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EMCLAIRE FINANCIAL CORP - Quarter Report: 2020 June (Form 10-Q)

emcf20190331_10q.htm
 

 

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q 

(Mark One)

 

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

 

For the quarterly period ended June 30, 2020

 

or

 

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

 

For the transition period from _____________ to _____________

 

Commission File Number: 001-34527

 

 

EMCLAIRE FINANCIAL CORP

(Exact name of registrant as specified in its charter)

 

Pennsylvania

25-1606091

(State or other jurisdiction of incorporation or organization)

(IRS Employer Identification No.)

 

 

612 Main Street, Emlenton, Pennsylvania

16373

(Address of principal executive offices)

(Zip Code)

 

(844) 767-2311

(Registrant’s telephone number)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

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)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes ☒ No ☐

 

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

 

Large accelerated filer ☐                Accelerated filer ☐                      Non-accelerated filer ☐

Smaller reporting company ☒        Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

The number of shares outstanding of the Registrant’s common stock was 2,708,712 at August 11, 2020.

 


 

 

 

EMCLAIRE FINANCIAL CORP

 

INDEX TO QUARTERLY REPORT ON FORM 10-Q

  

PART I – FINANCIAL INFORMATION

 

 

 

Item 1.

Interim Financial Statements (Unaudited)

 

 

 

 

 

Consolidated Balance Sheets as of June 30, 2020 and December 31, 2019

1

 

 

 

 

Consolidated Statements of Net Income for the three and six months ended June 30, 2020 and 2019

2

 

 

 

 

Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2020 and 2019

3

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2020 and 2019

4

 

 

 

 

Consolidated Statements of Changes in Stockholders’ Equity for the three and six months ended June 30, 2020 and 2019

5

 

 

 

 

Notes to Consolidated Financial Statements

6

 

 

 

Item 2.

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

28

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

39

 

 

 

Item 4.

Controls and Procedures

39

 

 

 

PART II – OTHER INFORMATION

 

 

 

Item 1.

Legal Proceedings

40

 

 

 

Item 1A.

Risk Factors

40

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

40

 

 

 

Item 3.

Defaults Upon Senior Securities

40

 

 

 

Item 4.

Mine Safety Disclosures

40

 

 

 

Item 5.

Other Information

40

 

 

 

Item 6.

Exhibits

40

 

 

 

Signatures

41

 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Interim Financial Statements

 

 
Emclaire Financial Corp
Consolidated Balance Sheets (Unaudited)
As of June 30, 2020 and December 31, 2019
(Dollar amounts in thousands, except share and per share data)

 

   

June 30, 2020

 

December 31, 2019

Assets

               

Cash and due from banks

  $ 3,769     $ 3,750  

Interest earning deposits with banks

    22,065       11,236  

Total cash and cash equivalents

    25,834       14,986  

Interest earning time deposits

    6,462       9,698  

Securities - available-for-sale

    91,387       120,107  

Securities - equity investments

    14       19  

Loans receivable, net of allowance for loan losses of $8,159 and $6,556

    803,732       695,348  

Federal bank stocks, at cost

    6,181       5,790  

Bank-owned life insurance

    15,276       15,287  

Accrued interest receivable

    3,449       2,600  

Premises and equipment, net

    18,905       19,041  

Goodwill

    19,460       19,460  

Core deposit intangible, net

    1,163       1,247  

Prepaid expenses and other assets

    11,406       11,713  

Total Assets

  $ 1,003,269     $ 915,296  

Liabilities and Stockholders' Equity

               

Liabilities

               

Deposits:

               

Non-interest bearing

  $ 187,971     $ 148,842  

Interest bearing

    680,741       638,282  

Total deposits

    868,712       787,124  

Short-term borrowed funds

    2,050       2,050  

Long-term borrowed funds

    30,000       26,500  

Accrued interest payable

    574       616  

Accrued expenses and other liabilities

    13,389       13,148  

Total Liabilities

    914,725       829,438  
                 

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 shares issued; 2,708,712 shares outstanding

    3,513       3,513  

Additional paid-in capital

    46,981       46,757  

Treasury stock, at cost; 102,017 shares

    (2,114 )     (2,114 )

Retained earnings

    39,599       38,831  

Accumulated other comprehensive loss

    (3,641 )     (5,335 )

Total Stockholders' Equity

    88,544       85,858  

Total Liabilities and Stockholders' Equity

  $ 1,003,269     $ 915,296  

 

See accompanying notes to consolidated financial statements.

 

 

 

 
Emclaire Financial Corp
Consolidated Statements of Net Income (Unaudited)
For the three and six months ended June 30, 2020 and 2019
(Dollar amounts in thousands, except share and per share data) 

 

    For the three months ended June 30,   For the six months ended June 30,
   

2020

 

2019

 

2020

 

2019

Interest and dividend income:

                               

Loans receivable, including fees

  $ 8,298     $ 8,113     $ 16,279     $ 16,344  

Securities:

                               

Taxable

    558       530       1,222       1,022  

Exempt from federal income tax

    90       100       174       222  

Federal bank stocks

    86       112       193       212  

Interest earning deposits with banks

    50       99       117       146  

Total interest and dividend income

    9,082       8,954       17,985       17,946  

Interest expense:

                               

Deposits

    1,901       1,636       3,841       3,107  

Borrowed funds

    259       236       532       537  

Total interest expense

    2,160       1,872       4,373       3,644  

Net interest income

    6,922       7,082       13,612       14,302  

Provision for loan losses

    1,100       270       1,892       450  

Net interest income after provision for loan losses

    5,822       6,812       11,720       13,852  

Noninterest income:

                               

Fees and service charges

    288       536       739       1,091  

Net realized gain (loss) on sales of securities

    557       (1 )     635       1  

Net gain on sales of loans

          38             52  

Earnings on bank-owned life insurance

    115       122       209       217  

Other

    418       436       820       827  

Total noninterest income

    1,378       1,131       2,403       2,188  

Noninterest expense:

                               

Compensation and employee benefits

    2,841       2,787       5,754       5,704  

Premises and equipment

    801       840       1,596       1,726  

Intangible asset amortization

    41       45       83       90  

Professional fees

    185       165       405       386  

Federal deposit insurance

    81       131       184       267  

Other

    1,691       1,362       3,109       2,716  

Total noninterest expense

    5,640       5,330       11,131       10,889  

Income before provision for income taxes

    1,560       2,613       2,992       5,151  

Provision for income taxes

    266       473       508       929  

Net income

    1,294       2,140       2,484       4,222  
Preferred stock dividends     91       91       91       91  
Net income available to common stockholders   $ 1,203     $ 2,049     $ 2,393     $ 4,131  

Basic earnings per common share

  $ 0.44     $ 0.76     $ 0.88     $ 1.53  

Diluted earnings per common share

    0.44       0.75       0.88       1.52  

Average common shares outstanding - basic

    2,708,712       2,698,712       2,708,712       2,698,712  

Average common shares outstanding - diluted

    2,722,149       2,715,658       2,722,665       2,714,049  

 

See accompanying notes to consolidated financial statements.

 

 

 
Emclaire Financial Corp
Consolidated Statements of Comprehensive Income (Unaudited)
For the three and six months ended June 30, 2020 and 2019
(Dollar amounts in thousands)

 

    For the three months ended June 30,   For the six months ended June 30,
   

2020

 

2019

 

2020

 

2019

Net income

  $ 1,294     $ 2,140     $ 2,484     $ 4,222  

Other comprehensive income (loss)

                               

Unrealized gains/(losses) on securities available-for-sale:

                               

Unrealized holding gain (loss) arising during the period

    1,186       1,152       2,781       2,259  

Reclassification adjustment for (gains) losses included in net income

    (557 )     1       (635 )     (1 )

Net period change

    629       1,153       2,146       2,258  

Tax effect

    (132 )     (242 )     (452 )     (474 )

Net of tax

    497       911       1,694       1,784  

Comprehensive income

  $ 1,791     $ 3,051     $ 4,178     $ 6,006  

 

See accompanying notes to consolidated financial statements.

 

 

 
Emclaire Financial Corp
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the six months ended June 30, 2020 and 2019
(Dollar amounts in thousands)

 

    For the six months ended June 30,
   

2020

 

2019

Cash flows from operating activities

               

Net income

  $ 2,484     $ 4,222  

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

               

Depreciation and amortization of premises and equipment

    707       669  

Provision for loan losses

    1,892       450  

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

    371       109  

Amortization of operating lease right-of-use assets

    68       65  

Amortization of intangible assets and mortgage servicing rights

    137       121  

Realized gain on sales of debt securities, net

    (635 )     (1 )

Change in fair value of equity securities, including realized gain

    5       (10 )

Net gain on sales of loans

          (52 )

Net loss on foreclosed real estate

          32  
Net gain on sale of premises and equipment           (11 )

Loans originated for sale

          (2,395 )

Proceeds from the sale of loans originated for sale

          2,313  

Write-down of foreclosed real estate

    32       35  

Stock compensation expense

    224       180  

Increase in bank-owned life insurance, net

    (209 )     (217 )
Proceeds from surrender of bank-owned life insurance     220        

Decrease (increase) in accrued interest receivable

    (849 )     66  

Increase in prepaid expenses and other assets

    (196 )     (9 )

Increase (decrease) in accrued interest payable

    (42 )     148  

Increase (decrease) in accrued expenses and other liabilities

    241       (1,005 )

Net cash provided by operating activities

    4,450       4,710  

Cash flows from investing activities

               

Loan originations and principal collections, net

    (110,767 )     16,035  

Available-for-sale securities:

               

Sales

    40,011       12,882  

Maturities, repayments and calls

    11,801       8,240  

Purchases

    (20,459 )     (21,602 )

Net change in federal bank stocks

    (391 )     587  

Net change in interest earning time deposits

    3,236       (3,220 )

Proceeds from the sale of bank premises and equipment

          251  

Purchases of premises and equipment

    (571 )     (1,111 )

Proceeds from the sale of foreclosed real estate

    166       625  

Net cash provided by (used in) investing activities

    (76,974 )     12,687  

Cash flows from financing activities

               

Net increase in deposits

    81,588       16,060  

Proceeds from long-term debt

    20,000        

Repayments on long-term debt

    (16,500 )     (500 )

Net change in short-term borrowings

          (10,800 )

Dividends paid

    (1,716 )     (1,656 )

Net cash provided by financing activities

    83,372       3,104  

Net increase in cash and cash equivalents

    10,848       20,501  

Cash and cash equivalents at beginning of period

    14,986       10,955  

Cash and cash equivalents at end of period

  $ 25,834     $ 31,456  

Supplemental information:

               

Interest paid

  $ 4,415     $ 3,496  
Income taxes paid     100       585  

Supplemental noncash disclosure:

               

Transfers from loans to foreclosed real estate

    267       324  

Initial recognition of operating lease right-of-use assets

          1,642  

Initial recognition of operating lease liabilities

          1,858  

 

See accompanying notes to consolidated financial statements.

