental Executive Retirement Plan Agreement between The Farmers National Bank of Emlenton and Jennifer A. Roxbury, dated as of November 18, 2015 (6)*

10.7

 

Supplemental Executive Retirement Plan Agreement between the Farmers National Bank of Emlenton and Amanda L. Engles, dated as of November 15, 2017 (5)*

10.8

 

Supplemental Executive Retirement Plan Agreement between The Farmers National Bank of Emlenton and Robert A. Vernick dated November 18, 2015*

10.9

 

First Amendment dated as of February 8, 2019 to the Amended and Restated Supplemental Executive Retirement Plan Agreement between The Farmers National Bank of Emlenton and William C. Marsh, dated as of November 18, 2015 (6)*

10.10   First Amendment dated as of February 8, 2019 to the Amended and Restated Supplemental Executive Retirement Plan Agreement between The Farmers National Bank of Emlenton and Jennifer A Roxbury, dated as of November 18, 2015 (6)*
10.11   First Amendment dated as of February 8, 2019 to the Amended and Restated Supplemental Executive Retirement Plan Agreement between The Farmers National Bank of Emlenton and Amanda L. Engles, dated as of November 15, 2017 (6)*
10.12   Group Term Carve-Out Plan between the Farmers National Bank of Emlenton and Officers and Employees (7)*
10.13   Farmers National Bank Deferred Compensation Plan (8)*

10.14

 

Emclaire Financial Corp 2014 Stock Incentive Plan (9)*

11.1

 

Statement regarding computation of earnings per share (see Note 1 of the Notes to Consolidated Financial Statements in the Annual Report).

14.0

 

Code of Personal and Business Conduct and Ethics. (10)

20.0

 

Emclaire Financial Corp Dividend Reinvestment and Stock Purchase Plan. (11)

21.0

 

Subsidiaries of the Registrant (see information contained herein under “Item 1. Description of Business - Subsidiary Activity”).

31.1

 

Principal Executive Officer Section 302 Certification.

31.2

 

Principal Financial Officer Section 302 Certification.

32.1

 

Principal Executive Officer Section 906 Certification.

32.2

 

Principal Financial Officer Section 906 Certification.

101.INS

 

XBRL Instance Document

101.SCH

 

XBRL Taxonomy Extension Schema Document

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF

 

XBRL Taxonomy Extension Definitions Linkbase Document

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

 


 

*

Compensatory plan or arrangement.

(1)

Incorporated by reference to the Registrant’s Current Report on Form 8-K/A dated May 23, 2018.

(2)

Incorporated by reference to the Registrant’s Registration Statement on Form SB-2, as amended, (File No. 333-11773) declared effective by the SEC on October 25, 1996.

(3)

Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1997. 

(4)

Incorporated by reference to the Registrant’s Current Report on Form 8-K dated November 18, 2015.

(5)

Incorporated by reference to the Registrant’s Current Report on Form 8-K dated November 15, 2017.

(6)

Incorporated by reference to the Registrant’s Current Report on Form 8-K dated February 8, 2019.

(7)

Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002.

(8)

Incorporated by reference to the Registrant’s Current Report on Form 8-K dated December 15, 2008.

(9) Incorporated by reference to the Registrant’s Definitive Proxy Statement dated March 24, 2016.
(10) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004.
(11) Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001.

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

EMCLAIRE FINANCIAL CORP

 

 

 

Dated: March 20, 2020

By:

/s/ William C. Marsh

 

 

William C. Marsh

 

 

Chairman, Chief Executive Officer, President and Director

 

 

(Duly Authorized Representative)

 

Pursuant to the requirement of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

By:

/s/ William C. Marsh

 

By:

/s/ Amanda L. Engles

 

William C. Marsh

 

 

Amanda L. Engles

 

Chairman of the Board

 

 

Treasurer and Chief Financial Officer

 

Chief Executive Officer

 

 

(Principal Financial Officer)

 

President

 

Date:

March 20, 2020

 

Director

 

 

 

 

(Principal Executive Officer)

 

 

 

Date:

March 20, 2020

 

 

 

 

By:

/s/ Milissa S. Bauer

 

By:

/s/ David L. Cox

 

Milissa S. Bauer

 

 

David L. Cox

 

Director

 

 

Director

Date:

March 20, 2020

 

Date:

March 20, 2020
         

By:

/s/ James M. Crooks

 

By:

/s/ Henry H. Deible

 

James M. Crooks

 

 

Henry H. Deible

 

Director

 

 

Director

Date:

March 20, 2020

 

Date:

March 20, 2020
         
By: /s/ Henry H. Deible II   By: /s/ Robert W. Freeman
  Henry H. Deible II     Robert W. Freeman
  Director     Director
Date: March 20, 2020   Date: March 20, 2020
         

By:

/s/ Mark A. Freemer

 

By:

/s/ Robert L. Hunter

 

Mark A. Freemer

 

 

Robert L. Hunter

 

Director

 

 

Director

Date:

March 20, 2020

 

Date:

March 20, 2020
         

 

/s/ John B. Mason

 

By:

/s/ Deanna K. McCarrier

 

John B. Mason

 

 

Deanna K. McCarrier

  

Director

 

 

Director

Date:

March 20, 2020

 

Date:

March 20, 2020
         
By: /s/ Nicholas D. Varischetti      

 

Nicholas D. Varischetti

 

 

Director

 

Date:

March 20, 2020

 

 

 

Financial Statements

Table of Contents

 

Report of Independent Registered Public Accounting Firm

F-2

Consolidated Balance Sheets

F-3

Consolidated Statements of Net Income

F-4

Consolidated Statements of Comprehensive Income

F-5

Consolidated Statements of Changes in Stockholders’ Equity

F-6

Consolidated Statements of Cash Flows

F-7

Notes to Consolidated Financial Statements

F-8

 

 

Report of Independent Registered Public Accounting Firm

 

 

Shareholders and the Board of Directors of Emclaire Financial Corp

Emlenton, Pennsylvania

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of Emclaire Financial Corp (the "Corporation") as of December 31, 2019 and 2018, the related consolidated statements of net income, comprehensive income, stockholders' equity, and cash flows for each of the years then ended, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Corporation as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on the Corporation's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Corporation in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Corporation's internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

 

 

/s/ Crowe LLP

 

We have served as the Corporation's auditor since 2010.

 

Cleveland, Ohio

March 20, 2020

 

 

 

Consolidated Balance Sheets

(Dollar amounts in thousands, except share and per share data)

 

   

December 31, 2019

   

December 31, 2018

 

Assets

               

Cash and due from banks

  $ 3,750     $ 3,623  

Interest earning deposits with banks

    11,236       7,332  

Total cash and cash equivalents

    14,986       10,955  

Interest earning time deposits

    9,698       6,738  

Securities - available-for-sale

    120,107       97,718  

Securities - equity investments

    19       7  

Loans receivable, net of allowance for loan losses of $6,556 and $6,508

    695,348       708,664  

Federal bank stocks, at cost

    5,790       6,351  

Bank-owned life insurance

    15,287       14,881  

Accrued interest receivable

    2,600       2,570  

Premises and equipment, net

    19,041       18,911  

Goodwill

    19,460       19,448  

Core deposit intangible, net

    1,247       1,423  

Prepaid expenses and other assets

    11,713       11,209  

Total Assets

  $ 915,296     $ 898,875  

Liabilities and Stockholders' Equity

               

Liabilities

               

Deposits:

               

Non-interest bearing

  $ 148,842     $ 148,893  

Interest bearing

    638,282       612,653  

Total deposits

    787,124       761,546  

Short-term borrowed funds

    2,050       12,850  

Long-term borrowed funds

    26,500       32,500  

Accrued interest payable

    616       495  

Accrued expenses and other liabilities

    13,148       11,476  

Total Liabilities

    829,438       818,867  

Commitments and Contingent Liabilities (Note 11)

           

Stockholders' Equity

               

Preferred stock, $1.00 par value, 3,000,000 shares authorized; Series C, non-cumulative preferred stock, $2.9 million liquidation value, 286,888 shares issued and outstanding; Series D, non-cumulative preferred stock, $1.3 million liquidation value, 133,705 shares issued and outstanding

    4,206       4,206  

Common stock, $1.25 par value, 12,000,000 shares authorized; 2,810,729 and 2,800,729 shares issued; 2,708,712 and 2,698,712 shares outstanding

    3,513       3,501  

Additional paid-in capital

    46,757       46,401  

Treasury stock, at cost; 102,017 shares

    (2,114 )     (2,114 )

Retained earnings

    38,831       34,371  

Accumulated other comprehensive loss

    (5,335 )     (6,357 )

Total Stockholders' Equity

    85,858       80,008  

Total Liabilities and Stockholders' Equity

  $ 915,296     $ 898,875  

 

See accompanying notes to consolidated financial statements.

 

 

 

Consolidated Statements of Net Income

(Dollar amounts in thousands, except share and per share data)

 

   

Year ended December 31,

   

2019

 

2018

Interest and dividend income

               

Loans receivable, including fees

  $ 32,507     $ 28,028  

Securities:

               

Taxable

    2,258       1,792  

Exempt from federal income tax

    395       560  

Federal bank stocks

    419       298  

Interest earning deposits with banks

    566       284  

Total interest and dividend income

    36,145       30,962  

Interest expense

               

Deposits

    7,087       4,724  

Short-term borrowed funds

    183       209  

Long-term borrowed funds

    813       453  

Total interest expense

    8,083       5,386  

Net interest income

    28,062       25,576  

Provision for loan losses

    715       1,280  

Net interest income after provision for loan losses

    27,347       24,296  

Noninterest income

               

Fees and service charges

    2,157       2,031  

Net gain (loss) on sales of available for sale securities

    78       (9 )

Net gain on sales of loans

    114       19  

Earnings on bank-owned life insurance

    566       401  

Other

    1,476       1,766  

Total noninterest income

    4,391       4,208  

Noninterest expense

               

Compensation and employee benefits

    11,738       10,320  

Premises and equipment

    3,373       3,165  

Intangible asset amortization

    176       266  

Professional fees

    928       969  

Federal deposit insurance

    273       533  

Acquisition costs

          3,592  

Other

    5,634       4,815  

Total noninterest expense

    22,122       23,660  

Income before provision for income taxes

    9,616       4,844  

Provision for income taxes

    1,662       633  
Net income     7,954       4,211  

Preferred stock dividends

    182       91  

Net income available to common stockholders

  $ 7,772     $ 4,120  
                 

Earnings per common share

               

Basic

  $ 2.88     $ 1.73  

Diluted

  $ 2.86     $ 1.72  

 

See accompanying notes to consolidated financial statements.

 

 

 

Consolidated Statements of Comprehensive Income

(Dollar amounts in thousands)

 

   

Year ended December 31,

   

2019

 

2018

Net income

  $ 7,954     $ 4,211  
                 

Other comprehensive loss

               

Unrealized gains/(losses) on securities:

               

Unrealized holding gain (loss) arising during the period

    1,861       (833 )

Reclassification adjustment for gains included in net income

    (78 )     9  
Other comprehensive loss on securities, before tax adjustment     1,783       (824 )

Tax effect

    (374 )     173  

Net of tax

    1,409       (651 )
                 

Defined benefit pension plans:

               

Net loss arising during the period

    (742 )     (253 )

Reclassification adjustment for amortization of prior service benefit and net loss included in net periodic pension cost

    252       252  
Other comprehensive loss on defined benefit plan, before tax adjustment     (490 )     (1 )

Tax effect

    103        

Net of tax

    (387 )     (1 )
                 

Total other comprehensive income (loss)

    1,022       (652 )

Comprehensive income

  $ 8,976     $ 3,559  

 

See accompanying notes to consolidated financial statements.

 

 

 

Consolidated Statements of Changes in Stockholders’ Equity

(Dollar amounts in thousands, except share and per share data)

 

 

   

Preferred Stock

   

Additional Paid-in Capital - Preferred

   

Common Stock

   

Additional Paid-in Capital - Common

   

Treasury Stock

   

Retained Earnings

   

Accumulated Other Comprehensive Loss

   

Total Stockholders' Equity

 

Balance at January 1, 2018, as previously presented

  $     $     $ 2,966     $ 31,031     $ (2,114 )   $ 32,726     $ (5,518 )   $ 59,091  

Cumulative effect of change in accounting principle for marketable equity securities, net of tax

                                  187       (187 )      

Balance at January 1, 2018, as adjusted

  $     $     $ 2,966     $ 31,031     $ (2,114 )   $ 32,913     $ (5,705 )   $ 59,091  

Net income

                                  4,211             4,211  

Other comprehensive loss

                                        (652 )     (652 )

Issuance of preferred stock (Series C - 286,888 shares, Series D - 133,705 shares)

    421       3,785                                     4,206  
Cash dividends declared on preferred stock (Series C - $0.225 per share)                                   (64 )           (64 )

Cash dividends declared on preferred stock (Series D - $0.20 per share)

                                  (27 )           (27 )

Issuance of common stock (419,173 shares)

                524       15,112                         15,636  

Issuance of common stock for restricted stock awards (8,400 shares)

                11       (11 )                        

Stock compensation expense

                      269                         269  

Cash dividends declared on common stock ($1.12 per share)

                                  (2,662 )           (2,662 )

Balance at December 31, 2018

  $ 421     $ 3,785     $ 3,501     $ 46,401     $ (2,114 )   $ 34,371     $ (6,357 )   $ 80,008  
                                                                 

Balance at January 1, 2019, as previously presented

  $ 421     $ 3,785     $ 3,501     $ 46,401     $ (2,114 )   $ 34,371     $ (6,357 )   $ 80,008  

Cumulative effect of change in accounting principle for leases and security premiums, net of tax

                                  (181 )           (181 )

Balance at January 1, 2019, as adjusted

  $ 421     $ 3,785     $ 3,501     $ 46,401     $ (2,114 )   $ 34,190     $ (6,357 )   $ 79,827  

Net income

                                  7,954             7,954  

Other comprehensive income

                                        1,022       1,022  
Cash dividends declared on preferred stock (Series C - $0.45 per share)                                   (129 )           (129 )

Cash dividends declared on preferred stock (Series D - $0.40 per share)

                                  (53 )           (53 )

Issuance of common stock for restricted stock awards (10,000 shares)

                12       (12 )                        

Stock compensation expense

                      368                         368  

Cash dividends declared on common stock ($1.16 per share)

                                  (3,131 )           (3,131 )

Balance at December 31, 2019

  $ 421     $ 3,785     $ 3,513     $ 46,757     $ (2,114 )   $ 38,831     $ (5,335 )   $ 85,858  

 

See accompanying notes to consolidated financial statements.

