FNCB BANCORP, INC. This Quarterly Report should be read in conjunction with the more detailed and comprehensive disclosures included in the Annual Report on Form 10-K for the year endedDecember 31, 2019 forFNCB Bancorp, Inc. In addition, please read this section in conjunction with the consolidated financial statements and notes to consolidated financial statements contained elsewhere herein.FNCB Bancorp, Inc. and its subsidiaries ("FNCB") are in the business of providing customary retail and commercial banking services to individuals, businesses and local governments and municipalities through its wholly-owned subsidiary,FNCB Bank , at its 17 full-service branch offices within its primary market area,Northeastern Pennsylvania , and a limited purpose office based inAllentown ,Lehigh County, Pennsylvania .
FORWARD-LOOKING STATEMENTS AND OTHER INFORMATION
FNCB may from time to time make written or oral "forward-looking statements," including statements contained in our filings with theSecurities and Exchange Commission ("SEC"), in our reports to shareholders, and in our other communications, which are made in good faith by us pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with respect to FNCB's beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond our control). The words "may," "could," "should," "will," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan," "project," "future" and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause FNCB's financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the effect of the coronavirus ("COVID-19") pandemic on FNCB and its customers, theCommonwealth of Pennsylvania andthe United States , related to the economy and overall financial stability; government and regulatory responses to the COVID-19 pandemic; government intervention in theU.S. financial system including the effects of recent legislative, tax, accounting and regulatory actions and reforms, including, but not limited to, the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") and the Tax Cuts and Jobs Act; political instability; the ability of FNCB to manage credit risk; weakness in the economic environment, in general, and within FNCB's market area; the deterioration of one or a few of the commercial real estate loans with relatively large balances contained in FNCB's loan portfolio; greater risk of loan defaults and losses from concentration of loans held by FNCB, including those to insiders and related parties; if FNCB's portfolio of loans to small and mid-sized community-based businesses increases its credit risk; if FNCB's ALLL is not sufficient to absorb actual losses or if increases to the ALLL were required; FNCB is subject to interest-rate risk and any changes in interest rates could negatively impact net interest income or the fair value of FNCB's financial assets; if management concludes that the decline in value of any of FNCB's investment securities is other-than-temporary could result in FNCB recording an impairment loss; if FNCB's risk management framework is ineffective in mitigating risks or losses to FNCB; if FNCB is unable to successfully compete with others for business; a loss of depositor confidence resulting from changes in either FNCB's financial condition or in the general banking industry; if FNCB is unable to retain or grow its core deposit base; inability or insufficient dividends from its subsidiary,FNCB Bank ; if FNCB loses access to wholesale funding sources; interruptions or security breaches of FNCB's information systems; any systems failures or interruptions in information technology and telecommunications systems of third parties on which FNCB depends; security breaches; if FNCB's information technology is unable to keep pace with growth or industry developments or if technological developments result in higher costs or less advantageous pricing; the loss of management and other key personnel; dependence on the use of data and modeling in both its management's decision-making generally and in meeting regulatory expectations in particular; additional risk arising from new lines of business, products, product enhancements or services offered by FNCB; inaccuracy of appraisals and other valuation techniques FNCB uses in evaluating and monitoring loans secured by real property and other real estate owned; unsoundness of other financial institutions; damage to FNCB's reputation; defending litigation and other actions; dependence on the accuracy and completeness of information about customers and counterparties; risks arising from future expansion or acquisition activity; environmental risks and associated costs on its foreclosed real estate assets; any remediation ordered, or adverse actions taken, by federal and state regulators, including requiring FNCB to act as a source of financial and managerial strength for theFNCB Bank in times of stress; costs arising from extensive government regulation, supervision and possible regulatory enforcement actions; new or changed legislation or regulation and regulatory initiatives; noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations; failure to comply with numerous "fair and responsible banking" laws; any violation of laws regarding privacy, information security and protection of personal information or another incident involving personal, confidential or proprietary information of individuals; any rulemaking changes implemented by theConsumer Financial Protection Bureau ; inability to attract and retain its highest performing employees due to potential limitations on incentive compensation contained in proposed federal agency rulemaking; any future increases inFNCB Bank's FDIC deposit insurance premiums and assessments; and the success of FNCB at managing the risks involved in the foregoing and other risks and uncertainties, including those detailed in FNCB's filings with theSEC . FNCB cautions that the foregoing list of important factors is not all inclusive. Readers are also cautioned not to place undue reliance on any forward-looking statements, which reflect management's analysis only as of the date of this report, even if subsequently made available by FNCB on its website or otherwise. FNCB does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of FNCB to reflect events or circumstances occurring after the date of this report. Readers should carefully review the risk factors described in the Annual Report and other documents that FNCB periodically files with theSEC , including its Annual Report on Form 10-K for the year endedDecember 31, 2019 .
Any references to FNCB's website, www.fncb.com or any variation thereof, shall not incorporate the contents of such website into this Report.
CRITICAL ACCOUNTING POLICIES
In preparing the consolidated financial statements, management has made
estimates, judgments and assumptions that affect the reported amounts of assets
and liabilities as of the date of the consolidated statements of condition and
results of operations for the periods indicated. Actual results could differ
significantly from those estimates.
FNCB's accounting policies are fundamental to understanding management's
discussion and analysis of its financial condition and results of operations.
Management has identified the policies on the determination of the allowance for
loan and lease losses ("ALLL"), securities' valuation and impairment evaluation,
the valuation of other real estate owned ("OREO") and income taxes to be
critical, as management is required to make subjective and/or complex judgments
about matters that are inherently uncertain and could be most subject to
revision as new information becomes available.
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The judgments used by management in applying the critical accounting policies discussed below may be affected by changes and/or deterioration in the economic environment, which may impact future financial results. Specifically, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the ALLL in future periods, and the inability to collect on outstanding loans could result in increased loan losses. In addition, the valuation of certain securities in FNCB's investment portfolio could be negatively impacted by illiquidity or dislocation in marketplaces resulting in significantly depressed market prices thus leading to impairment losses.
Allowance for Loan and Lease Losses
Management evaluates the credit quality of FNCB's loan portfolio on an ongoing basis and performs a formal review of the adequacy of the ALLL on a quarterly basis. The ALLL is established through a provision for loan losses charged to earnings and is maintained at a level management considers adequate to absorb estimated probable losses inherent in the loan portfolio as of the evaluation date. Loans, or portions of loans, determined by management to be uncollectible are charged off against the ALLL, while recoveries of amounts previously charged off are credited to the ALLL. Determining the amount of the ALLL is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, qualitative factors, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. Banking regulators, as an integral part of their examination of FNCB, also review the ALLL, and may require, based on their judgments about information available to them at the time of their examination, that certain loan balances be charged off or require that adjustments be made to the ALLL. Additionally, the ALLL is determined, in part, by the composition and size of the loan portfolio. The ALLL consists of two components, a specific component and a general component. The specific component relates to loans that are classified as impaired. For such loans, an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans and is based on historical loss experience adjusted by qualitative factors. The general reserve component of the ALLL is based on pools of unimpaired loans segregated by loan segment and risk rating categories of "Pass," "Special Mention" or "Substandard and Accruing." Historical loss factors and various qualitative factors are applied based on the risk profile in each risk rating category to determine the appropriate reserve related to those loans. Substandard loans on non-accrual status above the$100 thousand loan relationship threshold and all loans considered troubled debt restructurings ("TDRs") are classified as impaired.
See Note 4, "Loans" of the notes to consolidated financial statements included in Item 1 hereof for additional information about the ALLL.
Securities Valuation and Evaluation for Impairment
Management utilizes various inputs to determine the fair value of its investment
portfolio. To the extent they exist, unadjusted quoted market prices in active
markets (Level 1) or quoted prices for similar assets or models using inputs
that are observable, either directly or indirectly (Level 2) are utilized to
determine the fair value of each investment in the portfolio. In the absence of
observable inputs or if markets are illiquid, valuation techniques are used to
determine fair value of any investments that require inputs that are both
unobservable and significant to the fair value measurement (Level 3). For Level
3 inputs, valuation techniques are based on various assumptions, including, but
not limited to, cash flows, discount rates, adjustments for nonperformance and
liquidity, and liquidation values. A significant degree of judgment is involved
in valuing investments using Level 3 inputs. The use of different assumptions
could have a positive or negative effect on FNCB's financial condition or
results of operations. See Note 3, "Securities/Subsequent Event" and Note 13,
"Fair Value Measurements" of the notes to consolidated financial statements
included in Item 1 hereof for additional information about FNCB's securities
valuation techniques.
