The following discussion and analysis of financial condition and results of operations of the Company should be read in conjunction with the consolidated financial statements of the Company including the related notes thereto, included elsewhere herein. RESULTS OF OPERATIONS FOR THE YEARS ENDEDDECEMBER 31, 2019 , 2018, AND 2017 2019 SUMMARY OVERVIEW: OnJanuary 21, 2020 , AmeriServ issued a press release detailing our financial results for the fourth quarter and the full year of 2019. Results included net income of$669,000 , or$0.04 per share, as compared with the fourth quarter of 2018, when net income was$1,928,000 , or$0.11 per share. The full year of 2019 resulted in net income of$6,028,000 , or$0.35 per share, as compared with net income of$7,768,000 , or$0.43 per share, for 2018. This decline is explained primarily by two specific events during the fourth quarter of 2019. First, financial institutions such as AmeriServ are required to invest in positive economic progress within the markets where the institution conducts business. This Community Reinvestment Act (CRA) was passed into law byCongress in the latter half of the last century. Fortunately, there are occasions when such programs result in economic growth in areas where growth is needed. However, there are also occasions when the programs fail. AmeriServ previously provided$500,000 for such a program, but, in late 2019, AmeriServ was notified by a specific Federal agency that the managing company of this particular fund was placed into receivership. Consequently, a$500,000 impairment charge was recognized on this CRA investment in the fourth quarter of 2019, and there will be no further developments or losses. It should be noted that the Company only has one other similar CRA related investment that totals$100,000 that has been performing as expected. Secondly, shortly after Christmas in 2019, we were informed of the unexpected death of one of our large commercial borrowers. The$6.5 million loan had been on the books since the spring of 2018 and was performing as agreed. AmeriServ's legal counsel has already begun to work with the attorneys for the estate. In such situations, while AmeriServ regrets the passing of this individual, necessary actions are being taken to protect the interests of AmeriServ. As a result, an additional reserve of$675,000 was allocated against this loan while the legal discussions take place. Since the date of the borrower's passing wasDecember 26, 2019 , it was necessary for this reserve to be established in the fourth quarter of 2019. On a brighter note, the quarter and the year contained several positive results: 1) In spite of the disarray in the national economy from time to time, 2019 was a very strong year for loan closings. Both November and December were quite active, and this trend may continue in 2020.
2)
The 2019 deposit performance has been strong. Consumer and commercial customers were very active which resulted in solid growth that permitted AmeriServ to report the highest average level of deposits in the history of the company.
3)
In 2018, fees in our wealth management activities set a record. We are excited to report that, in 2019, wealth management reported an even higher total of fees. This is a new record for the second consecutive year. Additionally, our sizable wealth management company is well positioned for further revenue growth in 2020 with the equity markets reaching record highs to close out 2019.
4)
Additionally, during 2019, the tangible book value(1) of AmeriServ shares passed$5.00 . This was an increase of$0.20 per share, or 4.1%, overDecember 2018 and reflects the benefits of active capital management. As ofDecember 31, 2019 , our book value per share was$5.78 . This progress indicates that our business model is healthy. AmeriServ continues to lend approximately 90% of our deposits to small and medium size businesses and consumers in our region. We want this economic
(1)
See reconciliation of non-GAAP tangible book value later in this MD&A.
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expansion to continue. Our energies are focused on helping to keep our region economically strong while providing a competitive return to our shareholders. Specifically, in 2019, as a result of the increased cash dividend and the repurchase of 602,349 shares of AmeriServ common stock, we were able to return approximately 70% of our 2019 earnings to our shareholders while still maintaining a strong balance sheet which is conservatively constructed and maintained. PERFORMANCE OVERVIEW. The following table summarizes some of the Company's key profitability performance indicators for each of the past three years. YEAR ENDED DECEMBER 31, 2019 2018 2017 (IN THOUSANDS, EXCEPT PER SHARE DATA AND RATIOS) Net income$ 6,028 $ 7,768 $ 3,293 Diluted earnings per share 0.35 0.43 0.18 Return on average assets 0.51% 0.67% 0.28% Return on average equity 6.02 8.08 3.42 The Company reported net income of$6,028,000 , or$0.35 per diluted common share in 2019. This represents an 18.6% decrease in earnings per share from the full year of 2018 when net income totaled$7,768,000 , or$0.43 per diluted common share. The Company's return on average equity declined to 6.02% for the 2019 year from 8.08% in 2018. Finally, the Company increased tangible book value per share by 4.1% during 2019 and returned almost 70% of net income to its shareholders through accretive common stock buybacks and an increased cash dividend. The Company reported net income of$7.8 million , or$0.43 per diluted common share, for 2018. This represented an 139% increase in earnings per share from 2017 where net income totaled$3.3 million , or$0.18 per diluted common share. The strong growth in earnings resulted from a favorable combination of lower income tax expense, outstanding asset quality, and well controlled non-interest expense. The Company reported net income of$3.3 million , or$0.18 per diluted common share, for 2017. This represented a 50% increase in earnings per share from 2016 where net income totaled$2.3 million , or$0.12 per diluted share. In the fourth quarter of 2017, the enactment into law of "H.R.1.", known as the "Tax Cuts and Jobs Act", necessitated the revaluation of the Company's deferred tax asset because of the new lower corporate tax rate. This revaluation required that the Company recognize additional income tax expense of$2.6 million . The additional income tax expense negatively impacted diluted earnings per share by$0.14 for both the fourth quarter and full year of 2017. NET INTEREST INCOME AND MARGIN. The Company's net interest income represents the amount by which interest income on earning assets exceeds interest paid on interest bearing liabilities. Net interest income is a primary source of the Company's earnings; it is affected by interest rate fluctuations as well as changes in the amount and mix of earning assets and interest bearing liabilities. The following table summarizes the Company's net interest income performance for each of the past three years: YEAR ENDED DECEMBER 31, 2019 2018 2017 (IN THOUSANDS, EXCEPT RATIOS) Interest income$ 49,767 $ 47,094 $ 44,356 Interest expense 14,325 11,600 8,795 Net interest income 35,442 35,494 35,561 Net interest margin 3.29% 3.31% 3.32% 2019 NET INTEREST PERFORMANCE OVERVIEW. The Company's net interest income for the full year of 2019 decreased by$52,000 , or 0.1%, when compared to the full year of 2018. The Company's net interest margin was 3.29% for the full year of 2019 representing a two basis point decline from the full year 16
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of 2018. Our net interest margin performance was challenged throughout 2019 as theU.S. Treasury Yield Curve shifted downward, flattened and became inverted in certain segments, at various times during the year. The lower interest rate environment along with a lower full year average total loan portfolio balance resulted in the modest year over year unfavorable comparison for net interest income. Positively impacting net interest income during 2019 was a favorable shift experienced in the mix of total average interest bearing liabilities as the amount of total interest bearing deposits increased and resulted in less reliance on higher cost borrowings to fund interest earning assets. Total average earning assets increased by$6.7 million , or 0.6% in 2019. Specifically, total investment securities averaged$194 million in 2019 which is$9.5 million , or 5.1%, higher than the 2018 full year average. Total loans averaged$875 million in 2019 which is$6.6 million , or 0.7%, lower than the 2018 full year average. Total average interest bearing liabilities increased by$31.5 million , or 3.6%, as a lower level of total average FHLB borrowings was more than offset by a higher level of interest bearing deposits. Total interest bearing deposits averaged$828 million in 2019 and increased when compared to the 2018 average by$42.7 million , or 5.4%. The 2019 full year average of FHLB borrowed funds was$63.4 million , which represented a decrease of$14.7 million , or 18.8%. Total deposits, including non-interest bearing demand deposits, averaged$980 million for the full year of 2019, which was$19.9 million , or 2.1%, higher than the$960 million average for the full year of 2018. Overall, the Company's loan to deposit ratio averaged 89.1% in the fourth quarter of 2019 which we believe indicates that the Company has ample capacity to grow its loan portfolio. COMPONENT CHANGES IN NET INTEREST INCOME: 2019 VERSUS 2018. Regarding the separate components of net interest income, the Company's total interest income in 2019 increased by$2.7 million , or 5.7%, when compared to 2018. Total average earning assets