 

 

 

Consolidated Statements of Cash Flows

(Dollar amounts in thousands, except share and per share data)

 

   

For the year ended December 31,

 
   

2019

   

2018

 

Cash flows from operating activities

               

Net income

  $ 7,954     $ 4,211  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation and amortization of premises and equipment

    1,388       1,172  

Provision for loan losses

    715       1,280  

Amortization/accretion of premiums, discounts and deferred costs and fees, net

    406       63  

Amortization of operating lease right-of-use assets

    132        

Amortization of intangible assets and mortgage servicing rights

    249       321  

Realized (gain) loss on sales of debt securities, net

    (78 )     9  

Change in fair value of equity securities, including realized gain

    (12 )     (500 )

Net gain on sales of loans

    (114 )     (19 )

Net (gain) loss on foreclosed real estate

    (49 )     34  

Net loss on sale of premises and equipment

    279       108  

Loans originated for sale

    (6,027 )     (5,329 )

Proceeds from the sale of loans originated for sale

    6,178       5,906  

Write-down of foreclosed real estate

    37       266  

Stock compensation expense

    368       269  

Increase in bank-owned life insurance, net

    (406 )     (340 )

Proceeds from bank-owned life insurance claim

    (160 )      

Decrease in deferred taxes

    122       234  

Increase in accrued interest receivable

    (30 )     (65 )

Increase in prepaid expenses and other assets

    (107 )     (1,187 )

Increase in accrued interest payable

    121       21  

Increase (decrease) in accrued expenses and other liabilities

    (538 )     158  

Net cash provided by operating activities

    10,428       6,612  

Cash flows from investing activities

               

Loan originations and principal collections, net

    10,791       (24,474 )

Proceeds from sales of loans held for sale previously classified as portfolio loans

    967       2,355  

Available-for-sale securities:

               

Sales

    36,370       11,482  

Maturities, repayments and calls

    19,007       10,615  

Purchases

    (76,149 )     (19,145 )

Net cash received for acquisition

          1,557  

Net change in federal bank stocks

    561       (1,499 )

Net change in interest earning time deposits

    (2,960 )     (2,540 )

Proceeds from the sale of bank premises and equipment

    251       155  

Purchases of premises and equipment

    (1,809 )     (885 )

Proceeds from the sale of foreclosed real estate

    1,109       395  

Net cash used in investing activities

    (11,862 )     (21,984 )

Cash flows from financing activities

               

Net increase in deposits

    25,578       754  

Proceeds from long-term debt

          15,000  

Repayments on long-term debt

    (6,000 )     (6,000 )

Net change in short-term borrowings

    (10,800 )     9,150  

Dividends paid

    (3,313 )     (2,753 )

Net cash provided by financing activities

    5,465       16,151  

Net increase in cash and cash equivalents

    4,031       779  

Cash and cash equivalents at beginning of period

    10,955       10,176  

Cash and cash equivalents at end of period

  $ 14,986     $ 10,955  

Supplemental information:

               

Interest paid

  $ 7,962     $ 5,304  

Income taxes paid

    1,410       830  

Supplemental noncash disclosure:

               

Transfers from loans to foreclosed real estate

    645       904  

Initial recognition of operating lease right-of-use assets

    1,642        

Initial recognition of operating lease liabilities

    1,858        

Transfers from portfolio loans to loans held for sale

    1,004       2,409  

Equity securities retired as a result of business combination

          931  

 

See accompanying notes to consolidated financial statements.

 

 

Notes to Consolidated Financial Statements

 

 

 

1.

Summary of Significant Accounting Policies

 

Basis of Presentation and Consolidation. The consolidated financial statements include the accounts of Emclaire Financial Corp (the Corporation) and its wholly owned subsidiaries, The Farmers National Bank of Emlenton (the Bank) and Emclaire Settlement Services, LLC (the Title Company). During 2019, the Title Company ceased operations and was dissolved.  All significant intercompany balances and transactions have been eliminated in consolidation.

 

Nature of Operations. The Corporation provides a variety of financial services to individuals and businesses through its offices in Pennsylvania and West Virginia. Its primary deposit products are checking, savings and term certificate accounts and its primary lending products are residential and commercial mortgages, commercial business loans and consumer loans.

 

Use of Estimates and Classifications. In preparing consolidated financial statements in conformity with U.S. generally accepted accounting principles (GAAP), management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts previously reported may have been reclassified to conform to the current year financial statement presentation. Such reclassifications did not affect net income or stockholders’ equity.

 

Significant Group Concentrations of Credit Risk. Most of the Corporation’s activities are with customers located within the Western Pennsylvania region of the country. Note 2 discusses the type of securities that the Corporation invests in. Note 3 discusses the types of lending the Corporation engages in. The Corporation does not have any significant concentrations to any one industry or customer.

 

Cash and Cash Equivalents. For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, cash items, interest-earning deposits with other financial institutions and federal funds sold and due from correspondent banks. Interest-earning deposits are generally short-term in nature and are carried at cost. Federal funds are generally sold or purchased for one day periods. Net cash flows are reported for loan and deposit transactions, short term borrowings and purchases and redemptions of federal bank stocks.

 

Dividend Restrictions. Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Corporation or by the Corporation to stockholders.

 

Securities Available for Sale. Debt securities are classified as available for sale when they might be sold before maturity. Debt securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.

 

Interest income from securities includes amortization of purchase premium or discount. Discounts on securities are accreted using the level yield method through the maturity date.  Premiums are amortized using the level yield method through the first call date.  In the absence of a call date, the premium is amortized through the maturity date. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

 

Management evaluates debt securities for other-than-temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic, market or other concerns warrant such evaluation. Consideration is given to: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions and (4) whether the Corporation has the intent to sell the security or more likely than not will be required to sell the security before the recovery of its amortized cost basis. If the Corporation intends to sell an impaired security, or if it is more likely than not the Corporation will be required to sell the security before its anticipated recovery, the Corporation records an other-than-temporary loss in an amount equal to the entire difference between fair value and amortized cost through earnings. Otherwise, only the credit portion of the estimated loss on debt securities is recognized in earnings, with the other portion of the loss recognized in other comprehensive income.

 

Equity Securities.  Equity securities are carried at fair value.  The holding gains or losses are reported in net income.

 

Loans Receivable. The Corporation grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by loans collateralized by real estate primarily located throughout Western Pennsylvania. The ability of the Corporation’s debtors to honor their contracts is dependent upon real estate and general economic conditions in this area.

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans or premiums or discounts on purchased loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, and premiums and discounts are deferred and recognized in interest income as an adjustment of the related loan yield using the interest method.

 

 

Notes to Consolidated Financial Statements

 

 

1.

Summary of Significant Accounting Policies (continued)

 

The accrual of interest on all classes of loans is typically discontinued at the time the loan is 90 days past due unless the credit is well secured and in the process of collection. At 120 days past due, all loans are considered nonaccrual. Loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified as impaired loans. All interest accrued but not collected for loans that are placed on nonaccrual status or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for a return to accrual status. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Allowance for Loan Losses. The allowance for loan losses is established for probable incurred credit losses through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are typically credited to the allowance.

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of loans in light of historic experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other factors. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings (TDR) and classified as impaired.

 

Factors considered by management in determining impairment on all loan classes include demonstrated ability to repay, 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 loans by either the present value of expected future cash flows discounted at the loans effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of small balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.

 

TDRs are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a TDR is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of collateral. For TDRs that subsequently default, the Corporation determines the amount of reserves in accordance with accounting policies for the allowance for loan losses.

 

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Corporation over the prior 12 quarters. Qualitative factors considered by management include national and local economic and business conditions, changes in the nature and volume of the loan portfolio, quality of loan review systems, and changes in trends, volume and severity of past due, nonaccrual and classified loans, and loss and recovery trends. The Corporation’s portfolio segments are as follows:

 

Residential mortgages: Residential mortgage loans are loans to consumers utilized for the purchase, refinance or construction of a residence. Changes in interest rates or market conditions may impact a borrower’s ability to meet contractual principal and interest payments.

 

Home equity loans and lines of credit: Home equity loans and lines of credit are credit facilities extended to homeowners who wish to utilize the equity in their property in order to borrow funds for almost any consumer purpose. Property values may fluctuate due to economic and other factors.

 

 

Notes to Consolidated Financial Statements
 

 

1.

Summary of Significant Accounting Policies (continued)

 

Commercial real estate: Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans. These loans are viewed primarily as cash flow loans and the repayment of these loans is largely dependent on the successful operation of the property. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to real estate markets such as geographic location and property type.

 

Commercial business: Commercial credit is extended to business customers for use in normal operations to finance working capital needs, equipment purchases or other projects. The majority of these borrowers are customers doing business within our geographic region. These loans are generally underwritten individually and secured with the assets of the company and the personal guarantee of the business owners. Commercial loans are made based primarily on the historical and projected cash flow of the borrower and the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not behave as forecasted and collateral securing loans may fluctuate in value due to economic or individual performance factors.

 

Consumer: Consumer loans are loans to an individual for non-business purposes such as automobile purchases or debt consolidation. These loans are originated based primarily on credit scores and debt-to-income ratios which may be adversely affected by economic or individual performance factors.

 

Loans Held for Sale. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Mortgage loans held for sale are generally sold with servicing retained. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains and losses on sales of mortgages are based on the difference between the selling price and the carrying value of the related loan sold.

 

Federal Bank Stocks. The Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB) and the Federal Reserve Bank of Cleveland (FRB). As a member of these federal banking systems, the Bank maintains an investment in the capital stock of the respective regional banks. These stocks are held at cost and classified as restricted stock. These stocks are purchased and redeemed at par as directed by the federal banks and levels maintained are based primarily on borrowing and other correspondent relationships. These stocks are periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

 

Bank-Owned Life Insurance (BOLI). The Bank purchased life insurance policies on certain key officers and employees. BOLI is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

 

Premises and Equipment. Land is carried at cost. Premises, furniture and equipment, and leasehold improvements are carried at cost less accumulated depreciation or amortization. Depreciation is calculated on a straight-line basis over the estimated useful lives of the related assets, which are twenty-five years to forty years for buildings and three to ten years for furniture and equipment. Amortization of leasehold improvements is computed using the straight-line method over the shorter of their estimated useful life or the expected term of the leases. Expected terms include lease option periods to the extent that the exercise of such option is reasonably assured. Premises and equipment are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, assets are recorded at fair value.

 

Goodwill and Intangible Assets. Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired assets and liabilities. Core deposit intangible assets arise from whole bank or branch acquisitions and are measured at fair value and then are amortized over their estimated useful lives. Customer relationship intangible assets arise from the purchase of a customer list from another company or individual and then are amortized on a straight-line basis over two years. Goodwill is not amortized but is assessed at least annually for impairment. Any such impairment will be recognized in the period identified. The Corporation has selected November 30 as the date to perform the annual impairment test. Goodwill is the only intangible asset with an indefinite life on the Corporation’s balance sheet.

 

Servicing Assets. Servicing assets represent the allocated value of retained servicing rights on loans sold. Servicing assets are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the assets, using groupings of the underlying loans as to interest rates. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment of a grouping is reported as a valuation allowance, to the extent that fair value is less than the capitalized amount for a grouping.

 

 

Notes to Consolidated Financial Statements

 

 

1.

Summary of Significant Accounting Policies (continued)

 

Other Real Estate Acquired Through Foreclosure (OREO). Real estate properties acquired through foreclosure are initially recorded at fair value less cost to sell when acquired, thereby establishing a new cost basis for the asset. These assets are subsequently accounted for at the lower of carrying amount or fair value less cost to sell. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Revenue and expenses from operations of the properties, gains and losses on sales and additions to the valuation allowance are included in operating results. Real estate acquired through foreclosure is classified in prepaid expenses and other assets and totaled $249,000 and $701,000 at December 31, 2019 and 2018, respectively. Loans secured by residential real estate properties for which formal foreclosure proceedings are in process totaled $545,000 and $811,000 at December 31, 2019 and 2018, respectively.

 

Treasury Stock. Common stock purchased for treasury is recorded at cost. At the date of subsequent reissue, the treasury stock account is reduced by the cost of such stock on the first-in, first-out basis.

 

Income Taxes. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Corporation recognizes interest and/or penalties related to income tax matters in income tax expense.

