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

 

 

 

Table of Contents

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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, 2020

 

OR

 

☐

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

 

For the transition period from           to       

 

Commission File No. 001-38408

 

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)

(570) 346-7667

Registrant’s telephone number, including area code 

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common stock, $1.25 par value	FNCB	Nasdaq Capital Market

 

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 every Interactive Data File required to be submitted 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 such files). YES ☒ NO ☐

 

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

 

Large accelerated filer ☐		Accelerated filer ☒
Non-accelerated filer ☐		Smaller reporting company ☒
		Emerging growth company ☐

 

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

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: 20,174,922 shares as of May 4, 2020

 

 

 

 

 

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 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	33
Item 3. Quantitative and Qualitative Disclosures about Market Risk	53
Item 4. Controls and Procedures	53
PART II.  Other Information	54
Item 1. Legal Proceedings.	54
Item 1A. Risk Factors.	54
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.	54
Item 3. Defaults upon Senior Securities.	54
Item 4. Mine Safety Disclosures.	54
Item 5. Other Information.	54
Item 6. Exhibits.	55

     

 

		March 31,				December 31,
(in thousands, except share data)		2020				2019
Assets
Cash and cash equivalents:
Cash and due from banks		$	15,243			$	22,861
Interest-bearing deposits in other banks			30,304				11,704
Total cash and cash equivalents			45,547				34,565
Available-for-sale debt securities, at fair value			302,638				272,839
Equity securities, at fair value			934				920
Restricted stock, at cost			4,224				3,804
Loans held for sale			470				1,061
Loans, net of allowance for loan and lease losses of $9,907 and $8,950			825,028				819,529
Bank premises and equipment, net			17,447				17,518
Accrued interest receivable			3,387				3,234
Bank-owned life insurance			31,359				31,230
Other real estate owned			85				289
Net deferred tax assets			4,950				6,278
Other assets			12,163				12,274
Total assets		$	1,248,232			$	1,203,541
Liabilities
Deposits:
Demand (non-interest-bearing)		$	181,223			$	179,465
Interest-bearing			820,339				822,244
Total deposits			1,001,562				1,001,709
Borrowed funds:
Federal Reserve Bank Discount Window advances			10,000				-
Federal Home Loan Bank of Pittsburgh advances			77,934				46,909
Junior subordinated debentures			10,310				10,310
Total borrowed funds			98,244				57,219
Accrued interest payable			261				258
Other liabilities			10,233				10,748
Total liabilities			1,110,300				1,069,934
Shareholders' equity
Preferred shares ($1.25 par)
Authorized: 20,000,000 shares at March 31, 2020 and December 31, 2019
Issued and outstanding: 0 shares at March 31, 2020 and December 31, 2019			-				-
Common shares ($1.25 par)
Authorized: 50,000,000 shares at March 31, 2020 and December 31, 2019
Issued and outstanding: 20,174,250 shares at March 31, 2020 and 20,171,408 shares at December 31, 2019			25,217				25,214
Additional paid-in capital			81,209				81,130
Retained earnings			25,155				24,207
Accumulated other comprehensive income			6,351				3,056
Total shareholders' equity			137,932				133,607
Total liabilities and shareholders’ equity		$	1,248,232			$	1,203,541

 