On a quarterly basis, management evaluates individual investment securities in
an unrealized loss position for other than temporary impairment ("OTTI"). The
evaluation for OTTI requires the use of various assumptions, including but not
limited to, the length of time an investment's fair value is less than book
value, the severity of the investment's decline, any credit deterioration of the
issuer, whether management intends to sell the security, and whether it is
more-likely-than-not that FNCB will be required to sell the security prior to
recovery of its amortized cost basis. Debt investment securities deemed to have
OTTI are written down by the impairment related to the estimated credit loss,
and the non-credit related impairment loss is recognized in other comprehensive
income. FNCB did not recognize any OTTI charges on investment securities for
the three and six months ended June 30, 2020 and 2019 within the consolidated
statements of income.
Refer to Note 3, "Securities/Subsequent Event," of the notes to consolidated
financial statements included in Item 1 hereof for additional information about
valuation of securities.
Other Real Estate Owned
OREO consists of property acquired by foreclosure, abandonment or conveyance of
deed in-lieu of foreclosure of a loan, and bank premises that are no longer used
for operation or for future expansion. OREO is held for sale and is initially
recorded at fair value less estimated costs to sell at the date of acquisition
or transfer, which establishes a new cost basis. Upon acquisition of the
property through foreclosure or deed-in-lieu of foreclosure, any adjustment to
fair value less estimated selling costs is recorded to the ALLL. The
determination is made on an individual asset basis. Bank premises no longer used
for operations or future expansion are transferred to OREO at fair value less
estimated selling costs with any related write-down included in non-interest
expense. Subsequent to acquisition, valuations are periodically performed and
the assets are carried at the lower of cost or fair value less estimated cost to
sell. Fair value is determined through external appraisals, current letters of
intent, broker price opinions or executed agreements of sale, unless management
determines that conditions exist that warrant an adjustment to the value. Costs
relating to the development and improvement of the OREO properties may be
capitalized; holding period costs and any subsequent changes to the valuation
allowance are charged to expense as incurred.
Income Taxes
The objectives of accounting for income taxes are to recognize the amount of
taxes payable or refundable for the current year and deferred tax liabilities
and assets for the future tax consequences of events that have been recognized
in an entity's financial statements or tax returns. Judgment is required in
assessing the future tax consequences of events that have been recognized in
FNCB's consolidated financial statements or tax returns. Fluctuations in the
actual outcome of these future tax consequences could impact our consolidated
financial condition or results of operations.
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FNCB records an income tax provision or benefit based on the amount of tax currently payable or receivable and the change in deferred tax assets and liabilities. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial and tax reporting purposes. Management conducts quarterly assessments of all available positive and negative evidence to determine the amount of deferred tax assets that will more likely than not be realized. FNCB establishes a valuation allowance for deferred tax assets and records a charge to income if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, management considers past operating results, estimates of future taxable income based on approved business plans, future capital requirements and ongoing tax planning strategies. This evaluation process involves significant management judgment about assumptions that are subject to change from period to period depending on the related circumstances. The recognition of deferred tax assets requires management to make significant assumptions and judgments about future earnings, the periods in which items will impact taxable income, future corporate tax rates, and the application of inherently complex tax laws. The use of different estimates can result in changes in the amounts of deferred tax items recognized, which may result in equity and earnings volatility because such changes are reported in current period earnings. In connection with determining the income tax provision or benefit, management considers maintaining liabilities for uncertain tax positions and tax strategies that it believes contain an element of uncertainty. Periodically, management evaluates each of FNCB's tax positions and strategies to determine whether a liability for uncertain tax benefits is required. As ofJune 30, 2020 andDecember 31, 2019 , management determined that FNCB did not have any uncertain tax positions or tax strategies and that no liability was required to be recorded.
Refer to Note 8, "Income Taxes," of the notes to consolidated financial statements included in Item 1 hereof for additional information about income taxes.
New Authoritative Accounting Guidance and Accounting Guidance to be Adopted in Future Periods
Refer to Note 2, "New Authoritative Accounting Guidance," of the notes to consolidated financial statements included in Item 1 hereof for information about new authoritative accounting guidance adopted by FNCB during the three months endedJune 30, 2020 , as well as new accounting guidance issued, but not previously reported, that will be adopted by FNCB in future periods.
Impact of COVID-19 and FNCB's response to the pandemic
InMarch 2020 , the outbreak of the novel Coronavirus Disease 2019 ("COVID-19") was recognized as a pandemic by theWorld Health Organization . The spread of COVID-19 has created a global public health crisis that has resulted in unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity inthe United States and globally, including the markets that FNCB serves. Governmental authorities responded to the COVID-19 pandemic by mandating the closure of locations of non-essential businesses and requiring individuals to observe social distancing and "stay-at-home" restrictions. These governmental restrictions, coupled with fear of contracting the virus, have resulted in a rapid decline in commercial and consumer activity, loss of revenues by businesses, a severe spike in unemployment, material decreases in oil and gas prices and in business valuations, disrupted global supply chains and market volatility. The federal government responded by enacting bipartisan emergency response legislation. Additionally, theFederal Open Market Committee ("FOMC") lowered the federal funds target rate a total of 150 basis points in two emergency actions, 50 basis points onMarch 3, 2020 and 100 basis points onMarch 15, 2020 , with an expectation thatFederal Reserve policy will maintain a low interest rate environment for the foreseeable future. Late in the second quarter of 2020, state and local economies began the re-opening process subject to a resurgence of COVID-19 locally, regionally or nationally. Businesses were allowed to operate but must adhere to capacity restrictions and safety and social distancing requirements. As a financial institution, FNCB is considered essential and has remained open for business and is operating under its pandemic preparedness plan. To ensure the financial needs of its customers are addressed in a safe and consistent manner,FNCB Bank offices are open for regular business, with administrative, lending and community branch offices adhering to federal, state, and local governmental guidelines and social distancing mandates. However, in order to limit the spread of COVID-19 customers are encouraged to utilize FNCB's drive-thru facilities, automated teller machines, Customer Care center, remote deposit capture and online banking, including online chat capabilities, and mobile banking applications. FNCB is also providing the necessary technology, when needed, to its operational staff to work remotely in a secure environment. FNCB does not currently face any material resource constraints through the implementation of its pandemic preparedness plan. Through the six months endedJune 30, 2020 , FNCB incurred COVID-19 related expenses including stay-at-home pay, computer-related costs, cleaning and sanitizing facilities and safety supplies totaling$183 thousand , which is included in non-interest expense in the consolidated statements of income. Additionally, FNCB has not identified any material operational or internal control challenges or risks, nor does it anticipate any significant challenges to its ability to maintain its systems and controls, related to operational changes resulting from implementation of the pandemic preparedness plan. As part of the federal emergency response, onMarch 27, 2020 , the Coronavirus Aid, Relief, and Economic Security ("CARES") Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act includes the Paycheck Protection Program ("PPP") administered by theSmall Business Administration ("SBA"), initially a nearly$350 billion program designed to aid small- and medium-sized businesses through federally guaranteed loans distributed through banks. These loans were intended to guarantee eight weeks of payroll and other costs to help those businesses remain viable and allow their workers to pay their bills. ByApril 16, 2020 , the SBA announced funding under the initial allotment had been exhausted. Subsequently, onApril 24, 2020 ,President Trump signed the law replenishing the PPP with approximately$320 billion in new funds. As an SBA Lender,FNCB Bank is actively participating in PPP loans assisting our small business community in securing this important funding. As ofJune 30, 2020 , FNCB was able to serve 920 small business customers with PPP loans totaling$117.0 million . Additionally, in order to provide financial stability for both personal and business customers that are facing unemployment, temporary furloughs and closures, FNCB rolled out a payment deferral program providing for either an interest-only period or full payment deferral of up to six months. As ofJune 30, 2020 , FNCB assisted 905 customers under our payment deferral program, with the aggregate principal balance of loans modified totaling$176.9 million . FNCB also developed a special "Personal Relief Loan," an unsecured, 36-month, low interest loan up to$5,000 for individuals financially impacted by COVID-19 due to temporary loss of employment. Additionally, FNCB temporarily suspended all repossession and foreclosure activity and have suspended certain deposit service charges related to debit card usage. TheFederal Reserve Bank also established the Main Street Lending Program to support lending to small and mid-sized businesses and not-for-profit organizations impacted by the COVID-19 pandemic. Specifically, theMain Street Business Lending Program provides for five loan facilities with total potential funding of up to$600 billion . The Main Street New Loan Facility ("MSNLF"), the Main Street Priority Loan Facility ("MSPLF") and the Main Street Expanded Loan Facility ("MSELF") are three credit facilities that provide eligible business borrowers impacted by COVID-19 with financing in amounts of$250 thousand to$300 million depending on facility. Terms of all three facilities includeFederal Reserve Bank participation of 95.0%, lender participation of 5.0%, a maturity of 5 years, principal deferral for two years, interest deferral for one year, an adjustable interest rate based on one- or three-month LIBOR plus 300 basis points. Similarly, the Nonprofit Organization New Loan Facility ("NONLF") and the Nonprofit Organization Expanded Loan Facility ("NOELF") provide eligible not-for-profit organizations with financing in amounts of$250 thousand to$10 million .FNCB Bank has received approval from theFederal Reserve Bank as a participating lender in the Main Street Lending Program. As ofJune 30, 2020 , there were no loans outstanding that were originated under theMain Street Lending Program. Subsequent toJune 30, 2020 and before the filing date of this quarterly report on Form 10-Q, FNCB originated two MSPLF loans with an aggregate principal balance of$53.0 million and retained 5.0% of the outstanding principal balance or$2.7 million . 32
