FNCB Bancorp, Inc. - Quarter Report: 2020 June (Form 10-Q)

Part I - Financial Information

Item 1 - Financial Statements

The accompanying notes to consolidated financial statements are an integral part of these statements.

The accompanying notes to consolidated financial statements are an integral part of these statements.

The accompanying notes to consolidated financial statements are an integral part of these statements.

The accompanying notes to consolidated financial statements are an integral part of these statements.

The accompanying notes to consolidated financial statements are an integral part of these statements.

FNCB BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

Risks and Uncertainties Related to COVID-19

In March 2020, the outbreak of the novel Coronavirus Disease 2019 ("COVID-19") was recognized as a pandemic by the World Health Organization. The spread of COVID-19 has created a global public health crisis that has resulted in, and continues to pose, unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity in the United States and globally, including the markets that FNCB serves. Governmental authorities responded to the pandemic by mandating the closure of locations of non-essential businesses and requiring individuals to observe social distancing and "stay-at-home" restrictions. These governmental restrictions, coupled with fear of contracting the virus, have resulted in a rapid decline in commercial and consumer activity, loss of revenues by businesses, a severe spike in unemployment, material decreases in oil and gas prices and in business valuations, disrupted global supply chains and market volatility. 

The federal government has taken several actions designed to mitigate the impact of the economic disruption. Specifically, on March 27, 2020, the Coronavirus Aid, Relief, and Economic Security ("CARES") Act, a $2.0 trillion legislative package, was signed into law. The CARES Act contains substantial tax and spending provisions including direct financial aid to American families, extensive emergency funding for hospitals and medical providers, and economic stimulus to significantly impacted industry sectors. Management expects the general impact of COVID-19, as well as certain provisions of the CARES Act and other recent legislative and regulatory relief efforts, to have a material impact on FNCB's operations. Because the impact is contingent upon the duration and severity of the economic downturn, management cannot determine or estimate the magnitude of the impact at this time. However, FNCB is disclosing potentially material items it is currently aware of.

Business Continuity, Processes and Controls

As a financial institution, FNCB is considered essential and has remained open for business and is operating under its pandemic preparedness plan. To ensure the financial needs of its customers are addressed in a safe and consistent manner, FNCB Bank offices are open for regular business, with administrative, lending and community branch offices adhering to federal, state, and local governmental guidelines and social distancing mandates. However, in order to limit the spread of COVID-19 customers are encouraged to utilize FNCB's drive-thru facilities, automated teller machines, Customer Care center, remote deposit capture and online and mobile banking applications. FNCB is also providing the necessary technology, when needed, to its operational staff to work remotely in a secure environment. FNCB does not currently face any material resource constraints through the implementation of its pandemic preparedness plan. Through the six months ended June 30, 2020, FNCB incurred COVID-19 related expenses including stay-at-home pay, computer-related costs, cleaning and sanitizing facilities and safety supplies totaling $183 thousand, which is included in non-interest expense in the consolidated statements of income. Additionally, FNCB has not identified any material operational or internal control challenges or risks, nor does it anticipate any significant challenges to its ability to maintain its systems and controls, related to operational changes resulting from implementation of the pandemic preparedness plan.

Financial Position and Results of Operations

Bank regulators have issued guidance and are encouraging banks to work with customers affected by COVID-19. Accordingly, FNCB is actively working with borrowers affected by COVID-19 and has implemented a payment deferral program providing for either short-term interest-only or full payment deferral for periods of up to six months. While interest and fees will still accrue to income, under normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. As a result, interest income in future periods could be negatively impacted. While FNCB is unable to determine the effect of such an impact on its financial condition or results of operations at this time, it recognizes that the sustained economic impact may affect its borrowers’ ability to repay in future periods.