		Three Months Ended March 31,
(in thousands, except share data)		2020				2019
Interest income
Interest and fees on loans		$	9,139			$	9,407
Interest and dividends on securities:
U.S. government agencies			750				893
State and political subdivisions, tax free			57				37
State and political subdivisions, taxable			765				1,021
Other securities			412				205
Total interest and dividends on securities			1,984				2,156
Interest on interest-bearing deposits in other banks			21				46
Total interest income			11,144				11,609
Interest expense
Interest on deposits			1,660				2,238
Interest on borrowed funds:
Federal Reserve Bank Discount Window advances			-				-
Federal Home Loan Bank of Pittsburgh advances			219				287
Junior subordinated debentures			88				114
Subordinated debentures			-				24
Total interest on borrowed funds			307				425
Total interest expense			1,967				2,663
Net interest income before provision (credit) for loan and lease losses			9,177				8,946
Provision (credit) for loan and lease losses			1,151				(154	)
Net interest income after provision (credit) for loan and lease losses			8,026				9,100
Non-interest income
Deposit service charges			825				685
Net gain on the sale of available-for-sale debt securities			149				160
Net gain on equity securities			14				12
Net gain on the sale of mortgage loans held for sale			96				56
Loan-related fees			56				79
Income from bank-owned life insurance			129				131
Merchant services revenue			135				118
Other			290				274
Total non-interest income			1,694				1,515
Non-interest expense
Salaries and employee benefits			3,929				3,899
Occupancy expense			554				550
Equipment expense			371				307
Advertising expense			207				197
Data processing expense			725				781
Regulatory assessments			59				168
Bank shares tax			300				278
Expense of other real estate owned			55				51
Professional fees			188				332
Insurance expense			123				126
Other operating expenses			694				736
Total non-interest expense			7,205				7,425
Income before income tax expense			2,515				3,190
Income tax expense			452				555
Net income		$	2,063			$	2,635
Earnings per share
Basic		$	0.10			$	0.14
Diluted		$	0.10			$	0.14
Cash dividends declared per common share		$	0.055			$	0.050
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic			20,172,498				18,720,502
Diluted			20,176,565				18,733,652

 

		Three Months Ended March 31,
(in thousands)		2020				2019
Net income		$	2,063			$	2,635
Other comprehensive income:
Unrealized gains on available-for-sale debt securities			4,336				4,655
Taxes			(911	)			(978	)
Net of tax amount			3,425				3,677
Reclassification adjustment for gains included in net income			(149	)			(160	)
Taxes			32				34
Net of tax amount			(117	)			(126	)
Derivative adjustments			(16	)			-
Taxes			3				-
Net of tax amount			(13	)			-
Total other comprehensive income			3,295				3,551
Comprehensive income		$	5,358			$	6,186

 

(in thousands, except per share data)		Number of Common Shares				Common Stock				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive (Loss) Income				Total Shareholders' Equity
Balances, December 31, 2018			16,821,371			$	21,026			$	63,547			$	17,186			$	(4,540	)		$	97,219
Net income for the period			-				-				-				2,635				-				2,635
Cash dividends paid, $0.05 per share			-				-				-				(1,006	)			-				(1,006	)
Common shares issued for capital raise, net			3,285,550				4,107				17,201				-				-				21,308
Restricted stock awards			-				-				67				-				-				67
Common shares issued through dividend reinvestment/optional cash purchase plan			1,639				2				12				(6	)			-				8
Other comprehensive income, net of tax of $944			-				-				-				-				3,551				3,551
Balances, March 31, 2019			20,108,560			$	25,135			$	80,827			$	18,809			$	(989	)		$	123,782
Balances, December 31, 2019			20,171,408			$	25,214			$	81,130			$	24,207			$	3,056			$	133,607
Net income for the period			-				-				-				2,063				-				2,063
Cash dividends paid, $0.055 per share			-				-				-				(1,110	)			-				(1,110	)
Restricted stock awards			-				-				62				-				-				62
Common shares issued through dividend reinvestment/optional cash purchase plan			2,842				3				17				(5	)			-				15
Other comprehensive income, net of tax of $876			-				-				-				-				3,295				3,295
Balances, March 31, 2020			20,174,250			$	25,217			$	81,209			$	25,155			$	6,351			$	137,932

 

