AMERISERV FINANCIAL, INC. …..2021 SECOND QUARTER SUMMARY OVERVIEW…..AmeriServ reported second quarter 2021 net income of$1,708,000 , or$0.10 per diluted common share. This represents a 20.4%, or$289,000 , increase from the second quarter of 2020 when net income totaled$1,419,000 , or$0.08 per share. While the second quarter of 2021 trailed the first quarter of 2021 by$373,000 , it was stronger than any other quarter as far back as the second quarter of 2019 before the pandemic. It is our view that the 2021 second quarter represents another important step in the recovery from the pandemic based on the lockdown in 2020. Net interest income was at the highest level in more than two years with a record level of loans. Over$60 million of these loans were a part of theSmall Business Administration (SBA) Payroll Protection Program (PPP) which sought to stimulate the economic recovery process. Traditional loan products continued the increases that began late in 2020 and increased by$25 million or 2.8% during the second quarter of 2021. AmeriServ also continued to support borrowers who are disadvantaged by the slow economic recovery. TheFederal Reserve continues to encourage community banks, such as AmeriServ, to aid these victims of forces well beyond their control. Perhaps the most positive news for the second quarter is the continued growth of deposits. For the year 2020, deposits increased by over$94 million . But in just two quarters of 2021, the increase has totaled another$114 million . Admittedly, approximately$42 million of the total came from the acquisition of deposits from two branches inSomerset County . For the first time in the history of the franchise, deposits have exceeded$1 billion for five consecutive quarters. Thrifty western Pennsylvanians are building their reserve fund. In a tribute to its safety and soundness, AmeriServ continues to be their rainy day fund depository. AmeriServ has been at the forefront of residential mortgage loans. As families strive to protect their need for housing, AmeriServ is following up a record year in 2020, as 2021 will probably be the second strongest year ever. To add to our Banking for Life pledge, the AmeriServ Wealth Management group is laying the foundation for another record year. One of our most used services is Retirement Planning which includes our unique Pathroad investment products that many of our friends and neighbors utilize to enjoy a worry free retirement. This Board and this management team understand that these are unusual times throughout the nation. Many of our employees are continuing to work on a remote basis. The process of returning to normalcy is well underway within the limitations and restrictions governmental authorities set forth. It is these same employees who managed a seamless integration of twoSomerset County branch banks into AmeriServ. This acquisition strengthens our brand inSomerset County and along theMaryland border. We believe the recovery at AmeriServ is well demonstrated by our record so far in 2021. Earnings per share in the first two quarters of 2021 surpass the same two quarters in 2020 by 30%. Both loans and deposits are at historic record levels. Residential mortgage activity remains strong. The Wealth Management group is already more than 40% above its net contributions to the Corporation during the first six months of 2020, the strongest previous year on record. Challenges continue to exist, such as the age old challenge of balancing risk against reward, which is the very nature of the finance and commerce business. The ground rules of the pandemic continue to be a challenge. However, our goals 38 Table of Contents remain unchanged. It is to provide our markets with the very best in banking and wealth management services based on a safe and sound financial institution. We approach these challenges as just another test. We are also pleased that AmeriServ has maintained its quarterly common stock dividend and met all debt service requirements on our Trust Preferred shares and our subordinated debt issue.
THREE MONTHS ENDED
…..PERFORMANCE OVERVIEW…..The following table summarizes some of the Company's key performance indicators (in thousands, except per share and ratios).
Three months ended Three months ended
June 30, 2021 June 30, 2020
Net income $ 1,708 $ 1,419
Diluted earnings per share 0.10 0.08Return on average assets (annualized) 0.51 % 0.46 % Return on average equity (annualized) 6.46 %
5.63 %
The Company reported net income of$1,708,000 , or$0.10 per diluted common share. This earnings performance represented a$289,000 , or 20.4%, increase from the second quarter of 2020 when net income totaled$1,419,000 , or$0.08 per diluted common share. During the second quarter of 2021, the Company continued to achieve record levels of both loans and deposits. Excluding PPP loan activity, growth in both commercial real estate loans and residential mortgage loans caused our total loan portfolio to increase by$25 million , or 2.8%, during the second quarter of 2021. Our second quarter also included the successful completion of ourSomerset County branch acquisition which providedAmeriServ Financial with approximately$42 million of additional deposits. The Company will be able to utilize$33 million of these deposits to replace higher cost institutional deposits that mature during the third quarter of 2021, which will result in a meaningful reduction in our future interest expense. Additionally, the diversification of our revenue streams continues to be a strength for our Company as 31% of our second quarter revenue came from non-interest income sources, which included record contributions from our strong wealth management businesses. As a result of this good earnings momentum and our diligent and continuing focus on asset quality, the Company is well positioned for the second half of 2021. …..NET INTEREST INCOME AND MARGIN…..The Company's net interest income represents the amount by which interest income on earning assets exceeds interest paid on interest bearing liabilities. Net interest income is a primary source of the Company's earnings, and it is affected by interest rate fluctuations as well as changes in the amount and mix of earning assets and interest bearing liabilities. The following table compares the Company's net interest income performance for the second quarter of 2021 to the second quarter of 2020 (in thousands, except percentages): Three Three months ended months ended June 30, 2021 June 30, 2020 Change % Change Interest income$ 11,838 $ 12,061 $ (223) (1.8) % Interest expense 1,971 2,588 (617) (23.8) Net interest income$ 9,867 $ 9,473 $ 394 4.2 Net interest margin 3.13 % 3.30 % (0.17) % N/M N/M - not meaningful The Company's net interest income in the second quarter of 2021 increased by$394,000 , or 4.2%, from the prior year's second quarter while the net interest margin of 3.13% was 17 basis points lower than the net interest margin of 3.30% for the second quarter of 2020. The second quarter of 2021 results were indicative of the Company's effective execution of strategies as a solid economic recovery is underway in our core markets and we work to meet the challenges of the current low interest rate environment. The economy continued to demonstrate improvement during the second quarter as the COVID-19 vaccine was more widely distributed and some businesses began to operate at full capacity while consumers also experienced more normalcy as social restrictions dissipated. The Company continued to experience robust balance sheet growth as both total loans and total deposits reached new record levels due to business 39 Table of Contents development efforts and the impact from the government stimulus programs. Total deposit volumes were also positively impacted from the previously disclosedSomerset County branch acquisition which the Company successfully completed onMay 21, 2021 . Net interest income improved as fee income from existing PPP loan forgiveness and new fee income from the most recently completed second round of this program, that was implemented earlier in 2021, more than offset net interest margin pressure from the low interest rate environment. Also, the growth experienced in our commercial