 

Earnings Per Common Share (EPS). Basic EPS excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS includes the dilutive effect of additional potential common shares issuable under stock options and restricted stock awards.

 

Comprehensive Income. Comprehensive income includes net income and other comprehensive income. Other comprehensive income (loss) is comprised of unrealized holding gains and losses on securities available for sale and changes in the funded status of pension which are also recognized as separate components of equity.

 

Operating Segments. Operations are managed and financial performance is evaluated on a corporate-wide basis. Accordingly, all financial services operations are considered by management to be aggregated in one reportable operating segment.

 

Retirement Plans. The Corporation maintains a noncontributory defined benefit plan covering eligible employees and officers. Effective January 1, 2009 the plan was closed to new participants. The Corporation provided the requisite notice to plan participants on March 12, 2013 of the determination to freeze the plan (curtailment). While the freeze was not effective until April 30, 2013, the Corporation determined that participants would not satisfy, within the provisions of the plan, 2013 eligibility requirements based on minimum hours worked for 2013. Therefore, employees ceased to earn benefits as of January 1, 2013. This amendment to the plan did not affect benefits earned by the participant prior to the date of the freeze. The Corporation also maintains a 401(k) plan, which covers substantially all employees, and a supplemental executive retirement plan for key executive officers.

 

Stock Compensation Plans. Compensation expense is recognized for stock options and restricted stock awards issued based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. Compensation expense is recognized over the required service period, generally defined as the vesting period. It is the Corporation’s policy to issue shares on the vesting date for restricted stock awards. Unvested restricted stock awards do not receive dividends declared by the Corporation.

 

Transfers of Financial Assets. Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

 

Off-Balance Sheet Financial Instruments. In the ordinary course of business, the Corporation has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commitments under line of credit lending arrangements and letters of credit. Such financial instruments are recorded in the financial statements when they are funded.

 

 

Notes to Consolidated Financial Statements

 

 

1.

Summary of Significant Accounting Policies (continued)

 

Fair Value of Financial Instruments. Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates.

 

Loss Contingencies. Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there currently are such matters that will have a material effect on the financial statements.

 

 Newly Issued Not Yet Effective Accounting Standards.  In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. ASU 2016-13 significantly changes the way impairment of financial instruments is recognized by requiring immediate recognition of estimated credit losses expected to occur over the remaining life of the financial instruments. The main provisions of the guidance include (1) replacing the “incurred loss” approach under current GAAP with an “expected loss” model for instruments measured at amortized cost, (2) requiring entities to record an allowance for available-for-sale debt securities rather than reduce the carrying amount of the investments, as is required by the other-than-temporary impairment model under current GAAP, and (3) a simplified accounting model for purchased credit-impaired debt securities and loans. The ASU is effective for interim and annual reporting periods beginning after December 15, 2019, although early adoption is permitted. However, on October 16, 2019, FASB announced a delay for the effective date of this ASU for smaller reporting companies until fiscal years beginning after December 15, 2022.  As the Corporation is a smaller reporting company, the delay would be applicable.  

Management has selected a software vendor and is currently working through the implementation process.  The Corporation is reviewing available historical information in order to assess the expected credit losses and determine the impact the adoption of ASU 2016-13 will have on the financial statements.

 

In January 2017, the FASB issued ASU 2017-04, "Simplifying the Test for Goodwill Impairment". This ASU simplifies the measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Instead, under this amendment, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss should not exceed the total amount of goodwill allocated to that reporting unit. The amendments are effective for public business entities for the first interim and annual reporting periods beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Corporation has goodwill from prior and current year business combinations and performs an annual impairment test or more frequently if changes or circumstances occur that would more likely than not reduce the fair value of the reporting unit below its carrying value. The Corporation's most recent annual impairment assessment determined that the Corporation's goodwill was not impaired. Although the Corporation cannot anticipate future goodwill impairment assessments, based on the most recent assessment it is unlikely that an impairment amount would need to be calculated and, therefore, does not anticipate a material impact from these amendments to the Corporation's financial position and results of operations. The current accounting policies and processes are not anticipated to change, except for the elimination of the Step 2 analysis.

In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement".  ASU 2018-13 eliminates, adds and modifies certain disclosure requirements for fair value measurements.  Disclosures for transfers between Level 1 and Level 2, the policy for timing of transfers between levels, and the valuation processes for Level 3 fair value measurement will be removed.  Additional disclosures will be required relating to (a) changes in unrealized gains/losses in OCI for Level 3 fair value measurements for assets held at the end of the reporting period, and (b) the process of calculating weighted average for significant unobservable inputs used to develop Level 3 fair value measurements.  The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2019.  Early adoption is permitted.  The Corporation does not expect ASU 2018-13 to have a material impact on its financial statements and disclosures.

 

In August 2018, the FASB issued ASU 2018-14, "Compensation - Retirement Benefits - Defined Benefit Plans".  ASU 2018-14 removes disclosures pertaining to (a) the amounts of AOCI expected to be recognized as pension costs over the next fiscal year, (b) the amount and timing of plan assets expected to be returned to the employer, and (c) the effect of one-percentage-point change in the assumed health care trends on (i) service and interest costs and (ii) post-retirement health care benefit obligation.  A disclosure will be added requiring an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period.  The amendments in this update are effective retrospectively for annual periods and interim periods within those annual periods beginning after December 15, 2020.  Early adoption is permitted.  The Corporation does not expect ASU 2018-14 to have a material impact on its financial statements and disclosures.

 

In December 2019, the FASB issued ASU 2019-12, "Income Taxes - Simplifying the Accounting for Income Taxes".  ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, with early adoption permitted.  Certain provisions under ASU 2019-12 require prospective application, some require modified retrospective adoption, while other provisions require retrospective application to all periods presented in the consolidated financial statements upon adoption.  The Corporation is currently evaluating the effect that this ASU will have on its financial statements and disclosures.

 


 

 

Notes to Consolidated Financial Statements
 

 

1.

Summary of Significant Accounting Policies (continued)

 

Adoption of New Accounting Policies.  In February 2016, the FASB issued ASU 2016-02 "Leases". This ASU required lessees to record most leases on their balance sheet but recognize expenses in the income statement in a manner similar to prior accounting treatment. This ASU changed the guidance on sale-leaseback transactions, initial direct costs and lease execution costs, and, for lessors, modified the classification criteria and the accounting for sales-type and direct financing leases. ASU 2016-02 was effective for annual periods beginning after December 15, 2018, and interim periods therein. In January 2018, the FASB issued ASU 2018-01, which allowed entities the option to apply the provisions of the new lease guidance at the effective date without adjusting the comparative periods presented.  Adoption of this guidance as of January 1, 2019 resulted in the recording of initial lease right-of-use assets of $1.6 million and operating lease liabilities of $1.8 million.  The Corporation recorded a cumulative adjustment to retained earnings for prior period of $171,000, net of deferred taxes of $45,000.  See Note 5 - Premises, Equipment and Leases for more information on page F-21.

 

In March 2017, the FASB issued ASU 2017-08, "Receivable - Nonrefundable Fees and Other Costs (Subtopic 310-20) Premium Amortization on Purchased Callable Debt Securities."  ASU 2017-08 amended guidance on the amortizaton period of premiums on certain purchased callable debt securities to shorten the amortization period of premiums on certain purchased callable debt securities to the earliest call date. The amendments were effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods therein.  The adoption of this guidance on January 1, 2019 resulted in a cumulative adjustment to retained earnings of $10,000, net of deferred taxes of $3,000, for prior periods.  At the time of adoption, the remaining securities subject to this guidance have a call date one month prior to maturity, therefore the impact to the statement of income in subsequent periods is immaterial.  As of December 31, 2019, the Corporation held only one remaining callable security which has a maturity date of September 15, 2020.

In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." The amendments in this Update are to better reflect the economic results of hedging in the financial statements along with simplification of certain hedge accounting requirements. Specifically, the entire change in the fair value of the hedging instrument is required to be presented in the same income statement line as and in the same period that the earnings effect of the hedged item is recognized. Therefore, hedge ineffectiveness will not be reported separately or in a different period. In addition, hedge effectiveness can be determined qualitatively in periods following inception. The amendments permitted an entity to measure the change in fair value of the hedged item on the basis of the benchmark rate component. They also permitted an entity to measure the hedged item in a partial-term fair value hedge of interest rate risk by assuming the hedged item has a term that reflects only the designated cash flows being hedged. For a closed portfolio of prepayable financial assets, an entity is permitted to designate the amount that is not expected to be affected by prepayments or defaults as the hedged item. For public business entities, the new guidance was effective for fiscal years beginning after December 15, 2018, and interim periods therein. Early adoption was permitted. The Corporation currently does not have derivative or hedging instruments so this guidance had no impact on consolidated financial statements.

 

 

Notes to Consolidated Financial Statements
 

 

 

2.

Securities

 

Equity Securities. The Corporation held equity securities with fair values of $19,000 and $7,000 as of December 31, 2019 and 2018, respectively.  Beginning January 1, 2018, with the adoption of ASU 2016-01, changes in the fair value of these securities are included in other income on the consolidated statements of net income as opposed to accumulated other comprehensive loss on the consolidated balance sheets.  The Corporation recognized a gain of $12,000 and a loss of $10,000 on the equity securities held at December 31, 2019 and 2018, respectively.  During 2018, the Corporation sold $1.3 million of equity securities with a realized net loss of $43,000.  On October 1, 2018 the Corporation acquired Community First Bancorp, Inc. (CFB).  At the time of the acquisition, the Corporation held 18,000 shares of CFB's common stock which were retired resulting in a realized gain of $690,000.

 

Debt Securities - Available for Sale. The following table summarizes the Corporation’s securities as of December 31:

 

(Dollar amounts in thousands)

 

Amortized Cost

   

Gross Unrealized Gains

   

Gross Unrealized Losses

   

Fair Value

 

December 31, 2019:

                               

U.S. government sponsored entities and agencies

  $ 7,069     $ 14     $ (6 )   $ 7,077  

U.S. agency mortgage-backed securities: residential

    40,868       291       (84 )     41,075  

U.S. agency collateralized mortgage obligations: residential

    33,001       71       (235 )     32,837  

State and political subdivisions

    27,848       217       (269 )     27,796  

Corporate debt securities

    11,459       93       (230 )     11,322  

Total securities available-for-sale

  $ 120,245     $ 686     $ (824 )   $ 120,107  
                                 

December 31, 2018:

                               

U.S. Treasury

  $ 4,532     $     $ (87 )   $ 4,445  

U.S. government sponsored entities and agencies

    17,052       30       (299 )     16,783  

U.S. agency mortgage-backed securities: residential

    27,666             (490 )     27,176  

U.S. agency collateralized mortgage obligations: residential

    19,440       34       (810 )     18,664  

State and political subdivisions

    22,943       13       (224 )     22,732  

Corporate debt securities

    8,006       9       (97 )     7,918  

Total securities available-for-sale

  $ 99,639     $ 86     $ (2,007 )   $ 97,718  

 

Securities with carrying values of $22.1 million and $20.6 million as of December 31, 2019 and 2018, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.

 

Gains on sales of available for sale debt securities for the years ended December 31 were as follows: 

 

   

2019

   

2018

 

Proceeds

  $ 36,370     $ 11,482  

Gains

    135       17  

Losses

    (57 )     (26 )

Tax provision related to gains (losses)

    16       (2 )

 

 

Notes to Consolidated Financial Statements

 

 

2.

Securities (continued)

 

The following table summarizes scheduled maturities of the Corporation’s debt securities as of December 31, 2019. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities and collateralized mortgage obligations are not due at a single maturity and are shown separately.

 

(Dollar amounts in thousands)

 

Available-for-sale

 
   

Amortized Cost

   

Fair Value

 

Due in one year or less

  $ 265     $ 265  

Due after one year through five years

    10,072       10,122  

Due after five through ten years

    13,883       13,848  

Due after ten years

    22,155       21,960  

Mortgage-backed securities: residential

    40,868       41,075  

Collateralized mortgage obligations: residential

    33,001       32,837  

Total securities available-for-sale

  $ 120,245     $ 120,107  

 

Information pertaining to securities with gross unrealized losses at December 31, 2019 and 2018 aggregated by investment category and length of time that individual securities have been in a continuous loss position are included in the table below: 

 

(Dollar amounts in thousands)

 

Less than 12 Months

   

12 Months or More

   

Total

 
   

Fair Value

   

Unrealized Loss

   

Fair Value

   

Unrealized Loss

   

Fair Value

   

Unrealized Loss

 

December 31, 2019:

                                               

U.S. government sponsored entities and agencies

                2,032       (6 )     2,032       (6 )

U.S. agency mortgage-backed securities: residential

    14,578       (76 )     2,325       (8 )     16,903       (84 )

U.S. agency collateralized mortgage obligations: residential

    12,319       (32 )     11,621       (203 )     23,940       (235 )

State and political subdivisions

    15,636       (269 )                 15,636       (269 )

Corporate debt securities

    4,031       (229 )     499       (1 )     4,530       (230 )

Total

  $ 46,564     $ (606 )   $ 16,477     $ (218 )   $ 63,041     $ (824 )
                                                 

December 31, 2018:

                                               

U.S. Treasury

  $     $     $ 4,445     $ (87 )   $ 4,445     $ (87 )

U.S. government sponsored entities and agencies

    2,472       (30 )     10,337       (269 )     12,809       (299 )

U.S. agency mortgage-backed securities: residential

    19,483       (297 )     7,693       (193 )     27,176       (490 )

U.S. agency collateralized mortgage obligations: residential

    1,443       (5 )     15,388       (805 )     16,831       (810 )

State and political subdivisions

    7,061       (67 )     10,083       (157 )     17,144       (224 )

Corporate debt securities

    962       (38 )     2,448       (59 )     3,410       (97 )

Total

  $ 31,421     $ (437 )   $ 50,394     $ (1,570 )   $ 81,815     $ (2,007 )

 

Management evaluates debt securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic, market or other conditions warrant such evaluation. Consideration is given to: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions and (4) whether the Corporation has the intent to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If the Corporation intends to sell an impaired security, or if it is more likely than not the Corporation will be required to sell the security before its anticipated recovery, the Corporation records an other-than-temporary loss in an amount equal to the entire difference between fair value and amortized cost. Otherwise, only the credit portion of the estimated loss on debt securities is recognized in earnings, with the other portion of the loss recognized in other comprehensive income.