		Three Months Ended March 31,
(in thousands)		2020				2019
Cash flows from operating activities:
Net income		$	2,063			$	2,635
Adjustments to reconcile net income to net cash provided by operating activities:
Investment securities amortization, net			120				212
Equity in trust			(3	)			(3	)
Depreciation and amortization			744				802
Valuation adjustment for loan servicing rights			23				1
Stock-based compensation expense			62				67
Provision (credit) for loan and lease losses			1,151				(154	)
Valuation adjustment for off-balance sheet commitments			2				21
Net gain on the sale of available-for-sale debt securities			(149	)			(160	)
Net gain on equity securities			(14	)			(12	)
Net gain on the sale of mortgage loans held for sale			(96	)			(56	)
Income from bank-owned life insurance			(129	)			(131	)
Proceeds from the sale of mortgage loans held for sale			2,982				1,858
Funds used to originate mortgage loans held for sale			(2,295	)			(1,591	)
Decrease in net deferred tax assets			452				555
Increase in accrued interest receivable			(153	)			(92	)
Decrease (increase) in prepaid expenses and other assets			87				(3,257	)
Increase in accrued interest payable			3				1
(Decrease) increase in accrued expenses and other liabilities			(548	)			603
Total adjustments			2,239				(1,336	)
Net cash provided by operating activities			4,302				1,299
Cash flows from investing activities:
Maturities, calls and principal payments of available-for-sale debt securities			3,865				1,230
Proceeds from the sale of available-for-sale debt securities			7,975				25,130
Purchases of available-for-sale debt securities			(37,424	)			-
(Purchase) redemption of the stock in Federal Home Loan Bank of Pittsburgh			(420	)			3
Net increase in loans to customers			(6,966	)			(333	)
Proceeds from the sale of other real estate owned			204				-
Purchases of bank premises and equipment			(337	)			(894	)
Net cash (used in) provided by investing activities			(33,103	)			25,136
Cash flows from financing activities:
Net decrease in deposits			(147	)			(55,539	)
Net proceeds from Federal Home Loan Bank of Pittsburgh advances - overnight			21,025				8,400
Proceeds from Federal Home Loan Bank of Pittsburgh advances - term			10,000				8,478
Repayment of Federal Home Loan Bank of Pittsburgh advances - term			-				(6,820	)
Proceeds from Federal Reserve Bank Discount Window advances			10,000				-
Principal reduction on subordinated debentures			-				(5,000	)
Proceeds from issuance of common shares, net of discount			15				21,316
Cash dividends paid			(1,110	)			(1,006	)
Net cash provided by (used in) financing activities			39,783				(30,171	)
Net increase (decrease) in cash and cash equivalents			10,982				(3,736	)
Cash and cash equivalents at beginning of period			34,565				36,481
Cash and cash equivalents at end of period		$	45,547			$	32,745
Supplemental cash flow information
Cash paid during the period for:
Interest		$	1,963			$	2,662
Other transactions:
Lease liabilities arising from obtaining right-of-use assets			15				12

 

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, 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 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 have 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 significant 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. FNCB has invoked its pandemic preparedness plan. To address the financial needs of our customers in a safe and consistent manner, FNCB Bank offices remain open for regular business via drive-thru facilities, automated teller machines, Customer Care center, remote deposit capture and online and mobile banking applications. For customers needing in-person service, FNCB has been offering a by-appointment option while adhering to social distancing mandates. FNCB has also provided the technology for the majority of our operational staff can work remotely in a secure environment. FNCB does not currently face any material resource constraints through the implementation of its pandemic preparedness plan and does not anticipate incurring material cost related to its implementation. 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, the FNCB is actively working with borrowers affected by COVID-19 and has rolled out a payment deferral program providing for either a three-month interest-only period or full payment deferral for three 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 effective of such an impact on its financial condition or results of operations at this time, it recognizes sustained economic impact may affect its borrowers’ ability to repay in future periods.

 

At March 31, 2020, FNCB and FNCB Bank was 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 three-month interest-only period or full payment deferral for three months depending on the specific need of the borrower. As of April 30, 2020, FNCB assisted 771 customers under our payment deferral program, with the total principal balance of loans modified of $153.7 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 are intended to guarantee eight weeks of payroll and other costs to help those businesses remain viable and allow their workers to pay their bills. As an SBA Lender, FNCB Bank is actively participating in PPP loans assisting our small business community in securing this important funding. As of April 30, 2020, FNCB has approved and/or closed with the SBA 482 PPP loans representing $93.6 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. 