increased by$6.7 million , or 0.6%, in 2019 as a lower level of total average loans were more than offset by an increased level of total investment securities. Also contributing to the higher level of interest income was the earning asset yield increasing by 22 basis points from 4.39% to 4.61%. All categories within the earning asset base demonstrated an interest income increase between years. The average total loan portfolio yield increased by 25 basis points from 4.66% to 4.91% in 2019 while the yield on total investment securities increased by 19 basis points from 3.17% to 3.36%. Total investment securities averaged$194 million for the full year of 2019 which is$9.5 million , or 5.1%, higher than the$185 million average in 2018. The growth in the investment securities portfolio occurred primarily as the year progressed during 2018 and is the result of management taking advantage of the rising interest rate environment experienced during 2018 which provided an attractive market for additional security purchases. Purchases primarily focused on federal agency mortgage backed securities due to the ongoing cash flow that these securities provide. Also, management continued its portfolio diversification strategy through purchases of high quality corporate and taxable municipal securities. Investment security purchase activity slowed significantly during 2019 as the interest rate market was less favorable. Total loans averaged$875 million for the full year of 2019 which is$6.6 million , or 0.7%, lower than the 2018 full year average. Overall, total loan originations in 2019 exceeded the prior year's level by$50.4 million and also exceeded another strong level of loan payoffs during the year. However, because of the high level of loan payoffs received late in 2018, the full year average comparison between years is unfavorable. Loan pipelines remained strong throughout 2019. Loan interest income increased by$1.9 million , or 4.6%, between the full year of 2019 and the full year of 2018. The higher loan interest income primarily reflects theFederal Reserve increasing the federal funds interest rate in 2018. This resulted in new loans originating at higher yields throughout 2018 and during the first half of 2019 and also caused the upward repricing of certain loans tied to LIBOR or the prime rate as both of these indices moved up with the federal funds rate increases in 2018. Certain floating rate loans, however, did reprice down in the second half of 2019 as theFederal Reserve reduced the federal funds rate by a total of 75 basis points in the second half of 2019. Also, included in the favorable year over year loan interest income increase was a higher level of loan fee income by$325,000 , due primarily to prepayment fees collected on certain early loan payoffs. Total interest expense for the twelve months of 2019 increased by$2.7 million , or 23.5%, when compared to 2018, due to higher levels of deposit interest expense which more than offset a slight decrease in borrowings interest expense. Deposit interest expense in 2019 was higher by$2.7 million , or 32.5%, for the full the year which reflects the higher level of total average interest bearing deposits and certain indexed money market accounts repricing upward due to the impact of theFederal Reserve increasing interest rates during 2018. The full year average cost of total interest bearing deposits increased between years by 28 basis points from 17
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1.07% in 2018 to 1.35% in 2019. Even though total average interest bearing deposit cost increased for the full year of 2019, the Company did experience deposit pricing relief during the third and fourth quarters of 2019 because of theFederal Reserve easing interest rates late in July, September and October of 2019. Specifically, the Company's cost of interest bearing deposits declined by 10 basis points between the third and fourth quarters of 2019. However, the Company continues to experience competitive market pressure to retain existing deposit customers and attract new customer deposits. Customer product preference changed as well in 2019 resulting in movement of funds from non-interest bearing demand deposit accounts and lower yielding money market accounts into higher yielding certificates of deposits. Overall, total deposits grew during the year and averaged$980 million for the full year of 2019, which was$19.9 million , or 2.1%, higher than the 2018 full year average. The Company experienced a$21,000 , or 0.7%, decrease in the interest cost of borrowings for the full year of 2019. The decline is a result of the lower total average borrowings balance between years combined with the impact from theFederal Reserve's action to decrease interest rates three times in 2019 and the immediate impact that these rate decreases had on the cost of overnight borrowed funds and the replacement of matured FHLB term advances. The total full year average term advance borrowings balance increased by approximately$7.3 million , or 16.3%, when compared to the full year 2018. This increase is due to the inversion demonstrated by theU.S. Treasury Yield Curve in 2019 and resulted in certain term advances costing less than overnight borrowed funds. Overall, the 2019 full year average of FHLB borrowed funds was$63.4 million , which represented a decrease of$14.7 million , or 18.8%, due to the increase in total average deposits. 2018 NET INTEREST PERFORMANCE OVERVIEW. The Company's net interest income for the full year of 2018 decreased by$67,000 , or 0.2%, when compared to the full year of 2017. The net interest margin remained relatively stable in 2018 for a second consecutive year, even though rising interest rates and competitive pricing pressure to retain and attract new deposits resulted in the net interest margin decreasing during the fourth quarter of 2018. The Company's net interest margin was 3.31% for the full year of 2018 representing a one basis point decline from the full year of 2017. The 2018 decrease in net interest income is a result of a reduced level of total average earning assets as lower total loans more than offset an increased level of total investment securities. Total average earning assets decreased modestly by$1.4 million , or 0.1% in 2018. Specifically, total investment securities averaged$185 million in 2018 which is$11.9 million , or 6.9%, higher than the 2017 full year average. Total loans averaged$882 million in 2018 which is$12.1 million , or 1.4%, lower than the 2017 full year average. This combined with the upward repricing of interest bearing liabilities, as well as a higher level of average interest bearing liabilities, resulted in net interest income decreasing between years. Total average interest bearing liabilities increased by$7.0 million , or 0.8%, as a lower level of interest bearing deposits was more than offset by a higher level of total average borrowings. Total interest bearing deposits averaged$786 million in 2018 and decreased when compared to 2017 average by$8.5 million , or 1.1%. This decrease to average interest bearing deposits was more than offset by total average FHLB borrowings of$78.1 million increasing by$15.5 million , or 24.7%, between years. Total deposits, including non-interest bearing demand deposits, averaged$960 million for the full year of 2018 which was$16.7 million , or 1.7%, lower than the$976 million average for the full year of 2017. Overall, the Company's loan to deposit ratio averaged 90.4% in the fourth quarter of 2018. COMPONENT CHANGES IN NET INTEREST INCOME: 2018 VERSUS 2017. Regarding the separate components of net interest income, the Company's total interest income in 2018 increased by$2.7 million , or 6.2%, when compared to 2017. Total average earning assets decreased modestly by$1.4 million , or 0.1% in 2018 as a lower level of total loans more than offset an increased level of total investment securities. The modest decrease in total average earning assets was more than offset by a 25 basis point increase in the earning asset yield from 4.14% to 4.39%. Within the earning asset base, deposits with banks, short term investments in money market funds, and investment securities interest revenue increased by$927,000 or 18.0% in 2018 due to the increase in the average investment securities portfolio and the yield on total investment securities increasing by 27 basis points from 2.90% to 3.17%. The growth in the investment securities portfolio is the result of management taking advantage of the higher interest rate environment in 2018 to purchase additional securities. Purchases in 2018 primarily focused on federal agency mortgage backed securities due to the ongoing liquid cash flow that these securities provide. Also, management 18
