CORTLAND BANCORP
The following schedules show average balances of interest-earning and
noninterest-earning assets and liabilities, and shareholders' equity for the
years indicated. Also shown are the related amounts of interest earned or paid
and the related average yields or interest rates paid for the years indicated.
The averages are based on daily balances.
(Fully taxable equivalent basis in thousands of dollars)
2019 2018 2017
Average Interest Average Interest Average Interest
Balance Earned Yield Balance Earned Yield Balance Earned Yield
Outstanding or Paid or Rate Outstanding or Paid or Rate Outstanding or Paid or Rate
Interest-earning assets:
Interest-earning deposits and other
earning assets $ 14,122 $ 299 2.12 %
98 1.13 %
Investment securities (Note 1, 2, 3):
Taxable 78,745 1,905 2.42 % 93,372 2,270 2.43 % 101,768 2,229 2.19 %
Nontaxable 61,079 2,028 3.32 % 55,566 1,851 3.33 % 66,886 2,853 4.26 %
Total investment securities 139,824 3,933 2.81 % 148,938 4,121 2.77 % 168,654 5,082 3.01 %
Loans (Note 1, 2, 3, 4) 492,970 25,789 5.23 % 473,527 23,830 5.03 % 415,251 19,257 4.64 % Total interest-earning assets
646,916 $ 30,021 4.64 % 631,029 $ 28,113 4.46 % 592,573 $ 24,437 4.12 %
Noninterest-earning assets:
Cash and due from banks 7,569 7,277 7,804
Premises and equipment 10,366 9,089 9,193
Other assets 32,400 25,111 27,345
Total assets $ 697,251 $ 672,506 $ 636,915
Interest-bearing liabilities:
Deposits:
Interest-bearing demand deposits $ 197,196 $ 1,879 0.95 % $ 197,856 $ 1,378 0.70 % $ 168,536 $ 751 0.45 %
Savings 110,473 102 0.09 % 112,508 97 0.09 % 114,261 90 0.08 %
Time 141,080 2,862 2.03 % 120,986 2,052 1.70 % 128,251 1,730 1.35 %
Total interest-bearing deposits 448,749 4,843 1.08 % 431,350 3,527 0.82 % 411,048
2,571 0.63 % Borrowings: Securities sold under agreement to repurchase 1,493 5 0.33 % 1,679 6 0.33 % 2,018 7 0.33 % Subordinated debt 5,155 203 3.89 % 5,155 189 3.61 % 5,155 138 2.64 %Federal Home Loan Bank advances - short term 4,786 129 2.70 % 18,899 374 1.98 % 16,917 175 1.03 %Federal Home Loan Bank advances - long term 18,000 374 2.08 % 15,288 287 1.88 % 14,842 299 2.01 % Total borrowings 29,434 711 2.42 % 41,021 856 2.09 % 38,932
619 1.59 %
Total interest-bearing liabilities 478,183
3,190 0.71 % Noninterest-bearing liabilities: Demand deposits 135,388 128,571 116,605 Other liabilities 13,093 10,044 10,332 Shareholders' equity 70,587 61,520 59,998 Total liabilities and shareholders' equity$ 697,251 $ 672,506 $ 636,915 Net interest income$ 24,467 $ 23,730 $ 21,247 Net interest rate spread (Note 5) 3.48 % 3.53 % 3.41 % Net interest margin (Note 6) 3.79 % 3.76 % 3.59 %
Note 1 - Includes both taxable and tax-exempt securities and loans.
Note 2 - The amounts are presented on a fully taxable equivalent basis using the
statutory rate of 21% in 2019 and 2018 and 34% in 2017, and have been
adjusted to reflect the effect of disallowed interest expenses relatedto carrying tax-exempt assets. The tax equivalent income adjustment for
loans and investment securities was
for
31, 2018; and
Note 3 - Average balance outstanding includes the average amount outstanding of
all non-accrual investment securities and loans. Investment securities
consist of average total principal adjusted for amortization of premium
and accretion of discount and include both taxable and tax-exempt
securities. Loans consist of average total loans, including loans held
for sale, less average unearned income.
Note 4 - Interest earned on loans includes net loan fees of
Note 5 - Net interest rate spread represents the difference between the yield on
earning assets and the rate paid on interest-bearing liabilities.
Note 6 - Net interest margin is calculated by dividing the net interest income by
total interest-earning assets.
25
--------------------------------------------------------------------------------
FINANCIAL REVIEW
The following is management's discussion and analysis of the financial condition and results of operations of the Company. The discussion should be read in conjunction with the Consolidated Financial Statements and related notes and summary financial information included elsewhere in this annual report.
NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. In addition to historical information, certain information included in this discussion and other materials filed or to be filed by the Company with theSEC (as well as information included in oral statements or other written statements made or to be made by the Company) may contain forward-looking statements that involve risks and uncertainties. The words "believes," "expects," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends," or similar terminology identify forward-looking statements. These statements reflect management's beliefs and assumptions, and are based on information currently available to management. Economic circumstances, the Company's operations and actual results could differ significantly from those discussed in any forward-looking statements. Some of the factors that could cause or contribute to such differences are changes in the economy and interest rates either nationally or in the Company's market area, including the impact of the impairment of securities; political actions, including failure of theUnited States Congress to raise the federal debt ceiling or the imposition of changes in the federal budget; changes in customer preferences and consumer behavior; increased competitive pressures or changes in either the nature or composition of competitors; changes in the legal and regulatory environment; changes in factors influencing liquidity, such as expectations regarding the rate of inflation or deflation, currency exchange rates, and other factors influencing market volatility; changes in assumptions underlying the establishment of reserves for possible loan losses, reserves for repurchase of mortgage loans sold and other estimates; and risks associated with other global economic, political and financial factors. While actual results may differ significantly from the results discussed in the forward-looking statements, the Company undertakes no obligation to update publicly any forward-looking statement for any reason, even if new information becomes available.
Critical Accounting Policies and Estimates
The discussion and analysis of the Company's financial condition and results of operation are based upon the Consolidated Financial Statements, which have been prepared in accordance withU.S. Generally Accepted Accounting Principles (GAAP). The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of the Company's consolidated financial statements. Actual results may differ from these estimates under different assumptions or conditions. Certain accounting policies involve significant judgments and assumptions by management which has a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Management has discussed the development and selection of these accounting estimates with the Audit Committee.
Management believes the following are critical accounting policies that require the most significant judgments and estimates used in the preparation of the Company's consolidated financial statements.
26--------------------------------------------------------------------------------
Accounting for the Allowance for Loan Losses
The determination of the allowance for loan losses and the resulting amount of the provision for loan losses charged to operations reflects management's current judgment about the credit quality of the loan portfolio and takes into consideration changes in lending policies and procedures, changes in economic and business conditions, changes in the nature and volume of the portfolio and, in the terms of loans, changes in the experience, ability and depth of lending management, changes in the volume and severity of past due, non-accrual and adversely classified or graded loans, changes in the quality of the loan review system, changes in the value of underlying collateral for collateral-dependent loans, the existence and effect of any concentrations of credit and the effect of competition, legal and regulatory requirements and other external factors. The nature of the process by which we determine the appropriate allowance for loan losses requires the exercise of considerable judgment. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond our control, including the performance of the loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. The allowance is increased by the provision for loan losses and decreased by charge-offs when management believes the uncollectibility of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance. A weakening of the economy or other factors that adversely affect asset quality could result in an increase in the number of delinquencies, bankruptcies or defaults and a higher level of non-performing assets, net charge offs, and provision for loan losses in future periods. The Company's allowance for loan losses methodology consists of three elements: specific valuation allowances based on probable losses on specific loans; valuation allowances based on historical loan loss experience for similar loans with similar characteristics and trends; and general valuation allowances based on general economic conditions and other qualitative risk factors both internal and external to the Company. These elements support the basis for determining allocations between the various loan categories and the overall adequacy of our allowance to provide for probable losses inherent in the loan portfolio. With these methodologies, a general allowance is established for each loan type based on historical losses for each loan type in the portfolio. Additionally, management allocates a specific allowance for "Impaired Credits," which is based on current information and events; it is probable the Company will not collect all amounts due according to the original contractual terms of the loan agreement. The level of the general allowance is established to provide coverage for management's estimate of the credit risk in the loan portfolio by various loan segments not covered by the specific allowance. Additional information regarding allowance for credit losses can be found in Item 8, Note 3 to the Consolidated Financial Statements and elsewhere in this Management's Discussion and Analysis.
The classification and accounting for investment securities is discussed in
detail in Item 8, Notes 1 and 2 of the Consolidated Financial Statements.
