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PENNS WOODS BANCORP INC - Quarter Report: 2020 June (Form 10-Q)



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, 2020. 
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, $5.55 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, 2020 there were 7,046,676 shares of the Registrant’s common stock outstanding.




PENNS WOODS BANCORP, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

 
 
Page
 
 
Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2



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)
 
2020
 
2019
ASSETS:
 
 

 
 

Noninterest-bearing balances
 
$
26,932

 
$
24,725

Interest-bearing balances in other financial institutions
 
188,242

 
23,864

Total cash and cash equivalents
 
215,174

 
48,589

 
 
 
 
 
Investment debt securities, available for sale, at fair value
 
164,369

 
148,619

Investment equity securities, at fair value
 
1,291


1,261

Investment securities, trading
 
37

 
51

Restricted investment in bank stock, at fair value
 
14,849

 
13,528

Loans held for sale
 
5,146

 
4,232

Loans
 
1,349,347

 
1,355,544

Allowance for loan losses
 
(12,977
)
 
(11,894
)
Loans, net
 
1,336,370

 
1,343,650

Premises and equipment, net
 
32,873

 
32,929

Accrued interest receivable
 
8,068

 
5,246

Bank-owned life insurance
 
29,368

 
29,253

Goodwill
 
17,104

 
17,104

Intangibles
 
777

 
898

Operating lease right-of-use asset
 
3,231

 
4,154

Deferred tax asset
 
3,284

 
3,338

Other assets
 
6,423

 
12,471

TOTAL ASSETS
 
$
1,838,364

 
$
1,665,323

 
 
 
 
 
LIABILITIES:
 
 

 
 

Interest-bearing deposits
 
$
1,055,981

 
$
989,259

Noninterest-bearing deposits
 
418,324

 
334,746

Total deposits
 
1,474,305

 
1,324,005

 
 
 
 
 
Short-term borrowings
 
15,133

 
4,920

Long-term borrowings
 
171,885

 
161,920

Accrued interest payable
 
1,530

 
1,671

Operating lease liability
 
3,263

 
4,170

Other liabilities
 
12,640

 
13,655

TOTAL LIABILITIES
 
1,678,756

 
1,510,341

 
 
 
 
 
SHAREHOLDERS’ EQUITY:
 
 

 
 

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

 

Common stock, par value $5.55, 22,500,000 shares authorized; 7,522,573 and 7,520,740 shares issued; 7,042,348 and 7,040,515 outstanding
 
41,792

 
41,782

Additional paid-in capital
 
51,956

 
51,487

Retained earnings
 
78,910

 
76,583

Accumulated other comprehensive loss:
 
 

 
 

Net unrealized gain on available for sale securities
 
4,194

 
2,455

Defined benefit plan
 
(5,159
)
 
(5,232
)
Treasury stock at cost, 480,225
 
(12,115
)
 
(12,115
)
TOTAL PENNS WOODS BANCORP, INC. SHAREHOLDERS' EQUITY
 
159,578

 
154,960

Non-controlling interest
 
30

 
22

TOTAL SHAREHOLDERS' EQUITY
 
159,608

 
154,982

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
1,838,364

 
$
1,665,323


See accompanying notes to the unaudited consolidated financial statements.

3



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)
 
2020
 
2019
 
2020
 
2019
INTEREST AND DIVIDEND INCOME:
 
 

 
 

 
 

 
 

Loans, including fees
 
$
14,666

 
$
15,300

 
$
29,323

 
$
30,169

Investment securities:
 
 

 
 

 
 

 
 

Taxable
 
1,023

 
967

 
2,033

 
1,901

Tax-exempt
 
169

 
179

 
314

 
353

Dividend and other interest income
 
186

 
395

 
535

 
852

TOTAL INTEREST AND DIVIDEND INCOME
 
16,044

 
16,841

 
32,205

 
33,275

INTEREST EXPENSE:
 
 

 
 

 
 

 
 

Deposits
 
2,802

 
2,871

 
5,837

 
5,171

Short-term borrowings
 
7

 
178

 
29

 
783

Long-term borrowings
 
985

 
879

 
1,928

 
1,730

TOTAL INTEREST EXPENSE
 
3,794

 
3,928

 
7,794

 
7,684

NET INTEREST INCOME
 
12,250

 
12,913

 
24,411

 
25,591

PROVISION FOR LOAN LOSSES
 
645

 
315

 
1,395

 
675

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
 
11,605

 
12,598

 
23,016

 
24,916

NON-INTEREST INCOME:
 
 

 
 

 
 

 
 

Service charges
 
312

 
592

 
861

 
1,154

Net debt securities gains (losses), available for sale
 
186

 
(2
)
 
207

 
11

Net equity securities gains
 
10

 
22

 
30

 
65

Net securities gains (losses), trading
 

 
3

 
(14
)
 
13

Bank-owned life insurance
 
144

 
123

 
336

 
291

Gain on sale of loans
 
1,028

 
347

 
1,472

 
663

Insurance commissions
 
92

 
119

 
219

 
253

Brokerage commissions
 
186

 
356

 
555

 
679

Debit card fees
 
310

 
389

 
584

 
699

Other
 
353

 
520

 
808

 
895

TOTAL NON-INTEREST INCOME
 
2,621

 
2,469

 
5,058

 
4,723

NON-INTEREST EXPENSE:
 
 

 
 

 
 

 
 

Salaries and employee benefits
 
5,230

 
5,523

 
10,897

 
11,024

Occupancy
 
626

 
668

 
1,328

 
1,447

Furniture and equipment
 
828

 
784

 
1,688

 
1,536

Software amortization
 
236

 
188

 
486

 
395

Pennsylvania shares tax
 
323

 
285

 
608

 
578

Professional fees
 
658

 
727

 
1,280

 
1,249

Federal Deposit Insurance Corporation deposit insurance
 
185

 
236

 
379

 
504

Marketing
 
56

 
33

 
109

 
135

Intangible amortization
 
59

 
69

 
121

 
140

Other
 
1,410

 
1,546

 
2,825

 
2,865

TOTAL NON-INTEREST EXPENSE
 
9,611

 
10,059

 
19,721

 
19,873

INCOME BEFORE INCOME TAX PROVISION
 
4,615

 
5,008

 
8,353

 
9,766

INCOME TAX PROVISION
 
851

 
759

 
1,512

 
1,571

CONSOLIDATED NET INCOME
 
$
3,764

 
$
4,249

 
$
6,841

 
$
8,195

Less: Net income attributable to noncontrolling interest
 
4

 
4

 
8

 
6

NET INCOME ATTRIBUTABLE TO PENNS WOODS BANCORP, INC.
 
$
3,760

 
$
4,245

 
$
6,833

 
$
8,189

EARNINGS PER SHARE - BASIC
 
$
0.53

 
$
0.60

 
$
0.97

 
$
1.16

EARNINGS PER SHARE - DILUTED
 
$
0.53

 
$
0.60

 
$
0.97

 
$
1.16

WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC
 
7,041,629

 
7,038,503

 
7,041,185

 
7,038,068

WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED
 
7,041,629

 
7,038,503

 
7,041,185

 
7,038,068

DIVIDENDS DECLARED PER SHARE
 
$
0.32

 
$
0.31

 
$
0.64

 
$
0.63

See accompanying notes to the unaudited consolidated financial statements.

4





PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2020
 
2019
 
2020
 
2019
Net Income
 
$
3,760

 
$
4,245

 
$
6,833

 
$
8,189

Other comprehensive income:
 
 

 
 

 
 

 
 

Change in unrealized gain on available for sale securities
 
1,715

 
2,811

 
2,409

 
4,795

Tax effect
 
(360
)
 
(590
)
 
(506
)
 
(1,007
)
Net realized (gain) loss on available for sale securities included in net income
 
(186
)
 
2

 
(207
)
 
(11
)
Tax effect
 
39

 
(1
)
 
43

 
2

   Amortization of unrecognized pension gain
 
51

 
47

 
92

 
94

        Tax effect
 
(11
)
 
(10
)
 
(19
)
 
(20
)
Total other comprehensive income
 
1,248

 
2,259

 
1,812

 
3,853

Comprehensive income
 
$
5,008

 
$
6,504

 
$
8,645

 
$
12,042

 
See accompanying notes to the unaudited consolidated financial statements.

5



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, 2020
 
7,521,491

 
$
41,786

 
$
51,701

 
$
77,403

 
$
(2,213
)
 
$
(12,115
)
 
$
26

 
$
156,588

Net income
 
 

 
 

 
 

 
3,760

 
 

 
 

 
4

 
3,764

Other comprehensive income
 
 
 
 
 
 
 
 
 
1,248

 
 
 
 
 
1,248

Stock-based compensation
 
 
 
 
 
238

 
 
 
 

 
 

 
 
 
238

Dividends declared ($0.32 per share)
 
 

 
 

 
 

 
(2,253
)
 
 

 
 

 
 
 
(2,253
)
Common shares issued for employee stock purchase plan
 
1,082

 
6

 
17

 
 
 
 
 
 
 
 
 
23

Balance, June 30, 2020
 
7,522,573

 
$
41,792

 
$
51,956

 
$
78,910

 
$
(965
)
 
$
(12,115
)
 
$
30

 
$
159,608



 
 
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
 
7,518,410

 
$
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 ($0.31 per share)
 
 

 
 

 
 

 
(2,206
)
 
 

 
 

 
 
 
(2,206
)
Common shares issued for employee stock purchase plan
 
937

 
6

 
20

 
 

 
 

 
 

 
 
 
26

Balance, June 30, 2019
 
7,519,347

 
$
41,773

 
$
51,087

 
$
73,565

 
$
(2,783
)
 
$
(12,115
)
 
$
14

 
$
151,541













6





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, 2019
 
7,520,740

 
$
41,782

 
$
51,487

 
$
76,583

 
$
(2,777
)
 
$
(12,115
)
 
$
22

 
$
154,982

Net income
 
 

 
 

 
 

 
6,833

 
 

 
 

 
8

 
6,841

Other comprehensive income
 
 

 
 

 
 

 
 

 
1,812

 
 

 
 
 
1,812

Stock-based compensation
 
 
 
 
 
436

 
 
 
 
 
 
 
 
 
436

Dividends declared ($0.64 per share)
 
 

 
 

 
 

 
(4,506
)
 
 

 
 

 
 
 
(4,506
)
Common shares issued for employee stock purchase plan
 
1,833

 
10

 
33

 
 

 
 

 
 

 
 
 
43

Balance, June 30, 2020
 
7,522,573

 
$
41,792

 
$
51,956

 
$
78,910

 
$
(965
)
 
$
(12,115
)
 
$
30

 
$
159,608



 
 
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
 
7,517,547

 
$
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 ($0.63 per share)
 
 

 
 

 
 

 
(4,411
)
 
 

 
 

 
 
 
(4,411
)
Common shares issued for employee stock purchase plan
 
1,800

 
10

 
37

 
 

 
 

 
 

 
 
 
47

Balance, June 30, 2019
 
7,519,347

 
$
41,773

 
$
51,087

 
$
73,565

 
$
(2,783
)
 
$
(12,115
)
 
$
14

 
$
151,541





See accompanying notes to the unaudited consolidated financial statements.

7



PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED) 
 
 
Six Months Ended June 30,
(In Thousands)
 
2020
 
2019
OPERATING ACTIVITIES:
 
 

 
 

Net Income
 
$
6,841

 
$
8,195

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

 
 

Depreciation and amortization
 
1,286

 
1,376

Gain on sale of premise and equipment
 
(14
)
 

Amortization of intangible assets
 
121

 
140

Provision for loan losses
 
1,395

 
675

Stock based compensation
 
436

 
313

Accretion and amortization of investment security discounts and premiums
 
371

 
326

Net securities gains, available for sale
 
(207
)
 
(11
)
Originations of loans held for sale
 
(49,660
)
 
(21,400
)
Proceeds of loans held for sale
 
50,218

 
22,112

Gain on sale of loans
 
(1,472
)
 
(663
)
Net equity securities gains
 
(30
)
 
(65
)
Net securities losses (gains), trading
 
14

 
(13
)
Proceeds from the sale of trading securities
 

 
78

Purchases of trading securities
 

 
(73
)
Earnings on bank-owned life insurance
 
(336
)
 
(291
)
(Increase) decrease in deferred tax asset
 
(408
)
 
437

Other, net
 
3,434

 
(2,754
)
Net cash provided by operating activities
 
11,989

 
8,382

INVESTING ACTIVITIES:
 
 

 
 

Proceeds from sales of available for sale securities
 
5,163

 
8,132

Proceeds from calls and maturities of available for sale securities
 
6,691

 
1,951

Purchases of available for sale securities
 
(25,567
)
 
(17,018
)
Net decrease in loans
 
5,746

 
4,680

Acquisition of premises and equipment
 
(2,286
)
 
(1,324
)
Proceeds from the sale of premises and equipment
 
336

 

Proceeds from the sale of foreclosed assets
 
226

 
195

Purchase of bank-owned life insurance
 
(27
)
 
(26
)
Proceeds from bank-owned life insurance death benefit
 
248

 

Investment in limited partnership
 
(628
)
 

Proceeds from redemption of regulatory stock
 
1,795

 
10,515

Purchases of regulatory stock
 
(3,116
)
 
(6,740
)
Net cash (used for) provided by investing activities
 
(11,419
)
 
365

FINANCING ACTIVITIES:
 
 

 
 

Net increase in interest-bearing deposits
 
66,722

 
105,242

Net increase in noninterest-bearing deposits
 
83,578

 
1,941

Proceeds from long-term borrowings
 
35,000

 
25,000

Repayment of long-term borrowings
 
(25,000
)
 
(15,317
)
Net increase (decrease) in short-term borrowings
 
10,213

 
(108,412
)
Finance lease principal payments
 
(35
)
 
(54
)
Dividends paid
 
(4,506
)
 
(4,411
)
Issuance of common stock
 
43

 
47

Net cash provided by financing activities
 
166,015

 
4,036

NET INCREASE IN CASH AND CASH EQUIVALENTS
 
166,585

 
12,783

CASH AND CASH EQUIVALENTS, BEGINNING
 
48,589

 
66,742

CASH AND CASH EQUIVALENTS, ENDING
 
$
215,174

 
$
79,525

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 

 
 

Interest paid
 
$
7,935

 
$
7,352

Income taxes paid
 

 

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
 
139

 
281

See accompanying notes to the unaudited consolidated financial statements.