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continued its portfolio diversification strategy through purchases of high quality corporate and taxable municipal securities. Even though total average loans decreased since 2017, loan interest income increased by$1.8 million , or 4.6%, for the full year of 2018 when compared to 2017 as the yield on the total loan portfolio increased by 27 basis points from 4.39% to 4.66%. The higher loan interest income reflects new loans originating at higher yields as well as the upward repricing of certain loans tied to LIBOR or the prime rate as both of these indices have moved up with theFederal Reserve's program to increase the target federal funds interest rate. Overall, total loan originations were consistent with the prior year's level. However, loan payoffs exceeded what we experienced in 2017 and also exceeded loan originations in 2018, resulting in a net reduction to the loan portfolio. Included in the total level of payoffs experienced in 2018 was the successful workout of several criticized but performing loans which favorably impacted the quality of the loan portfolio. Total interest expense for the full year of 2018 increased$2.8 million , or 31.9%, when compared to 2017, due to higher levels of both deposit and borrowing interest expense. Deposit interest expense in 2018 was higher by$2.2 million which reflects certain indexed money market accounts and term CDs repricing upward after theFederal Reserve interest rate increases. The cost of interest bearing deposits increased by 28 basis points in 2018 to 1.07% due to the impact of increasing national interest rates. The higher national interest rate environment in 2018 resulted in increasing market competitive pressure to retain existing deposit customers and attract new customer deposits. Additionally, there has been customer movement of some funds out of lower yielding money market accounts into higher yielding certificates of deposits. The runoff of money market deposits has more than offset the growth of term deposit products and resulted in a decrease in the balance of total deposits in 2018. The Company experienced a$617,000 , or 24.3%, increase in the interest cost for borrowings in the full year of 2018 due to a higher average balance of total borrowed funds and the immediate impact that the increases in the federal funds rate had on the cost of overnight borrowed funds. Overall, total interest bearing funding costs increased by 31 basis points to 1.31%. The table that follows provides an analysis of net interest income on a tax-equivalent basis setting forth (i) average assets, liabilities, and stockholders' equity, (ii) interest income earned on interest earning assets and interest expense paid on interest bearing liabilities, (iii) average yields earned on interest earning assets and average rates paid on interest bearing liabilities, (iv) interest rate spread (the difference between the average yield earned on interest earning assets and the average rate paid on interest bearing liabilities), and (v) net interest margin (net interest income as a percentage of average total interest earning assets). For purposes of these tables, loan balances include non-accrual loans, and interest income on loans includes loan fees or amortization of such fees which have been deferred, as well as interest recorded on certain non-accrual loans as cash is received. Regulatory stock is included within available for sale investment securities for this analysis. Additionally, a tax rate of 21% was used to compute tax-equivalent interest income and yields (non-GAAP) during 2019 and 2018, while a tax rate of 34% was used for 2017. The tax equivalent adjustments to interest income on loans and municipal securities for the years endedDecember 31, 2019 , 2018, and 2017 was 24,000, 21,000, and 40,000, respectively, which is reconciled to the corresponding GAAP measure at the bottom of the table. Differences between the net interest spread and margin from a GAAP basis to a tax-equivalent basis were not material. 19
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TABLE OF CONTENTS YEAR ENDED DECEMBER 31, 2019 2018 2017 INTEREST INTEREST INTEREST AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ BALANCE EXPENSE RATE BALANCE EXPENSE RATE BALANCE EXPENSE RATE (IN THOUSANDS, EXCEPT PERCENTAGES) Interest earning assets: Loans, net of unearned income$ 875,198 $ 42,957 4.91%$ 881,767 $ 41,049 4.66%$ 893,849 $ 39,257 4.39% Deposits with banks 1,018 24 2.32 1,023 20 1.90 1,028 11 1.11 Short-term investment in money market funds 10,552 293 2.77 6,725 201 3.00 7,996 130 1.63 Investment securities: Available for sale 153,458 5,090 3.32 145,162 4,527 3.12 135,131 3,800 2.81 Held to maturity 40,553 1,427 3.52 39,388 1,318 3.35 37,484 1,198 3.20 Total investment securities 194,011 6,517 3.36 184,550 5,845 3.17 172,615 4,998 2.90 TOTAL INTEREST EARNING ASSETS/ INTEREST INCOME 1,080,779 49,791 4.61 1,074,065 47,115 4.39 1,075,488 44,396 4.14 Non-interest earning assets: Cash and due from banks 20,239 23,067 22,393 Premises and equipment 17,928 12,480 12,273 Other assets 64,083 62,040 67,169 Allowance for loan losses (8,404) (9,866) (10,241) TOTAL ASSETS$ 1,174,625 $ 1,161,786 $ 1,167,082 Interest bearing liabilities: Interest bearing deposits: Interest bearing demand$ 170,326 $ 1,595 0.94%$ 138,572 $ 1,134 0.82%$ 129,589 $ 638 0.49% Savings 96,783 162 0.17 98,035 163 0.17 97,405 162 0.17 Money market 234,387 2,525 1.08 249,618 2,183 0.87 275,636 1,446 0.52 Other time 326,867 6,907 2.11 299,391 4,963 1.66 291,475 4,009 1.38 Total interest bearing deposits 828,363 11,189 1.35 785,616 8,443 1.07 794,105 6,255 0.79 Federal funds purchased and other short-term borrowings 11,088 288 2.59 33,126 720 2.17 16,972 206 1.21 Advances fromFederal Home Loan Bank 52,309 1,090 2.09 44,974 797 1.77 45,657 694 1.52 Guaranteed junior subordinated deferrable interest debentures 13,085 1,121 8.57 13,085 1,120 8.57 13,085 1,120 8.57 Subordinated debt 7,650 520 6.80 7,650 520 6.80 7,650 520 6.80 Lease liabilities 3,444 117 3.40 - - - - - - TOTAL INTEREST BEARING LIABILITIES/INTEREST EXPENSE 915,939 14,325 1.56 884,451 11,600 1.31 877,469 8,795 1.00 Non-interest bearing liabilities: Demand deposits 151,292 174,108 182,301 Other liabilities 7,271 7,077 11,119 Stockholders' equity 100,123 96,150 96,193 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY$ 1,174,625 $ 1,161,786 $ 1,167,082 Interest rate spread 3.05 3.08 3.14 Net interest income/net interest margin 35,466 3.29% 35,515 3.31% 35,601 3.32% Tax-equivalent adjustment (24) (21) (40) Net interest income$ 35,442 $ 35,494 $ 35,561 20
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Net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. The table below sets forth an analysis of volume and rate changes in net interest income on a tax-equivalent basis. For purposes of this table, changes in interest income and interest expense are allocated to volume and rate categories based upon the respective percentage changes in average balances and average rates. Changes in net interest income that could not be specifically identified as either a rate or volume change were allocated proportionately to changes in volume and changes in rate. 2019 vs. 2018 2018 vs. 2017 INCREASE (DECREASE) INCREASE (DECREASE) DUE TO CHANGE IN: DUE TO CHANGE IN: AVERAGE AVERAGE VOLUME RATE TOTAL VOLUME RATE TOTAL (IN THOUSANDS) INTEREST EARNED ON: Loans, net of unearned income$ (308) $ 2,216 $ 1,908 $ (505) $ 2,297 $ 1,792 Deposits with banks - 4 4 (1) 10 9 Short-term investments in money market funds 106 (14) 92 (17) 88 71 Investment securities: Available for sale 265 298 563 292 435 727 Held to maturity 40 69 109 62 58 120 Total investment securities 305 367 672 354 493 847 Total interest income 103 2,573 2,676 (169) 2,888 2,719 INTEREST PAID ON: Interest bearing demand deposits 281 180 461 46 450 496 Savings deposits (1) - (1) 1 - 1 Money market (116) 458 342 (120) 857 737 Other time deposits 492 1,452 1,944 113 841 954 Federal funds purchased and other short-term borrowings (609) 177 (432) 280 234
514
Advances from Federal Home Loan Bank 139 154 293 (10) 113
103
Guaranteed junior subordinated deferrable interest debentures - 1 1 - - - Lease liabilities 117 - 117 - - - Total interest expense 303 2,422 2,725 310 2,495 2,805 Change in net interest income$ (200)
LOAN QUALITY. The Company's written lending policies require underwriting, loan documentation, and credit analysis standards to be met prior to funding any loan. After the loan has been approved and funded, continued periodic credit review is required. The Company's policy is to individually review, as circumstances warrant, each of its commercial and commercial mortgage loans to determine if a loan is impaired. At a minimum, credit reviews are mandatory for all commercial and commercial mortgage loan relationships with aggregate balances in excess of$1,000,000 within a 12-month period. The Company has also identified three pools of small dollar value homogeneous loans which are evaluated collectively for impairment. These separate pools are for small business relationships with aggregate balances of$250,000 or less, residential mortgage loans and consumer loans. Individual loans within these pools are reviewed and removed from the pool if factors such as significant delinquency in payments of 90 days or more, bankruptcy, or other negative economic concerns indicate impairment. The following table sets forth information concerning the Company's loan delinquency and other non-performing assets. 21
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TABLE OF CONTENTS AT DECEMBER 31, 2019 2018 2017 (IN THOUSANDS, EXCEPT PERCENTAGES) Total accruing loans past due 30 to 89 days$ 2,956 $ 4,752 $ 8,178 Total non-accrual loans 1,487 1,221 3,016 Total non-performing assets including TDRs(1) 2,339 1,378
3,034
Loan delinquency as a percentage of total loans, net of unearned income
0.33% 0.55%
0.92%
Non-accrual loans as a percentage of total loans, net of unearned income
0.17 0.14
0.34
Non-performing assets as a percentage of total loans, net of unearned income, and other real estate owned
0.26 0.16
0.34
Non-performing assets as a percentage of total assets 0.20 0.12
0.26
Total classified loans (loans rated substandard or doubtful)(2)$ 16,338 $ 4,302 $ 5,433 (1)
Non-performing assets are comprised of (i) loans that are on a non-accrual basis, (ii) loans that are contractually past due 90 days or more as to interest and principal payments, (iii) performing loans classified as troubled debt restructuring and (iv) other real estate owned.
(2)
Total includes residential real estate and consumer loans that are considered non-performing.
