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PENNS WOODS BANCORP INC - Quarter Report: 2019 June (Form 10-Q)

Table of Contents


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q
 
Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

for the Quarterly Period Ended June 30, 2019. 
Transition report pursuant to Section 13 or 15 (d) of the Exchange Act

For the Transition Period from                    to                   .

No. 0-17077
(Commission File Number)

PENNS WOODS BANCORP INC.
(Exact name of Registrant as specified in its charter) 
Pennsylvania
300 Market Street, P.O. Box 967
23-2226454
(State or other jurisdiction of
Williamsport
(I.R.S. Employer Identification No.)
incorporation or organization)
Pennsylvania
17703-0967
 
(Address of principal executive offices)
(Zip Code)
 

(570) 322-1111
Registrant’s telephone number, including area code


Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class
 
Trading Symbol(s)
 
Name of each exchange on which registered
Common stock, $8.33 par value
 
PWOD
 
The Nasdaq Global Select 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 an emerging growth company.  See the definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large accelerated filer
Accelerated filer
  Non-accelerated filer
   Smaller reporting company
 
 
Emerging growth company

If an emerging growth company, indicate by check mark if 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 
On August 1, 2019 there were 4,692,924 shares of the Registrant’s common stock outstanding.


Table of Contents


PENNS WOODS BANCORP, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

 
 
Page
 
 
Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2

Table of Contents


Part I.  FINANCIAL INFORMATION
Item 1.  Financial Statements
PENNS WOODS BANCORP, INC.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
 
 
June 30,
 
December 31,
(In Thousands, Except Share Data)
 
2019
 
2018
ASSETS:
 
 

 
 

Noninterest-bearing balances
 
$
21,102

 
$
24,325

Interest-bearing balances in other financial institutions
 
58,423

 
42,417

Total cash and cash equivalents
 
79,525

 
66,742

 
 
 
 
 
Investment debt securities, available for sale, at fair value
 
145,689

 
134,285

Investment equity securities, at fair value
 
1,841


1,776

Investment securities, trading
 
44

 
36

Restricted investment in bank stock, at fair value
 
15,087

 
18,862

Loans held for sale
 
2,880

 
2,929

Loans
 
1,379,285

 
1,384,757

Allowance for loan losses
 
(14,001
)
 
(13,837
)
Loans, net
 
1,365,284

 
1,370,920

Premises and equipment, net
 
33,483

 
27,580

Accrued interest receivable
 
5,708

 
5,334

Bank-owned life insurance
 
28,955

 
28,627

Goodwill
 
17,104

 
17,104

Intangibles
 
1,022

 
1,162

Operating lease right-of-use asset
 
4,279

 

Deferred tax asset
 
3,712

 
5,154

Other assets
 
6,887

 
4,260

TOTAL ASSETS
 
$
1,711,500

 
$
1,684,771

 
 
 
 
 
LIABILITIES:
 
 

 
 

Interest-bearing deposits
 
$
1,004,331

 
$
899,089

Noninterest-bearing deposits
 
322,755

 
320,814

Total deposits
 
1,327,086

 
1,219,903

 
 
 
 
 
Short-term borrowings
 
59,453

 
167,865

Long-term borrowings
 
154,597

 
138,942

Accrued interest payable
 
1,482

 
1,150

Operating lease liability
 
4,286

 

Other liabilities
 
13,055

 
13,367

TOTAL LIABILITIES
 
1,559,959

 
1,541,227

 
 
 
 
 
SHAREHOLDERS’ EQUITY:
 
 

 
 

Preferred stock, no par value, 3,000,000 shares authorized; no shares issued
 

 

Common stock, par value $8.33, 15,000,000 shares authorized; 5,012,898 and 5,011,698 shares issued; 4,692,748 and 4,691,548 outstanding
 
41,773

 
41,763

Additional paid-in capital
 
51,087

 
50,737

Retained earnings
 
73,565

 
69,787

Accumulated other comprehensive gain (loss):
 
 

 
 

Net unrealized gain (loss) on available for sale securities
 
2,419

 
(1,360
)
Defined benefit plan
 
(5,202
)
 
(5,276
)
Treasury stock at cost, 320,150
 
(12,115
)
 
(12,115
)
TOTAL PENNS WOODS BANCORP, INC. SHAREHOLDERS' EQUITY
 
151,527

 
143,536

Non-controlling interest
 
14

 
8

TOTAL SHAREHOLDERS' EQUITY
 
151,541

 
143,544

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
1,711,500

 
$
1,684,771


See accompanying notes to the unaudited consolidated financial statements.

3

Table of Contents


PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands, Except Per Share Data)
 
2019
 
2018
 
2019
 
2018
INTEREST AND DIVIDEND INCOME:
 
 

 
 

 
 

 
 

Loans, including fees
 
$
15,300

 
$
12,997

 
$
30,169

 
$
25,190

Investment securities:
 
 

 
 

 
 

 
 

Taxable
 
967

 
639

 
1,901

 
1,185

Tax-exempt
 
179

 
230

 
353

 
471

Dividend and other interest income
 
395

 
245

 
852

 
466

TOTAL INTEREST AND DIVIDEND INCOME
 
16,841

 
14,111

 
33,275

 
27,312

INTEREST EXPENSE:
 
 

 
 

 
 

 
 

Deposits
 
2,871

 
1,490

 
5,171

 
2,712

Short-term borrowings
 
178

 
252

 
783

 
476

Long-term borrowings
 
879

 
666

 
1,730

 
1,268

TOTAL INTEREST EXPENSE
 
3,928

 
2,408

 
7,684

 
4,456

NET INTEREST INCOME
 
12,913

 
11,703

 
25,591

 
22,856

PROVISION FOR LOAN LOSSES
 
315

 
335

 
675

 
495

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
 
12,598

 
11,368

 
24,916

 
22,361

NON-INTEREST INCOME:
 
 

 
 

 
 

 
 

Service charges
 
592

 
592

 
1,154

 
1,143

Net debt securities (losses) gains, available for sale
 
(2
)
 
14

 
11

 
5

Net equity securities gains (losses)
 
22

 
6

 
65

 
(28
)
Net securities gains (losses), trading
 
3

 
(5
)
 
13

 
(2
)
Bank-owned life insurance
 
123

 
158

 
291

 
331

Gain on sale of loans
 
347

 
400

 
663

 
655

Insurance commissions
 
119

 
64

 
253

 
181

Brokerage commissions
 
356

 
330

 
679

 
673

Debit card fees
 
389

 
373

 
699

 
706

Other
 
520

 
430

 
895

 
779

TOTAL NON-INTEREST INCOME
 
2,469

 
2,362

 
4,723

 
4,443

NON-INTEREST EXPENSE:
 
 

 
 

 
 

 
 

Salaries and employee benefits
 
5,523

 
4,919

 
11,024

 
9,967

Occupancy
 
668

 
699

 
1,447

 
1,440

Furniture and equipment
 
784

 
801

 
1,536

 
1,548

Software amortization
 
188

 
231

 
395

 
296

Pennsylvania shares tax
 
285

 
278

 
578

 
555

Professional fees
 
727

 
649

 
1,249

 
1,215

Federal Deposit Insurance Corporation deposit insurance
 
236

 
200

 
504

 
402

Marketing
 
33

 
268

 
135

 
519

Intangible amortization
 
69

 
78

 
140

 
158

Other
 
1,546

 
1,394

 
2,865

 
2,694

TOTAL NON-INTEREST EXPENSE
 
10,059

 
9,517

 
19,873

 
18,794

INCOME BEFORE INCOME TAX PROVISION
 
5,008

 
4,213

 
9,766

 
8,010

INCOME TAX PROVISION
 
759

 
733

 
1,571

 
1,322

CONSOLIDATED NET INCOME
 
$
4,249

 
$
3,480

 
$
8,195

 
$
6,688

Less: Net loss attributable to noncontrolling interest
 
4

 

 
6

 
(1
)
NET INCOME ATTRIBUTABLE TO PENNS WOODS BANCORP, INC.
 
$
4,245

 
$
3,480

 
$
8,189

 
$
6,689

EARNINGS PER SHARE - BASIC
 
$
0.91

 
$
0.74

 
$
1.75

 
$
1.43

EARNINGS PER SHARE - DILUTED
 
$
0.91

 
$
0.74

 
$
1.75

 
$
1.43

WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC
 
4,692,335

 
4,689,932

 
4,692,045

 
4,689,656

WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED
 
4,692,335

 
4,703,339

 
4,692,045

 
4,689,656

DIVIDENDS DECLARED PER SHARE
 
$
0.47

 
$
0.47

 
$
0.94

 
$
0.94

See accompanying notes to the unaudited consolidated financial statements.

4

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PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2019
 
2018
 
2019
 
2018
Net Income
 
$
4,245

 
$
3,480

 
$
8,189

 
$
6,689

Other comprehensive income (loss) income:
 
 

 
 

 
 

 
 

Change in unrealized gain (loss) on available for sale securities
 
2,811

 
(391
)
 
4,795

 
(1,852
)
Tax effect
 
(590
)
 
84

 
(1,007
)
 
390

Net realized (gain) loss on available for sale securities included in net income
 
2

 
(14
)
 
(11
)
 
(5
)
Tax effect
 
(1
)
 
4

 
2

 
1

   Amortization of unrecognized pension gain
 
47

 
42

 
94

 
84

        Tax effect
 
(10
)
 
(9
)
 
(20
)
 
(17
)
Total other comprehensive gain (loss) income
 
2,259

 
(284
)
 
3,853

 
(1,399
)
Comprehensive income
 
$
6,504

 
$
3,196

 
$
12,042

 
$
5,290

 
See accompanying notes to the unaudited consolidated financial statements.

5

Table of Contents


PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)



 Three months ended:

 
 
COMMON STOCK
 
ADDITIONAL
PAID-IN CAPITAL
 
RETAINED EARNINGS
 
ACCUMULATED OTHER
COMPREHENSIVE LOSS
 
TREASURY STOCK
 
NON-CONTROLLING INTEREST
 
TOTAL
SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)
 
SHARES
 
AMOUNT
 
 
 
 
 
 
Balance, March 31, 2019
 
5,012,273

 
$
41,767

 
$
50,890

 
$
71,526

 
$
(5,042
)
 
$
(12,115
)
 
$
10

 
$
147,036

Net income
 
 

 
 

 
 

 
4,245

 
 

 
 

 
4

 
4,249

Other comprehensive income
 
 
 
 
 
 
 
 
 
2,259

 
 
 
 
 
2,259

Stock-based compensation
 
 
 
 
 
177

 
 
 
 

 
 

 
 
 
177

Dividends declared ($0.47 per share)
 
 

 
 

 
 

 
(2,206
)
 
 

 
 

 
 
 
(2,206
)
Common shares issued for employee stock purchase plan
 
625

 
6

 
20

 
 

 
 
 
 
 
 
 
26

Balance, June 30, 2019
 
5,012,898

 
$
41,773

 
$
51,087

 
$
73,565

 
$
(2,783
)
 
$
(12,115
)
 
$
14

 
$
151,541



 
 
COMMON STOCK
 
ADDITIONAL
PAID-IN CAPITAL
 
RETAINED EARNINGS
 
ACCUMULATED OTHER
COMPREHENSIVE LOSS
 
TREASURY STOCK
 
NON-CONTROLLING INTEREST
 
TOTAL
SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)
 
SHARES
 
AMOUNT
 
 
 
 
 
 
Balance, March 31, 2018
 
5,009,898

 
$
41,748

 
$
50,199

 
$
64,906

 
$
(6,626
)
 
$
(12,115
)
 
$
1

 
$
138,113

Net income
 
 

 
 

 
 

 
3,480

 
 

 
 

 

 
3,480

Other comprehensive loss
 
 

 
 

 
 

 
 
 
(284
)
 
 

 
 
 
(284
)
Stock-based compensation
 
 
 
 
 
5

 
 
 
 
 
 
 
 
 
5

Dividends declared ($0.47 per share)
 
 

 
 

 
 

 
(2,205
)
 
 

 
 

 
 
 
(2,205
)
Common shares issued for employee stock purchase plan
 
637

 
5

 
21

 
 

 
 

 
 

 
 
 
26

Balance, June 30, 2018
 
5,010,535

 
$
41,753

 
$
50,225

 
$
66,181

 
$
(6,910
)
 
$
(12,115
)
 
$
1

 
$
139,135






See accompanying notes to the unaudited consolidated financial statements.





6

Table of Contents





Six months ended:



 
 
COMMON STOCK
 
ADDITIONAL
PAID-IN CAPITAL
 
RETAINED EARNINGS
 
ACCUMULATED OTHER
COMPREHENSIVE LOSS
 
TREASURY STOCK
 
NON-CONTROLLING INTEREST
 
TOTAL
SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)
 
SHARES
 
AMOUNT
 
 
 
 
 
 
Balance, December 31, 2018
 
5,011,698

 
$
41,763

 
$
50,737

 
$
69,787

 
$
(6,636
)
 
$
(12,115
)
 
$
8

 
$
143,544

Net income
 
 

 
 

 
 

 
8,189

 
 

 
 

 
6

 
8,195

Other comprehensive income
 
 

 
 

 
 

 
 

 
3,853

 
 

 
 
 
3,853

Stock-based compensation
 
 
 
 
 
313

 
 
 
 
 
 
 
 
 
313

Dividends declared ($0.94 per share)
 
 

 
 

 
 

 
(4,411
)
 
 

 
 

 
 
 
(4,411
)
Common shares issued for employee stock purchase plan
 
1,200

 
10

 
37

 
 

 
 

 
 

 
 
 
47

Balance, June 30, 2019
 
5,012,898

 
$
41,773

 
$
51,087

 
$
73,565

 
$
(2,783
)
 
$
(12,115
)
 
$
14

 
$
151,541



 
 
COMMON STOCK
 
ADDITIONAL
PAID-IN CAPITAL
 
RETAINED EARNINGS
 
ACCUMULATED OTHER
COMPREHENSIVE LOSS
 
TREASURY STOCK
 
NON-CONTROLLING INTEREST
 
TOTAL
SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)
 
SHARES
 
AMOUNT
 
 
 
 
 
 
Balance, December 31, 2017
 
5,009,339

 
$
41,744

 
$
50,173

 
$
63,364

 
$
(4,974
)
 
$
(12,115
)
 
$
2

 
$
138,194

Net income
 
 

 
 

 
 

 
6,689

 
 

 
 

 
(1
)
 
6,688

Adoption of ASU 2016-01
 
 
 
 
 
 
 
537

 
(537
)
 
 
 
 
 

Other comprehensive (loss)
 
 

 
 

 
 

 
 
 
(1,399
)
 
 

 
 
 
(1,399
)
Stock-based compensation
 
 
 
 
 
12

 
 
 
 
 
 
 
 
 
12

Dividends declared ($0.94 per share)
 
 

 
 

 
 

 
(4,409
)
 
 

 
 

 
 
 
(4,409
)
Common shares issued for employee stock purchase plan
 
1,196

 
9

 
40

 
 

 
 

 
 

 
 
 
49

Balance, June 30, 2018
 
5,010,535

 
$
41,753

 
$
50,225

 
$
66,181

 
$
(6,910
)
 
$
(12,115
)
 
$
1

 
$
139,135





See accompanying notes to the unaudited consolidated financial statements.