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FNCB is prepared to continue to offer short-term assistance in accordance with regulatory guidelines and participate in the PPP and Main Street Lending Program. As the fallout of the COVID-19 pandemic ripple through the national, regional and local economies, management continues to identify and monitor potential weaknesses in the loan portfolio. Management has identified and is monitoring exposures to borrowers and industries that may be impacted more immediately and acutely than others. Additionally, management has proactively reached out to specific borrowers to provide guidance and assistance as appropriate. On a portfolio level, management continues to monitor aggregate exposures to highly sensitive segments such as hotels and hospitality for changes in asset quality and payment performance, and liquidity levels. Management monitors unfunded commitments such as lines of credit and overdraft protection to determine liquidity and funding issues that may arise with our customers. During the first half of 2020, as part of its evaluations of the adequacy of the ALLL, management increased the unallocated portion of the ALLL, as well as adjusted the qualitative factors included in the calculation, due to economic and employment uncertainty and disruption due to the global pandemic. Should economic conditions worsen, FNCB could experience further increases in its required allowance for loan and lease losses and record additional provisions for loan and lease losses. It is possible that FNCB's asset quality metrics could be materially and adversely impacted in future periods if the effects of COVID-19 are prolonged. FNCB anticipates the COVID-19 pandemic will impact its business in future periods. However, because the impact is contingent upon the duration and severity of the economic downturn, management cannot determine or estimate the magnitude of the impact at this time. The FNCB team will continue to work diligently to address other issues due to the COVID-19 pandemic in a safe and sound manner as they arise. Management believes that the steps taken in 2019 to strengthen our balance sheet and capital position, as well as the additional credit provisioning will allow FNCB to withstand the challenges that may be presented.
The following are examples of items which may have a material adverse effect on FNCB's business, among others:
? Significantly lower market interest rates may have a negative impact on FNCB's
loan yields as variable-rate loans and securities indexed to prime and LIBOR
will reprice downward;
? Non-interest income could decrease because of waived service charges and loan
fees;
? Point-of-sale fee income may decline due to a decrease in debit card spending
due to the "Stay at Home" requirements;
? Non-interest expense could increase as a result of additional cleaning costs,
supplies, equipment and other items needed to address the effects of COVID-19;
? Additional loan modifications may occur and borrowers may default on their
loans, which may result in additional credit-related provisioning;
? Sustained contraction in economic activity may result in reduced demand for
our products and services; and
? Continued stock market volatility could cause the price of our common stock to
decline further.
Executive Summary
The following overview should be read in conjunction with this MD&A in its entirety.
FNCB recorded consolidated net income of$4.0 million , or$0.20 per basic and diluted common share, for the three months endedJune 30, 2020 , an increase of$1.5 million , or 57.7%, compared to$2.5 million , or$0.13 per basic and diluted common share, for the three months endedJune 30, 2019 . Net income for the six months endedJune 30, 2020 totaled$6.1 million , or$0.30 per basic and diluted share, an increase of$0.9 million , or 17.4%, compared to$5.2 million , or$0.27 per basic and diluted shares, for the same six months of 2019. The increase in second quarter and year-to-date 2020 earnings was primarily due to increases in net interest income and non-interest income and a decrease in non-interest expense. Partially offsetting these positive factors was an increase in the provision for loan and lease losses, which reflected deteriorating economic conditions and continued uncertainty brought on by the COVID-19 global pandemic. Additionally, the results for the second quarter and year-to-date periods of 2020 include the effect of$117.0 million in PPP loans, as well as COVID-19 related expenses of$183 thousand . For the three and six months endedJune 30, 2020 and 2019, the annualized return on average assets was 1.21% and 0.96%, respectively, and 0.85% and 0.86%, respectively, for the same periods of 2019. The annualized return on average equity was 11.62% and 8.87%, respectively, for the three and six months endedJune 30, 2020 , compared to 8.19% and 8.89%, respectively, for the comparable periods of 2019. FNCB declared and paid dividends to holders of common stock of$0.055 per share for the second quarter and$0.11 per share for the six months endedJune 30, 2020 , a 10.0% increase compared to$0.05 per share and$0.10 per share for the same periods of 2019. The dividend pay-out ratio was 36.5% for the six months endedJune 30, 2020 compared to 38.8% for the comparable period of 2019. Total assets increased$214.6 million , or 17.8%, to$1.418 billion atJune 30, 2020 from$1.204 billion atDecember 31, 2019 . The change in total assets primarily reflected increases in net loans, available-for-sale securities and cash and cash equivalents. Net loans increased$117.9 million , or 14.4%, to$937.4 million atJune 30, 2020 from$819.5 million atDecember 31, 2019 . Excluding the$117.0 million in PPP loans outstanding atJune 30, 2020 , net loans increased$0.9 million , or 0.1%. fromDecember 31, 2019 . Cash and cash equivalents increased$66.9 million , or 193.6%, to$101.5 million atJune 30, 2020 from$34.6 million atDecember 31, 2019 . Also contributing to the balance sheet expansion was a$32.8 million , or 12.0%, increase in available-for-sale debt securities to$305.6 million atJune 30, 2020 from$272.8 million atDecember 31, 2019 . Total deposits increased$167.9 million , or 16.8%, to$1.170 billion atJune 30, 2020 from$1.002 billion atDecember 31, 2019 . Total borrowed funds increased$32.2 million , or 56.2%, to$89.4 million atJune 30, 2020 from$57.2 million atDecember 31, 2019 . The increase in borrowed funds reflected an increase in term advances through the FHLB ofPittsburgh of$10.0 million , coupled with$36.2 million in funding from the Federal Reserve Discount Window Paycheck Protection Program Liquidity Facility ("PPPLF"), which were partially offset by a$14.0 million reduction in overnight borrowings through the FHLB ofPittsburgh . Total shareholders' equity increased$11.8 million , or 8.8%, to$145.4 million atJune 30, 2020 from$133.6 million atDecember 31, 2019 . Contributing to the increase in capital was net income for the six months endedJune 30, 2020 of$6.1 million and a$7.7 million increase in accumulated other comprehensive income related primarily to appreciation in the fair value of FNCB's available-for-sale securities, net of deferred taxes. Partially offsetting these increases were dividends declared and paid of$2.2 million for the six months endedJune 30, 2020 .FNCB Bank's total risk-based capital and Tier 1 leverage ratios improved to 15.68% and 10.42% atJune 30, 2020 , respectively, compared to 14.77% and 10.36% atDecember 31, 2019 , respectively. Summary of Performance Net Interest Income Net interest income, defined as the difference between (i) interest income, interest and fees on interest-earning assets, and (ii) interest expense, interest paid on deposits and borrowed funds, is the primary source of earnings for commercial banks. As such, it is the primary determinant of profitability for FNCB. Net interest income is impacted by variations in the volume, rate and composition of earnings assets and interest-bearing liabilities, changes in general market rates and the level of non-performing assets. Interest income is presented on a fully tax-equivalent basis using the corporate statutory tax rate of 21.0% in 2020 and 2019. 33
