FNCB Bancorp, Inc. - Quarter Report: 2018 September (Form 10-Q)

 

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		September 30,				December 31,
(in thousands, except share data)		2018				2017
Assets
Cash and cash equivalents:
Cash and due from banks		$	23,051			$	22,755
Interest-bearing deposits in other banks			7,246				14,991
Total cash and cash equivalents			30,297				37,746
Debt securities available for sale, at fair value			288,780				289,459
Equity securities			884				918
Restricted stock, at cost			3,333				2,763
Loans held for sale			938				1,095
Loans, net of allowance for loan and lease losses of $9,827 and $9,034			854,489				761,609
Bank premises and equipment, net			13,895				10,388
Accrued interest receivable			4,061				3,234
Bank-owned life insurance			30,873				30,460
Other real estate owned			715				1,023
Net deferred tax assets			16,382				15,785
Other assets			6,475				7,825
Total assets		$	1,251,122			$	1,162,305
Liabilities
Deposits:
Demand (non-interest-bearing)		$	166,967			$	176,325
Interest-bearing			928,154				826,123
Total deposits			1,095,121				1,002,448
Borrowed funds:
Federal Home Loan Bank of Pittsburgh advances			46,490				44,968
Subordinated debentures			5,000				5,000
Junior subordinated debentures			10,310				10,310
Total borrowed funds			61,800				60,278
Accrued interest payable			318				241
Other liabilities			7,306				10,147
Total liabilities			1,164,545				1,073,114
Shareholders' equity
Preferred stock ($1.25 par)
Authorized: 20,000,000 shares at September 30, 2018 and December 31, 2017
Issued and outstanding: 0 shares at September 30, 2018 and December 31, 2017			-				-
Common stock ($1.25 par)
Authorized: 50,000,000 shares at September 30, 2018 and December 31, 2017
Issued and outstanding: 16,819,471 shares at September 30, 2018 and 16,757,963 shares at December 31, 2017			21,024				20,947
Additional paid-in capital			63,469				63,210
Retained earnings			10,965				6,779
Accumulated other comprehensive loss			(8,881	)			(1,745	)
Total shareholders' equity			86,577				89,191
Total liabilities and shareholders’ equity		$	1,251,122			$	1,162,305

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		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(in thousands, except share data)		2018				2017				2018				2017
Interest income
Interest and fees on loans		$	9,501			$	7,576			$	26,820			$	21,748
Interest and dividends on securities:
U.S. government agencies			899				816				2,675				2,566
State and political subdivisions, tax-free			37				7				95				42
State and political subdivisions, taxable			1,028				1,016				3,079				2,816
Other securities			211				166				646				409
Total interest and dividends on securities			2,175				2,005				6,495				5,833
Interest on interest-bearing deposits in other banks			17				24				52				146
Total interest income			11,693				9,605				33,367				27,727
Interest expense
Interest on deposits			1,559				943				3,760				2,513
Interest on borrowed funds:
Federal Home Loan Bank of Pittsburgh advances			715				163				1,774				424
Subordinated debentures			58				97				171				323
Junior subordinated debentures			106				77				292				219
Total interest on borrowed funds			879				337				2,237				966
Total interest expense			2,438				1,280				5,997				3,479
Net interest income before provision for loan and lease losses			9,255				8,325				27,370				24,248
Provision for loan and lease losses			1,149				543				2,749				486
Net interest income after provision for loan and lease losses			8,106				7,782				24,621				23,762
Non-interest income
Deposit service charges			711				728				2,160				2,147
Net gain (loss) on the sale of available-for-sale securities			-				367				(4	)			1,338
Net loss on equity securities			(8	)			-				(34	)			-
Net gain on the sale of mortgage loans held for sale			71				106				171				241
Net gain on the sale of SBA guaranteed loans			-				23				322				79
Net gain on the sale of other repossessed assets			-				-				-				47
Net gain on the sale of other real estate owned			-				-				31				57
Loan-related fees			85				96				245				252
Income from bank-owned life insurance			141				129				413				399
Merchant services revenue			135				108				365				307
Other			185				157				699				440
Total non-interest income			1,320				1,714				4,368				5,307
Non-interest expense
Salaries and employee benefits			3,581				3,247				10,732				10,069
Occupancy expense			500				394				1,629				1,567
Equipment expense			299				474				936				1,380
Advertising expense			193				119				519				424
Data processing expense			745				506				2,040				1,502
Regulatory assessments			251				160				648				497
Bank shares tax			278				252				767				762
Expense of other real estate owned			91				104				191				432
Professional fees			241				206				733				662
Insurance expense			130				132				398				385
Other losses			28				49				155				334
Other operating expenses			851				754				2,638				2,251
Total non-interest expense			7,188				6,397				21,386				20,265
Income before income tax expense			2,238				3,099				7,603				8,804
Income tax expense			388				827				1,322				2,543
Net income		$	1,850			$	2,272			$	6,281			$	6,261
Earnings per share
Basic		$	0.11			$	0.14			$	0.37			$	0.37
Diluted		$	0.11			$	0.14			$	0.37			$	0.37
Cash dividends declared per common share		$	0.04			$	0.03			$	0.12			$	0.09
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic			16,818,625				16,757,963				16,791,815				16,711,172
Diluted			16,838,547				16,777,671				16,813,948				16,728,852