7

Table of Contents


PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED) 
 
 
Six Months Ended June 30,
(In Thousands)
 
2019
 
2018
OPERATING ACTIVITIES:
 
 

 
 

Net Income
 
$
8,195

 
$
6,688

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

 
 

Depreciation and amortization
 
1,376

 
1,244

Amortization of intangible assets
 
140

 
158

Provision for loan losses
 
675

 
495

Accretion and amortization of investment security discounts and premiums
 
326

 
395

Net securities (gains) losses, available for sale
 
(11
)
 
(5
)
Originations of loans held for sale
 
(21,400
)
 
(23,436
)
Proceeds of loans held for sale
 
22,112

 
23,169

Gain on sale of loans
 
(663
)
 
(655
)
Net equity securities (gains) losses
 
(65
)
 
28

Net securities gains, trading
 
(13
)
 
2

Proceeds from the sale of trading securities
 
78

 
254

Purchases of trading securities
 
(73
)
 
(309
)
Earnings on bank-owned life insurance
 
(291
)
 
(331
)
Decrease (increase) in deferred tax asset
 
437

 
(163
)
Other, net
 
(2,441
)
 
(93
)
Net cash provided by operating activities
 
8,382

 
7,441

INVESTING ACTIVITIES:
 
 

 
 

Proceeds from sales of available for sale securities
 
8,132

 
4,483

Proceeds from calls and maturities of available for sale securities
 
1,951

 
3,961

Purchases of available for sale securities
 
(17,018
)
 
(21,160
)
Net decrease (increase) in loans
 
4,680

 
(85,338
)
Acquisition of premises and equipment
 
(1,324
)
 
(948
)
Proceeds from the sale of foreclosed assets
 
195

 
181

Purchase of bank-owned life insurance
 
(26
)
 
(31
)
Security trades payable
 

 
(3,669
)
Proceeds from redemption of regulatory stock
 
10,515

 
8,744

Purchases of regulatory stock
 
(6,740
)
 
(12,128
)
Net cash provided (used) for investing activities
 
365

 
(105,905
)
FINANCING ACTIVITIES:
 
 

 
 

Net increase in interest-bearing deposits
 
105,242

 
36,821

Net increase in noninterest-bearing deposits
 
1,941

 
7,878

Proceeds from long-term borrowings
 
25,000

 
55,000

Repayment of long-term borrowings
 
(15,317
)
 
(2,000
)
Net decrease in short-term borrowings
 
(108,412
)
 
33,889

Finance lease principal payments
 
(54
)
 

Dividends paid
 
(4,411
)
 
(4,409
)
Issuance of common stock
 
47

 
49

Net cash provided by financing activities
 
4,036

 
127,228

NET INCREASE IN CASH AND CASH EQUIVALENTS
 
12,783

 
28,764

CASH AND CASH EQUIVALENTS, BEGINNING
 
66,742

 
27,243

CASH AND CASH EQUIVALENTS, ENDING
 
$
79,525

 
$
56,007

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 

 
 

Interest paid
 
$
7,352

 
$
4,062

Income taxes paid
 

 
1,500

Non-cash investing and financing activities:
 
 
 
 
Right-of-use lease assets obtained in exchange for lessee finance lease liabilities
 
6,026

 

Right-of-use lease assets obtained in exchange for lessee operating lease liabilities
 
4,298

 

Transfer of loans to foreclosed real estate
 
281

 
560

Transfer due to adoption of ASU 2016-01, equity securities fair value adjust, reclassification from AOCI to Retained Earnings, net of tax
 

 
537

See accompanying notes to the unaudited consolidated financial statements.

8

Table of Contents


PENNS WOODS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 

Note 1.  Basis of Presentation
 
The consolidated financial statements include the accounts of Penns Woods Bancorp, Inc. (the “Company”) and its wholly-owned subsidiaries: Woods Investment Company, Inc., Woods Real Estate Development Company, Inc., Luzerne Bank, and Jersey Shore State Bank (Jersey Shore State Bank and Luzerne Bank are referred to together as the “Banks”) and Jersey Shore State Bank’s wholly-owned subsidiary, The M Group, Inc. D/B/A The Comprehensive Financial Group (“The M Group”).  The Company also owns a controlling interest in United Insurance Solutions, LLC. All significant inter-company balances and transactions have been eliminated in the consolidation.

The interim financial statements are unaudited, but in the opinion of management reflect all adjustments necessary for the fair presentation of results for such periods.  The results of operations for any interim period are not necessarily indicative of results for the full year.  These financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

Newly Adopted Accounting Standards

In February 2016, the FASB issued the Leasing Standard, which is codified in ASC 842, Leases, and is intended to increase transparency and comparability among organizations and require lessees to record a right-of-use (ROU) asset and a liability representing the obligation to make lease payments for long-term leases. Accounting by lessors remains largely unchanged. The Company adopted the standard on January 1, 2019, using the modified retrospective transition under the option to apply the Leasing Standard at its effective date without adjusting the prior period comparative financial statements. Among other things, these updates require lessees to recognize a lease liability, measured on a discounted basis, related to the lessee's obligation to make lease payments arising under a lease contract; and a right-of-use asset related to the lessee’s right to use, or control the use of, a specified asset for the lease term. On January 1, 2019, the Company recorded operating lease liabilities and ROU asset of $4.3 million and finance lease liabilities and ROU asset of $6.0 million upon adoption of the Standard. The balance sheet effects of the new lease accounting standard also impacted regulatory capital ratios, performance ratios and other measures which are dependent upon asset or liability balances. For additional information and required disclosures related to ASC 842, see Note 13, “Leases.”

The accounting policies followed in the presentation of interim financial results are the same as those followed on an annual basis.  These policies are presented on pages 41 through 50 of the Form 10-K for the year ended December 31, 2018.

In reference to the attached financial statements, all adjustments are of a normal recurring nature pursuant to Rule 10-01(b) (8) of Regulation S-X.
 
Note 2.  Accumulated Other Comprehensive Gain (loss)

The changes in accumulated other comprehensive gain (loss) by component shown net of tax and parenthesis indicating debits, as of June 30, 2019 and 2018 were as follows:
 
 
Three Months Ended June 30, 2019
 
Three Months Ended June 30, 2018
(In Thousands)
 
Net Unrealized Gain
on Available
for Sale Securities
 
Defined
Benefit 
Plan
 
Total
 
Net Unrealized
Loss on Available
for Sale Securities
 
Defined
Benefit 
Plan
 
Total
Beginning balance
 
$
197

 
$
(5,239
)
 
$
(5,042
)
 
$
(1,740
)
 
$
(4,886
)
 
$
(6,626
)
Other comprehensive gain (loss) before reclassifications
 
2,221

 

 
2,221

 
(307
)
 

 
(307
)
Amounts reclassified from accumulated other comprehensive gain (loss)
 
1

 
37

 
38

 
(10
)
 
33

 
23

Net current-period other comprehensive income (loss)
 
2,222

 
37

 
2,259

 
(317
)
 
33

 
(284
)
Ending balance
 
$
2,419

 
$
(5,202
)
 
$
(2,783
)
 
$
(2,057
)
 
$
(4,853
)
 
$
(6,910
)

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Six Months Ended June 30, 2019
 
Six Months Ended June 30, 2018
(In Thousands)
 
Net Unrealized Loss
on Available
for Sale Securities
 
Defined
Benefit 
Plan
 
Total
 
Net Unrealized Gain (Loss) on Available
for Sale Securities
 
Defined
Benefit 
Plan
 
Total
Beginning balance
 
$
(1,360
)
 
$
(5,276
)
 
$
(6,636
)
 
$
(54
)
 
$
(4,920
)
 
$
(4,974
)
Other comprehensive (loss) gain before reclassifications
 
3,788

 

 
3,788

 
(1,462
)
 

 
(1,462
)
Amounts reclassified from accumulated other comprehensive gain (loss)
 
(9
)
 
74

 
65

 
(4
)
 
67

 
63

Net current-period other comprehensive (loss) income
 
3,779

 
74

 
3,853

 
(1,466
)
 
67

 
(1,399
)
Reclassification from adoption of 2016-01
 

 

 

 
(537
)
 

 
(537
)
Ending balance
 
$
2,419

 
$
(5,202
)
 
$
(2,783
)
 
$
(2,057
)
 
$
(4,853
)
 
$
(6,910
)


The reclassifications out of accumulated other comprehensive loss shown, net of tax and parenthesis indicating debits to net income, as of June 30, 2019 and 2018 were as follows:
Details about Accumulated Other Comprehensive Loss Components
 
Amount Reclassified from Accumulated Other Comprehensive Loss
 
Affected Line Item
 in the Consolidated 
Statement of Income
 
Three Months Ended June 30, 2019
 
Three Months Ended June 30, 2018
 
Net unrealized (loss) gain on available for sale securities
 
$
(2
)
 
$
14

 
Net debt securities gains (losses), available for sale
Income tax effect
 
1

 
(4
)
 
Income tax provision
Total reclassifications for the period
 
$
(1
)
 
$
10

 
 
 
 
 
 
 
 
 
Net unrecognized pension costs
 
$
(47
)
 
$
(42
)
 
Salaries and employee benefits
Income tax effect
 
10

 
9

 
Income tax provision
Total reclassifications for the period
 
$
(37
)
 
$
(33
)
 
 
Details about Accumulated Other Comprehensive Loss Components
 
Amount Reclassified from Accumulated Other Comprehensive Loss
 
Affected Line Item
 in the Consolidated 
Statement of Income
 
Six months ended June 30, 2019
 
Six months ended June 30, 2018
 
Net unrealized gain on available for sale securities
 
$
11

 
$
5

 
Net securities gains, available for sale
Income tax effect
 
(2
)
 
(1
)
 
Income tax provision
Total reclassifications for the period
 
$
9

 
$
4

 
 
 
 
 
 
 
 
 
Net unrecognized pension costs
 
$
(94
)
 
$
(84
)
 
Salaries and employee benefits
Income tax effect
 
20

 
17

 
Income tax provision
Total reclassifications for the period
 
$
(74
)
 
$
(67
)
 
 
 
Note 3.  Recent Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements.


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In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this Update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting units fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. A public business entity that is a U.S. Securities and Exchange Commission (SEC) filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. A public business entity that is not an SEC filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2020. All other entities, including not-for-profit entities, that are adopting the amendments in this Update should do so for their annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2021. This Update is not expected to have a significant impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes the Disclosure Requirements for Fair Value Measurements. The Update removes the requirement to disclose the amount of and reasons for transfers between Level I and Level II of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level III fair value measurements. The Update requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level III fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level III fair value measurements. This Update is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. This Update is not expected to have a significant impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-14, Compensation - Retirement Benefits (Topic 715-20). This Update amends ASC 715 to add, remove and clarify disclosure requirements related to defined benefit pension and other postretirement plans. The Update eliminates the requirement to disclose the amounts in accumulated other comprehensive income expected to be recognized as part of net periodic benefit cost over the next year. The Update also removes the disclosure requirements for the effects of a one-percentage-point change on the assumed health care costs and the effect of this change in rates on service cost, interest cost and the benefit obligation for postretirement health care benefits. This Update is effective for public business entities for fiscal years ending after December 15, 2020, and must be applied on a retrospective basis. For all other entities, this Update is effective for fiscal years ending after December 15, 2021. This Update is not expected to have a significant impact on the Company’s financial statements.

In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40). This Update addresses customers’ accounting for implementation costs incurred in a cloud computing arrangement that is a service contract and also adds certain disclosure requirements related to implementation costs incurred for internal-use software and cloud computing arrangements. The amendment 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). This Update is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. The amendments in this Update can be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. This Update is not expected to have a significant impact on the Company’s financial statements.

In October 2018, the FASB issued ASU 2018-16, Derivatives and Hedging (Topic 815). The amendments in this Update permit use of the Overnight Index Swap (OIS) rate based on the Secured Overnight Financing Rate (SOFR) as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to the interest rates on direct Treasury obligations of the U.S. government, the London Interbank Offered Rate (LIBOR) swap rate, the OIS rate based on the Fed Funds Effective Rate, and the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate. For entities that have not already adopted Update 2017-12, the amendments in this Update are required to be adopted concurrently with the amendments in Update 2017-12. For public business entities that already have adopted the amendments in Update 2017-12, the amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities that already have adopted the amendments in Update 2017-12, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted in any interim period upon issuance of this Update if an entity already has adopted Update 2017-12. This Update is not expected to have a significant impact on the Company’s financial statements.


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In November 2018, the FASB issued ASU 018-18, Collaborative Arrangements (Topic 808), which made the following targeted improvements to generally accepted accounting principles (GAAP) for collaborative arrangements (1) clarified that certain transactions between collaborative arrangement participants should be accounted for as revenue under Topic 606 when the collaborative arrangement participant is a customer in the context of a unit of account, (2) add unit-of-account guidance in Topic 808 to align with the guidance in Topic 606 (that is, a distinct good or service) when an entity is assessing whether the collaborative arrangement or a part of the arrangement is within the scope of Topic 606, and (3) require that in a transaction with a collaborative arrangement participant that is not directly related to sales to third parties, presenting the transaction together with revenue recognized under Topic 606 is precluded if the collaborative arrangement participant is not a customer. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. This Update is not expected to have a significant impact on the Company’s financial statements.

In March 2019, the FASB issued ASU 2019-01, Leases (Topic 842): Codification Improvements, which addressed issues lessors sometimes encounter. Specifically addressed in this Update were issues related to (1) determining the fair value of the underlying asset by the lessor that are not manufacturers or dealers (generally financial institutions and captive finance companies), and 2) lessors that are depository and lending institutions should classify principal and payments received under sales-type and direct financing leases within investing activities in the cash flow statement. The ASU also exempts both lessees and lessors from having to provide the interim disclosures required by ASC 250-10-50-3 in the fiscal year in which a company adopts the new leases standard. The amendments addressing the two lessor accounting issues are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other entities, the effective date is for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. This Update is not expected to have a significant impact on the Company’s financial statements.

In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which affects a variety of topics in the Codification and applies to all reporting entities within the scope of the affected accounting guidance. Topic 326, Financial Instruments - Credit Losses amendments are effective for SEC registrants for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other public business entities, the effective date is for fiscal years beginning after December 15, 2020, and for all other entities, the effective date is for fiscal years beginning after December 15, 2021. Topic 815, Derivatives and Hedging amendments are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020. For entities that have adopted the amendments in Update 2017- 12, the effective date is as of the beginning of the first annual period beginning after the issuance of this Update. Topic 825, Financial Instruments amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years. This Update is not expected to have a significant impact on the Company’s financial statements.

In May 2019, the FASB issued ASU 2019-05, Financial Instruments - Credit Losses, Topic 326, which allows entities to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost upon adoption of the new credit losses standard. To be eligible for the transition election, the existing financial asset must otherwise be both within the scope of the new credit losses standard and eligible for the applying the fair value option in ASC 825-10.3. The election must be applied on an instrument-by-instrument basis and is not available for either available-for-sale or held-to-maturity debt securities. For entities that elect the fair value option, the difference between the carrying amount and the fair value of the financial asset would be recognized through a cumulative-effect adjustment to opening retained earnings as of the date an entity adopted ASU 2016-13. Changes in fair value of that financial asset would subsequently be reported in current earnings. For entities that have not yet adopted ASU 2016-13, the effective dates and transition requirements are the same as those in ASU 2016-13. For entities that have adopted ASU 2016-13, ASU 2019-05 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted once ASU 2016-13 has been adopted. This Update is not expected to have a significant impact on the Company’s financial statements.

In July 2019, the FASB issued ASU 2019-07, Codification Updates to SEC Sections, Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization, and Miscellaneous Updates. This ASU amends various SEC paragraphs pursuant to the issuance of SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization. Other miscellaneous updates to agree to the electronic Code of Federal Regulations also have been incorporated.




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Table of Contents


Note 4. Per Share Data

There are no convertible securities which would affect the denominator in calculating basic and dilutive earnings per share. There were a total of 423,700 stock options, with an average exercise price of $43.95, outstanding on June 30, 2019. All options were excluded, on a weighted average basis, in the computation of diluted earnings per share for the period due to the average market price of common shares being $41.84 for the period. A portion of these options were included, on a weighted average basis, in the computation of diluted earnings per share for the 2018 period end due to the average market price of common shares of $43.37 exceeding the exercise price of the options issued during 2015. Net income as presented on the consolidated statement of income is used as the numerator.  The following table sets forth the composition of the weighted average common shares (denominator) used in the basic and dilutive earnings per share computation.
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2019
 
2018
 
2019
 
2018
Weighted average common shares issued
 
5,012,485

 
5,010,082

 
5,012,195

 
5,009,806

Weighted average treasury stock shares
 
(320,150
)
 
(320,150
)
 
(320,150
)
 
(320,150
)
Weighted average common shares outstanding - basic
 
4,692,335

 
4,689,932

 
4,692,045

 
4,689,656

Dilutive effect of outstanding stock options
 

 
13,407

 

 

Weighted average common shares outstanding - diluted
 
4,692,335

 
4,703,339

 
4,692,045

 
4,689,656


 

Note 5. Investment Securities
 
The amortized cost, gross unrealized gains and losses, and fair values of our investment securities portfolio at June 30, 2019 and December 31, 2018 are as follows:
 
 
June 30, 2019
 
 
 
 
Gross
 
Gross
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
(In Thousands)
 
Cost
 
Gains
 
Losses
 
Value
Available for sale (AFS):
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$
5,927

 
$
38

 
$
(61
)
 
$
5,904

State and political securities
 
87,078

 
3,361

 
(59
)
 
90,380

Other debt securities
 
49,622

 
303

 
(520
)
 
49,405

Total debt securities
 
$
142,627

 
$
3,702

 
$
(640
)
 
$
145,689

 
 
 
 
 
 
 
 
 
Investment equity securities:
 
 
 
 
 
 
 
 
Financial institution equity securities
 
$
328

 
$
256

 
$

 
$
584

Other equity securities
 
1,300

 

 
(43
)
 
1,257

Investment equity securities
 
$
1,628

 
$
256

 
$
(43
)
 
$
1,841

 
 
 
 
 
 
 
 
 
Trading:
 
 
 
 
 
 
 
 
Other equity securities
 
$
50

 
$

 
$
(6
)
 
$
44

 
 
 
 
 
 
 
 
 

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Table of Contents


 
 
December 31, 2018
 
 
 
 
Gross
 
Gross
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
(In Thousands)
 
Cost
 
Gains
 
Losses
 
Value
Available for sale (AFS):
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$
6,385

 
$
8

 
$
(240
)
 
$
6,153

State and political securities
 
79,358

 
609

 
(426
)
 
79,541

Other debt securities
 
50,264

 
17

 
(1,690
)
 
48,591

Total debt securities
 
$
136,007

 
$
634

 
$
(2,356
)
 
$
134,285

 
 
 
 
 
 
 
 
 
Investment equity securities:
 
 
 
 
 
 
 
 
Financial institution equity securities
 
$
328

 
$
224

 
$

 
$
552

Other equity securities
 
1,300

 

 
(76
)
 
1,224

Investment equity securities
 
$
1,628

 
$
224

 
$
(76
)
 
$
1,776

 
 
 
 
 
 
 
 


Trading:
 
 
 
 
 
 
 
 
Other equity securities
 
$
49

 
$

 
$
(13
)
 
$
36

 
 
 
 
 
 
 
 
 


The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time, that the individual debt securities have been in a continuous unrealized loss position, at June 30, 2019 and December 31, 2018.
 