 

 

 
Emclaire Financial Corp
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
For the three and six months ended June 30, 2020 and 2019
(Dollar amounts in thousands, except 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, 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

                                  2,082             2,082  

Other comprehensive income

                                        873       873  

Stock compensation expense

                      90                         90  

Cash dividends declared on common stock ($0.29 per share)

                                  (783 )           (783 )
Balance at March 31, 2019     421       3,785       3,501       46,491       (2,114 )     35,489       (5,484 )     82,089  
Net income                                   2,140             2,140  
Other comprehensive income                                         911       911  
Cash dividends declared on preferred stock                                   (91 )           (91 )

Stock compensation expense

                      90                         90  
Cash dividends declared on common stock ($0.29 per share)                                   (782 )           (782 )
Balance at June 30, 2019   $ 421     $ 3,785     $ 3,501     $ 46,581     $ (2,114 )   $ 36,756     $ (4,573 )   $ 84,357  
                                                                 

Balance at January 1, 2020

  $ 421     $ 3,785     $ 3,513     $ 46,757     $ (2,114 )   $ 38,831     $ (5,335 )   $ 85,858  
Net income                                   1,190             1,190  

Other comprehensive income

                                        1,197       1,197  
Stock compensation expense                       112                         112  
Cash dividends declared on common stock ($0.30 per share)                                   (812 )           (812 )

Balance at March 31, 2020

    421       3,785       3,513       46,869       (2,114 )     39,209       (4,138 )     87,545  

Net income

                                  1,294             1,294  
Other comprehensive income                                         497       497  
Cash dividends declared on preferred stock                                   (91 )           (91 )
Stock compensation expense                       112                         112  
Cash dividends declared on common stock ($0.30 per share)                                   (813 )           (813 )
Balance at June 30, 2020   $ 421     $ 3,785     $ 3,513     $ 46,981     $ (2,114 )   $ 39,599     $ (3,641 )   $ 88,544  

 

See accompanying notes to consolidated financial statements.

 

 

Emclaire Financial Corp

Notes to Consolidated Financial Statements (Unaudited)

 

 

1.

Nature of Operations and Basis of Presentation

 

Emclaire Financial Corp (the Corporation) is a Pennsylvania corporation and the holding company of The Farmers National Bank of Emlenton (the Bank). The Corporation provides a variety of financial services to individuals and businesses through its offices in western Pennsylvania and northern 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.

 

The consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiaries, the Bank and the Title Company. All significant intercompany transactions and balances have been eliminated in preparing the consolidated financial statements.

 

The accompanying unaudited consolidated financial statements for the interim periods include all adjustments, consisting of normal recurring accruals, which are necessary, in the opinion of management, to fairly reflect the Corporation’s consolidated financial position and results of operations. Additionally, these consolidated financial statements for the interim periods have been prepared in accordance with instructions for the Securities and Exchange Commission’s (SEC’s) Form 10-Q and Article 10 of Regulation S-X and therefore do not include all information or footnotes necessary for a complete presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (GAAP). For further information, refer to the audited consolidated financial statements and footnotes thereto for the year ended December 31, 2019, as contained in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019 filed with the SEC.

 

The balance sheet at December 31, 2019 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by GAAP for complete financial statements.

 

The preparation of financial statements, in conformity with GAAP, requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. The results of operations for interim quarterly or year-to-date periods are not necessarily indicative of the results that may be expected for the entire year or any other period. Certain amounts previously reported may have been reclassified to conform to the current year’s financial statement presentation.

 

The coronavirus (COVID-19) pandemic has negatively impacted the global economy, disrupted global supply chains and increased unemployment levels. Although the temporary closure of many businesses and shelter-in place policies have eased, restrictions and social distancing continue to impact many of the Corporation’s customers. While the full effects of the pandemic still remain unknown, the Corporation is committed to supporting its customers, employees and communities during this difficult time. The Corporation has given hardship relief assistance to customers, including the consideration of various loan payment deferral and fee waiver options, and encourages customers to reach out for assistance to support their individual circumstances.  The pandemic could result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses, particularly if businesses remain closed, the impact on the global economy worsens, or more customers draw on their lines of credit or seek additional loans to help finance their businesses. Similarly, because of changing economic and market conditions, we may be required to recognize impairments on securities, goodwill or other significant estimates.  The extent to which the COVID-19 pandemic impacts our business, results of operations, and financial condition, as well as our regulatory capital and liquidity ratios, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic.

 

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed by the President of the United States. Certain provisions within the CARES Act encourage financial institutions to practice prudent efforts to work with borrowers impacted by COVID-19. Under these provisions, loan modifications deemed to be COVID-19-related would not be considered a troubled debt restructuring (TDR) if the loan was not more than 30 days past due as of December 31, 2019 and the deferral was executed between March 1, 2020 and the earlier of 60 days after the date of termination of the COVID-19 national emergency or December 31, 2020. The banking regulators issued similar guidance, which also clarified that a COVID-19-related modification should not be considered a TDR if the borrower was current on payments at the time the underlying loan modification program was implemented and if the modification is considered to be short-term. Under these terms, as of June 30, 2020, the Corporation had processed payment deferrals for 430 loans with an aggregate balance of $106.6 million. Through August 5, 2020, the number of deferrals decreased to 428 with an aggregate balance of $111.6 million. The majority of these deferrals were generally 30 to 90 days in duration.  As a result of the continued uncertainty surrounding the COVID-19 pandemic, as of August 5, 2020, the Corporation has granted 41 requests with an aggregate balance of $44.9 million for a second deferral of up to 90 days in duration.

 

Additionally, the Bank is a lender for the Small Business Administration's (SBA) Paycheck Protection Program (PPP), a program under the CARES Act, and other SBA, Federal Reserve or United States Treasury programs that have been created in response to the pandemic, and may be a lender for programs created in the future. These programs are new and their effects on the Corporation’s business are uncertain. Through August 5, 2020, the Bank had closed 667 PPP loans amounting to $53.7 million under the allocation approved by Congress.

 

 

 

2.

Earnings per Common Share

 

Basic earnings per common share (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 for assumed issuance of restricted stock.

 

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

 

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

  For the three months ended June 30,   For the six months ended June 30,
   

2020

 

2019

 

2020

 

2019

Net income

  $ 1,294     $ 2,140     $ 2,484     $ 4,222  

Less: Preferred stock dividends

    91       91       91       91  

Net income available to common stockholders

  $ 1,203     $ 2,049     $ 2,393     $ 4,131  

Average common shares outstanding

    2,708,712       2,698,712       2,708,712       2,698,712  

Add: Dilutive effects of restricted stock awards

    13,437       16,946       13,953       15,337  

Average shares and dilutive potential common shares

    2,722,149       2,715,658       2,722,665       2,714,049  

Basic earnings per common share

  $ 0.44     $ 0.76     $ 0.88     $ 1.53  

Diluted earnings per common share

  $ 0.44     $ 0.75     $ 0.88     $ 1.52  

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

                       

 

 

 

3.

Securities

 

Equity Securities

 

The Corporation held equity securities with fair values of $14,000 and $19,000 at June 30, 2020 and December 31, 2019, 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. During the three and six months ended June 30, 2020 the Corporation recognized a gain of $5,000 and a loss of $5,000, respectively, on equity securities held at June 30, 2020, compared to a gain of $0 and $10,000, respectively, for the same period in 2019. During the three and six months ended June 30, 2020 and 2019, the Corporation did not sell any equity securities.

 

Debt Securities - Available-for-Sale

 

The following table summarizes the Corporation’s debt securities as of June 30, 2020 and December 31, 2019:

 

(Dollar amounts in thousands)

 

Amortized Cost

 

Gross Unrealized Gains

 

Gross Unrealized Losses

 

Fair Value

June 30, 2020:

                               

U.S. government sponsored entities and agencies

  $ 1,000     $ 22     $     $ 1,022  

U.S. agency mortgage-backed securities: residential

    18,614       556       (25 )     19,145  

U.S. agency collateralized mortgage obligations: residential

    20,278       372       (19 )     20,631  

State and political subdivisions

    37,046       1,071       (55 )     38,062  

Corporate debt securities

    12,441       343       (257 )     12,527  

Total securities available-for-sale

  $ 89,379     $ 2,364     $ (356 )   $ 91,387  
                                 

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  

 

The following table summarizes scheduled maturities of the Corporation’s debt securities as of June 30, 2020. 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

  $ 756     $ 766  

Due after one year through five years

    2,027       2,069  

Due after five years through ten years

    16,380       16,589  

Due after ten years

    31,324       32,187  

Mortgage-backed securities: residential

    18,614       19,145  

Collateralized mortgage obligations: residential

    20,278       20,631  

Total securities available-for-sale

  $ 89,379     $ 91,387  

 

 

3.

Securities (continued)

 

Information pertaining to debt securities with gross unrealized losses at June 30, 2020 and December 31, 2019, 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

June 30, 2020:

                                               

U.S. agency mortgage-backed securities: residential

  $ 3,213     $ (25 )   $     $     $ 3,213     $ (25 )

U.S. agency collateralized mortgage obligations: residential

  $ 4,244       (11 )     1,166       (8 )     5,410       (19 )

State and political subdivisions

  $ 2,699       (55 )                 2,699       (55 )

Corporate debt securities

  $ 4,020       (230 )     473       (27 )     4,493       (257 )

Total

  $ 14,176     $ (321 )   $ 1,639     $ (35 )   $ 15,815     $ (356 )
                                                 

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 )

 

Gains and losses on sales of securities for the three and six months ended June 30, 2020 were as follows:

 

(Dollar amounts in thousands)

 

For the three months ended June 30,

 

For the six months ended June 30,

   

2020

 

2019

 

2020

 

2019

Proceeds

  $ 31,785     $ 8,907     $ 40,011     $ 12,882  

Gains

    558       29       640       35  

Losses

    (1 )     (30 )     (5 )     (34 )

Tax provision related to gains (losses)

    117             133        

 

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.

 

There were 19 debt securities in an unrealized loss position as of June 30, 2020, two of which were in an unrealized loss position for more than 12 months. Of these 19 securities, 10 were corporate securities, four were collateralized mortgage obligations (issued by U.S. government sponsored entities), three were mortgage-backed securities and two were state and political subdivision securities. The unrealized losses associated with these securities were not due to the deterioration in the credit quality of the issuer that would likely 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 their amortized cost basis, the Corporation does not consider these debt securities with unrealized losses as of June 30, 2020 to be other-than-temporarily impaired.

 

 

 

4.

Loans Receivable and Related Allowance for Loan Losses

 

The Corporation’s loans receivable as of the respective dates are summarized as follows:

 

(Dollar amounts in thousands)

  June 30, 2020   December 31, 2019

Mortgage loans on real estate:

               

Residential first mortgages

  $ 306,986     $ 293,170  

Home equity loans and lines of credit

    93,652       97,541  

Commercial real estate

    264,909       229,951  

Total real estate loans

    665,547       620,662  

Other loans:

               

Commercial business

    117,399       66,603  

Consumer

    28,945       14,639  

Total other loans

    146,344       81,242  

Total loans, gross

    811,891       701,904  

Less allowance for loan losses

    8,159       6,556  

Total loans, net

  $ 803,732     $ 695,348  

 

Included in total loans above are net deferred costs of $1.2 million and $2.6 million at June 30, 2020 and December 31, 2019, 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.  While the Corporation has historically experienced strong trends in asset quality, as a result of the situation regarding the COVID-19 pandemic, management has recognized the need to incorporate factors into the allowance evaluation to help compensate for the effects of any credit deterioration due to the current economic situation.

 

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.

 

The allowance for loan losses is based on estimates and actual losses may 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 June 30, 2020, 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).

 

 

4.