 

 

Notes to Consolidated Financial Statements


 

 

2.

Securities (continued)

 

There were 78 debt securities in an unrealized loss position as of December 31, 2019, of which 29 were in an unrealized loss position for more than 12 months. Of these 78 securities, 30 were collateralized mortgage obligations (issued by U.S. government sponsored entities), 23 were state and political subdivisions securities, 13 were mortgage-backed securities, 10 were corporate securities and 2 were U.S. government sponsored entities and agencies securities. The unrealized losses associated with these securities were not due to the deterioration in the credit quality of the issuer that is likely to result in the non-collection of contractual principal and interest, but rather have been caused by a rise in interest rates from the time the securities were purchased. Based on that evaluation and other general considerations, and given that the Corporation’s current intention is not to sell any impaired securities and it is more likely than not it will not be required to sell these securities before the recovery of its amortized cost basis, the Corporation does not consider the debt securities with unrealized losses as of December 31, 2019 to be other-than-temporarily impaired.

 

 

 

3.

Loans Receivable and Related Allowance for Loan Losses

 

The following table summarizes the Corporation’s loans receivable as of December 31:

 

(Dollar amounts in thousands)

 

December 31, 2019

   

December 31, 2018

 

Mortgage loans on real estate:

               

Residential first mortgages

  $ 293,170     $ 295,405  

Home equity loans and lines of credit

    97,541       103,752  

Commercial real estate

    229,951       238,734  

Total real estate loans

    620,662       637,891  

Other loans:

               

Commercial business

    66,603       66,009  

Consumer

    14,639       11,272  

Total other loans

    81,242       77,281  

Total loans, gross

    701,904       715,172  

Less allowance for loan losses

    6,556       6,508  

Total loans, net

  $ 695,348     $ 708,664  

 

Included in total loans above are net deferred costs of $2.6 million and $2.2 million at December 31, 2019 and 2018, respectively.

 

An allowance for loan losses (ALL) is maintained to absorb probable incurred losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience and the amount of nonperforming loans.

 

 Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.

 

Following is an analysis of the changes in the ALL for the years ended December 31:

 

(Dollar amounts in thousands)

 

2019

 

2018

Balance at the beginning of the year

  $ 6,508     $ 6,127  

Provision for loan losses

    715       1,280  

Charge-offs

    (913 )     (989 )

Recoveries

    246       90  

Balance at the end of the year

  $ 6,556     $ 6,508  

 

 

 

Notes to Consolidated Financial Statements


 

 

3.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following table details activity in the ALL and the recorded investment by portfolio segment based on impairment method at December 31, 2019 and 2018:

 

           

Home Equity

                                 
   

Residential

   

& Lines

   

Commercial

   

Commercial

                 

(Dollar amounts in thousands)

 

Mortgages

   

of Credit

   

Real Estate

   

Business

   

Consumer

   

Total

 

December 31, 2019:

                                               

Beginning Balance

  $ 2,198     $ 648     $ 3,106     $ 500     $ 56     $ 6,508  

Charge-offs

    (227 )     (61 )     (242 )     (250 )     (133 )     (913 )

Recoveries

    40       6       134             66       246  

Provision

    298       33       (100 )     386       98       715  

Ending Balance

  $ 2,309     $ 626     $ 2,898     $ 636     $ 87     $ 6,556  
                                                 

Ending ALL balance attributable to loans:

                                               

Individually evaluated for impairment

  $ 5     $     $     $     $     $ 5  

Acquired loans collectively evaluated for impairment

                                   

Originated loans collectively evaluated for impairment

    2,304       626       2,898       636       87       6,551  

Total

  $ 2,309     $ 626     $ 2,898     $ 636     $ 87     $ 6,556  
                                                 

Total loans:

                                               

Individually evaluated for impairment

  $ 358     $ 4     $ 81     $ 40     $     $ 483  

Acquired loans collectively evaluated for impairment

    60,523       10,901       41,993       7,930       1,982       123,329  

Originated loans collectively evaluated for impairment

    232,289       86,636       187,877       58,633       12,657       578,092  

Total

  $ 293,170     $ 97,541     $ 229,951     $ 66,603     $ 14,639     $ 701,904  
                                                 

At December 31, 2018:

                                               

Beginning Balance

  $ 2,090     $ 646     $ 2,753     $ 585     $ 53     $ 6,127  

Charge-offs

    (71 )     (155 )     (484 )           (279 )     (989 )

Recoveries

    3       14       48       1       24       90  

Provision

    176       143       789       (86 )     258       1,280  

Ending Balance

  $ 2,198     $ 648     $ 3,106     $ 500     $ 56     $ 6,508  
                                                 

Ending ALL balance attributable to loans:

                                               

Individually evaluated for impairment

  $ 12     $     $     $     $     $ 12  

Acquired loans collectively evaluated for impairment

                                   

Originated loans collectively evaluated for impairment

    2,186       648       3,106       500       56       6,496  

Total

  $ 2,198     $ 648     $ 3,106     $ 500     $ 56     $ 6,508  
                                                 

Total loans:

                                               

Individually evaluated for impairment

  $ 389     $ 6     $ 34     $ 39     $     $ 468  

Acquired loans collectively evaluated for impairment

    72,654       13,750       56,690       12,974       3,306       159,374  

Originated loans collectively evaluated for impairment

    222,362       89,996       182,010       52,996       7,966       555,330  

Total

  $ 295,405     $ 103,752     $ 238,734     $ 66,009     $ 11,272     $ 715,172  
                                                 

 

The allowance for loan losses is based on estimates, and actual losses will vary from current estimates. Management believes that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.

 

At December 31, 2019 and 2018, there was no allowance for loan losses allocated to loans acquired from United American Savings Bank (2016), Northern Hancock Bank and Trust Co. (2017) or Community First Bancorp, Inc (2018).

 

Notes to Consolidated Financial Statements


 

 

3.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following tables present impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of December 31: 

 

(Dollar amounts in thousands)

                                               
   

Impaired Loans with Specific Allowance

 
   

As of December 31, 2019

   

For the year ended December 31, 2019

 
   

Unpaid Principal Balance

   

Recorded Investment

   

Related Allowance

   

Average Recorded Investment

   

Interest Income Recognized in Period

   

Cash Basis Interest Recognized in Period

 

Residential first mortgages

  $ 72     $ 72     $ 5     $ 72     $ 3     $ 3  

Home equity and lines of credit

    4       4             5              

Commercial real estate

                                   

Commercial business

                                   

Consumer

                                   

Total

  $ 76     $ 76     $ 5     $ 77     $ 3     $ 3  

 

   

Impaired Loans with No Specific Allowance

 
   

As of December 31, 2019

   

For the year ended December 31, 2019

 
   

Unpaid Principal Balance

   

Recorded Investment

   

Average Recorded Investment

   

Interest Income Recognized in Period

   

Cash Basis Interest Recognized in Period

 

Residential first mortgages

  $ 398     $ 286     $ 301     $ 4     $ 4  

Home equity and lines of credit

                             

Commercial real estate

    81       81       1,019       88       35  

Commercial business

    40       40       79       7       2  

Consumer

                             

Total

  $ 519     $ 407     $ 1,399     $ 99     $ 41  

 

 

(Dollar amounts in thousands)

                                               
   

Impaired Loans with Specific Allowance

 
   

As of December 31, 2018

   

For the year ended December 31, 2018

 
   

Unpaid Principal Balance

   

Recorded Investment

   

Related Allowance

   

Average Recorded Investment

   

Interest Income Recognized in Period

   

Cash Basis Interest Recognized in Period

 

Residential first mortgages

  $ 74     $ 74     $ 12     $ 74     $ 2     $ 2  

Home equity and lines of credit

    6       6             7              

Commercial real estate

                                   

Commercial business

                                   

Consumer

                                   

Total

  $ 80     $ 80     $ 12     $ 81     $ 2     $ 2  

 

   

Impaired Loans with No Specific Allowance

 
   

As of December 31, 2018

   

For the year ended December 31, 2018

 
   

Unpaid Principal Balance

   

Recorded Investment

   

Average Recorded Investment

   

Interest Income Recognized in Period

   

Cash Basis Interest Recognized in Period

 

Residential first mortgages

  $ 427     $ 315     $ 334     $ 5     $ 5  

Home equity and lines of credit

                             

Commercial real estate

    34       34       768       156       73  

Commercial business

    39       39       248       74       74  

Consumer

                             

Total

  $ 500     $ 388     $ 1,350     $ 235     $ 152  

 

 

Notes to Consolidated Financial Statements


 

 

 3.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

Unpaid principal balance includes any loans that have been partially charged off but not forgiven. Accrued interest is not included in the recorded investment in loans presented above or in the tables that follow based on the amounts not being material.

 

Troubled debt restructurings (TDR). The Corporation has certain loans that have been modified in order to maximize collection of loan balances. If, for economic or legal reasons related to the customer’s financial difficulties, management grants a concession compared to the original terms and conditions of the loan that it would not have otherwise considered, the modified loan is classified as a TDR. Concessions related to TDRs generally do not include forgiveness of principal balances. The Corporation has no legal obligation to extend additional credit to borrowers with loans classified as TDRs.

 

At December 31, 2019 and 2018, the Corporation had $409,000 and $394,000, respectively, of loans classified as TDRs, which are included in impaired loans above. At December 31, 2019 and 2018, the Corporation had $5,000 and $12,000, respectively, of the allowance for loan losses allocated to these specific loans.

 

During the year ended December 31, 2019, the Corporation modified one commercial mortgage loans with a recorded investment of $67,000.  In order to cure the delinquency on the loan, all interest and fees receivable were capitalized to the loan principal which was re-amortized through the original maturity date at the original interest rate on the loan.   The modification did not have a material impact on the Corporation’s income statement during the period.  At December 31, 2019, the Corporation did not have any allowance for loan losses allocated to this specific loan.  During the year ended December 31, 2018, the Corporation did not modify any loans as TDRs.

 

A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms. During the year ended December 31, 2019 and 2018, there were no loans classified as TDRs which defaulted within twelve months of their modification.

 

Credit Quality Indicators. Management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors.

 

Commercial real estate and commercial business loans not identified as impaired are evaluated as risk rated pools of loans utilizing a risk rating practice that is supported by a quarterly special asset review. In this review process, strengths and weaknesses are identified, evaluated and documented for each criticized and classified loan and borrower, strategic action plans are developed, risk ratings are confirmed and the loan’s performance status reviewed.

 

Management has determined certain portions of the loan portfolio to be homogeneous in nature and assigns like reserve factors for the following loan pool types: residential real estate, home equity loans and lines of credit, and consumer installment and personal lines of credit. These homogeneous loans are not rated unless identified as impaired.

 

Management uses the following definitions for risk ratings:

 

Pass: Loans classified as pass typically exhibit good payment performance and have underlying borrowers with acceptable financial trends where repayment capacity is evident. These borrowers typically would have sufficient cash flow that would allow them to weather an economic downturn and the value of any underlying collateral could withstand a moderate degree of depreciation due to economic conditions.

 

Special Mention: Loans classified as special mention are characterized by potential weaknesses that could jeopardize repayment as contractually agreed. These loans may exhibit adverse trends such as increasing leverage, shrinking profit margins and/or deteriorating cash flows. These borrowers would inherently be more vulnerable to the application of economic pressures.

 

Substandard: Loans classified as substandard exhibit weaknesses that are well-defined to the point that repayment is jeopardized. Typically, the Corporation is no longer adequately protected by both the apparent net worth and repayment capacity of the borrower.

 

Doubtful: Loans classified as doubtful have advanced to the point that collection or liquidation in full, on the basis of currently ascertainable facts, conditions and value, is highly questionable or improbable.