8



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, 2019.

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, 2020 and 2019 were as follows:
 
 
Three Months Ended June 30, 2020
 
Three Months Ended June 30, 2019
(In Thousands)
 
Net Unrealized Gain (Loss) on Available
for Sale Securities
 
Defined
Benefit 
Plan
 
Total
 
Net Unrealized
Gain on Available
for Sale Securities
 
Defined
Benefit 
Plan
 
Total
Beginning balance
 
$
2,986

 
$
(5,199
)
 
$
(2,213
)
 
$
197

 
$
(5,239
)
 
$
(5,042
)
Other comprehensive gain before reclassifications
 
1,355

 

 
1,355

 
2,221

 

 
2,221

Amounts reclassified from accumulated other comprehensive (loss) gain
 
(147
)
 
40

 
(107
)
 
1

 
37

 
38

Net current-period other comprehensive income
 
1,208

 
40

 
1,248

 
2,222

 
37

 
2,259

Ending balance
 
$
4,194

 
$
(5,159
)
 
$
(965
)
 
$
2,419

 
$
(5,202
)
 
$
(2,783
)
 
 
Six Months Ended June 30, 2020
 
Six Months Ended June 30, 2019
(In Thousands)
 
Net Unrealized Gain (Loss) on Available for Sale Securities
 
Defined
Benefit 
Plan
 
Total
 
Net Unrealized (Loss) Gain on Available
for Sale Securities
 
Defined
Benefit 
Plan
 
Total
Beginning balance
 
$
2,455

 
$
(5,232
)
 
$
(2,777
)
 
$
(1,360
)
 
$
(5,276
)
 
$
(6,636
)
Other comprehensive gain before reclassifications
 
1,903

 

 
1,903

 
3,788

 

 
3,788

Amounts reclassified from accumulated other comprehensive (loss) gain
 
(164
)
 
73

 
(91
)
 
(9
)
 
74

 
65

Net current-period other comprehensive income
 
1,739

 
73

 
1,812

 
3,779

 
74

 
3,853

Ending balance
 
$
4,194

 
$
(5,159
)
 
$
(965
)
 
$
2,419

 
$
(5,202
)
 
$
(2,783
)





9



The reclassifications out of accumulated other comprehensive loss shown, net of tax and parenthesis indicating debits to net income, as of June 30, 2020 and 2019 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, 2020
 
Three Months Ended June 30, 2019
 
Net unrealized gain (loss) on available for sale securities
 
$
186

 
$
(2
)
 
Net debt securities gains (losses), available for sale
Income tax effect
 
(39
)
 
1

 
Income tax provision
Total reclassifications for the period
 
$
147

 
$
(1
)
 
 
 
 
 
 
 
 
 
Net unrecognized pension costs
 
$
(51
)
 
$
(47
)
 
Salaries and employee benefits
Income tax effect
 
11

 
10

 
Income tax provision
Total reclassifications for the period
 
$
(40
)
 
$
(37
)
 
 
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, 2020
 
Six months ended June 30, 2019
 
Net unrealized gain on available for sale securities
 
$
207

 
$
11

 
Net debt securities gains, available for sale
Income tax effect
 
(43
)
 
(2
)
 
Income tax provision
Total reclassifications for the period
 
$
164

 
$
9

 
 
 
 
 
 
 
 
 
Net unrecognized pension costs
 
$
(92
)
 
$
(94
)
 
Salaries and employee benefits
Income tax effect
 
19

 
20

 
Income tax provision
Total reclassifications for the period
 
$
(73
)
 
$
(74
)
 
 


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. On October 16, 2019, the FASB voted to defer the effective date for ASC 326, Financial Instruments - Credit Losses, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years.  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.

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

10



December 15, 2021. On October 16, 2019, the FASB voted to defer the effective date for ASC 350, Intangibles - Goodwill and Other, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years.  This Update did not 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 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.On October 16, 2019, the FASB voted to defer the effective date for ASC 326, Financial Instruments - Credit Losses, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years.  The final ASU is expected to be issued in mid-November. 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. On October 16, 2019, the FASB voted to defer the effective date for ASC 326, Financial Instruments - Credit Losses, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years.  This Update is not expected to have a significant impact on the Company’s financial statements.

In November 2019, the FASB issued ASU 2019-09, Financial Services - Insurance (Topic 944), which defers the effective date of the amendments in Update 2018-12, Financial Services - Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts. For public business entities that meet the definition of an SEC filer, excluding entities eligible to be smaller reporting companies, as defined by the SEC, the amendments in Update 2018-12 are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. Early application of the amendments in Update 2018-12 is permitted. For all other entities, the amendments in Update 2018-12 are effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024. Early application of the amendments in Update 2018-12 is permitted. This Update is not expected to have a significant impact on the Company’s financial statements.

In November 2019, the FASB issued ASU 2019-10, Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). The Update defers the effective dates of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. This Update also amends the mandatory effective date for the elimination of Step 2 from

11



the goodwill impairment test under ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (Goodwill), to align with those used for credit losses. Furthermore, the ASU provides a one-year deferral of the effective dates of the ASUs on derivatives and hedging and leases for companies that are not public business entities. The Company qualifies as a smaller reporting company and does not expect to early adopt these ASUs.

In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, to clarify its new credit impairment guidance in ASC 326, based on implementation issues raised by stakeholders. This Update clarified, among other things, that expected recoveries are to be included in the allowance for credit losses for these financial assets; an accounting policy election can be made to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions instead of the prepayment assumptions applicable immediately prior to the restructuring event; and extends the practical expedient to exclude accrued interest receivable from all additional relevant disclosures involving amortized cost basis. The effective dates in this Update are the same as those applicable for ASU 2019-10. This Update is not expected to have a significant impact on the Company’s financial statements.

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), to simplify the accounting for income taxes, change the accounting for certain tax transactions, and make minor improvements to the codification. This Update provides a policy election to not allocate consolidated income taxes when a member of a consolidated tax return is not subject to income tax and provides guidance to evaluate whether a step-up in tax basis of goodwill relates to a business combination in which book goodwill was recognized or a separate transaction. The Update also changes current guidance for making an intraperiod allocation, if there is a loss in continuing operations and gains outside of continuing operations; determining when a deferred tax liability is recognized after an investor in a foreign entity transitions to or from the equity method of accounting; accounting for tax law changes and year-to-date losses in interim periods; and determining how to apply the income tax guidance to franchise taxes that are partially based on income. For public business entities, the amendments in this Update are effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2020. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. This Update is not expected to have a significant impact on the Company’s financial statements.

In January 2020, the FASB issued ASU 2020-1, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815), to clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the measurement alternative in accordance with Topic 321 immediately before applying or upon discontinuing the equity method. The amendments also clarify that, for the purpose of applying paragraph 815-10-15-141(a) an entity should not consider whether, upon the settlement of the forward contract or exercise of the purchased option, individually or with existing investments, the underlying securities would be accounted for under the equity method in Topic 323 or the fair value option, in accordance with the financial instruments guidance in Topic 825. An entity also would evaluate the remaining characteristics in paragraph 815-10-15-141 to determine the accounting for those forward contracts and purchased options. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. This Update is not expected to have a significant impact on the Company’s financial statements.

In January 2020, the FASB issued ASU 2020-2, Financial Instruments - Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842), to add and amend SEC paragraphs in the Accounting Standards Codification to reflect the issuance of SEC Staff Accounting Bulletin No. 119, related to the new credit losses standard, and comments by the SEC staff related to the revised effective date of the new leases standard. This ASU is effective upon issuance. This did not have a significant impact on the Company’s financial statements.

In March 2020, the FASB issued ASU 2020-3, Codification Improvements to Financial Instruments. This ASU was issued to improve and clarify various financial instruments topics, including the current expected credit losses (CECL) standard issued in 2016. The ASU includes seven issues that describe the areas of improvement and the related amendments to GAAP; they are intended to make the standards easier to understand and apply and to eliminate inconsistencies, and they are narrow in scope and are not expected to significantly change practice for most entities. Among its provisions, the ASU clarifies that all entities, other than public business entities that elected the fair value option, are required to provide certain fair value disclosures under ASC 825, Financial Instruments, in both interim and annual financial statements. It also clarifies that the contractual term of a net investment in a lease under Topic 842 should be the contractual term used to measure expected credit losses under Topic 326. Amendments related to ASU 2019-04 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is not permitted before an entity’s adoption of ASU 2016-01. Amendments related to ASU 2016-13 for entities that have not yet adopted that guidance are effective upon adoption of the amendments in ASU 2016-13.

12



Early adoption is not permitted before an entity’s adoption of ASU 2016-13. Amendments related to ASU 2016-13 for entities that have adopted that guidance are effective for fiscal years beginning after December 15, 2019, including interim periods within those years. Other amendments are effective upon issuance of this ASU. This Update is not expected to have a significant impact on the Company’s financial statements.

In January 2020, the FASB issued ASU 2020-4, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls reference rate reform, if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. The amendments in this ASU are effective for all entities upon issuance through December 31, 2022. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

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 864,300 stock options, with an average exercise price of $28.20, outstanding on June 30, 2020. These 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 of $22.32 exceeding the exercise price of the options issued. There were a total of 635,550 stock options outstanding for the same period end in 2019 that had an average exercise price of $29.30 and were excluded, on a weighted average basis, in the computation of diluted earnings per share because the quarterly average closing market price of common shares was $27.89 for the period.
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Weighted average common shares issued
 
7,521,854

 
7,518,728

 
7,521,410

 
7,518,293

Weighted average treasury stock shares
 
(480,225
)
 
(480,225
)
 
(480,225
)
 
(480,225
)
Weighted average common shares outstanding - basic
 
7,041,629

 
7,038,503

 
7,041,185

 
7,038,068

Dilutive effect of outstanding stock options
 

 

 

 

Weighted average common shares outstanding - basic and diluted
 
7,041,629

 
7,038,503

 
7,041,185

 
7,038,068


 























13



Note 5. Investment Securities
 
The amortized cost, gross unrealized gains and losses, and fair values of our investment securities portfolio at June 30, 2020 and December 31, 2019 are as follows:
 
 
June 30, 2020
 
 
 
 
Gross
 
Gross
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
(In Thousands)
 
Cost
 
Gains
 
Losses
 
Value
Available for sale (AFS):
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$
2,316

 
$
51

 
$

 
$
2,367

State and political securities
 
92,209

 
5,104

 
(49
)
 
97,264

Other debt securities
 
64,535

 
951

 
(748
)
 
64,738

Total debt securities
 
$
159,060

 
$
6,106

 
$
(797
)
 
$
164,369

 
 
 
 
 
 
 
 
 
Investment equity securities:
 
 
 
 
 
 
 
 
Other equity securities
 
$
1,300

 
$
11

 
$
(20
)
 
$
1,291

 
 
 
 
 
 
 
 
 
Trading:
 
 
 
 
 
 
 
 
Other equity securities
 
$
50

 
$

 
$
(13
)
 
$
37

 
 
 
 
 
 
 
 
 
 
 
December 31, 2019
 
 
 
 
Gross
 
Gross
 
 
 
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
(In Thousands)
 
Cost
 
Gains
 
Losses
 
Value
Available for sale (AFS):
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$
4,956

 
$
56

 
$
(46
)
 
$
4,966

State and political securities
 
79,064

 
3,299

 
(77
)
 
82,286

Other debt securities
 
61,492

 
401

 
(526
)
 
61,367

Total debt securities
 
$
145,512

 
$
3,756

 
$
(649
)
 
$
148,619

 
 
 
 
 
 
 
 
 
Investment equity securities:
 
 
 
 
 
 
 
 
Other equity securities
 
$
1,300

 
$

 
$
(39
)
 
$
1,261

 
 
 
 
 
 
 
 


Trading:
 
 
 
 
 
 
 
 
Other equity securities
 
$
50

 
$
3

 
$
(2
)
 
$
51

 
 
 
 
 
 
 
 
 


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, 2020 and December 31, 2019.
 