 

FNCB is prepared to continue to offer short-term assistance in accordance with regulatory guidelines. As the fallout of the COVID-19 pandemic ripple 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 Standards Update ("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 Financial Accounting Standards Board ("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 did not 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 business 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 did not have a material effect on the operating results or financial position of FNCB.

 

Accounting Policy for Derivative Instruments and Hedging Activities

 

The FASB Accounting Standards Codification  815, Derivatives and Hedging, provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Further, qualitative disclosures are required that explain FNCB’s objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

 

As required by ASC 815, FNCB records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether FNCB has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge.

 

In accordance with the FASB’s fair value measurement guidance in ASU 2011-04 Fair Value Measurement (Topic 820): "Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS," FNCB made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

 

In August 2017, the FASB issued ASU 2017-12 Derivatives and Hedging (Topic 815): "Targeted Improvements to Accounting for Hedging Activities." The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. ASU 2017-12 was effective for public business entities for fiscal years beginning after December 15, 2018, with early adoption, including adoption in an interim period, permitted. ASU 2017-12 requires a modified retrospective transition method in which FNCB will recognize the cumulative effect of the change on the opening balance of each affected component of equity in the statement of financial position as of the date of adoption. The adoption of ASU 2017-12 on January 1, 2019 did not have a material effect on the operating results or financial position of FNCB.

 

 

Accounting Guidance to be Adopted in Future Periods

 

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

 

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, 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 March 31, 2020 and 2019.

 

At March 31, 2020  and December 31, 2019 securities with a carrying amount of $262.5 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 March 31, 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.

 

 

Gross proceeds from the sale of available-for-sale debt securities were $8.0 million for the three months ended March 31, 2020, with gross gains realized upon the sales of $149 thousand. There were no gross losses realized upon the sale for the three months ended March 31, 2020. Gross proceeds from the sale of available-for-sale debt securities were $25.1 million for the three months ended March 31, 2019, with gross gains and losses of $176 thousand and $16 thousand, respectively, realized upon the sale. 

 

The following tables present the number, fair value and gross unrealized losses of available-for-sale debt securities with unrealized losses at March 31, 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 30 securities in an unrealized loss position at March 31, 2020, including seven asset-backed securities, seven non-agency collaterized mortgage obligations ("CMOs"), six CMOs issued by a U.S. government or government-sponsored agency, six obligations of state and political subdivisions and four corporate debt securities. Management performed a review of all securities in an unrealized loss position as of March 31, 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 March 31, 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 March 31, 2020.

 

Equity Securities

 

At March 31, 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 $66 thousand and $80 thousand, respectively, resulting in a fair value of $934 thousand and $920 thousand, respectively, at March 31, 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 months ended March 31, 2020 and 2019.

 

 

Restricted Securities

 

The following table presents FNCB's investment in restricted stock at March 31, 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 March 31, 2020 and December 31, 2019.

 

 

Equity Securities without Readily Determinable Fair Values

 

FNCB owns 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 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. The $1.7 million investment is included in other assets in the consolidated statements of financial condition at March 31, 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, management became aware that this privately held bank holding company had entered into an Agreement and Plan Merger ("Merger Agreement") with a publicly traded bank holding company. Pursuant to the Merger Agreement, this privately-held bank holding company will merge with and into the publicly traded bank holding company with that company surviving the merger ("surviving company"). At the effective time of the merger, anticipated to be sometime in the third quarter of 2020, 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.  Based on this event, management determined that no adjustment for impairment was required at March 31, 2020.