 
June 30, 2019
 
 
Less than Twelve Months
 
Twelve Months or Greater
 
Total
 
 
 
 
Gross
 
 
 
Gross
 
 
 
Gross
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
(In Thousands)
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Available for sale (AFS):
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
$

 
$

 
$
2,807

 
$
(61
)
 
$
2,807

 
$
(61
)
State and political securities
 

 

 
1,766

 
(59
)
 
1,766

 
(59
)
Other debt securities
 
2,981

 
(40
)
 
31,928

 
(480
)
 
34,909

 
(520
)
Total debt securities
 
$
2,981

 
$
(40
)
 
$
36,501

 
$
(600
)
 
$
39,482

 
$
(640
)
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
December 31, 2018
 
 
Less than Twelve Months
 
Twelve Months or Greater
 
Total
 
 
 
 
Gross
 
 
 
Gross
 
 
 
Gross
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
(In Thousands)
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Available for sale (AFS):
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
 
$
3,023

 
$
(75
)
 
$
2,930

 
$
(165
)
 
$
5,953

 
$
(240
)
State and political securities
 
14,819

 
(128
)
 
13,648

 
(298
)
 
28,467

 
(426
)
Other debt securities
 
10,133

 
(153
)
 
34,776

 
(1,537
)
 
44,909

 
(1,690
)
Total debt securities
 
$
27,975

 
$
(356
)
 
$
51,354

 
$
(2,000
)
 
$
79,329

 
$
(2,356
)
 
 
 
 
 
 
 
 
 
 
 
 
 

 
At June 30, 2019, there were a total of 3 securities in a continuous unrealized loss position for less than twelve months and 24 individual securities that were in a continuous unrealized loss position for twelve months or greater.

The Company reviews its position quarterly and has determined that, at June 30, 2019, the declines outlined in the above table represent temporary declines and the Company does not intend to sell and does not believe it will be required to sell these securities before recovery of their cost basis, which may be at maturity.  The Company has concluded that the unrealized losses disclosed

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above are not other than temporary but are the result of interest rate changes, sector credit ratings changes, or company-specific ratings changes that are not expected to result in the non-collection of principal and interest during the period.

The amortized cost and fair value of debt securities at June 30, 2019, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities since borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(In Thousands)
 
Amortized Cost
 
Fair Value
Due in one year or less
 
$
4,065

 
$
4,067

Due after one year to five years
 
49,986

 
49,656

Due after five years to ten years
 
62,857

 
65,226

Due after ten years
 
25,719

 
26,740

Total
 
$
142,627

 
$
145,689



Total gross proceeds from sales of debt securities available for sale for the three and six months ended June 30, 2019 were $1,146,000 and $8,132,000, respectively, an increase from the 2018 totals of $1,120,000 and $4,483,000.

The following table represents gross realized gains and losses from the sales of debt securities available for sale:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2019
 
2018
 
2019
 
2018
Available for sale (AFS):
 
 
 
 
 
 
 
 
Gross realized gains:
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$

 
$
5

 
$

 
$
5

State and political securities
 

 
19

 
15

 
19

Other debt securities
 

 

 
4

 

Total gross realized gains
 
$

 
$
24

 
$
19

 
$
24

 
 
 
 
 
 
 
 
 
Gross realized losses:
 
 

 
 

 
 

 
 

State and political securities
 
$
1

 
$

 
$
3

 
$
9

Other debt securities
 
1

 
10

 
5

 
10

Total gross realized losses
 
$
2

 
$
10

 
$
8

 
$
19

 
 
 
 
 
 
 
 
 

There were no impairment charges included in gross realized losses for the three and six months ended June 30, 2019 and 2018, respectively.

Investment securities with a carrying value of approximately $95,705,000 and $73,327,000 at June 30, 2019 and December 31, 2018, respectively, were pledged to secure certain deposits, repurchase agreements, and for other purposes as required by law.

At June 30, 2019 and December 31, 2018, we had $1,841,000 and $1,776,000, respectively, in equity securities recorded at fair value. Prior to January 1, 2018, equity securities were stated at fair value with unrealized gains and losses reported as a separate component of AOCI, net of tax. The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three and six months ended June 30, 2019 and 2018:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2019
 
2018
 
2019
 
2018
Net gains (losses) recognized in equity securities during the period
 
$
22

 
$
6

 
$
65

 
$
(28
)
Less: Net gains (losses) realized on the sale of equity securities during the period
 

 

 

 

Unrealized gains (losses) recognized in equity securities held at reporting date
 
$
22

 
6

 
$
65

 
(28
)
 
 
 
 
 
 
 
 
 




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Net gains and losses on trading account securities are as follows for the three and six months ended June 30, 2019 and 2018:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2019
 
2018
 
2019
 
2018
Net gains (losses) on sale transactions
 
$
3

 
$
11

 
$
8

 
$
(4
)
Net mark-to-market gains (losses)
 

 
(16
)
 
5

 
2

Net gain (loss) on trading account securities
 
$
3

 
$
(5
)
 
$
13

 
$
(2
)
 
 
 
 
 
 
 
 
 



Note 6. Loans

Management segments the Banks' loan portfolio to a level that enables risk and performance monitoring according to similar risk characteristics.  Loans are segmented based on the underlying collateral characteristics.  Categories include commercial, financial, and agricultural, real estate, and installment loans.  Real estate loans are further segmented into three categories: residential, commercial, and construction, while installment loans are classified as either consumer automobile loans or other installment loans.

The following table presents the related aging categories of loans, by segment, as of June 30, 2019 and December 31, 2018:
 
 
June 30, 2019
 
 
 
 
Past Due
 
Past Due 90
 
 
 
 
 
 
 
 
30 To 89
 
Days Or More
 
Non-
 
 
(In Thousands)
 
Current
 
Days
 
& Still Accruing
 
Accrual
 
Total
Commercial, financial, and agricultural
 
$
185,997

 
$
78

 
$
25

 
$
5,180

 
$
191,280

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

Residential
 
612,515

 
3,004

 
818

 
2,018

 
618,355

Commercial
 
350,655

 
1,350

 
227

 
6,826

 
359,058

Construction
 
39,617

 
171

 
132

 
72

 
39,992

Consumer automobile loans
 
145,246

 
190

 
43

 
37

 
145,516

Other consumer installment loans
 
23,620

 
464

 

 
5

 
24,089

 
 
1,357,650

 
$
5,257

 
$
1,245

 
$
14,138

 
1,378,290

Net deferred loan fees and discounts
 
995

 
 

 
 

 
 

 
995

Allowance for loan losses
 
(14,001
)
 
 

 
 

 
 

 
(14,001
)
Loans, net
 
$
1,344,644

 
 

 
 

 
 

 
$
1,365,284


 
 
December 31, 2018
 
 
 
 
Past Due
 
Past Due 90
 
 
 
 
 
 
 
 
30 To 89
 
Days Or More
 
Non-
 
 
(In Thousands)
 
Current
 
Days
 
& Still Accruing
 
Accrual
 
Total
Commercial, financial, and agricultural
 
$
182,651

 
$
616

 
$

 
$
5,294

 
$
188,561

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

Residential
 
611,281

 
7,688

 
1,238

 
2,172

 
622,379

Commercial
 
361,624

 
2,349

 

 
7,722

 
371,695

Construction
 
43,144

 
305

 

 
74

 
43,523

Consumer automobile loans
 
132,713

 
412

 
27

 
31

 
133,183

Other consumer installment loans
 
23,902

 
636

 
9

 
5

 
24,552

 
 
1,355,315

 
$
12,006

 
$
1,274

 
$
15,298

 
1,383,893

Net deferred loan fees and discounts
 
864

 
 

 
 

 
 

 
864

Allowance for loan losses
 
(13,837
)
 
 

 
 

 
 

 
(13,837
)
Loans, net
 
$
1,342,342

 
 

 
 

 
 

 
$
1,370,920


 

16

Table of Contents


The following table presents interest income the Banks would have recorded if interest had been recorded based on the original loan agreement terms and rate of interest for non-accrual loans and interest income recognized on a cash basis for non-accrual loans for the three and six months ended June 30, 2019 and 2018:
 
 
Three Months Ended June 30,
 
 
2019
 
2018
(In Thousands)
 
Interest Income That
Would Have Been
Recorded Based on
Original Term and Rate
 
Interest
Income
Recorded on
a Cash Basis
 
Interest Income That
Would Have Been
Recorded Based on
Original Term and Rate
 
Interest
Income
Recorded on
a Cash Basis
Commercial, financial, and agricultural
 
$
33

 
$
44

 
$
3

 
$
1

Real estate mortgage:
 
 

 
 

 
 

 
 

Residential
 
33

 
19

 
37

 
23

Commercial
 
76

 
34

 
77

 
22

Construction
 
1

 
1

 

 

Consumer automobile loans
 
1

 
1

 

 

Other consumer installment loans
 

 

 
1

 
1

 
 
$
144

 
$
99

 
$
118

 
$
47

 
 
Six Months Ended June 30,
 
 
2019
 
2018
(In Thousands)
 
Interest Income That
Would Have Been
Recorded Based on
Original Term and Rate
 
Interest
Income
Recorded on
a Cash Basis
 
Interest Income That
Would Have Been
Recorded Based on
Original Term and Rate
 
Interest
Income
Recorded on
a Cash Basis
Commercial, financial, and agricultural
 
$
57

 
$
83

 
$
4

 
$
1

Real estate mortgage:
 
 

 
 

 
 

 
 

Residential
 
66

 
42

 
68

 
34

Commercial
 
165

 
74

 
138

 
39

Construction
 
2

 
2

 

 

Consumer automobile loans
 
3

 
2

 

 

Other consumer installment loans
 
1

 

 
1

 
1

 
 
$
294

 
$
203

 
$
211

 
$
75


Impaired Loans

Impaired loans are loans for which it is probable the Banks will not be able to collect all amounts due according to the contractual terms of the loan agreement.  The Banks evaluate such loans for impairment individually and do not aggregate loans by major risk classifications.  The definition of “impaired loans” is not the same as the definition of “non-accrual loans,” although the two categories overlap.  The Banks may choose to place a loan on non-accrual status due to payment delinquency or uncertain collectability, while not classifying the loan as impaired. Factors considered by management in determining impairment include payment status and collateral value.  The amount of impairment for these types of loans is determined by the difference between the present value of the expected cash flows related to the loan, using the original interest rate, and its recorded value, or as a practical expedient in the case of collateralized loans, the difference between the fair value of the collateral and the recorded amount of the loan.  When foreclosure is probable, impairment is measured based on the fair value of the collateral.

Management evaluates individual loans in all of the commercial segments for possible impairment if the loan is greater than $100,000 and if the loan is either on non-accrual status or has a risk rating of substandard.  Management may also elect to measure an individual loan for impairment if less than $100,000 on a case-by-case basis.

Mortgage loans on one-to-four family properties and all consumer loans are large groups of smaller-balance homogeneous loans and are measured for impairment collectively. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired.  Management determines the significance of payment delays on a case-by-case basis taking into consideration all circumstances surrounding the loan and the borrower including the length of the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed.  Interest income for impaired loans is recorded consistent with the Banks' policy on non-accrual loans.



17

Table of Contents


The following table presents the recorded investment, unpaid principal balance, and related allowance of impaired loans by segment as of June 30, 2019 and December 31, 2018:
 
 
June 30, 2019
 
 
Recorded
 
Unpaid Principal
 
Related
(In Thousands)
 
Investment
 
Balance
 
Allowance
With no related allowance recorded:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
$
1,239

 
$
1,239

 
$

Real estate mortgage:
 
 

 
 

 
 

Residential
 
2,368

 
2,368

 

Commercial
 
2,980

 
2,980

 

Construction
 
72

 
72

 

Consumer automobile loans
 

 

 

Installment loans to individuals
 
5

 
5

 

 
 
6,664

 
6,664

 

With an allowance recorded:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
4,014

 
4,014

 
577

Real estate mortgage:
 
 

 
 

 
 

Residential
 
1,673

 
1,673

 
228

Commercial
 
6,333

 
6,333

 
1,161

Construction
 

 

 

Consumer automobile loans
 
37

 
37

 
20

Installment loans to individuals
 

 

 

 
 
12,057

 
12,057

 
1,986

Total:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
5,253

 
5,253

 
577

Real estate mortgage:
 
 

 
 

 
 

Residential
 
4,041

 
4,041

 
228

Commercial
 
9,313

 
9,313

 
1,161

Construction
 
72

 
72

 

Consumer automobile loans
 
37

 
37

 
20

Installment loans to individuals
 
5

 
5

 

 
 
$
18,721

 
$
18,721

 
$
1,986



18

Table of Contents


 
 
December 31, 2018
 
 
Recorded
 
Unpaid Principal
 
Related
(In Thousands)
 
Investment
 
Balance
 
Allowance
With no related allowance recorded:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
$
1,152

 
$
1,152

 
$

Real estate mortgage:
 
 

 
 

 
 

Residential
 
2,619

 
2,619

 

Commercial
 
2,457

 
2,457

 

Construction
 
74

 
74

 

Consumer automobile loans
 
31

 
31

 

Installment loans to individuals
 

 

 

 
 
6,333

 
6,333

 

With an allowance recorded:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
4,111

 
4,111

 
650

Real estate mortgage:
 
 

 
 

 
 

Residential
 
1,591

 
1,591

 
168

Commercial
 
9,207

 
9,207

 
1,720

Construction
 

 

 

Consumer automobile loans
 

 

 

Installment loans to individuals
 
5

 
5

 
5

 
 
14,914

 
14,914

 
2,543

Total:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
5,263

 
5,263

 
650

Real estate mortgage:
 
 

 
 

 
 

Residential
 
4,210

 
4,210

 
168

Commercial
 
11,664

 
11,664

 
1,720

Construction
 
74

 
74

 

Consumer automobile loans
 
31

 
31

 

Installment loans to individuals
 
5

 
5

 
5

 
 
$
21,247

 
$
21,247

 
$
2,543



The following table presents the average recorded investment in impaired loans and related interest income recognized for the three and six months ended for June 30, 2019 and 2018:
 
 
Three Months Ended June 30,
 
 
2019
 
2018
(In Thousands)
 
Average
Investment in
Impaired Loans
 
Interest Income
Recognized on an
Accrual Basis on
Impaired Loans
 
Interest Income
Recognized on a
Cash Basis on
Impaired Loans
 
Average
Investment in
Impaired Loans
 
Interest Income
Recognized on an
Accrual Basis on
Impaired Loans
 
Interest Income
Recognized on a
Cash Basis on
Impaired Loans
Commercial, financial, and agricultural
 
$
5,298

 
$
2

 
$
44

 
$
1,227

 
$
17

 
$
1

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

 
 

Residential
 
4,078

 
27

 
22

 
4,255

 
29

 
23

Commercial
 
9,894

 
30

 
33

 
9,170

 
36

 
22

Construction
 
72

 

 
1

 

 

 

Consumer automobile
 
55

 

 

 

 

 

Other consumer installment loans
 
18

 

 

 
1

 

 
1

 
 
$
19,415

 
$
59

 
$
100

 
$
14,653

 
$
82

 
$
47


19

Table of Contents


 
 
Six Months Ended June 30,
 
 
2019
 
2018
(In Thousands)
 
Average
Investment in
Impaired Loans
 
Interest Income
Recognized on an
Accrual Basis on
Impaired Loans
 
Interest Income
Recognized on a
Cash Basis on
Impaired Loans
 
Average
Investment in
Impaired Loans
 
Interest Income
Recognized on an
Accrual Basis on
Impaired Loans
 
Interest Income
Recognized on a
Cash Basis on
Impaired Loans
Commercial, financial, and agricultural
 
$
5,286

 
$
2

 
$
82

 
$
1,241

 
$
34

 
$
1

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

 
 

Residential
 
4,122

 
55

 
39

 
4,080

 
67

 
34

Commercial
 
10,484

 
61

 
69

 
9,211

 
94

 
39

Construction
 
73

 

 
2

 

 

 

Consumer automobile
 
47

 

 
1

 

 

 

Other consumer installment loans
 
13

 

 

 
1

 

 
1

 
 
$
20,012

 
$
118

 
$
193

 
$
14,533

 
$
195

 
$
75



Currently, there is $7,000 committed to be advanced in connection with impaired loans.