The Company continues to maintain good asset quality. Non-performing assets increased by$961,000 since the prior year-end and now total$2.3 million . The continued successful ongoing problem credit resolution efforts of the Company is demonstrated in the table above as levels of non-accrual loans, non-performing assets, and loan delinquency are below 1% of total loans. The Company did experience an increase in classified loans in the second half of 2019 due to the downgrade of several commercial loans, the largest of which was a$6.5 million C&I loan due to the unexpected death of the borrower in late 2019 (see further discussion on this loan later in the MD&A). We continue to closely monitor the loan portfolio given the number of relatively large-sized commercial and CRE loans within the portfolio. As ofDecember 31, 2019 , the 25 largest credits represented 24.3% of total loans outstanding. ALLOWANCE AND PROVISION FOR LOAN LOSSES. As described in more detail in the Critical Accounting Policies and Estimates section of this MD&A, the Company uses a comprehensive methodology and procedural discipline to maintain an ALL to absorb inherent losses in the loan portfolio. The Company believes this is a critical accounting policy since it involves significant estimates and judgments. The following table sets forth changes in the ALL and certain ratios for the periods ended. 22
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TABLE OF CONTENTS YEAR ENDED DECEMBER 31, 2019 2018 2017 2016 2015
(IN THOUSANDS, EXCEPT RATIOS AND PERCENTAGES) Balance at beginning of year
$ 8,671
(9) (574) (311) (3,662) (404) Commercial loans secured by non-owner occupied real estate (63) - (132) (82) (365) Real estate - residential mortgage (98) (380) (313) (208) (403) Consumer (262) (251) (172) (344) (188) Total charge-offs (432) (1,205) (928) (4,296) (1,360) Recoveries: Commercial 22 31 27 169 174 Commercial loans secured by non-owner occupied real estate 48 51 56 58 76 Real estate - residential mortgage 118 119 207 100 132 Consumer 52 61 120 30 26 Total recoveries 240 262 410 357 408 Net charge-offs (192) (943) (518) (3,939) (952) Provision (credit) for loan losses 800 (600) 800 3,950 1,250 Balance at end of year$ 9,279
$ 875,198
887,574 863,129 892,758 886,858 883,987 As a percent of average loans: Net charge-offs 0.02% 0.11% 0.06% 0.44% 0.11% Provision (credit) for loan losses 0.09 (0.07) 0.09 0.44 0.15 Allowance as a percent of each of the following: Total loans, net of unearned income 1.05 1.00 1.14 1.12 1.13 Total accruing delinquent loans (past due 30 to 89 days) 313.90 182.47 124.90 302.99 225.68 Total non-accrual loans 624.01 710.16 338.66 619.59 163.55 Total non-performing assets 396.71 629.25 336.65 611.58 157.55 Allowance as a multiple of net charge-offs 48.33x 9.20x 19.72x 2.52x 10.42x For 2019, the Company recorded an$800,000 provision expense for loan losses compared to a$600,000 provision recovery in 2018 which resulted in a net unfavorable shift of$1.4 million between years. The rating downgrade of a$6.5 million performing commercial loan to substandard as a result of the unexpected death of a borrower caused a$675,000 increase in fourth quarter 2019 provision expense. This rating action was prudent due to the inherent uncertainties associated with a large estate liquidation. Recent updates related to this loan indicate that the estate is presently illiquid due to holds placed on deposit accounts and significant real estate holdings and other unique assets that will need to be unwound. As such there is heightened risk that this loan may move into non-performing status in 2020 as a result of payment delays. The Company experienced net loan charge-offs of only$192,000 , or 0.02% of total loans, in 2019 compared to net loan charge-offs of$943,000 , or 0.11% of total loans, in 2018. Overall, nonperforming assets totaled$2.3 million , or only 0.26% of total loans, atDecember 31, 2019 . In summary, the allowance 23
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for loan losses provided 397% coverage of non-performing assets, and 1.05% of total loans, atDecember 31, 2019 , compared to 629% coverage of non-performing assets, and 1.00% of total loans, atDecember 31, 2018 . For 2018, the Company recorded a$600,000 provision recovery compared to an$800,000 provision for loan losses in 2017, or a decrease of$1.4 million between years. The 2018 provision recovery reflects our overall strong asset quality, reduced loan portfolio balance and the successful workout of several criticized loans which resulted in the release of reserves after two criticized loans that had balances totaling in excess of$11 million fully paid off during the third and fourth quarters of 2018. The Company experienced net loan charge-offs of$943,000 , or 0.11% of total loans in 2018 compared to net loan charge-offs of$518,000 , or 0.06%, of total loans in 2017. Overall, the Company continued to maintain outstanding asset quality as its nonperforming assets totaled$1.4 million , or only 0.16% of total loans, atDecember 31, 2018 . The following schedule sets forth the allocation of the ALL among various loan categories. This allocation is determined by using the consistent quarterly procedural discipline that was previously discussed. The entire ALL is available to absorb future loan losses in any loan category. AT DECEMBER 31, 2019 2018 2017 2016 2015 PERCENT PERCENT PERCENT PERCENT PERCENT OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS IN EACH IN EACH IN EACH IN EACH IN EACH CATEGORY CATEGORY CATEGORY CATEGORY CATEGORY TO TOTAL TO TOTAL TO TOTAL TO TOTAL TO TOTAL AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS (IN THOUSANDS, EXCEPT PERCENTAGES) Commercial$ 3,951 30.1%$ 3,057 29.0%$ 4,298 28.0%$ 4,041 29.8%$ 4,243 31.6% Commercial loans secured by non-owner occupied real estate 3,119 41.2 3,389 41.4 3,666 42.0 3,584 40.2 3,449 36.9 Real estate - residential mortgage 1,159 26.6 1,235 27.6 1,102 27.8 1,169 27.8 1,174 29.2 Consumer 126 2.1 127 2.0 128 2.2 151 2.2 151 2.3 Allocation to general risk 924 - 863 - 1,020 - 987 - 904 - Total$ 9,279 100.0%$ 8,671 100.0%$ 10,214 100.0%$ 9,932 100.0%$ 9,921 100.0% Even though residential real estate-mortgage loans comprise 26.6% of the Company's total loan portfolio, only$1.2 million or 12.5% of the total ALL is allocated against this loan category. The residential real estate-mortgage loan allocation is based upon the Company's three-year historical average of actual loan charge-offs experienced in that category and other qualitative factors. The disproportionately higher allocations for commercial loans and commercial loans secured by non-owner occupied real estate reflect the increased credit risk associated with those types of lending, the Company's historical loss experience in these categories, and other qualitative factors. The stability in the part of the allowance allocated to each loan category reflects the continued good asset quality of each sector. Based on the Company's current ALL methodology and the related assessment of the inherent risk factors contained within the Company's loan portfolio, we believe that the ALL is adequate atDecember 31, 2019 to cover losses within the Company's loan portfolio. NON-INTEREST INCOME. Non-interest income for 2019 totaled$14.8 million , an increase of$549,000 , or 3.9%, from 2018. Factors contributing to this higher level of non-interest income in 2019 included: • the Company recognized a$500,000 impairment charge on other investments related to a Community Reinvestment Act (CRA) investment.The Small Business Administration (SBA) recently gave formal notice that the managing company of this particular fund was placed into receivership which caused us to write off the full investment and no further action or loss will occur. It should be noted that the Company only has one other similar CRA related investment that totals$100,000 that has been performing as expected; 24
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•
Net realized gains on loans held for sale increased by$376,000 , or 76.9% between years due to increased residential mortgage loan sales in the secondary market as the lower interest rate environment in the second half of 2019 resulted in a greater level of residential mortgage loan production. In addition to increased residential mortgage originations, the full year favorable comparison in 2019 was also due to the sale of the guaranteed portion of a SBA loan that resulted in a$197,000 gain;
•
The Company recognized a net investment security sale gain of$118,000 in 2019 compared to a$439,000 net loss in 2018 as the opportunity existed to capture gains on certain securities that demonstrated higher than typical market appreciation in this low interest rate environment. The 2018 net loss resulted from the Company repositioning a portion of the investment portfolio for stronger future returns;
•
a
•
a
•
a$103,000 , or 4.4%, increase in other income was due to higher letter of credit fees and increased revenue from check supply sales as a result of a favorable vendor contract renegotiation; and
•
a$71,000 , or 0.7%, increase in wealth management fees was primarily due to the Company benefitting from a continuing increase in market values for assets under management as well as management's effective execution of managing client accounts. Wealth management continues to be an important strategic focus. Non-interest income for 2018 totaled$14.2 million , a decrease of$421,000 , or 2.9%, from 2017. Factors contributing to this lower level of non-interest income in 2018 included: • a$554,000 negative change in the net realized gain/loss on investment securities primarily results from two security sell transactions. Early in 2018, management viewed the gain recognized on the sale of equity securities, described in the third bulleted item, as an opportunity to rid the investment securities portfolio of certain investments having a low yield and a small balance. Similarly, because of the negative loan loss provision recognized during the fourth quarter of 2018, management viewed this as another opportunity to, again, sell certain low yielding securities. The funds from both sells were reinvested in securities with higher current market coupon rates. Both security sell transactions were negatively impacted by the market value of sold securities decreasing since 2017 due to the higher interest rate environment in 2018. However, because of the reinvestment of the sold funds into higher yielding instruments, the result of both transactions positions the Company for an increased future return from the investment securities portfolio;
•
a$489,000 increase in wealth management fees was primarily due to the Company benefitting from increased market values for assets under management in 2018 as well as management's effective execution of managing client accounts;
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a$285,000 increase in other income primarily was due to a$156,000 gain realized on the sale of certain equity method investments that the Company owned from a previous acquisition. The Company also benefitted from higher interchange fees, increased revenue from business services, and higher letter of credit fees;
•
a combined
•
a$201,000 decrease in revenue from bank owned life insurance (BOLI) occurred after the Company received a death claim in 2017 and there was no such claim in 2018; and
•
a
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NON-INTEREST EXPENSE. Non-interest expense for 2019 totaled$41.8 million , which represents a$942,000 , or 2.3%, increase from 2018. Factors contributing to the higher non-interest expense in 2019 included: • a$1.1 million , or 4.4%, increase in salaries & benefits expense was due to annual merit increases, the addition of several employees to address management succession planning as well as our expansion into theHagerstown, Maryland market. Increased pension and health care costs also contributed to the higher employee costs between years;
•