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In response to the significant disruption and uncertainty in the economic environment brought on by COVID-19, theFOMC lowered the federal funds 150 basis points in two emergency actions inMarch 2020 . As a result, the target range for federal funds fell to 0.00%-0.25% atMarch 31, 2020 from 1.50%-1.75% atDecember 31, 2019 . The emergency actions by theFOMC in 2020 followed three 25 basis-point actions to lower the federal funds target rate a total of 75 basis points in the second half of 2019. No additional changes were made to the federal funds target rate in the second quarter of 2020. TheFOMC actions resulted in decreases in both the tax-equivalent yield on earnings assets and the rate paid on interest-bearing liabilities comparing the three and six months endedJune 30, 2020 and 2019. Additionally, net interest income, earning asset yields and the net interest margin was impacted by the origination and funding of$117.0 million in PPP loans at an interest rate of 1.0%. Net interest income on a tax-equivalent basis increased$736 thousand , or 8.1%, to$9.8 million for the three months endedJune 30, 2020 from$9.1 million for the comparable period of 2019. The improvement in tax-equivalent net interest income for the second quarter of 2020 primarily reflected a decrease in interest expense of$898 thousand , or 35.8%, to$1.6 million from$2.5 million for the same period of 2019. The reduction in interest expense was partially offset by a decrease in tax-equivalent interest income of$162 thousand , or 1.4%, to$11.4 million for the three months endedJune 30, 2020 from$11.6 million for the same period of 2019. For the six months endedJune 30, 2020 , tax-equivalent net interest income increased$967 thousand , or 5.3%, to$19.1 million from$18.1 million for the same six months of 2019. Similarly, the improvement in tax-equivalent net interest income comparing the year-to-date period endedJune 30, 2020 and 2019 was due to a$1.6 million , or 30.8%, reduction in interest expense, partially offset by a$627 thousand , or 2.7%, decrease in tax-equivalent interest income. The tax-equivalent net interest margin, a key measurement used in the banking industry to measure income from earning assets relative to the cost to fund those assets, is calculated by dividing tax-equivalent net interest income by average interest-earning assets. Despite the increase in second quarter tax-equivalent net interest income, FNCB's tax-equivalent net interest margin contracted 13 basis points to 3.12% for the second quarter of 2020 from 3.25% for the same quarter of 2019. The margin compression primarily reflected a$140.4 million , or 12.6%, increase in average earning asset levels, which was largely due to PPP loan funding, coupled with the impact of the rate decreases on floating-rate loans. Rate spread, the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities shown on a fully tax-equivalent basis, contracted 9 basis points to 2.95% for the three months endedJune 30, 2020 from 3.04% for the same period of 2019. Conversely, both the tax-equivalent net interest margin and rate spread increased 4 basis points comparing the six months endedJune 30, 2020 and 2019. For the three months endedJune 30, 2020 , the$898 thousand , or 35.8%, decrease in interest expense was largely due to a reduction in funding costs. Specifically, the cost of interest-bearing deposits decreased 36 basis points to 0.65% for the second quarter of 2020 from 1.01% for the same period of 2019, resulting in decrease to interest expense of$636 thousand . The cost of interest-bearing demand deposits and certificates of deposit, which reflected the reduction in market interest rates, decreased 32 basis points and 33 basis points, respectively, comparing the three months endedJune 30, 2020 and 2019. The decrease in interest expense due to changes in deposit rates was coupled with a 164 basis point reduction in the cost of borrowed funds comparing the three months endedJune 30, 2020 to the same period in 2019, which resulted in a$276 thousand decrease in interest expense. Partially offsetting the reduction in interest expense due to lower funding costs was the increase in utilization of borrowed funds. Average borrowed funds increased by$29.5 million or 56.4% to$81.8 million for the second quarter of 2020 from$52.3 million for the same quarter of 2019, which resulted in a corresponding increase in interest expense of$146 thousand comparing the second quarters of 2020 and 2019. Partially offsetting the lower amount of interest expense was a$162 thousand , or 1.4%, decrease in tax-equivalent interest income to$11.4 million for the second quarter of 2020 from$11.6 million for the same quarter of 2019. The decrease in tax-equivalent interest income was due primarily to a reduction in the tax-equivalent yield on earning assets, partially offset by an increase in average earning asset levels. The tax-equivalent yield on earning assets decreased 51 basis points to 3.64% for the second quarter of 2020 from 4.15% for the same quarter of 2019, which resulted in a corresponding decrease in tax-equivalent interest income of$1.6 million . Specifically, the tax-equivalent yield on the loan portfolio decreased 66 basis points to 3.98% for the three months endedJune 30, 2020 from 4.64% for the same three months of 2019, which caused a corresponding decrease in tax-equivalent interest income of$1.4 million . Average earning assets increased$140.4 million , or 12.6%, to$1.254 billion for the three months endedJune 30, 2020 from$1.114 billion for the same three months of 2019. The increase in average earning assets caused an increase to tax-equivalent interest income of$1.5 million , which almost entirely mitigated the decrease in tax-equivalent interest income due to the decline in yields. PPP loans were the predominant factors causing an increase in average loans of$102.0 million , or 12.4%, to$922.0 million for the second quarter of 2020 from$820.0 million for the same quarter of 2019, resulting in a corresponding increase in interest income of$1.1 million . Additionally, comparing the second quarters of 2020 and 2019, average securities increased$25.0 million , or 8.9%, to$304.2 million from$279.2 million , respectively, which resulted in an increase to interest income of$265 thousand . The$967 thousand , or 5.3%, increase in net interest income for the six months endedJune 30, 2020 was mainly attributable to a$1.6 million , or 30.8% reduction in interest expense, which was partially offset by the decline in tax-equivalent interest income of$627 thousand , or 2.7%. The decrease in interest expense for the year-to-date period was primarily caused by decreases in funding costs due to lower market rates and lower average volumes of interest-bearing deposits. FNCB's total cost of funds decreased 32 basis points to 0.79% for the six months endedJune 30, 2020 from 1.11% for the same period of 2019, resulting in a decrease to interest expense of$1.3 million . Specifically, comparing the six months endedJune 30, 2020 and 2019, the cost of interest-bearing deposits decreased 27 basis points, while the cost of borrowed funds declined 134 basis points, resulting in corresponding decreases to interest expense of$901 thousand and$440 thousand , respectively. For the six months endedJune 30, 2020 , interest-bearing deposits averaged$835.9 million , a decrease of$41.6 million , or 4.7%, from$877.5 million for the same six-month period of 2019, which resulted in a decrease in interest expense on a tax-equivalent basis of$445 thousand . The reduction in interest-bearing deposits comparing the six months endedJune 30, 2020 and 2019 was entirely related to a$76.5 million , or 28.4%, decrease in average time deposits, which largely reflected maturing retail certificates of deposit that were not renewed, coupled with FNCB's decreased utilization of brokered deposits. The decline in average time deposit balances caused a$567 thousand decrease in interest expense comparing the year-to-date periods of 2020 and 2019. Volumes of interest-bearing demand deposits and savings deposits increased by$30.9 million and$4.1 million , respectively, comparing the six months endedJune 30, 2020 and 2019. Partially offsetting the net reduction in average interest-bearing deposits, was a$16.5 million , or 29.8%, increase in average borrowed funds to$71.8 million for the six months endedJune 30, 2020 , compared to$55.3 million for the same period in 2019, resulting in an increase in interest expense of$192 thousand . The$627 thousand decrease in tax-equivalent interest income largely reflected a reduction in tax-equivalent yield on average earning assets, partially mitigated by an increase in average earning assets. Tax-equivalent interest income was impacted by lower market interest rates, which resulted in a 28 basis point decrease in the yield on earning assets to 3.83% for the six months endedJune 30, 2020 from 4.11% for the same six months of 2019, which resulted in a$1.7 million decrease in tax-equivalent interest income. Specifically, the tax-equivalent yield on loans declined 38 basis points to 4.20% for the six months endedJune 30, 2020 from 4.58% for the same six months of 2019, causing a$1.6 million decline in tax-equivalent interest income. Earning assets averaged$1.184 billion for the six months endedJune 30, 2020 , an increase of$48.3 million , or 4.3% compared to$1.135 billion for the same six months of 2019, which resulted in a$1.1 million increase in tax-equivalent interest income. Specifically, comparing the first six months of 2020 and 2019, average loans increased$46.0 million , or 5.5%, which caused a$1.0 million increase in tax-equivalent interest income. PPP loans averaged$44.9 million for the six months endedJune 30, 2020 , with an average yield of 0.99%. 34
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Net interest income depends upon the relative amount of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them. The following tables present certain information about FNCB's consolidated statements of financial condition and consolidated statements of income for the three- and six-month periods endedJune 30, 2020 and 2019, and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are calculated by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are derived from average daily balances. The yields include amortization of fees which are considered adjustments to yields. Three Months Ended June 30, 2020 June 30, 2019 Average Yield/ Average Yield/ (dollars in thousands) Balance Interest Cost Balance Interest Cost Assets Earning assets (2)(3) Loans-taxable (4)$ 875,119 $ 8,661 3.96 %$ 778,540 $ 9,084 4.67 % Loans-tax free (4) 46,836 505 4.31 % 41,436 423 4.08 % Total loans (1)(2) 921,955 9,166 3.98 % 819,976 9,507 4.64 % Securities-taxable 247,939 1,739 2.81 % 274,552 1,927 2.81 % Securities-tax free 56,220 491 3.49 % 4,624 48 4.15 % Total securities (1)(5) 304,159 2,230 2.93 % 279,176 1,975 2.83 % Interest-bearing deposits in other banks 27,858 3 0.04 % 14,420 79 2.19 % Total earning assets 1,253,972 11,399 3.64 % 1,113,572 11,561 4.15 % Non-earning assets 97,303 94,709 Allowance for loan and lease losses (10,114 ) (9,280 ) Total assets$ 1,341,161 $ 1,199,001 Liabilities and Shareholders' Equity Interest-bearing liabilities Interest-bearing demand deposits$ 563,491 728 0.52 %$ 502,973 1,053 0.84 % Savings deposits 99,434 23 0.09 % 93,447 33 0.14 % Time deposits 187,600 625 1.33 % 255,306 1,058 1.66 % Total interest-bearing deposits 850,525 1,376 0.65 % 851,726 2,144 1.01 % Borrowed funds and other interest-bearing liabilities 81,813 234 1.14 % 52,313 364 2.78 % Total interest-bearing liabilities 932,338 1,610 0.69 % 904,039 2,508 1.11 % Demand deposits 258,609 158,413 Other liabilities 11,065 11,698 Shareholders' equity 139,149 124,851 Total liabilities and shareholder's equity$ 1,341,161 $ 1,199,001 Net interest income/interest rate spread (6) 9,789 2.95 % 9,053 3.04 % Tax equivalent adjustment (209 ) (99 ) Net interest income as reported$ 9,580 $ 8,954 Net interest margin (7) 3.12 % 3.25 %
(1) Interest income is presented on a tax equivalent basis using a 21% rate.