 
June 30, 2020
 
 
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
 
$

 
$

 
$

 
$

 
$

 
$

State and political securities
 
4,190

 
(30
)
 
240

 
(19
)
 
4,430

 
(49
)
Other debt securities
 
12,809

 
(287
)
 
7,049

 
(461
)
 
19,858

 
(748
)
Total debt securities
 
$
16,999

 
$
(317
)
 
$
7,289

 
$
(480
)
 
$
24,288

 
$
(797
)
 
 
 
 
 
 
 
 
 
 
 
 
 


14



 
 
December 31, 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
 
$

 
$

 
$
2,115

 
$
(46
)
 
$
2,115

 
$
(46
)
State and political securities
 
7,958

 
(40
)
 
224

 
(37
)
 
8,182

 
(77
)
Other debt securities
 
13,373

 
(216
)
 
14,258

 
(310
)
 
27,631

 
(526
)
Total debt securities
 
$
21,331

 
$
(256
)
 
$
16,597

 
$
(393
)
 
$
37,928

 
$
(649
)
 
 
 
 
 
 
 
 
 
 
 
 
 

 
At June 30, 2020, there were a total of 15 securities in a continuous unrealized loss position for less than twelve months and 7 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, 2020, 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 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, 2020, 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
 
$
6,714

 
$
6,769

Due after one year to five years
 
65,192

 
65,796

Due after five years to ten years
 
67,627

 
72,018

Due after ten years
 
19,527

 
19,786

Total
 
$
159,060

 
$
164,369



Total gross proceeds from sales of debt securities available for sale for the three and six months ended June 30, 2020 were $2,389,000 and $5,163,000 respectively, compared to 2019 totals of $1,146,000 and 8,132,000.

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)
 
2020
 
2019
 
2020
 
2019
Available for sale (AFS):
 
 
 
 
 
 
 
 
Gross realized gains:
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$
83

 
$

 
$
83

 
$

State and political securities
 
103

 

 
104

 
15

Other debt securities
 

 

 
20

 
4

Total gross realized gains
 
$
186

 
$

 
$
207

 
$
19

 
 
 
 
 
 
 
 
 
Gross realized losses:
 
 

 
 

 
 

 
 

State and political securities
 
$

 
$
1

 
$

 
$
3

Other debt securities
 

 
1

 

 
5

Total gross realized losses
 
$

 
$
2

 
$

 
$
8

 
 
 
 
 
 
 
 
 


There were no impairment charges included in gross realized losses for the three and six months ended June 30, 2020 and 2019, respectively.


15



Investment securities with a carrying value of approximately $111,168,381 and $74,163,000 at June 30, 2020 and December 31, 2019, respectively, were pledged to secure certain deposits, repurchase agreements, and for other purposes as required by law.

At June 30, 2020 and December 31, 2019, we had $1,291,000 and $1,261,000, respectively, in equity securities recorded at fair value. 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, 2020 and 2019:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2020
 
2019
 
2020
 
2019
Net gains recognized in equity securities during the period
 
$
10

 
$
22

 
$
30

 
$
65

Less: Net gains realized on the sale of equity securities during the period
 

 

 

 

Unrealized gains recognized in equity securities held at reporting date
 
$
10

 
$
22

 
$
30

 
$
65

 
 
 
 
 
 
 
 
 

Net gains and losses on trading account securities are as follows for the three and six months ended June 30, 2020 and 2019:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2020
 
2019
 
2020
 
2019
Net gains on sale transactions
 
$

 
$
3

 
$

 
$
8

Net mark-to-market (losses) gains
 

 

 
(14
)
 
5

Net (loss) gain on trading account securities
 
$

 
$
3

 
$
(14
)
 
$
13

 
 
 
 
 
 
 
 
 


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, 2020 and December 31, 2019:
 
 
June 30, 2020
 
 
 
 
Past Due
 
Past Due 90
 
 
 
 
 
 
 
 
30 To 89
 
Days Or More
 
Non-
 
 
(In Thousands)
 
Current
 
Days
 
& Still Accruing
 
Accrual
 
Total
Commercial, financial, and agricultural
 
$
167,025

 
$
41

 
$
2

 
$
1,836

 
$
168,904

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

Residential
 
602,480

 
1,709

 
933

 
1,092

 
606,214

Commercial
 
345,638

 
25

 
331

 
6,536

 
352,530

Construction
 
43,960

 

 

 
60

 
44,020

Consumer automobile loans
 
155,219

 
199

 
9

 
294

 
155,721

Other consumer installment loans
 
20,583

 
431

 
4

 

 
21,018

 
 
1,334,905

 
$
2,405

 
$
1,279

 
$
9,818

 
1,348,407

Net deferred loan fees and discounts
 
940

 
 

 
 

 
 

 
940

Allowance for loan losses
 
(12,977
)
 
 

 
 

 
 

 
(12,977
)
Loans, net
 
$
1,322,868

 
 

 
 

 
 

 
$
1,336,370



16



 
 
December 31, 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
 
$
153,737

 
$
249

 
$
30

 
$
2,197

 
$
156,213

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

Residential
 
615,580

 
4,881

 
1,529

 
1,266

 
623,256

Commercial
 
355,597

 
775

 
164

 
6,725

 
363,261

Construction
 
37,871

 
131

 

 
65

 
38,067

Consumer automobile loans
 
149,703

 
709

 

 
105

 
150,517

Other consumer installment loans
 
22,124

 
579

 
324

 
16

 
23,043

 
 
1,334,612

 
$
7,324

 
$
2,047

 
$
10,374

 
1,354,357

Net deferred loan fees and discounts
 
1,187

 
 

 
 

 
 

 
1,187

Allowance for loan losses
 
(11,894
)
 
 

 
 

 
 

 
(11,894
)
Loans, net
 
$
1,323,905

 
 

 
 

 
 

 
$
1,343,650


 
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, 2020 and 2019:
 
 
Three Months Ended June 30,
 
 
2020
 
2019
(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
 
$
26

 
$

 
$
33

 
$
44

Real estate mortgage:
 
 

 
 

 
 

 
 

Residential
 
4

 

 
33

 
19

Commercial
 
22

 

 
76

 
34

Construction
 
1

 

 
1

 
1

Consumer automobile loans
 

 
3

 
1

 
1

Other consumer installment loans
 
3

 

 

 

 
 
$
56

 
$
3

 
$
144

 
$
99

 
 
Six Months Ended June 30,
 
 
2020
 
2019
(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
 
$
35

 
$

 
$
57

 
$
83

Real estate mortgage:
 
 

 
 

 
 

 
 

Residential
 
13

 

 
66

 
42

Commercial
 
64

 

 
165

 
74

Construction
 
1

 

 
2

 
2

Consumer automobile loans
 
2

 
3

 
3

 
2

Other consumer installment loans
 
3

 

 
1

 

 
 
$
118

 
$
3

 
$
294

 
$
203







17



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 individually evaluate such loans for impairment 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 or worse.  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 with the exception of loans identified as troubled debt restructurings. 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 to the Banks' policy.





































18



The following table presents the recorded investment, unpaid principal balance, and related allowance of impaired loans by segment as of June 30, 2020 and December 31, 2019:
 
 
June 30, 2020
 
 
Recorded
 
Unpaid Principal
 
Related
(In Thousands)
 
Investment
 
Balance
 
Allowance
With no related allowance recorded:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
$
1,820

 
$
4,607

 
$

Real estate mortgage:
 
 

 
 

 
 

Residential
 
4,305

 
4,305

 

Commercial
 
4,113

 
4,113

 

Construction
 
60

 
60

 

Consumer automobile loans
 

 

 

Installment loans to individuals
 

 

 

 
 
10,298

 
13,085

 

With an allowance recorded:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
16

 
16

 

Real estate mortgage:
 
 

 
 

 
 

Residential
 
1,168

 
1,168

 
180

Commercial
 
3,311

 
3,361

 
959

Construction
 

 

 

Consumer automobile loans
 
111

 
293

 
151

Installment loans to individuals
 

 

 

 
 
4,606

 
4,838

 
1,290

Total:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
1,836

 
4,623

 

Real estate mortgage:
 
 

 
 

 
 

Residential
 
5,473

 
5,473

 
180

Commercial
 
7,424

 
7,474

 
959

Construction
 
60

 
60

 

Consumer automobile loans
 
111

 
293

 
151

Installment loans to individuals
 

 

 

 
 
$
14,904

 
$
17,923

 
$
1,290



19



 
 
December 31, 2019
 
 
Recorded
 
Unpaid Principal
 
Related
(In Thousands)
 
Investment
 
Balance
 
Allowance
With no related allowance recorded:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
$
2,285

 
$
5,072

 
$

Real estate mortgage:
 
 

 
 

 
 

Residential
 
5,008

 
5,008

 

Commercial
 
5,035

 
5,035

 

Construction
 
65

 
65

 

Consumer automobile loans
 

 

 

Installment loans to individuals
 

 

 

 
 
12,393

 
15,180

 

With an allowance recorded:
 
 

 
 

 
 

Commercial, financial, and agricultural
 

 

 

Real estate mortgage:
 
 

 
 

 
 

Residential
 
1,168

 
1,200

 
211

Commercial
 
3,540

 
3,590

 
1,104

Construction
 

 

 

Consumer automobile loans
 
130

 
130

 
62

Installment loans to individuals
 
16

 
16

 
16

 
 
4,854

 
4,936

 
1,393

Total:
 
 

 
 

 
 

Commercial, financial, and agricultural
 
2,285

 
5,072

 

Real estate mortgage:
 
 

 
 

 
 

Residential
 
6,176

 
6,208

 
211

Commercial
 
8,575

 
8,625

 
1,104

Construction
 
65

 
65

 

Consumer automobile loans
 
130

 
130

 
62

Installment loans to individuals
 
16

 
16

 
16

 
 
$
17,247

 
$
20,116

 
$
1,393



The following table presents the average recorded investment in impaired loans and related interest income recognized for the three and six months ended June 30, 2020 and 2019:
 
 
Three Months Ended June 30,
 
 
2020
 
2019
(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
 
$
1,931

 
$

 
$

 
$
5,298

 
$
2

 
$
44

Real estate mortgage:
 
 

 
 

 
 

 

 

 
 

 
 

Residential
 
5,602

 
57

 

 
4,078

 
27

 
22

Commercial
 
7,992

 
20

 

 
9,894

 
30

 
33

Construction
 
62

 

 


72

 

 
1

Consumer automobile
 
157

 
1

 
2


55

 

 

Other consumer installment loans
 

 

 


18

 

 

 
 
$
15,744

 
$
78

 
$
2

$

$
19,415

 
$
59

 
$
100


20



 
 
Six Months Ended June 30,
 
 
2020
 
2019
(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
 
$
2,049

 
$
1

 
$

 
$
5,286

 
$
2

 
$
82

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

 
 

Residential
 
5,793

 
114

 

 
4,122

 
55

 
39

Commercial
 
8,186

 
46

 

 
10,484

 
61

 
69

Construction
 
63

 

 

 
73

 

 
2

Consumer automobile
 
148

 
1

 
2

 
47

 

 
1

Other consumer installment loans
 
5

 

 

 
13

 

 

 
 
$
16,244

 
$
162

 
$
2

 
$
20,025

 
$
118

 
$
193



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 no loan modifications considered to be TDRs completed during the three and six months ended June 30, 2020. There were four loan modifications considered TDRs 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 were as follows:
 
Three Months Ended June 30,
 
 
2019
(In Thousands, Except Number of Contracts)
 
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
 

 

 

Commercial
 

 

 

Construction
 
2

 
2,862

 
2,862

 
 
4

 
$
6,876

 
$
6,876

 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
 
2019
(In Thousands, Except Number of Contracts)
 
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
 

 

 

Commercial
 

 

 

Construction
 
2

 
2,862

 
2,860

 
 
4

 
$
6,876

 
$
6,874



21



There were two loan modifications considered to be TDRs made during the twelve months previous to June 30, 2020 that defaulted during the six months ended June 30, 2020. The defaulted loan types and recorded investments at June 30, 2020 are as follows: one commercial real estate loan with a recorded investment of $1,040,000, and one commercial and agricultural loans with a recorded investment of $640,000. 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.

Troubled debt restructurings amounted to $11,546,000 and $13,282,000 as of June 30, 2020 and December 31, 2019, respectively.

The amount of foreclosed residential real estate held at June 30, 2020 and December 31, 2019, totaled $1,132,000 and $493,000, respectively. Consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process at June 30, 2020 and December 31, 2019, totaled $44,000 and $32,000, respectively.

The Company began offering short-term loan modifications to provide relief to borrowers during the COVID-19 national emergency. The CARES Act along with a joint agency statement issued by federal and state banking agencies, provides that short-term modifications made in a good faith basis in response to COVID-19 who were current at the time the modification program is implemented do not need to be accounted for as TDRs. Loan modifications and payment deferrals have been at historical high levels as the impact of the pandemic continues. As of June 30, 2020, the loan modification/deferral program in place has generated deferrals of up to 90 days that have been granted on 1,490 loans with an aggregate balance of $241,608,000. These loan modifications met applicable requirements to not be considered troubled debt restructurings. The number of customers seeking loan modifications or payment deferrals may increase as the effects of the pandemic continue.

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 semi-annual loan review of large commercial relationships is performed, as well as a sample of smaller transactions. The 2020 loan review has an aggregate commercial relationship threshold of $1,750,000 which can consist of outstanding loans, commercial real estate mortgages and outstanding commitments. 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, 2020 and December 31, 2019:
 
 
June 30, 2020
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Consumer automobile
 
Other consumer installment loans
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
Totals
Pass
 
$
162,604

 
$
603,806

 
$
339,507

 
$
44,010

 
$
155,694

 
$
21,018

 
$
1,326,639

Special Mention
 
5,043

 
1,444

 
10,368

 
10

 

 

 
16,865

Substandard
 
1,257

 
964

 
2,655

 

 
27

 

 
4,903

 
 
$
168,904

 
$
606,214

 
$
352,530

 
$
44,020

 
$
155,721

 
$
21,018

 
$
1,348,407



22



 
 
December 31, 2019
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Consumer automobile
 
Other consumer installment loans
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
Totals
Pass
 
$
149,349

 
$
618,350

 
$
348,864

 
$
37,931

 
$
150,517

 
$
23,039

 
$
1,328,050

Special Mention
 
3,174

 
2,436

 
5,080

 

 

 

 
10,690

Substandard
 
3,690

 
2,470

 
9,317

 
136

 

 
4

 
15,617

 
 
$
156,213

 
$
623,256

 
$
363,261

 
$
38,067

 
$
150,517

 
$
23,043

 
$
1,354,357



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.