At June 30, 2020, FNCB and FNCB Bank were considered well capitalized with capital ratios that were in excess of regulatory requirements. However, an extended economic recession resulting from the COVID-19 pandemic could adversely impact FNCB and FNCB Bank's capital position and regulatory capital ratios due to a potential increase in credit losses. 

Lending Operations and Credit Risk

As previously mentioned, FNCB is working with its lending customers that are facing unemployment, temporary furloughs and closures, by offering a payment deferral program. FNCB has provided either a short-term interest-only period or full payment deferral for periods of up to six months depending on the specific need of the borrower. As of  June 30, 2020, FNCB assisted 905 customers under its payment deferral program, with an the principal balance of loans modified totaling $176.6 million. In accordance with interagency guidance issued in March 2020, these short-term deferrals are not considered troubled debt restructurings.

The CARES Act includes a Paycheck Protection Program ("PPP"), a program administered by the Small Business Administration ("SBA") designed to aid small- and medium-sized businesses through federally guaranteed loans distributed through banks. These loans were originally intended to guarantee eight weeks of payroll and other costs to help those businesses remain viable and allow their workers to pay their bills. On June 5, 2020, the payroll coverage period was extended to from eight weeks to 24 weeks. As an SBA Lender, FNCB Bank is actively participating in the PPP by assisting our small business community in securing this important funding. As of June 30, 2020, FNCB has approved and/or closed with the SBA 920 PPP loans representing $117.0 million in funding. It is FNCB's understanding that loans funded through the PPP are fully guaranteed by the United States government. Should those circumstances change, FNCB could be required to increase its allowance for loan and lease losses related to these loans resulting in an increase in the provision for loan and lease losses. 

Additionally, the Federal Reserve Bank established the Main Street Lending Program to support lending to small and mid-sized businesses and not-for-profit organizations impacted by the COVID-19 pandemic. Specifically, the Main Street Business Lending Program provides for five loan facilities with total potential funding of up to $600 billion. The Main Street New Loan Facility ("MSNLF"), the Main Street Priority Loan Facility ("MSPLF") and the Main Street Expanded Loan Facility ("MSELF") are three credit facilities that provide eligible business borrowers impacted by COVID-19 with financing in amounts ranging from $250 thousand to $300 million, depending on the facility. Terms of all three facilities include Federal Reserve Bank participation of 95.0%, lender participation of 5.0%, a maturity of 5 years, principal deferral for two years, interest deferral for one year and an adjustable interest rate based on one- or three-month LIBOR plus 300 basis points. Similarly, the Nonprofit Organization New Loan Facility ("NONLF") and the Nonprofit Organization Expanded Loan Facility ("NOELF") provide eligible not-for-profit organizations with financing in amounts ranging from $250 thousand to $10 million. FNCB Bank has received approval from the Federal Reserve Bank as a participating lender in the Main Street Lending Program. As of June 30, 2020, there were no loans were originated under the Main Street Lending Program. Subsequent to June 30, 2020, and before the filing date of this quarterly report on Form 10-Q, FNCB originated two MSPLF loans with an aggregate principal balance of $53.0 million and retained 5.0% of the outstanding principal balance or $2.7 million.  

FNCB is prepared to continue to offer short-term assistance in accordance with regulatory guidelines and participate in the PPP and Main Street Lending Program. As the fallout of the COVID-19 pandemic ripples through the national, regional and local economies, management continues to identify and monitor potential weaknesses in the loan portfolio. Management has identified and is monitoring exposures to borrowers and industries that may be impacted more immediately and acutely than others.  Additionally, management has proactively reached out to specific borrowers to provide guidance and assistance as appropriate.  On a portfolio level, management continues to monitor aggregate exposures to highly sensitive segments, such as hotels and hospitality, for changes in asset quality and payment performance, and liquidity levels. Management monitors unfunded commitments such as lines of credit and overdraft protection to determine liquidity and funding issues that may arise with our customers. Should economic conditions worsen, FNCB could experience further increases in its required allowance for loan and lease losses and record additional provisions for loan and lease losses. It is possible that FNCB’s asset quality metrics could be materially and adversely impacted in future periods if the effects of COVID-19 are prolonged.