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		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(in thousands)		2018				2017				2018				2017
Net income		$	1,850			$	2,272			$	6,281			$	6,261
Other comprehensive (loss) income:
Unrealized (losses) gains on securities available for sale			(2,302	)			(1,290	)			(9,118	)			3,868
Taxes			483				438				1,914				(1,315	)
Net of tax amount			(1,819	)			(852	)			(7,204	)			2,553
Reclassification adjustment for (gains) losses included in net income			-				(367	)			4				(1,338	)
Taxes			-				125				(1	)			455
Net of tax amount			-				(242	)			3				(883	)
Total other comprehensive (loss) income			(1,819	)			(1,094	)			(7,201	)			1,670
Comprehensive income (loss)		$	31			$	1,178			$	(920	)		$	7,931

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																		Accumulated
		Number								Additional								Other				Total
		of Common				Common				Paid-in				Retained				Comprehensive				Shareholders'
(in thousands, except share data)		Shares				Stock				Capital				Earnings				(Loss) Income				Equity
Balances, December 31, 2016			16,645,845			$	20,807			$	62,593			$	8,531			$	(1,560	)		$	90,371
Net income for the period			-				-				-				6,261				-				6,261
Cash dividends paid, $0.09 per share			-				-				-				(1,505	)			-				(1,505	)
Restricted stock awards			-				-				234				-				-				234
Common shares issued under long-term incentive compensation plan			46,878				58				(58	)			-				-				-
Common shares issued through dividend reinvestment/optional cash purchase plan			65,240				82				374				(5	)			-				451
Other comprehensive income, net of tax of $860			-				-				-				-				1,670				1,670
Balances, September 30, 2017			16,757,963			$	20,947			$	63,143			$	13,282			$	110			$	97,482
Balances, December 31, 2017			16,757,963			$	20,947			$	63,210			$	6,779			$	(1,745	)		$	89,191
Net income for the period			-				-				-				6,281				-				6,281
Cash dividends paid, $0.12 per share			-				-				-				(2,016	)			-				(2,016	)
Reclassification of unrealized loss on equity securities, net of tax			-				-				-				(65	)			65				-
Restricted stock awards			-				-				215				-				-				215
Common shares issued under long-term incentive compensation plan			46,358				58				(58	)			-				-				-
Common shares issued through dividend reinvestment/optional cash purchase plan			15,150				19				102				(14	)			-				107
Other comprehensive loss, net of tax of $1,913			-				-				-				-				(7,201	)			(7,201	)
Balances, September 30, 2018			16,819,471			$	21,024			$	63,469			$	10,965			$	(8,881	)		$	86,577