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.














23



Activity in the allowance is presented for the three and six months ended June 30, 2020 and 2019:
 
 
Three Months Ended June 30, 2020
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Consumer automobile
 
Other consumer installment
 
 
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
Unallocated
 
Totals
Beginning Balance
 
$
1,897

 
$
4,537

 
$
3,414

 
$
160

 
$
1,855

 
$
267

 
$
370

 
$
12,500

Charge-offs
 
(8
)
 
(127
)
 

 

 
(14
)
 
(82
)
 

 
(231
)
Recoveries
 
2

 
26

 

 
3

 
6

 
26

 

 
63

Provision
 
62

 
42

 
(79
)
 
(13
)
 
367

 
(84
)
 
350

 
645

Ending Balance
 
$
1,953

 
$
4,478

 
$
3,335

 
$
150

 
$
2,214

 
$
127

 
$
720

 
$
12,977

 
 
 
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

 
t
 
Six Months Ended June 30, 2020
 
 
Commercial, Financial, and Agricultural
 
Real Estate Mortgages
 
Consumer automobile
 
Other consumer installment
 
 
 
 
(In Thousands)
 
 
Residential
 
Commercial
 
Construction
 
 
 
Unallocated
 
Totals
Beginning Balance
 
$
1,779

 
$
4,306

 
$
3,210

 
$
118

 
$
1,780

 
$
278

 
$
423

 
$
11,894

Charge-offs
 
(22
)
 
(168
)
 

 

 
(89
)
 
(182
)
 

 
(461
)
Recoveries
 
23

 
47

 

 
5

 
7

 
67

 

 
149

Provision
 
173

 
293

 
125

 
27

 
516

 
(36
)
 
297

 
1,395

Ending Balance
 
$
1,953

 
$
4,478

 
$
3,335

 
$
150

 
$
2,214

 
$
127

 
$
720

 
$
12,977

 
 
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



The shift in allocation of the loan provision is primarily due to changes in the credit metrics within the loan portfolio and the economic uncertainty caused by the COVID-19 pandemic. The decrease in consumer installment loans is related to the decrease in outstanding loan balances.

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, 2020 and 2019
 
 
June 30,
 
 
2020
 
2019
Owners of residential rental properties
 
15.98
%
 
15.07
%
Owners of commercial rental properties
 
13.00
%
 
12.09
%



24



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, 2020 and December 31, 2019:
 
 
June 30, 2020
 
 
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
 
$

 
$
180

 
$
959

 
$

 
$
151

 
$

 
$

 
$
1,290

Collectively evaluated for impairment
 
1,953

 
4,298

 
2,376

 
150

 
2,063

 
127

 
720

 
11,687

Total ending allowance balance
 
$
1,953

 
$
4,478

 
$
3,335

 
$
150

 
$
2,214

 
$
127

 
$
720

 
$
12,977

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

Individually evaluated for impairment
 
$
1,836

 
$
5,473

 
$
7,424

 
$
60

 
$
111

 
$

 


 
$
14,904

Collectively evaluated for impairment
 
167,068

 
600,741

 
345,106

 
43,960

 
155,610

 
21,018

 


 
1,333,503

Total ending loans balance
 
$
168,904

 
$
606,214

 
$
352,530

 
$
44,020

 
$
155,721

 
$
21,018

 


 
$
1,348,407


 
 
December 31, 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
 
$

 
$
211

 
$
1,104

 
$

 
$
62

 
$
16

 
$

 
$
1,393

Collectively evaluated for impairment
 
1,779

 
4,095

 
2,106

 
118

 
1,718

 
262

 
423

 
10,501

Total ending allowance balance
 
$
1,779

 
$
4,306

 
$
3,210

 
$
118

 
$
1,780

 
$
278

 
$
423

 
$
11,894

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

Individually evaluated for impairment
 
$
2,285

 
$
6,176

 
$
8,575

 
$
65

 
$
130

 
$
16

 
 

 
$
17,247

Collectively evaluated for impairment
 
153,928

 
617,080

 
354,686

 
38,002

 
150,387

 
23,027

 
 

 
1,337,110

Total ending loans balance
 
$
156,213

 
$
623,256

 
$
363,261

 
$
38,067

 
$
150,517

 
$
23,043

 
 

 
$
1,354,357



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, 2019.

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, 2020 and 2019, respectively:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2020
 
2019
 
2020
 
2019
Interest cost
 
$
160

 
$
191

 
$
320

 
$
382

Expected return on plan assets
 
(318
)
 
(249
)
 
(636
)
 
(498
)
Amortization of net loss
 
51

 
47

 
92

 
94

Net periodic benefit
 
$
(107
)
 
$
(11
)
 
$
(224
)
 
$
(22
)






25



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, 2019, that it expected to contribute a minimum of $500,000 to its defined benefit plan in 2020.  As of June 30, 2020, there were contributions of $1,250,000 made to the plan with additional contributions of at least $250,000 anticipated during the remainder of 2020.
 
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, 2020 and 2019, there were 1,833 and 1,800 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.

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, 2020 and December 31, 2019:
(In Thousands)
 
June 30, 2020
 
December 31, 2019
Commitments to extend credit
 
$
176,912

 
$
187,778

Standby letters of credit
 
9,937

 
9,638

Credit exposure from the sale of assets with recourse
 
7,744

 
6,826

 
 
$
194,593

 
$
204,242



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.

26



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, 2020 and December 31, 2019, 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, 2020
(In Thousands)
 
Level I
 
Level II
 
Level III
 
Total
Assets measured on a recurring basis:
 
 

 
 

 
 

 
 

Investment securities, available for sale:
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$

 
$
2,367

 
$

 
$
2,367

State and political securities
 

 
97,264

 

 
97,264

Other debt securities
 

 
64,738

 

 
64,738

Investment equity securities:
 
 
 
 
 
 
 
 
  Other equity securities
 
1,291

 

 

 
1,291

Investment securities, trading:
 
 
 
 
 
 
 
 
  Other equity securities
 
37

 

 

 
37


 
 
December 31, 2019
(In Thousands)
 
Level I
 
Level II
 
Level III
 
Total
Assets measured on a recurring basis:
 
 

 
 

 
 

 
 

Investment securities, available for sale:
 
 

 
 

 
 

 
 

Mortgage-backed securities
 
$

 
$
4,966

 
$

 
$
4,966

State and political securities
 

 
82,286

 

 
82,286

Other debt securities
 

 
61,367

 

 
61,367

Investment equity securities:
 
 
 
 
 
 
 
 
  Other equity securities
 
1,261

 

 

 
1,261

Investment securities, trading:
 
 
 
 
 
 
 
 
  Other equity securities
 
51

 

 

 
51



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, 2020 and December 31, 2019, 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, 2020
(In Thousands)
 
Level I
 
Level II
 
Level III
 
Total
Assets measured on a non-recurring basis:
 
 

 
 

 
 

 
 

Impaired loans
 
$

 
$

 
$
13,796

 
$
13,796

Other real estate owned
 

 

 
308

 
308



27



 
 
December 31, 2019
(In Thousands)
 
Level I
 
Level II
 
Level III
 
Total
Assets measured on a non-recurring basis:
 
 

 
 

 
 

 
 

Impaired loans
 
$

 
$

 
$
15,854

 
$
15,854

Other real estate owned
 

 

 
413

 
413



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, 2020 and December 31, 2019
 
 
June 30, 2020
 
 
Quantitative Information About Level III Fair Value Measurements
(In Thousands)
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Inputs
 
Range
 
Weighted Average
Impaired loans
 
$
5,745

 
Discounted cash flow
 
Temporary reduction in payment amount
 
17% to (59)%
 
(23)%
 
 
8,051

 
Appraisal of collateral (1)
 
Appraisal adjustments (1)
 
0 to (30)%
 
(8)%
Other real estate owned
 
$
308

 
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, 2019
 
 
Quantitative Information About Level III Fair Value Measurements
(In Thousands)
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Inputs
 
Range
 
Weighted Average
Impaired loans
 
$
6,950

 
Discounted cash flow
 
Temporary reduction in payment amount
 
17 to (59)%
 
(24)%
 
 
8,904

 
Appraisal of collateral (1)
 
Appraisal adjustments (1)
 
0 to (30)%
 
(9)%
Other real estate owned
 
$
413

 
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.


28



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.

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, 2020 and December 31, 2019:
 
 
Carrying
 
Fair
 
Fair Value Measurements at June 30, 2020
(In Thousands)
 
Value
 
Value
 
Level I
 
Level II
 
Level III
Financial assets:
 
 

 
 

 
 

 
 

 
 

Cash and cash equivalents (1)
 
$
215,174

 
$
215,174

 
$
215,174

 
$

 
$

Restricted investment in bank stock (1)
 
14,849

 
14,849

 
14,849

 

 

Loans held for sale (1)
 
5,146

 
5,146

 
5,146

 

 

Loans, net
 
1,336,370

 
1,351,981

 

 

 
1,351,981

Bank-owned life insurance (1)
 
29,368

 
29,368

 
29,368

 

 

Accrued interest receivable (1)
 
8,068

 
8,068

 
8,068

 

 

 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 

 
 

 
 

Interest-bearing deposits
 
$
1,055,981

 
$
1,092,886

 
$
712,065

 
$

 
$
380,821

Noninterest-bearing deposits (1)
 
418,324

 
418,324

 
418,324

 

 

Short-term borrowings (1)
 
15,133

 
15,133

 
15,133

 

 

Long-term borrowings
 
171,885

 
178,332

 

 

 
178,332

Accrued interest payable (1)
 
1,530

 
1,530

 
1,530

 

 

(1) The financial instrument is carried at cost at June 30, 2020, which approximate the fair value of the instruments
 
 
Carrying
 
Fair
 
Fair Value Measurements at December 31, 2019
(In Thousands)
 
Value
 
Value
 
Level I
 
Level II
 
Level III
Financial assets:
 
 

 
 

 
 

 
 

 
 

Cash and cash equivalents (1)
 
$
48,589

 
$
48,589

 
$
48,589

 
$

 
$

Restricted investment in bank stock (1)
 
13,528

 
13,528

 
13,528

 

 

Loans held for sale (1)
 
4,232

 
4,232

 
4,232

 

 

Loans, net
 
1,343,650

 
1,346,395

 

 

 
1,346,395

Bank-owned life insurance (1)
 
29,253

 
29,253

 
29,253

 

 

Accrued interest receivable (1)
 
5,246

 
5,246

 
5,246

 

 

 
 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 

 
 

 
 

 
 

 
 

Interest-bearing deposits
 
$
989,259

 
$
990,747

 
$
611,374

 
$

 
$
379,373

Noninterest-bearing deposits (1)
 
334,746

 
334,746

 
334,746

 

 

Short-term borrowings (1)
 
4,920

 
4,920

 
4,920

 

 

Long-term borrowings
 
161,920

 
163,931

 

 

 
163,931

Accrued interest payable (1)
 
1,671

 
1,671

 
1,671

 

 


(1) The financial instrument is carried at cost at December 31, 2019, 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, 2020 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.







29



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, 2020, the Company had a total of 625,800 stock options outstanding. During the period ended June 30, 2020, the Company issued 238,500 stock options with a strike price of $25.34 to a group of employees. The options granted in 2020 all expire ten years from the grant date. Of the 238,500 grants awarded in 2020, 119,300 of the options vest in 3 years while the 119,200 remaining options vest in five years.

Stock Options Granted
Date
 
Shares
 
Forfeited
 
Outstanding
 
Strike Price
 
Vesting Period
 
Expiration
March 11, 2020
 
119,300

 

 
119,300

 
$
25.34

 
3 years
 
10 years
March 11, 2020
 
119,200

 

 
119,200

 
25.34

 
5 years
 
10 years
March 15, 2019
 
120,900

 
(1,950
)
 
118,950

 
28.01

 
3 years
 
10 years
March 15, 2019
 
119,100

 
(1,800
)
 
117,300

 
28.01

 
5 years
 
10 years
August 24, 2018
 
75,300

 
(1,950
)
 
73,350

 
30.67

 
3 years
 
10 years
August 24, 2018
 
149,250

 
(4,050
)
 
145,200

 
30.67

 
5 years
 
10 years
January 5, 2018
 
18,750

 

 
18,750

 
30.07

 
3 years
 
10 years
January 5, 2018
 
18,750

 

 
18,750

 
30.07

 
5 years
 
10 years
March 24, 2017
 
69,375

 
(6,750
)
 
62,625

 
29.47

 
3 years
 
10 years
March 24, 2017
 
35,625

 

 
35,625

 
29.47

 
5 years
 
10 years
August 27, 2015
 
58,125

 
(22,875
)
 
35,250

 
28.02

 
5 years
 
10 years


A summary of stock option activity is presented below:
 
 
June 30, 2020
 
June 30, 2019
 
 
Shares
 
Weighted Average Exercise Price
 
Shares
 
Weighted Average Exercise Price
Outstanding, beginning of year
 
625,800

 
$
29.29

 
395,550

 
$
30.08

Granted
 
238,500

 
25.34

 
240,000

 
28.01

Exercised
 

 

 

 

Forfeited
 

 

 

 

Expired
 

 

 

 

Outstanding, end of period
 
864,300

 
$
28.20

 
635,550

 
$
29.30

 
 
 
 
 
 
 
 
 
Exercisable, end of period
 
62,625

 
$
29.47

 

 
$



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 $238,000 and $436,000 for the three and six months ended June 30, 2020 compared to $177,000 and $313,000 for the same period of 2019. As of June 30, 2020, a total of 62,625 stock options were exercisable and the weighted average years to expiration was 8.55 years. The fair value of options

30



granted during the six months ended June 30, 2020 was $1,343,000 or $5.63 per award. Total unrecognized compensation cost for non-vested options was $2,404,000 and will be recognized over their weighted average remaining vesting period of 1.55 years.