(2) Loans are stated net of unearned income.
(3) Non-accrual loans are included in loans within earning assets.
(4) Loan fees included in interest income are not significant.
(5) The yields for securities that are classified as available for sale is based
on the average historical amortized cost.
(6) Interest rate spread represents the difference between the average yield on
interest earning assets and the cost of interest-bearing liabilities and is
presented on a tax equivalent basis.
(7) Net interest income as a percentage of total average interest earning
assets.
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Six Months Ended
June 30, 2020 June 30, 2019
Average Yield/ Average Yield/
(dollars in thousands) Balance Interest Cost Balance Interest Cost
Assets
Earning assets (2)(3)
Loans-taxable (4) $ 827,987 $ 17,354 4.19 % $ 781,434 $ 18,024 4.61 %
Loans-tax free (4) 49,726 1,070 4.30 % 50,279 1,014 4.03 %
Total loans (1)(2) 877,713 18,424 4.20 % 831,712 19,038 4.58 %
Securities-taxable 255,817 3,666 2.87 % 286,956 4,046 2.82 %
Securities-tax free 31,959 563 3.52 % 4,631 95 4.10 %
Total securities (1)(5) 287,776 4,229 2.94 % 291,586 4,141 2.84 %
Interest-bearing deposits in
other banks 18,127 24 0.26 % 11,971 125 2.09 %
Total earning assets 1,183,616 22,677 3.83 % 1,135,270 23,304 4.11 %
Non-earning assets 98,328 93,136
Allowance for loan and lease
losses (9,540 ) (9,477 )
Total assets $ 1,272,404 $ 1,218,929
Liabilities and Shareholders'
Equity
Interest-bearing liabilities
Interest-bearing demand deposits $ 546,146 1,658 0.61 % $ 515,280 2,084 0.81 %
Savings deposits 96,712 51 0.11 % 92,651 65 0.14 %
Time deposits 193,013 1,327 1.38 % 269,561 2,233 1.66 %
Total interest-bearing deposits 835,871 3,036 0.73 % 877,491 4,382 1.00 %
Borrowed funds and other
interest-bearing liabilities 71,828 541 1.51 % 55,341 789 2.85 %
Total interest-bearing
liabilities 907,699 3,577 0.79 % 932,832 5,171 1.11 %
Demand deposits 215,371 156,777
Other liabilities 11,350 11,749
Shareholders' equity 137,984 117,571
Total liabilities and
shareholder's equity $ 1,272,404 $ 1,218,929
Net interest income/interest
rate spread (6) 19,100 3.04 % 18,133 3.00 %
Tax equivalent adjustment (343 ) (233 )
Net interest income as reported $ 18,757 $ 17,900
Net interest margin (7) 3.23 % 3.19 %
(1) Interest income is presented on a tax equivalent basis using a 21% rate.
(2) Loans are stated net of unearned income.
(3) Non-accrual loans are included in loans within earning assets.
(4) Loan fees included in interest income are not significant.
(5) The yields for securities that are classified as available for sale is based
on the average historical amortized cost.
(6) Interest rate spread represents the difference between the average yield on
interest earning assets and the cost of interest-bearing liabilities and is
presented on a tax equivalent basis.
(7) Net interest income as a percentage of total average interest earning
assets.
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Rate Volume Analysis
The most significant impact on net income between periods is derived from the
interaction of changes in the volume and rates earned or paid on
interest-earning assets and interest-bearing liabilities. The volume of earning
assets, specifically loans and investments, compared to the volume of
interest-bearing liabilities represented by deposits and borrowings, combined
with the spread, produces the changes in net interest income between periods.
Components of interest income and interest expense are presented on a
tax-equivalent basis using the corporate federal income tax rate of 21%.
The following table summarizes the effect that changes in volumes of earning
assets and interest-bearing liabilities and the interest rates earned and paid
on these assets and liabilities have on net interest income. The net change or
mix component attributable to the combined impact of rate and volume changes has
been allocated proportionately to the change due to volume and the change due to
rate.
Three Months Ended June 30, Six Months Ended June 30,
2020 vs. 2019 2020 vs. 2019
Increase (Decrease) Increase (Decrease)
Due to Due to Total Due to Due to Total
(in thousands) Volume Rate Change Volume Rate Change
Interest income:
Loans - taxable $ 1,050 $ (1,473 ) $ (423 ) $ 1,035 $ (1,705 ) $ (670 )
Loans - tax free 57 25 82 (11 ) 67 56
Total loans 1,107 (1,448 ) (341 ) 1,024 (1,638 ) (614 )
Securities - taxable (187 ) (1 ) (188 ) (445 ) 65 (380 )
Securities - tax free 452 (9 ) 443 483 (15 ) 468
Total securities 265 (10 ) 255 38 50 88
Interest-bearing
deposits in other
banks 109 (185 ) (76 ) 43 (144 ) (101 )
Total interest income 1,481 (1,643 ) (162 ) 1,105 (1,732 ) (627 )
Interest expense:
Interest-bearing
demand deposits 115 (440 ) (325 ) 119 (545 ) (426 )
Savings deposits 2 (12 ) (10 ) 3 (17 ) (14 )
Time deposits (249 ) (184 ) (433 ) (567 ) (339 ) (906 )
Total
interest-bearing
deposits (132 ) (636 ) (768 ) (445 ) (901 ) (1,346 )
Borrowed funds and
other
interest-bearing
liabilities 146 (276 ) (130 ) 192 (440 ) (248 )
Total interest
expense 14 (912 ) (898 )
(253 ) (1,341 ) (1,594 )
Net interest income
Provision for Loan and Lease Losses
Management closely monitors the loan portfolio and the adequacy of the ALLL by considering the underlying financial performance of the borrower, collateral values and associated credit risks. Future material adjustments may be necessary to the provision for loan and lease losses and the ALLL if economic conditions or loan performance differ substantially from the assumptions management considered in its evaluation of the ALLL. The provision for loan and lease losses is an expense charged against net interest income to provide for probable losses attributable to uncollectible loans and is based on management's analysis of the adequacy of the ALLL. A release of reserves, resulting in a credit for loan and lease losses, reflects the reversal of amounts previously charged to the ALLL. FNCB recorded a provision for loan and lease losses of$831 thousand for the three-month period endedJune 30, 2020 , an increase of$484 thousand compared to$347 thousand for the three months endedJune 30, 2019 . The provision for loan losses amounted to$2.0 million for the six months endedJune 30, 2020 , an increase of$1.8 million , from$193 thousand for the same six months of 2019. The increase in the credit provisioning for the quarter and year-to-date periods were primarily related to management's assessment of increased credit risk related to economic disruption and uncertainty caused by the COVID-19 pandemic. Non-interest Income Non-interest income increased$923 thousand , or 58.5%, to$2.5 million for the three months endedJune 30, 2020 from$1.6 million for the same three months of 2019. For the six months endedJune 30, 2020 , non-interest income increased$1.1 million , or 35.6%, to$4.2 million from$3.1 million for the same period of 2019. Higher net gains on the sale of available-for sale debt securities and increases in loan referral fees and net gains on the sale of residential mortgage loans held for sale were the predominant factors contributing to the increase in non-interest income comparing the three and six months endedJune 30, 2020 and 2019. FNCB realized net gains on the sales of available-for-sale securities of$922 thousand for the second quarter of 2020, an increase of$759 thousand , or 466.6%, compared to$163 thousand for the same quarter of 2019. Loan referral fees, which include commissions received from a correspondent bank related to an off-balance sheet commercial interest-rate hedge program and the referral of FHA residential mortgage loans to a third-party broker, increased$208 thousand , to$214 thousand for the three months endedJune 30, 2020 , compared to$6 thousand for the same period of 2019. FNCB realized net gains on the sale of mortgage loans of$183 thousand for the three months endedJune 30, 2020 , a$110 thousand or 150.7%, increase compared to$73 thousand in net gains realized for the same three-month period of 2019. For the six months endedJune 30, 2020 , net gains on the sale of available-for-sale securities amounted to$1.1 million , an increase of$748 thousand , or 231.6%, compared to$323 thousand for the same six months of 2019. Loan referral fees totaled$262 thousand for the six months endedJune 30, 2020 , an increase of$242 thousand compared to$20 thousand for the six months endedJune 30, 2019 . For the first half of 2020, net gains on the sale of mortgage loans amounted to$279 thousand , an increase of$150 thousand , or 116.3%, compared to$129 thousand for the first half of 2019. Additionally, in the second half of 2019, FNCB engaged an independent third party to conduct a comprehensive evaluation of FNCB's non-interest income and fee structure to identify opportunities for enhancement. Recommendations to the fee structure arising from this assessment were fully implemented prior to the beginning of 2020, resulting in the increase in deposit service charges, which increased$127 thousand or 9.0% year over year. These increases were slightly offset by a$47 thousand , or 6.5% decrease in loan-related fees to$25 thousand for the second quarter of 2020, compared to$72 thousand for the same quarter of 2019. Year-over-year, loan-related fees declined$70 thousand or 4.6% to$81 thousand atJune 30, 2020 compared to$151 thousand in 2019. The decrease in loan-related fees for the three and six months endedJune 30, 2020 was largely due to devaluation adjustments to FNCB's mortgage servicing rights. Additionally, other non-interest income declined$46 thousand , or 17.7%, to$214 thousand for second quarter of 2020 from$260 thousand for the second quarter of 2019. For the six months endedJune 30, 2020 and 2019, other non-interest income declined$64 thousand , or 12.3%, to$456 thousand from$520 thousand , respectively. 37