 

 

 

Note 4. Loans

 

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

 

 

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

 

FNCB originates 1-4 family mortgage loans for sale in the secondary market. During the three months ended March 31, 2020 and 2019, 1-4 family mortgages sold on the secondary market were $2.9 million and $1.9 million, respectively. Net gains on the sale of residential mortgage loans were $96 thousand for the three months ended March 31, 2020 and $56 thousand for the three months ended March 31, 2019. FNCB retains servicing rights on mortgages sold on the secondary market. At March 31, 2020 and December 31, 2019, there were $0.5 million and $1.1 million in 1-4 family residential mortgage loans held for sale, respectively.

 

 

There were no sales of Small Business Administration (“SBA”) guaranteed loans during the three months ended March 31, 2020 and 2019. The unpaid principal balance of loans serviced for others, including residential mortgages and SBA-guaranteed loans, was $105.7 million at March 31, 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 three months ended March 31, 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. 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 months ended March 31, 2020 and 2019.

 

 

 

 

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, 2020 and December 31, 2019:

 

 

 

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, 2020 and December 31, 2019:

 

 

 

 

 

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 $8.6 million and $9.1 million at March 31, 2020 and December 31, 2019, respectively. Generally, loans are placed on non-accrual status when they become 90 days or more delinquent. Once a loan is placed on non-accrual status, it remains on non-accrual status until it has been brought current, has 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, 2020 and December 31, 2019.

 

 

The following tables present the delinquency status of past due and non-accrual loans at March 31, 2020 and December 31, 2019:

 

 

 

 

 

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, 2020 and December 31, 2019. 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 homogeneous 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 $1.2 million at March 31, 2020 and $1.0 million at December 31, 2019.

 

 

 

 

The following table presents the average balance and interest income by loan category recognized on impaired loans for the three months ended March 31, 2020 and 2019:

 

(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 $111 thousand for the three months ended March 31, 2020 and $82 thousand for the three months ended March 31, 2019.

 

 

Troubled Debt Restructured Loans

 

TDRs at March 31, 2020 and December 31, 2019 were $9.0 million and $9.1 million, respectively. Accruing and non-accruing TDRs were $7.7 million and $1.3 million, respectively, at March 31, 2020, and $7.7 million and $1.4 million, respectively, at December 31, 2019. Approximately $65 thousand and $97 thousand in specific reserves have been established for TDRs as of March 31, 2020 and December 31, 2019, respectively. FNCB was not committed to lend additional funds to any loan classified as a TDR at March 31, 2020.

The modification of the terms of loans classified as TDRs may include one or a combination of the following changes, 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 a TDR during the three months ended March 31, 2020 and 2019. There were no loans modified as a TDR within the previous 12 months that subsequently defaulted, defined as 90 days or more past due, during the three months ended March 31, 2020 and 2019.

 

Modifications Related to COVID-19

 

In late March 2020, the federal banking regulators issued guidance that modifications made to a borrower affected by the COVID-19 pandemic and governmental shutdown orders does not need to be identified as a TDR if the loan was current at the time a modification plan was implemented. Section 4013 of the CARES Act also addressed COVID-19-related modifications and specified that such modifications made on loans that were current as of December 31, 2019 are not TDRs. As of March 31, 2020, FNCB has applied this guidance and made 266 such modifications with principal balances totaling $88.0 million. More of these types of modifications are likely to be executed in the second quarter of 2020 and FNCB will continue to follow the guidance issued by the banking regulators in making any TDR determinations.

 

Residential Real Estate Loan Foreclosures

 

There were no residential real estate properties foreclosed upon during the three months ended March 31, 2020 or included in OREO at March 31, 2020. 

 

There were three consumer mortgage loans secured by residential real estate properties in the process of foreclosure at March 31, 2019. There was no aggregate recorded investment to FNCB for these three loans at March 31, 2019.  The balance of one loan was previously charged-off in its entirety and two loans were sold to an investor on the secondary market. For the three months ended March 31, 2019, there were no residential real estate properties foreclosed upon, and there was one residential real estate property with a carrying value of $45 thousand included in OREO at March 31, 2019.