Note 13.  Leases

The following table shows finance lease right of use assets and finance lease liabilities as of June 30, 2020:
(In Thousands)
 
Statement of Financial Condition classification
 
June 30, 2020
 
December 31, 2019
Finance lease right of use assets
 
Premises and equipment, net
 
$
5,356

 
$
5,456

Finance lease liabilities
 
Long-term borrowings
 
5,552

 
5,587



The following table shows the components of finance and operating lease expense for the three and six months ended June 30, 2020 and 2019:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2020
 
2019
 
2020
 
2019
 
 
 
 
 
 
 
 
 
Finance Lease Cost:
 
 
 
 
 
 
 
 
Amortization of right-of-use asset
 
$
50

 
$
64

 
$
100

 
$
129

Interest expense
 
53

 
56

 
106

 
112

Operating lease cost
 
76

 
84

 
167

 
172

Variable lease cost
 

 
1

 

 
2

Total Lease Cost
 
$
179

 
$
205

 
$
373

 
$
415



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
2020
 
$
144

 
$
140

2021
 
291

 
282

2022
 
298

 
283

2023
 
273

 
284

2024
 
263

 
290

2025 and thereafter
 
3,176

 
8,004

Total undiscounted cash flows
 
4,445

 
9,283

Discount on cash flows
 
(1,182
)
 
(3,731
)
Total lease liability
 
$
3,263

 
$
5,552



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, 2020.
 
 
Operating
 
Finance
Weighted-average term (years)
 
18.6

 
27.2

Weighted-average discount rate
 
3.51
%
 
3.77
%


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.

31




Note 15.  Subsequent Events

All events subsequent to the date of the consolidated financial statements through August 10, 2020, and for which U.S. GAAP requires adjustment or disclosure, have been adjusted or disclosed, including that the 2019 novel coronavirus (or COVID-19) has adversely affected, and may continue to adversely affect, economic activity globally, nationally, and locally.  In response to COVID-19, among other things, the Company has incurred loan rate modifications and payment deferrals of up to 90 days.  For further discussion, see COVID-19 Impact section of Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation.


32




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 negative impacts and disruptions of the COVID-19 pandemic and measures taken to contain its spread on our employees, customers, business operations, credit quality, financial position, liquidity and results of operations; (vi) the length and extent of the economic contraction as a result of the COVID-19 pandemic; or (vii) the effect of changes in the business cycle and downturns in the local, regional or national economies; and (viii) the Risk Factors identified in Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2019 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.

33




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

EARNINGS SUMMARY

Comparison of the Three and Six Months Ended June 30, 2020 and 2019

Summary Results

Net income for the three and six months ended June 30, 2020 were $3,760,000 and $6,833,000 compared to $4,245,000 and $8,189,000 for the same periods of 2019, including the effects of an increase in after-tax securities gains of $138,000 (from a gain of $18,000 to a gain of $156,000) for the three month period and $108,000 (from a gain of $70,000 to a gain of $178,000) for the six month period. Basic and diluted earnings per share for the three and six months ended June 30, 2020 were $0.53 and $0.97, respectively, compared to the corresponding periods of 2019 basic and diluted earnings per share of $0.60 and $1.16. Return on average assets and return on average equity were 0.85% and 9.59% for the three months ended June 30, 2020 compared to 1.02% and 11.42% for the corresponding period of 2019. Return on average assets and return on average equity were 0.79% and 8.75%
for the six months ended June 30, 2020 compared to 0.99% and 11.27% for the corresponding period of 2019. Net income from core operations (“core earnings”) was $3,604,000 and $6,655,000 for the three and six months ended June 30, 2020, respectively, compared to $4,227,000 and $8,119,000 for the corresponding periods of 2019. Core basic and diluted earnings per share for the three and six months ended June 30, 2020 were $0.51 and $0.95, respectively, compared to $0.60 and $1.15 basic and diluted for the corresponding periods of 2019.

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,
 
 
2020
 
2019
 
2020
 
2019
GAAP net income
 
$
3,760

 
$
4,245

 
$
6,833

 
$
8,189

Less: net securities gains, net of tax
 
156

 
18

 
178

 
70

Non-GAAP core earnings
 
$
3,604

 
$
4,227

 
$
6,655

 
$
8,119

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Return on average assets (ROA)
 
0.85
%
 
1.02
%
 
0.79
%
 
0.99
%
Less: net securities gains, net of tax
 
0.04
%
 
0.01
%
 
0.02
%
 
0.01
%
Non-GAAP core ROA
 
0.81
%
 
1.01
%
 
0.77
%
 
0.98
%
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Return on average equity (ROE)
 
9.59
%
 
11.42
%
 
8.75
%
 
11.27
%
Less: net securities gains, net of tax
 
0.40
%
 
0.05
%
 
0.23
%
 
0.09
%
Non-GAAP core ROE
.
9.19
%
 
11.37
%
 
8.52
%
 
11.18
%

34



 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Basic earnings per share (EPS)
 
$
0.53

 
$
0.60

 
$
0.97

 
$
1.16

Less: net securities gains, net of tax
 
0.02

 

 
0.02

 
0.01

Non-GAAP core operating EPS
 
$
0.51

 
$
0.60

 
$
0.95

 
$
1.15

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Diluted EPS
 
$
0.53

 
$
0.60

 
$
0.97

 
$
1.16

Less: net securities gains, net of tax
 
0.02

 

 
0.02

 
0.01

Non-GAAP diluted core EPS
 
$
0.51

 
$
0.60

 
$
0.95

 
$
1.15

 

Interest and Dividend Income

Interest and dividend income for the three and six months ended June 30, 2020 decreased to $16,044,000 and $32,205,000, respectively, compared to $16,841,000 and $33,275,000 for the same periods of 2019. Loan portfolio income decreased due to a slight decrease in average rate paid on loans and a decrease in the average loan portfolio balance. Investment securities and dividend income decreased as the increase in the average portfolio balance was more than offset by a decrease in the average rate earned on the portfolio. The decrease in dividend and other interest income is due to a decrease in the amount of dividends received on restricted investment in bank stock held.

Interest and dividend income composition for the three and six months ended June 30, 2020 and 2019 was as follows:
 
 
Three Months Ended
 
 
June 30, 2020
 
June 30, 2019
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Loans including fees
 
$
14,666

 
91.41
%
 
$
15,300

 
90.85
%
 
$
(634
)
 
(4.14
)
%
Investment securities:
 
 

 
 
 
 
 

 
 
 
 
 

 
 

 
Taxable
 
1,023

 
6.38
 
 
967

 
5.74
 
 
56

 
5.79

 
Tax-exempt
 
169

 
1.05
 
 
179

 
1.06
 
 
(10
)
 
(5.59
)
 
Dividend and other interest income
 
186

 
1.16
 
 
395

 
2.35
 
 
(209
)
 
(52.91
)
 
Total interest and dividend income
 
$
16,044

 
100.00
%
 
$
16,841

 
100.00
%
 
$
(797
)
 
(4.73
)
%
 
 
Six Months Ended
 
 
 
June 30, 2020
 
June 30, 2019
 
Change
 
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
 
Loans including fees
 
$
29,323

 
91.05
%
 
$
30,169

 
90.67
%
 
$
(846
)
 
(2.80
)
%
Investment securities:
 
 

 
 
 
 
 

 
 
 
 
 

 
 

 
Taxable
 
2,033

 
6.31
 
 
1,901

 
5.71
 
 
132

 
6.94

 
Tax-exempt
 
314

 
0.98
 
 
353

 
1.06
 
 
(39
)
 
(11.05
)
 
Dividend and other interest income
 
535

 
1.66
 
 
852

 
2.56
 
 
(317
)
 
(37.21
)
 
Total interest and dividend income
 
$
32,205

 
100.00
%
 
$
33,275

 
100.00
%
 
$
(1,070
)
 
(3.22
)
%

Interest Expense

Interest expense for the three and six months ended June 30, 2020 decreased $134,000 and increased $110,000, respectively, compared to the same periods of 2019. The increase in interest expense for the six month period is the result of growth within the average interest-bearing deposit portfolio led by the use of the time deposit portfolio as part of a deposit acquisition strategy in select markets during the early part of the first quarter of 2020. During the three months ended June 30, 2020 interest-bearing deposit rates were significantly reduced. Long-term borrowings have been utilized to lock in funding and historically low interest rates and to assist with the funding of the loan and investment portfolios. The deposit portfolio growth coupled with increased utilization of long-term borrowings has resulted in a significant reduction in the use of short-term borrowings.


35



Interest expense composition for the three and six months ended June 30, 2020 and 2019 was as follows:
 
 
Three Months Ended
 
 
June 30, 2020
 
June 30, 2019
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Deposits
 
$
2,802

 
73.85
%
 
$
2,871

 
73.09
%
 
$
(69
)
 
(2.40
)
%
Short-term borrowings
 
7

 
0.18
 
 
178

 
4.53
 
 
(171
)
 
(96.07
)
 
Long-term borrowings
 
985

 
25.97
 
 
879

 
22.38
 
 
106

 
12.06

 
Total interest expense
 
$
3,794

 
100.00
%
 
$
3,928

 
100.00
%
 
$
(134
)
 
(3.41
)
%
 
 
Six Months Ended
 
 
June 30, 2020
 
June 30, 2019
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Deposits
 
$
5,837

 
74.89
%
 
$
5,171

 
67.30
%
 
$
666

 
12.88

%
Short-term borrowings
 
29

 
0.37
 
 
783

 
10.19
 
 
(754
)
 
(96.30
)
 
Long-term borrowings
 
1,928

 
24.74
 
 
1,730

 
22.50
 
 
198

 
11.45

 
Total interest expense
 
$
7,794

 
100.00
%
 
$
7,684

 
99.99
%
 
$
110

 
1.43

%

Net Interest Margin

The net interest margin (“NIM”) for the three and six months ended June 30, 2020 was 3.01% and 3.09%, respectively, compared to 3.39% and 3.37% for the corresponding periods of 2019. The increase for the six month period was the result of the first quarter 2020 performance prior to the impact of the COVID-19 pandemic being felt. The decrease in the net interest margin for the three month period was driven by a decrease in the yield on earning assets of 47 basis points ("bps") as the economic impact of the COVID-19 pandemic drove loan and investment yields downward. In addition, the balance of interest-bearing deposits increased significantly as deposits swelled which limited the impact of the reduction in rate paid on interest-bearing deposits that occurred during the three months ended June 30, 2020.

36



The following is a schedule of average balances and associated yields for the three and six months ended June 30, 2020 and 2019:
 
 
AVERAGE BALANCES AND INTEREST RATES
 
 
Three Months Ended June 30, 2020
 
Three Months Ended June 30, 2019
(In Thousands)
 
Average Balance (1)
 
Interest
 
Average Rate
 
Average Balance (1)
 
Interest
 
Average Rate
Assets:
 
 

 
 

 
 

 
 

 
 

 
 

Tax-exempt loans (3)
 
$
44,916

 
$
348

 
3.12
%
 
$
71,193

 
$
548

 
3.09
%
All other loans
 
1,294,745

 
14,391

 
4.47
%
 
1,313,388

 
14,867

 
4.54
%
Total loans (2)
 
1,339,661

 
14,739

 
4.43
%
 
1,384,581

 
15,415

 
4.47
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable securities
 
147,352

 
1,193

 
3.29
%
 
130,802

 
1,300

 
4.03
%
Tax-exempt securities (3)
 
28,280

 
213

 
3.06
%
 
27,971

 
227

 
3.29
%
Total securities
 
175,632

 
1,406

 
3.26
%
 
158,773

 
1,527

 
3.90
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
144,948

 
16

 
0.04
%
 
10,431

 
62

 
2.38
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest-earning assets
 
1,660,241

 
16,161

 
3.92
%
 
1,553,785

 
17,004

 
4.39
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Other assets
 
116,750

 
 

 
 

 
113,443

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
1,776,991

 
 

 
 

 
$
1,667,228

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and shareholders’ equity:
 
 

 
 

 
 

 
 

 
 

 
 

Savings
 
$
190,243

 
67

 
0.14
%
 
$
170,142

 
51

 
0.12
%
Super Now deposits
 
251,691

 
409

 
0.65
%
 
246,454

 
453

 
0.74
%
Money market deposits
 
229,362

 
418

 
0.73
%
 
249,169

 
596

 
0.96
%
Time deposits
 
362,545

 
1,908

 
2.12
%
 
335,721

 
1,771

 
2.12
%
Total interest-bearing deposits
 
1,033,841

 
2,802

 
1.09
%
 
1,001,486

 
2,871

 
1.15
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
11,174

 
7

 
0.83
%
 
32,086

 
178

 
2.23
%
Long-term borrowings
 
171,895

 
985

 
2.21
%
 
147,571

 
879

 
2.24
%
Total borrowings
 
183,069

 
992

 
2.12
%
 
179,657

 
1,057

 
2.23
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest-bearing liabilities
 