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		Nine Months Ended
		September 30,
(in thousands)		2018				2017
Cash flows from operating activities:
Net income		$	6,281			$	6,261
Adjustments to reconcile net income to net cash provided by operating activities:
Investment securities amortization, net			607				756
Equity in trust			(9	)			(7	)
Depreciation and amortization			2,126				1,984
Valuation adjustment for loan servicing rights			-				(4	)
Stock-based compensation expense			215				234
Provision for loan and lease losses			2,749				486
Valuation adjustment for off-balance sheet commitments			(111	)			23
Net loss (gain) on the sale of available-for-sale securities			4				(1,338	)
Net loss on equity securities			34				-
Net gain on the sale of mortgage loans held for sale			(171	)			(241	)
Net gain on the sale of SBA guaranteed loans			(322	)			(79	)
Net gain on the sale of other real estate owned			(31	)			(57	)
Valuation adjustment of other real estate owned			89				307
Net gain on the sale of other repossessed assets			-				(47	)
Loss on the disposition of bank premises and equipment			44				63
Income from bank-owned life insurance			(413	)			(399	)
Proceeds from the sale of mortgage loans held for sale			7,904				10,216
Funds used to originate mortgage loans held for sale			(7,576	)			(9,526	)
Decrease in net deferred tax assets			1,316				2,507
Increase in accrued interest receivable			(827	)			(446	)
Decrease (increase) in prepaid expenses and other assets			1,311				(1,733	)
Increase in accrued interest payable			77				2
Decrease in director indemnification liability			(2,553	)			-
Decrease in accrued expenses and other liabilities			(177	)			(1,552	)
Total adjustments			4,286				1,149
Net cash provided by operating activities			10,567				7,410
Cash flows from investing activities:
Maturities, calls and principal payments of debt securities available for sale			4,675				5,655
Proceeds from the sale of debt securities available for sale			4,559				130,972
Purchases of debt securities available for sale			(18,280	)			(133,524	)
(Purchase) redemption of the stock in Federal Home Loan Bank of Pittsburgh			(570	)			861
Net increase in loans to customers			(102,370	)			(30,068	)
Proceeds from the sale of SBA guaranteed loans			6,032				979
Proceeds from the sale of other real estate owned			470				820
Proceeds from the sale of other repossessed assets			-				280
Purchases of bank premises and equipment			(4,818	)			(852	)
Net cash used in investing activities			(110,302	)			(24,877	)
Cash flows from financing activities:
Net increase (decrease) in deposits			92,673				(31,927	)
Proceeds from Federal Home Loan Bank of Pittsburgh advances - term			73,929				34,673
Repayment of Federal Home Loan Bank of Pittsburgh advances - term			(72,407	)			(47,860	)
Principal reduction on subordinated debentures			-				(5,000	)
Proceeds from issuance of common shares, net of discount			107				451
Cash dividends paid			(2,016	)			(1,505	)
Net cash provided by (used in) financing activities			92,286				(51,168	)
Net decrease in cash and cash equivalents			(7,449	)			(68,635	)
Cash and cash equivalents at beginning of period			37,746				112,445
Cash and cash equivalents at end of period		$	30,297			$	43,810
Supplemental cash flow information:
Cash paid during the period for:
Interest		$	5,920			$	3,477
Income taxes			23				205
Other transactions:
Transfer of bank premises and equipment to other real estate owned			220				-
Loans transferred to other real estate owned and repossessed assets			-				80
Investor loans tranferred to other real estate owned or other assets, net of valuation adjustments			-				30
Available-for-sale securities purchased, not settled			-				6,012

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Note 1.     Basis of Presentation

 

The consolidated financial statements of FNCB are comprised of the accounts of FNCB Bancorp, Inc., and its wholly-owned subsidiary, FNCB Bank (the “Bank”), as well as the Bank’s wholly-owned subsidiaries (collectively, “FNCB”). The accounting and reporting policies of FNCB conform to accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10-01 of Regulation S-X. Accordingly, they do not include all the information and accompanying notes required by GAAP for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the financial position and the results of operations for the periods presented have been included in the consolidated financial statements. All intercompany balances and transactions have been eliminated in consolidation. Prior period amounts have been reclassified when necessary to conform to the current period’s presentation. Such reclassifications did not have an impact on the operating results or financial position of FNCB. The operating results and financial position of FNCB for the three and nine months ended September 30, 2018, may not be indicative of future results of operations and financial position.

 

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to change in the near term are the allowance for loan and lease losses (“ALLL”), securities’ valuation and impairment evaluation, the valuation of other real estate owned (“OREO”), and income taxes.

 

These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in FNCB’s audited financial statements, included in the Annual Report filed on Form 10-K as of and for the year ended December 31, 2017.