Troubled Debt Restructurings

The loan portfolio also includes certain loans that have been modified in a Troubled Debt Restructuring (“TDR”), where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties.  These concessions typically result from loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions.  Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.

There were four loan modifications considered TDR's completed during the six months ended June 30, 2019. Loan modifications that are considered TDRs completed during the three and six months ended June 30, 2019 and 2018 were as follows:

 
 
Three Months Ended June 30,
 
 
2019
 
2018
(In Thousands, Except Number of Contracts)
 
Number
of
Contracts
 
Pre-Modification Outstanding Recorded Investment
 
Post-Modification Outstanding Recorded Investment
 
Number
of
Contracts
 
Pre-Modification Outstanding Recorded Investment
 
Post-Modification Outstanding Recorded Investment
Commercial, financial, and agricultural
 
2

 
$
4,014

 
$
4,014

 

 
$

 
$

Real estate mortgage:
 
 

 
 

 
 

 
 
 
 
 
 
Residential
 

 

 

 
1

 
67

 
67

Commercial
 
2

 
2,862

 
2,862

 

 

 

 
 
4

 
$
6,876

 
$
6,876

 
1

 
$
67

 
$
67

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
 
2019
 
2018
(In Thousands, Except Number of Contracts)
 
Number
of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment
 
Number
of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment
Commercial, financial, and agricultural
 
2

 
$
4,014

 
$
4,014

 

 
$

 
$

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

 
 

Residential
 

 

 

 
3

 
169

 
169

Commercial
 
2

 
2,862

 
2,862

 
1

 
106

 
106

 
 
4

 
$
6,876

 
$
6,876

 
4

 
$
275

 
$
275




20

Table of Contents


There were no loan modifications considered to be TDRs made during the twelve months previous to June 30, 2019 that defaulted during the six months ended June 30, 2019. There was one loan modification considered to be a TDR made during the twelve months previous to June 30, 2018 that defaulted during the six months ended June 30, 2018.The defaulted loan type and recorded investment as of June 30, 2018 are as follows: a residential real estate loan with a recorded investment of $3,750.

Troubled debt restructurings amounted to $14,862,000 and $9,599,000 as of June 30, 2019 and December 31, 2018, respectively.

The amount of foreclosed residential real estate held at June 30, 2019 and December 31, 2018, totaled $639,000 and $624,000, respectively. Consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process at June 30, 2019 and December 31, 2018, totaled $19,000 and $167,000, respectively.

Internal Risk Ratings

Management uses a ten point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The special mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a substandard classification. Loans in the substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are evaluated for substandard classification.  Loans in the doubtful category exhibit the same weaknesses found in the substandard loans, however, the weaknesses are more pronounced.  Such loans are static and collection in full is improbable.  However, these loans are not yet rated as loss because certain events may occur which would salvage the debt.  Loans classified loss are considered uncollectible and charge-off is imminent.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Banks have a structured loan rating process with several layers of internal and external oversight.  Generally, consumer and residential mortgage loans are included in the pass category unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event.  An external annual loan review of large commercial relationships is performed, as well as a sample of smaller transactions. Confirmation of the appropriate risk category is included in the review. Detailed reviews, including plans for resolution, are performed on loans classified as substandard, doubtful, or loss on a quarterly basis.

The following table presents the credit quality categories identified above as of June 30, 2019 and December 31, 2018:
 
 
June 30, 2019
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Consumer automobile
 
Other consumer installment loans
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
Totals
Pass
 
$
182,799

 
$
613,770

 
$
342,166

 
$
39,979

 
$
145,516

 
$
24,089

 
$
1,348,319

Special Mention
 
3,300

 
2,750

 
5,769

 

 

 

 
11,819

Substandard
 
5,181

 
1,835

 
11,123

 
13

 

 

 
18,152

 
 
$
191,280

 
$
618,355

 
$
359,058

 
$
39,992

 
$
145,516

 
$
24,089

 
$
1,378,290


 
 
December 31, 2018
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Consumer automobile
 
Other consumer installment loans
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
Totals
Pass
 
$
179,840

 
$
619,800

 
$
351,703

 
$
43,523

 
$
133,183

 
$
24,552

 
$
1,352,601

Special Mention
 
3,426

 
694

 
6,587

 

 

 

 
10,707

Substandard
 
5,295

 
1,885

 
13,405

 


 

 

 
20,585

 
 
$
188,561

 
$
622,379

 
$
371,695

 
$
43,523

 
$
133,183

 
$
24,552

 
$
1,383,893



Allowance for Loan Losses

An allowance for loan losses (“ALL”) is maintained to absorb losses from the loan portfolio.  The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated future loss experience, and the amount of non-performing loans.


21

Table of Contents


The Banks' methodology for determining the ALL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (previously discussed) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance.  The total of the two components represents the Banks' ALL.

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate.  Allowances are segmented based on collateral characteristics previously disclosed, and consistent with credit quality monitoring.  Loans that are collectively evaluated for impairment are grouped into two classes for evaluation.  A general allowance is determined for “Pass” rated credits, while a separate pool allowance is provided for “Criticized” rated credits that are not individually evaluated for impairment.

For the general allowances, historical loss trends are used in the estimation of losses in the current portfolio.  These historical loss amounts are modified by other qualitative factors.  A historical charge-off factor is calculated utilizing a twelve quarter moving average.  However, management may adjust the moving average time frame by up to four quarters to adjust for variances in the economic cycle. Management has identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience.  The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry and/or geographic standpoint.

Loans in the criticized pools, which possess certain qualities or characteristics that may lead to collection and loss issues, are closely monitored by management and subject to additional qualitative factors.  Management also monitors industry loss factors by loan segment for applicable adjustments to actual loss experience.

Management reviews the loan portfolio on a quarterly basis in order to make appropriate and timely adjustments to the ALL.  When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.

Activity in the allowance is presented for the three and six months ended June 30, 2019 and 2018:
 
 
Three Months Ended June 30, 2019
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Consumer automobile
 
Other consumer installment
 
 
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
Unallocated
 
Totals
Beginning Balance
 
$
1,732

 
$
5,730

 
$
3,802

 
$
130

 
$
1,402

 
$
278

 
$
718

 
$
13,792

Charge-offs
 
(30
)
 
(64
)
 
(11
)
 

 
(38
)
 
(66
)
 

 
(209
)
Recoveries
 
36

 

 
1

 
2

 
34

 
30

 

 
103

Provision
 
(154
)
 
83

 
(269
)
 

 
37

 
(2
)
 
620

 
315

Ending Balance
 
$
1,584

 
$
5,749

 
$
3,523

 
$
132

 
$
1,435

 
$
240

 
$
1,338

 
$
14,001

 
 
 
Three Months Ended June 30, 2018
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Consumer automobile
 
Other consumer installment
 
 
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
Unallocated
 
Totals
Beginning Balance
 
$
1,372

 
$
5,656

 
$
4,003

 
$
156

 
$
1,016

 
$
305

 
$
328

 
$
12,836

Charge-offs
 
(3
)
 
(91
)
 

 

 
(22
)
 
(47
)
 

 
(163
)
Recoveries
 
8

 
1

 

 
3

 
2

 
12

 

 
26

Provision
 
(322
)
 
17

 
(189
)
 
(41
)
 
73

 
47

 
750

 
335

Ending Balance
 
$
1,055

 
$
5,583

 
$
3,814

 
$
118

 
$
1,069

 
$
317

 
$
1,078

 
$
13,034

 

22

Table of Contents


 
 
Six Months Ended June 30, 2019
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Consumer automobile
 
Other consumer installment
 
 
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
Unallocated
 
Totals
Beginning Balance
 
$
1,680

 
$
5,616

 
$
4,047

 
$
143

 
$
1,328

 
$
259

 
$
764

 
$
13,837

Charge-offs
 
(80
)
 
(137
)
 
(150
)
 

 
(138
)
 
(162
)
 

 
(667
)
Recoveries
 
42

 
1

 
1

 
7

 
60

 
45

 

 
156

Provision
 
(58
)
 
269

 
(375
)
 
(18
)
 
185

 
98

 
574

 
675

Ending Balance
 
$
1,584

 
$
5,749

 
$
3,523

 
$
132

 
$
1,435

 
$
240

 
$
1,338

 
$
14,001

 
 
Six Months Ended June 30, 2018
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Consumer automobile
 
Other consumer installment
 
 
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
Unallocated
 
Totals
Beginning Balance
 
$
1,177

 
$
5,679

 
$
4,277

 
$
155

 
$
804

 
$
271

 
$
495

 
$
12,858

Charge-offs
 
(36
)
 
(142
)
 
(55
)
 

 
(52
)
 
(118
)
 

 
(403
)
Recoveries
 
15

 
25

 

 
5

 
3

 
36

 

 
84

Provision
 
(101
)
 
21

 
(408
)
 
(42
)
 
314

 
128

 
583

 
495

Ending Balance
 
$
1,055

 
$
5,583

 
$
3,814

 
$
118

 
$
1,069

 
$
317

 
$
1,078

 
$
13,034



The shift in allocation of the loan provision is primarily due to portfolio segment growth and changes in the credit metrics within the real estate mortgage portfolio.

The Company grants commercial, industrial, residential, and installment loans to customers primarily throughout north-east and central Pennsylvania. Although the Company has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent on the economic conditions within this region.

The Company has a concentration of the following to gross loans at June 30, 2019 and 2018
 
 
June 30,
 
 
2019
 
2018
Owners of residential rental properties
 
15.07
%
 
14.90
%
Owners of commercial rental properties
 
12.09
%
 
13.30
%


The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of June 30, 2019 and December 31, 2018:
 
 
June 30, 2019
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Consumer Automobile
 
Other consumer installment
 
Unallocated
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
 
Totals
Allowance for Loan Losses:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

Ending allowance balance attributable to loans:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

Individually evaluated for impairment
 
$
577

 
$
228

 
$
1,161

 
$

 
$
20

 
$

 
$

 
$
1,986

Collectively evaluated for impairment
 
1,007

 
5,521

 
2,362

 
132

 
1,415

 
240

 
1,338

 
12,015

Total ending allowance balance
 
$
1,584

 
$
5,749

 
$
3,523

 
$
132

 
$
1,435

 
$
240

 
$
1,338

 
$
14,001

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

Individually evaluated for impairment
 
$
5,253

 
$
4,041

 
$
9,313

 
$
72

 
$
37

 
$
5

 


 
$
18,721

Collectively evaluated for impairment
 
186,027

 
614,314

 
349,745

 
39,920

 
145,479

 
24,084

 


 
1,359,569

Total ending loans balance
 
$
191,280

 
$
618,355

 
$
359,058

 
$
39,992

 
$
145,516

 
$
24,089

 


 
$
1,378,290



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December 31, 2018
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Consumer Automobile
 
Other consumer installment
 
Unallocated
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
 
Totals
Allowance for Loan Losses:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

Ending allowance balance attributable to loans:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

Individually evaluated for impairment
 
$
650

 
$
168

 
$
1,720

 
$

 
$

 
$
5

 
$

 
$
2,543

Collectively evaluated for impairment
 
1,030

 
5,448

 
2,327

 
143

 
1,328

 
254

 
764

 
11,294

Total ending allowance balance
 
$
1,680

 
$
5,616

 
$
4,047

 
$
143

 
$
1,328

 
$
259

 
$
764

 
$
13,837

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

Individually evaluated for impairment
 
$
5,263

 
$
4,210

 
$
11,664

 
$
74

 
$
31

 
$
5

 
 

 
$
21,247

Collectively evaluated for impairment
 
183,298

 
618,169

 
360,031

 
43,449

 
133,152

 
24,547

 
 

 
1,362,646

Total ending loans balance
 
$
188,561

 
$
622,379

 
$
371,695

 
$
43,523

 
$
133,183

 
$
24,552

 
 

 
$
1,383,893



Note 7.  Net Periodic Benefit Cost-Defined Benefit Plans

For a detailed disclosure on the Company’s pension and employee benefits plans, please refer to Note 13 of the Company’s Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2018.

The following sets forth the components of the net periodic benefit/cost of the domestic non-contributory defined benefit plan for the three and six months ended June 30, 2019 and 2018, respectively:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2019
 
2018
 
2019
 
2018
Interest cost
 
$
191

 
$
177

 
$
382

 
$
353

Expected return on plan assets
 
(249
)
 
(274
)
 
(498
)
 
(548
)
Amortization of net loss
 
47

 
42

 
94

 
84

Net periodic benefit
 
$
(11
)
 
$
(55
)
 
$
(22
)
 
$
(111
)


Employer Contributions

The Company previously disclosed in its consolidated financial statements, included in the Annual Report on Form 10-K for the year ended December 31, 2018, that it expected to contribute a minimum of $500,000 to its defined benefit plan in 2019.  As of June 30, 2019, there were contributions of $500,000 made to the plan with additional contributions of at least $250,000 anticipated during the remainder of 2019.
 

Note 8.  Employee Stock Purchase Plan

The Company maintains an Employee Stock Purchase Plan (“Plan”).  The Plan is intended to encourage employee participation in the ownership and economic progress of the Company.  The Plan allows for up to 1,000,000 shares to be purchased by employees.  The purchase price of the shares is 95% of market value with an employee eligible to purchase up to the lesser of 15% of base compensation or $12,000 in market value annually.  During the six months ended June 30, 2019 and 2018, there were 1,200 and 1,196 shares issued under the plan, respectively.


Note 9.  Off-Balance Sheet Risk

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments are primarily comprised of commitments to extend credit, standby letters of credit, and credit exposure from the sale of assets with recourse.  These instruments involve, to varying degrees, elements of credit, interest rate, or liquidity risk in excess of the amount recognized in the Consolidated Balance Sheet.  The contract amounts of these instruments express the extent of involvement the Company has in particular classes of financial instruments.

24

Table of Contents



The Company’s exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments.  The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.  The Company may require collateral or other security to support financial instruments with off-balance sheet credit risk.

Financial instruments whose contract amounts represent credit risk are as follows at June 30, 2019 and December 31, 2018:
(In Thousands)
 
June 30, 2019
 
December 31, 2018
Commitments to extend credit
 
$
157,830

 
$
166,417

Standby letters of credit
 
10,506

 
10,566

Credit exposure from the sale of assets with recourse
 
6,393

 
6,152

 
 
$
174,729

 
$
183,135



Commitments to extend credit are legally binding agreements to lend to customers.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements.  The Company evaluates each customer’s credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Company, on an extension of credit is based on management’s credit assessment of the counterparty.

Standby letters of credit represent conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  These instruments are issued primarily to support bid or performance related contracts.  The coverage period for these instruments is typically a one year period with an annual renewal option subject to prior approval by management.  Fees earned from the issuance of these letters are recognized upon expiration of the coverage period.  For secured letters of credit, the collateral is typically Bank deposit instruments or customer business assets.


Note 10.  Fair Value Measurements

The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value.
Level I:
 
Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
 
 
 
Level II:
 
Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.
 
 
 
Level III:
 
Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

This hierarchy requires the use of observable market data when available.

The following table presents the assets reported on the Consolidated Balance Sheet at their fair value on a recurring basis as of June 30, 2019 and December 31, 2018, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

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Table of Contents


 
 
June 30, 2019
(In Thousands)
 
Level I
 
Level II
 
Level III
 
Total
Assets measured on a recurring basis:
 
 

 
 

 
 

 
 

Investment securities, available for sale:
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$

 
$
5,904

 
$

 
$
5,904

State and political securities
 

 
90,380

 

 
90,380

Other debt securities
 

 
49,405

 

 
49,405

Investment equity securities:
 
 
 
 
 
 
 
 
Financial institution equity securities
 
584

 

 

 
584

  Other equity securities
 
1,257

 

 

 
1,257

Investment securities, trading:
 
 
 
 
 
 
 
 
  Other equity securities
 
44

 

 

 
44


 
 
December 31, 2018
(In Thousands)
 
Level I
 
Level II
 
Level III
 
Total
Assets measured on a recurring basis:
 
 

 
 

 
 

 
 

Investment securities, available for sale:
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$

 
$
6,153

 
$

 
$
6,153

State and political securities
 

 
79,541

 

 
79,541

Other debt securities
 

 
48,591

 

 
48,591

Financial institution equity securities
 
552

 

 

 
552

  Other equity securities
 
1,224

 

 

 
1,224

Investment securities, trading:
 
 
 
 
 
 
 
 
  Other equity securities
 
36

 

 

 
36



The following table presents the assets reported on the Consolidated Balance Sheet at their fair value on a non-recurring basis as of June 30, 2019 and December 31, 2018, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. 
 