1,216,910

 
3,794

 
1.24
%
 
1,181,143

 
3,928

 
1.31
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
 
384,591

 
 

 
 

 
317,623

 
 

 
 

Other liabilities
 
18,583

 
 

 
 

 
19,747

 
 

 
 

Shareholders’ equity
 
156,907

 
 

 
 

 
148,715

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders’ equity
 
$
1,776,991

 
 

 
 

 
$
1,667,228

 
 

 
 

Interest rate spread
 
 

 
 

 
2.68
%
 
 

 
 

 
3.08
%
Net interest income/margin
 
 

 
$
12,367

 
3.01
%
 
 

 
$
13,076

 
3.39
%


37



 
 
AVERAGE BALANCES AND INTEREST RATES
 
 
Six Months Ended June 30, 2020
 
Six Months Ended June 30, 2019
(In Thousands)
 
Average Balance (1)
 
Interest
 
Average Rate
 
Average Balance (1)
 
Interest
 
Average Rate
Assets:
 
 

 
 

 
 

 
 

 
 

 
 

Tax-exempt loans (3)
 
$
48,346

 
$
752

 
3.13
%
 
$
71,874

 
$
1,087

 
3.05
%
All other loans
 
1,299,893

 
28,729

 
4.44
%
 
1,313,121

 
29,310

 
4.50
%
Total loans (2)
 
1,348,239

 
29,481

 
4.40
%
 
1,384,995

 
30,397

 
4.43
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Taxable securities
 
145,070

 
2,466

 
3.46
%
 
128,431

 
2,650

 
4.18
%
Tax-exempt securities
 
26,027

 
397

 
3.10
%
 
27,344

 
447

 
3.31
%
Total securities
 
171,097

 
2,863

 
3.40
%
 
155,775

 
3,097

 
4.03
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
85,832

 
102

 
0.24
%
 
8,493

 
103

 
2.45
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest-earning assets
 
1,605,168

 
32,446

 
4.07
%
 
1,549,263

 
33,597

 
4.38
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Other assets
 
114,085

 
 

 
 

 
112,806

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
1,719,253

 
 

 
 
 
$
1,662,069

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and shareholders’ equity:
 
 

 
 

 


 


 
 

 
 

Savings
 
$
184,042

 
158

 
0.17
%
 
$
168,543

 
81

 
0.10
%
Super Now deposits
 
235,758

 
833

 
0.71
%
 
239,022

 
832

 
0.70
%
Money market deposits
 
220,035

 
895

 
0.82
%
 
245,307

 
1,068

 
0.88
%
Time deposits
 
370,902

 
3,951

 
2.14
%
 
317,782

 
3,190

 
2.02
%
Total interest-bearing deposits
 
1,010,737

 
5,837

 
1.16
%
 
970,654

 
5,171

 
1.07
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
11,011

 
29

 
0.53
%
 
63,881

 
783

 
2.47
%
Long-term borrowings
 
166,024

 
1,928

 
2.34
%
 
145,890

 
1,730

 
2.24
%
Total borrowings
 
177,035

 
1,957

 
2.22
%
 
209,771

 
2,513

 
2.31
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Total interest-bearing liabilities
 
1,187,772

 
7,794

 
1.32
%
 
1,180,425

 
7,684

 
1.29
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
 
355,704

 
 

 
 

 
315,380

 
 

 
 

Other liabilities
 
19,551

 
 

 
 

 
20,953

 
 

 
 

Shareholders’ equity
 
156,226

 
 

 
 

 
145,311

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders’ equity
 
$
1,719,253

 
 

 
 

 
$
1,662,069

 
 

 
 

Interest rate spread
 
 

 
 

 
2.75
%
 
 

 
 

 
3.09
%
Net interest income/margin
 
 

 
$
24,652

 
3.09
%
 
 

 
$
25,913

 
3.37
%

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, 2020 and 2019:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2020
 
2019
 
2020
 
2019
Total interest income
 
$
16,044

 
$
16,841

 
$
32,205

 
$
33,275

Total interest expense
 
3,794

 
3,928

 
7,794

 
7,684

Net interest income
 
12,250

 
12,913

 
24,411

 
25,591

Tax equivalent adjustment
 
117

 
163

 
241

 
322

Net interest income (fully taxable equivalent)
 
$
12,367

 
$
13,076

 
$
24,652

 
$
25,913

 

38



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, 2020 and 2019:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2020 vs. 2019
 
2020 vs. 2019
 
 
Increase (Decrease) Due to
 
Increase (Decrease) Due to
(In Thousands)
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
Interest income:
 
 

 
 

 
 

 
 

 
 

 
 

Tax-exempt loans
 
$
(205
)
 
$
5

 
$
(200
)
 
$
(364
)
 
$
29

 
$
(335
)
All other loans
 
(228
)
 
(248
)
 
(476
)
 
(250
)
 
(331
)
 
(581
)
Taxable investment securities
 
154

 
(261
)
 
(107
)
 
315

 
(499
)
 
(184
)
Tax-exempt investment securities
 
3

 
(17
)
 
(14
)
 
(22
)
 
(28
)
 
(50
)
Interest bearing deposits
 
9

 
(55
)
 
(46
)
 
10

 
(11
)
 
(1
)
Total interest-earning assets
 
(267
)
 
(576
)
 
(843
)
 
(311
)
 
(840
)
 
(1,151
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense:
 
 

 
 

 
 

 
 

 
 

 
 

Savings deposits
 
6

 
10

 
16

 
9

 
68

 
77

Super Now deposits
 
10

 
(54
)
 
(44
)
 
(11
)
 
12

 
1

Money market deposits
 
(45
)
 
(133
)
 
(178
)
 
(104
)
 
(69
)
 
(173
)
Time deposits
 
137

 

 
137

 
562

 
199

 
761

Short-term borrowings
 
(87
)
 
(84
)
 
(171
)
 
(387
)
 
(367
)
 
(754
)
Long-term borrowings
 
118

 
(12
)
 
106

 
150

 
48

 
198

Total interest-bearing liabilities
 
139

 
(273
)
 
(134
)
 
219

 
(109
)
 
110

Change in net interest income
 
$
(406
)
 
$
(303
)
 
$
(709
)
 
$
(530
)
 
$
(731
)
 
$
(1,261
)

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, 2020, 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 from $11,894,000 at December 31, 2019 to $12,977,000 at June 30, 2020. The increase in the allowance for loan losses was allocated primarily to the consumer automobile segment along with the residential and commercial real estate mortgage segments. The majority of the loans charged-off during the three month period had a specific allowance within the allowance for losses. At June 30, 2020 and December 31, 2019, the allowance for loan losses to total loans was 0.96% and 0.88%, respectively.

The provision for loan losses totaled $645,000 and $1,395,000 for the three six months ended June 30, 2020, respectively, and the amounts for the corresponding 2019 periods were $315,000 and $675,000. The increase in the provision for loan losses for the

39



three and six months ended June 30, 2020 compared to the corresponding 2019 periods was the result of the economic impact caused by the COVID-19 pandemic and the uncertainty for the future that it presents.

Nonperforming loans decreased to $11,097,000 at June 30, 2020 from $15,383,000 at June 30, 2019. 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 0.82% and 1.12% at June 30, 2020 and 2019, respectively, and the ratio of the allowance for loan losses to nonperforming loans was 116.94% and 91.02% at June 30, 2020 and 2019, respectively. Internal loan review and analysis coupled with changes in the loan portfolio composition and the impact of the COVID-19 pandemic dictated a provision for loan losses of $1,395,000 for the six months ended June 30, 2020.

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, 2020
 
$
1,279

 
$
9,818

 
$
11,097

March 31, 2020
 
1,503

 
9,797

 
11,300

December 31, 2019
 
2,047

 
10,374

 
12,421

September 30, 2019
 
1,304

 
15,904

 
17,208

June 30, 2019
 
1,245

 
14,138

 
15,383

 
Non-interest Income

Total non-interest income for the three and six months ended June 30, 2020 compared to the same periods in 2019 increased $152,000 to $2,621,000 and $335,000 to $5,058,000, repectively. Excluding net securities gains, non-interest income for the three and six months ended June 30, 2020 decreased $21,000 and increased $199,000, respectively, compared to the same periods in 2019. Gain on sale of loans increased as the low rate environment has led to an increase in refinancing activity. Service charges declined as the overdraft fee income has declined as a result of the impact of the COVID-19 pandemic. The decrease in brokerage commissions is due to a change in the product mix and reduced consumer activity during the COVID-19 pandemic. The decrease in debit card fees is a result of a decrease in debit card usage resulting from the impact of the COVID-19 pandemic. The fluctuation in other income results primarily from other fees associated with loans sold on the secondary market.

Non-interest income composition for the three and six months ended June 30, 2020 and 2019 was as follows:
 
 
Three Months Ended
 
 
June 30, 2020
 
June 30, 2019
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Service charges
 
$
312

 
11.90
%
 
$
592

 
23.99
 %
 
$
(280
)
 
(47.30
)%
Net debt securities gains (losses), available for sale
 
186

 
7.10

 
(2
)
 
(0.08
)
 
188

 
9,400.00

Net equity securities gains
 
10

 
0.38

 
22

 
0.89

 
(12
)
 
54.55

Net securities gains, trading
 

 

 
3

 
0.12

 
(3
)
 
(100.00
)
Bank-owned life insurance
 
144

 
5.49

 
123

 
4.98

 
21

 
17.07

Gain on sale of loans
 
1,028

 
39.22

 
347

 
14.05

 
681

 
196.25

Insurance commissions
 
92

 
3.51

 
119

 
4.82

 
(27
)
 
(22.69
)
Brokerage commissions
 
186

 
7.10

 
356

 
14.42

 
(170
)
 
(47.75
)
Debit card fees
 
310

 
11.83

 
389

 
15.76

 
(79
)
 
(20.31
)
Other
 
353

 
13.47

 
520

 
21.05

 
(167
)
 
(32.12
)
Total non-interest income
 
$
2,621

 
100.00
%
 
$
2,469

 
100.00
 %
 
$
152

 
6.16
 %

40



 
 
Six Months Ended
 
 
June 30, 2020
 
June 30, 2019
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Service charges
 
$
861

 
17.02
 %
 
$
1,154

 
24.43
%
 
$
(293
)
 
(25.39
)%
Net debt securities gains, available for sale
 
207

 
4.09

 
11

 
0.23

 
196

 
(1,781.82
)
Net equity securities gains
 
30

 
0.59

 
65

 
1.38

 
(35
)
 
53.85

Net securities (losses) gains, trading
 
(14
)
 
(0.28
)
 
13

 
0.28

 
(27
)
 
(207.69
)
Bank-owned life insurance
 
336

 
6.64

 
291

 
6.16

 
45

 
15.46

Gain on sale of loans
 
1,472

 
29.10

 
663

 
14.04

 
809

 
122.02

Insurance commissions
 
219

 
4.33

 
253

 
5.36

 
(34
)
 
(13.44
)
Brokerage commissions
 
555

 
10.97

 
679

 
14.38

 
(124
)
 
(18.26
)
Debit card fees
 
584

 
11.55

 
699

 
14.80

 
(115
)
 
(16.45
)
Other
 
808

 
15.98

 
895

 
18.94

 
(87
)
 
(9.72
)
Total non-interest income
 
$
5,058

 
99.99
 %
 
$
4,723

 
100.00
%
 
$
335

 
7.09
 %

Non-interest Expense

Total non-interest expense decreased $448,000 and $152,000 for the three and six months ended June 30, 2020 compared to the same periods of 2019. The decrease in salaries and employee benefits is attributable to employee layoffs during the three months ended June 30, 2020 due to the COVID-19 pandemic. Furniture and equipment expenses have increased as maintenance costs have increased and older equipment has been replaced. Software amortization increased due to updating software programs that require new licensing fee structures. Marketing expenses decreased for the six month periosd as targeted direct mail marketing has replaced mass marketing. The fluctuation in professional fees consists primarily of an decrease in legal and audit fees. The decrease in deposit insurance reflects the assessment credits issued by the FDIC.