Investment securities must be classified as held-to-maturity,
available-for-sale, or trading. The appropriate classification is based
partially on our ability to hold the securities to maturity and largely on
management's intentions, if any, with respect to either holding or selling the
securities. The classification of investment securities is significant since it
directly impacts the accounting for unrealized gains and losses on securities.
Unrealized gains and losses on trading securities, if any, flow directly through
earnings during the periods in which they arise, whereas available-for-sale
securities are recorded as a separate component of shareholders' equity
(accumulated other comprehensive income or loss) and do not affect earnings
until realized. The fair values of our investment securities are generally
determined by reference to quoted market prices and reliable independent
sources. At each reporting date, the Company assesses whether there is an
"other-than-temporary" impairment to the Company's investment securities. Such
impairment must be recognized in current earnings rather than in other
comprehensive income (loss).
The Company reviews investment debt securities on an ongoing basis for the
presence of other-than-temporary impairment (OTTI) with formal reviews performed
quarterly. OTTI losses on individual investment securities are recognized in
accordance with FASB ASC topic 320, Investments - Debt and Equity Securities.
The purpose of this ASC is to provide greater clarity to investors about the
credit and noncredit component of an OTTI event and to communicate more
effectively when an OTTI event has occurred. This ASC amends the OTTI guidance
in GAAP for debt securities, improves the presentation and disclosure of OTTI on
investment securities and changes the calculation of the OTTI recognized in
earnings in the financial statements. This ASC does not amend existing
recognition and measurement guidance related to OTTI of equity securities.
For debt securities, ASC topic 320 requires an entity to assess whether it has
the intent to sell the debt security or it is more-likely-than-not that it will
be required to sell the debt security before its anticipated recovery. If either
of these conditions is met, an OTTI on the security must be recognized.
In instances in which a determination is made that a credit loss (defined as the
difference between the present value of the cash flows expected to be collected
and the amortized cost basis) exists but the entity does not intend to sell the
debt security and it is not more-likely-than-not that the entity will be
required to sell the debt security before the anticipated recovery of its
remaining amortized cost basis (i.e., the amortized cost basis less any
current-period credit loss), ASC topic 320 changes the presentation and amount
of the OTTI recognized in the income statement.
27
--------------------------------------------------------------------------------
In these instances, the impairment is separated into the amount of the total
impairment related to the credit loss and the amount of the total impairment
related to all other factors. The amount of the total other-than-temporary
impairment related to the credit loss is recognized in earnings. The amount of
the total impairment related to all other factors is recognized in other
comprehensive income (loss). The total OTTI is presented in the income statement
with an offset for the amount of the total OTTI that is recognized in other
comprehensive income (loss). In determining the amount of impairment related to
credit loss, the Company uses a third party discounted cash flow model, several
inputs for which require estimation and judgment. Among these inputs are
projected deferral and default rates and estimated recovery rates. Realization
of events different than that projected could result in a large variance in the
values of the securities.
Additional information regarding investment securities can be found in Item 8,
Notes 2 and 11 to the Consolidated Financial Statements and elsewhere in this
Management's Discussion and Analysis.
Income Taxes
The provision for income taxes is based on income reported for financial statement purposes and differs from the amount of taxes currently payable, since certain income and expense items are reported for financial statement purposes in different periods than those for tax reporting purposes. Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, the Company assesses the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial and regulatory guidance in the context of the Company's tax position. The Company accounts for income taxes using the asset and liability approach, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and tax basis of our assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. The Company conducts periodic assessments of deferred tax assets, including net operating loss carryforwards, to determine if it is more-likely-than-not that they will be realized. In making these assessments, the Company considers taxable income in prior periods, projected future taxable income, potential tax planning strategies and projected future reversals of deferred tax items. These assessments involve a certain degree of subjectivity which may change significantly depending on the related circumstances.
CORPORATE PROFILE
The Company, with total assets of approximately$737 million atDecember 31, 2019 , is a bank holding company headquartered inCortland, Ohio whose principle activity is to manage, supervise and otherwise serve as a source of strength to the Bank.
The Bank's results of operations depend primarily on net interest income, which, in part, is a direct result of the market interest rate environment. Net interest income is the difference between the interest income earned on interest-earning assets and the interest paid on interest-bearing liabilities. Net interest income is affected by the shape of the market yield curve, the repricing of interest-earning assets and interest-bearing liabilities and the prepayment rate of mortgage-related assets. Results of operations may be affected significantly by general and local economic conditions, particularly those with respect to changes in market interest rates, credit quality, governmental policies and actions of regulatory authority.
2019 OVERVIEW
In 2019, the Company's net income was$7.3 million compared to$8.8 million in 2018, the primary difference being a$1.55 million gain on life insurance proceeds from the death of a former executive. Amid rigorous regulatory standards and an uncertain economy, the Company continues to follow its core strategic direction. Operating results reflect its commitment to growing loans and deposits in the markets in which it operates and in producing consistent positive earnings.
Highlights of 2019 financial results:
• Net income of
net profits of
stated on a normalized basis, after adjusting for non-recurring items,
including
received on life insurance policies upon the death of former directors or
officers that exceeded the cash value of the policies.
• The Company's net interest margin for the year ended December 31, 2019 improved to 3.79% versus 3.76% for the same period last year despite three
rate cuts enacted by the Federal Open Market Committee in 2019.
• The return on average asset ratio for the Company was 1.04% for the year
compared to 1.31% for the same period in 2018. Likewise, the return on
average equity ratio for the Company was 10.32% for the year compared to
14.36% for the same period in 2018. Ratios in 2018 are unadjusted for the
$1.55 million life insurance gain.
28
--------------------------------------------------------------------------------
• The efficiency ratio for the Company was 67.01% for the year versus 64.82%
for 2018.
• Non-interest expenses of $19.8 million for the full year represent a 9.2%
increase over the
is a result of onboarding costs relating to the NASDAQ listing, increased
equity awards and new branch initiatives.
• A quarterly cash dividend of
shareholders of record on
previous
share was payable concurrently, reflecting the consistent earnings
performance.
• The effective tax rate was 15.7% compared to 13.8% for 2019 and 2018,
respectively. The tax-free life insurance gain in 2018 significantly reduced
the effective rate. Further reductions in the 21% statutory rate are
realized by the Company as a result of tax-free investment income.
In the midst of earnings pressures brought on by economic instability, interest rate compression and increased competition, the Company devoted substantial attention in the three years 2017-2019 to profit improvement measures and balance sheet positioning. The Company's management team continues to focus on measures designed to maintain capital and to provide for adequate liquidity for lending and business development purposes. New strategies are being pursued to improve market penetration and product expansion, with the objective of increasing both the interest income and non-interest income revenue base. Total shareholders' equity atDecember 31, 2019 was$74.3 million , representing a ratio of equity capital to total assets of 10.1%. In comparison, total shareholders' equity was$64.9 million atDecember 31, 2018 , representing a ratio of equity capital to total assets of 9.1%. A component of shareholders' equity is accumulated other comprehensive income (loss), which includes the net after-tax impact of unrealized gains or losses on investment securities classified as available-for-sale. Net unrealized gains on available-for-sale investment securities, net of tax, were$1.1 million atDecember 31, 2019 , compared with net unrealized losses, net of tax, of$3.7 million atDecember 31, 2018 . Such unrealized gains or losses represent the difference, net of applicable income tax effect, between the estimated fair value and amortized cost of investment securities classified as available-for-sale and is driven by market interest rates. The$4.8 million increase in securities valuation is a result of the decline in interest rates during 2019. Return on average equity was 10.32% in 2019, compared to 14.36% in 2018, while return on average assets measured 1.04% in 2019 and 1.31% in 2018. Adjusted for nonrecurring items, the return on average assets and return on average equity in 2018 were 1.08% and 11.84%. Book value per share increased by$2.27 to$17.19 atDecember 31, 2019 from$14.92 atDecember 31, 2018 . The price of the Company's common shares traded in a range between a low of$20.10 and a high of$28.68 , closing the year at$21.81 per share.
The Company continues to maintain capital sufficient to be deemed well capitalized under all regulatory measures. In the current regulatory environment, regulatory oversight bodies expect banks to maintain ratios above the statutory levels as a margin of safety.
CERTAIN NON-GAAP MEASURES
Certain financial information has been determined by methods other than GAAP. Specifically, certain financial measures are based on core earnings rather than net income. Core earnings exclude income, expense, gains and losses that either are not reflective of ongoing operations or that are not expected to reoccur with any regularity or reoccur with a high degree of uncertainty and volatility. Such information may be useful to both investors and management and can aid them in understanding the Company's current performance trends and financial condition. Core earnings are a supplemental tool for analysis and not a substitute for GAAP net income. Reconciliation from GAAP net income to the non-GAAP measure of core earnings is referenced as part of management's discussion and analysis of quarterly and year-to-date financial results of operations.
