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

 

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

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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 March 31, 2018

 

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 No. 000-53869

 

FNCB BANCORP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Pennsylvania		23-2900790
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
102 E. Drinker St., Dunmore, PA		18512
(Address of Principal Executive Offices)		(Zip Code)

 

Registrant’s telephone number, including area code (570) 346-7667

 

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

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, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐		Accelerated filer ☒
Non-accelerated filer ☐  (Do not check if smaller reporting company)		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 ☒

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

 

Common Stock, $1.25 par value		16,769,208 shares
(Title of Class)		(Outstanding at May 4, 2018)

 

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Contents
PART I. Financial Information	3
Item 1. Financial Statements (unaudited)	3
Consolidated Statements of Financial Condition	3
Consolidated Statements of Income	4
Consolidated Statements of Comprehensive (Loss) Income	5
Consolidated Statements of Changes in Shareholders’ Equity	6
Consolidated Statements of Cash Flows	7
Notes to Consolidated Financial Statements	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3. Quantitative and Qualitative Disclosures about Market Risk	51
Item 4. Controls and Procedures	52
PART II.  Other Information	52
Item 1. Legal Proceedings.	52
Item 1A. Risk Factors.	52
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.	52
Item 3. Defaults upon Senior Securities.	52
Item 4. Mine Safety Disclosures.	53
Item 5. Other Information.	53
Item 6. Exhibits.	53

     

 

 

		March 31,				December 31,
(in thousands, except share data)		2018				2017
Assets
Cash and cash equivalents:
Cash and due from banks		$	12,323			$	22,755
Interest-bearing deposits in other banks			1,873				14,991
Total cash and cash equivalents			14,196				37,746
Debt securities available for sale, at fair value			298,314				289,459
Equity securities			899				918
Restricted stock, at cost			5,703				2,763
Loans held for sale			366				1,095
Loans, net of allowance for loan and lease losses of $9,562 and $9,034			798,640				761,609
Bank premises and equipment, net			12,870				10,388
Accrued interest receivable			3,430				3,234
Bank-owned life insurance			30,594				30,460
Other real estate owned			579				1,023
Net deferred tax assets			16,405				15,785
Other assets			7,264				7,825
Total assets		$	1,189,260			$	1,162,305
Liabilities
Deposits:
Demand (non-interest-bearing)		$	172,896			$	176,325
Interest-bearing			782,357				826,123
Total deposits			955,253				1,002,448
Borrowed funds:
Federal Home Loan Bank of Pittsburgh advances			121,485				44,968
Subordinated debentures			5,000				5,000
Junior subordinated debentures			10,310				10,310
Total borrowed funds			136,795				60,278
Accrued interest payable			284				241
Other liabilities			10,190				10,147
Total liabilities			1,102,522				1,073,114
Shareholders' equity
Preferred shares ($1.25 par)
Authorized: 20,000,000 shares at March 31, 2018 and December 31, 2017
Issued and outstanding: 0 shares at March 31, 2018 and December 31, 2017			-				-
Common shares ($1.25 par)
Authorized: 50,000,000 shares at March 31, 2018 and December 31, 2017
Issued and outstanding: 16,766,600 shares at March 31, 2018 and 16,757,963 shares at December 31, 2017			20,958				20,947
Additional paid-in capital			63,335				63,210
Retained earnings			8,057				6,779
Accumulated other comprehensive loss			(5,612	)			(1,745	)
Total shareholders' equity			86,738				89,191
Total liabilities and shareholders’ equity		$	1,189,260			$	1,162,305