real estate portfolio resulted in traditional loan fee income increasing by$244,000 for the second quarter of 2021 when compared to the same time period from last year. The low interest rate environment is positively impacting deposit and borrowings interest expense cost. As a result, total interest expense decreased significantly more than the decrease in total interest income, resulting in net interest income increasing for the second quarter of 2021, compared to last year. Overall, the increase to net interest income, a higher level of non-interest income, and a reduced loan loss provision more than offset a higher level of non-interest expense resulting in an improved earnings performance for the second quarter of 2021. The average balance of total interest earning assets for the second quarter of 2021 continued to grow and is now$114 million , or 10.0%, higher than the second quarter of 2020. Likewise, on the liability side of the balance sheet, total average deposits for the second quarter increased by$129 million , or 12.5%, since last year. As stated previously, total loans reached a new record level and averaged$991.5 million in the second quarter of 2021 which is$79.0 million , or 8.7%, higher than the$912.5 million average for the second quarter of 2020. The solid economic recovery was evident in our lending activity as we continued to experience commercial loan growth during the second quarter of 2021. Commercial loan pipelines had returned to pre-COVID levels earlier this year and remained at that level through the end of this reporting period. Strong residential mortgage loan production also continued through the second quarter of 2021. The Company revised strategy in 2021 and retained a higher percentage of our residential mortgage loan production in the loan portfolio as opposed to selling into the secondary market. In the second quarter of 2021, the Company retained approximately 91% of total residential mortgage loan production in the loan portfolio. This compares to a retention of approximately 32% in the second quarter of 2020. This strategic change allowed us to more profitably deploy a portion of the increased liquidity that we have on our balance sheet that resulted from the significant influx of deposits. Additionally, loan volumes were positively impacted by the previously mentioned second round of the 100% guaranteed PPP loans. Overall, the combination of growth in traditional loan products and our participation in the latest round of the PPP resulted in total loans reaching a record level. The Company remains committed to prudently working with and supporting our borrowers that have been hardest hit by the pandemic by granting them loan payment modifications. All of these borrowers are those that have requested more than one payment deferral plan. Borrower requested modifications primarily consist of the deferral of principal and/or interest payments for a period of three to six months. OnJune 30, 2021 , loans totaling approximately$26.7 million , or 2.7% of total loans, were on a payment modification plan. These loans include 11 commercial borrowers primarily in the hospitality industry. This current level of borrowers requesting payment deferrals is down sharply from its peak level of approximately$200 million as ofJune 30, 2020 . Management continues to carefully monitor asset quality with a particular focus on these customers that have requested payment deferrals. Deferral extension requests are considered based upon the customer's needs and their impacted industry, borrower and guarantor capacity to service debt and issued regulatory guidance. Total investment securities averaged$212.3 million for the second quarter of 2021, which is$25.0 million , or 13.4%, higher than the$187.3 million average for the second quarter of 2020. The Company continues to be selective when purchasing securities due to the low interest rate environment. However, the yield curve began to steepen during the latter part of the first quarter and held this position through the end of May as the long end of theU.S. Treasury yield curve increased while the short end of the curve remained relatively stable. This resulted in improved yields for federal agency mortgage-backed securities and federal agency bonds, and management decided to add more of these investments to our portfolio. Similar to our change in strategy to retain more residential mortgage loan production in our loan portfolio, the steeper yield curve provided the opportunity to more profitably deploy a portion of the increased liquidity on our balance sheet into the securities portfolio as opposed to leaving these funds in low yielding federal funds sold. This redeployment of funds also resulted in securities growing between years. The Company also continued to purchase corporate securities, particularly subordinated debt issued by other financial institutions, along with taxable municipal securities. 40 Table of Contents Similar to what is occurring across the financial services industry, our liquidity position continues to be very strong due to the significant influx of deposits. The challenges this increased liquidity presents are twofold. First, there is uncertainty regarding the duration that these increased funds will remain on the balance sheet which will be determined by customer behavior as the economic conditions change. The second challenge is to profitably deploy this increased liquidity given the current low yields on short-term investment products. As a result, short-term investment balances averaged$50.4 million in the second quarter of 2021, which remains high by historical standards. Therefore, future loan growth and continued prudent investment in securities are critical to achieve the best return on the excess funds. Overall, total interest income on both loans and investments decreased by$223,000 , or 1.8%, between years despite increased volume. Total interest expense for the second quarter of 2021 decreased by$617,000 , or 23.8%, when compared to the second quarter of 2020, due to lower levels of both deposit and borrowing interest expense. Deposit interest expense was lower by$563,000 , or 30.1%, despite the previously mentioned record increase in deposits that occurred reflecting new deposit inflows as well as the loyalty of the bank's core deposit base. Management continued to effectively execute several deposit product pricing reductions in order to address the net interest margin challenges presented by the low interest rate environment. As a result, the Company experienced deposit cost relief. Specifically, our total deposit cost averaged 0.45% in the second quarter of 2021 compared to 0.73% in the second quarter of 2020, representing a meaningful decrease of 28 basis points. Management expects to utilize$33 million of the additional deposits from theSomerset County branch acquisition to replace institutional funds that have an interest cost of 2.95% later during the third quarter of 2021, which will result in further deposit interest cost savings. Overall, the Company's loan to deposit ratio averaged 85.1% in the second quarter of 2021, which we believe indicates that the Company has ample capacity to continue to grow its loan portfolio and is strongly positioned to provide the necessary assistance to our customers and our community as they recover from the COVID-19 pandemic and respond to an improving economy. The Company experienced a$54,000 , or 7.5%, decrease in the interest cost of borrowings in the second quarter of 2021 when compared to the second quarter of 2020. The current strong liquidity position has allowed the Company to paydownFederal Home Loan Bank (FHLB) advances, which typically cost more than similar term deposit products. On an end of period basis, atJune 30, 2021 , total FHLB advances were$48.1 million , which is$14.2 million , or 22.8%, lower than theJune 30, 2020 level. The table that follows provides an analysis of net interest income on a tax-equivalent basis (non-GAAP) for the three month periods endedJune 30, 2021 and 2020 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) the Company's 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) the Company's net interest margin (net interest income as a percentage of average total interest earning assets). For purposes of this table, 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). The tax equivalent adjustments to interest income on loans and municipal securities for the three months endedJune 30, 2021 and 2020 was$5,000 and$6,000 , 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. 41 Table of Contents