 
June 30, 2019
(In Thousands)
 
Level I
 
Level II
 
Level III
 
Total
Assets measured on a non-recurring basis:
 
 

 
 

 
 

 
 

Impaired loans
 
$

 
$

 
$
16,735

 
$
16,735

Other real estate owned
 

 

 
471

 
471


 
 
December 31, 2018
(In Thousands)
 
Level I
 
Level II
 
Level III
 
Total
Assets measured on a non-recurring basis:
 
 

 
 

 
 

 
 

Impaired loans
 
$

 
$

 
$
18,704

 
$
18,704

Other real estate owned
 

 

 
402

 
402












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Table of Contents


The following tables present a listing of significant unobservable inputs used in the fair value measurement process for items valued utilizing level III techniques as of June 30, 2019 and December 31, 2018
 
 
June 30, 2019
 
 
Quantitative Information About Level III Fair Value Measurements
(In Thousands)
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Inputs
 
Range
 
Weighted Average
Impaired loans
 
$
11,477

 
Discounted cash flow
 
Temporary reduction in payment amount
 
0% to (70)%
 
(35)%
 
 
5,258

 
Appraisal of collateral (1)
 
Appraisal adjustments (1)
 
0 to (40)%
 
(2)%
Other real estate owned
 
$
471

 
Appraisal of collateral (1)
 
Appraisal adjustments (1)
 
(20)%
 
(20)%
(1) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.
 
 
December 31, 2018
 
 
Quantitative Information About Level III Fair Value Measurements
(In Thousands)
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Inputs
 
Range
 
Weighted Average
Impaired loans
 
$
12,929

 
Discounted cash flow
 
Temporary reduction in payment amount
 
7 to (70)%
 
(6)%
 
 
5,775

 
Appraisal of collateral (1)
 
Appraisal adjustments (1)
 
0 to (90)%
 
(20)%
Other real estate owned
 
$
402

 
Appraisal of collateral (1)
 
Appraisal adjustments (1)
 
(20)%
 
(20)%
(1) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.

The discounted cash flow valuation technique is utilized to determine the fair value of performing impaired loans, while non-performing impaired loans utilize the appraisal of collateral method.

The significant unobservable inputs used in the fair value measurement of the Company’s impaired loans using the discounted cash flow valuation technique include temporary changes in payment amounts and the probability of default.  Significant increases (decreases) in payment amounts would result in significantly higher (lower) fair value measurements.  The probability of default is 0% for impaired loans using the discounted cash flow valuation technique because all defaulted impaired loans are valued using the appraisal of collateral valuation technique.

The significant unobservable input used in the fair value measurement of the Company’s impaired loans using the appraisal of collateral valuation technique include appraisal adjustments, which are adjustments to appraisals by management for qualitative factors such as economic conditions and estimated liquidation expenses.  The significant unobservable input used in the fair value measurement of the Company’s other real estate owned are the same inputs used to value impaired loans using the appraisal of collateral valuation technique.
 

Note 11. Fair Value of Financial Instruments

The Company is required to disclose fair values for its financial instruments.  Fair values are made at a specific point in time, based on relevant market information and information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument.  Also, it is the Company’s general practice and intention to hold most of its financial instruments to maturity and not to engage in trading or sales activities.  Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.  These fair values are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.  Changes in assumptions can significantly affect the fair values.

Fair values have been determined by the Company using historical data and an estimation methodology suitable for each category of financial instruments.  The Company’s fair values, methods, and assumptions are set forth below for the Company’s other financial instruments.


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Table of Contents


As certain assets and liabilities, such as deferred tax assets, premises and equipment, and many other operational elements of the Company, are not considered financial instruments but have value, this fair value of financial instruments would not represent the full market value of the Company.

The fair values of the Company’s financial instruments not recorded at fair value on a recurring or nonrecurring basis are as follows at June 30, 2019 and December 31, 2018:
 
 
Carrying
 
Fair
 
Fair Value Measurements at June 30, 2019
(In Thousands)
 
Value
 
Value
 
Level I
 
Level II
 
Level III
Financial assets:
 
 

 
 

 
 

 
 

 
 

Cash and cash equivalents (1)
 
$
79,525

 
$
79,525

 
$
79,525

 
$

 
$

Restricted investment in bank stock (1)
 
15,087

 
15,087

 
15,087

 

 

Loans held for sale (1)
 
2,880

 
2,880

 
2,880

 

 

Loans, net
 
1,365,284

 
1,377,063

 

 

 
1,377,063

Bank-owned life insurance (1)
 
28,955

 
28,955

 
28,955

 

 

Accrued interest receivable (1)
 
5,708

 
5,708

 
5,708

 

 

 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 

 
 

 
 

Interest-bearing deposits
 
$
1,004,331

 
$
1,015,799

 
$
659,464

 
$

 
$
356,335

Noninterest-bearing deposits (1)
 
322,755

 
322,755

 
322,755

 

 

Short-term borrowings (1)
 
59,453

 
59,453

 
59,453

 

 

Long-term borrowings
 
154,597

 
155,968

 

 

 
155,968

Accrued interest payable (1)
 
1,482

 
1,482

 
1,482

 

 

(1) The financial instrument is carried at cost at June 30, 2019, which approximate the fair value of the instruments
 
 
Carrying
 
Fair
 
Fair Value Measurements at December 31, 2018
(In Thousands)
 
Value
 
Value
 
Level I
 
Level II
 
Level III
Financial assets:
 
 

 
 

 
 

 
 

 
 

Cash and cash equivalents (1)
 
$
66,742

 
$
66,742

 
$
66,742

 
$

 
$

Restricted investment in bank stock (1)
 
18,862

 
18,862

 
18,862

 

 

Loans held for sale (1)
 
2,929

 
2,929

 
2,929

 

 

Loans, net
 
1,370,920

 
1,381,581

 

 

 
1,381,581

Bank-owned life insurance (1)
 
28,627

 
28,627

 
28,627

 

 

Accrued interest receivable (1)
 
5,334

 
5,334

 
5,334

 

 

 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 

 
 

 
 

Interest-bearing deposits
 
$
899,089

 
$
882,108

 
$
612,478

 
$

 
$
269,630

Noninterest-bearing deposits (1)
 
320,814

 
320,814

 
320,814

 

 

Short-term borrowings (1)
 
167,865

 
167,865

 
167,865

 

 

Long-term borrowings
 
138,942

 
137,773

 

 

 
137,773

Accrued interest payable (1)
 
1,150

 
1,150

 
1,150

 

 


(1) The financial instrument is carried at cost at December 31, 2018, which approximate the fair value of the instruments

The methods and assumptions used by the Company in estimating fair values of financial instruments at June 30, 2019 is in accordance with ASC Topic 825, Financial Instruments, as amended by ASU 2016-01 which requires public entities to use exit pricing in the calculation of the above tables.

Loans:
Fair values are estimated for portfolios of loans with similar financial characteristics.  Loans are segregated by type such as commercial, financial, and agricultural, commercial real estate, residential real estate, construction real estate, and installment loans to individuals.  Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories.

The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan.  The estimate of maturity is based on the

28

Table of Contents


Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions.

Fair value for significant nonperforming loans is based on recent external appraisals.  If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows.  Assumptions regarding credit risk, cash flows, and discounted rates are judgmentally determined using available market information and specific borrower information.

Deposits:
The fair value of deposits with no stated maturity, such as savings, NOW, and money market accounts, is equal to the amount payable on demand.  The fair value of certificates of deposit is based on the discounted value of contractual cash flows.

Long Term Borrowings:
The fair value of long term borrowings is based on the discounted value of contractual cash flows.

Commitments to Extend Credit, Standby Letters of Credit, and Financial Guarantees Written:
There is no material difference between the notional amount and the estimated fair value of off-balance sheet items.  The contractual amounts of unfunded commitments and letters of credit are presented in Note 9 (Off-Balance Sheet Risk).
 
Note 12.  Stock Options

In 2014, the Company adopted the 2014 Equity Incentive Plan designed to help the Company attract, retain, and motivate employees and non-employee directors. Incentive stock options, non-qualified stock options, and restricted stock may be granted as part of the plan.

As of January 1, 2019, the Company had a total of 263,700 stock options outstanding. During the period ended June 30, 2019, the Company issued 160,000 stock options with a strike price of $42.01 to a group of employees. The options granted in 2019 all expire ten years from the grant date. Of the 160,000 grants awarded in 2019, 80,600 of the options vest in 3 years while the remaining 79,400 options vest in five years.

Stock Options Granted
Date
 
Shares
 
Forfeited
 
Outstanding
 
Strike Price
 
Vesting Period
 
Expiration
March 15, 2019
 
80,600

 

 
80,600

 
$
42.01

 
3 years
 
10 years
March 15, 2019
 
79,400

 

 
79,400

 
42.01

 
5 years
 
10 years
August 24, 2018
 
50,200

 

 
50,200

 
46.00

 
3 years
 
10 years
August 24, 2018
 
99,500

 

 
99,500

 
46.00

 
5 years
 
10 years
January 5, 2018
 
12,500

 

 
12,500

 
45.11

 
3 years
 
10 years
January 5, 2018
 
12,500

 

 
12,500

 
45.11

 
5 years
 
10 years
March 24, 2017
 
46,250

 
(4,500
)
 
41,750

 
44.21

 
3 years
 
10 years
March 24, 2017
 
23,750

 

 
23,750

 
44.21

 
5 years
 
10 years
August 27, 2015
 
38,750

 
(15,250
)
 
23,500

 
42.03

 
5 years
 
10 years
















29

Table of Contents


A summary of stock option activity is presented below:
 
 
June 30, 2019
 
June 30, 2018
 
 
Shares
 
Weighted Average Exercise Price
 
Shares
 
Weighted Average Exercise Price
Outstanding, beginning of year
 
263,700

 
$
45.12

 
93,500

 
$
43.59

Granted
 
160,000

 
42.01

 
25,000

 
45.11

Exercised
 

 

 

 

Forfeited
 

 

 
(3,500
)
 
42.96

Expired
 

 

 

 

Outstanding, end of period
 
423,700

 
$
43.95

 
115,000

 
$
43.94

 
 
 
 
 
 
 
 
 
Exercisable, end of period
 

 
$

 

 
$



The estimated fair value of options, including the effect of estimated forfeitures, is recognized as expense on a straightline basis over the options’ vesting periods while ensuring that the cumulative amount of compensation cost recognized at least equals the value of the vested portion of the award at that date. The Company determines the fair value of options granted using the Black-Scholes option-pricing model. The risk-free interest rate is based on the United States Treasury bond with a similar term to the expected life of the options at the grant date. Expected volatility was estimated based on the adjusted historic volatility of the Company’s shares. The expected life was estimated to equal the contractual life of the options. The dividend yield rate was based upon recent historical dividends paid on shares.

Compensation expense for stock options is recognized using the fair value when the stock options are granted and is amortized over the options' vesting period. Compensation expense related to stock options was $177,000 and $313,000 for the three and six months ended June 30, 2019 compared to $5,000 and $12,000 for the same periods of 2018. As of June 30, 2019, no stock options were exercisable and the weighted average years to expiration was 8.95 years. The fair value of options granted during the six months ended June 30, 2019 was approximately $1,208,000 or $7.55 per award. Total unrecognized compensation cost for non-vested options was $2,345,000 and will be recognized over their weighted average remaining vesting period of 1.79 years.


Note 13.  Leases

The following table shows finance lease right of use assets and finance lease liabilities as of June 30, 2019:
(In Thousands)
 
Statement of Financial Condition classification
 
June 30, 2019
Finance lease right of use assets
 
Premises and equipment, net
 
$
5,870

Finance lease liabilities
 
Long-term borrowings
 
$
5,972



The following table shows the components of finance and operating lease expense for the three and six months ended June 30, 2019:
 
 
Three Months Ended June 30,
 
Six months ended June 30,
(In Thousands)
 
2019
 
2019
 
 
 
 
 
Finance Lease Cost:
 
 
 
 
Amortization of right-of-use asset
 
$
64

 
$
129

Interest expense
 
56

 
112

Operating lease cost
 
84

 
172

Variable lease cost
 
1

 
2

Total Lease Cost
 
$
205

 
$
415


Gross rental expense for the three and six months ended June 30, 2018 was $125,000 and $255,000.



30

Table of Contents


A maturity analysis of operating and finance lease liabilities and reconciliation of the undiscounted cash flows to the total operating lease liability is as follows:
(In Thousands)
 
Operating
 
Finance
2019
 
$
183

 
$
176

2020
 
370

 
318

2021
 
378

 
320

2022
 
385

 
321

2023
 
360

 
322

2024 and thereafter
 
3,969

 
8,494

Total undiscounted cash flows
 
5,645

 
9,951

Discount on cash flows
 
(1,359
)
 
(3,979
)
Total lease liability
 
$
4,286

 
$
5,972



The following table shows the weighted average remaining lease term and weighted average discount rate for both operating and finance leases outstanding as of June 30, 2019.
 
 
Operating
 
Finance
Weighted-average term (years)
 
18.0

 
27.8

Weighted-average discount rate
 
3.49
%
 
3.73
%



Note 14.  Reclassification of Comparative Amounts

Certain comparative amounts for the prior period have been reclassified to conform to current period presentations. Such reclassifications had no effect on net income or shareholders’ equity.


CAUTIONARY STATEMENT FOR PURPOSES OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Report contains certain “forward-looking statements” including statements concerning plans, objectives, future events or performance and assumptions and other statements which are other than statements of historical fact.  The Company cautions readers that the following important factors, among others, may have affected and could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward-looking statement made by or on behalf of the Company herein:  (i) the effect of changes in laws and regulations, including federal and state banking laws and regulations, with which the Company must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable; (ii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board, or of changes in the Company’s organization, compensation and benefit plans; (iii) the effect on the Company’s competitive position within its market area of the  increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services; (iv) the effect of changes in interest rates; (v) the effect of changes in the business cycle and downturns in the local, regional or national economies; and (vi) the Risk Factors identified in Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2018 and in other filings made by the Company under the Securities Exchange Act of 1934.

You should not put undue reliance on any forward-looking statements.  These statements speak only as of the date of this Quarterly Report on Form 10-Q, even if subsequently made available by the Company on its website or otherwise.  The Company undertakes no obligation to update or revise these statements to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q.







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

EARNINGS SUMMARY

Comparison of the and Six Months Ended June 30, 2019 and 2018

Summary Results

Net income for the three and six months ended June 30, 2019 was $4,245,000 and $8,189,000 compared to $3,480,000 and $6,689,000 for the same period of 2018, including the effects of an increase in after-tax securities gains of $6,000 (from a gain of $12,000 to a gain of $18,000) for the three month periods and $90,000 (from a loss of $20,000 to a gain of $70,000) for the six month periods. Basic and diluted earnings per share for the three and six months ended June 30, 2019 was $0.91 and $1.75 compared to $0.74 and $1.43 for the corresponding period of 2018. Return on average assets and return on average equity were 1.02% and 11.42% for the three months ended June 30, 2019 compared to 0.91% and 10.07% for the corresponding period of 2018. Return on average assets and return on average equity were 0.99% and 11.27% for the six months ended June 30, 2019, compared to 0.89% and 9.68% for the corresponding period of 2018. Net income from core operations (“core earnings”) was $4,227,000 and $8,119,000 for the three and six months ended June 30, 2019 compared to $3,468,000 and $6,709,000 for the corresponding period of 2018. Basic and diluted adjusted earnings per share for the three and six months ended June 30, 2019 were $0.90 and $1.73 compared to $0.74 and $1.43 basic and diluted for the corresponding periods of 2018.

Management uses the non-GAAP measure of net income from core operations in its analysis of the Company’s performance.  This measure, as used by the Company, adjusts net income by excluding significant gains or losses that are unusual in nature.  Because certain of these items and their impact on the Company’s performance are difficult to predict, management believes the presentation of financial measures excluding the impact of such items provides useful supplemental information in evaluating the operating results of the Company’s core businesses.  For purposes of this Quarterly Report on Form 10-Q, net income from core operations means net income adjusted to exclude after-tax net securities gains or losses. These disclosures should not be viewed as a substitute for net income determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.