Note 2.   New Authoritative Accounting Guidance

Accounting Guidance to be Adopted in Future Periods

Accounting Standards Update (“ASU”) 2020-04, Reference Rate Reform (Topic 848): “Facilitation of the Effects of Reference Rate Reform on Financial Reporting,” provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. It provides optional expedients and exceptions for applying generally accepted accounting principles to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. The amendments in ASU 2020-04 are effective for all entities as of March 12, 2020 through December 31, 2022. FNCB is currently evaluating the impact the reference rate reform may have on its operating results and 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. ASU 2016-13 is commonly referred to as Current Expected Credit Losses ("CECL") and 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 was originally effective for public business entities that are registered with the U.S. Securities and Exchange Commission (“SEC”) under the Securities and Exchange Act of 1934, as amended, including smaller reporting companies, 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. On November 15, 2019, the FASB issued ASU 2019-10, "Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates," which finalized various effective dates delay for private companies, not-for-profit organizations, and certain smaller reporting companies. Specifically under ASU 2019-10, the effective date for implementation of CECL for smaller reporting companies, private companies and not-for-profits was extended to fiscal years, and interim periods within those years, beginning after December 15, 2022. FNCB is a smaller reporting company, and accordingly, will adopt this guidance on  January 1, 2023. FNCB has created a CECL task group comprised of members of its finance, credit administration, lending, internal audit, loan operations and information systems units. The CECL task group understands the provisions of ASU 2016-13 and is currently in the process of implementing the new guidance, which includes, but is not limited to: (1) identifying segments and sub-segments within the loan portfolio that have similar risk characteristics; (2) determining the appropriate methodology for each segment; (3) implementing changes that are necessary to its core operating system and interfaces to be able to capture appropriate data requirements; and (4) evaluating  qualitative factors and economic to develop appropriate forecasts for integration into the model. FNCB is currently evaluating the effect this guidance  may have on its 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 2019 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/Subsequent Event

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 June 30, 2020 and December 31, 2019:

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 June 30, 2020 and December 31, 2019.

At  June 30, 2020 and December 31, 2019 securities with a carrying amount of $254.3 million and $235.0 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 June 30, 2020.  Expected maturities will differ from contractual maturities 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.

The following table presents the gross proceeds received and gross realized gains and losses on sales of available-for-sale debt securities for the three and six months ended June 30, 2020 and 2019.

The following tables present the number, fair value and gross unrealized losses of available-for-sale debt securities with unrealized losses at June 30, 2020 and December 31, 2019, 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 21 securities in an unrealized loss position at June 30, 2020, including seven corporate debt securities, five asset-backed securities, four non-agency collaterized mortgage obligations ("CMOs"), three obligations of state and political subdivisions and two CMOs issued by U.S. government or government-sponsored agencies. Management performed a review of all securities in an unrealized loss position as of June 30, 2020 and determined that changes in the fair values of the securities were consistent with movements in market interest rates or market disruption stemming from the COVID-19 global pandemic. 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 June 30, 2020. 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 June 30, 2020.

Equity Securities

At June 30, 2020 and December 31, 2019, equity securities consisted entirely of a $1.0 million investment in a mutual fund, comprised of 1-4 family residential mortgage-backed securities collateralized by properties within FNCB's geographical market.  This mutual fund had an unrealized loss of $62 thousand and $80 thousand, respectively, resulting in a fair value of $938 thousand and $920 thousand, respectively, at June 30, 2020 and December 31, 2019.

The following table presents unrealized and realized gains and losses recognized in net income on equity securities for the three and six months ended June 30, 2020 and 2019.

Restricted Securities

The following table presents FNCB's investment in restricted stock at June 30, 2020 and  December 31, 2019.  Restricted stock has limited marketability and is 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 June 30, 2020 and  December 31, 2019.