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Table of Contents Non-interest Expense Non-interest expense decreased$698 thousand , or 9.8%, to$6.4 million for the three months endedJune 30, 2020 from$7.1 million for the three months endedJune 30, 2019 . The decrease primarily reflected decreases in salaries and employee benefits, other operating expenses and data processing costs, partially offset by increases in equipment expense, occupancy expense and bank shares tax. Comparing the three months endedJune 30, 2020 and 2019, salaries and employee benefits decreased$326 thousand , or 8.5%, other operating expenses decreased$355 thousand , or 39.8%, and data processing costs decreased$80 thousand , or 10.1%. These expense reductions were partially offset by an increase in equipment expense of$31 thousand , or 9.4%, to$360 thousand for the three months endedJune 30, 2020 compared to$329 thousand for the same period in 2019. For the six months endedJune 30, 2020 , non-interest expense decreased$918 thousand , or 6.3%, to$13.6 million compared to$14.5 million for the same six-month period of 2019, primarily due to the decline in salaries and employee benefits, data processing expenses, regulatory assessments and professional fees. Salaries and employee benefits declined$296 thousand , or 3.8%, to$7.4 million atJune 30, 2020 , compared to$7.7 million atJune 30, 2019 , reflecting an increase in deferred loan origination costs associated with the origination of PPP loans, partially offset by merit increases. Data processing expenses and professional fees declined$136 thousand , or 8.7%, and$154 thousand , or 28.8%, respectively comparing the year-to-date periods of 2020 and 2019. In addition, regulatory assessments decreased$111 thousand , or 45.5%, comparing the six months endedJune 30, 2020 to 2019. The reduction in data processing costs and professional fees reflected more efficient utilization of third-party services, while the decrease in regulatory assessments was primarily due to the reversal of the fourth quarter 2019 accrual and partial reversal of the first quarter 2020 accrual following receipt of the small bank assessment credit in 2020. These decreases were partially offset by the$95 thousand or 14.9% increase in equipment expense, reflecting higher amounts of depreciation expense on furniture and equipment for the two new offices opened in mid-2019. For the six months endedJune 30, 2020 , FNCB incurred COVID-19 related costs, including stay-at-home pay, computer-related equipment to enable employees to work remotely, cleaning and sanitizing facilities and safety supplies, totaling$183 thousand , which is included in non-interest expense. Provision for Income Taxes FNCB recorded income tax expense of$1.3 million for the six months endedJune 30, 2020 , an increase of$188 thousand , or 17.6%, compared to income tax expense of$1.1 million for the same period of 2019. The increase in income tax expense primarily reflected an increase in pre-tax net income of$1.1 million , or 17.4%, when comparing the six months endedJune 30, 2020 and 2019. Management evaluates the carrying amount of its deferred tax assets on a quarterly basis, or more frequently, if necessary, in accordance with guidance set forth in ASC Topic 740 "Income Taxes," and applies the criteria in the guidance to determine whether it is more likely than not that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight of available evidence. If management determines based on available evidence, both positive and negative, that it is more likely than not that some portion or all of the deferred tax asset will not be realized in future periods, a valuation allowance is calculated and recorded. These determinations are inherently subjective and depend upon management's estimates and judgments used in their evaluation of both positive and negative evidence. In evaluating available evidence, management considers, among other factors, historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. In assessing the need for a valuation allowance, management carefully weighs both positive and negative evidence currently available. Management performed an evaluation of FNCB's deferred tax assets atJune 30, 2020 taking into consideration both positive and negative evidence that existed as of that date. Based on this evaluation, management believes that FNCB's future taxable income will be sufficient to utilize deferred tax assets. Accordingly, management concluded that no valuation allowance for deferred tax assets was required atJune 30, 2020 . FINANCIAL CONDITION Assets Total assets increased$214.6 million , or 17.8%, to$1.418 billion atJune 30, 2020 from$1.204 billion atDecember 31, 2019 . The change in total assets primarily reflected increases in net loans, available-for-sale debt securities and cash and cash equivalents. Net loans increased$117.9 million , or 14.4%, to$937.4 million atJune 30, 2020 from$819.5 million atDecember 31, 2019 , primarily reflecting the origination and funding of PPP loans, of which$117.0 million were outstanding atJune 30, 2020 . Available-for-sale debt securities increased$32.8 million , or 12.0%, to$305.6 million atJune 30, 2020 from$272.8 million atDecember 31, 2019 as security purchases outpaced sales and repayments. Total deposits increased$167.9 million to$1.170 billion atJune 30, 2020 from$1.002 billion atDecember 31, 2019 . Meanwhile, borrowed funds increased$32.2 million , or 56.2%, to$89.4 million atJune 30, 2020 as compared to$57.2 million atDecember 31, 2019 , which was primarily due to receipt of$36.2 million in PPPLF funding through the Federal Reserve Discount Window. Cash and Cash Equivalents Cash and cash equivalents increased$66.9 million , or 193.6%, to$101.5 million atJune 30, 2020 from$34.6 million atDecember 31, 2019 . The increase was primarily due to proceeds received from deposit gathering and borrowed funds, partially offset by increases in available-for-sale debt securities and gross loans. FNCB paid dividends of$0.055 per share and$0.11 per share for the three and six months endedJune 30, 2020 and 2019, an increase of 10% compared to dividends of$0.05 per share and$0.10 per share paid in the respective periods of 2019. Securities FNCB's investment securities portfolio provides a source of liquidity needed to meet expected loan demand and interest income to increase profitability. Additionally, the investment securities portfolio is used to meet pledging requirements to secure public deposits and for other purposes. Debt securities are classified as either held-to-maturity or available-for-sale at the time of purchase based on management's intent. Held-to-maturity securities are carried at amortized cost, while available-for-sale securities are carried at fair value, with unrealized holding gains and losses reported as a component of shareholders' equity in accumulated other comprehensive income (loss), net of tax. AtJune 30, 2020 andDecember 31, 2019 , all debt securities were classified as available-for-sale. Equity securities with readily determinable fair values are carried at fair value, with gains and losses due to fluctuations in market value included in the consolidated statements of income. Securities with limited marketability and/or restrictions, such as FHLB ofPittsburgh stock, are carried at cost. Management monitors the investment portfolio regularly. Decisions to purchase or sell investment securities are based upon management's current assessment of long- and short-term economic and financial conditions, including the interest rate environment and asset/liability management, liquidity and tax-planning strategies. 38
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AtJune 30, 2020 , the investment portfolio was comprised principally of fixed-rate taxable and tax-exempt obligations of state and political subdivisions, fixed-rate and floating-rate securities issued byU.S. government orU.S. government-sponsored agencies, which include mortgage-backed securities and residential and commercial collateralized mortgage obligations ("CMOs"), private CMOs and corporate debt securities. Except forU.S. government and government-sponsored agencies, there were no securities of any individual issuer that exceeded 10.0% of shareholders' equity atJune 30, 2020 . The following table presents the carrying value of debt securities, all of which were classified as available-for-sale and carried at fair value atJune 30, 2020 andDecember 31, 2019 :
Composition of the Investment Portfolio
June 30, December 31,
(in thousands) 2020 2019
Available-for-sale debt securities
Obligations of state and political subdivisions $ 179,200 $ 117,763
U.S. government/government-sponsored agencies:
Collateralized mortgage obligations - residential 59,346 80,294
Collateralized mortgage obligations - commercial 4,710
17,723
Mortgage-backed securities 11,098
18,485
Private collateralized mortgage obligations 28,485 25,075 Corporate debt securities 15,687 7,182 Asset-backed securities 6,390 5,621 Negotiable certificates of deposit 695