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:

 

(Dollar amounts in thousands)

  Residential Mortgages   Home Equity & Lines of Credit  

Commercial Real Estate

  Commercial Business  

Consumer

 

Total

Three months ended June 30, 2020:

                                               

Allowance for loan losses:

                                               

Beginning Balance

  $ 2,329     $ 641     $ 3,434     $ 681     $ 135     $ 7,220  

Charge-offs

                      (147 )     (39 )     (186 )

Recoveries

          11       2       1       11       25  

Provision

    253       2       465       268       112       1,100  

Ending Balance

  $ 2,582     $ 654     $ 3,901     $ 803     $ 219     $ 8,159  
                                                 
Six months ended June 30, 2020:                                                
Allowance for loan losses:                                                
Beginning Balance   $ 2,309     $ 626     $ 2,898     $ 636     $ 87     $ 6,556  
Charge-offs     (11 )     (39 )     (73 )     (147 )     (54 )     (324 )
Recoveries           11       5       1       18       35  
Provision     284       56       1,071       313       168       1,892  
Ending Balance   $ 2,582     $ 654     $ 3,901     $ 803     $ 219     $ 8,159  
                                                 

At June 30, 2020:

                                               

Ending ALL balance attributable to loans:

                                               

Individually evaluated for impairment

  $ 1     $     $     $ 11     $     $ 12  

Acquired loans collectively evaluated for impairment

                                   

Originated loans collectively evaluated for impairment

    2,581       654       3,901       792       219       8,147  

Total

  $ 2,582     $ 654     $ 3,901     $ 803     $ 219     $ 8,159  

Total loans:

                                               

Individually evaluated for impairment

  $ 344     $ 4     $ 1,734     $ 213     $     $ 2,295  

Acquired loans collectively evaluated for impairment

    53,050       9,239       36,630       6,099       1,325       106,343  

Originated loans collectively evaluated for impairment

    253,592       84,409       226,545       111,087       27,620       703,253  

Total

  $ 306,986     $ 93,652     $ 264,909     $ 117,399     $ 28,945     $ 811,891  
                                                 

At December 31, 2019:

                                               

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  
                                                 

Three months ended June 30, 2019:

                                               

Allowance for loan losses:

                                               

Beginning Balance

  $ 2,256     $ 650     $ 3,043     $ 635     $ 55     $ 6,639  

Charge-offs

    (194 )     (30 )     (23 )     (63 )     (36 )     (346 )

Recoveries

                13             4       17  

Provision

    163       22       10       43       32       270  

Ending Balance

  $ 2,225     $ 642     $ 3,043     $ 615     $ 55     $ 6,580  
                                                 
Six months ended June 30, 2019:                                                
Allowance for loan losses:                                                
Beginning Balance   $ 2,198     $ 648     $ 3,106     $ 500     $ 56     $ 6,508  
Charge-offs     (204 )     (34 )     (28 )     (134 )     (75 )     (475 )
Recoveries     40       1       28             28       97  
Provision     191       27       (63 )     249       46       450  
Ending Balance   $ 2,225     $ 642     $ 3,043     $ 615     $ 55     $ 6,580  

 

 

4.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following table presents 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 June 30, 2020:

 

(Dollar amounts in thousands)

                                               
   

Impaired Loans with Specific Allowance

   

As of June 30, 2020

 

For the three months ended June 30, 2020

    Unpaid Principal Balance   Recorded Investment   Related Allowance   Average Recorded Investment   Interest Income Recognized in Period   Cash Basis Interest Recognized in Period

Residential first mortgages

  $ 71     $ 71     $ 1     $ 71     $ 1     $ 1  

Home equity and lines of credit

    4       4             4              

Commercial real estate

                      75              

Commercial business

    72       72       11       58              

Consumer

                                   

Total

  $ 147     $ 147     $ 12     $ 208     $ 1     $ 1  

 

   

For the six months ended June 30, 2020

   

Average Recorded Investment

 

Interest Income Recognized in Period

 

Cash Basis Interest Recognized in Period

Residential first mortgages

  $ 71     $ 2     $ 2  

Home equity and lines of credit

    4              

Commercial real estate

    50              

Commercial business

    39       1       1  

Consumer

                 

Total

  $ 164     $ 3     $ 3  

 

   

Impaired Loans with No Specific Allowance

   

As of June 30, 2020

 

For the three months ended June 30, 2020

    Unpaid Principal Balance   Recorded Investment   Average Recorded Investment   Interest Income Recognized in Period   Cash Basis Interest Recognized in Period

Residential first mortgages

  $ 384     $ 273     $ 276     $     $  

Home equity and lines of credit

                             

Commercial real estate

    1,734       1,734       1,400       40       24  

Commercial business

    141       141       92       4       2  

Consumer

                             

Total

  $ 2,259     $ 2,148     $ 1,768     $ 44     $ 26  

 

   

For the six months ended June 30, 2020

   

Average Recorded Investment

 

Interest Income Recognized in Period

 

Cash Basis Interest Recognized in Period

Residential first mortgages

  $ 279     $ 1     $ 1  

Home equity and lines of credit

                 

Commercial real estate

    960       54       37  

Commercial business

    75       4       2  

Consumer

                 

Total

  $ 1,314     $ 59     $ 40  

 

 

4.

Loans Receivable and Related Allowance for Loan Losses (continued)

 
The following table presents 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, 2019:
 

(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  

 

 

4.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following table presents 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 June 30, 2019:

 

(Dollar amounts in thousands)

                                               
   

Impaired Loans with Specific Allowance

   

As of June 30, 2019

 

For the three months ended June 30, 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

  $ 73     $ 73     $ 6     $ 73     $ 1     $ 1  

Home equity and lines of credit

    5       5             5              

Commercial real estate

                                   

Commercial business

                      31              

Consumer

                                   

Total

  $ 78     $ 78     $ 6     $ 109     $ 1     $ 1  

 

   

For the six months ended June 30, 2019

   

Average Recorded Investment

 

Interest Income Recognized in Period

 

Cash Basis Interest Recognized in Period

Residential first mortgages

  $ 73     $ 2     $ 2  

Home equity and lines of credit

    6              

Commercial real estate

                 

Commercial business

    21              

Consumer

                 

Total

  $ 100     $ 2     $ 2  

 

   

Impaired Loans with No Specific Allowance

   

As of June 30, 2019

 

For the three months ended June 30, 2019

    Unpaid Principal Balance   Recorded Investment   Average Recorded Investment   Interest Income Recognized in Period   Cash Basis Interest Recognized in Period

Residential first mortgages

  $ 378     $ 303     $ 305     $     $  

Home equity and lines of credit

                             

Commercial real estate

    2,478       2,478       1,255       52        

Commercial business

    238       238       139       6       1  

Consumer

                             

Total

  $ 3,094     $ 3,019     $ 1,699     $ 58     $ 1  

 

   

For the six months ended June 30, 2019

   

Average Recorded Investment

 

Interest Income Recognized in Period

 

Cash Basis Interest Recognized in Period

Residential first mortgages

  $ 308     $ 1     $ 1  

Home equity and lines of credit

                 

Commercial real estate

    848       53       1  

Commercial business

    106       7       2  

Consumer

                 

Total

  $ 1,262     $ 61     $ 4  

 

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.

 

 

4.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

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 generally does not extend additional credit to borrowers with loans classified as TDRs.

At June 30, 2020 and December 31, 2019, the Corporation had $339,000 and $409,000, respectively, of loans classified as TDRs, which are included in impaired loans above. The Corporation had allocated $1,000 and $5,000 of specific allowance for these loans at June 30, 2020 and December 31, 2019, respectively.

During the three and six months ended June 30, 2020, the Corporation did not modify any loans as TDRs.  During the three and six months ended June 30, 2019, the Corporation modified the interest rate and extended the payment amortization on one commercial real estate loan with a recorded investment of $73,000. At June 30, 2019, the Corporation did not have any specific allowance for loan losses allocated to this specific loan. 

Under the provisions of the CARES Act, as of June 30, 2020, the Corporation has granted modifications on 430 loans with an aggregate balance of $106.6 million, representing 13.1% of gross outstanding loan balances.  As of June 30, 2020, hotel loans comprise $40.0 million, or 31.9%, or the total deferrals.  Through August 5, 2020, the number of modifications totaled 428 loans with an aggregate balance of $111.6 million, or 13.6% of gross loans outstanding.  The characteristics of these modifications are considered short-term and do not result in a reclassification of these loans to TDR status.

A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms. During the three and six months ended June 30, 2020 and 2019, the Corporation did not have any loans which were modified as TDRs for which there was a payment default within twelve months following the 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 is 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.

 

The reserve allocation for risk rated loan pools is developed by applying the following factors:

 

Historic: Management utilizes a computer model to develop the historical net charge-off experience which is used to formulate the assumptions employed in the migration analysis applied to estimate losses in the portfolio. Outstanding balance and charge-off information are input into the model and historical loss migration rate assumptions are developed to apply to pass, special mention, substandard and doubtful risk rated loans. A twelve-quarter rolling weighted-average is utilized to estimate probable incurred losses in the portfolios.

 

Qualitative: Qualitative adjustment factors for pass, special mention, substandard and doubtful ratings are developed and applied to risk rated loans to allow for: quality of lending policies and procedures; national and local economic and business conditions; changes in the nature and volume of the portfolio; experiences, ability and depth of lending management; changes in trends, volume and severity of past due, nonaccrual and classified loans and loss and recovery trends; quality of loan review systems; concentrations of credit and other external factors.

 

 

4.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

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 a 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.

 

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 June 30, 2020 and December 31, 2019:

 

(Dollar amounts in thousands)

                                               
   

Not Rated

 

Pass

  Special Mention  

Substandard

 

Doubtful

 

Total

June 30, 2020:

                                               

Residential first mortgages

  $ 305,446     $     $     $ 1,540     $     $ 306,986  

Home equity and lines of credit

    93,206                   446             93,652  

Commercial real estate

          247,661       5,198       12,050             264,909  

Commercial business

          114,577       217       2,605             117,399  

Consumer

    28,828                   117             28,945  

Total loans

  $ 427,480     $ 362,238     $ 5,415     $ 16,758     $     $ 811,891  
                                                 

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  

 

 

4.

Loans Receivable and Related Allowance for Loan Losses (continued)

 

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 recorded payment is past due. As of June 30, 2020, the Corporation had made short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment for borrowers.  Under the CARES Act, borrowers that are considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented.  As such, the modifications made under the CARES Act are not included in the Corporation's past due or nonaccrual loans as of June 30, 2020.  The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonperforming loans as of June 30, 2020 and December 31, 2019:

 

(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

June 30, 2020:

                                               

Residential first mortgages

  $ 303,425     $ 1,440     $ 581     $ 634     $ 906     $ 306,986  

Home equity and lines of credit

    92,781       425             107       339       93,652  

Commercial real estate

    258,366       3,908       134       792       1,709       264,909  

Commercial business

    116,728       67       126       240       238       117,399  

Consumer

    28,588       225       15             117       28,945  

Total loans

  $ 799,888     $ 6,065     $ 856     $ 1,773     $ 3,309     $ 811,891  
                                                 

December 31, 2019:

                                               

Residential first mortgages

  $ 288,399     $ 2,405     $ 1,039     $ 372     $ 955     $ 293,170  

Home equity and lines of credit

    95,908       626       553       26       428       97,541  

Commercial real estate

    226,133       2,141       543       227       907       229,951  

Commercial business

    66,087       225       72       4       215       66,603  

Consumer

    14,458       84       15             82       14,639  

Total loans

  $ 690,985     $ 5,481     $ 2,222     $ 629     $ 2,587     $ 701,904  

 

The following table presents the Corporation’s nonaccrual loans by aging category as of June 30, 2020 and December 31, 2019:

 

(Dollar amounts in thousands)

                                       
    Not Past Due   30-59 Days Past Due   60-89 Days Past Due   90 Days + Past Due  

Total

June 30, 2020:

                                       

Residential first mortgages

  $ 233     $ 70     $     $ 603     $ 906  

Home equity and lines of credit

    3                   336       339  

Commercial real estate

    940       71       171       527       1,709  

Commercial business

    95                   143       238  

Consumer

                      117       117  

Total loans

  $ 1,271     $ 141     $ 171     $ 1,726     $ 3,309  
                                         

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  

 

 

 

5.