Reconciliation of GAAP and Non-GAAP Financial Measures
(Dollars in Thousands, Except Per Share Data)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2019
 
2018
 
2019
 
2018
GAAP net income
 
$
4,245

 
$
3,480

 
$
8,189

 
$
6,689

Less: net securities gains (losses), net of tax
 
18

 
12

 
70

 
(20
)
Non-GAAP core earnings
 
$
4,227

 
$
3,468

 
$
8,119

 
$
6,709

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2019
 
2018
 
2019
 
2018
Return on average assets (ROA)
 
1.02
%
 
0.91
%
 
0.99
%
 
0.89
%
Less: net securities gains, net of tax
 
0.01
%
 
0.01
%
 
0.01
%
 
%
Non-GAAP core ROA
 
1.01
%
 
0.90
%
 
0.98
%
 
0.89
%
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2019
 
2018
 
2019
 
2018
Return on average equity (ROE)
 
11.42
%
 
10.07
%
 
11.27
%
 
9.68
 %
Less: net securities gains (losses), net of tax
 
0.05
%
 
0.03
%
 
0.09
%
 
(0.03
)%
Non-GAAP core ROE
 
11.37
%
 
10.04
%
 
11.18
%
 
9.71
 %
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2019
 
2018
 
2019
 
2018
Basic earnings per share (EPS)
 
$
0.91

 
$
0.74

 
$
1.75

 
$
1.43

Less: net securities gains, net of tax
 
0.01

 

 
0.02

 

Non-GAAP core operating EPS
 
$
0.90

 
$
0.74

 
$
1.73

 
$
1.43


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Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2019
 
2018
 
2019
 
2018
Diluted EPS
 
$
0.91

 
$
0.74

 
$
1.75

 
$
1.43

Less: net securities gains (losses), net of tax
 
0.01

 

 
0.02

 

Non-GAAP diluted core EPS
 
$
0.90

 
$
0.74

 
$
1.73

 
$
1.43

 

Interest and Dividend Income

Interest and dividend income for the three and six months ended June 30, 2019 increased to $16,841,000 and $33,275,000 compared to $14,111,000 and $27,312,000 for the same periods of 2018. Loan portfolio income increased due to the impact of portfolio growth, primarily in consumer automobile lending and commercial real estate mortgages. Investment securities and dividend income increased by $427,000 and $984,000 for the three and six month periods ended June 30, 2019 to $1,541,000 and $3,106,000 as the average balance of the investment portfolio increased by $25,449,000 and $25,880,000, respectively.

Interest and dividend income composition for the three and six months ended June 30, 2019 and 2018 was as follows:
 
 
Three Months Ended
 
 
June 30, 2019
 
June 30, 2018
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Loans including fees
 
$
15,300

 
90.85
%
 
$
12,997

 
92.11
%
 
$
2,303

 
17.72

%
Investment securities:
 
 

 
 
 
 
 

 
 
 
 
 

 
 

 
Taxable
 
967

 
5.74
 
 
639

 
4.53
 
 
328

 
51.33

 
Tax-exempt
 
179

 
1.06
 
 
230

 
1.63
 
 
(51
)
 
(22.17
)
 
Dividend and other interest income
 
395

 
2.35
 
 
245

 
1.73
 
 
150

 
61.22

 
Total interest and dividend income
 
$
16,841

 
100.00
%
 
$
14,111

 
100.00
%
 
$
2,730

 
19.35

%
 
 
Six Months Ended
 
 
 
June 30, 2019
 
June 30, 2018
 
Change
 
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
 
Loans including fees
 
$
30,169

 
90.67
%
 
$
25,190

 
92.23
%
 
$
4,979

 
19.77

%
Investment securities:
 
 

 
 
 
 
 

 
 
 
 
 

 
 

 
Taxable
 
1,901

 
5.71
 
 
1,185

 
4.34
 
 
716

 
60.42

 
Tax-exempt
 
353

 
1.06
 
 
471

 
1.72
 
 
(118
)
 
(25.05
)
 
Dividend and other interest income
 
852

 
2.56
 
 
466

 
1.71
 
 
386

 
82.83

 
Total interest and dividend income
 
$
33,275

 
100.00
%
 
$
27,312

 
100.00
%
 
$
5,963

 
21.83

%
Interest Expense

Interest expense for the three and six months ended June 30, 2019 increased $1,520,000 and $3,228,000 to $3,928,000 and $7,684,000, respectively, compared to $2,408,000 and $4,456,000 for the same periods of 2018. The increase in interest expense is the result of growth within the deposit portfolio and the use of the time deposit portfolio as part of a deposit acquisition strategy in select markets. In addition, short and long-term borrowings have been utilized to assist with the funding of the loan portfolio growth.

Interest expense composition for the three and six months ended June 30, 2019 and 2018 was as follows:
 
 
Three Months Ended
 
 
June 30, 2019
 
June 30, 2018
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Deposits
 
$
2,871

 
73.09
%
 
$
1,490

 
61.88
%
 
$
1,381

 
92.68

%
Short-term borrowings
 
178

 
4.53
 
 
252

 
10.47
 
 
(74
)
 
(29.37
)
 
Long-term borrowings
 
879

 
22.38
 
 
666

 
27.65
 
 
213

 
31.98

 
Total interest expense
 
$
3,928

 
100.00
%
 
$
2,408

 
100.00
%
 
$
1,520

 
63.12

%

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Six Months Ended
 
 
June 30, 2019
 
June 30, 2018
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Deposits
 
$
5,171

 
67.30
%
 
$
2,712

 
60.86
%
 
$
2,459

 
90.67
%
Short-term borrowings
 
783

 
10.19
 
 
476

 
10.68
 
 
307

 
64.50
 
Long-term borrowings
 
1,730

 
22.51
 
 
1,268

 
28.46
 
 
462

 
36.44
 
Total interest expense
 
$
7,684

 
100.00
%
 
$
4,456

 
100.00
%
 
$
3,228

 
72.44
%
Net Interest Margin

The net interest margin (“NIM”) for the three and six months ended June 30, 2019 was 3.39% and 3.37% compared to 3.32% and 3.31% for the corresponding periods of 2018. The increase in the net interest margin was driven by an increase in the yield on earning assets of 40 and 44 basis points ("bps") for the three and six month periods. The impact of the increase in yield on earning assets was limited by the increase in rate paid on interest-bearing liabilities of 42 bps and 45 bps for the three and six month periods. The increase in the yield on earning assets was driven by an increase in the loan portfolio yield in conjunction with an increase in the average loan portfolio of $83,379,000 and $103,502,000, respectively. The loan growth for the three and six month periods was primarily funded by an increase in average total deposits of $119,236,000 and $108,021,000, respectively. Deposits increased $136,067,000 to $1.3 billion at June 30, 2019 compared to June 30, 2018. Noninterest-bearing deposits increased $11,561,000 million to $322,755,000 million at June 30, 2019 compared to June 30, 2018.




34

Table of Contents


The following is a schedule of average balances and associated yields for the three and six months ended June 30, 2019 and 2018:
 
 
AVERAGE BALANCES AND INTEREST RATES
 
 
Three Months Ended June 30, 2019
 
Three Months Ended June 30, 2018
(In Thousands)
 
Average Balance (1)
 
Interest
 
Average Rate
 
Average Balance (1)
 
Interest
 
Average Rate
Assets:
 
 

 
 

 
 

 
 

 
 

 
 

Tax-exempt loans (3)
 
$
71,193

 
$
548

 
3.09
%
 
$
75,859

 
$
563

 
2.98
%
All other loans
 
1,313,388

 
14,867

 
4.54
%
 
1,225,343

 
12,552

 
4.11
%
Total loans (2)
 
1,384,581

 
15,415

 
4.47
%
 
1,301,202

 
13,115

 
4.04
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable securities
 
130,802

 
1,300

 
4.03
%
 
93,024

 
871

 
3.75
%
Tax-exempt securities (3)
 
27,971

 
227

 
3.29
%
 
40,300

 
291

 
2.89
%
Total securities
 
158,773

 
1,527

 
3.90
%
 
133,324

 
1,162

 
3.49
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
10,431

 
62

 
2.38
%
 
3,034

 
13

 
1.72
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest-earning assets
 
1,553,785

 
17,004

 
4.39
%
 
1,437,560

 
14,290

 
3.99
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Other assets
 
113,443

 
 

 
 

 
97,034

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
1,667,228

 
 

 
 

 
$
1,534,594

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and shareholders’ equity:
 
 

 
 

 
 

 
 

 
 

 
 

Savings
 
$
170,142

 
51

 
0.12
%
 
$
165,231

 
16

 
0.04
%
Super Now deposits
 
246,454

 
453

 
0.74
%
 
234,731

 
242

 
0.41
%
Money market deposits
 
249,169

 
596

 
0.96
%
 
243,771

 
290

 
0.48
%
Time deposits
 
335,721

 
1,771

 
2.12
%
 
253,398

 
942

 
1.49
%
Total interest-bearing deposits
 
1,001,486

 
2,871

 
1.15
%
 
897,131

 
1,490

 
0.67
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
32,086

 
178

 
2.23
%
 
56,530

 
252

 
1.76
%
Long-term borrowings
 
147,571

 
879

 
2.24
%
 
123,970

 
666

 
2.12
%
Total borrowings
 
179,657

 
1,057

 
2.23
%
 
180,500

 
918

 
2.01
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest-bearing liabilities
 
1,181,143

 
3,928

 
1.31
%
 
1,077,631

 
2,408

 
0.89
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
 
317,623

 
 

 
 

 
302,742

 
 

 
 

Other liabilities
 
19,747

 
 

 
 

 
16,024

 
 

 
 

Shareholders’ equity
 
148,715

 
 

 
 

 
138,197

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders’ equity
 
$
1,667,228

 
 

 
 

 
$
1,534,594

 
 

 
 

Interest rate spread
 
 

 
 

 
3.08
%
 
 

 
 

 
3.10
%
Net interest income/margin
 
 

 
$
13,076

 
3.39
%
 
 

 
$
11,882

 
3.32
%

1.              Information on this table has been calculated using average daily balance sheets to obtain average balances.
2.              Non-accrual loans have been included with loans for the purpose of analyzing net interest earnings.
3.              Income and rates on a fully taxable equivalent basis include an adjustment for the difference between annual income from tax-exempt obligations and the taxable equivalent of such income at the standard tax rate of 21%.

35

Table of Contents


 
 
AVERAGE BALANCES AND INTEREST RATES
 
 
Six Months Ended June 30, 2019
 
Six Months Ended June 30, 2018
(In Thousands)
 
Average Balance (1)
 
Interest
 
Average Rate
 
Average Balance (1)
 
Interest
 
Average Rate
Assets:
 
 

 
 

 
 

 
 

 
 

 
 

Tax-exempt loans (3)
 
$
71,874

 
$
1,087

 
3.05
%
 
$
75,548

 
$
1,130

 
3.02
%
All other loans
 
1,313,121

 
29,310

 
4.50
%
 
1,205,945

 
24,297

 
4.06
%
Total loans (2)
 
1,384,995

 
30,397

 
4.43
%
 
1,281,493

 
25,427

 
4.00
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable securities
 
128,431

 
2,650

 
4.18
%
 
88,670

 
1,630

 
3.68
%
Tax-exempt securities
 
27,344

 
447

 
3.31
%
 
41,225

 
596

 
2.89
%
Total securities
 
155,775

 
3,097

 
4.03
%
 
129,895

 
2,226

 
3.43
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
8,493

 
103

 
2.45
%
 
2,603

 
21

 
1.63
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest-earning assets
 
1,549,263

 
33,597

 
4.38
%
 
1,413,991

 
27,674

 
3.94
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Other assets
 
112,806

 
 

 
 

 
97,318

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
1,662,069

 
 

 
 
 
$
1,511,309

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and shareholders’ equity:
 
 

 
 

 


 


 
 

 
 

Savings
 
$
168,543

 
81

 
0.10
%
 
$
164,140

 
32

 
0.04
%
Super Now deposits
 
239,022

 
832

 
0.70
%
 
230,930

 
449

 
0.39
%
Money market deposits
 
245,307

 
1,068

 
0.88
%
 
240,127

 
500

 
0.42
%
Time deposits
 
317,782

 
3,190

 
2.02
%
 
244,805

 
1,731

 
1.43
%
Total interest-bearing deposits
 
970,654

 
5,171

 
1.07
%
 
880,002

 
2,712

 
0.62
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
63,881

 
783

 
2.47
%
 
59,152

 
476

 
1.60
%
Long-term borrowings
 
145,890

 
1,730

 
2.24
%
 
119,274

 
1,268

 
2.11
%
Total borrowings
 
209,771

 
2,513

 
2.31
%
 
178,426

 
1,744

 
1.94
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest-bearing liabilities
 
1,180,425

 
7,684

 
1.29
%
 
1,058,428

 
4,456

 
0.84
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
 
315,380

 
 

 
 

 
298,011

 
 

 
 

Other liabilities
 
20,953

 
 

 
 

 
16,645

 
 

 
 

Shareholders’ equity
 
145,311

 
 

 
 

 
138,225

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders’ equity
 
$
1,662,069

 
 

 
 

 
$
1,511,309

 
 

 
 

Interest rate spread
 
 

 
 

 
3.09
%
 
 

 
 

 
3.10
%
Net interest income/margin
 
 

 
$
25,913

 
3.37
%
 
 

 
$
23,218

 
3.31
%

The following table presents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the three and six months ended June 30, 2019 and 2018:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2019
 
2018
 
2019
 
2018
Total interest income
 
$
16,841

 
$
14,111

 
$
33,275

 
$
27,312

Total interest expense
 
3,928

 
2,408

 
7,684

 
4,456

Net interest income
 
12,913

 
11,703

 
25,591

 
22,856

Tax equivalent adjustment
 
163

 
179

 
322

 
362

Net interest income (fully taxable equivalent)
 
$
13,076

 
$
11,882

 
$
25,913

 
$
23,218

 

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Table of Contents


The following table sets forth the respective impact that both volume and rate changes have had on net interest income on a fully taxable equivalent basis for the three and six months ended June 30, 2019 and 2018:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2019 vs. 2018
 
2019 vs. 2018
 
 
Increase (Decrease) Due to
 
Increase (Decrease) Due to
(In Thousands)
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
Interest income:
 
 

 
 

 
 

 
 

 
 

 
 

Tax-exempt loans
 
$
(36
)
 
$
21

 
$
(15
)
 
$
(54
)
 
$
11

 
$
(43
)
All other loans
 
943

 
1,372

 
2,315

 
2,259

 
2,754

 
5,013

Taxable investment securities
 
362

 
67

 
429

 
783

 
237

 
1,020

Tax-exempt investment securities
 
(99
)
 
35

 
(64
)
 
(224
)
 
75

 
(149
)
Interest bearing deposits
 
42

 
7

 
49

 
48

 
34

 
82

Total interest-earning assets
 
1,212

 
1,502

 
2,714

 
2,812

 
3,111

 
5,923

 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense:
 
 

 
 

 
 

 
 

 
 

 
 

Savings deposits
 

 
35

 
35

 
1

 
48

 
49

Super Now deposits
 
12

 
199

 
211

 
17

 
366

 
383

Money market deposits
 
6

 
300

 
306

 
11

 
557

 
568

Time deposits
 
361

 
468

 
829

 
609

 
850

 
1,459

Short-term borrowings
 
(128
)
 
54

 
(74
)
 
40

 
267

 
307

Long-term borrowings
 
164

 
49

 
213

 
365

 
97

 
462

Total interest-bearing liabilities
 
415

 
1,105

 
1,520

 
1,043

 
2,185

 
3,228

Change in net interest income
 
$
797

 
$
397

 
$
1,194

 
$
1,769

 
$
926

 
$
2,695


Provision for Loan Losses

The provision for loan losses is based upon management’s quarterly review of the loan portfolio.  The purpose of the review is to assess loan quality, identify impaired loans, analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets served.  An external independent loan review is also performed annually for the Banks.  Management remains committed to an aggressive program of problem loan identification and resolution.

The allowance for loan losses is determined by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined.  Loss factors are based on management’s consideration of the nature of the portfolio segments, changes in mix and volume of the loan portfolio, and historical loan loss experience.  In addition, management considers industry standards and trends with respect to non-performing loans and its knowledge and experience with specific lending segments.

Although management believes it uses the best information available to make such determinations and that the allowance for loan losses is adequate at June 30, 2019, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations.  A downturn in the local economy, increased unemployment, and delays in receiving financial information from borrowers could result in increased levels of nonperforming assets, charge-offs, loan loss provisions, and reductions in income.  Additionally, as an integral part of the examination process, bank regulatory agencies periodically review the Banks' loan loss allowance.  The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

When determining the appropriate allowance level, management has attributed the allowance for loan losses to various portfolio segments; however, the allowance is available for the entire portfolio as needed.

The allowance for loan losses increased slightly from $13,837,000 at December 31, 2018 to $14,001,000 at June 30, 2019. The slight increase in the allowance for loan losses was driven by an increase in the consumer automobile segment of the loan portfolio. The majority of the loans charged-off during the six month period had a specific allowance within the allowance for losses. At June 30, 2019 and December 31, 2018, the allowance for loan losses to total loans was 1.02% and 1.00%, respectively.

The provision for loan losses totaled $315,000 and $675,000 for the three and six months ended June 30, 2019 and the respective amounts for the corresponding 2018 periods were $335,000 and $495,000. The decrease in the provision for loans for the three months ended June 30, 2019 compared to the corresponding 2018 period was due to the change in loan balance outstanding. The

37

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increase in the provision for loan losses for the six months ended June 30, 2019 compared to the same period of 2018 was primarily due to an increase in net charge-offs.