Non-interest expense composition for the three and six months ended June 30, 2020 and 2019 was as follows:
 
 
Three Months Ended
 
 
June 30, 2020
 
June 30, 2019
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Salaries and employee benefits
 
$
5,230

 
54.42
%
 
$
5,523

 
54.91
%
 
$
(293
)
 
(5.31
)%
Occupancy
 
626

 
6.51

 
668

 
6.64

 
(42
)
 
(6.29
)
Furniture and equipment
 
828

 
8.62

 
784

 
7.79

 
44

 
5.61

Software amortization
 
236

 
2.46

 
188

 
1.87

 
48

 
25.53

Pennsylvania shares tax
 
323

 
3.36

 
285

 
2.83

 
38

 
13.33

Professional fees
 
658

 
6.85

 
727

 
7.23

 
(69
)
 
(9.49
)
Federal Deposit Insurance Corporation deposit insurance
 
185

 
1.92

 
236

 
2.35

 
(51
)
 
(21.61
)
Marketing
 
56

 
0.58

 
33

 
0.33

 
23

 
69.70

Intangible amortization
 
59

 
0.61

 
69

 
0.69

 
(10
)
 
(14.49
)
Other
 
1,410

 
14.67

 
1,546

 
15.36

 
(136
)
 
(8.80
)
Total non-interest expense
 
$
9,611

 
100.00
%
 
$
10,059

 
100.00
%
 
$
(448
)
 
(4.45
)%

41



 
 
Six Months Ended
 
 
June 30, 2020
 
June 30, 2019
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Salaries and employee benefits
 
$
10,897

 
55.26
%
 
$
11,024

 
55.47
%
 
$
(127
)
 
(1.15
)%
Occupancy
 
1,328

 
6.73

 
1,447

 
7.28

 
(119
)
 
(8.22
)
Furniture and equipment
 
1,688

 
8.56

 
1,536

 
7.73

 
152

 
9.90

Software amortization
 
486

 
2.46

 
395

 
1.99

 
91

 
23.04

Pennsylvania shares tax
 
608

 
3.08

 
578

 
2.91

 
30

 
5.19

Professional fees
 
1,280

 
6.49

 
1,249

 
6.28

 
31

 
2.48

Federal Deposit Insurance Corporation deposit insurance
 
379

 
1.92

 
504

 
2.54

 
(125
)
 
(24.80
)
Marketing
 
109

 
0.55

 
135

 
0.68

 
(26
)
 
(19.26
)
Intangible amortization
 
121

 
0.61

 
140

 
0.70

 
(19
)
 
(13.57
)
Other
 
2,825

 
14.34

 
2,865

 
14.42

 
(40
)
 
(1.40
)
Total non-interest expense
 
$
19,721

 
100.00
%
 
$
19,873

 
100.00
%
 
$
(152
)
 
(0.76
)%

Provision for Income Taxes

Income taxes increased $92,000 and a decrease of $59,000 for the three and six months ended June 30, 2020 compared to the same periods of 2019. The effective tax rate for the three and six months ended June 30, 2020 was 18.44% and 18.10% compared to 15.16% and 16.09% for the same period of 2019. 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 $166,585,000 from $48,589,000 at December 31, 2019 to $215,174,000 at June 30, 2020, primarily as a result of the following activities during the six months ended June 30, 2020.

Loans Held for Sale

Activity regarding loans held for sale resulted in sales proceeds trailing loan originations, less $1,472,000 in realized gains, by $914,000 for the six months ended June 30, 2020.

Loans

Gross loans decreased $6,197,000 since December 31, 2019 due primarily to a decrease in both residential and commercial real estate mortgage categories. The decrease in the real estate mortgage portfolio was partially offset by the growth in commercial, financial and agricultural loans along with construction real estate mortgages and the consumer automobile loan segments.


42



The allocation of the loan portfolio, by category, as of June 30, 2020 and December 31, 2019 is presented below:
 
 
June 30, 2020
 
December 31, 2019
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Commercial, financial, and agricultural
 
$
168,904

 
12.52
%
 
$
156,213

 
11.52
%
 
$
12,691

 
8.12
 %
Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

 
 

Residential
 
606,214

 
44.93

 
623,256

 
45.98

 
(17,042
)
 
(2.73
)%
Commercial
 
352,530

 
26.13

 
363,261

 
26.80

 
(10,731
)
 
(2.95
)%
Construction
 
44,020

 
3.26

 
38,067

 
2.81

 
5,953

 
15.64
 %
Consumer automobile loans
 
155,721

 
11.54

 
150,517

 
11.10

 
5,204

 
3.46
 %
Other consumer installment loans
 
21,018

 
1.56

 
23,043

 
1.70

 
(2,025
)
 
(8.79
)%
Net deferred loan fees and discounts
 
940

 
0.06

 
1,187

 
0.09

 
(247
)
 
(20.81
)%
Gross loans
 
$
1,349,347

 
100.00
%
 
$
1,355,544

 
100.00
%
 
$
(6,197
)
 
(0.46
)%

The following table shows the amount of accrual and non-accrual TDRs at June 30, 2020 and December 31, 2019:
 
 
June 30, 2020
 
December 31, 2019
(In Thousands)
 
Accrual
 
Non-accrual
 
Total
 
Accrual
 
Non-accrual
 
Total
Commercial, financial, and agricultural
 
$

 
$
1,833

 
$
1,833

 
$

 
$
2,190

 
$
2,190

Real estate mortgage:
 
 

 
 

 
 

 
 

 
 

 
 

Residential
 
3,915

 
140

 
4,055

 
4,089

 
144

 
4,233

Commercial
 
1,107

 
4,551

 
5,658

 
2,127

 
4,732

 
6,859

 
 
$
5,022

 
$
6,524

 
$
11,546

 
$
6,216

 
$
7,066

 
$
13,282

 
Investments

The fair value of the investment debt securities portfolio at June 30, 2020 increased $15,750,000 since December 31, 2019 while the amortized cost of the portfolio increased $13,548,000.  The growth in the investment portfolio occurred within the municipal segment as bonds with a final maturity of approximately 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 78.92% 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 $1,300,000 for June 30, 2020 and December 31, 2019 while the fair value increased $30,000 over the same time period.




43



The distribution of credit ratings by amortized cost and fair values for the debt security portfolio at June 30, 2020 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
 
$
2,316

 
$
2,367

 
$

 
$

 
$

 
$

 
$
2,316

 
$
2,367

State and political securities
 
89,813

 
94,867

 
1,380

 
1,399

 
1,016

 
998

 
92,209

 
97,264

Other debt securities
 
33,399

 
33,309

 
19,864

 
20,153

 
11,272

 
11,276

 
64,535

 
64,738

Total debt securities AFS
 
$
125,528

 
$
130,543

 
$
21,244

 
$
21,552

 
$
12,288

 
$
12,274

 
$
159,060

 
$
164,369

 
Financing Activities

Deposits

Total deposits increased $150,300,000 from December 31, 2019 to June 30, 2020. The increase in core deposits (deposits less time deposits) has provided relationship driven funding for the loan and investment portfolios. Driving deposit growth was the receipt of PPP funding by commercial customers, stimulus funding by retail customers, and customers becoming more risk adverse and seeking safety in a bank deposit. Emphasis during 2020 has been on increasing the utilization of electronic (internet and mobile) deposit banking among our customers. Utilization of internet and mobile banking has increased since the start of 2020 due to these efforts coupled with a change in consumer behavior due to the business and travel restrictions caused by the COVID-19 pandemic.

Deposit balances and their changes for the periods being discussed follow:
 
 
June 30, 2020
 
December 31, 2019
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Demand deposits
 
$
418,324

 
28.37
%
 
$
334,746

 
25.28
%
 
$
83,578

 
24.97
 %
NOW accounts
 
268,348

 
18.20

 
218,605

 
16.51

 
49,743

 
22.75

Money market deposits
 
247,753

 
16.80

 
216,038

 
16.32

 
31,715

 
14.68

Savings deposits
 
195,964

 
13.29

 
176,732

 
13.35

 
19,232

 
10.88

Time deposits
 
343,916

 
23.34

 
377,884

 
28.54

 
(33,968
)
 
(8.99
)
 Total deposits
 
$
1,474,305

 
100.00
%
 
$
1,324,005

 
100.00
%
 
$
150,300

 
11.35
 %

Borrowed Funds

Total borrowed funds increased 12.09%, or $20,178,000, to $187,018,000 at June 30, 2020 compared to $166,840,000 at December 31, 2019. The increase in long term borrowings occurred as fixed rate funding was obtained during this time of low interest rates. Securities sold under agreement to repurchase have increased as customers balances have increased.. The long-term borrowings originating during the six months ended June 30, 2020 have a blended interest rate of 1.60% and mature by 2025.

 
 
June 30, 2020
 
December 31, 2019
 
Change
(In Thousands)
 
Amount
 
% Total
 
Amount
 
% Total
 
Amount
 
%
Short-term borrowings:
 
 

 
 

 
 

 
 

 
 

 
 

FHLB repurchase agreements
 
$

 
%
 
$

 
%
 
$

 
n/a

Securities sold under agreement to repurchase
 
15,133

 
8.09

 
4,920

 
2.95

 
10,213

 
207.58

Total short-term borrowings
 
15,133

 
8.09

 
4,920

 
2.95

 
10,213

 
207.58

Long-term borrowings:
 
 
 
 
 
 
 
 
 
 
 
 
Long-term FHLB borrowings
 
166,333

 
88.93

 
156,333

 
93.70

 
10,000

 
6.40

Long-term finance lease
 
5,552

 
2.97

 
5,587

 
3.35

 
(35
)
 
(0.63
)
Total long-term borrowings
 
171,885

 
91.91

 
161,920

 
97.05

 
9,965

 
6.15

Total borrowed funds
 
$
187,018

 
100.00
%
 
$
166,840

 
100.00
%
 
$
20,178

 
12.09
 %




44




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, 2020
 
December 31, 2019
Investment debt securities pledged, fair value
 
$
17,853

 
$
6,752

Repurchase agreements
 
15,133

 
4,920


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.

Banking institutions are generally required to comply with risk-based capital guidelines set by bank regulatory agencies.  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. 

























45



The Company's capital ratios as of June 30, 2020 and December 31, 2019 were as follows:
 
 
June 30, 2020
 
December 31, 2019
(In Thousands)
 
Amount
 
Ratio
 
Amount
 
Ratio
Common Equity Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
143,299

 
10.803
%
 
$
140,372

 
10.674
%
For Capital Adequacy Purposes
 
59,691

 
4.500

 
59,179

 
4.500

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
92,853

 
7.000

 
92,056

 
7.000

To Be Well Capitalized
 
86,221

 
6.500

 
85,480

 
6.500

Total Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
153,357

 
11.562
%
 
$
149,748

 
11.387
%
For Capital Adequacy Purposes
 
106,111

 
8.000

 
105,206

 
8.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
139,271

 
10.500

 
138,083

 
10.500

To Be Well Capitalized
 
132,639

 
10.000

 
131,508

 
10.000

Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
143,299

 
10.803
%
 
$
140,372

 
10.674
%
For Capital Adequacy Purposes
 
79,588

 
6.000

 
78,905

 
6.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
112,750

 
8.500

 
111,782

 
8.500

To Be Well Capitalized
 
106,118

 
8.000

 
105,207

 
8.000

Tier I Capital (to Average Assets)
 
 

 
 

 
 

 
 

Actual
 
$
143,299

 
8.463
%
 
$
140,372

 
8.514
%
For Capital Adequacy Purposes
 
67,730

 
4.000

 
65,949

 
4.000

To Be Well Capitalized
 
84,662

 
5.000

 
82,436

 
5.000

 
Jersey Shore State Bank's capital ratios as of June 30, 2020 and December 31, 2019 were as follows:
 
 
June 30, 2020
 
December 31, 2019
(In Thousands)
 
Amount
 
Ratio
 
Amount
 
Ratio
Common Equity Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
101,211

 
10.624
%
 
$
99,317

 
10.381
%
For Capital Adequacy Purposes
 
42,870

 
4.500

 
43,052

 
4.500

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
66,686

 
7.000

 
66,970

 
7.000

To Be Well Capitalized
 
61,923

 
6.500

 
62,187

 
6.500

Total Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
109,086

 
11.451
%
 
$
106,093

 
11.089
%
For Capital Adequacy Purposes
 
76,211

 
8.000

 
76,539

 
8.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
100,026

 
10.500

 
100,458

 
10.500

To Be Well Capitalized
 
95,263

 
10.000

 
95,674

 
10.000

Tier I Capital (to Risk-weighted Assets)
 
-

 
 

 
-

 
 

Actual
 
$
101,211

 
10.624
%
 
$
99,317

 
10.381
%
For Capital Adequacy Purposes
 
57,160

 
6.000

 
57,403

 
6.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
80,976

 
8.500

 
81,321

 
8.500

To Be Well Capitalized
 
76,213

 
8.000

 
76,538

 
8.000

Tier I Capital (to Average Assets)
 
 

 
 

 
 

 
 

Actual
 
$
101,211

 
7.930
%
 
$
99,317

 
8.191
%
For Capital Adequacy Purposes
 
51,052

 
4.000

 
48,501

 
4.000

To Be Well Capitalized
 
63,815

 
5.000

 
60,626

 
5.000








46




Luzerne Bank's capital ratios as of June 30, 2020 and December 31, 2019 were as follows:
 
 
June 30, 2020
 
December 31, 2019
(In Thousands)
 
Amount
 
Ratio
 
Amount
 
Ratio
Common Equity Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
39,292

 
10.528
%
 
$
38,340

 
10.577
%
For Capital Adequacy Purposes
 
16,795

 
4.500

 
16,312

 
4.500

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
26,125

 
7.000

 
25,374

 
7.000

To Be Well Capitalized
 
24,259

 
6.500

 
23,562

 
6.500

Total Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
41,475

 
11.110
%
 
$
40,940

 
11.295
%
For Capital Adequacy Purposes
 
29,865

 
8.000

 
28,997

 
8.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
39,198

 
10.500

 
38,058

 
10.500

To Be Well Capitalized
 
37,331

 
10.000

 
36,246

 
10.000

Tier I Capital (to Risk-weighted Assets)
 
 

 
 

 
 

 
 

Actual
 
$
39,292

 
10.528
%
 
$
38,340

 
10.577
%
For Capital Adequacy Purposes
 
22,393

 
6.000

 
21,749

 
6.000

Minimum To Maintain Capital Conservation Buffer At Reporting Date
 
31,723

 
8.500

 
30,811

 
8.500

To Be Well Capitalized
 
29,857

 
8.000

 
28,999

 
8.000

Tier I Capital (to Average Assets)
 
 

 
 

 
 

 
 

Actual
 
$
39,292

 
8.295
%
 
$
38,340

 
8.653
%
For Capital Adequacy Purposes
 
18,947

 
4.000

 
17,723

 
4.000

To Be Well Capitalized
 
23,684

 
5.000

 
22,154

 
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.