Core earnings, which exclude non-recurring items, were
29--------------------------------------------------------------------------------
The following is a reconciliation between core earnings and earnings under GAAP:
(Amounts in thousands, except per share data)
Years Ended December 31,
2019 2018 2017
GAAP earnings $ 7,282 $ 8,835 $ 4,350
Gains recognized on Bank Owned Life Insurance
policy (tax free)* (51 ) (1,548 ) (898 )
Change in corporate tax rate - - 1,246
Recognition (reversal) of deferred tax
valuation allowance - 28 -
Core earnings $ 7,231 $ 7,315 $ 4,698
GAAP earnings per share $ 1.68 $ 2.03 $ 0.99
Gains recognized on Bank Owned Life Insurance
policy (tax free)* (0.01 ) (0.36 ) (0.20 )
Change in corporate tax rate - - 0.28
Recognition (reversal) of deferred tax
valuation allowance - 0.01 -
Core earnings per share $ 1.67 $ 1.68 $ 1.07 * This is the amount of proceeds received on life insurance policies upon the
death of former directors or officers that exceeded the cash value of the
policies.
BALANCE SHEET COMPOSITION
The following table illustrates, during the years presented, the mix of the
Company's funding sources and the assets in which those funds are invested as a
percentage of the Company's average total assets at December 31 for the periods
indicated. Average assets totaled $697.3 million in 2019 compared to $672.5
million in 2018 and $636.9 million in 2017.
December 31,
2019 2018 2017
Sources of Funds:
Deposits:
Non-interest bearing 19.4 % 19.1 % 18.3 %
Interest bearing 64.4 64.1 64.6
Long-term debt and other borrowings 3.5 5.3 5.3
Subordinated debt 0.7 0.8 0.8
Other non-interest bearing liabilities 1.9 1.5 1.6
Shareholders' equity 10.1 9.2 9.4
Total 100.0 % 100.0 % 100.0 %
Uses of Funds:
Loans, including loans held for sale 70.7 % 70.4 % 65.2 %
Investment securities 20.1 22.2 26.5
Interest-earning deposits and other earning assets 2.0 1.3 1.4
Bank-owned life insurance 2.3 2.4 2.7
Partnerships and other investments 1.8 1.6 1.4
Other non-interest earning assets 3.1 2.1 2.8
Total 100.0 % 100.0 % 100.0 %
Deposits continue to be the Company's primary source of funding. During 2019,
the relative mix of deposits has remained steady with interest-bearing being the
main source. Average non-interest bearing deposits totaled 23.2% of total
average deposits in 2019, compared to 23.0% in 2018 and 22.1% in 2017.
Additional information regarding deposits can be found in Item 8, Note 5 to the
Consolidated Financial Statements and elsewhere in this Management's Discussion
and Analysis.
The Company primarily invests funds in loans and securities. Loans continue to
be the focus of the Company's asset allocation. Average securities decreased
$9.1 million , or 6.1%, to $139.8 million during 2019 from $148.9 million in
2018, while average loans increased by $19.4 million , or 4.1%, to $493.0 million
during 2019 from $473.5 million in 2018.
30--------------------------------------------------------------------------------
ASSET QUALITY
The Company's management regularly monitors and evaluates trends in asset quality. Loan review practices and procedures require detailed monthly analysis of delinquencies, nonperforming assets and other sensitive credits. Loans are moved to non-accrual status once they reach 90 days past due or when analysis of a borrower's creditworthiness indicates the collection of interest and principal is in doubt. Nonperforming loans include loans in non-accrual status, restructured loans and real estate acquired in satisfaction of debts previously contracted. Additionally, as part of the Company's loan review process, management routinely evaluates risks which could potentially affect the ability to collect loan balances in their entirety. Reviews of individual credits, aggregate account relationships or any concentration of credits in particular industries are subject to a detailed loan review. Gross income that would have been recorded in 2019 on these nonperforming loans, had they been in compliance with their original terms, was$544,000 . Interest income that actually was included in income on these loans amounted to$381,000 . In addition to nonperforming loans, nonperforming assets include nonperforming investment securities. AtDecember 31, 2017 , there were two investments classified as nonperforming and both of these investments were sold inJune 2018 . Gross income that would have been recorded in the first six months of 2018 on nonperforming investments, had they been in compliance with their original terms, was$21,000 . Interest income that actually was included in income on these investments during this period amounted to$25,000 , a higher amount due to interest collected upon sale. There are no accruing loans which are contractually past due 90 days or more as to principal or interest payments. The following table depicts the trend in these potentially problematic asset categories: (Amounts in thousands) December 31, 2019 2018 2017 2016 2015 Non-accrual loans: Commercial$ 1,152 $ 1,291 $ - $ -$ 1,196 Commercial real estate 566 512 506 1,458 2,176 Residential real estate 469 310 247 1,265 1,252 Consumer - home equity 147 120 129 55 262 Consumer - other - - - - - Total non-accrual loans 2,334 2,233 882 2,778 4,886 Investment securities - - 895 825 778 Other real estate owned - - - - 61
Troubled debt restructured loans 6,211 7,907 4,232
5,508 6,656
Nonperforming assets$ 8,545 $ 10,140 $ 6,009
Loans past due greater than 30 days
or on nonaccrual $ 2,593 $ 2,493 $ 1,409 $ 4,533 $ 7,242
December 31,
2019 2018 2017 2016 2015
Non-accrual loans as a 0.45 % 0.43 % 0.18 % 0.66 % 1.24 %percentage of total loans
Nonperforming assets as a 1.16 % 1.42 % 0.85 %
1.39 % 2.02 %
percentage of total assets
Nonperforming assets as a
percentage of equity capital
plus allowance for loan losses 10.84 % 14.67 % 9.08 %
14.57 % 20.01 % As ofDecember 31, 2019 , there were$7.0 million in loans not included in this table where known information about borrowers' possible credit problems caused management to have some doubts as to the ability of these borrowers to comply with present loan payment terms and which may result in disclosure of such loans in this table. Loans accounted for on a non-accrual basis ranged from a high of$4.9 million in 2015 to a low of$882,000 in 2017. Non-accrual loans in 2019 of$2.3 million is slightly lower than the average of the past five years, which is$2.6 million . In 2015, non-accrual loans were mainly impacted by loans to one related group in both the commercial and commercial real estate categories, which were resolved favorably in 2016. In 2015 to 2016, non-accrual loans were impacted by one residential real estate loan for$1.0 million which paid off in 2017. The total of all loans past due more than 30 days or on non-accrual ranged from a low of$1.4 million in 2017 to a high of$7.2 million in 2015. Loans charged-off, net of recoveries, was$448,000 in 2019, compared to$ 1.1 million in 2018,$390,000 for 2017,$376,000 for 2016, and$463,000 for 2015. The resulting ratios do not indicate any trends of concern from management's perspective. 31 -------------------------------------------------------------------------------- Troubled-debt restructured loans are loans that have been modified when economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. In 2018, there were$4.2 million in new troubled debt restructurings. In 2015, there were$3.2 million in new troubled debt restructurings. There were none added in 2019, 2017 or 2016. Past due loans, potential problem loans, as well as loans on non-accrual have all been stable, helping to require a provision of$715,000 in 2019, and$725,000 in 2018 which is lower than the net charge-off of$1.1 million (of which previously had a specific reserve of$625,000 ). In 2017 and 2016, the provision for loan losses was$100,000 and$50,000 , respectively, aided by large recoveries. Additional information regarding loans can be found in Item 8, Note 3 to the Consolidated Financial Statements and elsewhere in this Management's Discussion and Analysis. AtDecember 31, 2017 , there was$895,000 of the Company's holdings in trust preferred securities considered to be in non-accrual status. The quarterly interest payments for both of its investments in trust preferred securities had been placed in "payment in kind" status. Payment in kind status results in a temporary delay in the payment of interest. As a result of a delay in the collection of the interest payments, management placed these securities in non-accrual status. They were sold in 2018. RESULTS OF OPERATIONS (Amounts in thousands) December 31, 2019 2018 2017 Net interest income$ 24,089 $ 23,366 $ 20,302
Tax equivalent income adjustment for investment
securities 372 357
931
Tax equivalent income adjustment for loans 6 7
14
Net interest income on a fully taxable equivalent
basis$ 24,467 $ 23,730
Interest and dividends on investment securities
Tax equivalent income adjustment for investment
securities 372 357
931
Investment securities income on a fully taxable
equivalent basis$ 3,933 $ 4,121 $ 5,082 Interest and fees on loans$ 25,783 $ 23,823 $ 19,243 Tax equivalent income adjustment for loans 6 7
14
Loan income on a fully taxable equivalent basis
$ 19,257
Analysis of Net Interest Income - Years Ended