 

Note 2.     New Authoritative Accounting Guidance

 

Accounting Guidance to be Adopted in Future Periods

 

ASU 2016-02, Leases (Topic 842): “Leases” will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases with lease terms of more than 12 months. Consistent with current GAAP, the recognition, measurement and presentation of expenses and cash flows arising from a lease by the lessee will primarily depend on its classification as a finance or operating lease. However, unlike current GAAP, which requires only capital leases to be recognized on the balance sheet, the new ASU will require both finance and operating leases to be recognized on the balance sheet. ASU 2016-02 will also require disclosures to help investors and other financial statement users better understand the amount, timing and uncertainty of cash flows arising from leases. The new disclosures will include both qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. ASU 2016-02 is effective with fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 for public entities. Accordingly, FNCB will adopt this guidance on January 1, 2019. Management is currently evaluating the effect this guidance may have on its operating results or financial position, including working with various business units within the organization and reviewing contractual arrangements for embedded leases in an effort to identify FNCB’s full lease population. Upon adoption, FNCB will recognize right-of-use assets and lease liabilities for the majority of its operating lease commitments. The amounts of right-to-use assets and corresponding lease liabilities recorded upon adoption will be based primarily on the present value of unpaid future minimum lease payments as of January 1, 2019. The amounts will also be impacted by assumptions around renewals and/or extensions, and the interest rate used to discount those future lease obligations. As of December 31, 2017, FNCB reported approximately $825 thousand in minimum lease payments due under such agreements for the period January 1, 2019 and forward. While these leases represent a majority of the leases within the scope of the standard, the lease portfolio is subject to change as a result of the execution of new leases and the termination of existing leases prior to the effective date, as well as the identification of potential embedded and other leases through the date of adoption.

 

 

ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): “Measurement of Credit Losses on Financial Instruments,” replaces the current loss impairment methodology under GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to form credit loss estimates in an effort to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit. Specifically, the amendments in this ASU will require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The amendments in this update affect entities holding financial assets and net investment in leases that are not accounted for at fair value through net income, including such financial assets as loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. On June 17, 2016, the four, federal financial institution regulatory agencies (the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration and the Office of the Comptroller of the Currency), issued a joint statement to provide information about ASU 2016-13 and the initial supervisory views regarding the implementation of the new standard. The joint statement applies to all banks, savings associations, credit unions and financial institution holding companies, regardless of asset size. The statement details the key elements of, and the steps necessary for, the successful transition to the new accounting standard. In addition, the statement notifies financial institutions that because the appropriate allowance levels are institution-specific amounts, the agencies will not establish benchmark targets or ranges for the change in institutions’ allowance levels upon adoption of the ASU, or for allowance levels going forward. Due to the importance of ASU 2016-13, the agencies encourage financial institutions to begin planning and preparing for the transition and state that senior management, under the oversight of the board of directors, should work closely with staff in their accounting, lending, credit risk management, internal audit, and information technology functions during the transition period leading up to, and well after, adoption. ASU 2016-13 is effective for public business entities that are U.S. Securities and Exchange Commission (“SEC”) filers for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. All entities may adopt the amendments in this ASU earlier as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Accordingly, FNCB will adopt this guidance on January 1, 2020. FNCB has created a Current Expected Credit Loss (“CECL”) task group comprised of members of its finance, credit administration, lending, internal audit, loan operations and information systems units. The CECL task group has become familiar with the provisions of ASU 2016-13 and is in the process of planning and preparing for the transition to the new guidance, which includes, but is not limited to: (1) developing an appropriate course of action for FNCB taking into consideration the nature, scope, and risk of its lending and investing activities; (2) identifying segments and sub-segments within the loan portfolio that have similar risk characteristics; (3) reviewing the existing allowance and credit risk management practices to identify processes that may be leveraged when applying the new guidance; (4) identifying data needs and implementing changes that are necessary to its core operating system and interfaces to be able to capture data requirements; and (5) evaluating the effect this guidance may have on FNCB’s operating results and/or financial position, including assessing any potential impact on its capital.

 

ASU 2018-13 Fair Value Measurement (Topic 820): “Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement” modifies the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, based on the FASB Concepts Statement, “Conceptual Framework for Financial Reporting – Chapter 8: Notes to Financial Statements”. In accordance with the Concepts Statement, this ASU removes, modifies and adds select disclosure requirements under Topic 820 after consideration of costs and benefits. ASU 2018-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 for public entities, with early adoption permitted. The adoption of this guidance on January 1, 2020 is not expected to have a material effect on the operating results or financial position of FNCB.

 

ASU 2018-15 Intangibles – Goodwill and Other–Internal-Use Software (Subtopic 350-40): “Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract” aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software and hosting arrangements that include an internal-use software license. ASU 2018-15 requires that a customer in a hosting arrangement that is a service contract follow the guidance in Subtopic 350-40 to determine which implementation costs to capitalize and which costs to expense, as well as requiring costs that cannot be capitalized to be expensed over the term of the hosting arrangement. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019 for public entities, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted. The adoption of this guidance on January 1, 2020 is not expected to have a material effect on the operating results or financial position of FNCB.