Goodwill and Intangible Assets

 

The following table summarizes the Corporation’s acquired goodwill and intangible assets as of June 30, 2020 and December 31, 2019

 

(Dollar amounts in thousands)

 

June 30, 2020

 

December 31, 2019

    Gross Carrying Amount   Accumulated Amortization   Gross Carrying Amount   Accumulated Amortization

Goodwill

  $ 19,460     $     $ 19,460     $  

Core deposit intangibles

    5,634       4,471       5,634       4,387  

Total

  $ 25,094     $ 4,471     $ 25,094     $ 4,387  

 

Goodwill resulted from five acquisitions. 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 value of goodwill 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 during 2019 or in the first six months of 2020.  Although the annual review of goodwill revealed no impairment consideration, based on current economic conditions related to COVID-19, management performed an interim assessment as of June 30, 2020.  Management concluded that goodwill was not impaired at this date.  While it is impossible to know the future impact of the evolving economic conditions, the impact could be material. 

 

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. During the three and six month periods ended June 30, 2020, the Corporation recorded intangible amortization expense totaling $41,000 and $83,000, respectively, compared to $45,000 and $90,000, respectively, for the same periods in 2019.

 

 

6.

Stock Compensation Plan

 

In April 2014, the Corporation adopted the 2014 Stock Incentive Plan (the Plan), which was approved by shareholders 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. As of June 30, 2020, 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 Plan. 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.

 

At June 30, 2020, there were no options that were granted or outstanding under the Plan.

 

A summary of the status of the Corporation’s nonvested restricted stock awards as of June 30, 2020, and changes during the period then ended is presented below:

 

   

Shares

  Weighted-Average Grant-date Fair Value

Nonvested at January 1, 2020

    44,450     $ 31.11  

Granted

           

Vested

           

Forfeited

           

Nonvested as of June 30, 2020

    44,450     $ 31.11  

 

For the three and six month periods ended June 30, 2020, the Corporation recognized stock compensation expense of $112,000 and $224,000, respectively, compared to $90,000 and $180,000, respectively, for the same periods in 2019.  As of June 30, 2020, there was $727,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over the next three years. 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.

 

 

 

7.

Fair Value

 

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 period 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.

 

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 and equity securities held by the Corporation.

 

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

June 30, 2020:

                               

Securities available-for-sale

                               

U.S. government sponsored entities and agencies

  $ 1,022     $     $ 1,022     $  

U.S. agency mortgage-backed securities: residential

    19,145             19,145        

U.S. agency collateralized mortgage obligations: residential

    20,631             20,631        

State and political subdivision

    38,062             38,062        

Corporate debt securities

    12,527             8,505       4,022  

Total available-for-sale securities

  $ 91,387     $     $ 87,365     $ 4,022  
                                 

Equity securities

  $ 14     $ 14     $     $  
                                 

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 subdivisions

    27,796             27,796        

Corporate debt securities

    11,322             7,300       4,022  

Total available-for-sale securities

  $ 120,107     $     $ 116,085     $ 4,022  
                                 

Equity securities

  $ 19     $ 19     $     $  

 

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 the three and six month periods ended June 30, 2020, the Corporation had no transfers between levels.  During the three and six month periods ended June 30, 2019, the Corporation reclassified one corporate security from Level 3 to Level 2.

 

 

7.

Fair Value (continued)

 

The following table presents changes in Level 3 assets measured on a recurring basis for the three and six month periods ended June 30, 2020 and 2019:

 

(Dollar amounts in thousands)

  Three months ended June 30,   Six months ended June 30,
   

2020

 

2019

 

2020

 

2019

Balance at the beginning of the period

  $ 4,022     $ 3,500     $ 4,022     $ 3,500  

Total gains or losses (realized/unrealized):

                               

Included in earnings

                       

Included in other comprehensive income

                       

Transfers in and/or out of Level 3

          (500 )           (500 )

Balance at the end of the period

  $ 4,022     $ 3,000     $ 4,022     $ 3,000  

 

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 June 30, 2020, the Corporation had one impaired commercial business loan carried at a fair value of $60,000, which consisted of the outstanding balance of $67,000 less a specific reserve of $7,000. As of December 31, 2019, the Corporation did not have any impaired loans carried at fair value measured using the fair value of collateral. During the three and six month periods ended June 30, 2020there was additional provision for loans losses recorded for impaired loans of $7,000 and $31,000, respectively, compared to $63,000 for the three and six month periods ended June 30, 2019.

 

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 June 30, 2020, OREO measured at fair value less costs to sell had a carrying amount of $9,000, which consisted of the outstanding balance of $18,000, less write-downs of $9,000.  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.  This property was sold during the first quarter of 2020.  During the three and six month periods ended June 30, 2020, there was $32,000 of expense recorded associated with the write-down of OREO. During the three and six month periods ended June 30, 2019, there was expense recorded of $14,000 and $35,000, respectively, associated with the write-down of OREO.

 

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.

 

For assets measured at fair value on a non-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
June 30, 2020:                                
Impaired commercial business loans   $ 60     $     $     $ 60  
Other real estate owned     9                   9  

Total

  $ 69     $     $     $ 69  
                                 

December 31, 2019:

                               

Other real estate owned

  $ 88     $     $     $ 88  
Total   $ 88     $     $     $ 88  

 

 

7.

Fair Value (continued)

 

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

June 30, 2020:                  
Impaired commercial business loans   $ 60   Liquidation value of business assets Adjustment for differences between comparable sales   10 %
Other real estate owned     9   Sales comparison approach Adjustment for differences between comparable sales   10 %
                   

December 31, 2019:

                 

Other real estate owned

  $ 88  

Sales comparison approach

Adjustment for differences between comparable sales

  10 %

 

At June 30, 2020 and December 31, 2019, there was an impaired residential mortgage loan totaling $70,000 and $67,000, respectively, and an impaired home equity loan totaling $4,000 and $4,000, respectively, which were classified as TDRs and measured using a discounted cash flow methodology.

 

The following table sets forth the carrying amount and fair value of the Corporation’s financial instruments included in the consolidated balance sheet: 

 

(Dollar amounts in thousands)

                                       
   

Carrying

 

Fair Value Measurements using:

Description

 

Amount

 

Total

 

Level 1

 

Level 2

 

Level 3

June 30, 2020:

                                       

Financial Assets:

                                       

Cash and cash equivalents

  $ 25,834     $ 25,834     $ 25,834     $     $  

Interest earning time deposits

    6,462       6,462             6,462        

Securities - available-for-sale

    91,387       91,387             87,365       4,022  

Securities - equities

    14       14       14              

Loans, net

    803,732       801,735                   801,735  

Federal bank stock

    6,181       N/A       N/A       N/A       N/A  

Accrued interest receivable

    3,449       3,449       57       361       3,031  

Total

  $ 937,058     $ 928,881     $ 25,905     $ 94,188     $ 808,788  

Financial Liabilities:

                                       
Deposits     868,712       874,599       670,755       203,844        
Borrowed funds     32,050       33,268             33,268        

Accrued interest payable

    574       574       50       524        

Total

  $ 901,336     $ 908,441     $ 670,805     $ 237,636     $  

 

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             116,085       4,022  

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     $ 126,202     $ 704,115  

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     $  

 

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.

 

 

 

8.

Regulatory Matters

 

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.

 

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 for 2018 was 1.875%. Amounts recorded to accumulated other comprehensive income are not included in computing regulatory capital. Management believes as of June 30, 2020, the Bank met all capital adequacy requirements to which it was 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 June 30, 2020, 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.

 

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)

 

June 30, 2020

 

December 31, 2019

   

Amount

 

Ratio

 

Amount

 

Ratio

Total capital to risk-weighted assets:

                               

Actual

  $ 81,312       12.77 %   $ 80,418       13.74 %

For capital adequacy purposes

    50,924       8.00 %     46,836       8.00 %

To be well capitalized

    63,655       10.00 %     58,544       10.00 %

Tier 1 capital to risk-weighted assets:

                               

Actual

  $ 73,353       11.52 %   $ 73,862       12.62 %

For capital adequacy purposes

    38,193       6.00 %     35,127       6.00 %

To be well capitalized

    50,924       8.00 %     46,836       8.00 %

Common Equity Tier 1 capital to risk-weighted assets:

                               

Actual

  $ 73,353       11.52 %   $ 73,862       12.62 %

For capital adequacy purposes

    28,645       4.50 %     26,345       4.50 %

To be well capitalized

    41,376       6.50 %     38,054       6.50 %

Tier 1 capital to average assets:

                               

Actual

  $ 73,353       7.47 %   $ 73,862       8.17 %

For capital adequacy purposes

    39,292       4.00 %     36,146       4.00 %

To be well capitalized

    49,116       5.00 %     45,182       5.00 %

 

 

 

9.

Accumulated Other Comprehensive Income (Loss)

 

The following tables summarize the changes within each classification of accumulated other comprehensive income (loss), net of tax, for the three month periods ended June 30, 2020 and 2019 and summarizes the significant amounts reclassified out of each component of accumulated other comprehensive income (loss):

 

 

(Dollar amounts in thousands)

 

Unrealized Gains and Losses on Available-for-Sale Securities

 

Defined Benefit Pension Items

 

Totals

Accumulated Other Comprehensive Income (Loss) at April 1, 2020

  $ 1,089     $ (5,227 )   $ (4,138 )

Other comprehensive income before reclassification

    937             937  

Amounts reclassified from accumulated other comprehensive income (loss)

    (440 )           (440 )

Net current period other comprehensive income (loss)

    497             497  

Accumulated Other Comprehensive Income (Loss) at June 30, 2020

  $ 1,586     $ (5,227 )   $ (3,641 )

 

(Dollar amounts in thousands)

 

Amount Reclassified

 
    from Accumulated Other Comprehensive Income  
Details about Accumulated Other Comprehensive (Income) Loss Components   For the three months ended June 30, 2020 Affected Line Item in the Statement Where Net Income is Presented

Unrealized gains and losses on available-for-sale securities

  $ (557 )

Net gain on sale of available-for-sale securities

Tax effect

    117  

Provision for income taxes

Total reclassifications for the period

  $ (440 )

Net of tax


 

(Dollar amounts in thousands)

 

Unrealized Gains and Losses on Available-for-Sale Securities

 

Defined Benefit Pension Items

 

Totals

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

  $ (644 )   $ (4,840 )   $ (5,484 )

Other comprehensive income before reclassification

    910             910  

Amounts reclassified from accumulated other comprehensive income (loss)

    1             1  

Net current period other comprehensive income (loss)

    911             911  

Accumulated Other Comprehensive Income (Loss) at June 30, 2019

  $ 267     $ (4,840 )   $ (4,573 )

 

 

(Dollar amounts in thousands)

 

Amount Reclassified

 
    from Accumulated Other Comprehensive Income  
Details about Accumulated Other Comprehensive (Income) Loss Components   For the three months ended June 30, 2019 Affected Line Item in the Statement Where Net Income is Presented

Unrealized gains and losses on available-for-sale securities

  $ 1  

Net loss on sale of available-for-sale securities

Tax effect

     

Provision for income taxes

Total reclassifications for the period

  $ 1  

Net of tax


 

 

 

9.