Net interest income, the principal source of the Company's earnings, is the amount by which interest and fees generated by interest-earning assets, primarily loans and investment securities, exceed the interest cost of deposits and borrowed funds. On a fully taxable equivalent basis, net interest income measured$24.5 million for 2019 and$23.7 million for 2018. The resulting net interest margin was 3.79% for 2019 and 3.76% for 2018. The increase in interest income, on a fully taxable equivalent basis, of$1.9 million is the product of a 2.5% year-over-year increase in average earning assets along with a 18 basis point increase in yield. The increase in interest expense of$1.2 million was a product of a 23 basis point increase in rates paid and a 1.2% increase in average interest-bearing liabilities. The net result was a 3.1% increase in net interest income on a fully taxable equivalent basis, and a 3 basis point increase in the Company's net interest margin on a growing asset base with a different mix. On a fully taxable equivalent basis, income on investment securities decreased by$188,000 , or 4.6%. The average invested balances in these securities decreased by$9.1 million , or 6.1%, from the levels of a year ago. The decrease in the average balance of investment securities was accompanied by a 4 basis point increase in the tax equivalent yield of the portfolio. The Company will continue attempting to redeploy liquidity into loans which generate greater yields than securities, thus sacrificing securities balances when beneficial. Additional information regarding investment securities can be found in Item 8, Notes 2 and 11 to the Consolidated Financial Statements and elsewhere in this Management's Discussion and Analysis. On a fully taxable equivalent basis, income on loans increased by$2.0 million , or 8.2%, for 2019 compared to the same period in 2018. A$19.4 million increase in the average balance of the loan portfolio, or 4.1%, was accompanied by a 20 basis point increase in the portfolio's tax equivalent yield. The four rate increases in 2018 by theFederal Open Market Committee (FOMC) aggregating to 100 basis points was tempered with three rate reductions in the latter part of 2019. Coupled with strong competition for good credits, there is continued downward pressure on offering rates. The commercial loan portfolio housed the majority of the net increase in balances. Additional information regarding loans can be found in Item 8, Note 3 to the Consolidated Financial Statements and elsewhere in this Management's Discussion and Analysis. 32 -------------------------------------------------------------------------------- Other interest income increased by$137,000 , or 84.6%, from the same period a year ago. The average balance of interest-earning deposits increased by$5.6 million , or 64.9%. The yield increased by 23 basis points from 2018 to 2019, reflecting the aggregate net increases in the federal funds rate. Management intends to remain fully invested, minimizing on-balance sheet liquidity. Average interest-bearing demand deposits and money market accounts decreased by$660,000 , or 0.3%, while average savings balances decreased by$2.0 million , or 1.8%. The average rate paid on interest-bearing demand deposits and money market accounts increased 25 basis points from 2018 to 2019 to 0.95%, reflecting the promotional specials offered during the year. The average rate paid on savings accounts was 0.09% for both 2019 and 2018. The average balance of time deposit products increased by$20.1 million , or 16.6%, as the average rate paid increased by 33 basis points, from 1.70% to 2.03%. The current low-rate environment offers little opportunity for time deposit customers, except for periodic special rates offered on a limited basis. Time deposits also include wholesale funds, generally brokered deposits, obtained at generally higher rates than in-market accounts. Brokered deposits are one of several borrowing sources, primarily used when rates therein are beneficial versus other sources. Additional information regarding deposits can be found in Item 8, Note 5 to the Consolidated Financial Statements and elsewhere in this Management's Discussion and Analysis. Average borrowings and subordinated debt decreased by$11.6 million while the average rate paid on borrowings increased by 33 basis points. As lower cost short-term borrowings matured, the longer-term borrowings at higher rates remained. Management continues to utilize short-term borrowings to bridge liquidity gaps, along with wholesale deposit alternatives. With the possibility of continued rate reductions by theFOMC , wholesale and borrowing rates can reprice lower, while deposit rates may show modest decline. Additional information regarding FHLB Advances and Other Borrowings and Subordinated Debt can be found in Item 8, Notes 6 and 7 to the Consolidated Financial Statements and elsewhere in this Management's Discussion and Analysis.
Analysis of Net Interest Income - Years Ended
Net interest income, the principal source of the Company's earnings, is the amount by which interest and fees generated by interest-earning assets, primarily loans and investment securities, exceed the interest cost of deposits and borrowed funds. On a fully taxable equivalent basis, net interest income measured$23.7 million for 2018 and$21.2 million for 2017. The resulting net interest margin was 3.76% for 2018 and 3.59% for 2017. The increase in interest income, on a fully taxable equivalent basis, of$3.7 million was the product of a 6.5% year-over-year increase in average earning assets along with a 34 basis point increase in yield. The increase in interest expense of$1.2 million was a product of a 22 basis point increase in rates paid and a 5.0% increase in average interest-bearing liabilities. The net result was a 11.7% increase in net interest income on a fully taxable equivalent basis, and a 17 basis point increase in the Company's net interest margin on a growing asset base with a different mix. The key driver to the margin expansion was the loan rate increases exceeding the deposit rate increases by 20 basis points. On a fully taxable equivalent basis, income on investment securities decreased by$961,000 , or 18.9%. The average invested balances in these securities decreased by$19.7 million , or 11.7%, from the levels of a year ago. The decrease in the average balance of investment securities was accompanied by a 24 basis point decrease in the tax equivalent yield of the portfolio. The Company continued attempting to redeploy liquidity into loans which generate greater yields than securities, thus sacrificing securities balances when beneficial. The lower corporate tax rate effective in 2018 had a 22 basis point impact on the tax equivalent yield, otherwise security yields were comparable among periods. Additional information regarding investment securities can be found in Item 8, Notes 2 and 11 to the Consolidated Financial Statements and elsewhere in this Management's Discussion and Analysis. On a fully taxable equivalent basis, income on loans increased by$4.6 million , or 23.7%, for 2018 compared to the same period in 2017. A$58.3 million increase in the average balance of the loan portfolio, or 14.0%, was accompanied by a 39 basis point increase in the portfolio's tax equivalent yield. Despite four rate increases by the Federal Reserve Open Market Committee, strong competition for good credits kept pressure on offering rates. Higher than usual prepayment fees contributed 5 basis points to the loan yield. The commercial loan portfolio housed the majority of the increase in balances. Additional information regarding loans can be found in Item 8, Note 3 to the Consolidated Financial Statements and elsewhere in this Management's Discussion and Analysis. Other interest income increased by$64,000 , or 65.3%, from the same period a year ago. The average balance of interest-earning deposits decreased by$104,000 , or 1.2%. The yield increased by 76 basis points from 2017 to 2018, reflecting increases in the federal funds rate. Management intended to remain fully invested, minimizing on-balance sheet liquidity. 33 -------------------------------------------------------------------------------- Average interest-bearing demand deposits and money market accounts increased by$29.3 million , or 17.4%, while average savings balances decreased by$1.8 million , or 1.5%. Total interest paid on interest-bearing demand deposits and money market accounts was$1.4 million , a$627,000 increase from last year. The average rate paid increased 25 basis points from 2017 to 2018. Total interest paid on savings accounts was$97,000 , a$7,000 increase from last year. The average rate paid on savings accounts increased 1 basis point from 2017 to 2018. The average balance of time deposit products decreased by$7.3 million , or 5.7%, as the average rate paid increased by 35 basis points, from 1.35% to 1.70%. Interest expense increased on time deposits by$322,000 from the prior year. The low-rate environment offered little opportunity for time deposit customers, except for periodic special rates offered on a limited basis. Time deposits also include wholesale funds obtained at generally higher rates than in-market accounts. Additional information regarding deposits can be found in Item 8, Note 5 to the Consolidated Financial Statements and elsewhere in this Management's Discussion and Analysis. Average borrowings and subordinated debt increased by$2.1 million while the average rate paid on borrowings increased by 50 basis points. Cost of borrowings continued to rise in tandem with the Federal funds rate, resulting in higher interest expense, despite comparable borrowing levels. Management continued to utilize short-term borrowings to bridge liquidity gaps. Additional information regarding FHLB Advances and Other Borrowings and Subordinated Debt can be found in Item 8, Notes 6 and 7 to the Consolidated Financial Statements and elsewhere in this Management's Discussion and Analysis. The following table provides a detailed analysis of changes in net interest income on a tax equivalent basis, identifying that portion of the change that is due to a change in the volume of average assets and liabilities outstanding versus that portion which is due to a change in the average yields on earning assets and average rates on interest-bearing liabilities. Changes in interest due to both rate and volume which cannot be segregated have been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each. (Amounts in thousands) 2019 Compared to 2018 2018 Compared to 2017 Volume Rate Total Volume Rate Total Increase (decrease) in interest income: Interest-earning deposits and other money markets$ 116 $ 21 $ 137 $ (1 ) $ 65 $ 64 Investment securities: Taxable (354 ) (11 ) (365 ) (193 ) 234 41 Nontaxable 183 (6 ) 177 (437 ) (565 ) (1,002 ) Loans 998 961 1,959 2,846 1,727 4,573 Total interest income change 943 965 1,908 2,215 1,461 3,676 Increase (decrease) in interest expense: Interest-bearing demand deposits (5 ) 506 501 148 479 627 Savings deposits (2 ) 7 5 (1 ) 8 7 Time deposits 371 439 810 (103 ) 425 322 Securities sold under agreements to repurchase (1 ) - (1 ) (1 ) - (1 ) FHLB advances - short term (347 ) 102 (245 ) 23 176 199 FHLB advances - long term 54 33 87 8 (20 ) (12 ) Subordinated debt - 14 14 - 51 51 Total interest expense change 70 1,101 1,171 74 1,119 1,193 Increase (decrease) in net interest income on a