 

 

Notes to Consolidated Financial Statements


 

 

3.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following table presents the classes of the loan portfolio summarized by the aggregate pass and the criticized categories of special mention, substandard and doubtful within the Corporation’s internal risk rating system as of December 31, 2019 and 2018:

 

(Dollar amounts in thousands)

                                               
   

Not Rated

   

Pass

   

Special Mention

   

Substandard

   

Doubtful

   

Total

 

December 31, 2019:

                                               

Residential first mortgages

  $ 291,843     $     $     $ 1,327     $     $ 293,170  

Home equity and lines of credit

    97,087                   454             97,541  

Commercial real estate

          216,744       5,370       7,837             229,951  

Commercial business

          64,636       204       1,763             66,603  

Consumer

    14,557                   82             14,639  

Total loans

  $ 403,487     $ 281,380     $ 5,574     $ 11,463     $     $ 701,904  
                                                 

December 31, 2018:

                                               

Residential first mortgages

  $ 293,919     $     $     $ 1,486     $     $ 295,405  

Home equity and lines of credit

    102,869                   883             103,752  

Commercial real estate

          222,335       5,942       10,457             238,734  

Commercial business

          62,022       542       3,445             66,009  

Consumer

    11,157                   115             11,272  

Total loans

  $ 407,945     $ 284,357     $ 6,484     $ 16,386     $     $ 715,172  

 

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a required payment is past due. The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonperforming loans as of December 31, 2019 and 2018:

 

(Dollar amounts in thousands)

                                               
   

Performing

   

Nonperforming

         
   

Accruing Loans Not Past Due

   

Accruing 30-59 Days Past Due

   

Accruing 60-89 Days Past Due

   

Accruing 90+ Days Past Due

   

Nonaccrual

   

Total

 

December 31, 2019:

                                               

Residential first mortgages

  $ 288,462     $ 2,405     $ 1,039     $ 309     $ 955     $ 293,170  

Home equity and lines of credit

    95,923       626       553       11       428       97,541  

Commercial real estate

    226,360       2,141       543             907       229,951  

Commercial business

    66,091       225       72             215       66,603  

Consumer

    14,458       84       15             82       14,639  

Total loans

  $ 691,294     $ 5,481     $ 2,222     $ 320     $ 2,587     $ 701,904  
                                                 

December 31, 2018:

                                               

Residential first mortgages

  $ 289,732     $ 3,586     $ 747     $ 485     $ 855     $ 295,405  

Home equity and lines of credit

    101,920       707       351       287       487       103,752  

Commercial real estate

    232,865       5,013       231       19       606       238,734  

Commercial business

    65,538       50       247             174       66,009  

Consumer

    10,961       160       36             115       11,272  

Total loans

  $ 701,016     $ 9,516     $ 1,612     $ 791     $ 2,237     $ 715,172  

 

 

 

Notes to Consolidated Financial Statements


 

 

3.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following table presents the Corporation’s nonaccrual loans by aging category as of December 31, 2019 and 2018:
 

(Dollar amounts in thousands)

                                       
   

Not Past Due

   

30-59 Days Past Due

   

60-89 Days Past Due

   

90 Days + Past Due

   

Total

 

December 31, 2019:

                                       

Residential first mortgages

  $ 245     $     $ 72     $ 638     $ 955  

Home equity and lines of credit

    4                   424       428  

Commercial real estate

    28       309       31       539       907  

Commercial business

                175       40       215  

Consumer

                      82       82  

Total loans

  $ 277     $ 309     $ 278     $ 1,723     $ 2,587  
                                         

December 31, 2018:

                                       

Residential first mortgages

  $ 335     $     $ 74     $ 446     $ 855  

Home equity and lines of credit

    6                   481       487  

Commercial real estate

    111       265             230       606  

Commercial business

                39       135       174  

Consumer

                      115       115  

Total loans

  $ 452     $ 265     $ 113     $ 1,407     $ 2,237  

 


 

 

 

4.

Federal Bank Stocks

 

The Bank is a member of the FHLB and the FRB. As a member of these federal banking systems, the Bank maintains an investment in the capital stock of the respective regional banks, which are carried at cost. These stocks are purchased and redeemed at par as directed by the federal banks and levels maintained are based primarily on borrowing and other correspondent relationships. The Bank’s investment in FHLB and FRB stocks was $4.0 million and $1.8 million, respectively, at December 31, 2019, and $5.0 million and $1.3 million, respectively, at December 31, 2018.

 

 

 

5.

Premises, Equipment and Leases

 

Premises and Equipment

 

Premises and equipment at December 31 are summarized by major classification as follows:

 

(Dollar amounts in thousands)

 

2019

 

2018

Land

  $ 5,269     $ 5,129  

Buildings and improvements

    15,127       15,008  

Leasehold improvements

    1,522       1,519  

Furniture, fixtures and equipment

    10,539       9,157  

Software

    3,397       3,347  

Construction in progress

    321       576  
Total     36,175       34,736  

Less: accumulated depreciation and amortization

    17,134       15,825  
Net premises and equipment   $ 19,041     $ 18,911  

 

Depreciation and amortization expense for the years ended December 31, 2019 and 2018 were $1.4 million and $1.2 million, respectively.

 

 

 

Notes to Consolidated Financial Statements


 

 

5.

Premises, Equipment and Leases (continued)

 

Leases

 

Effective January 1, 2019, the Corporation adopted ASU 2016-02, Leases (Topic 842).  As of December 31, 2019, the Corporation leases real estate for five branch offices under various operating lease agreements.  The lease agreements have maturity dates ranging from August 2025 to December 2056, including all extension periods.  The Corporation has assumed that there are currently no circumstances in which the leases would be terminated before expiration.  The weighted average remaining life of the lease term for these leases was 12.99 years as of December 31, 2019.

 

The discount rate used in determining the lease liability for each individual lease was the FHLB fixed advance rate which corresponded with the remaining lease terms as of January 1, 2019 for leases that existed at adoption.  This methodology will be continued for the commencement of any subsequent lease agreements.  The weighted average discount rate for the leases was 3.49% as of December 31, 2019.

 

The total operating lease costs were $194,000 for the year ended December 31, 2019.  The right-of-use asset, included in other assets, and lease liability, included in other liabilities, were $1.5 million and $1.7 million, respectively, as of December 31, 2019.  Rental expense for operating leases classified under ASC 840 was $208,000 for the year ended December 31, 2018.

 

Total estimated rental commitments for the operating leases were as follows as of December 31, 2019:

 

(Dollar amounts in thousands)

       

Year ending December 31:

       

2020

  $ 212  

2021

    217  

2022

    222  

2023

    222  

2024

    227  

Thereafter

    1,063  

Total minimum lease payments

    2,163  

Discount effect of cash flows

    (456 )

Present value of lease liabilities

  $ 1,707  

 

 

 

6.

Goodwill and Intangible Assets

 

The following table summarizes the Corporation’s acquired goodwill and intangible assets as of December 31:

 

(Dollar amounts in thousands)

 

December 31, 2019

   

December 31, 2018

 
   

Gross Carrying Amount

   

Accumulated Amortization

   

Gross Carrying Amount

   

Accumulated Amortization

 

Goodwill

  $ 19,460     $     $ 19,448     $  

Core deposit intangibles

    5,634       4,387       5,634       4,211  

Total

  $ 25,094     $ 4,387     $ 25,082     $ 4,211  

 

 

Goodwill resulted from five acquisitions. During 2018, the Corporation recorded $9.2 million of goodwill related to the acquisition of CFB (see Note 20). Goodwill represents the excess of the total purchase price paid for the acquisitions over the fair value of the identifiable assets acquired, net of the fair value of the liabilities assumed. Goodwill is not amortized but is evaluated for impairment on an annual basis or whenever events or changes in circumstances indicate the carrying value may not be recoverable. Impairment exists when a reporting unit’s carrying amount exceeds its fair value. The Corporation has selected November 30 as the date to perform the annual impairment test. No goodwill impairment charges were recorded in 2019 or 2018. Goodwill is the only intangible asset with an indefinite life on the Corporation’s balance sheet.

The core deposit intangible asset, resulting from three acquisitions, is amortized over a weighted average estimated life of the related deposits and is not estimated to have a significant residual value. The Corporation recorded intangible amortization expense totaling $176,000 and $266,000 in 2019 and 2018, respectively.

 

 

 

Notes to Consolidated Financial Statements


 

 

6.

Goodwill and Intangible Assets (continued)

 

The estimated amortization expense of the core deposit intangible for the years ending December 31 is as follows:

 

(Dollar amounts in thousands)

 

Amortization

   

Expense

2020

  $ 164  

2021

    154  

2022

    149  

2023

    149  

2024

    149  

Thereafter

    482  
Total   $ 1,247  

 

 

 

7.

Related Party Balances and Transactions

 

In the ordinary course of business, the Bank maintains loan and deposit relationships with employees, principal officers and directors and their affiliates. The Bank has granted loans to principal officers and directors and their affiliates amounting to $4.7 million and $5.3 million at December 31, 2019 and 2018, respectively. During 2019, there were no principal additions while total principal reductions associated with these loans were $562,000. Deposits from principal officers and directors and their affiliates held by the Bank at December 31, 2019 and 2018 totaled $3.1 million and $3.2 million, respectively.

 

In addition, directors and their affiliates may provide certain professional and other services to the Corporation and the Bank in the ordinary course of business.  The Corporation did not pay directors or their affiliates for any such services in 2019.  During 2018, one director was paid an immaterial amount for consulting services.

 

 

8.

Deposits

 

The following table summarizes the Corporation’s deposits as of December 31:

 

(Dollar amounts in thousands)

 

2019

 

2018

   

Weighted

                 

Weighted

               

Type of accounts

 

average rate

 

Amount

 

Percent

 

average rate

 

Amount

 

Percent

Non-interest bearing deposits

        $ 148,842       18.9 %         $ 148,893       19.5 %

Interest bearing demand deposits

    0.76 %     420,515       53.4 %     0.52 %     391,054       51.4 %

Time deposits

    2.17 %     217,767       27.7 %     1.84 %     221,599       29.1 %

Total

    1.01 %   $ 787,124       100.0 %     0.80 %   $ 761,546       100.0 %

 

Scheduled maturities of time deposits for the next five years and thereafter are as follows:

 

(Dollar amounts in thousands)

 

Amount

   

Percent

 

2020

  $ 66,039       30.3 %

2021

    54,923       25.2 %

2022

    17,110       7.9 %

2023

    39,096       17.9 %

2024

    34,382       15.8 %

Thereafter

    6,217       2.9 %

Total

  $ 217,767       100.0 %

 

 

 

Notes to Consolidated Financial Statements


 

 

8.

Deposits (continued)

 

The Corporation had a total of $67.9 million and $61.2 million in time deposits of $250,000 or more at December 31, 2019 and 2018, respectively. Scheduled maturities of time deposits of $250,000 or more at December 31, 2019 are as follows:

 

(Dollar amounts in thousands)

 

Amount

Three months or less

  $ 6,036  

Over three months to six months

    9,844  

Over six months to twelve months

    6,749  

Over twelve months

    45,292  
Total   $ 67,921  

 

 

 

9.

Borrowed Funds

 

The following table summarizes the Corporation’s borrowed funds as of and for the year ended December 31:

 

(Dollar amounts in thousands)

 

2019

 

2018

           

Average

 

Average

         

Average

 

Average

   

Balance

 

Balance

 

Rate

 

Balance

 

Balance

 

Rate

Short-term borrowed funds

  $ 2,050     $ 4,663       3.93%     $ 12,850     $ 5,660       3.70%  

Long-term borrowed funds

    26,500       31,845       2.55%       32,500       18,590       2.43%  
Total   $ 28,550     $ 36,508             $ 45,350     $ 24,250          

 

Short-term borrowed funds at December 31, 2019 consisted of $2.1 million outstanding on a $7.0 million unsecured line of credit with a correspondent bank with a rate of 5.00%, compared to $10.8 million in overnight advances with a rate of 2.62% and $2.1 million outstanding on a $7.0 million unsecured line of credit with a correspondent bank with a rate of 5.75% at December 31, 2018.

 

Long-term borrowed funds at December 31, 2019 consisted of five $5.0 million FHLB term advances totaling $25.0 million, maturing between 2020 and 2023 and having fixed interest rates between 1.97% and 2.85%. This compares to six $5.0 million FHLB advances totaling $30.0 million at December 31, 2018. All borrowings from the FHLB are secured by a blanket lien of qualified collateral. Qualified collateral at December 31, 2019 totaled $407.4 million. In addition, the Corporation has a five year unsecured term advance with a correspondent bank. The term advance has a fixed rate of 4.75% and principal payments of $250,000 are due on the first day of each quarter until maturity. At December 31, 2019 and 2018, the outstanding balance on this term advance was $1.5 million and $2.5 million, respectively.

 

Scheduled maturities of borrowed funds for the next five years are as follows:

 

(Dollar amounts in thousands)

 

Amount

2020

  $ 8,050  

2021

    10,500  

2022

     

2023

    10,000  

2024

     

Thereafter

     
Total   $ 28,550  

 

The Bank maintains a credit arrangement with the FHLB as a source of additional liquidity. The total maximum borrowing capacity with the FHLB, excluding loans outstanding of $25.0 million and irrevocable standby letters of credit issued to secure certain deposit accounts of $130.4 million at December 31, 2019 was $252.0 million. In addition, the Corporation has $4.9 million of funds available on a line of credit through a correspondent bank.

 

 

Notes to Consolidated Financial Statements


 

 

 

10.

Regulatory Matters

 

Restrictions on Dividends, Loans and Advances

 

The Bank is subject to a regulatory dividend restriction that generally limits the amount of dividends that can be paid by the Bank to the Corporation. Prior regulatory approval is required if the total of all dividends declared in any calendar year exceeds net profits (as defined in the regulations) for the year combined with net retained earnings (as defined) for the two preceding calendar years. In addition, dividends paid by the Bank to the Corporation would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum capital requirements. As of December 31, 2019, $6.7 million of undistributed earnings of the Bank was available for distribution of dividends without prior regulatory approval.

 

Loans or advances from the Bank to the Corporation are limited to 10% of the Bank’s capital stock and surplus on a secured basis. Funds available for loans or advances by the Bank to the Corporation amounted to approximately $6.0 million. As of December 31, 2019, the Corporation had no outstanding loans or advances from the Bank.  During 2018, the Corporation paid off a $2.2 million commercial line of credit available at the Bank for the primary purpose of purchasing qualified equity investments.