Three months ended
2021 2020
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
Interest earning assets:
Loans and loans held for sale,
net of unearned income $ 991,527 $ 10,288 4.12 % $ 912,541 $ 10,454 4.55 %
Short-term investments and bank
deposits 50,357 11 0.09 40,446 99 0.97
Investment securities - AFS 162,282 1,171 2.89 145,579 1,159 3.20
Investment securities - HTM 50,050 373 2.98 41,709 355 3.35
Total investment securities 212,332 1,544 2.91 187,288 1,514 3.24
Total interest earning
assets/interest income 1,254,216 11,843 3.77 1,140,275 12,067 4.22
Non-interest earning assets:
Cash and due from banks 17,770 17,586
Premises and equipment 17,805 18,545
Other assets 75,267 70,657
Allowance for loan losses (11,876) (9,373)
TOTAL ASSETS $ 1,353,182 $ 1,237,690
Interest bearing liabilities:
Interest bearing deposits:
Interest bearing demand $ 213,968 $ 59 0.11 % $172,786$ 118 0.29 % Savings 125,545 43 0.14 102,505 34 0.13 Money markets 269,814 170 0.25 230,863 212 0.37 Time deposits 339,331 1,034 1.22 346,314 1,505 1.75 Total interest bearing deposits 948,658 1,306 0.55 852,468 1,869 0.88 Short-term borrowings - - - 4,245 4 0.34 Advances from Federal Home Loan Bank 50,469 227 1.83 59,786 276 1.86 Guaranteed junior subordinated deferrable interest debentures 13,085 281 8.57
13,085 281 8.57 Subordinated debt 7,650 130 6.80 7,650 130 6.80 Lease liabilities 3,766 27 2.85 3,977 28 2.84 Total interest bearing
liabilities/interest expense 1,023,628 1,971 0.77
941,211 2,588 1.10 Non-interest bearing liabilities: Demand deposits 216,223 183,352 Other liabilities 7,322 11,791 Shareholders' equity 106,009 101,336 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY$ 1,353,182 $ 1,237,690 Interest rate spread 3.00 3.12 Net interest income/ Net interest margin (non-GAAP) 9,872 3.13 % 9,479 3.30 % Tax-equivalent adjustment (5) (6) Net Interest Income (GAAP)$ 9,867 $ 9,473 …..PROVISION FOR LOAN LOSSES…..The Company recorded a$100,000 provision expense for loan losses in the second quarter of 2021 as compared to a$450,000 provision expense in the second quarter of 2020. The 2021 provision reflects an improved credit quality outlook for the overall portfolio as both classified and criticized asset levels as well as non-accrual loan balances have demonstrated improvement during the second quarter. This is a reflection of the Company's loan officers working effectively with our customers as the economy improves and as businesses begin to open to full capacity. The Company, however, continues to believe that a strong allowance for loan losses is needed 42
Table of Contents
until certain borrowers have fully recovered from the COVID-19 pandemic. Overall, non-performing assets remain well controlled and totaled$3.7 million , or 0.38% of total loans, atJune 30, 2021 compared to$3.3 million , or 0.34% of total loans, atDecember 31, 2020 . The Company experienced net loan recoveries of$21,000 , or 0.01% of total loans, in the second quarter of 2021 which compares favorably to net loan charge-offs of$85,000 , or 0.04% of total loans, in the second quarter of 2020. Since the end of the second quarter of 2020, the balance of the allowance for loan losses increased by$2.1 million , or 21.2%, to$11.8 million atJune 30, 2021 . Management continues to carefully monitor asset quality with a particular focus on loan customers that have requested an additional payment deferral.The Asset Quality Task Force is meeting at least monthly to review these particular relationships, receiving input from the business lenders regarding their ongoing discussions with the borrowers. In summary, the allowance for loan losses provided 315% coverage of non-performing assets, and 1.18% of total loans, atJune 30, 2021 , compared to 341% coverage of non-performing assets, and 1.16% of total loans, atDecember 31, 2020 . The reserve coverage of total loans, excluding PPP loans, was 1.24% (non-GAAP) atJune 30, 2021 .The Small Business Administration guarantees 100% of the PPP loans made to eligible borrowers which minimizes the level of credit risk associated with these loans. See the reconciliation of the non-GAAP measure of the reserve coverage of total loans, excluding PPP loans, within the Allowance for Loan Losses Section of the MD&A.
…..NON-INTEREST INCOME….. Non-interest income for the second quarter of 2021
totaled
a
management group has performed exceptionally well through the pandemic,
actively working with clients to increase the value of their holdings in the
? financial markets and adding new business. The fair market value of wealth
management assets has increased for the fifth consecutive quarter and is now in
excess of
low point at
a
? Company's revised strategy to retain a higher percentage of our residential
mortgage loan production in the loan portfolio as opposed to selling into the
secondary market; a$142,000 , or 29.1%, increase in other income primarily due to higher
interchange fee income that resulted from increased usage of debit cards as the
pandemic caused consumers to increase online purchases and many businesses to
? implement contactless services by not accepting cash due to health safety
concerns. Another indication that consumers are becoming more active and
increasing their spending habits is service charges on deposit accounts
comparing favoraby by
? the Company recognized an
compared to last year when no securities were sold; and
a
? of a financial floor taking hold which caused increased earnings and a higher
rate of return on certain policies.
…..NON-INTEREST EXPENSE….. Non-interest expense for the second quarter of 2021
totaled
a
? recognition of an
defined benefit pension plan, which is described in Note 18, Pension Benefits;
a
Factors causing the increase included greater incentive compensation primarily
? due to commissions earned as a result of the strong residential mortgage loan
production and incentives earned from the good performance in the wealth
management
43
Table of Contents
division. Also contributing to the higher salaries and employee benefits expense
was increased health care costs and the normal annual employee merit salary
increases;
a
? majority of the personal protective equipment to protect our employees and
customers during the pandemic was purchased last year;
a
? level of outside professional services related costs and increased fees due to
the PPP lending activity; and
? a
increase in the asset assessment base.
…..INCOME TAX EXPENSE…..The Company recorded an income tax expense of$420,000 , or an effective tax rate of 19.7%, in the second quarter of 2021. This compares to an income tax expense of$365,000 , or an effective tax rate of 20.5%, for the second quarter of 2020. The lower effective tax rate in 2021 is primarily due to an increase in tax-free bank owned life insurance income.
SIX MONTHS ENDED
…..PERFORMANCE OVERVIEW…..The following table summarizes some of the Company's key performance indicators (in thousands, except per share and ratios).
Six months ended Six months ended
June 30, 2021 June 30, 2020
Net income $ 3,789 $ 2,828
Diluted earnings per share 0.22 0.17
Return on average assets 0.58 % 0.47 %
Return on average equity 7.24 5.66
For the six-month period ended June 30, 2021 , the Company reported net income of
$3,789,000 , or $0.22 per diluted common share. This earnings performance was a
$961,000 improvement from the six-month period of 2020 when net income totaled
$2,828,000 , or $0.17 per diluted common share. The earnings per share
performance for the six-month period of 2021 increased 29.4% when compared to
the six-month period of 2020. Overall, increased net interest income, a higher
level of non-interest income, and a reduced loan loss provision more than offset
a higher level of non-interest expense resulting in an improved earnings
performance for the first six months of 2021.