Nonperforming loans increased to $15,383,000 at June 30, 2019 from $7,132,000 at June 30, 2018. The majority of nonperforming loans are centered on loans that are either in a secured position and have sureties with a strong underlying financial position or have a specific allocation for any impairment recorded within the allowance for loan losses. The ratio of nonperforming loans to total loans was 1.12% and 0.44% at June 30, 2019 and 2018, respectively, and the ratio of the allowance for loan losses to nonperforming loans was 91.00% and 182.75% at June 30, 2019 and 2018, respectively. Internal loan review and analysis coupled with loan growth dictated a provision for loan losses of $315,000 and $675,000 for the three and six months ended June 30, 2019

The following is a table showing total nonperforming loans as of:
 
 
Total Nonperforming Loans
(In Thousands)
 
90 Days Past Due

Non-accrual

Total
June 30, 2019
 
$
1,245

 
$
14,138

 
$
15,383

March 31, 2019
 
1,268

 
14,526

 
15,794

December 31, 2018
 
1,274

 
15,298

 
16,572

September 30, 2018
 
512

 
8,227

 
8,739

June 30, 2018
 
463

 
6,669

 
7,132

 
Non-interest Income

Total non-interest income for the three and six months ended June 30, 2019 compared to the same periods in 2018 increased $107,000 and $280,000, respectively, to $2,469,000 and $4,723,000. Excluding net securities gains, non-interest income for the three and six months ended June 30, 2019 increased $99,000 and $166,000 compared to the same periods in 2018. The changes in insurance commissions is primarily the result of continued growth in United Insurance Solution, LLC. The increase in brokerage commissions are due to a change in the product mix of consumer purchases. The fluctuation in other income consists primarily due to increases in loans sold on the secondary market.

Non-interest income composition for the three and six months ended June 30, 2019 and 2018 was as follows:
 
 
Three Months Ended
 
 
June 30, 2019
 
June 30, 2018
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Service charges
 
$
592

 
23.99
 %
 
$
592

 
25.07
 %
 
$

 
 %
Net debt securities (losses) gains, available for sale
 
(2
)
 
(0.08
)
 
14

 
0.59

 
(16
)
 
(114.29
)
Net equity securities gains (losses)
 
22

 
0.89

 
6

 
0.25

 
16

 
266.67

Net securities gains (losses), trading
 
3

 
0.12

 
(5
)
 
(0.21
)
 
8

 
(160.00
)
Bank-owned life insurance
 
123

 
4.98

 
158

 
6.69

 
(35
)
 
(22.15
)
Gain on sale of loans
 
347

 
14.05

 
400

 
16.93

 
(53
)
 
(13.25
)
Insurance commissions
 
119

 
4.82

 
64

 
2.71

 
55

 
85.94

Brokerage commissions
 
356

 
14.42

 
330

 
13.97

 
26

 
7.88

Debit card fees
 
389

 
15.76

 
373

 
15.79

 
16

 
4.29

Other
 
520

 
21.05

 
430

 
18.21

 
90

 
20.93

Total non-interest income
 
$
2,469

 
100.00
 %
 
$
2,362

 
100.00
 %
 
$
107

 
4.53
 %

38

Table of Contents


 
 
Six Months Ended
 
 
June 30, 2019
 
June 30, 2018
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Service charges
 
$
1,154

 
24.43
%
 
$
1,143

 
25.73
 %
 
$
11

 
0.96
 %
Net debt securities (losses) gains, available for sale
 
11

 
0.23

 
5

 
0.11

 
6

 
120.00

Net equity securities gains (losses)
 
65

 
1.38

 
(28
)
 
(0.63
)
 
93

 
332.14

Net securities gains (losses), trading
 
13

 
0.28

 
(2
)
 
(0.05
)
 
15

 
750.00

Bank-owned life insurance
 
291

 
6.16

 
331

 
7.45

 
(40
)
 
(12.08
)
Gain on sale of loans
 
663

 
14.04

 
655

 
14.74

 
8

 
1.22

Insurance commissions
 
253

 
5.36

 
181

 
4.07

 
72

 
39.78

Brokerage commissions
 
679

 
14.38

 
673

 
15.15

 
6

 
0.89

Debit card fees
 
699

 
14.80

 
706

 
15.89

 
(7
)
 
(0.99
)
Other
 
895

 
18.94

 
779

 
17.54

 
116

 
14.89

Total non-interest income
 
$
4,723

 
100.00
%
 
$
4,443

 
100.00
 %
 
$
280

 
6.30
 %
Non-interest Expense

Total non-interest expense increased $542,000 and $1,079,000 for the three and six months ended June 30, 2019 compared to the same period of 2018. The increase in salaries and employee benefits is primarily attributable to routine wage increases coupled with an increase in the number of employees. Occupancy and furniture and equipment expenses have decreased slightly as maintenance costs were reduced. Software amortization increased for the six month period due to updating software programs that require new licensing fee structures. Marketing expenses decreased as targeted marketing has replaced mass marketing. The fluctuation in professional fees consists primarily of an increase in legal fees.

Non-interest expense composition for the three and six months ended June 30, 2019 and 2018 was as follows:
 
 
Three Months Ended
 
 
June 30, 2019
 
June 30, 2018
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Salaries and employee benefits
 
$
5,523

 
54.91
%
 
$
4,919

 
51.69
%
 
$
604

 
12.28
 %
Occupancy
 
668

 
6.64

 
699

 
7.34

 
(31
)
 
(4.43
)
Furniture and equipment
 
784

 
7.79

 
801

 
8.42

 
(17
)
 
(2.12
)
Software amortization
 
188

 
1.87

 
231

 
2.43

 
(43
)
 
(18.61
)
Pennsylvania shares tax
 
285

 
2.83

 
278

 
2.92

 
7

 
2.52

Professional fees
 
727

 
7.23

 
649

 
6.82

 
78

 
12.02

Federal Deposit Insurance Corporation deposit insurance
 
236

 
2.35

 
200

 
2.10

 
36

 
18.00

Marketing
 
33

 
0.33

 
268

 
2.82

 
(235
)
 
(87.69
)
Intangible amortization
 
69

 
0.69

 
78

 
0.82

 
(9
)
 
(11.54
)
Other
 
1,546

 
15.36

 
1,394

 
14.64

 
152

 
10.90

Total non-interest expense
 
$
10,059

 
100.00
%
 
$
9,517

 
100.00
%
 
$
542

 
5.70
 %

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Six Months Ended
 
 
June 30, 2019
 
June 30, 2018
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Salaries and employee benefits
 
$
11,024

 
55.47
%
 
$
9,967

 
53.03
%
 
$
1,057

 
10.60
 %
Occupancy
 
1,447

 
7.28

 
1,440

 
7.66

 
7

 
0.49

Furniture and equipment
 
1,536

 
7.73

 
1,548

 
8.24

 
(12
)
 
(0.78
)
Software amortization
 
395

 
1.99

 
296

 
1.57

 
99

 
33.45

Pennsylvania shares tax
 
578

 
2.91

 
555

 
2.95

 
23

 
4.14

Professional fees
 
1,249

 
6.28

 
1,215

 
6.46

 
34

 
2.80

Federal Deposit Insurance Corporation deposit insurance
 
504

 
2.54

 
402

 
2.14

 
102

 
25.37

Marketing
 
135

 
0.68

 
519

 
2.76

 
(384
)
 
(73.99
)
Intangible amortization
 
140

 
0.70

 
158

 
0.84

 
(18
)
 
(11.39
)
Other
 
2,865

 
14.42

 
2,694

 
14.35

 
171

 
6.35

Total non-interest expense
 
$
19,873

 
100.00
%
 
$
18,794

 
100.00
%
 
$
1,079

 
5.74
 %
Provision for Income Taxes

Income taxes increased $26,000 and $249,000 for the three and six months ended June 30, 2019 compared to the same periods of 2018. The effective tax rate for the three and six months ended June 30, 2019 was 15.16% and 16.09%, respectively, compared to 17.40% and 16.50% for the same periods of 2018. The Company currently is in a deferred tax asset position. Management has reviewed the deferred tax asset and has determined that the asset will be utilized within the appropriate carry forward period and therefore does not require a valuation allowance.

ASSET/LIABILITY MANAGEMENT

Cash and Cash Equivalents

Cash and cash equivalents increased $12,783,000 from $66,742,000 at December 31, 2018 to $79,525,000 at June 30, 2019, primarily as a result of the following activities during the six months ended June 30, 2019.

Loans Held for Sale

Activity regarding loans held for sale resulted in sales proceeds trailing loan originations, less $663,000 in realized gains, by $49,000 for the six months ended June 30, 2019.

Loans

Gross loans decreased $5,472,000 since December 31, 2018 due primarily to a decrease across all three real estate mortgage categories. The decrease in the real estate mortgage portfolio was partially offset by the growth in the consumer automobile loan segment.

The allocation of the loan portfolio, by category, as of June 30, 2019 and December 31, 2018 is presented below:
 
 
June 30, 2019
 
December 31, 2018
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Commercial, financial, and agricultural
 
$
191,280

 
13.87
%
 
$
188,561

 
13.62
%
 
$
2,719

 
1.44
 %
Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

 
 

Residential
 
618,355

 
44.83

 
622,379

 
44.94

 
(4,024
)
 
(0.65
)%
Commercial
 
359,058

 
26.03

 
371,695

 
26.84

 
(12,637
)
 
(3.40
)%
Construction
 
39,992

 
2.90

 
43,523

 
3.14

 
(3,531
)
 
(8.11
)%
Consumer automobile loans
 
145,516

 
10.55

 
133,183

 
9.63

 
12,333

 
9.26
 %
Other consumer installment loans
 
24,089

 
1.75

 
24,552

 
1.77

 
(463
)
 
(1.89
)%
Net deferred loan fees and discounts
 
995

 
0.07

 
864

 
0.06

 
131

 
15.16
 %
Gross loans
 
$
1,379,285

 
100.00
%
 
$
1,384,757

 
100.00
%
 
$
(5,472
)
 
(0.40
)%

40

Table of Contents



The following table shows the amount of accrual and non-accrual TDRs at June 30, 2019 and December 31, 2018:
 
 
June 30, 2019
 
December 31, 2018
(In Thousands)
 
Accrual
 
Non-accrual
 
Total
 
Accrual
 
Non-accrual
 
Total
Commercial, financial, and agricultural
 
$

 
$
5,131

 
$
5,131

 
$

 
$
1,127

 
$
1,127

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

 
 

Residential
 
2,100

 
156

 
2,256

 
2,225

 
159

 
2,384

Commercial
 
2,563

 
4,912

 
7,475

 
3,959

 
2,129

 
6,088

 
 
$
4,663

 
$
10,199

 
$
14,862

 
$
6,184

 
$
3,415

 
$
9,599

 
Investments

The fair value of the investment debt securities portfolio at June 30, 2019 increased $11,404,000 since December 31, 2018 while the amortized cost of the portfolio increased $6,620,000.  The growth in the investment portfolio has occurred within the municipal segment as bonds with a final maturity of inside of ten years have been purchased. The portfolio continues to be actively managed in order to reduce interest rate and market risk. The unrealized losses within the debt securities portfolio are the result of market activity, not credit issues/ratings, as approximately 79.28% of the debt securities portfolio on an amortized cost basis is currently rated A or higher by either S&P or Moody’s.

The Company considers various factors, which include examples from applicable accounting guidance, when analyzing the available for sale portfolio for possible other than temporary impairment.  The Company primarily considers the following factors in its analysis: length of time and severity of the fair value being less than carrying value; reduction of dividend paid (equities); continued payment of dividend/interest, credit rating, and financial condition of an issuer; intent and ability to hold until anticipated recovery (which may be maturity); and general outlook for the economy, specific industry, and entity in question.

The bond portion of the portfolio review is conducted with emphases on several factors.  Continued payment of principal and interest is given primary importance with credit rating and financial condition of the issuer following as the next most important.  Credit ratings were reviewed with the ratings of the bonds being satisfactory.  Bonds that were not currently rated were discussed with a third party and/or underwent an internal financial review. Each bond is reviewed to determine whether it is a general obligation bond, which is backed by the credit and taxing power of the issuing jurisdiction, or a revenue bond, which is only payable from specified revenues.  Based on the review undertaken by the Company, the Company determined that the decline in value of the various bond holdings were temporary and were the result of the general market downturns and interest rate/yield curve changes, not credit issues.  The fact that almost all of such bonds are general obligation bonds further solidified the Company’s determination that the decline in the value of these bond holdings is temporary.

The fair value of the equity portfolio continues to fluctuate as the economic and political environment continues to impact stock pricing. The amortized cost of the available for sale equity securities portfolio has remained flat at $1,628,000 for June 30, 2019 and December 31, 2018 while the fair value increased $65,000 over the same time period.

The distribution of credit ratings by amortized cost and fair values for the debt security portfolio at June 30, 2019 follows:
 
 
A- to AAA
 
B- to BBB+
 
Not Rated
 
Total
(In Thousands)
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Available for sale (AFS):
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$
5,927

 
$
5,904

 
$

 
$

 
$

 
$

 
$
5,927

 
$
5,904

State and political securities
 
84,895

 
88,175

 
2,183

 
2,205

 

 

 
87,078

 
90,380

Other debt securities
 
22,247

 
21,931

 
19,111

 
19,201

 
8,264

 
8,273

 
49,622

 
49,405

Total debt securities AFS
 
$
113,069

 
$
116,010

 
$
21,294

 
$
21,406

 
$
8,264

 
$
8,273

 
$
142,627

 
$
145,689

 







41

Table of Contents


Financing Activities

Deposits

Total deposits increased $107,183,000 from December 31, 2018 to June 30, 2019. The increase in core deposits (deposits less time deposits) has provided relationship driven funding for the loan and investment portfolios. While deposit gathering efforts have centered on core deposits, the growth of the time deposit portfolio is the result of targeted marketing efforts in select markets. The increase in deposits is the result of our focus on building relationships, not by offering market leading rates.

Deposit balances and their changes for the periods being discussed follow:
 
 
June 30, 2019
 
December 31, 2018
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Demand deposits
 
$
322,755

 
24.32
%
 
$
320,814

 
26.30
%
 
$
1,941

 
0.61
 %
NOW accounts
 
238,410

 
17.96

 
207,819

 
17.04

 
30,591

 
14.72

Money market deposits
 
238,352

 
17.96

 
238,596

 
19.56

 
(244
)
 
(0.10
)
Savings deposits
 
171,992

 
12.96

 
166,063

 
13.61

 
5,929

 
3.57

Time deposits
 
355,577

 
26.80

 
286,611

 
23.49

 
68,966

 
24.06

 Total deposits
 
$
1,327,086

 
100.00
%
 
$
1,219,903

 
100.00
%
 
$
107,183

 
8.79
 %

Borrowed Funds

Total borrowed funds decreased 30.23%, or $92,757,000, to $214,050,000 at June 30, 2019 compared to $306,807,000 at December 31, 2018. The decrease in total borrowing occurred due to the strong growth in deposits as a funding source as the loan portfolio remained flat. The long-term borrowings originating during the six months ended June 30, 2019 have a blended interest rate of 2.94% and mature by 2024.

 
 
June 30, 2019
 
December 31, 2018
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Short-term borrowings:
 
 

 
 

 
 

 
 

 
 

 
 

FHLB repurchase agreements
 
$
52,553

 
24.55
%
 
$
162,203

 
52.87
%
 
$
(109,650
)
 
(67.60
)%
Securities sold under agreement to repurchase
 
6,900

 
3.22

 
5,662

 
1.85

 
1,238

 
21.87

Total short-term borrowings
 
59,453

 
27.77

 
167,865

 
54.72

 
(108,412
)
 
(64.58
)
Long-term borrowings:
 
 
 
 
 
 
 
 
 
 
 
 
Long-term FHLB borrowings
 
148,625

 
69.43

 
138,625

 
45.18

 
10,000

 
7.21

Long-term finance lease
 
5,972

 
2.79

 

 

 
5,972

 
n/a

Long-term capital lease
 

 

 
317

 
0.10

 
(317
)
 
(100.00
)
Total long-term borrowings
 
154,597

 
72.23

 
138,942

 
45.28

 
15,655

 
11.27

Total borrowed funds
 
$
214,050

 
100.00
%
 
$
306,807

 
100.00
%
 
$
(92,757
)
 
(30.23
)%

Short-Term Borrowings

The following table provides further information in regards to secured borrowings that have been accounted for as repurchase agreements.
 
 
Remaining Contractual Maturity Overnight and Continuous
(In Thousands)
 
June 30, 2019
 
December 31, 2018
Investment debt securities pledged, fair value
 
$
9,729

 
$
8,380

Repurchase agreements
 
6,900

 
5,662







42

Table of Contents


Capital

The adequacy of the Company’s capital is reviewed on an ongoing basis with reference to the size, composition, and quality of the Company’s resources and regulatory guidelines.  Management seeks to maintain a level of capital sufficient to support existing assets and anticipated asset growth, maintain favorable access to capital markets, and preserve high quality credit ratings.