Accumulated Other Comprehensive Income (Loss)

 

The following tables summarize the changes within each classification of accumulated other comprehensive income (loss), net of tax, for the six months ended June 30, 2020 and 2019 and summarizes the significant amounts reclassified out of each component of accumulated other comprehensive income (loss):

 

(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, 2020

  $ (108 )   $ (5,227 )   $ (5,335 )

Other comprehensive income before reclassification

    2,196             2,196  

Amounts reclassified from accumulated other comprehensive income (loss)

    (502 )           (502 )

Net current period other comprehensive income (loss)

    1,694             1,694  

Accumulated Other Comprehensive Income (Loss) at June 30, 2020

  $ 1,586     $ (5,227 )   $ (3,641 )

 

(Dollar amount in thousands)

 

Amount Reclassified

 
    from Accumulated Other Comprehensive Income  

Details about Accumulated Other Comprehensive (Income) Loss Components

 

For the six months ended June 30, 2020

Affected Line Item in the Statement Where Net Income is Presented

Unrealized gains and losses on available-for-sale securities

  $ (635 )

Net gain on sale of available-for-sale securities

Tax effect

    133  

Provision for income taxes

Total reclassifications for the period

  $ (502 )

Net of tax


 

(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

    1,785             1,785  

Amounts reclassified from accumulated other comprehensive income (loss)

    (1 )           (1 )

Net current period other comprehensive income (loss)

    1,784             1,784  

Accumulated Other Comprehensive Income (Loss) at June 30, 2019

  $ 267     $ (4,840 )   $ (4,573 )

 

(Dollar amount in thousands)

 

Amount Reclassified

 
    from Accumulated Other Comprehensive Income  

Details about Accumulated Other Comprehensive (Income) Loss Components

 

For the six months ended June 30, 2019

Affected Line Item in the Statement Where Net Income is Presented

Unrealized gains and losses on available-for-sale securities

  $ (1 )

Net gain on sale of available-for-sale securities

Tax effect

     

Provision for income taxes

Total reclassifications for the period

  $ (1 )

Net of tax


 

 

 

10.

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 a 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 three and six months ended June 30, 2020 and 2019.

 

(Dollar amounts in thousands)

  For the three months ended June 30,   For the six months ended June 30,
   

2020

 

2019

 

2020

 

2019

Noninterest income

                               

In-scope of Topic 606:

                               

Service charges on deposits

                               

Maintenance fees

  $ 48     $ 42     $ 100     $ 82  

Overdraft fees

    180       412       508       850  

Other fees

    60       82       130       159  

Electronic banking fees (1)

    371       371       704       695  

Noninterest income (in-scope of Topic 606)

    659       907       1,442       1,786  

Noninterest income (out-of-scope of Topic 606) (2)

    719       224       961       402  

Total noninterest income

  $ 1,378     $ 1,131     $ 2,403     $ 2,188  

 

(1)

Included in other noninterest income on the consolidated statement of income.

 

(2)

Noninterest income items that are out-of-scope include net realized gains (losses) on sales of securities, net gains (losses) on sales of loans, earnings on bank-owned life insurance and certain other noninterest income items.

 

 

 

11.

Leases

 

Effective January 1, 2019, the Corporation adopted ASU 2016-02, Leases (Topic 842).  As of June 30, 2020, 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 12.70 years as of June 30, 2020 compared to 13.40 years as of June 30, 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 term 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 3.50% as of June 30, 2020 compared to 3.48% as of June 30, 2019.

 

The total operating lease costs were $48,000 and $96,000, respectively, for the three and six months ended June 30, 2020 and $48,000 and $97,000, respectively, for the three and six months ended June 30, 2019.  The right-of-use asset, included in premises and equipment, and lease liability, included in other liabilities, was $1.4 million and $1.6 million, respectively, as of June 30, 2020, and $1.6 million and $1.8 million, respectively, as of June 30, 2019.

 

Total estimated rental commitments for the operating leases were as follows as of June 30, 2020:

 

(Dollar amounts in thousands)

       

Year ending December 31:

       

2020 (excluding six months)

  $ 106  

2021

    217  

2022

    222  

2023

    222  

2024

    227  

Thereafter

    1,063  

Total minimum lease payments

    2,057  

Discount effect of cash flows

    (427 )

Present value of lease liabilities

  $ 1,630  

 

 

 

12.

Recent Accounting Pronouncements

 

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 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.

 

In March 2020, the FASB issued ASU 2020-04, "Facilitation of the Effects of Reference Rate Reform on Financial Reporting".  The ASU is intended to provide relief for companies preparing for discontinuation of interest rates based on LIBOR, or other reference rates that may be discontinued, and provides optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships, subject to meeting certain criteria.  The ASU also provides for a one-time sale and/or transfer to AFS or trading to be made for HTM debt securities that both reference an eligible reference rate and were classified as HTM before January 1, 2020.  ASU 2020-04 is effective March 12, 2020 through December 31, 2022.  The guidance requires companies to apply the guidance prospectively to contract modifications and hedging relationships while the one-time election to sell and/or transfer debt securities classified as HTM may be made any time after March 12, 2020.  The Corporation does not expect ASU 2020-04 to have a material impact on its financial statements and disclosures.  

Adoption of New Accounting Policies

In January 2017, FASB 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 was permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Corporation has goodwill from prior 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. In conjunction with most recent annual impairment assessment as of November 30, 2019, the Corporation adopted the simplified measurement of goodwill.  Although the Corporation cannot anticipate future goodwill impairment assessments, based on the most recent assessment, the adoption of this guidance had no impact on consolidated financial statements.

 

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 became effective for annual periods and interim periods within those annual periods beginning after December 15, 2019.  The adoption of this ASU did not have a material impact on the Corporation's financial statements and disclosures.

 

In March 2020, in accordance with provisions in the CARES Act, the Corporation has elected not to apply the guidance in ASC 310-40 on accounting for TDRs to loan modifications related to COVID-19 made between March 1, 2020 and the earlier of (1) December 31, 2020 or (2) 60 days after the end of the COVID-19 national emergency.  This relief was only applied to modifications for borrowers that were not more than 30 days past due as of December 31, 2019 and may include payment deferrals, fee waivers, extension of repayments or other delays in payment.

 

 

 

 

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

 

This section discusses the consolidated financial condition and results of operations of Emclaire Financial Corp and its wholly owned subsidiaries for the three and six months ended June 30, 2020, compared to the same periods in 2019 and should be read in conjunction with the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC and with the accompanying consolidated financial statements and notes presented in this Form 10-Q.

 

FORWARD LOOKING STATEMENTS

 

This Form 10-Q, including the financial statements and related notes, contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These forward looking statements represent plans, estimates, objectives, goals, guidelines, expectations, intentions, projections and statements of our beliefs concerning future events, business plans, objectives, expected operating results and the assumptions upon which those statements are based. Forward looking statements include without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and are typically identified with words such as “may,” “could,” “should,” “will,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” or words or phrases of similar meaning. We caution that the forward looking statements are based largely on our expectations and are subject to a number of known and unknown risks and uncertainties that are subject to change based on factors which are, in many instances, beyond our control. Actual results, performances or achievements could differ materially from those contemplated, expressed or implied by the forward looking statements. Therefore, we caution you not to place undue reliance on our forward looking information and statements. Except as required by applicable law or regulation, we will not update the forward looking statements to reflect actual results or changes in factors affecting the forward looking statements.

 

USE OF NON-GAAP FINANCIAL MEASURES

 

In addition to the results of operations presented in accordance with generally accepted accounting principals (GAAP), management uses certain non-GAAP financial measures, such as net interest income on a fully taxable equivalent basis.  Management believes these non-GAAP financial measures provide information that is useful to investors in understanding the underlying operational performance and business and performance trends as they facilitate comparison with the performance of others in the financial services industry.  Although management believes that these non-GAAP financial measures enhance investors' understanding of the Corporation's business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP.

 

Management believes the presentation of net interest income on a fully taxable equivalent basis ensures comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice.  Interest income per the unaudited Consolidated Statements of Income is reconciled to net interest income adjusted to a fully taxable equivalent basis on pages 30 and 34 for the three and six months ended June 30, 2020 and 2019, respectively.

 

COVID-19 UPDATE

 

The outbreak of the novel coronavirus (COVID-19) has adversely impacted certain industries in which the Corporation's clients operate and may have impaired their ability to fulfill their outstanding obligations. The Corporation's business is dependent upon the willingness and ability of our employees and clients to conduct banking and other financial transactions. The spread of COVID-19 has caused severe disruptions in the U.S. economy at large, and for small businesses in particular, which could further disrupt operations. If the global response to contain COVID-19 escalates or is unsuccessful, the Corporation could experience a more material adverse effect on it's financial condition, results of operations, cash flows and capital levels. The outbreak may result in a decrease in the Corporation's clients' businesses, a decrease in consumer confidence and a possible disruption in the services provided by vendors. Continued disruptions to the operations of the Corporation's clients could result in increased risk of delinquencies, defaults, foreclosures and losses on loans, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability and negatively impact the implementation of the Corporation's growth strategy. The Corporation relies upon third-party vendors to conduct business and to process, record and monitor transactions. If any of these vendors are unable to continue to provide these services, it could negatively impact the ability to serve our clients. Furthermore, the continued disruptions due to the outbreak could negatively impact the ability of employees and clients to engage in banking and other financial transactions in the geographic areas in which the Corporation operates and could create widespread business continuity issues. The Corporation also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of a more substantial COVID-19 outbreak in local market areas. Although the Corporation has business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will continue to be effective.

 

 

 

The Corporation has responded to the circumstances surrounding the pandemic to support the safety and well-being of the employees, customers and shareholders by enacting the following measures:

 

•  The Annual Shareholder Meeting was held virtually.

•  Operational areas within the Bank have been segregated and employees directed to work from home or alternate locations, where possible, to mitigate possible spread of illness to an entire department.

•  Limited branch lobby hours have been reinstated to the public for walk-in transactions.  Appointments can be made as necessary to complete paperwork or complex transactions.  Drive-thru services remain open where available, and the use of ATMs and on-line banking is still encouraged.

•  Loan modifications, including extensions and deferrals, have been made available to customers who were not 30 days past due as of December 31, 2019.

•  Customers were assisted with applications for resources available through the PPP, administered by the SBA.  These government guaranteed, forgivable loans were created as part of the CARES Act.

 

The duration and full impact of this economic disruption is unknown at this time, and continued deterioration of the economic environment could adversely impact the Corporation's financial condition.  While the full impact of the COVID-19 pandemic cannot be predicted or measured, there will be a definite impact on net income.  It is anticipated that provision for loan loss expense will remain elevated in expectation of a deterioration in a portion of the loan portfolio.  As a result of the significant decline in interest rates, the Corporation has and will continue to experience a decline in net income and resulting net interest margin, however, there will be a benefit from the fees arising from the PPP loan program.  Also, it is expected that noninterest income will be reduced as customers may use fewer fee-based services due to COVID-19 mitigation efforts such as stay-at-home orders.  The Corporation will continue to closely monitor situations arising from the pandemic and adjust operations accordingly.

 

CHANGES IN FINANCIAL CONDITION

 

Total assets increased $88.0 million, or 9.6%, to $1.0 billion at June 30, 2020 from $915.3 million at December 31, 2019. The increase in assets was driven primarily by a $108.4 million increase in net loans receivable, partially offset by a decrease in securities of $28.7 million. Loan balances at June 30, 2020 included $51.9 million of PPP loans which were funded during the second quarter of 2020. Total liabilities increased $85.3 million, or 10.3%, to $914.7 million at June 30, 2020 from $829.4 million at December 31, 2019 due to an increases in customer deposits and borrowed funds of $81.6 million and $3.5 million, respectively. The increase in customer deposits was primarily associated with the retention of PPP loan proceeds, consumer economic stimulus payments and a decrease in overall consumer spending resulting from the COVID-19 pandemic.