…..NET INTEREST INCOME AND MARGIN….. The following table compares the Company's
net interest income performance for the first six months of 2021 to the first
six months of 2020 (in thousands, except percentages):
Six months ended Six months ended
June 30, 2021 June 30, 2020 Change % Change
Interest income $ 23,607 $ 24,005 $ (398) (1.7) %
Interest expense 4,048 5,781 (1,733) (30.0)
Net interest income $ 19,559 $ 18,224 $ 1,335 7.3
Net interest margin 3.18 % 3.26 % (0.08) % N/M
N/M - not meaningful
The Company's net interest income in the first six months of 2021 increased by$1.3 million , or 7.3%, when compared to the first six months of 2020. The Company's net interest margin of 3.18% for the first half of 2021 declined by eight basis points from the prior year's first six-month time period. Total average earning assets increased in the first half of 2021 by$117.9 million , or 10.6%, due to growth in total loans, short term investments and investment securities. Both non-interest and interest bearing deposits increased resulting in less reliance on higher cost borrowed funds. 44
Table of Contents
Overall, total interest expense decreased significantly more than the decrease in total interest income, resulting in net interest income increasing for the year-to-date time period of 2021, compared to last year. Total loans averaged$986.7 million in the first half of 2021 which was$91.9 million , or 10.3%, higher than the 2020 first six-month average. As previously mentioned, the solid economic recovery was evident in our lending activity as we continued to experience commercial loan growth throughout the first six months of 2021. Strong residential mortgage loan production also continued through the first half of 2021. Residential mortgage loan production totaled$57.7 million in the first six months of 2021 and improved by 4.3% from the production level of$55.3 million achieved in the first half of 2020. The Company revised strategy in 2021 and retained a higher percentage of our residential mortgage loan production in the loan portfolio as opposed to selling into the secondary market. In the first half of 2021, the Company retained approximately 71% of total residential mortgage loan production in the loan portfolio. This compares to a retention of approximately 26% in the first half of 2020. This strategic change allowed us to more profitably deploy a portion of the increased liquidity that we have on our balance sheet. Additionally, loan volumes were positively impacted by the second round of PPP loans, which was announced in lateDecember 2020 as part of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act and implemented during the middle ofJanuary 2021 . The Company processed 264 PPP loans totaling$32.3 million from the second round of this program which ended inMay 2021 . Also, the Company recorded a total of$1.7 million of processing fee income and interest income from PPP lending activity through six months of 2021, which is$637,000 higher than the 2020 level. The combination of growth in traditional loan products and our participation in the latest round of the PPP resulted in total loans reaching a record level. This growth resulted in traditional loan fee income increasing by$180,000 , or 39.4%, for the first six months of 2021 when compared to the same time period from last year. Finally, on an end of period basis, excluding total PPP loans, the total loan portfolio grew by approximately$83.4 million , or 9.7%. since the end of the second quarter of 2020. Total investment securities averaged$201.4 million for the first six months of 2021, which is$14.9 million , or 8.0%, higher than the$186.5 million average for the first six months from last year. The Company continues to be selective in 2021 when purchasing securities due to the low interest rate environment. However, the yield curve began to steepen during the latter part of the first quarter and held this position through the end of May as the long end of theU.S. Treasury yield curve increased while the short end of the curve remained relatively stable. This resulted in improved yields for federal agency mortgage-backed securities and federal agency bonds, and management decided to add more of these investments to our portfolio. Similar to the result of our change in strategy to retain more residential mortgage loan production in our loan portfolio, the steeper yield curve provided the opportunity to more profitably deploy a portion of the increased liquidity on our balance sheet into the securities portfolio as opposed to leaving these funds in low yielding federal funds sold. This redeployment of funds also resulted in securities growing between years. The Company continued to purchase corporate securities, particularly subordinated debt issued by other financial institutions, along with taxable municipal securities. During the first quarter of 2021, the President signed into law another round of economic stimulus as part of the American Rescue Plan Act of 2021. The stimulus checks delivered to most Americans and the financial assistance provided to municipalities and school districts as part of this program contributed to total deposits increasing significantly and, similar to the loan portfolio, reaching a record level. Our deposit balances were also positively impacted in the second quarter of 2021 by theSomerset County branch acquitision, which provided approximately$42 million of additional deposits. As a result of this robust deposit growth, the Company's liquidity position has been increasing and is exceptionally strong. Therefore, the challenge exists to profitably deploy this increased liquidity given the current low yields on short-term investment products. The significant influx of deposits onto the balance sheet resulted in short-term investment balances averaging$40.6 million for the first six months of 2021, which remains high by historical standards. Management expects to utilize$33 million of this short-term liquidity during the third quarter of 2021 to repay maturing institutional deposits that have an interest cost of 2.95% which is expected to result in a meaningful reduction in our future interest expense. Overall, for the first half of 2021, total interest income on both loans and investments decreased by$398,000 , or 1.7%, between years despite the increased volumes. Total interest expense for the first six months of 2021 decreased by$1.7 million , or 30.0%, when compared to 2020, due to lower levels of both deposit and borrowing interest expense. Through six months, deposit interest expense in 2021 is lower by$1.6 million , or 37.4%, despite the previously mentioned increase in the level of deposits. The deposit growth reflects new deposit inflows as well as the loyalty of the bank's core deposit base. Management
continued to
45
Table of Contents
effectively execute several deposit product pricing reductions to address the
net interest margin challenges presented by the low interest rate environment.
As a result, the Company experienced deposit cost relief. Specifically, our
total deposit cost averaged 0.48% in the first half of 2021 compared to 0.86% in
the first half of 2020, representing a meaningful decrease of 38 basis points.
As previously mentioned, the Company is planning to use a significant portion of
the additional deposits from the branch acquisition to replace higher cost funds
later during the third quarter of 2021, which will result in further deposit
interest cost savings. Total borrowings interest expense in 2021 is lower by
$114,000 , or 7.8%, compared to the same time frame in 2020. The current strong
liquidity position has allowed the Company to paydown Federal Home Loan Bank
(FHLB) advances, which typically cost more than similar term deposit products.
In the first half of 2021, total average short-term borrowings and advances from
FHLB were $55.3 million , a decrease of $5.8 million , or 9.5%, from the same
period during 2020.
The table that follows provides an analysis of net interest income on a
tax-equivalent basis (non-GAAP) for the six month periods ended June 30, 2021
and 2020. For a detailed discussion of the components and assumptions included
in the table, see the paragraph before the quarterly table on page 41. The tax
equivalent adjustments to interest income on loans and municipal securities for
the six months ended June 30, 2021 and 2020 was $10,000 and $13,000 ,
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.