a$457,000 , or 82.0%, reduction inFDIC insurance expense. As part of the application of the Small Bank Assessment Credit regulation, theFDIC awarded community banks under$10 billion in assets an assessment credit because the banking industry reserve ratio exceeded its 1.38% target. The Company currently expects to receive one additional assessment credit of less than$100,000 in the first quarter of 2020.;
•
a$397,000 , or 7.6%, increase in other expense was due to additional expense for the unfunded commitment reserve as a result of increased loan approvals in 2019, as well as, an increased investment in technology as evidenced by higher website costs and additional telecommunications expense; and
•
a
Non-interest expense for 2018 totaled$40.9 million , which represents a$170,000 , or 0.4%, increase from 2017. Factors contributing to the higher non-interest expense in 2018 included: • a$438,000 , or 1.8%, increase in salaries & benefits expense due to higher salaries and incentive compensation as a result of the typical annual salary merit increases and additional incentives paid primarily within our Wealth Management division due to the increased level of fee income mentioned previously. Also in the fourth quarter of 2018, four additional employees were hired for our newHagerstown, Maryland financial banking center; and
•
a combined$259,000 reduction in occupancy & equipment costs is primarily attributable to the Company's ongoing efforts to carefully manage and contain non-interest expense. Specifically, a branch office closure inCambria County along with a branch consolidation in theState College market resulted in reduced rent expense and other occupancy related costs. INCOME TAX EXPENSE. The Company recorded an income tax expense of$1.6 million , or an effective tax rate of 20.7%, in 2019, compared to income tax expense of$1.7 million , or a 17.8% effective tax rate, in 2018, and compared to income tax expense of$5.4 million , or a 62.1% effective tax rate, in 2017. The lower effective tax rate in 2019 and 2018 reflected the benefits of corporate tax reform as a result of the enactment of the "Tax Cuts and Jobs Act" late in the fourth quarter of 2017, which lowered the corporate income tax rate from 34% to 21%. Also, because of the enactment of this new tax law, the Company was able to achieve a greater income tax benefit in the third quarter of 2018 by making a one-time additional contribution to the defined benefit pension plan. The tax benefit of this additional pension contribution favorably reduced income tax expense by$264,000 in the third quarter of 2018. Finally, the higher income tax expense in 2017 resulted from an additional income tax charge of$2.6 million recorded in the fourth quarter of 2017 as corporate income tax reform necessitated the revaluation of the Company's deferred tax asset because of the new lower corporate tax rate. The Company's deferred tax asset was$4.0 million atDecember 31, 2019 . SEGMENT RESULTS. The community banking segment reported a net income contribution of$10.9 million in 2019 which decreased from the$11.1 million contribution in 2018 and increased from the$8.6 million contribution in 2017. The primary driver for the lower level of net income in 2019 was the Company recording an$800,000 provision expense for loan losses compared to a$600,000 provision recovery in 2018 which resulted in a net unfavorable shift of$1.4 million between years. This is discussed previously in the "Allowance and Provision for Loan Losses" section within this document. Also, unfavorably impacting net income was total employee costs increasing, a higher level of funding for the unfunded commitment reserve due to increased loan approvals within the commercial lending division and the lower level of deposit service charge income within the retail banking division. Nearly offsetting these unfavorable items was 26
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total loan interest income increasing between years which primarily reflects theFederal Reserve increasing the federal funds interest rate in 2018. This resulted in new commercial loans originating at higher yields throughout 2018 and during the first half of 2019 and also caused the upward repricing of certain loans tied to LIBOR or the prime rate as both of these indices moved up with the federal funds rate increases in 2018. Also, included in the favorable year over year loan interest income comparison was a higher level of commercial loan fee income by$325,000 , due primarily to prepayment fees collected on certain early loan payoffs. Within the retail banking division, net interest income increased between years as the funding benefit for deposits improved due to the growth of total deposits. This funding benefit more than offset the impact of the immediate upward repricing of money market deposit accounts because of the increases to the federal funds rate during 2018 and the corresponding incremental increase to other term deposit products. Note that the retail banking division did experience deposit cost relief during the second half of 2019 because of theFederal Reserve's action to decrease the fed funds rate in July, September and October. Retail banking was also positively impacted by the lower level ofFDIC insurance expense due to the application of the assessment credit during 2019. Finally, there was a higher level of net gains on loan sales into the secondary market as well as a higher level of mortgage related fee income due to increased residential mortgage loan production. The wealth management segment's net income contribution was$1.9 million in 2019 compared to$1.8 million in 2018 and$1.4 million in 2017. The increase is due to wealth management fees increasing as this segment has benefitted from increased market values for assets under management which occurred as the year progressed as well as management's effective execution of managing client accounts. Also, positively impacting the wealth management segment's net income was a lower level of incentive compensation and decreased professional fees due to lower legal fees and costs for other professional services. Slightly offsetting these items was higher employee costs due to higher salaries because of annual merit increases and a greater level of pension cost. Also, there was a decrease in the volume of life insurance sales within the financial services division. Overall, the fair market value of trust assets under administration totaled$2.238 billion atDecember 31, 2019 , an increase of$132 million , or 6.3%, from theDecember 31, 2018 total of$2.106 billion . The investment/parent segment reported a net loss of$6.8 million in 2019, which was greater than the net loss of$5.1 million in 2018 and$6.7 million in 2017. The increased loss between years is reflective of the previously discussed$500,000 impairment charge on other investments related to a CRA investment. Also, the increased loss was the result of overnight borrowed funds having a higher cost due to the increase in national interest rates during 2018 and the immediate impact that the rising interest rates had on overnight borrowed funds. Additionally, the replacement of maturing FHLB term advances repriced upward during the first nine months of 2019. Slightly offsetting these unfavorable items was the Company recognizing a net investment security sale gain of$118,000 in 2019 compared to a$439,000 net loss in 2018 as the opportunity existed to capture gains on certain securities that demonstrated higher than typical market appreciation in this low interest rate environment. The 2018 net loss resulted from the Company repositioning a portion of the investment portfolio for stronger future returns. For greater discussion on the future strategic direction of the Company's key business segments, see "Management's Discussion and Analysis - Forward Looking Statements." For a more detailed analysis of the segment results, see Note 24. BALANCE SHEET. The Company's total consolidated assets of$1.171 billion atDecember 31, 2019 increased by$10.5 million , or 0.9% from the$1.161 billion level atDecember 31, 2018 . The increase to total consolidated assets was due primarily to a$24.4 million , or 2.8%, increase in total loans which more than offset total investment securities decreasing by$5.8 million , or 3.1% and cash balances declining by$12 million . Overall, total loan originations in 2019 exceeded the prior year's level by$50 million and also exceeded another strong level of loan payoffs in 2019. Loan pipelines remained strong throughout 2019. The Company experienced growth in the investment securities portfolio during 2018 as a result of management taking advantage of the rising interest rate environment during 2018 which provided an attractive market for additional security purchases. Investment security purchase activity slowed significantly during 2019 as the interest rate market was less favorable resulting in a decrease of total investment securities between years. Also, as a result of the adoption of ASU 2016-02, Leases (Topic 842), the Company reported$3.9 million of right of use assets within the fixed assets line of the Consolidated Balance Sheets atDecember 31, 2019 . 27
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The Company's deposits at period end increased by$11.3 million and was offset by a decrease in FHLB borrowings of$11.7 million . The decrease in FHLB borrowings was the result of an$18.6 million , or 45.4%, decline in overnight borrowed funds. The substantial decrease in short term borrowings was partially offset by an increase in FHLB term advances. Specifically, total FHLB term advances increased by$6.9 million , or 14.9%, and totaled$53.7 million . The Company has utilized these term advances to help manage interest rate risk and the inversion demonstrated by theU.S. Treasury Yield Curve at certain times in 2019 resulted in certain term advances costing less than overnight borrowed funds. In addition, the Company reported$4.0 million of lease liabilities as a result of the adoption of ASU 2016-02, Leases (Topic 842). Other liabilities increased by$6.1 million primarily due to an increase in the Company's pension liability. Total stockholders' equity increased by$637,000 , or 0.7%, since year-end 2018. Capital decreased during 2019 by the Company's common stock repurchase program and the annual revaluation of the Company's pension obligation which negatively impacted other comprehensive income by$5.1 million due to an approximate 1% decline in the discount rate between years. Offsetting these decreases, was the Company's$6.0 million of net income and the positive$3.1 million impact capital experienced due to the improved market value of the available for sale investment securities portfolio. The Company returned approximately 70% of our 2019 earnings to our shareholders through the accretive common stock repurchases and an increased quarterly common stock cash dividend. The Company continues to be considered well capitalized for regulatory purposes with a risk based capital ratio of 13.49% and an asset leverage ratio of 9.87% atDecember 31, 2019 . The Company's book value per common share was$5.78 , its tangible book value per common share (non-GAAP) was$5.08 and its tangible common equity to tangible assets ratio (non-GAAP) was 7.48% atDecember 31, 2019 . The tangible common equity ratio and tangible book value per share are considered to be non-GAAP measures and are calculated by dividing tangible equity by tangible assets or shares outstanding. The following table sets forth the calculation of the Company's tangible common equity ratio and tangible book value per share atDecember 31, 2019 , 2018, and 2017 (in thousands, except share and ratio data): AT DECEMBER 31, 2019 2018 2017 Total shareholders' equity$ 98,614 $ 97,977 $ 95,102 Less: Goodwill 11,944 11,944 11,944 Tangible equity 86,670 86,033 83,158 Total assets 1,171,184 1,160,680 1,167,655 Less: Goodwill 11,944 11,944 11,944 Tangible assets 1,159,240 1,148,736 1,155,711 Tangible common equity ratio (non-GAAP) 7.48% 7.49% 7.20% Total shares outstanding 17,057,871 17,619,303 18,128,247 Tangible book value per share (non-GAAP)$ 5.08 $ 4.88 $ 4.59 LIQUIDITY. The Company's liquidity position continues to be strong. Our core retail deposit base has remained relatively stable over the past several years and demonstrated growth during 2019. The core deposit base is adequate to fund the Company's operations. Cash flow from maturities, prepayments and amortization of securities is used to help fund loan growth. We strive to operate our loan to deposit ratio in a range of 85% to 100%. AtDecember 31, 2019 , the Company's loan to deposit ratio was 92.4%. Given current commercial loan pipelines and the continued development of our existing loan production offices, we are optimistic that we can grow our loan to deposit ratio and remain within our guideline parameters. Liquidity can also be analyzed by utilizing the Consolidated Statements of Cash Flows. Cash and cash equivalents decreased by$12.7 million fromDecember 31, 2018 , to$22.2 million atDecember 31, 2019 , due to$4.9 million of cash provided by operating activities being more than offset by$13.0 million of cash used in investing activities and$4.6 million of cash used in financing activities. Within investing activities, 28