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		Three Months Ended
		March 31,
(in thousands, except share data)		2018				2017
Interest income
Interest and fees on loans		$	8,288			$	6,980
Interest and dividends on securities:
U.S. government agencies			890				900
State and political subdivisions, tax free			20				23
State and political subdivisions, taxable			1,024				822
Other securities			195				124
Total interest and dividends on securities			2,129				1,869
Interest on interest-bearing deposits in other banks			23				90
Total interest income			10,440				8,939
Interest expense
Interest on deposits			1,067				744
Interest on borrowed funds:
Interest on Federal Home Loan Bank of Pittsburgh advances			352				131
Interest on subordinated debentures			56				112
Interest on junior subordinated debentures			87				69
Total interest on borrowed funds			495				312
Total interest expense			1,562				1,056
Net interest income before provision (credit) for loan and lease losses			8,878				7,883
Provision (credit) for loan and lease losses			720				(478	)
Net interest income after provision (credit) for loan and lease losses			8,158				8,361
Non-interest income
Deposit service charges			702				691
Net gain on the sale of available-for-sale securities			-				278
Net loss on equity securities			(19	)			-
Net gain on the sale of mortgage loans held for sale			49				25
Net gain on the sale of SBA guaranteed loans			251				-
Net gain on the sale of other repossessed assets			-				57
Net gain on the sale of other real estate owned			38				51
Loan-related fees			84				91
Income from bank-owned life insurance			134				135
Other			280				242
Total non-interest income			1,519				1,570
Non-interest expense
Salaries and employee benefits			3,666				3,524
Occupancy expense			603				587
Equipment expense			314				460
Advertising expense			113				114
Data processing expense			648				487
Regulatory assessments			201				173
Bank shares tax			267				258
Expense of other real estate owned			45				40
Professional fees			296				276
Insurance expense			135				125
Other losses			41				138
Other operating expenses			903				746
Total non-interest expense			7,232				6,928
Income before income tax expense			2,445				3,003
Income tax expense			426				806
Net income		$	2,019			$	2,197
Earnings per share
Basic		$	0.12			$	0.13
Diluted		$	0.12			$	0.13
Cash dividends declared per common share		$	0.04			$	0.03
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic			16,763,401				16,657,551
Diluted			16,789,336				16,670,788

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		Three Months Ended
		March 31,
(in thousands)		2018				2017
Net income		$	2,019			$	2,197
Other comprehensive (loss) income:
Unrealized (losses) gains on debt securities available for sale			(4,976	)			1,836
Taxes			1,044				(625	)
Net of tax amount			(3,932	)			1,211
Reclassification adjustment for gains included in net income			-				(278	)
Taxes			-				95
Net of tax amount			-				(183	)
Total other comprehensive (loss) income			(3,932	)			1,028
Comprehensive (loss) income		$	(1,913	)		$	3,225

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																		Accumulated
		Number								Additional								Other				Total
		of Common				Common				Paid-in				Retained				Comprehensive				Shareholders'
(in thousands, except per 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			-				-				-				2,197				-				2,197
Cash dividends declared, $0.03 per share			-				-				-				(500	)			-				(500	)
Common shares issued under long-term incentive compensation plan			11,090				14				(14	)			-				-				-
Restricted stock awards			-				-				74				-				-				74
Common shares issued through dividend reinvestment / optional cash purchase plan			35,379				44				188				-				-				232
Other comprehensive income, net of tax of $530			-				-				-				-				1,028				1,028
Balances, March 31, 2017			16,692,314			$	20,865			$	62,841			$	10,228			$	(532	)		$	93,402
Balances, December 31, 2017			16,757,963			$	20,947			$	63,210			$	6,779			$	(1,745	)		$	89,191
Net income for the period			-				-				-				2,019				-				2,019
Cash dividends paid, $0.04 per share			-				-				-				(671	)			-				(671	)
Reclassification of unrealized loss on equity securities, net of tax			-				-				-				(65	)			65				-
Restricted stock awards			-				-				72				-				-				72
Common shares issued through dividend reinvestment / optional cash purchase plan			8,637				11				53				(5	)			-				59
Other comprehensive loss, net of tax of $1,044			-				-				-				-				(3,932	)			(3,932	)
Balances, March 31, 2018			16,766,600			$	20,958			$	63,335			$	8,057			$	(5,612	)		$	86,738