 

Stockholders’ equity increased $2.7 million, or 3.1%, to $88.5 million at June 30, 2020 from $85.9 million at December 31, 2019 primarily due to a $1.7 million increase in accumulated other comprehensive income and a $768,000 increase in retained earnings as a result of $2.4 million of net income available to common stockholders, partially offset by $1.7 million of common dividends paid.  The Corporation remains well capitalized and is positioned for continued growth with total stockholders’ equity at 8.8% of total assets.  Book value per common share was $31.14 at June 30, 2020, compared to $30.14 at December 31, 2019

At June 30, 2020, the Bank was considered “well-capitalized” with a Tier 1 leverage ratio, Common Equity Tier 1 ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio of 7.47%, 11.52%, 11.52% and 12.77%, respectively. The Bank was also considered “well-capitalized” at December 31, 2019 with a Tier 1 leverage ratio, Common Equity Tier 1 ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio of 8.17%, 12.62%, 12.62% and 13.74%, respectively.

RESULTS OF OPERATIONS

 

Comparison of Results for the Three Months Ended June 30, 2020 and 2019

 

General. Net income available to common stockholders decreased $846,000, or 41.3%, to $1.2 million for the three months ended June 30, 2020 from $2.0 million for the same period in 2019. This decrease resulted from a decrease in net interest income of $160,000 and increases in the provision for loan losses and noninterest expense of $830,000 and $310,000, respectively, partially offset by an increase in noninterest income of $247,000 and a decrease in the provision for income taxes of $207,000.

 

Net interest income. Tax equivalent net interest income decreased $166,000, or 2.3%, to $7.0 million for the three months ended June 30, 2020 from $7.1 million for the three months ended June 30, 2019. This decrease was attributed to an increase in interest expense of $288,000 partially offset by an increase in tax equivalent interest income of $122,000.

 

Interest income. Tax equivalent interest income increased $122,000, or 1.4%, to $9.1 million for the three months ended June 30, 2020 from $9.0 million for the same period in 2019. This increase was attributed to increases in interest earned on loans and securities of $181,000 and $16,000, respectively, partially offset by decreases in interest on interest-earning deposits with banks and dividends on federal bank stocks of $49,000 and $26,000, respectively.

 

 

 

Tax equivalent interest earned on loans receivable increased $181,000, or 2.2%, to $8.3 million for the three months ended June 30, 2020 compared to $8.1 million for the same period in 2019. The increase resulted from an $81.5 million increase in average loans primarily due to record loan production during the first quarter and the addition of $51.9 million of PPP loans in the second quarter of 2020. This increase in average loan volumes accounted for a $900,000 increase in interest income.  Partially offsetting this favorable variance, the average yield on loans decreased by 38 basis to 4.28% for the three months ended June 30, 2020, versus 4.66% for the same period in 2019.  This unfavorable yield variance accounted for a $719,000 decrease in interest income.  Interest income recognized on the PPP loans was $265,000 for the three months ended June 30, 2020, resulting in a yield of 2.96%, which includes the accretion of origination fees paid by the SBA.  While the PPP loans contributed to the increase in average loans and interest income, they negatively impacted the overall yield on loans by approximately 6 basis points.  The accretion of purchase accounting adjustments on acquired loans mitigated the yield decrease by approximately 3 basis points.

 

Tax equivalent interest earned on securities increased $16,000, or 2.5%, to $662,000 for the three months ended June 30, 2020 compared to $646,000 for the same period in 2019. The average balance of securities increased $5.2 million, or 5.3%, accounting for a $33,000 increase in interest income.  Partially offsetting the favorable variance in the average balance, the average yield on securities decreased by 6 basis points to 2.57% for the three months ended June 30, 2020 versus 2.63% for the same period in 2019. This unfavorable yield variance accounted for a $17,000 decrease in interest income.

 

Interest earned on deposits with banks decreased $49,000, or 49.5%, to $50,000 for the three months ended June 30, 2020 compared to $99,000 for the same period in 2019.  This decrease was due to a 103 basis point decrease in the average yield on these balances to 0.61% for the three months ended June 30, 2020, versus 1.64% for the same period in 2019, accounting for a $76,000 decrease in interest income.  Partially offsetting this unfavorable variance,  average cash balances increased by $8.5 million, or 35.3%, accounting for a $27,000 increase in interest income.

 

Dividends on federal bank stocks decreased $26,000, or 23.2%, to $86,000 for the three months ended June 30, 2020 from $112,000 for the same period in 2019. This decrease was primarily due to a 235 basis point decrease in the average yield to 5.44% for the three months ended June 30, 2020, versus 7.79% for the same period in 2019, accounting for a $37,000 decrease in interest income.  Partially offsetting this unfavorable variance, the average balance of federal bank stocks increased $592,000, or 10.3%, accounting for an $11,000 increase in interest income. 

 

Interest expense. Interest expense increased $288,000, or 15.4%, to $2.2 million for the three months ended June 30, 2020 from $1.9 million for the same period in 2019. This increase in interest expense can be attributed to increases in interest incurred on deposits and borrowed funds of $265,000 and $23,000, respectively.

 

Interest expense incurred on deposits increased $265,000, or 16.2%, to $1.9 million for the three months ended June 30, 2020 compared to $1.6 million for the same period in 2019. The average cost of interest-bearing deposits increased 8 basis points to 1.15% for the three months ended June 30, 2020, versus 1.07% for the same period in 2019, accounting for a $134,000 increase in interest expense.  This increase in cost was driven primarily due to money market and CD specials offered in 2019 and will gradually decline as the special rates expire or the accounts mature.  Additionally, the average balance of interest-bearing deposits increased $47.6 million, or 7.7%, to $662.1 million for the three months ended June 30, 2020, compared to $614.6 million for the same period in 2019 causing a $131,000 increase in interest expense.

 

Interest expense incurred on borrowed funds increased $23,000, or 9.7%, to $259,000 for the three months ended June 30, 2020, compared to $236,000 for the same period in the prior year.  The increase was primarily the result of a $14.3 million, or 41.6%, increase in the average balance of borrowed funds to $48.6 million for the three months ended June 30, 2020 compared to $34.3 million for the same period in 2019 causing an $81,000 increase in interest expense.  Partially offsetting this increase, the average cost of borrowed funds decreased 62 basis points to 2.14% for the three months ended June 30, 2020, compared to 2.76% for the same period in 2019 causing a $58,000 decrease in interest expense.

 

The following table reconciles interest income in the Consolidated Statements of Income to net interest income adjusted to a fully taxable equivalent basis for the three months ended June 30:

 

Dollar amounts in thousands)

 

2020

   

2019

 

Interest income per Consolidated Statements of Income

  $ 9,082     $ 8,954  

Adjustment to fully taxable equivalent basis

    44       50  

Interest income adjusted to fully taxable equivalent basis (non-GAAP)

    9,126       9,004  

Interest expense

    2,160       1,872  

Net interest income adjusted to fully taxable equivalent basis (non-GAAP)

  $ 6,966     $ 7,132  

 

 

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)

 

Three months ended June 30,

   

2020

 

2019

   

Average Balance

 

Interest

 

Yield/ Rate

 

Average Balance

 

Interest

 

Yield/ Rate

Interest-earning assets:

                                               

Loans, taxable

  $ 763,455     $ 8,140       4.29 %   $ 680,410     $ 7,937       4.68 %

Loans, tax exempt

    19,725       188       3.84 %     21,278       210       3.95 %

Total loans receivable

    783,180       8,328       4.28 %     701,688       8,147       4.66 %

Securities, taxable

    87,951       558       2.55 %     81,224       530       2.62 %

Securities, tax exempt

    15,607       104       2.68 %     17,131       116       2.71 %

Total securities

    103,558       662       2.57 %     98,355       646       2.63 %

Interest-earning deposits with banks

    32,721       50       0.61 %     24,184       99       1.64 %

Federal bank stocks

    6,357       86       5.44 %     5,765       112       7.79 %

Total interest-earning cash equivalents

    39,078       136       1.40 %     29,949       211       2.83 %

Total interest-earning assets

    925,816       9,126       3.96 %     829,992       9,004       4.35 %

Cash and due from banks

    3,469                       3,232                  

Other noninterest-earning assets

    61,917                       62,927                  

Total Assets

  $ 991,202                     $ 896,151                  

Interest-bearing liabilities:

                                               

Interest-bearing demand deposits

  $ 454,992     $ 779       0.69 %   $ 393,513     $ 586       0.60 %

Time deposits

    207,125       1,122       2.18 %     221,053       1,050       1.91 %

Total interest-bearing deposits

    662,117       1,901       1.15 %     614,566       1,636       1.07 %

Borrowed funds, short-term

    2,778       23       3.27 %     2,322       32       5.47 %

Borrowed funds, long-term

    45,822       236       2.07 %     32,000       204       2.56 %

Total borrowed funds

    48,600       259       2.14 %     34,322       236       2.76 %

Total interest-bearing liabilities

    710,717       2,160       1.22 %     648,888       1,872       1.16 %

Noninterest-bearing demand deposits

    178,386                   150,807              

Funding and cost of funds

    889,103       2,160       0.98 %     799,695       1,872       0.94 %

Other noninterest-bearing liabilities

    14,204                       13,597                  

Total Liabilities

    903,307                       813,292                  

Stockholders' Equity

    87,895                       82,859                  

Total Liabilities and Stockholders' Equity

  $ 991,202                     $ 896,151                  

Net interest income

          $ 6,966                     $ 7,132          
                                                 

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

                    2.74 %                     3.19 %
                                                 

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

                    3.03 %                     3.45 %

 

 

 

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 volume (changes in volume multiplied by prior year rate), rate (change in rate multiplied by prior year volume) 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)

 

Three months ended June 30,

   

2020 versus 2019

   

Increase (Decrease) due to

   

Volume

 

Rate

 

Total

Interest income:

                       

Loans

  $ 900     $ (719 )   $ 181  

Securities

    33       (17 )     16  

Interest-earning deposits with banks

    27       (76 )     (49 )

Federal bank stocks

    11       (37 )     (26 )

Total interest-earning assets

    971       (849 )     122  
                         

Interest expense:

                       

Interest-bearing deposits

    131       134       265  

Borrowed funds, short-term

    5       (14 )     (9 )

Borrowed funds, long-term

    76       (44 )     32  

Total interest-bearing liabilities

    212       76       288  

Net interest income

  $ 759     $ (925 )   $ (166 )

 

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.

 

Information pertaining to the allowance for loan losses and nonperforming assets for the three month periods ended June 30, 2020 and 2019 is as follows:

 

(Dollar amounts in thousands)

 

As of or for the three months ended

   

June 30,

   

2020

 

2019

Balance at the beginning of the period

  $ 7,220     $ 6,639  

Provision for loan losses

    1,100       270  

Charge-offs

    (186 )     (346 )

Recoveries

    25       17  

Balance at the end of the period

  $ 8,159     $ 6,580  
                 

Nonperforming loans

  $ 5,082     $ 5,998  

Nonperforming assets

    5,400       6,331  

Nonperforming loans to total loans

    0.63 %     0.86 %

Nonperforming assets to total assets

    0.54 %     0.70 %

Allowance for loan losses to total loans

    1.00 %     0.94 %

Allowance for loan losses to nonperforming loans

    160.55 %     109.70 %

 

Nonperforming loans increased $2.0 million, or 65.8% to $5.1 million at June 30, 2020 from $3.1 million at March 31, 2020. This was primarily due to a $1.3 million increase in loans 90+ days past due and still accruing and the addition of two commercial relationships totaling $752,000 being placed on non-accrual status during the three months ended June 30, 2020.