taxable equivalent basis
34
--------------------------------------------------------------------------------
PROVISION FOR LOAN LOSSES, NON-INTEREST INCOME, NON-INTEREST EXPENSE & FEDERAL INCOME TAX
During 2019, 2018 and 2017, the amount charged to operations as a provision for loan losses was adjusted to account for charge-offs against the allowance, as well as an increase in loan balances recorded in the portfolio, expected losses on specific problem loans and several qualitative factors, including factors specific to the local economy and to industries operating in the local market. The Company had allocated a portion of the allowance for a select few specific problem loans in 2019, 2018 and 2017, and has not experienced significant deterioration in any loan type, including the residential real estate portfolios or the commercial loan portfolio, and accordingly has not added any special provision for these loan types. Past due loans, potential problem loans, as well as loans on non-accrual have all been stable, helping to require a provision of$715,000 in 2019 which is higher than the$448,000 net charge offs, providing allocation to a specific reserve. A$725,000 provision was recorded in 2018 which is lower than the net charge-off of$1.1 million (of which previously had a specific reserve of$625,000 ) and required a provision of only$100,000 in the 2017. In 2017, there was a favorable ruling in a bankruptcy court surrounding the eventual sale of a business to which the Company lent funds, resulting in a large recovery of amounts previously charged off. These recoveries displaced provisions throughout 2017. Provision expense levels are in recognition of loan growth and a changing composition of the loan portfolio as the Company manages its balance sheet with a commercially-oriented focus.
The following table provides a detailed analysis of non-interest income:
(Amounts in thousands)
December 31,
2019 2018 2017
Fees for customer services $ 2,312 $ 2,273 Mortgage banking gains, net 1,554 974
1,074
Earnings on bank-owned life insurance 392 1,869 1,203 Other real estate gains - - 170 Other non-interest income 808 597 471
Non-interest income, excluding investment
gains 5,066 5,713
5,159
Investment securities available-for-sale
(losses) gains, net (44 ) (21 ) 7 Total non-interest income$ 5,022 $ 5,692 $ 5,166 Total non-interest income, excluding investment gains, decreased by$647,000 , or 11.3%, for 2019 compared to an increase of$554,000 , or 10.7%, for 2018. After gains on investment securities and impairment losses, non-interest income decreased by$670,000 , or 11.8%, in 2019 compared to an increase of$526,000 , or 10.2%, in 2018.
Fees for customer services increased by
Mortgage banking gains totaled
Earnings on bank-owned life insurance decreased by$1.5 million in 2019 compared to an increase of$666,000 in 2018. Proceeds received on policies upon the deaths of former executives exceeded the cash value of the policies by$51,000 in 2019 and$1.5 million in 2018.
A gain of
Other sources of non-interest income increased by$211,000 in 2019 from the same period a year ago, and increased by$126,000 in 2018 from 2017. This latter income category is subject to fluctuation due to the non-recurring nature of some of the items. 35
--------------------------------------------------------------------------------
The following table provides a summary of non-interest expenses:
(Amounts in thousands)
December 31,
2019 2018 2017
Salaries and employee benefits $ 11,198 $ 10,260 $ 10,631
Net occupancy and equipment 2,400 2,232 2,331
State and local taxes 518 493 463
FDIC insurance 63 176 199
Professional fees 1,093 879 786
Advertising and marketing 388 322 478
Data processing fees 277 250 251
Other non-interest expense 3,818 3,471 3,462
Total non-interest expenses $ 19,755 $ 18,083 $ 18,601 Total non-interest expenses increased by
During 2019, expenditures for salaries and employee benefits increased by$938,000 , or 9.1%, and in 2018 decreased by$371,000 , or 3.5%. The increase in 2019 is mainly due to an increase in equity compensation of$547,000 in connection with attaining the most profitable year in the Company's history in 2018, and the result of opening of a new branch in the first quarter of 2019. The decrease in 2018 is mainly a result of a workforce realignment and a branch consolidation in latter 2017. Full-time equivalent employment averaged 162 in 2019 compared to 159 in 2018 and 160 in 2017. Salaries and employee benefits represent 56.7% of all non-interest expenses in 2019 and 2018 and 57.2% in 2017. The following table details components of these increases and decreases. Amounts (in thousands) Percentages December 31, December 31, 2019 2018 2017 2019 2018 2017 Salaries$ 899 $ (361 ) $ 330 11.2 % (4.3 )% 4.1 % Employee benefits 1 (39 ) 122 0.0 (1.5 ) 4.8 900 (400 ) 452 8.5 (3.6 ) 4.3 Deferred loan origination costs 38 29 10 9.8 6.9 (2.3 ) Total$ 938 $ (371 ) $ 462 9.1 % (3.5 )% 4.5 % Salary expense per employee averaged$55,000 in 2019 and$50,000 in 2018 and$52,000 in 2017. Average earning assets per employee measured approximately$4.2 million in 2019 and in 2018 and$4.1 million in 2017. Charges for insurance premiums paid to theFDIC decreased from 2018 by$113,000 . Because theDeposit Insurance Fund (DIF) reserve ratio exceeded a threshold amount, the Bank was given a Small Bank Assessment credit against quarterly premiums. We anticipate using the remainder of the credits in the first quarter of 2020. Deposits are insured by theFDIC up to a maximum amount, which is generally$250,000 per depositor subject to aggregation rules. As anFDIC -insured institution, the Bank is required to pay deposit insurance premium assessments to theFDIC . State and local taxes increased by$25,000 in 2019 or 5.1% compared to a$30,000 increase, or 6.5%, in 2018, reflecting the growing shareholders' equity on which the state tax is based. Professional fees increased by$214,000 or 24.4% from 2018, compared to a$93,000 increase in 2018 from 2017. This is due in part to an increase in legal fees attributable to loan collection efforts. All other categories of non-interest expenses increased$608,000 , or 9.7%, in 2019 compared to a decrease of$247,000 , or 3.8%, in 2018. These expense categories are subject to fluctuation due to non-recurring items. The increase in expenses in 2019 is a result of the NASDAQ listing, increased equity awards and new branch initiatives. Income before federal income tax expense amounted to$8.6 million for 2019, compared to$10.3 million and$6.8 million for 2018 and 2017, respectively. The effective tax rate was 15.7% in 2019, 13.8% in 2018 and 35.7% in 2017, resulting in income tax expense of$1.4 million in 2019 and 2018 and$2.4 million in 2017. The effective rate is affected by the current level of profitability and tax-free components of the revenue stream. The lower rates in 2019 and 2018 are primarily affected by the change in corporate tax rate from 34% to 21%. The gains on bank-owned life insurance mentioned previously were tax free and contributed to the lower effective tax rate in both 2018 and 2017. The increase in the effective tax rate in 2017 was also a result of the Tax Act, which increased the deferred tax charges by$1.2 million , or 18.4%. 36 -------------------------------------------------------------------------------- The effective federal income tax rate varies from the applicableU.S. statutory federal income tax rate of 21% for 2019 and 2018, and 34% for 2017 due to the following differences: December 31, 2019 2018 2017
Provision at statutory rate 21.00 % 21.00 % 34.00 %
(Deduct) add tax effects of:
Earnings on bank-owned life insurance-net (1.08 ) (3.93 )
(6.11 )
Non-taxable interest income (4.02 ) (3.11 ) (9.80 )
Change in corporate tax rate - - 18.41
Low income housing tax credits (1.81 ) (1.37 ) (2.21 )
Deferred tax valuation (reversal) recognition - 0.27
-
Non-deductible expenses 1.64 0.94 1.43
Federal income tax effective rate 15.73 % 13.80 % 35.72 % Net income registered$7.3 million in 2019,$8.8 million in 2018 and$4.4 million in 2017, representing per share amounts of$1.68 in 2019,$2.03 in 2018 and$0.99 in 2017. Cash dividends of$0.50 ,$0.49 and$0.39 per share were paid to shareholders of record in 2019, 2018 and 2017, respectively.