The following liquidity measures are monitored for compliance and were within the limits cited at June 30, 2020:

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.

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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 $595,158,000. 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 $166,333,000 as of June 30, 2020.

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.

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, 2021 assuming a static balance sheet as of June 30, 2020.
 
 
Parallel Rate Shock in Basis Points
(In Thousands)
 
-200
 
-100
 
Static
 
+100
 
+200
 
+300
 
+400
Net interest income
 
$
42,788

 
$
45,827

 
$
48,205

 
$
48,806

 
$
49,439

 
$
49,754

 
$
50,000

Change from static
 
(5,417
)
 
(2,378
)
 

 
601

 
1,234

 
1,549

 
1,795

Percent change from static
 
-11.24
 %
 
-4.93
 %
 

 
1.25
%
 
2.56
%
 
3.21
%
 
3.72
%
 
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

48



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.

COVID-19 Impact
Employees
The Company has undertaken various actions to maintain a safe work environment for employees during the pandemic, including supplying employees with hand sanitizer, face masks, disinfecting supplies, and gloves. The Company has also allowed approximately one-third of the workforce to work remotely in accordance with the Company’s pre-existing business continuity plans, while also maintaining data security and internal controls. Permitting employees to work remotely has allowed for increased social distancing capabilities within the Company’s buildings. To protect employees and customers and promote social distancing, branch lobbies were closed, other than by appointment, until early June at which time lobbies were reopened with sneeze guards in place and foot traffic being directed in a manner that encourages proper social distancing. During the lobby closure and continuing to today, drive-thru, mobile banking, and internet banking have become more popular channels for customers to complete transactions.
The change to a “drive-thru” only strategy until early June coupled with the mandated closure of nonessential businesses in Pennsylvania for a part of the second quarter led to a reduced workload in certain areas of the Company. As a result, approximately 80 employees were furloughed and other employees had their normal work week hours reduced. As businesses have been reopening, the Company has called back all but a few of the previously furloughed employees. Because the Company views its employees as a critical resource, it took certain steps to mitigate the negative impact on them of workforce disruption: for employees who were furloughed, the Company paid 100% of their health insurance premiums; employees who had hours reduced were paid based on their pre-reduction average normal working hours; and a bonus of $50 per week was paid to employees working in customer servicing areas.
Liquidity
The Company has focused on increasing balance sheet liquidity by means of increased levels of cash within the branches and ATMs, and within correspondent bank accounts. Deposit growth has provided liquidity as commercial customers received PPP funding, retail customers received stimulus funding, and customers became more risk averse and sought greater safety in bank deposits. In addition to the buildup in cash reserves, the Company has remaining borrowing capacity of approximately $650 million with the FHLB and other correspondent banks. The Company anticipates slowly reducing the amount of cash reserves as the economy is reopened and the rate of infections declines. The Company believes that it currently has sufficient liquidity to meet customer needs and the Company’s financial obligations based on present circumstances.
Loans
The mandated closure of nonessential businesses and the closure or limited access to many government offices, including court houses, during a portion of the second quarter, has limited the addition of new loans to the portfolio. Indirect auto lending was completely closed for several weeks beginning in late March 2020, and has only recently reopened on a full scale. Secondary mortgage market activity continues to flourish as individuals seek to refinance at historically low interest rates. As businesses begin to reopen, the Company anticipates utilizing its strong liquidity position to offer favorable lending terms to its customers to assist them in returning to normal operations and to grow their businesses.
The yield on the loan portfolio has declined, as the low rate environment has resulted in any new loans generated and any loans repricing to be at yields less than the historical average yield of the portfolio. The Company expects the loan portfolio yield to continue to decline due to the projected low rate environment caused by the COVID-19 pandemic. Looking forward, as in the past, the Company’s focus for building the loan portfolio will be on quality of the credit, not necessarily yield.
The Company participated in the Paycheck Protection Program (“PPP”). The Company booked $12.3 million in loans directly into the PPP and also utilized a third party to match customer needs with a lending outlet. This method did not result in the Company earning any processing fees under the PPP for loans extended by others, but was the quickest manner to service the greatest number of customers resulting in 586 customers obtaining $57.4 million in funding. The goal was to have as many customers as possible receive requested funding before PPP funding expired, even if the Company did not recognize fee income from making the loans.
Loan modifications and payment deferrals have been at historical high levels as the impact of the pandemic continues. As of June 30, 2020 rate modifications or payment deferrals up to 90 days have been granted on loans with an aggregate balance of $241.6 million. Loan modifications met applicable requirements to not be considered troubled debt restructurings. The number of customers seeking loan modifications or payment deferrals may increase as the effects of the pandemic continue.

49



The Company has not to date experienced significant credit quality deterioration. However, the provision for loan losses for the three and six months ended June 30, 2020 was increased to $645,000 and $1.4 million (from $315,000 and $675,000 for the corresponding periods of 2019) and is expected to remain at levels above those historically reported. The increase in the provision for the three and six months ended June 30, 2020 is the result of the uncertainty surrounding the strength of the economy as businesses reopen and communities in general attempt to return to pre-pandemic life. From an industry concentration perspective, the Company has minimal exposure to the hospitality and travel industries, which have been greatly affected by the pandemic. The Company does, however, have some potential exposure to student housing in markets such as State College and Williamsport, Pennsylvania; this potential exposure continues to be monitored and to date has not resulted in any credit quality concerns.
Investments
The Company’s investment portfolio is weighted toward municipal bonds and, to a lesser extent, corporate bonds. The credit quality of the investment portfolio continues to be monitored for impairment. The reinvestment of cash flows from the investment portfolio is being focused primarily on bonds with solid credit quality and a final maturity before 2027. The Company continues to limit investments in equity securities due to the significant fluctuations in pricing, uncertain economic future, and the belief that the adverse impact of the COVID-19 pandemic may continue for some time.
Deposits
The impact of the COVID-19 pandemic on the deposit portfolio has been lower rates with an increase in balances. Rates were significantly reduced toward the end of March and beginning April as the Federal Reserve took steps to mitigate the negative economic impact of the pandemic. Although rates have been reduced, in many cases the amount of the rate reduction on the deposit side has not coincided with the amount of rate reduction occurring within the loan portfolio because of the already historically low levels of deposit rates. In many cases, rates on non-maturity deposit products have reduced to levels below 10bps. Time deposits have experienced a significant reduction in rate, with rates for terms less than twelve months being below the current cost of overnight funding from the FHLB or other correspondent banks.
The deposit portfolio has experienced significant growth with a correlation drawn to the stimulus checks sent to certain taxpayers by the federal government under the CARES Act, PPP funding, and customers became more risk averse and sought safety in bank deposits . Although the stimulus checks provided funding, lower debit and credit card usage has resulted in fewer withdrawals from deposit accounts.
Net Interest Margin
For the reasons noted in the loan, investment, and deposit sections above, the Company anticipates that the net interest margin will compress as the COVID-19 pandemic continues. Although the Company has taken actions to lower the cost of funding, the yield on earning assets continues to decrease due to the volume of loan modifications and the historically low interest rate environment. As the impact of the COVID-19 pandemic lessens, the Company does not anticipate significant increases in the net interest margin quickly. The Company anticipates granting favorable lending terms to assist the economic recovery of the communities in which the Company operates, while anticipated competition for deposits is expected to increase in funding costs.
Non-Interest Income
Two areas of non-interest income have experienced a significant reduction during the six months ended June 30, 2020 due to the COVID-19 pandemic. Overdraft fees and debit card income have been reduced by approximately one-third. The mandated closure of nonessential businesses coupled with shelter in place orders during the end of the first quarter and into the second quarter have resulted in a reduction in the overall number and the amount of purchases by individuals. The Company anticipates that a return to historical levels for these two non-interest income items could be months after the COVID-19 pandemic wanes and consumer behavior may take significant time to return to normal. Buoying non-interest income during the six months ended June 30, 2020 was the gain on sale of loans as the volume of mortgage refinancing has increased due to the historically low rates. The Company has focused on its mortgage business line and anticipates the strong second quarter to continue into the third quarter in this business line due to the number of individuals expected to refinance existing mortgages.
Non-Interest Expense
The level of non-interest expense is not expected to change significantly due to the COVID-19 pandemic. Although the Company furloughed certain employees, any compensation expense savings was significantly offset by the Company’s paying 100% of the health insurance for furloughed employees and the weekly bonus being paid to customer service employees who remained working. Other expenses may remain above historical levels as items such as sanitizer, disinfectant, gloves, masks, sneeze guards, directional/social distancing signage, and other safety items continue to be purchased.



50




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, 2019.  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, 2020.

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, 2020 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

51



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

Item 1A.  Risk Factors
 
Certain risk factors are 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, 2019.  Please refer to that section for disclosures regarding the risks and uncertainties related to the Company’s business. The risk factor set forth below supplements the risk factors set forth in the Company's Annual Report on Form 10-K for the year ended December 31, 2019.

The continuing COVID-19 pandemic has adversely impacted our business and financial results, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

The COVID-19 pandemic has materially and negatively impacted the global economy, disrupted global supply chains, lowered equity market valuations, created significant volatility and disruption in financial markets, increased unemployment levels, and decreased consumer confidence. In addition, the pandemic has resulted in temporary closures of many businesses and the institution of social distancing and other requirements in many states and communities, including in our primary market areas of Pennsylvania. As a result, the demand for our products and services may be significantly impacted, which could adversely affect our revenue. Federal Reserve actions to address the economic contraction caused by the COVID-19 pandemic, including the reduction in the target federal funds rate and quantitative easing programs, could, if prolonged, adversely affect our net interest income, net interest margins, and profitability. Furthermore, the pandemic could continue to result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses, particularly if businesses remain closed, the impact on the global economy worsens, or more customers draw on their lines of credit or seek additional loans to help finance their businesses. Similarly, because of changing economic and market conditions affecting issuers, we may be required to recognize impairments on the securities we hold as well as reductions in other comprehensive income. Our business operations may be further disrupted if significant portions of our workforce are unable to work effectively, including because of illness, quarantines, government actions, or other restrictions in connection with the pandemic.

 Moreover, the pandemic has created additional operational and compliance risks, including the need to quickly implement and execute new programs and procedures for the products and services we offer our customers, provide enhanced safety measures for our employees and customers, comply with rapidly changing regulatory requirements, address any increased risk of fraudulent activity, and protect the integrity and functionality of our systems and networks as a larger number of our employees work remotely. The extent to which the COVID-19 pandemic impacts our business, results of operations, and financial condition, as well as our regulatory capital and liquidity ratios and our cost of capital, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic.

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, 2020.
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, 2020)
 

 

 

 
513,669

Month #2 (May 1 - May 31, 2020)
 

 

 

 
513,669

Month #3 (June 1 - June 30, 2020)
 

 

 

 
513,669


On April 30, 2020, the Board of Directors extended the previously approved authorization to repurchase up to 723,000 shares, or approximately 10%, of the outstanding shares of the Company for an additional year to April 30, 2021.  As of June 30, 2020 there have been 209,331 shares repurchased under this plan.




52



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

53



Item 6.                           Exhibits
 
 
Articles of Incorporation of the Registrant, as presently in effect (incorporated by reference to Exhibit 3(i) of the Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 2019).
 
Bylaws of the Registrant (incorporated by reference to Exhibit 3(ii) of the Registrant's Quarterly Report on Form 10-Q for the period ended March 31, 2020).
 
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, 2020 and December 31, 2019; (ii) the Consolidated Statement of Income for the three and six months ended June 30, 2020 and 2019; (iii) Consolidated Statement of Comprehensive Income for the three and six months ended June 30, 2020 and 2019; (iv) the Consolidated Statement of Shareholders’ Equity for the three and six months ended June 30, 2020 and 2019; (v) the Consolidated Statement of Cash Flows for the six months ended June 30, 2020 and 2019 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.

54



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 10, 2020
/s/ Richard A. Grafmyre
 
 
Richard A. Grafmyre, Chief Executive Officer
 
 
(Principal Executive Officer)
 
 
 
 
 
 
Date:
August 10, 2020
/s/ Brian L. Knepp
 
 
Brian L. Knepp, President and Chief Financial Officer
 
 
(Principal Financial Officer and Principal Accounting
 
 
Officer)

55



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 Quarterly Report on Form 10-Q for the period ended September 30, 2019).
Exhibit 3(ii)
 
Bylaws of the Registrant (incorporated by reference to Exhibit 3(ii) of the Registrant's Quarterly Report on Form 10-Q for the period ended March 31, 2020).
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, 2020 and December 31, 2019; (ii) the Consolidated Statement of Income for the three and six months ended June 30, 2020 and 2019; (iii) Consolidated Statement of Comprehensive Income for the three and six months ended June 30, 2020 and 2019; (iv) the Consolidated Statement of Shareholders’ Equity for the three and six months ended June 30, 2020 and 2019; (v) the Consolidated Statement of Cash Flows for the six months ended June 30, 2020 and 2019 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.

56