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cash advanced for new loan fundings and participations purchased totaled$205.6 million and was$20.5 million higher than the$185.1 million of cash received from loan principal payments and participations sold. Within financing activities, deposits increased by$11.3 million while total FHLB borrowings declined as short term borrowings decreased by$18.6 million and advances, both short-term and long term, increased by$6.9 million . The holding company had a total of$6.4 million of cash, short-term investments, and investment securities atDecember 31, 2019 . Additionally, dividend payments from our subsidiaries can also provide ongoing cash to the holding company. AtDecember 31, 2019 , our subsidiary Bank had$10.2 million of cash available for immediate dividends to the holding company under applicable regulatory formulas. As such, the holding company has good liquidity to meet its trust preferred debt service requirements, its subordinated debt interest payments, and its common stock dividends, which in total should approximate$3.2 million over the next twelve months. Financial institutions must maintain liquidity to meet day-to-day requirements of depositors and borrowers, take advantage of market opportunities, and provide a cushion against unforeseen needs. Liquidity needs can be met by either reducing assets or increasing liabilities. Sources of asset liquidity are provided by short-term investment securities, time deposits with banks, federal funds sold, and short-term investments in money market funds. These assets totaled$22.2 million and$34.9 million atDecember 31, 2019 and 2018, respectively. Maturing and repaying loans, as well as the monthly cash flow associated with mortgage-backed securities and security maturities are other significant sources of asset liquidity for the Company. Liability liquidity can be met by attracting deposits with competitive rates, using repurchase agreements, buying federal funds, or utilizing the facilities of theFederal Reserve or the FHLB systems. The Company utilizes a variety of these methods of liability liquidity. Additionally, the Company's subsidiary bank is a member of the FHLB, which provides the opportunity to obtain short- to longer-term advances based upon the Company's investment in certain residential mortgage, commercial real estate, and commercial and industrial loans. AtDecember 31, 2019 , the Company had$358 million of overnight borrowing availability at the FHLB,$30 million of short-term borrowing availability at theFederal Reserve Bank and$35 million of unsecured federal funds lines with correspondent banks. The Company believes it has ample liquidity available to fund outstanding loan commitments if they were fully drawn upon. CAPITAL RESOURCES. The Company meaningfully exceeds all regulatory capital ratios for each of the periods presented and is considered well capitalized. The Company's common equity tier 1 capital ratio was 10.47%, the tier 1 capital ratio was 11.68%, and the total capital ratio was 13.49% atDecember 31, 2019 . The Company's tier 1 leverage ratio was 9.87% atDecember 31, 2019 . We anticipate that we will maintain our strong capital ratios throughout 2020. Capital generated from earnings will be utilized to pay the common stock cash dividend, fund the stock repurchase program and will also support controlled balance sheet growth. Our common dividend payout ratio for the full year 2019 was 27.1%.Total Parent Company cash was$6.4 million atDecember 31, 2019 . There is a particular emphasis on ensuring that the subsidiary bank has appropriate levels of capital to support its non-owner occupied commercial real estate loan concentration, which stood at 334% of regulatory capital atDecember 31, 2019 . The Basel III capital standards establish the minimum capital levels in addition to the well capitalized requirements under the federal banking regulations prompt corrective action. The capital rules also impose a capital conservation buffer ("CCB") on top of the three minimum risk-weighted asset ratios. As ofJanuary 1, 2019 , the CCB was 2.5%. Banking institutions that fail to meet the effective minimum ratios once the CCB is taken into account will be subject to constraints on capital distributions, including dividends and share repurchases, and certain discretionary executive compensation. The severity of the constraints depends on the amount of the shortfall and the institution's "eligible retained income" (four quarter trailing net income, net of distributions and tax effects not reflected in net income). The Company and the Bank meet all capital requirements, including the CCB, and continue to be committed to maintaining strong capital levels that exceed regulatory requirements while also supporting balance sheet growth and providing a return to our shareholders. 29
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Under the Basel III capital standards, the minimum capital ratios are:
MINIMUM CAPITAL RATIO MINIMUM PLUS CAPITAL CAPITAL RATIO CONSERVATION BUFFER Common equity tier 1 capital to risk-weighted assets 4.5% 7.0% Tier 1 capital to risk-weighted assets 6.0 8.5 Total capital to risk-weighted assets 8.0 10.5 Tier 1 capital to total average consolidated assets 4.0 In the first quarter of 2019, the Company completed the previous common stock repurchase program where it bought back 540,000 shares, or 3% of its common stock, over a 9-month period at a total cost of$2.38 million . Specifically, during the first three months of 2019, the Company was able to repurchase 112,311 shares of its common stock and return$476,000 of capital to its shareholders through this program. OnApril 16, 2019 , the Company announced that its Board of Directors approved a new common stock repurchase program which calls forAmeriServ Financial, Inc. to buy back up to 3%, or approximately 526,000 shares, of its outstanding common stock during the next 12 months. The authorized repurchases will be made from time to time in either the open market or through privately negotiated transactions. The timing, volume and nature of share repurchases will be at the sole discretion of management, dependent on market conditions, applicable securities laws, and other factors, and may be suspended or discontinued at any time. No assurance can be given that any particular amount of common stock will be repurchased. This buyback program may be modified, extended or terminated by the Board of Directors at any time. The Company was able to repurchase 490,038 shares of its common stock and return$2.1 million of capital to its shareholders through this program. Overall in 2019, this latest common stock buyback program, combined with the first quarter completion of the previously authorized common stock buyback program, resulted in the Company returning$2.6 million to its shareholders through the repurchase of 602,349 shares of its common stock. When including the increased cash dividend payments on our common stock, total capital returned to our shareholders was approximately 70% of net income for 2019. AtDecember 31, 2019 , the Company had approximately 17.1 million common shares outstanding. INTEREST RATE SENSITIVITY. Asset/liability management involves managing the risks associated with changing interest rates and the resulting impact on the Company's net interest income, net income and capital. The management and measurement of interest rate risk at the Company is performed by using the following tools: 1) simulation modeling, which analyzes the impact of interest rate changes on net interest income, net income and capital levels over specific future time periods. The simulation modeling forecasts earnings under a variety of scenarios that incorporate changes in the absolute level of interest rates, the shape of the yield curve, prepayments and changes in the volumes and rates of various loan and deposit categories. The simulation modeling incorporates assumptions about reinvestment and the repricing characteristics of certain assets and liabilities without stated contractual maturities; 2) market value of portfolio equity sensitivity analysis; and 3) static GAP analysis, which analyzes the extent to which interest rate sensitive assets and interest rate sensitive liabilities are matched at specific points in time. The overall interest rate risk position and strategies are reviewed by senior management and the Company's Board of Directors on an ongoing basis. 30
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The following table presents a summary of the Company's static GAP positions atDecember 31, 2019 : OVER OVER 3 MONTHS 6 MONTHS 3 MONTHS THROUGH THROUGH OVER INTEREST SENSITIVITY PERIOD OR LESS 6 MONTHS 1 YEAR 1 YEAR TOTAL (IN THOUSANDS, EXCEPT RATIOS AND PERCENTAGES) RATE SENSITIVE ASSETS: Loans and loans held for sale$ 290,368 $ 51,288 $ 95,376 $ 450,542 $ 887,574 Investment securities 38,832 7,223 12,092 123,538 181,685 Short-term assets 6,526 - - - 6,526 Regulatory stock 3,985 - - 2,125 6,110 Bank owned life insurance - - 38,916 - 38,916 Total rate sensitive assets$ 339,711 $ 58,511 $ 146,384 $ 576,205 $ 1,120,811 RATE SENSITIVE LIABILITIES: Deposits: Non-interest bearing demand deposits $ - $
- $ -
56,910 834 1,667 118,356 177,767 Savings 512 512 1,024 93,885 95,933 Money market 56,252 5,177 10,354 136,560 208,343 Certificates of deposit of$100,000 or more 4,893 10,325 18,227 5,325 38,770 Other time deposits 115,850 19,427 42,005 125,956 303,238 Total deposits 234,417 36,275 73,277 616,544 960,513 Borrowings 28,981 4,110 8,324 59,159 100,574 Total rate sensitive liabilities$ 263,398 $ 40,385 $ 81,601 $ 675,703 $ 1,061,087 INTEREST SENSITIVITY GAP: Interval 76,313 18,126 64,783 (99,498) - Cumulative$ 76,313 $ 94,439 $ 159,222 $ 59,724 $ 59,724 Period GAP ratio 1.29X 1.45X 1.79X 0.85X Cumulative GAP ratio 1.29 1.31 1.41 1.06 Ratio of cumulative GAP to total assets 6.52% 8.06% 13.59% 5.10% WhenDecember 31, 2019 is compared toDecember 31, 2018 , the Company's cumulative GAP ratio through one year indicates that the Company's balance sheet is still asset sensitive and the level of asset sensitivity increased between years. We continue to see loan customer preference for fixed rate loans given the low overall level of interest rates. The increase in total deposits resulted in overnight borrowings decreasing which are immediately impacted by changes to national interest rates. We continue to have a relatively consistent level of term advances with the FHLB to help manage our interest rate risk position. It should be noted that the level of term advances increased by$6.9 million in 2019 for interest rate risk management purposes. Due to theU.S. Treasury Yield curve becoming inverted in certain segments at various times during the year, term advances had a lower interest rate cost than overnight borrowed funds. Management places primary emphasis on simulation modeling to manage and measure interest rate risk. The Company's asset/liability management policy seeks to limit net interest income variability over the first twelve months of the forecast period to -5.0% and -7.5%, which include interest rate movements of 100 and 200 basis points, respectively. Additionally, the Company also uses market value sensitivity measures to further evaluate the balance sheet exposure to changes in interest rates. The Company monitors the trends in market value of portfolio equity sensitivity analysis on a quarterly basis. 31