 

Refer to Note 2 to FNCB’s consolidated financial statements included in the 2017 Annual Report on Form 10-K and the Quarterly Report on Form 10-Q for the periods ended March 31, 2018 and June 30, 2018 for a discussion of additional accounting guidance applicable to FNCB that will be adopted in future periods and accounting guidance adopted by FNCB during the periods ended March 31, 2018 and June 30, 2018, respectively.

 

 

 

Note 3. Securities

 

Debt Securities

 

The following tables present the amortized cost, gross unrealized gains and losses, and the fair value of FNCB’s available-for-sale debt securities at September 30, 2018 and December 31, 2017:

 

 

 

Except for securities of U.S. government and government-sponsored agencies there were no securities of any individual issuer that exceeded 10.0% of shareholders’ equity at September 30, 2018.

 

At September 30, 2018 and December 31, 2017, securities with a carrying amount of $282.8 million and $282.3 million, respectively, were pledged as collateral to secure public deposits and for other purposes.

 

 

The following table presents the maturity information of FNCB’s available-for-sale debt securities at September 30, 2018.  Expected maturities will differ from contractual maturity because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Because collateralized mortgage obligations, mortgage-backed securities and asset-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following maturity summary:

 

 

 

There were no sales of available-for-sale debt securities for the three months ended September 30, 2018. Gross proceeds from the sale of available-for-sale debt securities were $4.6 million for the nine months ended September 30, 2018, with gross losses of $4 thousand realized upon the sales. There were no gains realized upon the sales of available-for-sale debt securities for the nine months ended September 30, 2018.

 

Gross proceeds from the sale of available-for-sale debt securities were $54.5 million and $131.0 million for the three and nine months ended September 30, 2017, respectively, with gross gains of $0.4 million and $1.4 million, respectively, realized upon the sales. Gross losses realized upon the sales were $24 thousand and $67 thousand for the three and nine months ended September 30, 2017.

 

The following tables present the number, fair value and gross unrealized losses of available-for-sale debt securities with unrealized losses at September 30, 2018 and December 31, 2017, aggregated by investment category and length of time the securities have been in an unrealized loss position.

 

 

 

 

 

Management evaluates individual securities in an unrealized loss position quarterly for other than temporary impairment (“OTTI”). As part of its evaluation, management considers, among other things, the length of time a security’s fair value is less than its amortized cost, the severity of decline, any credit deterioration of the issuer, whether or not management intends to sell the security, and whether it is more likely than not that FNCB will be required to sell the security prior to recovery of its amortized cost.

 

There were 206 securities in an unrealized loss position at September 30, 2018, including 137 obligations of state and political subdivisions, 52 securities issued by a U.S. government or government-sponsored agency, 12 negotiable certificates of deposit, two asset-backed securities and three corporate bonds. Management performed a review of all securities in an unrealized loss position as of September 30, 2018 and determined that movements in the fair values of the securities were consistent with changes in market interest rates. In addition, as part of its review, management noted that there was no material change in the credit quality of any of the issuers or any other event or circumstance that may cause a significant adverse effect on the fair value of these securities. Moreover, to date, FNCB has received all scheduled principal and interest payments and expects to fully collect all future contractual principal and interest payments on all securities in an unrealized loss position at September 30, 2018. FNCB does not intend to sell the securities, nor is it more likely than not that it will be required to sell the securities, prior to recovery of their amortized cost. Based on the results of its review and considering the attributes of these debt securities, management concluded that the individual unrealized losses were temporary and OTTI did not exist at September 30, 2018.

 

Equity Securities 

 

FNCB’s investment in equity securities consists entirely of a mutual fund investment comprised of one- to four-family residential mortgage-backed securities collateralized by properties within FNCB’s geographical market. At December 31, 2017, this mutual fund had an amortized cost of $1.0 million and an unrealized loss of $82 thousand, resulting in a fair value of $918 thousand. In accordance with ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): “Recognition and Measurement of Financial Assets and Financial Liabilities” which became effective January 1, 2018, FNCB will recognize any changes in the fair value of this equity security in the consolidated statements of income on a prospective basis. As a result of the adoption of this new accounting guidance on January 1, 2018, FNCB recorded a one-time reclassification between retained earnings and accumulated other comprehensive loss for the unrealized loss on this mutual fund, net of taxes, of $65 thousand. During the three and nine months ended September 30, 2018, the fair value of this equity security declined by $8 thousand and $34 thousand, respectively, which is included in net loss on equity securities in the consolidated statements of income. The following table presents unrealized and realized gains and losses recognized in net income on equity securities for the nine months ended September 30, 2018.