 

Minimum Regulatory Capital Requirements

 

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

 

In 2018, the Board of Governors of the Federal Reserve System amended its Small Bank Holding Company Policy Statement by increasing the policy’s consolidated assets threshold from $1 billion to $3 billion. The primary benefit of being deemed a "small bank holding company" is the exemption from the requirement to maintain consolidated regulatory capital ratios; instead, regulatory capital ratios only apply at the subsidiary bank level.

 

The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (BASEL III rules) became effective for the Bank on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in on January 1, 2019. Under the BASEL III rules, the Bank must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer was phased in from 0.0% for 2015 to 2.50% in 2019. The capital conservation buffer for 2019 and subsequent periods is 2.50% and was 1.875% for 2018. Amounts recorded to accumulated other comprehensive income are not included in computing regulatory capital. Management believes as of December 31, 2019, the Bank meets all capital adequacy requirements to which they are subject.

 

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end 2019 and 2018, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution's category.

 

 

Notes to Consolidated Financial Statements


 

 

10.

Regulatory Matters (continued)

 

The following table sets forth certain information concerning the Bank’s regulatory capital as of the dates presented. The capital adequacy ratios disclosed below are exclusive of the capital conservation buffer. 

 

(Dollar amounts in thousands)

 

December 31, 2019

   

December 31, 2018

 
   

Amount

   

Ratio

   

Amount

   

Ratio

 

Total capital to risk-weighted assets:

                               

Actual

  $ 80,418       13.74 %   $ 76,344       12.93 %

For capital adequacy purposes

    46,836       8.00 %     47,252       8.00 %

To be well capitalized

    58,544       10.00 %     59,065       10.00 %

Tier 1 capital to risk-weighted assets:

                               

Actual

  $ 73,862       12.62 %   $ 69,836       11.82 %

For capital adequacy purposes

    35,127       6.00 %     35,439       6.00 %

To be well capitalized

    46,836       8.00 %     47,252       8.00 %

Common Equity Tier 1 capital to risk-weighted assets:

                               

Actual

  $ 73,862       12.62 %   $ 69,836       11.82 %

For capital adequacy purposes

    26,345       4.50 %     26,579       4.50 %

To be well capitalized

    38,054       6.50 %     38,393       6.50 %

Tier 1 capital to average assets:

                               

Actual

  $ 73,862       8.17 %   $ 69,836       7.95 %

For capital adequacy purposes

    36,146       4.00 %     35,126       4.00 %

To be well capitalized

    45,182       5.00 %     43,908       5.00 %

 

 

 

11.

Commitments and Legal Contingencies

 

In the ordinary course of business, the Corporation has various outstanding commitments and contingent liabilities that are not reflected in the accompanying consolidated financial statements. In addition, the Corporation is involved in certain claims and legal actions arising in the ordinary course of business. The outcome of these claims and actions are not presently determinable; however, in the opinion of the Corporation’s management, after consulting legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the consolidated financial statements. 

 

 

 

12.

Income Taxes

 

The Corporation and the Bank file a consolidated federal income tax return. The provision for income taxes for the years ended December 31 is comprised of the following:

 

(Dollar amounts in thousands)

 

2019

 

2018

Current

  $ 1,437     $ 298  

Deferred

    225       335  
Total   $ 1,662     $ 633  

 

A reconciliation between the provision for income taxes and the amount computed by multiplying operating results before income taxes by the statutory federal income tax rate of 21% for the years ended December 31, 2019 and 2018 is as follows:

 

(Dollar amounts in thousands)

 

2019

 

2018

           

% Pre-tax

         

% Pre-tax

   

Amount

 

Income

 

Amount

 

Income

Provision at statutory tax rate

  $ 2,019       21.0 %   $ 1,017       21.0 %

Increase (decrease) resulting from:

                               

Tax free interest, net of disallowance

    (210 )     (2.2 %)     (234 )     (4.8 %)

Earnings on bank-owned life insurance

    (85 )     (0.9 %)     (71 )     (1.5 %)
Tax free gain on retirement of CMFP shares                 (145 )     (3.0 %)

Other, net

    (62 )     (0.6 %)     66       1.4 %

Provision

  $ 1,662       17.3 %   $ 633       13.1 %

 

 

 

Notes to Consolidated Financial Statements


 

 

12.

Income Taxes (continued)

 

The tax effects of temporary differences between the financial reporting basis and income tax basis of assets and liabilities that are included in the net deferred tax asset as of December 31 relate to the following:

 

(Dollar amounts in thousands)

 

2019

 

2018

Deferred tax assets:

               

Allowance for loan losses

  $ 1,365     $ 1,351  

Funded status of pension plan

    1,389       1,287  
Lease liability     358        

Net unrealized loss on securities

    26       401  

Deferred compensation

    417       391  

Accrued incentive compensation

    91       148  

Nonaccrual loan interest income

    40       75  

Securities impairment

    70       70  

Stock compensation

    91       69  

Other

    9       17  

Gross deferred tax assets

    3,856       3,809  

Deferred tax liabilities:

               

Accrued pension liability

    1,029       1,044  

Depreciation

    656       619  

Deferred loan fees and costs

    555       461  
Lease right-of-use asset     317        

Intangible assets

    260       215  
Business combination adjustments     137       68  

Other

    51       53  

Gross deferred tax liabilities

    3,005       2,460  

Net deferred tax asset

  $ 851     $ 1,349  

 

In accordance with relevant accounting guidance, the Corporation determined that it was not required to establish a valuation allowance for deferred tax assets since it is more likely than not that the deferred tax asset will be realized through future taxable income, future reversals of existing taxable temporary differences and tax strategies. The Corporation’s net deferred tax asset or liability is recorded in the consolidated financial statements as a component of other assets or other liabilities.

 

At December 31, 2019 and December 31, 2018, the Corporation had no unrecognized tax benefits. The Corporation does not expect the total amount of unrecognized tax benefits to significantly increase within the next twelve months. The Corporation recognizes interest and penalties on unrecognized tax benefits in income taxes expense in its Consolidated Statements of Income. 

 

The Corporation and the Bank are subject to U.S. federal income tax, a capital-based franchise tax in the Commonwealth of Pennsylvania as well as a corporate income tax in West Virginia based on earnings derived from business activity in the state. The Corporation and the Bank are no longer subject to examination by taxing authorities for years before 2016.

 

 

 

Notes to Consolidated Financial Statements


 

 

13.

Employee Benefit Plans

 

Defined Benefit Plan

 

The Corporation provides pension benefits for eligible employees through a defined benefit pension plan. Substantially all employees participate in the retirement plan on a non-contributing basis, and are fully vested after three years of service. Effective January 1, 2009, the plan was closed to new participants. The Corporation provided the requisite notice to plan participants on March 12, 2013 of the determination to freeze the plan (curtailment). While the freeze was not effective until April 30, 2013, management determined that participants would not satisfy, within the provisions of the plan, 2013 eligibility requirements based on minimum hours worked for 2013. Therefore, employees ceased to earn benefits as of January 1, 2013. This amendment to the plan did not affect benefits earned by the participant prior to the date of the freeze. The Corporation measures the funded status of the plan as of December 31.

 

Information pertaining to changes in obligations and funded status of the defined benefit pension plan for the years ended December 31 is as follows: 

 

(Dollar amounts in thousands)

 

2019

 

2018

Change in plan assets:

               

Fair value of plan assets at beginning of year

  $ 9,482     $ 10,159  

Actual return on plan assets

    1,534       (479 )

Employer contribution

          500  

Benefits paid

    (417 )     (698 )

Fair value of plan assets at end of year

    10,599       9,482  

Change in benefit obligation:

               

Benefit obligation at beginning of year

    10,628       11,801  

Interest cost

    443       423  

Actuarial (gain) loss

    (22 )     85  

Effect of change in assumptions

    1,672       (983 )

Benefits paid

    (417 )     (698 )

Benefit obligation at end of year

    12,304       10,628  

Funded status (plan assets less benefit obligation)

  $ (1,705 )   $ (1,146 )
Amounts recognized in accumulated other comprehensive loss consists of:                

Accumulated net actuarial loss

  $ 6,616     $ 6,126  

Accumulated prior service benefit

           

Amount recognized, end of year

  $ 6,616     $ 6,126  

 

 

Notes to Consolidated Financial Statements


 

 

13.

Employee Benefit Plans (continued)

 

The following table presents the Corporation’s pension plan assets measured and recorded at estimated fair value on a recurring basis and their level within the estimated fair value hierarchy as described in Note 15: 

 

(Dollar amounts in thousands)

         

(Level 1)

 

(Level 2)

 

(Level 3)

           

Quoted Prices in

 

Significant

 

Significant

           

Active Markets

 

Other

 

Unobservable

           

for Identical

 

Observable

 

Inputs

Description

 

Total

 

Assets

 

Inputs

       

December 31, 2019:

                               

Money markets

  $ 385     $ 385     $     $  

Mutual funds - debt

    4,322       4,322              

Mutual funds - equity

    4,981       4,981              

Emclaire stock

    911       911              
    $ 10,599     $ 10,599     $     $  

December 31, 2018:

                               

Money markets

  $ 77     $ 77     $     $  

Mutual funds - debt

    4,183       4,183              

Mutual funds - equity

    4,373       4,373              

Emclaire stock

    849       849              
    $ 9,482     $ 9,482     $     $  

 

There were no transfers between Level 1 and Level 2 during 2019.

 

The accumulated benefit obligation for the defined benefit pension plan was $12.3 million and $10.6 million at December 31, 2019 and 2018, respectively.

 

The components of the periodic pension costs and other amounts recognized in other comprehensive income for the years ended December 31 are as follows:

 

(Dollar amounts in thousands)

 

2019

 

2018

Interest cost

  $ 443     $ 423  

Expected return on plan assets

    (626 )     (672 )

Amortization of prior service beneft and net loss

    252       251  

Net periodic pension cost

    69       2  

Amortization of prior service benefit and net loss

    (252 )     (251 )

Net loss

    742       253  

Total recognized in other comprehensive loss

    490       2  

Total recognized in net periodic benefit and other comprehensive loss

  $ 559     $ 4  

 

The estimated net loss and prior service benefit for the defined benefit pension plan that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year is $269,000 as of December 31, 2019.

 

Weighted-average actuarial assumptions for the years ended December 31 include the following:

 

   

2019

 

2018

Discount rate for net periodic benefit cost

    4.26 %     3.62 %

Discount rate for benefit obligations

    3.28 %     4.26 %

Expected rate of return on plan assets

    6.75 %     6.75 %

 

 

Notes to Consolidated Financial Statements


 

 

13.

Employee Benefit Plans (continued)

 

The Corporation’s pension plan asset allocation at December 31, 2019 and 2018, target allocation for 2020, and expected long-term rate of return by asset category are as follows:

 

Asset Category

 

Target Allocation

 

Percentage of Plan Assets at Year End

  Weighted-Average Expected Long-Term Rate of Return
   

2020

 

2019

 

2018

 

2019

Equity securities

    55%       56%       55%       5.02%  

Debt securities

    37%       41%       44%       1.70%  

Money markets

    8%       3%       1%       0.03%  
      100%       100%       100%       6.75%  

 

Investment Strategy

 

The intent of the pension plan is to provide a range of investment options for building a diversified asset allocation strategy that will provide the highest likelihood of meeting the aggregate actuarial projections. In selecting the options and asset allocation strategy, the Corporation has determined that the benefits of reduced portfolio risk are best achieved through diversification. The following asset classes or investment categories are utilized to meet the Pension plan’s objectives: Small company stock, International stock, Mid-cap stock, Large company stock, Diversified bond, Money Market/Stable Value and Cash. The pension plan does not prohibit any certain investments.

 

The Corporation does currently not expect to make a contribution to its pension plan in 2020.

 

Estimated future benefit payments are as follows:

 

(Dollar amounts in thousands)

 

Pension

For year ended December 31,

 

Benefits

2020

  $ 450  

2021

    451  

2022

    491  

2023

    492  

2024

    500  

2025-2029

    2,715  

 

Defined Contribution Plan

 

The Corporation maintains a defined contribution 401(k) Plan. Employees are eligible to participate by providing tax-deferred contributions up to 20% of qualified compensation. Employee contributions are vested at all times. The Corporation provides a matching contribution of up to 4% of the participant’s salary. For the years ended 2019 and 2018, matching contributions were $266,000 and $235,000, respectively. The Corporation may also make, at the sole discretion of its Board of Directors, a profit sharing contribution. For the years ended 2019 and 2018, the Corporation made profit sharing contributions of $140,000 and $124,000, respectively.

 

Supplemental Executive Retirement Plan

 

The Corporation maintains a Supplemental Executive Retirement Plan (SERP) to provide certain additional retirement benefits to participating officers. The SERP is subject to certain vesting provisions and provides that the officers shall receive a supplemental retirement benefit if the officer’s employment is terminated after reaching the normal retirement age of 65, with benefits also payable upon death, disability, a change of control or a termination of employment prior to normal retirement age. As of December 31, 2019 and 2018, the Corporation’s SERP liability was $1.9 million and $1.8 million, respectively. For the years ended December 31, 2019 and 2018, the Corporation recognized expense of $224,000 and $156,000, respectively, related to the SERP.

 

 

Notes to Consolidated Financial Statements


 

 

 

14.