46
Table of Contents
Six months ended
2021 2020
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
Interest earning assets:
Loans and loans held for sale,
net of unearned income $ 986,702 $ 20,620 4.17 % $ 894,819 $ 20,793 4.62 %
Short-term investments and bank
deposits 40,605 19 0.09 29,486 175 1.17
Investment securities - AFS 154,100 2,259 2.93 145,071 2,342 3.23
Investment securities - HTM 47,289 719 3.04 41,467 708 3.41
Total investment securities 201,389 2,978 2.96 186,538 3,050 3.27
Total interest earning
assets/interest income 1,228,696 23,617 3.85 1,110,843 24,018 4.31
Non-interest earning assets:
Cash and due from banks 17,921 18,337
Premises and equipment 17,894 18,569
Other assets 72,763 69,447
Allowance for loan losses (11,729) (9,345)
TOTAL ASSETS $ 1,325,545 $ 1,207,851
Interest bearing liabilities:
Interest bearing deposits:
Interest bearing demand $ 204,970 $ 119 0.12 % $169,926$ 360 0.43 % Savings 120,588 81 0.14 99,836 75 0.15 Money markets 263,548 342 0.26 230,350 676 0.59 Time deposits 339,275 2,166 1.29 344,131 3,216 1.88 Total interest bearing deposits 928,381 2,708 0.59 844,243 4,327 1.03 Short-term borrowings 590 1 0.12 3,576 16 0.88 Advances from Federal Home Loan Bank 54,709 464 1.71 57,539 560 1.98 Guaranteed junior subordinated deferrable interest debentures 13,085 561 8.57
13,085 561 8.57 Subordinated debt 7,650 260 6.80 7,650 260 6.80 Lease liabilities 3,803 54 2.84 3,985 57 2.85 Total interest bearing
liabilities/interest expense 1,008,218 4,048 0.81
930,078 5,781 1.25 Non-interest bearing liabilities: Demand deposits 205,764 165,096 Other liabilities 6,093 12,203 Shareholders' equity 105,470 100,474 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY$ 1,325,545 $ 1,207,851 Interest rate spread 3.04 3.06 Net interest income/ Net interest margin (non-GAAP) 19,569 3.18 % 18,237 3.26 % Tax-equivalent adjustment (10) (13) Net Interest Income (GAAP)$ 19,559 $ 18,224 …..PROVISION FOR LOAN LOSSES…..For the first six months of 2021, the Company recorded a$500,000 provision expense for loan losses compared to a$625,000 provision expense recorded in the first six months of 2020. The 2021 provision reflects an improved credit quality outlook for the overall portfolio as both classified and criticized asset levels as well as non-accrual loan balances have demonstrated improvement. The Company experienced low net loan charge-offs of$93,000 , or 0.02% of total loans, in the first half of 2021 which compare favorably to net loan charge-offs of$205,000 , or 0.05% of total loans, for the first half of 2020. Since the end of the second quarter of 2020, 47
Table of Contents
the balance of the allowance for loan losses increased by
…..NON-INTEREST INCOME….. Non-interest income for the first six months of 2021 totaled$9.0 million and increased by$1.4 million , or 18.6%, from the first six months of 2020 performance. Factors contributing to the higher level of non-interest income for the six-month period included:
an
? management group has performed exceptionally well through the pandemic,
actively working with clients to increase the value of their holdings in the
financial markets and adding new business;
a
? receipt of a
being positively impacted by a financial floor taking hold which caused increased earnings and a higher rate of return on certain policies; a$222,000 , or 22.4%, increase in other income primarily due to higher
interchange fee income that resulted from increased usage of debit cards as the
? pandemic caused consumers to increase online purchases and many businesses to
implement contactless services by not accepting cash due to health safety
concerns; and
? the Company recognized an
compared to last year when no securities were sold.
…..NON-INTEREST EXPENSE….. Non-interest expense for the first six months of 2021
totaled
an
recognition of an
defined benefit pension plan, which is described in Note 18, Pension Benefits.
? Other items that contributed to the higher level of other expense were costs
for the branch acquisition which totaled
2021 and the Company recognizing$56,000 of expense associated with the unfunded commitment reserve so far in 2021 which represents a$223,000 unfavorable shift from the credit balance of$167,000 in 2020;
a
several factors. Factors causing the increase included greater incentive
compensation primarily due to commissions earned as a result of the strong
? residential mortgage loan production and incentives earned from the good
performance in the wealth management division. Also contributing to the higher
salaries and employee benefits expense was increased health care costs and
employee merit salary increases;
a
? level of outside professional services related costs and increased fees due to
the PPP lending activity;
an
? increase in the asset assessment base and the benefit of the
Assessment Credit being fully utilized in the first quarter of 2020; and
a
? majority of the personal protective equipment to protect our employees and
customers during the pandemic was purchased last year.
…..INCOME TAX EXPENSE…..The Company recorded an income tax expense of
48
Table of Contents
…..SEGMENT RESULTS.…..The community banking segment reported a net income contribution of$2,938,000 in the second quarter of 2021 and$6,258,000 for the six months of 2021 which was higher by$183,000 from the second quarter of last year and by$979,000 from the net income contribution for the six months of 2020. The improvement between years in both time periods is due to a higher level of total revenue and a reduced loan loss provision which more than offset an increased level of non-interest expense. Net interest income improved between years as the reduction to total interest expense more than offset the reduction to total interest income. The unfavorable impact that the lower interest rate environment had on the Company's net interest margin performance more than offset the favorable impact of commercial real estate loan growth which correspondingly resulted in loan charge income increasing in both time periods. Also, loan growth was favorably impacted by the Company retaining more residential mortgage loans in the portfolio as opposed to selling in the secondary market. This growth more than offset payoff activity and maturities in the commercial & industrial loan portfolio. Additionally, PPP processing fee income and interest income totaled$765,000 for the quarter and$1,662,000 for the six months, which was lower by$260,000 for the quarter but higher by$637,000 for the six months. Overall, total loan interest income decreased by$165,000 for the quarter and by$170,000 for the six month time period. Favorably impacting net interest income was this segment experiencing deposit cost relief as total deposit interest expense decreased in both time periods between years due to management's action to lower pricing of several deposit products, given the low interest rate environment. The decrease to total deposit interest expense occurred even though total deposits reached another record level which is described previously in the MD&A. The Company recorded a$100,000 provision expense for loan losses for the second quarter of 2021 compared to a$450,000 provision in the second quarter of 2020 and a$500,000 provision expense for the first six months of 2021 compared to a$625,000 provision expense in 2020. This was discussed previously in the Provision for Loan Losses sections within this document. The continued strong level of residential mortgage loan activity in 2021 resulted in this segment recognizing a higher gain on the sale of residential mortgage loans in the secondary market in the first six months of 2021. Non-interest income was also favorably impacted by a higher level of other income for the six months due to higher levels of interchange income and revenue from bank owned life insurance (BOLI). Note that non-interest income was stable for the quarterly comparison between 2021 and 2020 due to the Company electing to retain the majority of residential mortgage loans production in the loan portfolio, as mentioned previously, thereby resulting in a decrease to loan sale gains. Non-interest expense compares unfavorably for both the quarterly comparison and the six months due to the Company recognizing a settlement charge on its defined benefit pension plan, which was discussed in the MD&A. The other significant increase to non-interest expense between years for both time periods was additional expense recognized for theSomerset County branch acquisition. Finally, non-interest expense was unfavorably impacted by higher professional fees,FDIC insurance expense and occupancy costs. The wealth management segment's net income contribution was$734,000 in the second quarter and$1,396,000 for the first six months of 2021 which was$258,000 higher than the second quarter of 2020 and$433,000 higher for the six-month time period. The increase is due to wealth management fees increasing as the entire wealth management group has performed exceptionally well through the pandemic, actively working with clients to increase the value of their holdings in the financial markets and adding new business. Slightly offsetting this favorable performance were higher levels of professional fees and incentive compensation. Overall, the fair market value of trust assets under administration totaled$2.615 billion atJune 30, 2021 , an improvement from the early pandemic fair market value low point atMarch 31, 2020 , exceeding by 31.8%. The investment/parent segment reported a net loss of$1,964,000 