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		Three Months Ended
		March 31,
(in thousands)		2018				2017
Cash flows from operating activities:
Net income		$	2,019			$	2,197
Adjustments to reconcile net income to net cash provided by operating activities:
Investment securities amortization, net			188				270
Equity in trust			(3	)			(2	)
Depreciation and amortization			674				681
Valuation adjustment for loan servicing rights			-				(4	)
Stock-based compensation expense			72				74
Provision (credit) for loan and lease losses			720				(478	)
Valuation adjustment for off-balance sheet commitments			(10	)			9
Net gain on the sale of available-for-sale securities			-				(278	)
Net loss on equity securities			19				-
Net gain on the sale of mortgage loans held for sale			(49	)			(25	)
Net gain on the sale of SBA guaranteed loans			(251	)			-
Net gain on the sale of other real estate owned			(38	)			(51	)
Valuation adjustment of other real estate owned			17				-
Net gain on the sale of other repossessed assets			-				(57	)
Loss on the disposition of bank premises and equipment			-				41
Income from bank-owned life insurance			(134	)			(135	)
Proceeds from the sale of mortgage loans held for sale			2,878				1,846
Funds used to originate mortgage loans held for sale			(2,100	)			(1,788	)
Decrease in net deferred tax assets			424				806
Increase in accrued interest receivable			(196	)			(193	)
Decrease (increase) in prepaid expenses and other assets			548				(50	)
Increase (decrease) in accrued interest payable			43				(17	)
Increase (decrease) in accrued expenses and other liabilities			53				(948	)
Total adjustments			2,855				(299	)
Net cash provided by operating activities			4,874				1,898
Cash flows from investing activities:
Maturities, calls and principal payments of debt securities available for sale			1,334				1,018
Proceeds from the sale of debt securities available for sale			-				23,171
Purchases of debt securities available for sale			(15,353	)			(34,902	)
(Purchase) redemption of the stock in Federal Home Loan Bank of Pittsburgh			(2,940	)			633
Net (increase) decrease in loans to customers			(43,006	)			15,900
Proceeds from the sale of SBA guaranteed loans			5,206				-
Proceeds from the sale of other real estate owned			465				793
Proceeds from the sale of other repossessed assets			-				185
Purchases of bank premises and equipment			(2,840	)			(530	)
Net cash (used in) provided by investing activities			(57,134	)			6,268
Cash flows from financing activities:
Net decrease in deposits			(47,195	)			(91,713	)
Net proceeds from Federal Home Loan Bank of Pittsburgh advances - overnight			59,325				4,900
Proceeds from Federal Home Loan Bank of Pittsburgh advances - term			27,631				14,241
Repayment of Federal Home Loan Bank of Pittsburgh advances - term			(10,439	)			(21,046	)
Proceeds from issuance of common shares			64				232
Discount on optional cash purchase plan			(5	)			-
Cash dividends paid			(671	)			(500	)
Net cash provided by (used in) financing activities			28,710				(93,886	)
Net decrease in cash and cash equivalents			(23,550	)			(85,720	)
Cash and cash equivalents at beginning of period			37,746				112,445
Cash and cash equivalents at end of period		$	14,196			$	26,725
Supplemental cash flow information
Cash paid during the period for:
Interest		$	1,519			$	1,073
Income taxes			18				-
Other transactions:
Investor loans transferred to other real estate owned			-				45
Change in deferred gain on sale of other real estate owned			-				1

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Note 1.   Basis of Presentation/Subsequent Event

 

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 months ended March 31, 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.

 

On April 11, 2018, FNCB announced that the Bank has entered into an agreement with Branch Banking and Trust Company to purchase real property, improvements and fixtures located at 196 North Main Street, Shavertown, Luzerne County, Pennsylvania for a purchase price of $750 thousand. Pursuant to the agreement, the closing will take place on or before the later of: June 14, 2018, or the date that is fourteen (14) days after that date that the seller’s branch banking operations at this location closes. The agreement also contains a deed restriction under which the Bank has agreed to not operate, sell, lease or allow the operation, sale or lease of the property for a banking use for a period of six months after the date of the recording of the deed. After the deed restriction period ends, FNCB intends to relocate its existing branch, located at 1919 Memorial Highway, Shavertown, Luzerne County, Pennsylvania, to the new location, pending approval from all required regulatory authorities.

 

 

Note 2.   New Authoritative Accounting Guidance

 