Stock Compensation Plans

 

In April 2014, the Corporation adopted the 2014 Stock Incentive Plan (the 2014 Plan), which is shareholder approved and permits the grant of restricted stock awards and options to its directors, officers and employees for up to 176,866 shares of common stock, of which 19,833 shares of restricted stock and 88,433 stock options remain available for issuance under the plan.

 

Incentive stock options, non-incentive or compensatory stock options and share awards may be granted under the Plans. The exercise price of each option shall at least equal the market price of a share of common stock on the date of grant and have a contractual term of ten years. Options shall vest and become exercisable at the rate, to the extent and subject to such limitations as may be specified by the Corporation. Compensation cost related to share-based payment transactions must be recognized in the financial statements with measurement based upon the fair value of the equity instruments issued.

 

During 2019 and 2018, the Corporation granted restricted stock awards of 17,950 and 14,750 shares, respectively, with a face value of $558,000 and $456,000, respectively, based on the weighted-average grant date stock prices of $31.10 and $30.90, respectively. These restricted stock awards are 100% vested on the third anniversary of the date of grant, except in the event of death, disability or retirement. Nonvested restricted stock is not included in common shares outstanding on the consolidated balance sheets. It is the Corporation's policy to issue shares on the vesting date for restricted stock awards. Unvested restricted stock awards do not receive dividends declared by the Corporation. There were no stock options granted during 2019 or 2018. For the year ended December 31, 2019 and 2018 the Corporation recognized $368,000 and $269,000, respectively, in stock compensation expense.

 

A summary of the status of the Corporation’s nonvested restricted stock awards as of December 31, 2019, and changes during the period then ended is presented below:

 

   

Shares

   

Weighted-Average Grant-date Fair Value

 

Nonvested at January 1, 2019

    37,250     $ 29.94  

Granted

    17,950       31.10  

Vested

    (10,000 )     26.74  

Forfeited

    (750 )     30.90  

Nonvested as of December 31, 2019

    44,450     $ 31.11  

 

As of December 31, 2019, there was $951,000 of total unrecognized compensation expense related to nonvested share-based compensation arrangements granted under the plans. That expense is expected to be recognized over the next three years.

 

 

 

15.

Fair Values of Financial Instruments

 

The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  An asset or liability's level is based on the lowest level of input that is significant to the fair value measurement.  There are three levels of inputs that may be used to measure fair value.

 

  Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Corporation has the ability to access at the measurement date.
     
  Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
     
  Level 3: Significant unobservable inputs that reflect the Corporation’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

 

Notes to Consolidated Financial Statements


 

 

15.

Fair Values of Financial Instruments (continued)

 

Management uses its best judgment in estimating the fair value of the Corporation’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Corporation could have realized in a sale transaction or exit price on the date indicated. The estimated fair value amounts have been measured as of their respective year-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at year-end.

 

Assets measured at fair value on a recurring basis. The Corporation used the following methods and significant assumptions to estimate the fair value of the following assets:

 

Debt securities available for sale, equity securities – The fair value of all investment securities are based upon the assumptions market participants would use in pricing the security. If available, investment securities are determined by quoted market prices (Level 1). Level 1 includes U.S. Treasury, federal agency securities and certain equity securities. For investment securities where quoted market prices are not available, fair values are calculated based on market prices on similar securities (Level 2). Level 2 includes U.S. Government sponsored entities and agencies, mortgage-backed securities, collateralized mortgage obligations, state and political subdivision securities and certain corporate debt securities. For investment securities where quoted prices or market prices of similar securities are not available, fair values are calculated by using unobservable inputs (Level 3) and may include certain corporate debt securities held by the Corporation. The Level 3 corporate debt securities valuations were supported by inputs such as the security issuer’s publicly attainable financial information, multiples derived from prices in observed transactions involving comparable businesses and other market, financial and nonfinancial factors.

 

For assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy are as follows:

 

(Dollar amounts in thousands)

         

(Level 1)

   

(Level 2)

   

(Level 3)

 

Description

 

Total

   

Quoted Prices in Active Markets for Identical Assets

   

Significant Other Observable Inputs

   

Significant Unobservable Inputs

 

December 31, 2019:

                               

Securities available-for-sale

                               

U.S. government sponsored entities and agencies

  $ 7,077     $     $ 7,077     $  

U.S. agency mortgage-backed securities: residential

    41,075             41,075        

U.S. agency collateralized mortgage obligations: residential

    32,837             32,837        

State and political subdivision

    27,796             27,796        

Corporate debt securities

    11,322             7,072       4,250  

Total available-for-sale securities

  $ 120,107     $     $ 115,857     $ 4,250  
                                 

Equity securities

  $ 19     $ 19     $     $  
                                 

December 31, 2018:

                               

Securities available-for-sale

                               

U.S. Treasury

  $ 4,445     $ 4,445     $     $  

U.S. government sponsored entities and agencies

    16,783             16,783        

U.S. agency mortgage-backed securities: residential

    27,176             27,176        

U.S. agency collateralized mortgage obligations: residential

    18,664             18,664        

State and political subdivisions

    22,732             22,732        

Corporate debt securities

    7,918             4,418       3,500  

Total available-for-sale securities

  $ 97,718     $ 4,445     $ 89,773     $ 3,500  
                                 

Equity securities

  $ 7     $ 7     $     $  

 

 

Notes to Consolidated Financial Statements


 

 

15.

Fair Values of Financial Instruments (continued)

 

The Corporation’s policy is to transfer assets or liabilities from one level to another when the methodology to obtain the fair value changes such that there are more or fewer unobservable inputs as of the end of the reporting period.  During 2019, certain corporate debt securities were purchased and placed into Level 3 because of a lack of observable market data.  During 2018, the Corporation reclassified a restricted bank stock from the equity security portfolio to other assets and certain corporate securities from Level 3 to Level 2.  Also during 2018, $25,000 in Level 3 equity securities were sold from the portfolio.  The following table presents changes in Level 3 assets measured on a recurring basis for the years ended December 31, 2019 and 2018:

 

(Dollar amounts in thousands)

 

2019

   

2018

 

Balance at the beginning of the period

  $ 3,500     $ 8,132  

Total gains or losses (realized/unrealized):

               

Included in earnings

          1  

Purchased into Level 3

    750        

Sold out of Level 3

          (25 )

Transfers in and/or out of Level 3

          (4,608 )

Balance at the end of the period

  $ 4,250     $ 3,500  

 

Assets measured at fair value on a non-recurring basis. The Corporation used the following methods and significant assumptions to estimate the fair value of the following assets:

 

Impaired loans – At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive a specific allowance for loan losses. For collateral dependent loans, fair value is commonly based on real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly. As of December 31, 2019 and 2018, the Corporation did not have any impaired loans carried at fair value measured using the fair value of collateral. There was no additional provision for loan losses recorded for impaired loans during 2019 or 2018.

 

Other real estate owned (OREO) – Assets acquired through or instead of foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. Management’s ongoing review of appraisal information may result in additional discounts or adjustments to the valuation based upon more recent market sales activity or more current appraisal information derived from properties of similar type and/or locale. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. As of December 31, 2019, OREO measured at fair value less costs to sell had a net carrying amount of $88,000, which consisted of the outstanding balance of $91,000 less write-downs of $3,000.  As of December 31, 2018, OREO measured at fair value less costs to sell had a net carrying amount of $160,000, which consisted of the outstanding balance of $415,000 less write-downs of $255,000.

 

Appraisals for both collateral-dependent impaired loans and OREO are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed by the Corporation. Once received, management reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. On an annual basis, the Corporation compares the actual selling price of OREO that has been sold to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value. The most recent analysis performed indicated that a discount of 10% should be applied.

 

 

Notes to Consolidated Financial Statements


 

 

15.

Fair Values of Financial Instruments (continued)

 

For assets measured at fair value on a non-recurring basis at December 31, 2019 and 2018, the fair value measurements by level within the fair value hierarchy are as follows:

 

(Dollar amounts in thousands)

         

(Level 1)

   

(Level 2)

   

(Level 3)

 

Description

 

Total

   

Quoted Prices in Active Markets for Identical Assets

   

Significant Other Observable Inputs

   

Significant Unobservable Inputs

 
December 31, 2019:                                

Other real estate owned

  $ 88     $     $     $ 88  

Total

  $ 88     $     $     $ 88  
                                 

December 31, 2018:

                               
Other real estate owned   $ 160     $     $     $ 160  
Total   $ 160     $     $     $ 160  

 

The following table presents quantitative information about Level 3 fair value measurements for assets measured at fair value on a non-recurring basis:

 

(Dollar amounts in thousands)

       

Valuation

 

Unobservable

 

Weighted

 
         

Techniques(s)

 

Input(s)

 

Average

 
December 31, 2019:                      

Other real estate owned

  $ 88  

Sales comparison approach

 

Adjustment for differences between comparable sales

    10%
                       

December 31, 2018:

                     
Other real estate owned   $ 160   Sales comparison approach   Adjustment for differences between comparable sales     10%

 

Excluded from the tables above at December 31, 2019 and 2018 was an impaired residential mortgage loan totaling $67,000 and $61,000, respectively, and an impaired home equity loan totaling $4,000 and $6,000, respectively, which were classified as TDRs and measured using a discounted cash flow methodology.

 

 

Notes to Consolidated Financial Statements


 

 

15.

Fair Values of Financial Instruments (continued)

 

During the first quarter of 2018, the Corporation adopted ASU 2016-01 that requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. The following table sets forth the carrying amount and fair value of the Corporation’s financial instruments included in the consolidated balance sheet as of December 31: 

 

(Dollar amounts in thousands)

                                       
   

Carrying

   

Fair Value Measurements using:

 

Description

 

Amount

   

Total

   

Level 1

   

Level 2

   

Level 3

 

December 31, 2019:

                                       

Financial Assets:

                                       

Cash and cash equivalents

  $ 14,986     $ 14,986     $ 14,986     $     $  

Interest earning time deposits

    9,698       9,698             9,698        

Securities - available-for-sale

    120,107       120,107             115,857       4,250  

Securities - equities

    19       19       19              

Loans, net

    695,348       697,990                   697,990  

Federal bank stock

    5,790       N/A       N/A       N/A       N/A  

Accrued interest receivable

    2,600       2,600       78       419       2,103  

Total

  $ 848,548     $ 845,400     $ 15,083     $ 125,974     $ 704,343  

Financial Liabilities:

                                       

Deposits

    787,124       793,999       569,357       224,642        

Borrowed funds

    28,550       29,133             29,133        

Accrued interest payable

    616       616       51       565        

Total

  $ 816,290     $ 823,748     $ 569,408     $ 254,340     $  

 

December 31, 2018:

                                       

Financial Assets:

                                       

Cash and cash equivalents

  $ 10,955     $ 10,955     $ 10,955     $     $  

Interest earning time deposits

    6,738       6,738             6,738        

Securities - available-for-sale

    97,718       97,718       4,445       89,773       3,500  

Securities - equities

    7       7       7              

Loans, net

    708,664       702,747                   702,747  

Federal bank stock

    6,351       N/A       N/A       N/A       N/A  

Accrued interest receivable

    2,570       2,570       63       351       2,156  

Total

  $ 833,003     $ 820,735     $ 15,470     $ 96,862     $ 708,403  

Financial Liabilities:

                                       

Deposits

    761,546       767,009       539,946       227,063        

Borrowed funds

    45,350       44,869             44,869        

Accrued interest payable

    495       495       30       465        

Total

  $ 807,391     $ 812,373     $ 539,976     $ 272,397     $  

 

This information should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those of other companies may not be meaningful.

 

Off-Balance Sheet Financial Instruments

 

The Corporation is party to credit related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and commercial letters of credit. Commitments to extend credit involve, to a varying degree, elements of credit and interest rate risk in excess of amounts recognized in the consolidated balance sheets. The Corporation’s exposure to credit loss in the event of non-performance by the other party for commitments to extend credit is represented by the contractual amount of these commitments, less any collateral value obtained. The Corporation uses the same credit policies in making commitments as for on-balance sheet instruments. The Corporation’s distribution of commitments to extend credit approximates the distribution of loans receivable outstanding.

 

 

Notes to Consolidated Financial Statements


 

 

15.

Fair Values of Financial Instruments (continued)

 

The following table presents the notional amount of the Corporation’s off-balance sheet commitment financial instruments as of December 31:

 

(Dollar amounts in thousands)

 

2019

 

2018

   

Fixed Rate

 

Variable Rate

 

Fixed Rate

 

Variable Rate

Commitments to make loans

  $ 1,646     $ 10,840     $ 684     $ 7,450  

Unused lines of credit

    21,928       88,071       16,287       81,261  
Total   $ 23,574     $ 98,911     $ 16,971     $ 88,711  

 

Commitments to make loans are generally made for periods of 30 days or less. Commitments to extend credit include agreements to lend to a customer as long as there is no violation of any condition established in the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Commitments to extend credit also include unfunded commitments under commercial and consumer lines of credit, revolving credit lines and overdraft protection agreements. These lines of credit may be collateralized and usually do not contain a specified maturity date and may be drawn upon to the total extent to which the Corporation is committed.

 

Standby letters of credit are conditional commitments issued by the Corporation usually for commercial customers to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation generally holds collateral supporting those commitments if deemed necessary. Standby letters of credit, net of collateral maintained by the Bank, were $548,000 and $1.0 million at December 31, 2019 and 2018, respectively. The current amount of the liability as of December 31, 2019 and 2018 for guarantees under standby letters of credit issued is not material.