in the second quarter of 2021 which is a greater loss by$152,000 than the second quarter of 2020 and a net loss of$3,865,000 in the first six months of 2021 which is a greater loss by$451,000 . The increased loss in both time periods was due to short-term investments interest income decreasing by a higher amount than the decrease to total short-term FHLB borrowings interest expense as well as interest cost from FHLB term advances. The decrease to short-term investments interest income occurred even though the balance of short-term investments increased as the Company experienced exceptionally strong growth in its liquidity position between years from the significant influx of deposits that resulted from the government stimulus programs and branch acquisition. Sightly offsetting the lower level of short-term investments interest income was an increase in interest income from the securities portfolio due to a higher volume of securities. As a result of the increased level of liquidity on the Company's balance sheet, management elected to more profitably deploy these funds into the securities portfolio as opposed to leaving them in low yielding federal funds sold. Finally, and also favorably impacting this segment was the recognition of an$84,000 security sale gain in 2021 after no gain was recognized last year. 49 Table of Contents …..BALANCE SHEET…..The Company's total consolidated assets were$1.4 billion atJune 30, 2021 , which increased by$80.9 million , or 6.3%, from theDecember 31, 2020 asset level. This change was related, primarily, to increased levels of cash and cash equivalents, investment securities, and loans. Specifically, cash and cash equivalents increased$28.7 million , or 91.2%, as the Company experienced a significant influx of deposits resulting from the government stimulus programs and financial assistance provided to municipalities and school districts. Our liquidity position was also positively impacted by theSomerset County branch acquisition completed inMay 2021 , which provided approximately$42 million of additional deposits. Total investment securities increased$31.0 million , or 16.5%, as the steepening of theU.S. Treasury yield curve in the latter part of the first quarter improved the yield for federal agency mortgage-backed securities and federal agency bonds, making these types of securities more attractive for purchase. The Company also continued to purchase corporate securities, particularly subordinated debt issued by other financial institutions, along with taxable municipal securities. In addition, loans, net of unearned fees, and loans held for sale increased by$14.5 million , or 1.5%, as a result of the Company's participation in the PPP and higher levels of commercial real estate and residential mortgage loan production. Finally, other assets increased$8.2 million , or 80.6%, as a result of a reclassification of the accrued pension liability, which had a positive balance of$11.4 million as ofJune 30, 2021 , from other liabilities to other assets. The balance of the accrued pension liability became a positive value as a result of the$4.0 million contribution made earlier in 2021 and the revaluation of the obligation due to the settlement charge during the second quarter of 2021. Total deposits increased by$113.8 million , or 10.8%, in the first six months of 2021. As previously mentioned, this robust growth is the result of the government stimulus programs and theSomerset County branch acquisition. As ofJune 30, 2021 , the 25 largest depositors represented 21.2% of total deposits, which remained relatively unchanged fromDecember 31, 2020 when it was 21.1%. Total borrowings have decreased by$41.7 million , or 36.5%, since year-end 2020. The decrease was driven, primarily, by a lower level of both short-term borrowings and FHLB term advances. Specifically, atJune 30, 2021 , the Company had no short-term borrowings outstanding as compared to$24.7 million atDecember 31, 2020 . In addition, FHLB term advances decreased by$16.8 million , or 25.9%, and totaled$48.1 million atJune 30, 2021 . The current strong liquidity position has allowed the Company to paydown FHLB advances. However, the Company continues to utilize the FHLB term advances to help manage interest rate risk. The Company's total shareholders' equity increased by$6.9 million , or 6.6%, over the first six months of 2021 due to the retention of earnings more than offsetting our common stock dividend payments to shareholders. Additionally, the recording of the settlement charge in connection with the defined benefit pension plan and the revaluation of the pension obligation had a positive impact on accumulated other comprehensive loss. The Company continues to be considered well capitalized for regulatory purposes with a total capital ratio of 12.79%, and a common equity tier 1 capital ratio of 9.94% atJune 30, 2021 . See the discussion of the Basel III capital requirements under the Capital Resources section below. As ofJune 30, 2021 , the Company's book value per common share was$6.52 and its tangible book value per common share was$5.71 (non-GAAP). When compared toDecember 31, 2020 , book value per common share improved by$0.40 per common share and tangible book value per common share improved by$0.29 per common share. The tangible common equity to tangible assets ratio was 7.24% (non-GAAP) atJune 30, 2021 and declined by five basis points when compared toDecember 31, 2020 . 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 Company believes that these non-GAAP financial measures provide information to investors that is useful in understanding its financial condition. This non-GAAP data should be considered in addition to results prepared in accordance with GAAP, and is not a substitute for, or superior to, GAAP results. Limitations associated with non-GAAP financial measures include the risks that persons might disagree as to the appropriateness of items included in these measures, and, because not all companies use the same calculation of tangible common equity and tangible assets, this presentation may not be comparable to other similarly titled measures calculated by other companies. The following table sets forth the
calculation of the Company's
50
Table of Contents
tangible common equity ratio and tangible book value per share at
June 30, December 31,
2021 2020
Total shareholders' equity $ 111,272 $ 104,399
Less: Intangible assets 13,785 11,944
Tangible common equity 97,487 92,455
Total assets 1,360,583 1,279,713
Less: Intangible assets 13,785 11,944
Tangible assets 1,346,798 1,267,769Tangible common equity ratio (non-GAAP) 7.24 % 7.29 % Total shares outstanding 17,075,000 17,060,144
Tangible book value per share (non-GAAP)
…..LOAN QUALITY…..The following table sets forth information concerning the
Company's loan delinquency, non-performing assets, and classified assets (in
thousands, except percentages):
June 30, December 31, June 30,
2021 2020 2020
Total accruing loan delinquency (past due 30 to
89 days) $ 1,904 $ 5,504 $ 3,394
Total non-accrual loans 3,713 2,500 2,325
Total non-performing assets including TDRs* 3,727 3,331 3,122 Accruing loan delinquency, as a percentage of total loans, net of unearned income
0.19 % 0.56 % 0.37 % Non-accrual loans, as a percentage of total loans, net of unearned income
0.37 0.26 0.25
Non-performing assets, as a percentage of total
loans, net of unearned income, and other real
estate owned 0.38 0.34 0.34
Non-performing assets as a percentage of total
assets 0.27 0.26 0.25
As a percent of average loans, net of unearned
income:
Annualized net charge-offs 0.02 0.03 0.05
Annualized provision for loan losses 0.10 0.26 0.14
Total classified loans (loans rated substandard or
doubtful)** $ 10,002 $
11,829
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 a
troubled debt restructuring and (iv) other real estate owned.
** Total classified loans include non-performing residential mortgage and
consumer loans.
Overall, the Company continued to maintain good asset quality in the first six months of 2021 as evidenced by low levels of non-accrual loans, non-performing assets, and loan delinquency levels that continue to be below 1% of total loans. The increase in non-accrual loans is the result of three commercial loan relationships, two of which were previously designated as a troubled debt restructure (TDR), being transferred into non-accrual status during the first half of 2021, which was partially offset by a decrease in non-accrual residential mortgage loans. Additionally, the Company experienced a substantial decrease in accruing loan delinquency primarily attributable to the curing of commercial account delinquency during the period. The Company remains committed to prudently working with and supporting our borrowers that have been hardest hit by the pandemic by granting them loan payment modifications. Management continues to carefully monitor asset quality with a particular focus on customers that have requested payment deferrals.The Asset Quality Task Force meets at least monthly to review these particular relationships, receiving input from the business lenders regarding their ongoing discussions with the borrowers. Deferral extension requests are considered based upon the customer's needs and their impacted industry, borrower and guarantor capacity to service debt and issued regulatory guidance. See the 51
Table of Contents
disclosures regarding COVID-19 related modifications within the Non-Performing Assets Including Troubled Debt Restructurings (TDR) footnote.