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The following table presents an analysis of the sensitivity inherent in the Company's net interest income and market value of portfolio equity. The interest rate scenarios in the table compare the Company's base forecast, which was prepared using a flat interest rate scenario, to scenarios that reflect immediate interest rate changes of 100 and 200 basis points. Note that we suspended the 200 basis point downward rate shock since it has little value due to the absolute low level of interest rates. Each rate scenario contains unique prepayment and repricing assumptions that are applied to the Company's existing balance sheet that was developed under the flat interest rate scenario. VARIABILITY OF CHANGE IN NET INTEREST MARKET VALUE OF INTEREST RATE SCENARIO INCOME PORTFOLIO EQUITY 200 bp increase 5.5% 26.6% 100 bp increase 3.3 16.1 100 bp decrease (4.1) (24.6) The Company believes that its overall interest rate risk position is well controlled. The variability of net interest income is positive in the upward rate shocks due to the Company's short duration investment securities portfolio, the scheduled repricing of loans tied to LIBOR or prime, and the reduction to overnight borrowed funds. Also, the Company will continue its disciplined approach to price its core deposit accounts in a controlled but competitive manner. The variability of net interest income is negative in the 100 basis point downward rate scenario as the Company has more exposure to assets repricing downward to a greater extent than liabilities due to the absolute low level of interest rates with the fed funds rate currently at a targeted range of 1.50% to 1.75%. The market value of portfolio equity increases in the upward rate shocks due to the improved value of the Company's core deposit base. Negative variability of market value of portfolio equity occurs in the downward rate shock due to a reduced value for core deposits. Within the investment portfolio atDecember 31, 2019 , 78.5% of the portfolio is classified as available for sale and 21.5% as held to maturity. The available for sale classification provides management with greater flexibility to manage the securities portfolio to better achieve overall balance sheet rate sensitivity goals and provide liquidity if needed. The mark to market of the available for sale securities does inject more volatility in the book value of equity, but has no impact on regulatory capital. There are 54 securities that are temporarily impaired atDecember 31, 2019 . The Company reviews its securities quarterly and has asserted that atDecember 31, 2019 , the impaired value of securities represents temporary declines due to movements in interest rates and the Company does have the ability and intent to hold those securities to maturity or to allow a market recovery. Furthermore, it is the Company's intent to manage its long-term interest rate risk by continuing to sell a portion of newly originated fixed-rate 30-year mortgage loans into the secondary market (excluding construction and any jumbo loans). The Company also sells 15-year fixed-rate mortgage loans into the secondary market as well, depending on market conditions. For the year 2019, 76% of all residential mortgage loan production was sold into the secondary market. The amount of loans outstanding by category as ofDecember 31, 2019 , which are due in (i) one year or less, (ii) more than one year through five years, and (iii) over five years, are shown in the following table. Loan balances are also categorized according to their sensitivity to changes in interest rates. 32
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TABLE OF CONTENTS MORE THAN ONE ONE YEAR YEAR OR THROUGH OVER FIVE TOTAL LESS FIVE YEARS YEARS LOANS (IN THOUSANDS, EXCEPT RATIOS) Commercial and industrial$ 40,194 $ 93,467 $ 40,261 $ 173,922 Commercial loans secured by owner occupied real estate 603 29,233 61,819 91,655
Commercial loans secured by non-owner occupied real estate
29,955 118,755 214,925 363,635 Real estate - residential mortgage 10,581 39,109 190,417 240,107 Consumer 6,712 4,488 7,055 18,255 Total$ 88,045 $ 285,052 $ 514,477 $ 887,574 Loans with fixed-rate$ 36,237 $ 189,670 $ 197,217 $ 423,124 Loans with floating-rate 51,808 95,382 317,260 464,450 Total$ 88,045 $ 285,052 $ 514,477 $ 887,574 Percent composition of maturity 9.9% 32.1% 58.0% 100.0% Fixed-rate loans as a percentage of total loans 47.7% Floating-rate loans as a percentage of total loans 52.3% The loan maturity information is based upon original loan terms and is not adjusted for principal paydowns and rollovers. In the ordinary course of business, loans maturing within one year may be renewed, in whole or in part, as to principal amount at interest rates prevailing at the date of renewal. OFF BALANCE SHEET ARRANGEMENTS. The Company incurs off-balance sheet risks in the normal course of business in order to meet the financing needs of its customers. These risks derive from commitments to extend credit and standby letters of credit. Such commitments and standby letters of credit involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated financial statements. The Company's exposure to credit loss in the event of nonperformance by the other party to these commitments to extend credit and standby letters of credit is represented by their contractual amounts. The Company uses the same credit and collateral policies in making commitments and conditional obligations as for all other lending. The Company had various outstanding commitments to extend credit approximating$195.5 million and standby letters of credit of$14.7 million as ofDecember 31, 2019 . The Company can also use various interest rate contracts, such as interest rate swaps, caps, floors and swaptions to help manage interest rate and market valuation risk exposure, which is incurred in normal recurrent banking activities. As ofDecember 31, 2019 , the Company had$63.3 million in the notional amount of interest rate swaps outstanding. As ofDecember 31, 2019 and 2018, municipal deposit letters of credit issued by theFederal Home Loan Bank of Pittsburgh on behalf ofAmeriServ Financial Bank naming applicable municipalities as beneficiaries totaled$41.5 million and$52.3 million , respectively. The letters of credit serve as collateral, in place of pledged securities, for municipal deposits maintained atAmeriServ Financial Bank . CRITICAL ACCOUNTING POLICIES AND ESTIMATES. The accounting and reporting policies of the Company are in accordance with Generally Accepted Accounting Principles (GAAP) and conform to general practices within the banking industry. Accounting and reporting policies for the pension liability, allowance for loan losses, goodwill, income taxes, and investment securities are deemed critical because they involve the use of estimates and require significant management judgments. Application of assumptions different than those used by the Company could result in material changes in the Company's financial position or results of operation. 33
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ACCOUNT - Pension liability BALANCE SHEET REFERENCE - Other liabilities INCOME STATEMENT REFERENCE - Salaries and employee benefits and Other expense DESCRIPTION Pension costs and liabilities are dependent on assumptions used in calculating such amounts. These assumptions include discount rates, benefits earned, interest costs, expected return on plan assets, mortality rates, and other factors. In accordance with GAAP, actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense and the recorded obligation of future periods. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect the Company's pension obligations and future expense. Our pension benefits are described further in Note 18 of the Notes to Consolidated Financial Statements. ACCOUNT - Allowance for loan losses BALANCE SHEET REFERENCE - Allowance for loan losses INCOME STATEMENT REFERENCE - Provision (credit) for loan losses DESCRIPTION The allowance for loan losses is calculated with the objective of maintaining reserve levels believed by management to be sufficient to absorb estimated probable credit losses. Management's determination of the adequacy of the allowance is based on periodic evaluations of the credit portfolio and other relevant factors. However, this quarterly evaluation is inherently subjective as it requires material estimates, including, among others, likelihood of customer default, loss given default, exposure at default, the amounts and timing of expected future cash flows on impaired loans, value of collateral, estimated losses on consumer loans and residential mortgages, and general amounts for historical loss experience. This process also considers economic conditions, uncertainties in estimating losses and inherent risks in the various credit portfolios. All of these factors may be susceptible to significant change. Also, the allocation of the allowance for credit losses to specific loan pools is based on historical loss trends and management's judgment concerning those trends. Commercial and commercial real estate loans are the largest category of credits and the most sensitive to changes in assumptions and judgments underlying the determination of the allowance for loan losses. Approximately$7.1 million , or 76%, of the total allowance for loan losses atDecember 31, 2019 has been allocated to these two loan categories. This allocation also considers other relevant factors such as actual versus estimated losses, economic trends, delinquencies, levels of non-performing and troubled debt restructured (TDR) loans, concentrations of credit, trends in loan volume, experience and depth of management, examination and audit results, effects of any changes in lending policies and trends in policy, financial information and documentation exceptions. To the extent actual outcomes differ from management estimates, additional provision for loan losses may be required that would adversely impact earnings in future periods. ACCOUNT -Goodwill BALANCE SHEET REFERENCE -Goodwill INCOME STATEMENT REFERENCE -Goodwill impairment DESCRIPTION The Company considers our accounting policies related to goodwill to be critical because the assumptions or judgment used in determining the fair value of assets and liabilities acquired in past acquisitions are subjective and complex. As a result, changes in these assumptions or judgment could have a significant impact on our financial condition or results of operations. The fair value of acquired assets and liabilities, including the resulting goodwill, was based either on quoted market prices or provided by other third party sources, when available. When third party information was not available, estimates were made in good faith by management primarily through the use of internal cash flow modeling techniques. The assumptions that were used in the cash flow modeling were subjective and are susceptible to significant changes. The Company routinely utilizes the services of an independent third party that is regarded within the banking industry as an expert in valuing core deposits to monitor the ongoing 34