 

 

 

16.

Emclaire Financial Corp – Condensed Financial Statements, Parent Corporation Only

 

Following are condensed financial statements for the parent company as of and for the years ended December 31: 

 

Condensed Balance Sheets

               

(Dollar amounts in thousands)

 

2019

 

2018

Assets:

               

Cash and cash equivalents

  $ 40     $ 18  

Equity in net assets of subsidiaries

    84,065       79,302  
Goodwill     5,190       5,190  

Other assets

    171       113  

Total Assets

  $ 89,466     $ 84,623  

Liabilities and Stockholders' Equity:

               

Other short-term borrowed funds

  $ 2,050     $ 2,050  

Long-term borrowed funds

    1,500       2,500  

Accrued expenses and other liabilities

    58       65  

Stockholders' equity

    85,858       80,008  

Total Liabilities and Stockholders' Equity

  $ 89,466     $ 84,623  

 

 

 

Consolidated Financial Statements


 

 

16.

Emclaire Financial Corp – Condensed Financial Statements, Parent Corporation Only (continued)

 

Condensed Statements of Income

               

(Dollar amounts in thousands)

 

2019

 

2018

Income:

               

Dividends from subsidiaries

  $ 4,688     $ 3,316  

Investment income

          10  
Net gains on equity securities           510  

Total income

    4,688       3,836  

Expense:

               

Interest expense

    205       272  

Noninterest expense

    634       539  

Total expense

    839       811  

Income before income taxes and undistributed subsidiary income

    3,849       3,025  

Undistributed equity in net income of subsidiary

    3,922       1,125  

Net income before income taxes

    7,771       4,150  

Income tax benefit

    183       61  

Net income

  $ 7,954     $ 4,211  

Comprehensive income

  $ 8,976     $ 3,559  

 

Condensed Statements of Cash Flows

               

(Dollar amounts in thousands)

 

2019

   

2018

 

Operating activities:

               

Net income

  $ 7,954     $ 4,211  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Undistributed equity in net income of subsidiary

    (3,922 )     (1,125 )

Change in fair value of equity securities

          (510 )

Other, net

    303       1,323  

Net cash provided by operating activities

    4,335       3,899  
                 

Investing activities:

               

Sales of investment securities

          1,269  

Net cash provided by investing activities

          1,269  
                 

Financing activities:

               

Net change in borrowings

    (1,000 )     (2,450 )

Dividends paid

    (3,313 )     (2,753 )

Net cash used in financing activities

    (4,313 )     (5,203 )

Increase (decrease) in cash and cash equivalents

    22       (35 )

Cash and cash equivalents at beginning of period

    18       53  

Cash and cash equivalents at end of period

  $ 40     $ 18  

 

 

Notes to Consolidated Financial Statements


 

 

 

17.

Other Noninterest Income and Expense

 

Other noninterest income includes electronic banking fees of $1.4 million and $1.3 million for 2019 and 2018, respectively.

 

The following summarizes the Corporation’s other noninterest expenses for the years ended December 31:

 

(Dollar amounts in thousands)

 

2019

 

2018

Customer bank card processing

 

$

697

   

$

673

 
Subscriptions     607       513  

Telephone and data communications

   

567

     

414

 

Pennsylvania shares and use taxes

   

482

     

316

 

Correspondent bank and courier fees

   

411

     

395

 

Travel, entertainment and conferences

   

390

     

337

 

Internet banking and bill pay

   

347

     

416

 

Item processing

   

310

     

 

Printing and supplies

   

278

     

333

 

Marketing and advertising

   

264

     

292

 

Charitable contributions

   

240

     

220

 

Regulatory examinations

   

204

     

207

 
Bad checks and other losses     199       197  

Postage and freight

   

169

     

134

 
Credit bureau and other loan expense     132       120  

Memberships and dues

   

112

     

98

 

Other

   

225

     

150

 

Total other noninterest expenses

 

$

5,634

   

$

4,815

 
                 

 

 

 

18.

Earnings Per Share

 

The factors used in the Corporation’s earnings per share computation follow:

 

(Dollar amounts in thousands, except for per share amounts)

 

For the year ended December 31,

 
   

2019

   

2018

 

Net income

  $ 7,954     $ 4,211  

Less: Preferred stock dividends

    182       91  

Net income available to common stockholders

  $ 7,772     $ 4,120  

Average common shares outstanding

    2,699,397       2,377,277  

Add: Dilutive effects of restricted stock awards

    19,349       18,400  

Average shares and dilutive potential common shares

    2,718,746       2,395,677  

Basic earnings per common share

  $ 2.88     $ 1.73  

Diluted earnings per common share

  $ 2.86     $ 1.72  

Restricted stock awards not considered in computing earnings per share because they were antidulitive

           

 

 

Notes to Consolidated Financial Statements


 

 

 

19.

Accumulated Other Comprehensive Income (Loss)

 

The following is changes in Accumulated Other Comprehensive Income (Loss) by component, net of tax for the year ending December 31, 2019: 

 

(Dollar amounts in thousands)

 

Unrealized Gains and Losses on Available-for-Sale Securities

   

Defined Benefit Pension Items

   

Totals

 

Accumulated Other Comprehensive Income (Loss) at January 1, 2019

  $ (1,517 )   $ (4,840 )   $ (6,357 )

Other comprehensive income before reclassification

    1,471       (586 )     885  

Amounts reclassified from accumulated other comprehensive income (loss)

    (62 )     199       137  

Net current period other comprehensive income (loss)

    1,409       (387 )     1,022  

Accumulated Other Comprehensive Income (Loss) at December 31, 2019

  $ (108 )   $ (5,227 )   $ (5,335 )

 

The following is significant amounts reclassified out of each component of Accumulated Other Comprehensive Income (Loss) for the year ending December 31, 2019: 

 

(Dollar amount in thousands)

 

Amount Reclassified

   

Details about Accumulated Other Comprehensive Income Components

 

from Accumulated Other Comprehensive Income For the year ended December 31, 2019

 

Affected Line Item in the Statement Where Net Income is Presented

Unrealized gains and losses on available-for-sale securities

  $ (78 )

Net gain on sale of available-for-sale securities

Tax effect

    16  

Provision for income taxes

Total security reclassifications for the period

    (62 )  
           

Amortization of defined benefit pension items

         

Prior service costs

     

Other noninterest income

Actuarial gains

    252  

Compensation and employee benefits

Total before tax

    252    

Tax effect

    (53 )

Provision for income taxes

Total defined benefit pension reclassifications for the period

    199    

Total reclassifications for the period

  $ 137  

Net of tax


 

The following is changes in Accumulated Other Comprehensive Income (Loss) by component, net of tax for the year ending December 31, 2018:

 

(Dollar amounts in thousands)

 

Unrealized Gains and Losses on Available-for-Sale Securities

   

Defined Benefit Pension Items

   

Totals

 

Accumulated Other Comprehensive Income (Loss) at January 1, 2018

  $ (679 )   $ (4,839 )   $ (5,518 )

Cumulative effect of change in accounting principle for marketable equity securities, net of tax

    (187 )           (187 )

Accumulated Other Comprehensive Income (Loss) at January 1, 2018, as adjusted

  $ (866 )   $ (4,839 )   $ (5,705 )
                         

Other comprehensive income before reclassification

    (658 )     (200 )     (858 )

Amounts reclassified from accumulated other comprehensive income (loss)

    7       199       206  

Net current period other comprehensive income (loss)

    (651 )     (1 )     (652 )
                         

Accumulated Other Comprehensive Income (Loss) at December 31, 2018

  $ (1,517 )   $ (4,840 )   $ (6,357 )

 

 

Notes to Consolidated Financial Statements


 

 

19.

Accumulated Other Comprehensive Income (Loss) (continued)

 

The following is significant amounts reclassified out of each component of Accumulated Other Comprehensive Income (Loss) for the year ending December 31, 2018:

 

(Dollar amount in thousands)

 

Amount Reclassified

   

Details about Accumulated Other Comprehensive Income Components

 

from Accumulated Other Comprehensive Income For the year ended December 31, 2018

 

Affected Line Item in the Statement Where Net Income is Presented

Unrealized gains and losses on available-for-sale securities

  $ 9  

Net loss on sale of available-for-sale securities

Tax effect

    (2 )

Provision for income taxes

Total security reclassifications for the period

    7    
           

Amortization of defined benefit pension items

         

Prior service costs

     

Other noninterest income

Actuarial gains

    252  

Compensation and employee benefits

Total before tax

    252    

Tax effect

    (53 )

Provision for income taxes

Total defined benefit pension reclassifications for the period

    199    

Total reclassifications for the period

  $ 206  

Net of tax


 

 

 

20.

Mergers and Acquisitions

 

Community First Bancorp, Inc.

 

On October 1, 2018, the Corporation completed the acquisition of Community First Bancorp, Inc. (CFB) in accordance with the terms of the Agreement and Plan of Merger, dated as of May 25, 2018, in exchange for 419,173 shares of common stock valued at $15.6 million and $2.4 million in cash. In addition, the Corporation issued $4.2 million of preferred stock in exchange for 420,593 shares of similar preferred stock of Community First Bank, valued at $4.2 million.  The acquisition strengthened the Corporation’s franchise within current market areas and increased the Corporation’s consolidated total assets, loans and deposits.  The Corporation owned 18,000 shares of CFB common stock and recognized a $690,000 non-taxable gain on the retirement of the shares in connection with the acquisition.

 

The assets and liabilities of CFB were recorded on the Corporation’s consolidated balance sheet at their estimated fair value as of October 1, 2018.

 

Included in the purchase price was goodwill and a core deposit intangible of $9.2 million and $1.2 million, respectively.  Goodwill is the excess of the purchase price over the fair value of the identifiable net assets acquired and is the result of expected operational synergies and other factors.  This goodwill is not deductible for tax purposes.  The goodwill will not be amortized, but will be measured annually for impairment or more frequently if circumstances require.  The core deposit intangible will be amortized over an estimated life of ten years using the straight line method.  Core deposit intangible expense was $121,000 for 2019 and is projected for the succeeding five years beginning 2020 to be $121,000 per year with $453,000 in total for years after 2024.

 

 

Notes to Consolidated Financial Statements


 

 

20.

Mergers and Acquisitions (continued)

 

The following table summarizes the estimated fair value of the assets acquired, liabilities assumed and consideration transferred in connection with the acquisition:

 

(Dollar amounts in thousands)

       

Assets acquired:

       

Cash and cash equivalents

  $ 3,986  

Securities available for sale

     

Loans receivable

    111,555  

Federal bank stocks

    190  

Accrued interest receivable

    288  

Premises and equipment

    1,321  

Core deposit intangible

    1,208  

Prepaid expenses and other assets

    3,341  

Total assets acquired

    121,889  
         

Liabilities assumed:

       

Deposits

    106,149  

Overnight borrowings

    1,200  

Accrued interest payable

    61  

Accrued expenses and other liabilities

    449  

Total liabilities assumed

    107,859  

Identifiable net assets acquired

    14,030  
         

Consideration paid:

       

Cash

    2,429  

Preferred stock

    4,206  

Previously owned common stock of CFB

    931  

Common stock

    15,636  

Total consideration

    23,202  
         

Goodwill

  $ (9,172 )

 

The fair value of loans was estimated using discounted contractual cash flows. The book balance of the loans at the time of the acquisition was $112.8 million before considering CFB’s allowance for loan losses, which was not carried over. The fair value disclosed above reflects a credit-related adjustment of $(1.7 million) and an adjustment for other factors of $441,000. Loans evidencing credit deterioration since origination (purchased credit impaired loans) included in loans receivable were immaterial.

 

 Costs related to the acquisition for the year ended December 31, 2018 totaled $3.6 million including employee non-compete and severance costs, professional fees, system conversion costs, contract termination fees, legal fees, accounting and auditing fees and other costs of $1.5 million, $531,000, $481,000, $427,000, $330,000, $50,000 and $228,000, respectively.

 

 

 

 

Notes to Consolidated Financial Statements


 

 

21.

Revenue Recognition

 

On January 1, 2018, the Corporation adopted ASU 2014-09 "Revenue from Contracts with Customers" (Topic 606) and all subsequent ASUs that modified Topic 606. Interest income, net securities gains (losses) and bank-owned life insurance are not included within the scope of Topic 606. For the revenue streams in the scope of Topic 606, service charges on deposits and electronic banking fees, there are no significant judgments related to the amount and timing of revenue recognition. All of the Corporation's revenue from contracts with customers is recognized within noninterest income.

 

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

 

Electronic banking fees: The Corporation earns interchange and other ATM related fees from cardholder transactions conducted through the various payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The gross amount of these fees are processed through noninterest income. Other fees, such as transaction surcharges and card replacement fees are withdrawn from the customer's account balance at the time of service.

 

The following table presents the Corporation's sources of noninterest income for the year ended December 31:

 

(Dollar amounts in thousands)

 

2019

   

2018

 

Noninterest income

               

In-scope of Topic 606:

               

Service charges on deposits

               

Maintenance fees

  $ 190     $ 160  

Overdraft fees

    1,657       1,587  

Other fees

    310       285  

Electronic banking fees (1)

    1,446       1,344  

Noninterest income (in-scope of Topic 606)

    3,603       3,376  

Noninterest income (out-of-scope of Topic 606)

    788       832  

Total noninterest income

  $ 4,391     $ 4,208  

(1) included in other noninterest income on the consolidated statements of income

 

 

F-42