We also continue to closely monitor the loan portfolio given the number of relatively large-sized commercial and commercial real estate loans within the portfolio. As ofJune 30, 2021 , the 25 largest credits represented 22.1% of total loans outstanding, which represents a decrease from the second quarter of 2020 when it was 23.4%. …..ALLOWANCE FOR LOAN LOSSES…..The following table sets forth the allowance for loan losses and certain ratios for the periods ended (in thousands, except percentages): June 30, December 31, June 30, 2021 2020 2020 Allowance for loan losses$ 11,752 $ 11,345 $ 9,699 Allowance for loan losses as a percentage of each of the following: total loans, net of unearned income 1.18 % 1.16 % 1.04 % total accruing delinquent loans (past due 30 to 89 days) 617.23 206.12 285.77 total non-accrual loans 316.51 453.80 417.16 total non-performing assets 315.32 340.59 310.67 The Company recorded a$500,000 provision expense for loan losses in the first six months of 2021 compared to a$625,000 provision expense in the first six months of 2020. As mentioned previously, the Company continues to believe that a strong allowance for loan losses is needed until certain borrowers have fully recovered from the COVID-19 pandemic. The 2021 provision reflects an improved credit quality outlook for the overall portfolio as both classified and criticized asset levels as well as non-accrual loan balances have demonstrated improvement. As a result of the provision expense sharply exceeding net loan charge-offs over the last 12 months, the balance in the allowance for loan losses increased by$2.1 million , or 21.2%, to$11.8 million atJune 30, 2021 . The Company's asset quality continues to remain strong as evidenced by low levels of net loan charge-offs and non-performing assets. Note that the reserve coverage to total loans, excluding PPP loans, is 1.24% (non-GAAP) atJune 30, 2021 . Management believes that this non-GAAP measure provides a greater understanding of ongoing operations and enhances comparability of results of operations with prior periods. The Company believes that investors may use this non-GAAP measure to analyze the Company's financial condition without the impact of unusual items or events that may obscure trends in the Company's underlying financial condition. This non-GAAP data should be considered in addition to results prepared in accordance with GAAP, and is not a substitute for, or superior to, GAAP results. Limitations associated with non-GAAP financial measures include the risks that persons might disagree as to the appropriateness of items included in these measures and that different companies might calculate these measures differently. The following table sets forth the calculation of the Company's allowance for loan loss reserve coverage to total loans (GAAP) and the reserve coverage to total loans, excluding PPP loans (non-GAAP), atJune 30, 2021 (in thousands, except percentages). JUNE 30, 2021 Allowance for loan losses$ 11,752 Total loans, net of unearned income 992,712 Reserve coverage 1.18 %
Reserve coverage to total loans, excluding PPP loans: Allowance for loan losses
$ 11,752 Total loans, net of unearned income 992,712 PPP loans (48,098) 944,614 Non-GAAP reserve coverage 1.24 %
…..LIQUIDITY…..The Company's liquidity position continues to be exceptionally strong due to the significant influx of deposits that resulted from the government stimulus programs, customers continuing to exhibit a degree of
52
Table of Contents
caution and demonstrating a reduced level of spending activity due to the economic uncertainty. Also, deposit levels were positively impacted in the second quarter of 2021 by theSomerset County branch acquisition. As a result, total deposits reached another record level, averaging$1.165 billion for the second quarter of 2021. In addition, the Company's loyal core deposit base continues to prove to be a source of strength for the Company during periods of market volatility. 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. Average short-term investments grew during the second quarter of 2021 and continue to be higher than they have been historically which presents the challenge of profitably deploying this excess liquidity given the current low yields on short term investment products. An additional challenge is the uncertainty regarding the duration that these excess funds will remain on the balance sheet which will be determined by customer behavior as the economic conditions change. On an end of period basis, atJune 30, 2021 , total interest bearing deposits and short-term investments increased by$34.4 million sinceDecember 31, 2020 . In addition to the commercial real estate loan growth experienced during the year and greater level of residential mortgage loans being retained in the portfolio, a portion of this increased liquidity was invested in additional securities to more profitably deploy these funds. We strive to operate our loan to deposit ratio in a range of 80% to 100%. The Company's loan to deposit ratio averaged 85.1% in the second quarter of 2021. The Company has ample capacity to continue to grow its loan portfolio and is strongly positioned to provide the necessary assistance to our customers and our community as they continue their recovery from the COVID-19 pandemic and respond to an improving economy. We are also well positioned to service our existing loan pipeline and grow our loan to deposit ratio while remaining within our guideline parameters. Liquidity can also be analyzed by utilizing the Consolidated Statements of Cash Flows. Cash and cash equivalents increased by$28.7 million fromDecember 31, 2020 , to$60.2 million atJune 30, 2021 , due to$28.9 million of cash provided by financing activities and$9.3 million of cash provided by operating activities which more than offset$9.5 million of cash used in investing activities. Within financing activities, deposits increased by$71.4 million while total short-term and FHLB borrowings decreased by$41.5 million . Within investing activities, cash advanced for new loans originated totaled$163.7 million and was$19.9 million higher than the$143.7 million of cash received from loan principal payments. Within operating activities,$10.6 million of mortgage loans held for sale were originated while$17.3 million of mortgage loans were sold into the secondary market. The holding company had$5.5 million of cash, short-term investments, and investment securities atJune 30, 2021 . Additionally, dividend payments from our subsidiaries also provide ongoing cash to the holding company. AtJune 30, 2021 , our subsidiary Bank had$10.2 million of cash available for immediate dividends to the holding company under applicable regulatory formulas. Management follows a policy that limits dividend payments from theTrust Company to 75% of annual net income. Overall, we believe that the holding company has sufficient liquidity to meet its trust preferred debt service requirements, its subordinated debt interest payments, and its current dividend payout level with respect to its common stock. 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 investments, interest bearing deposits with banks, and federal funds sold. These assets totaled$60.2 million and$31.5 million atJune 30, 2021 andDecember 31, 2020 , 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. AtJune 30, 2021 , the Company had$388 million of overnight borrowing availability at the FHLB,$33 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 Bank 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 9.94%, the 53
Table of Contents
tier 1 capital ratio was 11.05%, and the total capital ratio was 12.79% atJune 30, 2021 . The Company's tier 1 leverage ratio was 8.89% atJune 30, 2021 . We anticipate that we will maintain our strong capital ratios throughout the remainder of 2021. 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 364% of regulatory capital atJune 30, 2021 . While we work through the COVID-19 pandemic, our focus is on preserving capital to support customer lending and allow the Company to take advantage of opportunities that should result from the continued improvement in the economy during the second half of 2021. Additionally, we currently believe that we have sufficient capital and earnings power to continue to pay our common stock cash dividend at its current rate of$0.025 per quarter. AtJune 30, 2021 , the Company had approximately 17.1 million common shares outstanding. 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 2.5% capital conservation buffer ("CCB") on top of the three minimum risk-weighted asset ratios. 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.