ASU 2014-09, Revenue from Contracts with Customers (Topic 606): Section A, “Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs-Contract with Customers (Subtopic 340-40);” Section B, “Conforming Amendments to Other Topics and Subtopics in the Codification and Status Tables;” and Section C, “Background Information and Basis for Conclusions,” provides a robust framework for addressing revenue recognition issues, and replaced almost all existing revenue recognition guidance, including industry specific guidance, in current GAAP. The core principle of ASU 2014-09 is for companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration to which FNCB expects to be entitled in exchange for those goods or services. ASU 2014-09 also resulted in enhanced interim and annual disclosures, both qualitative and quantitative, about revenue in order to help financial statement users understand the nature, amount, timing and uncertainty of revenue and related cash flows. ASU 2014-09 establishes a five-step model which entities must follow to recognize revenue and removes inconsistencies and weaknesses in existing guidance. The guidance does not apply to revenue associated with financial instruments, including loans and investment securities that are accounted for under other GAAP, which comprises a significant portion of FNCB’s revenue stream. ASU 2014-09 became effective for FNCB on January 1, 2018. FNCB elected to implement the new guidance using the modified retrospective application, with the cumulative effect recorded as an adjustment to opening retained earnings upon adoption. The adoption of ASU 2014-09 did not have a material effect on the operating results or financial position of FNCB, and there was no cumulative effect adjustment required to be recorded. See below for additional information related to revenue generated from contracts with customers.

 

 

The majority of FNCB’s revenue generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as loans and investment securities, as well as revenue related to mortgage servicing activities, as these activities are subject to other GAAP discussed elsewhere with the disclosures. Descriptions of FNCB’s revenue-generating activities that are within the scope of ASC 606, which are presented in the consolidated statements of income as components of non-interest income are as follows:

 

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Service charges on deposit accounts - include general service fees for monthly account maintenance, account analysis fees, non-sufficient funds fees, wire transfer fees and other deposit account related fees. Revenue is recognized when FNCB’s performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payment for service charges on deposit accounts is received immediately or in the following month through a direct charge to customers’ accounts.

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ATM surcharge and card services income – include income related to ATM and debit card transactions. ATM surcharges are generated when an FNCB cardholder uses a non-FNCB ATM or a non-FNCB cardholder uses an FNCB ATM. Card services income is primarily comprised of interchange fees earned whenever a customer uses an FNCB debit card as payment for goods and/or services through a card payment network such as Mastercard/Visa. FNCB’s performance obligation is satisfied on a daily basis as transactions are processed. FNCB recognizes ATM surcharges and card services income as transactions with merchants are settled, generally on a daily basis.

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Title insurance revenue – FNCB is a member in a limited liability company that provides title insurance services to customers referred by member financial institutions. In accordance with an operating agreement, the title insurance company makes quarterly discretionary distributions to member institutions on a pro-rata basis based on their respective membership interest percentage at the time of distribution. FNCB’s performance obligation under the operating agreement was satisfied with its capital contribution. There are no future minimum referral quotas required under the operating agreement. FNCB records revenue from quarterly distributions at the time of receipt.

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Other income – primarily includes wealth management fee income and merchant services fee income. Wealth management fee income represents fees received from a third-party broker-dealer as part of a revenue-sharing agreement for fees earned from customers that we refer to the third party. Merchant services fees represent commissions received from VISA/Mastercard on activity generated by customers on their merchant account. Wealth management and merchant services fee income are transactional in nature and are recognized in income monthly when FNCB’s performance obligation is complete, which is generally the time that payment is received.

 

ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): “Recognition and Measurement of Financial Assets and Financial Liabilities” requires all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under the equity method of accounting or those that result in consolidation of the investee). The amendments in this ASU also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition, this ASU eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities and the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet for public business entities. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017 for public entities. Accordingly, FNCB adopted this guidance on a prospective basis on January 1, 2018. The adoption resulted in a $65 thousand reclassification from accumulated other comprehensive income to retained earnings to reflect the fair value of FNCB’s equity securities, which is included in the consolidated statements of changes in shareholders’ equity. ASU 2016-01 also requires the use of exit prices to measure fair value of financial instruments. Accordingly, we refined the calculation used to determine the disclosed fair value of FNCB’s loans held for investment as part of adopting this standard. The refined calculation did not have a significant impact on FNCB’s fair value disclosures. For more information about fair value disclosures, refer to Note 11, “Fair Value Disclosures” to these consolidated financial statements.

 

ASU 2016-15, Statement of Cash Flows (Topic 230): “Classification of Certain Cash Receipts and Cash Payments,” provides guidance on eight specific cash flow issues in order to reduce current and potential future diversity in reporting. The specific cash flow items addressed include debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, distributions received from equity method investees, beneficial interest in securitization transactions, and separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. ASU 2016-15 is effective for all entities that are required to present a statement of cash flows under Topic 320, and early adoption is permitted. The adoption of this guidance on January 1, 2018 had no effect on the statement of cash flows of FNCB.