Bank holding companies are required to comply with the Federal Reserve Board’s risk-based capital guidelines.  The risk-based capital rules are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and to minimize disincentives for holding liquid assets.  Specifically, each is required to maintain certain minimum dollar amounts and ratios of common equity tier I risk-based, tier I risk-based, total risk-based, and tier I leverage capital. In addition to the capital requirements, the Federal Deposit Insurance Corporation Improvements Act ("FDICIA") established five capital categories for banks ranging from “well capitalized” to “critically undercapitalized” for purposes of the FDIC's prompt corrective action rules. To be classified as “well capitalized” under the prompt corrective action rules, common equity tier I risk-based, tier I risked-based, total risk-based, and tier I leverage capital ratios must be at least 6.5%, 8%, 10%, and 5%, respectively.

Under existing capital rules, the minimum capital to risk-adjusted assets requirements for banking organizations, are a common equity tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”), a tier 1 capital ratio of 6.0% (8.0% to be considered “well capitalized”), and total capital ratio of 8.0% (10.0% to be considered “well capitalized”).  Under existing capital rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. The capital contribution buffer requirements phased in over a three-year period beginning January 1, 2016.

The Company's capital ratios as of June 30, 2019 and December 31, 2018 were as follows:
 
 
June 30, 2019
 
December 31, 2018
(In Thousands)
 
Amount
 
Ratio
 
Amount
 
Ratio
Common Equity Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
136,821

 
10.390
%
 
$
132,543

 
10.178
%
For Capital Adequacy Purposes
 
59,258

 
4.500

 
58,601

 
4.500

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
92,180

 
7.000

 
83,018

 
6.375

To Be Well Capitalized
 
85,595

 
6.500

 
84,646

 
6.500

Total Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
147,875

 
11.230
%
 
$
142,876

 
10.972
%
For Capital Adequacy Purposes
 
105,343

 
8.000

 
104,175

 
8.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
138,262

 
10.500

 
128,591

 
9.875

To Be Well Capitalized
 
131,679

 
10.000

 
130,219

 
10.000

Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
136,821

 
10.390
%
 
$
132,543

 
10.178
%
For Capital Adequacy Purposes
 
79,011

 
6.000

 
78,135

 
6.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
111,932

 
8.500

 
102,552

 
7.875

To Be Well Capitalized
 
105,348

 
8.000

 
104,180

 
8.000

Tier I Capital (to Average Assets)
 
 

 
 

 
 

 
 

Actual
 
$
136,821

 
8.320
%
 
$
132,543

 
8.176
%
For Capital Adequacy Purposes
 
65,779

 
4.000

 
64,845

 
4.000

To Be Well Capitalized
 
82,224

 
5.000

 
81,056

 
5.000

 

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Table of Contents


Jersey Shore State Bank's capital ratios as of June 30, 2019 and December 31, 2018 were as follows:
 
 
June 30, 2019
 
December 31, 2018
(In Thousands)
 
Amount
 
Ratio
 
Amount
 
Ratio
Common Equity Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
96,911

 
10.056
%
 
$
94,105

 
9.879
%
For Capital Adequacy Purposes
 
43,367

 
4.500

 
42,866

 
4.500

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
67,460

 
7.000

 
60,727

 
6.375

To Be Well Capitalized
 
62,641

 
6.500

 
61,917

 
6.500

Total Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
105,673

 
10.965
%
 
$
102,534

 
10.764
%
For Capital Adequacy Purposes
 
77,098

 
8.000

 
76,205

 
8.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
101,192

 
10.500

 
94,066

 
9.875

To Be Well Capitalized
 
96,373

 
10.000

 
95,256

 
10.000

Tier I Capital (to Risk-weighted Assets)
 
-

 
 

 
 

 
 

Actual
 
$
96,911

 
10.056
%
 
$
94,105

 
9.879
%
For Capital Adequacy Purposes
 
57,823

 
6.000

 
57,155

 
6.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
81,916

 
8.500

 
75,015

 
7.875

To Be Well Capitalized
 
77,097

 
8.000

 
76,206

 
8.000

Tier I Capital (to Average Assets)
 
 

 
 

 
 

 
 

Actual
 
$
96,911

 
7.874
%
 
$
94,105

 
7.724
%
For Capital Adequacy Purposes
 
49,231

 
4.000

 
48,734

 
4.000

To Be Well Capitalized
 
61,539

 
5.000

 
60,917

 
5.000


Luzerne Bank's capital ratios as of June 30, 2019 and December 31, 2018 were as follows:
 
 
June 30, 2019
 
December 31, 2018
(In Thousands)
 
Amount
 
Ratio
 
Amount
 
Ratio
Common Equity Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
37,108

 
10.384
%
 
$
35,378

 
10.061
%
For Capital Adequacy Purposes
 
16,081

 
4.500

 
15,824

 
4.500

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
25,015

 
7.000

 
22,417

 
6.375

To Be Well Capitalized
 
23,228

 
6.500

 
22,856

 
6.500

Total Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
39,400

 
11.026
%
 
$
37,283

 
10.603
%
For Capital Adequacy Purposes
 
28,587

 
8.000

 
28,130

 
8.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
37,520

 
10.500

 
34,723

 
9.875

To Be Well Capitalized
 
35,734

 
10.000

 
35,163

 
10.000

Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
37,108

 
10.384
%
 
$
35,378

 
10.061
%
For Capital Adequacy Purposes
 
21,441

 
6.000

 
21,098

 
6.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
30,375

 
8.500

 
27,691

 
7.875

To Be Well Capitalized
 
28,589

 
8.000

 
28,131

 
8.000

Tier I Capital (to Average Assets)
 
 

 
 

 
 

 
 

Actual
 
$
37,108

 
8.581
%
 
$
35,378

 
8.655
%
For Capital Adequacy Purposes
 
17,298

 
4.000

 
16,350

 
4.000

To Be Well Capitalized
 
21,622

 
5.000

 
20,438

 
5.000


Liquidity; Interest Rate Sensitivity and Market Risk

The asset/liability committee addresses the liquidity needs of the Company to ensure that sufficient funds are available to meet credit demands and deposit withdrawals as well as to the placement of available funds in the investment portfolio.  In assessing liquidity requirements, equal consideration is given to the current position as well as the future outlook.

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The following liquidity measures are monitored for compliance and were within the limits cited, except for net loans to total deposits, at June 30, 2019:

1.            Net Loans to Total Assets, 85% maximum
2.              Net Loans to Total Deposits, 100% maximum
3.              Cumulative 90 day Maturity GAP %, +/- 20% maximum
4.              Cumulative 1 Year Maturity GAP %, +/- 25% maximum

Fundamental objectives of the Company’s asset/liability management process are to maintain adequate liquidity while minimizing interest rate risk. The maintenance of adequate liquidity provides the Company with the ability to meet its financial obligations to depositors, loan customers, and shareholders. Additionally, it provides funds for normal operating expenditures and business opportunities as they arise.  The objective of interest rate sensitivity management is to increase net interest income by managing interest sensitive assets and liabilities in such a way that they can be repriced in response to changes in market interest rates.

The Banks, like other financial institutions, must have sufficient funds available to meet liquidity needs for deposit withdrawals, loan commitments and originations, and expenses. In order to control cash flow, the Banks estimate future cash flows from deposits, loan payments, and investment security payments. The primary sources of funds are deposits, principal and interest payments on loans and investment securities, FHLB borrowings, and brokered deposits. Management believes the Banks have adequate resources to meet their normal funding requirements.

Management monitors the Company’s liquidity on both a long and short-term basis, thereby providing management necessary information to react to current balance sheet trends. Cash flow needs are assessed and sources of funds are determined. Funding strategies consider both customer needs and economical cost. Both short and long-term funding needs are addressed by maturities and sales of available for sale and trading investment securities, loan repayments and maturities, and liquidating money market investments such as federal funds sold. The use of these resources, in conjunction with access to credit, provides core funding to satisfy depositor, borrower, and creditor needs.

Management monitors and determines the desirable level of liquidity. Consideration is given to loan demand, investment opportunities, deposit pricing and growth potential, as well as the current cost of borrowing funds. The Company has a total current maximum borrowing capacity at the FHLB of $603,404,000. In addition to this credit arrangement, the Company has additional lines of credit with correspondent banks of $57,000,000. Management believes it has sufficient liquidity to satisfy estimated short-term and long-term funding needs. FHLB borrowings totaled $201,178,000 as of June 30, 2019.

Interest rate sensitivity, which is closely related to liquidity management, is a function of the repricing characteristics of the Company’s portfolio of assets and liabilities. Asset/liability management strives to match maturities and rates between loan and investment security assets with the deposit liabilities and borrowings that fund them. Successful asset/liability management results in a balance sheet structure which can cope effectively with market rate fluctuations. The matching process segments both assets and liabilities into future time periods (usually 12 months, or less) based upon when repricing can be effected. Repriceable assets are subtracted from repriceable liabilities for a specific time period to determine the “gap”, or difference. Once known, the gap is managed based on predictions about future market interest rates. Intentional mismatching, or gapping, can enhance net interest income if market rates move as predicted.  However, if market rates behave in a manner contrary to predictions, net interest income will suffer. Gaps, therefore, contain an element of risk and must be prudently managed. In addition to gap management, the Company has an asset/liability management policy which incorporates a market value at risk calculation which is used to determine the effects of interest rate movements on shareholders’ equity and a simulation analysis to monitor the effects of interest rate changes on the Company’s consolidated balance sheet.

The Company currently maintains a gap position of being asset sensitive.  The Company has strategically taken this position as it has decreased the duration of the earning asset portfolio by adding quality short and intermediate term loans such as home equity loans and the selling of long-term municipal bonds.  Lengthening of the liability portfolio is being undertaken to build protection in a rising rate environment.

A market value at risk calculation is utilized to monitor the effects of interest rate changes on the Company’s balance sheet and more specifically shareholders’ equity.  The Company does not manage the balance sheet structure in order to maintain compliance with this calculation.  The calculation serves as a guideline with greater emphasis placed on interest rate sensitivity.  Changes to calculation results from period to period are reviewed as changes in results could be a signal of future events.  As of the most recent analysis, the results of the market value at risk calculation were within established guidelines due to the strategic direction being taken.


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Interest Rate Sensitivity

In this analysis the Company examines the result of a 100, 200, 300, and 400 basis point change in market interest rates and the effect on net interest income. It is assumed that the change is instantaneous and that all rates move in a parallel manner.  Assumptions are also made concerning prepayment speeds on mortgage loans and mortgage securities.

The following is a rate shock forecast for the twelve month period ending June 30, 2020 assuming a static balance sheet as of June 30, 2019.
 
 
Parallel Rate Shock in Basis Points
(In Thousands)
 
-200
 
-100
 
Static
 
+100
 
+200
 
+300
 
+400
Net interest income
 
$
47,706

 
$
50,569

 
$
52,948

 
$
54,710

 
$
56,391

 
$
57,898

 
$
59,444

Change from static
 
(5,242
)
 
(2,379
)
 

 
1,762

 
3,443

 
4,950

 
6,496

Percent change from static
 
-9.90
 %
 
-4.49
 %
 

 
3.33
%
 
6.50
%
 
9.35
%
 
12.27
%
 
The model utilized to create the report presented above makes various estimates at each level of interest rate change regarding cash flow from principal repayment on loans and mortgage-backed securities and/or call activity on investment securities.  Actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change.  In addition, the limits stated above do not necessarily represent the level of change under which management would undertake specific measures to realign its portfolio in order to reduce the projected level of change.  Generally, management believes the Company is well positioned to respond expeditiously when the market interest rate outlook changes.

Inflation

The asset and liability structure of a financial institution is primarily monetary in nature.  Therefore, interest rates rather than inflation have a more significant impact on the Company’s performance.  Interest rates are not always affected in the same direction or magnitude as prices of other goods and services, but are reflective of fiscal policy initiatives or economic factors which are not measured by a price index.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Market risk for the Company is comprised primarily of interest rate risk exposure and liquidity risk.  Interest rate risk and liquidity risk management is performed at both the level of the Company and the Banks.  The Company’s interest rate sensitivity is monitored by management through selected interest rate risk measures produced by an independent third party.  There have been no substantial changes in the Company’s gap analysis or simulation analysis compared to the information provided in the Annual Report on Form 10-K for the period ended December 31, 2018.  Additional information and details are provided in the “Liquidity, Interest Rate Sensitivity, and Market Risk” section of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Generally, management believes the Company is well positioned to respond in a timely manner when the market interest rate outlook changes.

Item 4.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An analysis was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2019.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2019 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II.  OTHER INFORMATION
Item 1.                           Legal Proceedings
 
None.

Item 1A.  Risk Factors
 
There are no material changes to the risk factors set forth in Part I, Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.  Please refer to that section for disclosures regarding the risks and uncertainties related to the Company’s business.

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

The following table provides certain information with respect to the Company's repurchase of common stock during the quarter ended June 30, 2019.
Period
 
Total
Number of
Shares (or
Units) Purchased
 
Average
Price Paid
per Share
(or Units) Purchased
 
Total Number of
Shares (or Units)
Purchased as Part of
Publicly Announced Plans or Programs
 
Maximum Number (or
Approximate Dollar Value)
of Shares (or Units) that
May Yet Be Purchased Under the Plans or Programs
Month #1 (April 1 - April 30, 2019)
 

 

 

 
342,446

Month #2 (May 1 - May 31, 2019)
 

 

 

 
342,446

Month #3 (June 1 - June 30, 2019)
 

 

 

 
342,446


On April 29, 2019, the Board of Directors extended the previously approved authorization to repurchase up to 482,000 shares, or approximately 10%, of the outstanding shares of the Company for an additional year to April 30, 2020.  As of June 30, 2019 there have been 139,554 shares repurchased under this plan.

Item 3.                           Defaults Upon Senior Securities
 
None.
 
Item 4.                           Mine Safety Disclosures
 
Not applicable.
 
Item 5.                           Other Information
 
None.
 

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Item 6.                           Exhibits
 
 
Articles of Incorporation of the Registrant, as presently in effect (incorporated by reference to Exhibit 3(i) of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2018).
 
Bylaws of the Registrant (incorporated by reference to Exhibit 3(ii) of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2011).
 
Amended and Restated Employment Agreement, dated as of July 23, 2019, between Karen S. Young, Penns Woods Bancorp, Inc. and Jersey Shore State Bank.
 
Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer.
 
Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Financial Officer.
 
Section 1350 Certification of Chief Executive Officer.
 
Section 1350 Certification of Chief Financial Officer.
101
 
Interactive data file containing the following financial statements formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheet at June 30, 2019 and December 31, 2018; (ii) the Consolidated Statement of Income for the three and six months ended June 30, 2019 and 2018; (iii) Consolidated Statement of Comprehensive Income for the three and six months ended June 30, 2019 and 2018; (iv) the Consolidated Statement of Shareholders’ Equity for the three and six months ended June 30, 2019 and 2018; (v) the Consolidated Statement of Cash Flows for the six months ended June 30, 2019 and 2018 and (vi) the Notes to Consolidated Financial Statements. As provided in Rule 406T of Regulation S-T, this interactive data file shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, and shall not be deemed “filed” or part of any registration statement or prospectus for purposes of Section 11 or 12 under the Securities Act of 1933, or otherwise subject to liability under those sections.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
PENNS WOODS BANCORP, INC.
 
 
(Registrant)
 
 
 
Date:    
August 9, 2019
/s/ Richard A. Grafmyre
 
 
Richard A. Grafmyre, Chief Executive Officer
 
 
(Principal Executive Officer)
 
 
 
 
 
 
Date:
August 9, 2019
/s/ Brian L. Knepp
 
 
Brian L. Knepp, President and Chief Financial Officer
 
 
(Principal Financial Officer and Principal Accounting
 
 
Officer)

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EXHIBIT INDEX
 
Exhibit 3(i)
 
Articles of Incorporation of the Registrant, as presently in effect (incorporated by reference to Exhibit 3(i) of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2018).
Exhibit 3(ii)
 
Bylaws of the Registrant (incorporated by reference to Exhibit 3(ii) of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2011).
10(i)
 
Amended and Restated Employment Agreement, dated as of July 23, 2019, between Karen S. Young, Penns Woods Bancorp, Inc. and Jersey Shore State Bank.
Exhibit 31(i)
 
Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer
Exhibit 31(ii)
 
Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Financial Officer
Exhibit 32(i)
 
Section 1350 Certification of Chief Executive Officer
Exhibit 32(ii)
 
Section 1350 Certification of Chief Financial Officer
Exhibit 101
 
Interactive data file containing the following financial statements formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheet at June 30, 2019 and December 31, 2018; (ii) the Consolidated Statement of Income for the three and six months ended June 30, 2019 and 2018; (iii) Consolidated Statement of Comprehensive Income for the three and six months ended June 30, 2019 and 2018; (iv) the Consolidated Statement of Shareholders’ Equity for the three and six months ended June 30, 2019 and 2018; (v) the Consolidated Statement of Cash Flows for the six months ended June 30, 2019 and 2018 and (vi) the Notes to Consolidated Financial Statements. As provided in Rule 406T of Regulation S-T, this interactive data file shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, and shall not be deemed “filed” or part of any registration statement or prospectus for purposes of Section 11 or 12 under the Securities Act of 1933, or otherwise subject to liability under those sections.

50