Equity Securities without Readily Determinable Fair Values/Subsequent Event

At June 30, 2020 and December 31, 2019, FNCB owned 201,000 shares of the common stock of a privately-held bank holding company. The common stock was purchased during 2017 for $8.25 per share, or $1.7 million in aggregate, as part of a private placement pursuant to an exemption from the registration requirements of the Securities Act of 1933, as amended for offerings not involving any public offering.  The common stock of such bank holding company was not traded on any established market at June 30, 2020. The $1.7 million investment is included in other assets in the consolidated statements of financial condition at June 30, 2020 and December 31, 2019. FNCB has elected to account for this transaction as an investment in an equity security without a readily determinable fair value. Under GAAP, 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.

On December 18, 2019, this privately held bank holding company had entered into an Agreement and Plan Merger ("Merger Agreement") with a publicly traded bank holding company. The Merger Agreement provided for this privately-held bank holding company to merge with and into the publicly traded bank holding company, the company surviving the merger ("surviving company"). At the effective time of the merger, each share of the privately-held bank holding company's common stock issued and outstanding prior to the effective time of merger will be converted into the right to receive 0.6212 shares of common stock of the surviving company or $16.50 in cash, at the election of holder; provided, however, individual shareholder elections of consideration will be prorated as necessary to ensure that, in aggregate, 25% of the privately held bank holding company's stock will be converted into the cash consideration with the remaining 75% converted into stock consideration.  The acquisition was subsequently completed on July 1, 2020. FNCB received 78,822 shares of the surviving company's common stock and $1.2 million in cash. Based on these events, management determined that no adjustment for impairment was required at June 30, 2020.

Note 4. Loans

The following table summarizes loans receivable, net, by category at June 30, 2020 and  December 31, 2019:

Included in commercial and industrial loans at June 30, 2020 were $117.0 million in loans originated under the PPP, which was established under the Cares Act and is administered by the SBA. Included in net deferred loan fees at June 30, 2020 were $3.8 million deferred loan origination fees, net of deferred loan origination costs, associated with the PPP loans. PPP loans may be forgiven by the SBA and are 100.0% guaranteed by the SBA, Accordingly, there was no ALLL allocated to PPP loans at June 30, 2020.

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 9, “Related Party Transactions” to these consolidated financial statements.

FNCB originates 1-4 family mortgage loans for sale in the secondary market. During the three and six months ended June 30, 2020, the principal balance of 1-4 family mortgages sold on the secondary market were $3.0 million and $5.9 million, respectively. For the three and six months ended June 30, 2019, the principal balance of 1-4 family mortgages sold on the secondary market were $2.3 million and $4.2 million, respectively. Net gains on the sale of residential mortgage loans for the three and six months ended June 30, 2020 were $183 thousand and $279 thousand, respectively, and $73 thousand and $129 thousand, respectively, for the comparable periods of 2019. FNCB retains servicing rights on mortgages sold on the secondary market. At June 30, 2020 and  December 31, 2019, there were $765 thousand and $1.1 million, respectively, in 1-4 family residential mortgage loans held for sale.

There were no sales of Small Business Administration (“SBA”) guaranteed loans during the three and six months ended June 30, 2020 and 2019. The unpaid principal balance of loans serviced for others, including residential mortgages and SBA-guaranteed loans, was $104.5 million at June 30, 2020 and $106.0 million at December 31, 2019.

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 six months ended June 30, 2020. Refer to Note 2, “Summary of Significant Accounting Policies” to FNCB’s consolidated financial statements included in the 2019 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. In response to economic disruption and uncertainty caused by the COVID-19 pandemic, management increased the qualitative factor related to its assessment of national, state and local factors as part of its evaluation of the adequacy of the ALLL at June 30, 2020. However, 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 six months ended June 30, 2020 and 2019.