 

 

 

Restricted Securities

 

The following table presents FNCB’s investment in restricted securities at September 30, 2018 and December 31, 2017. Restricted securities have limited marketability and are carried at cost:

 

 

Management noted no indicators of impairment for the Federal Home Loan Bank (“FHLB”) of Pittsburgh or Atlantic Community Bankers Bank stock at September 30, 2018 and December 31, 2017.

 

Equity Securities without Readily Determinable Fair Values

 

FNCB owns a $1.7 million investment in the common stock of a privately-held bank holding company. The common stock was purchased during 2017 as part of a private placement pursuant to an exemption from the registration requirements of the Securities Act of 1933 for offerings not involving any public offering. The common stock of such bank holding company is not currently traded on any established market and is not expected to be traded in the near future on any securities exchange or established over-the-counter market. FNCB has elected to account for this transaction as an investment in an equity security without a readily determinable fair value. An equity security without a readily determinable fair value shall be written down to its fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than its carrying value. The $1.7 million investment is included in other assets in the consolidated statements of financial condition at September 30, 2018. As part of its qualitative assessment, management engaged an independent third party to provide a valuation of this investment as of September 30, 2018, which indicated that the investment was not impaired. Management determined that no adjustment for impairment was required at September 30, 2018.

 

Note 4. Loans

 

The following table summarizes loans receivable, net, by category at September 30, 2018 and December 31, 2017:

 

 

FNCB has granted loans, letters of credit and lines of credit to certain of its executive officers and directors as well as to certain of their related parties. For more information about related party transactions, refer to Note 7, “Related Party Transactions” to these consolidated financial statements.

 

FNCB originates one- to four-family mortgage loans for sale in the secondary market. During the three and nine months ended September 30, 2018, one- to four-family mortgages sold on the secondary market were $2.7 million and $7.7 million, respectively. Net gains on the sale of residential mortgage loans for the three and nine months ended September 30, 2018 were $71 thousand and $171 thousand, respectively, and $106 thousand and $241 thousand, respectively, for the comparable periods of 2017. FNCB retains servicing rights on mortgages sold in the secondary market. At September 30, 2018 and December 31, 2017, there were $0.9 million and $1.1 million one- to four-family residential mortgage loans held for sale, respectively.

 

 

During the nine months ended September 30, 2018, FNCB sold the guaranteed principal balance of loans that were guaranteed by the Small Business Administration (“SBA”) totaling $5.7 million. Net gains of $322 thousand were realized upon the sales and included in non-interest income for the nine months ended September 30, 2018. FNCB has retained the servicing rights on these loans. There were no sales of SBA-guaranteed loans for the three months ended September 30, 2018. For the three and nine months ended September 30, 2017, FNCB sold SBA-guaranteed loans of $0.3 million and $0.9 million, respectively. Net gains realized on the sales of guaranteed loans were $23 thousand and $79 thousand for the three and nine months ended September 30, 2017, respectively. The unpaid principal balance of loans serviced for others, including residential mortgages and SBA-guaranteed loans were $109.3 million at September 30, 2018 and $103.0 million at December 31, 2017.

 

FNCB does not have any lending programs commonly referred to as subprime lending. Subprime lending generally targets borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, and bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios.

 

There were no material changes to the risk characteristics of FNCB’s loan segments, loan classification and credit grading systems and methodology for determining the adequacy of the ALLL during the nine months ended September 30, 2018. Refer to Note 2, “Summary of Significant Accounting Policies” to FNCB’s consolidated financial statements included in the 2017 Annual Report on Form 10-K for information about the risk characteristics related to FNCB’s loan segments, loan classification and credit grading systems and methodology for determining the adequacy of the ALLL.