The following table shows unaudited financial results by quarter:
(Amounts in thousands)
For the 2019 quarter ended: For the 2018 quarter ended:
Dec. 31 Sept. 30 June 30 Mar. 31 Dec. 31 Sept. 30 June 30 Mar. 31
Interest income $ 7,428 $ 7,224 $ 7,401 $ 7,590 $ 7,489 $ 6,962 $ 6,727 $ 6,571
Interest expense 1,387 1,402 1,399 1,366 1,236 1,148 1,020 979
Net interest income 6,041 5,822 6,002 6,224 6,253 5,814 5,707 5,592
Loan loss provision 180 180 180 175 75 75 75 500
Investment securities - - (44 ) - - - (41 ) 20
(losses) gains, net
Mortgage banking gains, 381 492 344 337 203 272 261 238
net
Other income 958 935 752 867 752 876 2,357 754
Other expenses 4,903 4,761 5,339 4,752 4,643 4,529 4,585 4,326
Income before tax 2,297 2,308 1,535 2,501 2,490 2,358 3,624 1,778
Federal income tax 393 363 207 396 466 386 322 241
expense
Net income $ 1,904 $ 1,945 $ 1,328 $ 2,105 basis)
Net interest rate spread 3.45 % 3.38 % 3.48 % 3.62 % 3.68 % 3.48 % 3.52 % 3.43 %
Net interest margin 3.74 % 3.70 % 3.80 % 3.90 % 3.95 % 3.73 % 3.74 % 3.62 %
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is a reserve established through a provision for
loan losses charged to expense, which represents management's best estimate of
probable losses that have been incurred within the existing portfolio of loans.
The allowance, with the judgment of management, is necessary to reserve for
estimated loan losses on risks inherent in the loan portfolio. Accordingly, the
methodology to establish the amount of the allowance is based on historical loss
experience by type of credit and internal risk grade, specific homogeneous risk
pools, and specific loss allocations, with adjustments for current events and
conditions. The Company's process for determining the appropriate level of the
allowance for loan losses is designed to account for credit deterioration as it
occurs.
The Company's allowance for loan loss methodology consists of three elements:
(i) specific valuation allowances on probable losses on specific loans;
(ii) historical valuation allowances based on historical loan loss experience
for similar loans with similar characteristics and trends; and (iii) general
valuation allowances based on general economic conditions and other qualitative
risk factors both internal and external to the Company.
37
--------------------------------------------------------------------------------
The allowances established for probable losses on specific loans are based on
recurring analyses and evaluations of classified loans. Loans are categorized
into risk grade classifications based on an internal credit risk grading process
that evaluates, among other things: (i) the obligor's ability to repay; (ii) the
underlying collateral, if any; and (iii) the economic environment and industry
in which the borrower operates. The Bank currently divides the loan and lease
portfolio into the following major categories: 1) Pooled Loans (unclassified)
with similar risk characteristics; 2) Substandard Loans (classified) defined as
being inadequately protected by current sound net worth, paying capacity of the
borrower, or pledged collateral; 3) Special Mention (classified) defined as
having potential weaknesses that deserve management's close attention. If left
uncorrected, these potential weaknesses may, at some future date, result in the
deterioration of the repayment prospects for the credit or the Bank's credit
position; 4) Loss or doubtful loans (classified) have all the weaknesses of the
previous classifications, with the added characteristic that the weaknesses make
collection or liquidation in full, on the basis of currently existing facts,
conditions, and values highly questionable and improbable; and 5) Impaired Loans
which generally include non-accrual loans. Once a loan is assigned a risk grade
of classified, the loan review officer assesses whether the loan is to be
evaluated for impairment based on the Company policy. A portion of the allowance
for loan loss is specifically allocated to those loans which are evaluated for
impairment and determined to be impaired. Specific valuation allowances are
determined by analyzing the borrower's ability to repay amounts owed, collateral
deficiencies, the relative risk grade of the loan and economic conditions
affecting the borrower's industry, among other things. If after review, the loan
is not considered to be impaired, the loan is included with a pool of similar
loans that is assigned a valuation allowance calculated based on the historical
loss experience and qualitative factors of the pool type. The valuation
allowance is calculated based on the historical loss experience of specific
types of classified loans. The Company calculates historical loss ratios for
pools of loans with similar characteristics based on the proportion of actual
charge-offs experienced to the total population of loans in the pool. The
historical loss ratios are updated quarterly based on actual charge-off
experience.
A general valuation allowance is established for pools of homogeneous loans
based upon the product of the historical loss ratio adjusted for qualitative
factors and the total dollar amount of the loans in the pool. Specific
qualitative factors considered by management include trends in volume or terms,
changes in lending policy levels and trends in charge-offs, classification and
non-accrual loans, concentrations of credit and local and national economic
factors. The Company's pools of similar loans include similarly risk-graded
groups of commercial loans, commercial real estate loans, residential real
estate loans, home equity loans and other consumer loans. Beginning at year-end
2017, due to their growing significance, the pools of commercial and commercial
real estate loans are also broken out further by industry sectors when analyzing
the related pools. These industry sectors include non-residential buildings;
skilled nursing and nursing care; residential real estate lessors, agents and
managers; hotel and motels and trucking. Additional factors are used on pools of
loans considered special mention; specifically, levels and trends in
classification, declining trends in financial performance, structure and lack of
performance measures and migration from special mention to substandard. For
loans graded as substandard, a separate historical loss rate is calculated as a
percent of charge-offs net of recoveries to the balance of substandard loans,
which results in a higher historical loss factor. This is also adjusted for the
qualitative factors discussed previously.
Loans identified as losses by management, internal loan review and/or bank examiners are charged off. Furthermore, consumer loan accounts are charged off in accordance with regulatory requirements.
The Company maintains an allowance for losses on unfunded commercial lending commitments to provide for the risk of loss inherent in these arrangements. The allowance is computed using a methodology similar to that used to determine the allowance for loan losses. This allowance is reported as a liability on the consolidated balance sheets within other liabilities, while the corresponding provision for these losses is recorded as a component of other non-interest expenses. At bothDecember 31, 2019 and 2018, this allowance was$84,000 . Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management's judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company's control, including the performance of the Company's loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. Although management believes the Company uses the best information available to make allowance for loan loss determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. Increased levels of job loss and high unemployment, home foreclosures and business failures could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions and reductions in income. Additionally, as an integral part of their examination process, bank regulatory agencies periodically review our allowance for loan losses. The banking agencies could require the recognition of additions to the allowance for loan loss based on their judgment of information available to them at the time of their examination.