696
Total available-for-sale debt securities$ 305,611 $ 272,839 During the six months endedJune 30, 2020 , FNCB sold 22 available-for-sale debt securities which included thirteenU.S. government/government sponsored agency CMOs and nine taxable obligations of state and political subdivisions. The securities sold had an aggregate amortized cost of$50.8 million with a weighted-average yield of 1.84%. For the six months endedJune 30, 2020 , gross proceeds received totaled$51.9 million , with a net gain of$1.1 million realized upon the sales and included in non-interest income. During the six months endedJune 30, 2020 , FNCB purchased 40 available-for-sale debt securities including 30 tax-exempt obligations of state and political subdivisions, four corporate debt securities, three taxable obligations of state and political subdivisions, two private asset-backed securities and one private CMO with an aggregate cost of$83.1 million and a weighted-average yield of 2.92%. Due to tax planning strategies designed to utilize NOL carryovers, management previously minimized holdings of tax-exempt obligations. However, market volatility in the first half of 2020 resulted in a favorable shift in yields on tax-exempt bonds, which was the driving factor leading to the purchase of the tax-exempt bonds. The following table presents the maturities of available-for-sale debt securities, based on carrying value atJune 30, 2020 and the weighted-average yields of such securities calculated on the basis of the amortized cost and effective yields weighted for the scheduled maturity of each security. The yields on tax-exempt obligations of state and political subdivisions are presented on a tax-equivalent basis using the federal corporate income tax rate of 21.0%. Because residential, commercial and private collateralized mortgage obligations, mortgage-backed securities and asset-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following summary.
Maturity Distribution of the Investment Portfolio
June 30, 2020
Collateralized
Mortgage
Obligations,
Mortgage-Backed
Over 10 and Asset-Backed
(dollars in thousands) < 1 Year >1 - 5 Years 6 - 10 Years Years Securities Total
Available-for-sale debt securities
Obligations of state and political
subdivisions $ 501 $ 55,853 $ 31,392 $ 91,454 $ - $ 179,200
Yield 2.29 % 2.89 % 2.96 % 3.09 % 3.00 %
U.S. government/government-sponsored
agencies:
Collateralized mortgage obligations -
residential - - - - 59,346 59,346
Yield 2.74 % 2.74 %
Collateralized mortgage obligations -
commercial - - - - 4,710 4,710
Yield 1.59 % 1.59 %
Mortgage-backed securities - - - - 11,098 11,098
Yield 3.51 % 3.51 %
Private collateralized mortgage
obligations - - - - 28,485 28,485
Yield 2.93 % 2.93 %
Corporate debt securities - - 15,687 - - 15,687
Yield 5.54 % 5.54 %
Asset-backed securities - - - - 6,390 6,390
Yield 1.72 % 1.72 %
Negotiable certificates of deposit 695 - - - - 695
Yield 2.31 % 2.31 %
Total available-for-sale debt
securities $ 1,196 $ 55,853 $ 47,079 $ 91,454 $ 110,029 $ 305,611
Weighted average yield 2.30 % 2.89 % 3.82 % 3.09 % 2.76 % 3.04 %
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Table of Contents OTTI Evaluation There was no OTTI recognized during the six months endedJune 30, 2020 or 2019. For additional information regarding management's evaluation of securities for OTTI, see Note 3, "Securities/Subsequent Event" of the notes to consolidated financial statements included in Item 1 hereof.
The following table presents the investment in FNCB's restricted securities,
which have limited marketability and are carried at cost, at
June 30, December 31,
(in thousands) 2020 2019
Stock in
10 10
Total restricted securities, at cost$ 3,309 $ 3,804
Management noted no indicators of impairment for the
AtJune 30, 2020 andDecember 31, 2019 , FNCB owned 201,000 shares of the common stock of a privately-held bank holding company. The common stock was purchased during 2017 for$8.25 per share, or$1.7 million in aggregate, as part of a private placement pursuant to an exemption from the registration requirements of the Securities Act of 1933, as amended for offerings not involving any public offering. The common stock of such bank holding company is not currently traded on any established market and is not expected to be traded in the near future on any securities exchange or established over-the-counter market. The$1.7 million investment is included in other assets in the consolidated statements of financial condition atJune 30, 2020 andDecember 31, 2019 . FNCB has elected to account for this transaction as an investment in an equity security without a readily determinable fair value. Under GAAP, an equity security without a readily determinable fair value shall be written down to its fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than its carrying value. OnDecember 18, 2019 , this privately held bank holding company had entered into an Agreement and Plan Merger ("Merger Agreement") with a publicly traded bank holding company. The Merger Agreement provided for this privately-held bank holding company to merge with and into the publicly traded bank holding company, the company surviving the merger ("surviving company"). At the effective time of the merger, each share of the privately-held bank holding company's common stock issued and outstanding prior to the effective time of merger will be converted into the right to receive 0.6212 shares of common stock of the surviving company or$16.50 in cash, at the election of holder; provided, however, individual shareholder elections of consideration will be prorated as necessary to ensure that, in aggregate, 25% of the privately held bank holding company's stock will be converted into the cash consideration with the remaining 75% converted into stock consideration. The acquisition was subsequently completed onJuly 1, 2020 . FNCB received 78,822 shares of the surviving company's common stock and$1.2 million in cash. Based on these events, management determined that no adjustment for impairment was required atJune 30, 2020 . Loans Total loans, gross, increased$124.6 million , or 15.1%, to$950.9 million atJune 30, 2020 from$826.3 million atDecember 31, 2019 , which was predominantly due to the origination and funding of$117.0 million in PPP loans. FNCB saw modest growth in loans to the commercial sector, excluding PPP loans, and loans to state and political subdivisions, partially offset by a reduction in consumer loans. Residential mortgage loans were flat. Historically, commercial lending activities represented a significant portion of FNCB's loan portfolio. As a percentage of total loans, gross, commercial loans including commercial and industrial loans, commercial real estate loans and construction, land acquisition and development loans, increased to 64.5% atJune 30, 2020 from 57.3% atDecember 31, 2019 , which largely reflected the origination and funding of PPP loans. From a collateral standpoint, a majority of FNCB's loan portfolio consists of loans secured by real estate. Real estate secured loans, which include commercial real estate, construction, land acquisition and development, residential real estate loans and home equity lines of credit ("HELOCs"), increased$7.3 million , or 1.4%, to$521.0 million atJune 30, 2020 from$513.7 million atDecember 31, 2019 . The increase was concentrated in construction, land acquisition and development loans and commercial real estate loans. Real estate secured loans represented 54.8% and 62.2% of total loans atJune 30, 2020 andDecember 31, 2019 , respectively. Commercial real estate loans increased$3.6 million , or 1.3%, to$282.0 million atJune 30, 2020 from$278.4 million atDecember 31, 2019 . Commercial real estate loans include long-term commercial mortgage financing and are primarily secured by first or second lien mortgages. Commercial and industrial loans, which consist primarily of equipment loans, working capital financing, revolving lines of credit and loans secured by cash and marketable securities and PPP loans,increased$132.7 million , or 89.9%, to$280.3 million atJune 30, 2020 from$147.6 million atDecember 31, 2019 . Excluding PPP loans, commercial and industrial loans increased$15.7 million , or 10.6%. Construction, land acquisition and development loans increased$3.6 million , or 7.6%, to$51.1 million atJune 30, 2020 from$47.5 million atDecember 31, 2019 . Residential real estate loans totaled$170.5 million atJune 30, 2020 , a decrease of$0.2 million , or 0.1%, from$170.7 million atDecember 31, 2019 . The components of residential real estate loans include fixed-rate and variable-rate, amortizing mortgage loans. HELOCs are not included in this category but are included in consumer loans. FNCB primarily underwrites fixed-rate residential mortgage loans for sale in the secondary market to reduce interest rate risk and provide funding for additional loans. Additionally, FNCB offers its proprietary "WOW" mortgage product, which is a non-saleable mortgage with maturity terms of 7.5 to 19.5 years that provides customers with an attractive fixed interest rate, low closing costs and a guaranteed 30-day close. Consumer loans, which are primarily comprised of indirect automobile loans and HELOCs, decreased by$17.6 million , or 12.8%, to$120.6 million atJune 30, 2020 from$138.2 million atDecember 31, 2019 . The majority of this decrease was concentrated within the indirect auto loan portfolio, as FNCB did not aggressively compete for these loans. Loans to state and political subdivisions increased$2.5 million , or 5.8%, to$46.4 million atJune 30, 2020 from$43.9 million atDecember 31, 2019 . 40