 

Management evaluates the credit quality of the loan portfolio on an ongoing basis and performs a formal review of the adequacy of the ALLL on a quarterly basis. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions. Actual loan losses may be significantly more than the established ALLL, which could have a material negative effect on FNCB’s operating results or financial condition. While management uses the best information available to make its evaluations, future adjustments to the ALLL may be necessary if conditions differ substantially from the information used in making the evaluations. Banking regulators, as an integral part of their examination of FNCB, also review the ALLL, and may require, based on their judgments about information available to them at the time of their examination, that certain loan balances be charged off or require that adjustments be made to the ALLL.

 

The following table summarizes activity in the ALLL by loan category for the three and nine months ended September 30, 2018 and 2017:

 

 

 

The following table represents the allocation of the ALLL and the related loan balance, by loan category, disaggregated based on the impairment methodology at September 30, 2018 and December 31, 2017:

 

 

 

Credit Quality Indicators – Commercial Loans

 

Management continuously monitors and evaluates the credit quality of FNCB’s commercial loans by regularly reviewing certain credit quality indicators. Management utilizes credit risk ratings as the key credit quality indicator for evaluating the credit quality of FNCB’s loan receivables.

 

FNCB’s loan rating system assigns a degree of risk to commercial loans 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. Management analyzes these non-homogeneous loans individually by grading the loans as to credit risk and probability of collection for each type of loan. Commercial and industrial loans include commercial indirect auto loans which are not individually risk rated, and construction, land acquisition and development loans include residential construction loans which are also not individually risk rated. These loans are monitored on a pool basis due to their homogeneous nature as described in “Credit Quality Indicators – Other Loans” below. FNCB risk rates certain residential real estate loans and consumer loans that are part of a larger commercial relationship using a credit grading system as described in “Credit Quality Indicators – Commercial Loans.” The grading system contains the following basic risk categories:

 

1. Minimal Risk

2. Above Average Credit Quality

3. Average Risk

4. Acceptable Risk

5. Pass - Watch

6. Special Mention

7. Substandard - Accruing

8. Substandard - Non-Accrual

9. Doubtful

10. Loss

 

This analysis is performed on a quarterly basis using the following definitions for risk ratings:

 

Pass – Assets rated 1 through 5 are considered pass ratings. These assets show no current or potential problems and are considered fully collectible. All such loans are evaluated collectively for ALLL calculation purposes. However, accruing loans restructured under a troubled debt restructuring (“TDRs”) that have been performing for an extended period, do not represent a higher risk of loss, and have been upgraded to a pass rating are evaluated individually for impairment.

 

Special Mention – Assets classified as special mention do not currently expose FNCB to a sufficient degree of risk to warrant an adverse classification but do possess credit deficiencies or potential weaknesses deserving close attention.  Special mention assets have a potential weakness or pose an unwarranted financial risk which, if not corrected, could weaken the asset and increase risk in the future.

 

Substandard – Assets classified as substandard have well defined weaknesses based on objective evidence and are characterized by the distinct possibility that FNCB will sustain some loss if the deficiencies are not corrected.

 

Doubtful – Assets classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that such weaknesses make collection or liquidation in full highly questionable and improbable based on current circumstances.

 

Loss – Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets is not warranted.

 

Credit Quality Indicators – Other Loans

 

Certain residential real estate loans, consumer loans, and commercial indirect auto loans are monitored on a pool basis due to their homogeneous nature. Loans that are delinquent 90 days or more are placed on non-accrual status unless collection of the loan is in process and reasonably assured. FNCB utilizes accruing versus non-accrual status as the credit quality indicator for these loan pools.

 

 

The following tables present the recorded investment in loans receivable by loan category and credit quality indicator at September 30, 2018 and December 31, 2017:

 

 

 

 

Included in loans receivable are loans for which the accrual of interest income has been discontinued due to deterioration in the financial condition of the borrowers. The recorded investment in these non-accrual loans was $4.4 million and $2.6 million at September 30, 2018 and December 31, 2017, respectively. Generally, loans are placed on non-accrual status when they become 90 days or more delinquent and remain on non-accrual status until they are brought current, have six months of performance under the loan terms, and factors indicating reasonable doubt about the timely collection of payments no longer exist. Therefore, loans may be current in accordance with their loan terms, or may be less than 90 days delinquent, and still be on a non-accrual status. There were no loans past due 90 days or more and still accruing at September 30, 2018 and December 31, 2017.