Current Expected Credit Loss Standard
As disclosed in Note 1 to the Consolidated Financial Statements, the adoption of ASC 326, which changes the impairment model for most financial assets, was delayed for small reporting companies until fiscal years beginning afterDecember 15, 2022 . As a small reporting company, the Company does not currently expect to early adopt the new standard. As the new standard is a significant change in both philosophy and methodology, the Company has been formulating an approach to adoption. As recommended by regulators for community banks, the Company has selected the Weighted Average Remaining Maturity ("WARM") method. 38 -------------------------------------------------------------------------------- As the Company's loss history is sporadic and statistically insignificant, peer group loss history will be incorporated into the model. This is likely to produce an allowance greater than the Company's current level. Near term economic forecasts at the time of adoption are also likely to affect the level of the allowance. Pending further methodology refinement and nearer adoption, the Company cannot assess the magnitude of the initial adoption. The following is an analysis of changes in the allowance for loan losses for the period ended: (Amounts in thousands) December 31, 2019 2018 2017 2016 2015 Balance at beginning of year$ 4,198 $ 4,578 $ 4,868 $ 5,194 $ 5,202 Loan losses: Commercial (231 ) (1,163 ) - - (470 ) Commercial real estate (40 ) - (654 ) (287 ) (84 ) Residential real estate (78 ) - (14 ) (35 ) (45 ) Consumer - home equity - - (26 ) (144 ) - Consumer - other (205 ) (175 ) (146 ) (148 ) (124 ) Total (554 ) (1,338 ) (840 ) (614 ) (723 )
Recoveries on previous loan losses:
Commercial 28 - 388 117 134 Commercial real estate - 166 - 35 10 Residential real estate - 3 5 2 37 Consumer - home equity 2 5 10 23 17 Consumer - other 76 59 47 61 62 Total 106 233 450 238 260 Net loan losses (448 ) (1,105 ) (390 ) (376 ) (463 ) Provision charged to operations 715 725 100
50 455
Balance at end of year$ 4,465 $ 4,198 $ 4,578
Ratio of net loan losses to average 0.09 % 0.23 % 0.09 %
0.10 % 0.13 %
total loans outstanding
Ratio of loan loss allowance to total 0.86 % 0.82 % 0.94 %
1.16 % 1.32 % loans The commercial charge-off in 2018 is related to loans (to one borrower) that were restructured to a new borrowing relationship with no principal forgiveness, but with a substantial concession in interest rate. The below market rate triggered recognition of a charge-off equivalent to the difference in present value of loan payments discounted at the market rate of interest. The charged off amount of$1.1 million is recorded as a loan discount. As loan payments are made, interest is recognized at the market rate versus the negotiated rate via the amortization of the discount over the various lives of the loans. There was$625,000 in specific reserve previously allocated to these loans atDecember 31, 2017 . Included in the$654,000 commercial real estate charge-off in 2017 is a loan for$352,000 , which had a$148,000 specific reserve. The$470,000 commercial charge-off in 2015 contains a$468,000 charge-off to an isolated credit relationship that already had a specific reserve recorded. The following is an allocation of the year end allowance for loan losses and the percentage to total loans. The allowance has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans as of: (Amounts in thousands) December 31, 2019 2018 2017 2016 2015 Balance % Balance % Balance % Balance % Balance % Commercial$ 1,756 0.34$ 1,232 0.24 $
1,591 0.33
117 0.02 163 0.04 153 0.04 Consumer - home equity 104 0.02 115 0.02
70 0.01 150 0.04 52 0.01 Consumer - other 141 0.03 123 0.02 98 0.02 89 0.02 86 0.02 Total$ 4,465 $ 4,198 $ 4,578 $ 4,868 $ 5,194 39
-------------------------------------------------------------------------------- The allocations of the allowance as shown in the previous table should not be interpreted as an indication that future loan losses will occur in the same proportions or that the allocations indicate future loan loss trends. Furthermore, the portion allocated to each loan category is not the total amount available for future losses that might occur within such categories since the total allowance is applicable to the entire portfolio, and allocation of a portion of the allowance to one category of loans does not preclude availability to absorb losses in other categories.
LOAN PORTFOLIO
The following table represents the composition of the loan portfolio as of:
(Amounts in thousands)
December 31,
2019 2018 2017 2016 2015
Balance % Balance % Balance % Balance % Balance %
Commercial $ 99,864 19.3 $ 112,440 21.9 $
113,341 23.3
62,071 12.7 57,008 13.6 45,414 11.5 Consumer - home equity 25,856 5.0 25,076 4.9
26,018 5.3 25,061 6.0 23,334 5.9 Consumer - other 3,740 0.7 3,227 0.6 2,925 0.6 2,726 0.6 3,756 1.0 Total loans$ 518,716 $ 514,392 $ 487,490 $ 419,768 $ 394,254
The following schedule sets forth maturities based on remaining scheduled repayments of principal or next re-pricing opportunity for loans (excluding residential real estate, consumer- home equity and consumer-other).
(Amounts in thousands)
December 31, 2019
Over 1 Year
1 Year or Less to 5 Years Over 5 Years Total
Commercial $ 61,090 $ 20,294 $ 18,480 $ 99,864
Commercial real estate 90,478 142,186 69,420 302,084
Total loans $ 151,568 $ 162,480 $ 87,900 $ 401,948
The following schedule sets forth loans based on next re-pricing opportunity for
floating and adjustable interest rate products, and by remaining scheduled
principal payments for loan products with fixed rates of interest. Residential
real estate, consumer - home equity and consumer - other loans have again been
excluded.
(Amounts in thousands)
December 31, 2019
1 Year or
Less Over 1 Year Total
Floating or adjustable rates of interest $ 141,922 $ 92,052 $ 233,974
Fixed rates of interest 9,647 158,327 167,974
Total loans $ 151,569 $ 250,379 $ 401,948
The Company recorded an increase of $4.3 million in the loan portfolio in 2019
from the level of $514.4 million recorded at December 31, 2018 . Gross loans as a
percentage of earning assets stood at 76.1% as of December 31, 2019 and 77.6% at
December 31, 2018 . The loan-to-deposit ratio at December 31, 2019 was 83.9% as
compared to 85.1% at December 31, 2018 . Despite the slow economic recovery in
the region, the Bank posted year-over-year growth in total loans of 0.8%.
However, included in year-end total loans are 60-day or less, non-core loans
closed in December 2019 for $25.2 million , compared to $40.9 million in 2018.
Absent the short-term year end transaction, the Company reported core loan
year-over-year growth of 4.2% and 6.5%, respectively for 2019 and 2018. As the
balance sheet is adequately structured to accommodate additional loan growth,
management remains committed to fulfilling the credit needs of creditworthy
customers. At December 31, 2019 , the loan loss allowance of $4.5 million
represented approximately 0.9% of outstanding loans, and at December 31, 2018 ,
the loan loss allowance of $4.2 million represented approximately 0.8% of
outstanding loans.
40
--------------------------------------------------------------------------------
The decrease in commercial real estate and the increase in residential real
estate is due to reclassification of loans between these categories in 2019 by
approximately $14.9 million . The portion of the loan portfolio represented by
commercial loans (including commercial real estate) modestly decreased from
80.9% in 2018 to 77.5% in 2019. Consumer loans (including home equity loans)
were approximately 5.7% of the loan portfolio in 2019 and 5.5% in 2018. Between
2018 and 2019, the balance of residential real estate loans in relationship to
total loans increased from 13.6% to 16.8%. However, year-over-year balances grew
$17.3 million , or 24.8%, primarily due to the aforementioned re-classification.
The Bank's majority of mortgage originations are sold to the secondary market in
order to take advantage of historically low interest rates as management does
not intend to take on material long term interest rate risk on the balance
sheet.
Commercial, commercial real estate and residential real estate loans continue to
comprise the largest share of the Company's loan portfolio. At the end of 2019,
commercial, commercial real estate and residential real estate loans comprised a
combined 94.3% of the portfolio compared to 93.1% at December 31, 2015 ,
reflecting a consistent strategy of portfolio diversification over the five-year
period. The loan portfolio at December 31, 2019 also included home equity loans
at 5.0% and consumer installment loans at 0.7%. These percentages compare to
home equity loans at 5.9% and consumer installment loans at 1.0% on December 31,
2015 .
The commercial loan portfolio, which includes both commercial and commercial
real estate (CRE) loans, is $402.0 million at December 31, 2019 , a decrease of
$14.2 million from the balance of $416.2 million recorded at December 31, 2018 ,
or 3.4%. Commercial loans, including lines of credit, decreased by $12.6
million , or 11.2%, during the year and represented 19.3% of the portfolio, or a
2.6% composition decrease over the prior period. However, excluding the
year-end, 60-day or less, cash-secured loans that decreased by $15.7 million
from 2018 to 2019, commercial loans grew by $3.1 million , or 4.4%. CRE loans
decreased $1.7 million , or 0.6%, which substantially represents investment real
estate supported by third-party rents and leases along with other known Bank
concentrations such as Skilled Nursing, Assisted Living, Residential Lessors
(including Multi-family) and Hotels that are classified as non-owner occupied
CRE. At December 31, 2019 , the total CRE portfolio consisted of 23.2% in
owner-occupied real estate and 76.8% in non-owner occupied real estate. Taken
into account the aforementioned re-classification from CRE to 1-4 Residential
loan, the CRE portfolio grew at a rate of 4.3%, or $13.2 million . The increase
in CRE loans was a direct result of management taking strategic advantage of
competitive market conditions and the Bank's considerable liquidity position
since 2010. The CRE portfolio was also enhanced by lending into the Skilled
Nursing, Personal Health Care industries and Multi-family. In 2006, the federal
banking regulatory agencies published interagency guidance on CRE Concentration
Risk Management stating that if total commercial real estate concentration
exceeded 300% of a bank's total capital (or if the CRE portfolio increased by
over 50% in the preceding 3 years), the portfolio may represent significant
concentration risk and additional monitoring may be required. The Bank's CRE
concentration, excluding owner-occupied real estate, as of December 31, 2019 was
$232.1 million , which is 288.9% of total unimpaired or risk-based capital,
compared to 313.1% for 2018. As the Company reflected a 0.6% CRE balance
decline, it modestly decreased its concentration risk relative to capital. CRE
similarly reflected 7.3% growth in the prior year 2018. Management also believes
that its current level of credit review, portfolio monitoring and stress testing
adequately assures that the Bank is mitigating CRE concentration levels. In a
strategic effort to diversify, the Bank continues to develop its commercial
loans and, as such, the December 31, 2019 balance of $99.9 million represents
24.9% of the total commercial loan portfolio, compared to the period ended
December 31, 2018 of 27.0%.