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
…..INTEREST RATE SENSITIVITY…..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 6.8 % 37.9 %
100 bp increase 3.6 20.6
100 bp decrease (3.1) 0.7
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
and the scheduled repricing of loans tied to LIBOR or prime. 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 0% to 0.25%. The market value of portfolio equity increases
in the upward rate shocks due to the improved value of the Company's core
deposit base. The reduced value of the Company's core deposits caused the market
value of portfolio equity to be less positive in the downward rate shock, as
compared to the upward rate shocks.
54
Table of Contents
…..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 had various outstanding commitments to extend credit approximating$246.2 million and standby letters of credit of$13.4 million as ofJune 30, 2021 . 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. …..REGULATORY UPDATE…..The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted into law onMarch 27, 2020 . Federal, state, and local governments have adopted various statutes, rules, regulations, orders, and guidelines in order to address the COVID-19 pandemic and the adverse economic effects of this pandemic on individuals, families, businesses, and governments. Financial institutions, including the Company, are affected by many of these measures, including measures that are broadly applicable to businesses operating in the communities where the Company does business. These measures included "stay-at-home orders" that allowed only essential businesses to operate. Financial services firms are generally regarded as "essential businesses" under these orders, but financial services firms, like other essential businesses, are required to operate in a manner that seeks to protect the health and safety of their customers and employees. In addition, the federal banking agencies along with state bank regulators issued an interagency statement onMarch 22, 2020 , addressing loan modifications that are made by financial institutions for borrowers affected by the COVID-19 crisis. The agencies stated that short-term loan modifications made on a good faith basis in response to COVID-19 for borrowers who were current prior to any relief do not need to be categorized as TDRs and that financial institutions are not expected to designate loans with deferrals granted due to COVID-19 as past due because of the deferral. The CARES Act contains a number of provisions that affect banking organizations. The CARES Act provides funding for various programs under which the federal government will lend to, guarantee loans to, or make investments in, businesses. Banking organizations are expected to play a role in some of these programs, and when they do so, they will be subject to certain requirements. One of these programs is the Paycheck Protection Program (PPP), a program administered by theSmall Business Administration (the SBA) to provide loans to small businesses for payroll and other basic expenses during the COVID-19 crisis. The loans can be made by SBA-certified lenders and are 100% guaranteed by the SBA. The loans are eligible to be forgiven if certain conditions are satisfied, in which event the SBA will make payment to the lender for the forgiven amounts. The Bank has participated in the PPP as a lender. In accordance with the CARES Act, a PPP loan will be assigned a risk weight of zero percent under the federal banking agencies' risk-based capital rules. The CARES Act also authorizes temporary changes to certain provisions applicable to banking organizations. Among other changes, Section 4013 of the CARES Act gives financial institutions the right to elect to suspend GAAP principles and regulatory determinations for loan modifications relating to COVID-19 that would otherwise be categorized as TDRs fromMarch 1, 2020 , through the earlier ofDecember 31, 2020 , or 60 days after the COVID-19 national emergency ends. OnApril 7, 2020 , the federal banking agencies, in consultation with state bank regulators, issued an interagency statement clarifying the interaction between (i) their earlier statement discussing whether loan modifications relating to COVID-19 need to be treated as TDRs and (ii) the CARES Act provision on this subject. In this interagency statement, the agencies also said that when exercising supervisory and enforcement responsibility with respect to consumer protection requirements, they will take into account the unique circumstances impacting borrowers and institutions resulting from the COVID-19 emergency and that they do not expect to take a consumer compliance public enforcement action against an institution, provided that the circumstances were related to this emergency and the institution made good faith efforts to support borrowers and comply with the consumer protection requirements and addressed any needed corrective action. The suspension of TDR identification and accounting triggered by the effects of the COVID-19 pandemic was extended by the Consolidated Appropriations Act, 2021, signed into law onDecember 27, 2020 . The period established by Section 4013 of the CARES Act was extended to the earlier ofJanuary 1, 2022 or 60 days after the date on which the national COVID-19 emergency terminates. 55 Table of Contents Additionally, onMarch 15, 2020 , theFederal Reserve reduced the target range for the federal funds rate to 0% to 0.25% and announced that it would increase its holdings ofU.S. Treasury securities and agency mortgage-backed securities and begin purchasing agency commercial mortgage-backed securities. TheFederal Reserve has also encouraged depository institutions to borrow from the discount window and has lowered the primary credit rate for such borrowing by 150 basis points while extending the term of such loans up to 90 days. Reserve requirements have been reduced to zero as ofMarch 26, 2020 . …..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, intangible assets, 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. ACCOUNT - Pension liability
BALANCE SHEET REFERENCE - Other assets
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. Additionally, pension expense can also be impacted by settlement accounting charges if the amount of employees selected lump sum distributions exceed the total amount of service and interest component costs of the net periodic pension cost in a particular year. Our pension benefits are described further in Note 18 of the Notes to Unaudited Consolidated Financial Statements.
ACCOUNT - Allowance for Loan Losses
BALANCE SHEET REFERENCE - Allowance for loan losses
INCOME STATEMENT REFERENCE - Provision 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$9.1 million , or 77%, of the total allowance for loan losses atJune 30, 2021 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. 56 Table of Contents ACCOUNT - Intangible assets
BALANCE SHEET REFERENCE - Intangible assets
INCOME STATEMENT REFERENCE -
DESCRIPTION
The Company considers our accounting policies related to goodwill and core deposit intangible to be critical because the assumptions or judgment used in determining the fair value of assets and liabilities acquired in 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 and core deposit intangible, 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 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. The core deposit intangible, which is a wasting asset, is amortized and reported in other expense for a period of ten years using the sum of the years digits amortization method.
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 ofJune 30, 2021 , 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. 57
Table of Contents
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 -
BALANCE SHEET REFERENCE - Investment securities
INCOME STATEMENT REFERENCE - Net realized gains 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 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. AtJune 30, 2021 , 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 STATEMENT…..
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 earnings to shareholders through a combination of
dividends and share repurchases subject to maintaining sufficient capital to
support balance sheet growth and economic uncertainty. 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.
58
Table of Contents
Customers - The Company expects to provide exceptional customer service,
identifying opportunities to enhance the Banking for Life philosophy byproviding 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.
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.
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-Q 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-Q, 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-Q. 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; (xii) potential risks and uncertainties also include those relating to the duration of the COVID-19 outbreak, and actions that may be taken by governmental authorities to contain the outbreak or to treat its impact, including the distribution and effectiveness of COVID-19 vaccines; and (xiii) other external developments which could materially impact the Company's operational and financial performance. 59 Table of Contents
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.
© Edgar Online, source