 

 

The following tables present the delinquency status of past due and non-accrual loans at September 30, 2018 and December 31, 2017:

 

 

 

 

The following tables present a distribution of the recorded investment, unpaid principal balance and the related allowance for FNCB’s impaired loans, which have been analyzed for impairment under ASC 310, at September 30, 2018 and December 31, 2017. Non-accrual loans, other than TDRs, with balances less than the $100 thousand loan relationship threshold are not evaluated individually for impairment and accordingly, are not included in the following tables. However, these loans are evaluated collectively for impairment as homogenous pools in the general allowance under ASC Topic 450. Total non-accrual loans, other than TDRs, with balances less than the $100 thousand loan relationship threshold that were evaluated under ASC Topic 450 amounted to $0.5 million at September 30, 2018 and December 31, 2017.

 

 

 

 

 

The following table presents the average balance of, and interest income recognized on, impaired loans summarized by loan category for the three and nine months ended September 30, 2018 and 2017:

 

 

(1) Interest income represents income recognized on accruing TDRs.

 

The additional interest income that would have been earned on non-accrual and restructured loans had these loans performed in accordance with their original terms approximated $65 thousand and $150 thousand for the three and nine months ended September 30, 2018, respectively, and $50 thousand and $116 thousand for the three and nine months ended September 30, 2017, respectively.

 

Troubled Debt Restructured Loans

 

TDRs at September 30, 2018 and December 31, 2017 were $9.3 million and $10.2 million, respectively. Accruing and non-accruing TDRs were $8.5 million and $0.8 million, respectively at September 30, 2018, and $9.3 million and $0.9 million, respectively at December 31, 2017. Approximately $671 thousand and $750 thousand in specific reserves have been established for TDRs as of September 30, 2018, and December 31, 2017, respectively. FNCB was not committed to lend additional funds to any loan classified as a TDR at September 30, 2018.

 

 

The modification of the terms of loans classified as TDRs may include one or a combination of the following, among others: a reduction of the stated interest rate of the loan, an extension of the maturity date, capitalization of real estate taxes, a payment modification under a forbearance agreement, or a permanent reduction of the recorded investment in the loan.

 

There were no loans modified as TDRs during the three and nine months ended September 30, 2018. The following tables present the pre- and post-modification recorded investment in loans modified as TDRs and type of modifications made during the three and nine months ended September 30, 2017.

 

 

 

There were eight loan relationships modified as TDRs during the nine months ended September 30, 2017, which incorporated a total of fifteen individual loans. There were three loan relationships, comprised of eight commercial real estate loans totaling $5.3 million, and two loan relationships comprised of four commercial and industrial loans totaling $1.8 million, that were modified under varying forms of forbearance agreements during the nine months ended September 30, 2017. Additional TDRs included two consumer loans totaling $85 thousand that had their terms extended and delinquent taxes capitalized, as well as one residential real estate loan in the amount of $63 thousand that had its terms extended. The commercial real estate modifications included a principal forbearance agreement for one loan in the amount of $4.0 million and reductions in required monthly principal payments resulting in balloon payments due at maturity for seven loans to two borrowers aggregating $1.2 million. The four commercial and industrial loan modifications involved the delay of required principal and interest payments for predefined time periods. In addition, a charge-off in the amount of $0.3 million was recorded as part of the modification of three commercial and industrial loans aggregating $1.8 million to one borrower.

 

There were no TDRs modified within the previous 12 months that defaulted (defined as past due 90 days or more) during the three and nine months ended September 30, 2018. There was one construction, land acquisition and development loan in the amount of $10 thousand that was modified during the previous 12 months that defaulted during the nine months ended September 30, 2017.

 

Residential Real Estate Loan Foreclosures

 

There were four consumer mortgage loans secured by residential real estate properties with an aggregate recorded investment of $20 thousand in the process of foreclosure at September 30, 2018. For the three and nine months ended September 30, 2018, there were no residential real estate properties foreclosed upon, and there was one residential real estate property with an aggregate carrying value of $59 thousand included in OREO at September 30, 2018.

 

 

There were two consumer mortgage loans secured by residential real estate properties with an aggregate recorded investment of $14 thousand that were in the process of foreclosure at September 30, 2017. There were no residential real estate properties that were foreclosed upon during the three months ended September 30, 2017. For the nine months ended September 30, 2017, there were two residential real estate properties with an aggregate carrying value of $125 thousand that were foreclosed upon. Of the two loans foreclosed upon during the nine months ended September 30, 2017, one was an investor-owned residential real estate property with a current carrying value of $30 thousand. There were four residential real estate properties with an aggregate carrying value of $149 thousand included in OREO at September 30, 2017.