Loan personnel will continue to aggressively pursue both commercial and small
business opportunities supported by product incentives and marketing efforts.
When necessary, management will continue to offer competitive fixed-rate and
derivative pricing options on commercial real estate products to qualifying
customers in an effort to establish new business relationships, retain existing
relationships, and capture additional market share. The Bank's lending function
continues to provide business services to a wide array of medium and small
businesses, including but not limited to, commercial and industrial accounts
such as health care facilities, grocery stores, manufacturers, trucking
companies, physicians and medical groups, service contractors, restaurants,
hospitality industry companies, retailers, wholesalers, educational institutions
and other political subdivisions as well as commercial and residential real
estate lessors, developers and builders.
Commercial and small business loans are originated by commercial loan personnel and other loan personnel assigned to the Bank's offices within various geographical regions. These loans are all processed in accordance with established business loan underwriting standards and practices.
41
--------------------------------------------------------------------------------
The following table provides an overview of commercial loans by various business
sectors reflecting the areas of largest concentration. It should be noted that
these are current loan balances including executed commitments to fund and do
not reflect existing commitments that have not been accepted or executed.
(Amounts in thousands)
December 31,
2019 2018 2017
% of % of % of
Balances Portfolio Balances Portfolio Balances Portfolio
Non-residential
building/apartment building $ 103,134 25.66 $ 97,411 23.40 $ 79,918 20.16
Residential real estate
lessors, agents and
managers (including
multi-family) 38,849 9.67 50,496 12.13 51,431 12.97
Skilled nursing 34,159 8.50 33,818 8.12 26,805 6.76
Hotels/motels 29,455 7.33 30,378 7.30 22,072 5.57
Trucking/courier services 28,311 7.04 24,487 5.88 21,613 5.45
The most substantial increase in concentrations growth by percentage since 2017
occurred in non-residential building/apartment building, which was a result of a
2016 strategic initiative to target multi-family loans to further diversify CRE
into a growing market segment. This increase remains the largest concentration
relative to the total portfolio composition. The single largest customer
relationship had an aggregate balance at year end 2019 of $10.7 million compared
to $13.3 million in 2018. This balance represented approximately 2.7% of the
total commercial and CRE portfolio in 2019 and 3.2% in 2018. It is important to
note that within this relationship, there is a 60-day or less note for $4.9
million in 2019 and the entire amount of $13.3 million in 2018, which were fully
secured by segregated deposit accounts with the Bank at the time of origination.
The Bank continues to be modestly active in home equity financing. Home equity
term loans and credit lines (HELOCs) remain popular with consumers wishing to
finance home improvement costs, education expenses, vacations and consumer goods
purchased at favorable interest rates. As first mortgage refinancing and
elimination of some eligible tax deductions impacted this product line in 2018,
this portfolio reflected slight deterioration in 2018 and reflected a small
increase of 3.8% for 2019. In order to improve customer retention and provide
better overall loan diversification, management will continue to evaluate and
reposition the Company's portfolio product offerings during 2020.
In the consumer lending area, the Company provides financing for a variety of
consumer purchases, such as: fixed- and variable-rate amortizing mortgage
products that consumers utilize for home improvements; the purchase of consumer
goods of all types; and education, travel and other personal expenditures. The
consolidation of credit card balances and other existing debt into term payouts
continues to remain a popular financing option among consumers. In an effort to
increase consumer relationship banking, the Company implemented a Private Bank
product line in 2016 that focuses on high net worth and income consumers, the
balances from which are modest and primarily reside in home equity lines.
Additional information regarding the loan portfolio can be found in Item 8, Notes 1, 3, 8, 11 and 14 to the Consolidated Financial Statements.
MORTGAGE BANKING
Since theMay 2013 Taper Tantrum when mortgage rates rose dramatically, the Company shifted its focus from wholesale to retail origination. With the majority of loans sold into the secondary market, the resulting gains have enhanced non-interest revenue. In 2019, the Company reported net gains on saleable loans of$1.6 million , representing an increase of$580,000 from the prior year's gain of$1.0 million , reflecting the 50% improvement in origination volume. As originators were added in the retail footprint, as well as expanding into adjacent markets, originations grew from$45.8 million in 2018 to$68.8 million in 2019. As previously referenced, the residential portfolio grew by$17.3 million , or 24.8%. However, deducting the aforementioned reclassification from CRE to 1-4 residential of approximately$14.9 million , this portfolio reflected nominal growth. The Company continues to portfolio quality, non-secondary market qualified and construction loans. Currently, the Company is not retaining the servicing on loans sold. Although the Company's primary strategy is to sell long-term residential mortgages, loans are occasionally retained in the portfolio when requested by a customer or to enhance account relationships, and tend to be variable rate or shorter term. The mix of portfolio retained to those sold to investors will vary from year to year. The Company maintains reserves for mortgage loans sold to agencies and investors in the event that, either through error or disagreement between the parties, the Company is required to indemnify the purchase. The reserves take into consideration risks associated with underwriting, key factors in the mortgage industry, past due loans and potential indemnification by the Company. Reserves are estimated based on consideration of factors in the mortgage industry, such as declining collateral values and rising levels of delinquency, default and foreclosure, coupled with increased incidents of quality reviews at all levels of the mortgage industry seeking justification for pushing back losses to loan originators and wholesalers. As ofDecember 31, 2019 and 2018, the Company had reserves for mortgage loans sold of$700,000 . For the years endedDecember 31, 2019 and 2018, the Company did not repurchase any mortgage loans sold. 42
--------------------------------------------------------------------------------
INVESTMENT SECURITIES
Investment securities are segregated into three separate portfolios:
available-for-sale, held-to-maturity and trading. Each portfolio type has its
own method of accounting. The Company currently does not maintain a
held-to-maturity portfolio. Securities classified as available-for-sale are
those that could be sold for liquidity, investment management, or similar
reasons even though management has no present intentions to do so. Securities
available-for-sale are carried at fair value using the specific identification
method. Changes in the unrealized gains and losses on available-for-sale
securities are recorded net of tax effect as a component of comprehensive
income.
Held-to-maturity securities are recorded at historical cost and adjusted for
amortization of premiums and accretion of discounts. Securities designated by
the Company as held-to-maturity tend to be higher yielding but less liquid
either due to maturity, size or other characteristics of the issue. The Company
must have both the intent and the ability to hold such securities to maturity.
The Company has no securities classified as held-to-maturity.
Trading securities were an investment in obligations of states and political
subdivisions and a short duration bond fund. Management had purchased these
securities principally for the purpose of selling them in the near term. Trading
securities were carried at fair value with valuation adjustments included in
other non-interest income. The Company no longer has any investment in trading
securities.
Securities the Company has designated as available-for-sale may be sold prior to
maturity in order to fund loan demand, to adjust for interest rate sensitivity,
to reallocate bank resources or to reposition the portfolio to reflect changing
economic conditions and shifts in the relative values of market sectors.
Available-for-sale securities tend to be more liquid investments and generally
exhibit less price volatility as interest rates fluctuate.
Securities are evaluated periodically to determine whether a decline in their
value is other-than-temporary. Management utilizes criteria such as the
magnitude and duration of the decline, in addition to the reasons underlying the
decline, to determine whether the loss in value is other-than-temporary. The
OTTI is not intended to indicate that the decline is permanent, but indicates
that the prospect for a near-term recovery of value is not necessarily
favorable, or that there is a lack of evidence to support a realizable value
equal to or greater than the carrying value of the investment. Once a decline in
value is determined to be an OTTI, the credit-related OTTI is recognized in
earnings while the non-credit related OTTI on securities not expected to be sold
is recognized in other comprehensive income (loss).
The following table shows the fair value of available-for-sale securities by
type of obligation at:
(Amounts in thousands)
December 31,
2019 2018 2017
U.S. Treasury and U.S. Government agencies and
corporations $ 3,310 $ 9,002 $ 3,205
Obligations of states and political subdivisions 69,626 51,658 72,116
U.S. Government -sponsored mortgage-backed and related securities 63,195 76,263
83,625
Trust preferred securities - -
895
Total fair value of investment securities available-for-sale$ 136,131 $ 136,923 $ 159,841
Impairment Analysis of
© Edgar Online, source