 

As of June 30, 2020, the Corporation’s classified and criticized assets amounted to $22.2 million, or 2.2% of total assets, with $16.8 million classified as substandard and $5.4 million identified as special mention. This compares to classified and criticized assets of $16.2 million, or 1.7% of total assets, with $10.8 million classified as substandard and $5.4 million identified as special mention at March 31, 2020. This $6.0 million increase was primarily related to the downgrade of five commercial relationships from pass to substandard after the receipt of updated financial information. This increase is not indicative of the entire loan portfolio performance and did not result directly from COVID-19 related issues. 

 

The provision for loan losses increased $830,000 to $1.1 million for the three months ended June 30, 2020 from $270,000 for the same period in 2019. The increase in the provision for loan losses was due to growth in the residential and consumer loan portfolios, risk rating changes for loans which were granted payment deferrals in connection with COVID-19, an increase in criticized and classified loans, and an increase in the specific pandemic qualitative allowance factor. This pandemic factor, which was initially set at 2 basis points for the first quarter of 2020, was increased to 5.5 basis points and added approximately $231,000 to the provision expense for the quarter ended June 30, 2020.  Significant uncertainty remains regarding future levels of criticized and classified loans, nonperforming loans and charge-offs, but some deterioration is expected as a result of the COVID-19 pandemic.  The Corporation will continue to closely monitor changes in the loan portfolio and adjust the provision accordingly.

 

 

Noninterest income.  Noninterest income increased $247,000, or 21.8%, to $1.4 million for the three months ended June 30, 2020, compared to $1.1 million for the same period in 2019 due to a $558,000 increase in gains on the sale of securities, partially offset by a $248,000 decrease in fees and service charges. During the quarter ended June 30, 2020, the Corporation sold $31.2 million of primarily low yielding mortgage-backed and collateralized mortgage obligation securities and realized a net gain of $557,000.  The sale proceeds were utilized to fund loans, purchase higher yielding municipal securities and repay borrowed funds.  The decrease in fees and service charges was primarily due to a decline in overdraft charges as the COVID-19 pandemic resulted in widespread government mandated stay-at-home orders and business shut downs which dramatically impacted consumer spending.

 

Noninterest expense.  Noninterest expense increased $310,000, or 5.8%, to $5.6 million for the three months ended June 30, 2020 from $5.3 million for the same period in 2019.  The increase was primarily attributable to increases in other noninterest expense, compensation and benefits expense and professional fees of $329,000, $54,000 and $20,000, respectively, partially offset by decreases in FDIC insurance expense and premises and equipment expense of $50,000 and $39,000, respectively.  The increase in other noninterest expense primarily related to prepayment penalties of $238,000 incurred as a result of the early repayment of $15.0 million of FHLB term advances.

 

Provision for income taxes. The provision for income taxes decreased $207,000, or 43.8%, to $266,000 for the three months ended June 30, 2020 compared to $473,000 for the same period in the prior year as a result of the decrease in net income before provision for income taxes.

 

Comparison of Results for the Six Months Ended June 30, 2020 and 2019

 

General. Net income available to common stockholders decreased $1.7 million, or 42.1%, to $2.4 million for the six months ended June 30, 2020 from $4.1 million for the same period in 2019. This decrease resulted from a decrease in net interest income of $690,000 and increases in the provision for loan losses and noninterest expense of $1.4 million and $242,000, respectively, partially offset by an increase in noninterest income of $215,000 and a decrease in the provision for income taxes of $421,000.

 

Net interest income. Tax equivalent net interest income decreased $700,000, or 4.9%, to $13.7 million for the six months ended June 30, 2020 from $14.4 million for the six months ended June 30, 2019. This decrease was attributed to an increase in interest expense of $729,000, partially offset by an increase in tax equivalent interest income of $29,000.

 

Interest income. Tax equivalent interest income increased $29,000 to $18.1 million for the six months ended June 30, 2020 from $18.0 million for the same period in 2019. This increase was attributed to a $144,000 increase in interest earned on securities, partially offset by decreases in interest on loans and interest-earning deposits with banks and dividends on federal bank stocks of $67,000, $29,000 and $19,000, respectively.

 

Tax equivalent interest earned on loans receivable decreased $67,000 to $16.3 million for the six months ended June 30, 2020 compared to $16.4 million for the same period in 2019. This decrease resulted from a 32 basis point decrease in the average yield on loans to 4.37% for the six months ended June 30, 2020, versus 4.69% for the same period in 2019.  The average yield was impacted by the 150 basis point decline in the Wall Street Journal Prime Rate in March 2020 which resulted in the immediate decrease in interest rates on adjustable rate loans linked to that index.  This unfavorable yield variance accounted for a $1.1 million decrease in interest income.  Partially offsetting this unfavorable variance, average loans increased $46.9 million, or 6.7%, accounting for a $1.1 million increase in interest income.  Interest income recognized on the PPP loans was $265,000 for the six months ended June 30, 2020, resulting in a yield of 2.96%, which includes the accretion of origination fees paid by the SBA. While the PPP loans contributed to the increase in average loans and interest income, they negatively impacted the overall yield on loans by approximately 4 basis points.  The accretion of purchase accounting adjustments on acquired loans mitigated the yield decrease by approximately 4 basis points.

 

Tax equivalent interest earned on securities increased $144,000, or 11.3%, to $1.4 million for the six months ended June 30, 2020 compared to $1.3 million for the same period in 2019. The average balance of securities increased $11.7 million, or 11.9%, accounting for a $151,000 increase in interest income.  Partially offsetting this favorable variance, the average yield on securities decreased by 2 basis points to 2.62% for the six months ended June 30, 2020 versus 2.64% for the same period in 2019 causing a $7,000 decrease in interest income.

 

Interest earned on deposits with banks decreased $29,000, or 19.9%, to $117,000 for the six months ended June 30, 2020 compared to $146,000 for the same period in 2019. This decrease resulted from a 65 basis point decrease in the average yield on these balances to 0.95% for the six months ended June 30, 2020, versus 1.60% for the same period in 2019, accounting for a $71,000 decrease in interest income.  Partially offsetting this unfavorable variance, average cash balances increased the $6.4 million, or 35.0%, accounting for a $42,000 increase in interest income.

 

Dividends on federal bank stocks decreased $19,000, or 9.0%, to $193,000 for the six months ended June 30, 2020 from $212,000 for the same period in 2019. This decrease was primarily due to a decrease of 119 basis points in the average yield to 6.08% for the six months ended June 30, 2020, versus 7.27% for the same period in 2019, accounting for a $36,000 decrease in interest income. Partially offsetting this unfavorable variance, the average balance of federal bank stocks increased $497,000, or 8.4%, accounting for a $17,000 increase in interest income.

 

Interest expense. Interest expense increased $729,000, or 20.0%, to $4.4 million for the six months ended June 30, 2020 from $3.6 million for the same period in 2019. This increase in interest expense can be attributed to an increase in interest incurred on deposits of $734,000, partially offset by a decrease in interest incurred on borrowed funds of $5,000.

 

Interest expense incurred on deposits increased $734,000, or 23.6%, to $3.8 million for the six months ended June 30, 2020 compared to $3.1 million for the same period in 2019. The average cost of interest-bearing deposits increased 16 basis points to 1.19% for the six months ended June 30, 2020, versus 1.03% for the same period in 2019, accounting for a $541,000 increase in interest expense.  This increase in cost was driven primarily due to money market and CD specials offered in 2019 and will gradually decline as the special rates expire or the accounts mature.  Additionally, the average balance of interest-bearing deposits increased $36.3 million, or 5.9%, to $647.5 million for the six months ended June 30, 2020, compared to $611.2 million for the same period in 2019 causing a $193,000 increase in interest expense.

 

 

 

Interest expense incurred on borrowed funds decreased $5,000 to $532,000 for the six months ended June 30, 2020, compared to $537,000 for the same period in the prior year.  The decrease was primarily the result of a 50 basis point decrease in the average cost of borrowed funds to 2.24% for the six months ended June 30, 2020 compared to 2.74% for the same period in 2019 causing a $98,000 decrease in interest expense.  Partially offsetting this reduction, the average balance of borrowed funds increased $8.4 million, or 21.2%, to $47.8 million for the six months ended June 30, 2020, compared to $39.4 million for the same period in 2019 causing a $93,000 increase in interest expense.

 

The following table reconciles interest income in the Consolidated Statements of Income to net interest income adjusted to a fully taxable equivalent basis for the six months ended June 30:

 

Dollar amounts in thousands)

 

2020

   

2019

 

Interest income per Consolidated Statements of Income

  $ 17,985     $ 17,946  

Adjustment to fully taxable equivalent basis

    88       98  

Interest income adjusted to fully taxable equivalent basis (non-GAAP)

    18,073       18,044  

Interest expense

    4,373       3,644  

Net interest income adjusted to fully taxable equivalent basis (non-GAAP)

  $ 13,700     $ 14,400  

 

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)

  Six months ended June 30,
   

2020

 

2019

   

Average

         

Yield/

 

Average

         

Yield/

   

Balance

 

Interest

 

Rate

 

Balance

 

Interest

 

Rate

Interest-earning assets:

                                               

Loans, taxable

  $ 732,582     $ 15,958       4.38 %   $ 684,915     $ 16,008       4.71 %

Loans, tax exempt

    19,839       382       3.87 %     20,570       399       3.91 %

Total loans receivable

    752,421       16,340       4.37 %     705,485       16,407       4.69 %

Securities, taxable

    94,475       1,222       2.60 %     78,344       1,022       2.63 %

Securities, tax exempt

    14,979       201       2.70 %     19,459       257       2.66 %

Total securities

    109,454       1,423       2.62 %     97,803       1,279       2.64 %

Interest-earning deposits with banks

    24,841       117       0.95 %     18,396       146       1.60 %

Federal bank stocks

    6,381       193       6.08 %     5,884       212       7.27 %

Total interest-earning cash equivalents

    31,222       310       2.00 %     24,280       358       2.97 %

Total interest-earning assets

    893,097       18,073       4.07 %     827,568       18,044       4.40 %

Cash and due from banks

    3,480                       3,246                  

Other noninterest-earning assets

    62,071                       62,926                  

Total Assets

  $ 958,648                     $ 893,740                  

Interest-bearing liabilities:

                                               

Interest-bearing demand deposits

  $ 436,282     $ 1,558       0.72 %   $ 390,664     $ 1,115       0.58 %

Time deposits

    211,247       2,283       2.17 %     220,544       1,992       1.82 %

Total interest-bearing deposits

    647,529       3,841       1.19 %     611,208       3,107       1.03 %

Borrowed funds, short-term

    6,684       87       2.60 %     7,307       127       3.51 %

Borrowed funds, long-term

    41,121       445       2.18 %     32,124       410       2.57 %

Total borrowed funds

    47,805       532       2.24 %     39,431       537       2.74 %

Total interest-bearing liabilities

    695,334       4,373       1.26 %     650,639       3,644       1.13 %

Noninterest-bearing demand deposits

    161,527                   147,705              

Funding and cost of funds

    856,861       4,373       1.03 %     798,344       3,644       0.92 %

Other noninterest-bearing liabilities

    14,150                       13,655                  

Total Liabilities

    871,011                       811,999                  

Stockholders' Equity

    87,637                       81,741                  

Total Liabilities and Stockholders' Equity

  $ 958,648                     $ 893,740                  

Net interest income

          $ 13,700                     $ 14,400          
                                                 

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

                    2.80 %                     3.27 %
                                                 

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

                    3.08 %                     3.51 %

 

 

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 volume (changes in volume multiplied by prior year rate), rate (change in rate multiplied by prior year volume) 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)

  Six months ended June 30,
   

2020 versus 2019

   

Increase (Decrease) due to

   

Volume

 

Rate

 

Total

Interest income:

                       

Loans

  $ 1,055     $ (1,122 )   $ (67 )

Securities

    151       (7 )     144  

Interest-earning deposits with banks

    42       (71 )     (29 )

Federal bank stocks

    17       (36 )     (19 )

Total interest-earning assets

    1,265       (1,236 )     29  
                         

Interest expense:

                       

Interest-bearing deposits

    193       541       734  

Borrowed funds, short-term

    (10 )     (30 )     (40 )

Borrowed funds, long-term

    103       (68 )     35  

Total interest-bearing liabilities

    286       443       729  

Net interest income

  $ 979     $ (1,679 )   $ (700 )


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.