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value and changes in the Company's core deposit base. These core deposit valuation updates are based upon specific data provided from statistical analysis of the Company's own deposit behavior to estimate the duration of these non-maturity deposits combined with market interest rates and other economic factors.Goodwill arising from business combinations represents the value attributable to unidentifiable intangible elements in the business acquired. The Company's goodwill relates to value inherent in the banking and wealth management businesses, and the value is dependent upon the Company's ability to provide quality, cost-effective services in the face of free competition from other market participants on a regional basis. This ability relies upon continuing investments in processing systems, the development of value-added service features and the ease of use of the Company's services. As such, goodwill value is supported ultimately by revenue that is driven by the volume of business transacted and the loyalty of the Company's deposit and customer base over a longer time frame. The quality and value of a Company's assets is also an important factor to consider when performing goodwill impairment testing. A decline in earnings as a result of a lack of growth or the inability to deliver cost-effective value added services over sustained periods can lead to the impairment of goodwill.Goodwill which has an indefinite useful life is tested for impairment at least annually and written down and charged to results of operations only in periods in which the recorded value is more than the estimated fair value. ACCOUNT - Income Taxes BALANCE SHEET REFERENCE - Net deferred tax asset INCOME STATEMENT REFERENCE - Provision for income taxes DESCRIPTION The provision for income taxes is the sum of income taxes both currently payable and deferred. The changes in deferred tax assets and liabilities are determined based upon the changes in differences between the basis of assets and liabilities for financial reporting purposes and the basis of assets and liabilities as measured by the enacted tax rates that management estimates will be in effect when the differences reverse. This income tax review is completed on a quarterly basis. In relation to recording the provision for income taxes, management must estimate the future tax rates applicable to the reversal of tax differences, make certain assumptions regarding whether tax differences are permanent or temporary and the related timing of the expected reversal. Also, estimates are made as to whether taxable operating income in future periods will be sufficient to fully recognize any gross deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. Alternatively, we may make estimates about the potential usage of deferred tax assets that decrease our valuation allowances. As ofDecember 31, 2019 , we believe that all of the deferred tax assets recorded on our balance sheet will ultimately be recovered and that no valuation allowances were needed. In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes will be due. If we ultimately determine that payment of these amounts is unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine that the liability is no longer necessary. We record an additional charge in our provision for taxes in the period in which we determine that the recorded tax liability is less than we expect the ultimate assessment to be. ACCOUNT -Investment Securities BALANCE SHEET REFERENCE - Investment securities INCOME STATEMENT REFERENCE - Net realized gains (losses) on investment securities DESCRIPTION Available-for-sale and held-to-maturity securities are reviewed quarterly for possible other-than-temporary impairment. The review includes an analysis of the facts and circumstances of each individual investment such as the severity of loss, the length of time the fair value has been below cost, the expectation for that security's performance, the creditworthiness of the issuer and the Company's intent and ability to 35
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hold the security to recovery. A decline in value that is considered to be other-than-temporary is recorded as a loss within non-interest income in the Consolidated Statements of Operations. AtDecember 31, 2019 , the unrealized losses in the available-for-sale security portfolio were comprised of securities issued by government agencies or government sponsored agencies and certain high quality corporate and taxable municipal securities. The Company believes the unrealized losses are primarily a result of increases in market yields from the time of purchase. In general, as market yields rise, the value of securities will decrease; as market yields fall, the fair value of securities will increase. Management generally views changes in fair value caused by changes in interest rates as temporary; therefore, these securities have not been classified as other-than-temporarily impaired. Management has also concluded that based on current information we expect to continue to receive scheduled interest payments as well as the entire principal balance. Furthermore, management does not intend to sell these securities and does not believe it will be required to sell these securities before they recover in value. FORWARD LOOKING STATEMENTS THE STRATEGIC FOCUS:AmeriServ Financial is committed to increasing shareholder value by striving for consistently improving financial performance; providing our customers with products and exceptional service for every step in their lifetime financial journey; cultivating an employee atmosphere rooted in trust, empowerment and growth; and serving our communities through employee involvement and a philanthropic spirit. We will strive to provide our shareholders with consistently improved financial performance; the products, services and know-how needed to forge lasting banking for life customer relationships; a work environment that challenges and rewards staff; and the manpower and financial resources needed to make a difference in the communities we serve. Our strategic initiatives will focus on these four key constituencies: • Shareholders - We strive to increase earnings per share; identifying and managing revenue growth and expense control and reduction; and managing risk. Our goal is to increase value for AmeriServ shareholders by growing earnings per share and narrowing the financial performance gap between AmeriServ and its peer banks. We try to return up to 75 percent of earnings to shareholders through a combination of dividends and share repurchases subject to maintaining sufficient capital to support balance sheet growth. We strive to educate our employee base as to the meaning/importance of earnings per share as a performance measure. We will develop a value added combination for increasing revenue and controlling expenses that is rooted in developing and offering high-quality financial products and services; an existing branch network; electronic banking capabilities with 24/7 convenience; and providing truly exceptional customer service. We will explore branch consolidation opportunities and further leverage union affiliated revenue streams, prudently manage the Company's risk profile to improve asset yields and increase profitability and continue to identify and implement technological opportunities and advancements to drive efficiency for the holding company and its affiliates.
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Customers - The Company expects to provide exceptional customer service, identifying opportunities to enhance the Banking for Life philosophy by providing products and services to meet the financial needs in every step through a customer's life cycle, and further defining the role technology plays in anticipating and satisfying customer needs. We anticipate providing leading banking systems and solutions to improve and enhance customers' Banking for Life experience. We will provide customers with a comprehensive offering of financial solutions including retail and business banking, home mortgages and wealth management at one location. We have upgraded and modernized select branches to be more inviting and technologically savvy to meet the needs of the next generation of AmeriServ customers without abandoning the needs of our existing demographic.
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Staff - We are committed to developing high-performing employees, establishing and maintaining a culture of trust and effectively and efficiently managing staff attrition. We will employ a work force succession plan to manage anticipated staff attrition while identifying and grooming high performing staff members to assume positions with greater responsibility within the organization. We will employ technological systems and solutions to provide staff with the tools they need to perform more efficiently and effectively. 36
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Communities - We will continue to promote and encourage employee community involvement and leadership while fostering a positive corporate image. This will be accomplished by demonstrating our commitment to the communities we serve through assistance in providing affordable housing programs for low-to-moderate-income families; donations to qualified charities; and the time and talent contributions of AmeriServ staff to a wide-range of charitable and civic organizations. This Form 10-K contains various forward-looking statements and includes assumptions concerning the Company's beliefs, plans, objectives, goals, expectations, anticipations, estimates, intentions, operations, future results, and prospects, including statements that include the words "may," "could," "should," "would," "believe," "expect," "anticipate," "estimate," "intend," "project," "plan" or similar expressions. These forward-looking statements are based upon current expectations, are subject to risk and uncertainties and are applicable only as of the dates of such statements. Forward-looking statements involve risks, uncertainties and assumptions. Although we do not make forward-looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy. You should not put undue reliance on any forward-looking statements. These statements speak only as of the date of this Form 10-K, even if subsequently made available on our website or otherwise, and we undertake no obligation to update or revise these statements to reflect events or circumstances occurring after the date of this Form 10-K. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary statement identifying important factors (some of which are beyond the Company's control) which could cause the actual results or events to differ materially from those set forth in or implied by the forward-looking statements and related assumptions. Such factors include the following: (i) the effect of changing regional and national economic conditions; (ii) the effects of trade, monetary and fiscal policies and laws, including interest rate policies of theFederal Reserve ; (iii) significant changes in interest rates and prepayment speeds; (iv) inflation, stock and bond market, and monetary fluctuations; (v) credit risks of commercial, real estate, consumer, and other lending activities; (vi) changes in federal and state banking and financial services laws and regulations; (vii) the presence in the Company's market area of competitors with greater financial resources than the Company; (viii) the timely development of competitive new products and services by the Company and the acceptance of those products and services by customers and regulators (when required); (ix) the willingness of customers to substitute competitors' products and services for those of the Company and vice versa; (x) changes in consumer spending and savings habits; (xi) unanticipated regulatory or judicial proceedings; and (xii) other external developments which could materially impact the Company's operational and financial performance. The foregoing list of important factors is not exclusive, and neither such list nor any forward-looking statement takes into account the impact that any future acquisition may have on the Company and on any such forward-looking statement. ITEM 7A.
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