 

ASU 2017-09, Compensation – Stock Compensation (Topic 718): “Scope of Modification Accounting” clarifies when it is appropriate to apply modification accounting guidance when there is a change to the terms or conditions of a share-based payment award. Specifically, the standard provides that an entity should account for the effects of a modification unless the fair value of the modified award is the same as the original award immediately before modification, if the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before modification, and the classification of the modified award is the same as the classification of the original award immediately before modification. ASU 2017-09 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The adoption of this guidance on January 1, 2018 had no effect on the operating results or financial position of FNCB.

 

 

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, and is currently evaluating the effect this guidance may have on its operating results or financial position.

 

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.

 

Refer to Note 2 to FNCB’s consolidated financial statements included in the 2017 Annual Report on Form 10-K for a discussion of additional accounting guidance applicable to FNCB that will be adopted in future periods.

 

 

 

Note 3. Securities

 

During the third quarter of 2017, management identified two subordinated notes issued by other financial institutions in the amount of $1.0 million each and $1.0 million in mandatory-redeemable preferred stock of a subsidiary of another financial institution that were included in loans receivable at  December 31, 2016 and 2015. Management determined that these financial instruments are in fact securities and upon identification reclassified the recorded investment in these instruments of $3.0 million from loans receivable to available-for-sale securities. Management also conducted an assessment of materiality of the reclassification to determine if FNCB’s previously-issued consolidated financial statements should be amended. Based on its qualitative and quantitative assessment of materiality, management determined that the reclassification did not have a material impact to FNCB’s financial position or results of operations as of and for the years ended  December 31, 2016 and 2015, including the interim periods within those years. In addition, the reclassification did not have a material impact to FNCB’s financial position or results of operations as of and for the interim periods ended  March 31, 2017 and  June 30, 2017. Accordingly, management concluded that FNCB’s previously-issued consolidated financial statements and notes to the consolidated financial statements could still be relied upon. However, management has elected to correct the error in these current-period consolidated financial statements and notes to the consolidated financial statements by adjusting the prior-period information for comparability. Management engaged an independent third party to conduct a valuation of and provide fair values for these available-for-sale securities as of  September 30, 2017,  December 31, 2016,  December 31, 2015 and for each quarterly period-end of 2017 and 2016. Based on the valuations, management adjusted these available-for-sale securities to fair value at  December 31, 2016 and 2015 and each of the quarter-end periods of 2017 and 2016. Specifically, these reclassifications and valuations resulted in the following adjustments to balances included in previously-issued consolidated statements of financial position at  December 31, 2016 and 2015 of: 1) increases to securities available for sale of $3.3 million, or 1.22%, and $3.3 million, or 1.29%; 2) decreases to loans, net of the allowance for loan and lease losses of $3.0 million, or 0.41%, for both period ends; 3) increases to total capital, specifically accumulated other comprehensive income, net of income taxes, of $224 thousand, or 0.25%, and $178 thousand, or 0.21%; and 4) decreases to net deferred tax assets of $115 thousand, or 0.43%, and $91 thousand, or 0.32%, respectively. Adjustments to these balances at each of the quarter-end periods of 2017 and 2016 were comparable to those made at  December 31, 2016 and 2015, which management has deemed to be immaterial. These reclassifications and valuations had no effect on the consolidated statements of income, the consolidated statements of cash flows, or on earnings per share for the annual and interim periods of 2016 and interim periods of 2017.

 

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 March 31, 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 March 31, 2018.

 

At March 31, 2018 and December 31, 2017, securities with a carrying amount of $287.2 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 March 31, 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 during the three months ended March 31, 2018. Gross proceeds from the sale of available-for-sale debt securities were $23.2 million for the three months ended March 31, 2017, with gross gains of $278 thousand realized upon the sales. There were no losses realized upon the sales for the three months ended March 31, 2017.

 

 

The following tables present the number, fair value and gross unrealized losses of available-for-sale debt securities with unrealized losses at March 31, 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 193 securities in an unrealized loss position at March 31, 2018, including 130 obligations of state and political subdivisions, 48 securities issued by a U.S. government or government-sponsored agency, 12 negotiable certificates of deposit, one corporate bond and two asset-backed securities. Management performed a review of all securities in an unrealized loss position as of March 31, 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 March 31, 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 March 31, 2018.