 

 

Information pertaining to the allowance for loan losses and nonperforming assets for the six months ended June 30, 2020 and 2019 is as follows:

 

(Dollar amounts in thousands)

  As of or for the six months ended
    June 30,
   

2020

 

2019

Balance at the beginning of the period

  $ 6,556     $ 6,508  

Provision for loan losses

    1,892       450  

Charge-offs

    (324 )     (475 )

Recoveries

    35       97  

Balance at the end of the period

  $ 8,159     $ 6,580  
                 

Nonperforming loans

  $ 5,082     $ 5,998  

Nonperforming assets

    5,400       6,331  

Nonperforming loans to total loans

    0.63 %     0.86 %

Nonperforming assets to total assets

    0.54 %     0.70 %

Allowance for loan losses to total loans

    1.00 %     0.94 %

Allowance for loan losses to nonperforming loans

    160.55 %     109.70 %

 

Nonperforming loans increased $2.2 million, or 74.8% to $5.1 million at June 30, 2020 from $2.9 million at December 31, 2019. This was primarily due to a $1.1 million increase in loans 90+ days past due and still accruing and the addition of two commercial relationships totaling $752,000 being placed on non-accrual status during the six months ended June 30, 2020.

 

As of June 30, 2020, the Corporation’s classified and criticized assets amounted to $22.2 million, or 2.2% of total assets, with $16.8 million classified as substandard and $5.4 million identified as special mention. This compares to classified and criticized assets of $17.0 million, or 1.9% of total assets, with $11.5 million classified as substandard and $5.6 million identified as special mention at December 31, 2019. This $5.2 million increase was primarily related to the downgrade of five commercial relationships from pass to substandard after the receipt of updated financial information. This increase is not indicative of the entire loan portfolio performance and did not result directly from COVID-19 related issues. 

 

The provision for loan losses increased $1.4 million to $1.9 million for the six months ended June 30, 2020 from $450,000 for the same period in 2019. The increase in the provision for loan losses was primarily due to a $108.4 million increase in loan portfolio balances, risk rating changes for loans which were granted payment deferrals in connection with COVID-19, an increase in criticized and classified loans and the addition of a new specific pandemic qualitative factor to the allowance for loan losses calculation.  This new pandemic factor, set at 5.5 basis points, added approximately $364,000 to the provision expense for the six months ended June 30, 2020. Significant uncertainty remains regarding future levels of criticized and classified loans, nonperforming loans and charge-offs, but some deterioration is expected as a result of the COVID-19 pandemic.  The Corporation will continue to closely monitor changes in the loan portfolio and adjust the provision accordingly.

 

Noninterest income.  Noninterest income increased $215,000, or 9.8%, to $2.4 million for the six months ended June 30, 2020, compared to $2.2 million for the same period in 2019 due to a $634,000 increase in gains on the sale of securities, partially offset by a $352,000 decrease in fees and service charges. During the six months ended June 30, 2020, the Corporation sold $39.4 million of primarily low yielding mortgage-backed and collateralized mortgage obligation securities and realized a net gain of $635,000.  The sale proceeds were utilized to fund loans, purchase higher yielding municipal securities and repay borrowed funds.  The decrease in fees and service charges was primarily due to a decline in overdraft charges as the COVID-19 pandemic resulted in widespread government mandated stay-at-home orders and business shut downs which dramatically impacted consumer spending.

 

Noninterest expense.  Noninterest expense increased $242,000, or 2.2%, to $11.1 million for the six months ended June 30, 2020 from $10.9 million for the same period in 2019.  The increase was primarily attributable to increases in other noninterest expense, compensation and benefits expense and professional fees of $393,000, $50,000 and $19,000, respectively, partially offset by decreases in premises and equipment expense and FDIC insurance expense of $130,000 and $83,000, respectively.  The increase in other noninterest expense primarily related to prepayment penalties of $238,000 incurred as a result of the early repayment of $15.0 million of FHLB term advances.

 

Provision for income taxes. The provision for income taxes decreased $421,000, or 45.3%, to $508,000 for the six months ended June 30, 2020 compared to $929,000 for the same period in the prior year as a result of the decrease in net income before provision for income taxes.

 

 

LIQUIDITY

 

The Corporation’s primary sources of funds generally have been deposits obtained through the offices of the Bank, borrowings from the FHLB, Federal Reserve and other correspondent banks, and amortization and prepayments of outstanding loans and sold or maturing securities. During the six months ended June 30, 2020, the Corporation used its sources of funds primarily to fund the production of new loans. As of June 30, 2020, the Corporation had outstanding loan commitments, including undisbursed loans and amounts available under credit lines, totaling $140.9 million, and standby letters of credit totaling $530,000, net of collateral maintained by the Bank.

 

At June 30, 2020, time deposits amounted to $198.0 million, or 22.8% of the Corporation’s total consolidated deposits, including approximately $58.2 million of which are scheduled to mature within the next year. Management of the Corporation believes (i) it has adequate resources to fund all of its commitments, (ii) all of its commitments will be funded as required by related maturity dates and (iii) based upon past experience and current pricing policies, it can adjust the rates of time deposits to retain a substantial portion of maturing liabilities if necessary.

 

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 the Federal Reserve’s discount window and, to a more limited extent, through the sale of loans. At June 30, 2020, the Corporation had borrowed funds of $32.1 million consisting of $30.0 million of long-term FHLB advances and $2.1 million outstanding on a line of credit with a correspondent bank. At June 30, 2020, the Corporation’s borrowing capacity with the FHLB, net of funds borrowed and irrevocable standby letters of credit issue to secure certain deposit accounts, was $267.2 million.

 

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.

 

RECENT REGULATORY DEVELOPMENTS

 

The final rules implementing the Basel Committee on Banking Supervision’s (BCBS) capital guidelines for U.S. banks were approved by the FRB and FDIC. Under the final rules, minimum requirements increased for both the quantity and quality of capital. The rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of Total Capital to risk-weighted assets of 8.0% and require a minimum Tier 1 leverage ratio of 4.0%. A new capital conservation buffer comprised of common equity Tier 1 capital was also established above the regulatory minimum capital requirements. This capital conservation buffer was phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increased each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. Eligibility criteria for regulatory capital instruments were also implemented under the final rules. The final rules also revised the definition and calculation of Tier 1 capital, Total Capital and risk-weighted assets. The phase-in period for the final rules became effective on January 1, 2015 with full compliance with all of the final rules’ requirements phased in over a multi-year schedule which was fully phased-in on January 1, 2019.

 

At June 30, 2020, the Bank exceeded all minimum capital requirements under these capital guidelines.

 

 

CRITICAL ACCOUNTING POLICIES

 

The Corporation’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America 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 included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019. 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 its 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 debt security or more likely than not will be required to sell the debt 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. Although the annual review of goodwill revealed no impairment consideration, based on current economic conditions related to COVID-19, management performed an interim assessment as of June 30, 2020.  Management concluded that goodwill was not impaired at this date.  While it is impossible to know the future impact of the evolving economic conditions, the impact could be material. 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 3. Quantitative and Qualitative Disclosures About Market Risk

 

Market risk for the Corporation consists primarily of interest rate risk exposure and liquidity risk. Since virtually all of the interest-earning assets and interest-bearing liabilities are at the Bank, virtually all of the interest rate risk and liquidity risk lies at the Bank level. The Bank 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 Bank 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 and interest-bearing liabilities. Interest rate risk and liquidity risk management is performed at the Bank level. Although the Bank has a diversified loan portfolio, loans outstanding to individuals and businesses depend upon the local economic conditions in the immediate trade area.

 

One of the primary functions of the Corporation’s asset/liability management committee is to monitor the level to which the balance sheet is subject to interest rate risk. The goal of the asset/liability committee is to manage the relationship between interest rate sensitive assets and liabilities, thereby minimizing the fluctuations in the net interest margin, which achieves consistent growth of net interest income during periods of changing interest rates.

 

Interest rate sensitivity is the result of differences in the amounts and repricing dates of the Bank’s rate sensitive assets and rate sensitive liabilities. These differences, or interest rate repricing “gap”, provide an indication of the extent that the Corporation’s net interest income is affected by future changes in interest rates. 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 that gap is maintained, generally, the lesser the impact of market interest rate changes on net interest income.

 

Assumptions about the timing and variability of cash flows are critical in gap analysis. Particularly important are the assumptions driving mortgage prepayments and the expected attrition of the core deposits portfolios. These assumptions are based on the Corporation’s historical experience, industry standards and assumptions provided by a federal regulatory agency, which management believes most accurately represents the sensitivity of the Corporation’s assets and liabilities to interest rate changes. As of June 30, 2020, the Corporation’s interest-earning assets maturing or repricing within one year totaled $375.9 million while the Corporation’s interest-bearing liabilities maturing or repricing within one-year totaled $132.2 million, providing an excess of interest-earning assets over interest-bearing liabilities of $243.7 million. At June 30, 2020, the percentage of the Corporation’s assets to liabilities maturing or repricing within one year was 284.5%.

 

For more information, see “Market Risk Management” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019.

 

Item 4. 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 Chief Executive Officer (CEO) and Chief Financial Officer (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 June 30, 2020, 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. 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 evaluation.

 

There has been no change made in the Corporation’s internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

 

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

The Corporation is involved in various legal proceedings occurring in the ordinary course of business. It is the opinion of management, after consultation with legal counsel, that these matters will not materially affect the Corporation’s consolidated financial position or results of operations.

 

Item 1A. Risk Factors

 

Not applicable.

 

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

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

(a)

Not applicable.

 

(b)

Not applicable.

 

Item 6. Exhibits

 

Exhibit 31.1

Rule 13a-14(a) Certification of Principal Executive Officer

Exhibit 31.2

Rule 13a-14(a) Certification of Principal Financial Officer

Exhibit 32.1

CEO Certification Pursuant to 18 U.S.C. Section 1350

Exhibit 32.2

CFO Certification Pursuant to 18 U.S.C. Section 1350

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

 

 

Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

     

 

EMCLAIRE FINANCIAL CORP

 

 

 

Date: August 11, 2020

By:

/s/ William C. Marsh

 

William C. Marsh

 

Chairman of the Board,

 

President and Chief Executive Officer

 

 

 

Date: August 11, 2020

By:

/s/ Amanda L. Engles

 

Amanda L. Engles

 

Chief Financial Officer

 

Treasurer

 

41