 

 

Equity Securities

 

FNCB’s investment in equity securities is comprised 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 months ended March 31, 2018, the fair value of this equity security declined by $19 thousand, 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 three months ended March 31, 2018.

 

 

Restricted Securities

 

The following table presents the investment in FNCB’s restricted securities, which have limited marketability and are carried at cost:

 

 

Management noted no indicators of impairment for the Federal Home Loan Bank of Pittsburgh or Atlantic Community Banker’s Bank stock at March 31, 2018 and December 31, 2017.

 

Equity Securities without Readily Determinable Fair Values

 

FNCB owns a 4.9% interest, or $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 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  March 31, 2018. Management engaged an independent third party to provide a valuation of this investment as of  March 31, 2018. The valuation indicated that the investment was not impaired and accordingly, no adjustment for impairment was required at  March 31, 2018.

 

 

 

Note 4. Loans

 

The following table summarizes loans receivable, net, by category at March 31, 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 quarter ended March 31, 2018, one-to four-family mortgages sold on the secondary market were $2.8 million. Net gains on the sale of residential mortgage loans for the three months ended March 31, 2018 and 2017 were $49 thousand and $25 thousand, respectively. FNCB retains servicing rights on these mortgages. At March 31, 2018 and December 31, 2017, there were $366 thousand and $1.1 million in one-to four-family residential mortgage loans held for sale, respectively.

 

During the three months ended March 31, 2018, FNCB sold the guaranteed principal balance of loans that were guaranteed by the Small Business Administration (“SBA”) totaling $5.0 million. Net gains realized upon the sales for the period ended March 31, 2018 and included in non-interest income totaled $251 thousand. FNCB retained the servicing rights on these loans. There were no sales of guaranteed loans during the three months ended March 31, 2017. The unpaid principal balance of loans serviced for others, including residential mortgages and SBA guaranteed loans were $107.8 million at March 31, 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 three months ended March 31, 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 ALLL that is established, 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 months ended March 31, 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 March 31, 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 March 31, 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 $2.4 million and $2.6 million at March 31, 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 March 31, 2018 and December 31, 2017.

 

 

The following tables present the delinquency status of past due and non-accrual loans at March 31, 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 March 31, 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 $0.4 million at March 31, 2018 and $0.5 million at December 31, 2017.

 

 

 

 

 

The following table presents the average balance and interest income by loan category recognized on impaired loans for the three months ended March 31, 2018 and 2017:

 

(1) Interest income represents income recognized on performing 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 $40 thousand and $27 thousand for the three months ended March 31, 2018 and 2017, respectively.

 

 

Troubled Debt Restructured Loans

 

TDRs at March 31, 2018 and December 31, 2017 were $9.7 million and $10.2 million, respectively. Accruing and non-accruing TDRs were $8.8 million and $0.9 million, respectively, at March 31, 2018, and $9.3 million and $0.9 million, respectively, at December 31, 2017. Approximately $713 thousand and $750 thousand in specific reserves have been established for TDRs as of March 31, 2018 and December 31, 2017, respectively. FNCB was not committed to lend additional funds to any loan classified as a TDR at March 31, 2018.

 

The modification of the terms of such loans 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 months ended March 31, 2018. The following table presents the pre- and post-modification recorded investment in loans modified as TDRs and type of modifications made during the three months ended March 31, 2017:

 

 

The two loans modified as TDRs during the three months ended March 31, 2017 resulted in an increase to the ALLL of $337 thousand through allocation of a specific reserve.

 

There were no TDRs modified within the previous 12 months that defaulted (defined as past due 90 days or more) during the three months ended March 31, 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 three months ended March 31, 2017.

 

Residential Real Estate Loan Foreclosures

 

There were four consumer mortgage loans secured by residential real estate properties with no aggregate recorded investment in the process of foreclosure at March 31, 2018. For the three months ended March 31, 2018, there were no residential real estate properties foreclosed upon, and there were two residential real estate properties with an aggregate carrying value of $75 thousand included in OREO at March 31, 2018.

 

There were four consumer mortgage loans secured by residential real estate properties with an aggregate recorded investment of $91 thousand in the process of foreclosure at March 31, 2017. There was one investor-owned residential real estate property with a carrying value of $45 thousand that was foreclosed upon during the three months ended March 31, 2017. There were three residential real estate properties with an aggregate carrying value of $86 thousand included in OREO at March 31, 2017.