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The following table presents loans receivable, net by major category at
Loan Portfolio Detail
June 30, December 31,
(in thousands) 2020 2019
Residential real estate $ 170,517 $ 170,723
Commercial real estate 281,950 278,379
Construction, land acquisition and development 51,144 47,484
Commercial and industrial 280,270 147,623
Consumer 120,578 138,239
State and political subdivisions 46,443 43,908
Total loans, gross 950,902 826,356
Unearned income (123 ) (69 )
Net deferred loan costs (2,351 ) 2,192
Allowance for loan and lease losses (11,024 ) (8,950 )
Loans, net $ 937,404 $ 819,529
Under industry regulations, a concentration is considered to exist when there
are amounts loaned to a multiple number of borrowers engaged in similar
activities which would cause them to be similarly impacted by economic or other
conditions. Typically, industry guidelines require disclosure of concentrations
of loans exceeding 10.0% of total loans outstanding. FNCB had no such
concentrations at June 30, 2020 or December 31, 2019 . In addition to industry
guidelines, FNCB's internal policy considers a concentration to exist in its
loan portfolio if an aggregate loan balance outstanding to borrowers within a
specific industry exceeds 25.0% of capital. However, management regularly
reviews loans by all industry categories to determine if a potential
concentration exists.
The following table presents industry concentrations within FNCB's loan
portfolio at
Loan Concentrations
June 30, 2020 December 31, 2019
(in thousands) Amount % of Gross Loans Amount % of Gross Loans
Retail space/shopping centers $ 41,571 4.37 % $ 43,865 5.31 %
1-4 family residential
investment properties 46,392 4.88 % 38,122 4.61 %
As the fallout of the COVID-19 pandemic continues to impact the national,
regional and local economies, management continues to proactively monitor the
loan portfolio to identify potential weaknesses that may develop. Specifically,
management has identified and is monitoring exposures to borrowers and
industries that may be impacted more immediately and acutely than others. In
many instances, management has directly reached out to specific borrowers to
provide guidance and assistance as appropriate. At June 30, 2020 , FNCB had $14.5
million in outstanding loan balances to borrowers in the hotel industry and
$17.3 million in outstanding loans to borrowers of full-service, limited-service
and other establishments serving alcoholic and non-alcoholic beverages and
snacks. On a portfolio level, management continues to monitor aggregate
exposures to these highly sensitive segments, among others, for changes in asset
quality and payment performance, and even liquidity levels. Additionally,
management is monitoring unfunded commitments such as lines of credit and
overdraft protection to determine liquidity and funding issues that may arise
with our customers.
Asset Quality
Loans that management has the intent and ability to hold for the foreseeable
future or until maturity or payoff are stated at the amount of unpaid principal,
net of unearned interest, deferred loan fees and costs, and reduced by the ALLL.
The ALLL is established through a provision for loan and lease losses charged to
earnings.
FNCB has established and consistently applies loan policies and procedures
designed to foster sound underwriting and credit monitoring practices. Credit
risk is managed through the efforts of the Chief Lending Officer and loan
officers, the Chief Credit Officer, the loan review function, and the Credit
Risk Management, ALLL, Officers Loan and Directors Loan Committees, as well as
through oversight of the Board of Directors. Management continually evaluates
its credit risk management practices to ensure it is reacting to problems in the
loan portfolio in a timely manner, although, as is the case with any financial
institution, a certain degree of credit risk is dependent in part on local and
general economic conditions that are beyond management's control.
Under FNCB's risk rating system, loans that are rated pass, special mention,
substandard, doubtful, or loss are reviewed regularly as part of the risk
management practices. The Credit Risk Management Committee, which consists of
key members of management fromfinance, legal, retail lending and credit
administration, meet monthly or more often as necessary to review individual
problem credits and workout strategies and provides monthly reports to the Board
of Directors.
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A loan is considered impaired when it is probable that FNCB will be unable to collect all amounts due (including principal and interest) according to the contractual terms of the note and loan agreement. For purposes of the analysis, all TDRs, loan relationships with an aggregate outstanding balance greater than$100 thousand rated substandard and non-accrual, and loans that are identified as doubtful or loss are considered impaired. Impaired loans are analyzed individually to determine the amount of impairment. For collateral-dependent loans, impairment is measured based on the fair value of the collateral supporting the loans. A loan is determined to be collateral dependent when repayment of the loan is expected to be provided through the liquidation of the collateral held. For impaired loans that are secured by real estate, collateral evaluations and external appraisals are obtained annually, or more frequently as warranted, to ascertain a fair value so that the impairment analysis can be updated. Should a collateral evaluation or current appraisal not be available at the time of impairment analysis, other sources of valuation may be used, including current letters of intent, broker price opinions or executed agreements of sale. For non-collateral-dependent loans, impairment is measured based on the present value of expected future cash flows, net of any deferred fees and costs, discounted at the loan's original effective interest rate. Loans to borrowers that are experiencing financial difficulty that are modified and result in the granting of concessions to the borrowers are classified as TDRs. Such concessions generally involve an extension of a loan's stated maturity date, a reduction of the stated interest rate, payment modifications, capitalization of property taxes with respect to mortgage loans or a combination of these modifications. Non-accrual TDRs are returned to accrual status if principal and interest payments, under the modified terms, are brought current, are performing under the modified terms for six consecutive months, and management believes that collection of the remaining interest and principal is probable. FNCB conservatively considers all TDRs to be impaired. Non-performing loans are monitored on an ongoing basis as part of FNCB's loan review process. Additionally, work-out for non-performing loans and OREO are actively monitored through the Credit Risk Management Committee. A potential loss on a non-performing asset is generally determined by comparing the outstanding loan balance to the fair market value of the pledged collateral, less cost to sell. Loans are placed on non-accrual when a loan is specifically determined to be impaired or when management believes that the collection of interest or principal is doubtful. This generally occurs when a default of interest or principal has existed for 90 days or more, unless the loan is well secured and in the process of collection, or when management becomes aware of facts or circumstances that the loan would default before 90 days. FNCB determines delinquency status based on the number of days since the date of the borrower's last required contractual loan payment. When the interest accrual is discontinued, all unpaid interest income is reversed and charged back against current earnings. Any subsequent cash payments received are applied, first to the outstanding loan amounts, then to the recovery of any charged-off loan amounts, with any excess treated as a recovery of lost interest. A non-accrual loan is returned to accrual status when the loan is current as to principal and interest payments, is performing according to contractual terms for six consecutive months and future payments are reasonably assured. Management actively manages impaired loans in an effort to mitigate loss to FNCB by working with customers to develop strategies to resolve borrower difficulties, through sale or liquidation of collateral, foreclosure, and other appropriate means. In addition, management monitors employment and economic conditions within FNCB's market area, as weakening of conditions could result in real estate devaluations and an increase in loan delinquencies, which could negatively impact asset quality and cause an increase in the provision for loan and lease losses. Under the fair value of collateral method, the impaired amount of the loan is deemed to be the difference between the loan amount and the fair value of the collateral, less the estimated costs to sell. For real estate secured loans, management generally estimates selling costs using a factor of 10%, which is based on typical cost factors, such as a 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process. If the valuation indicates that the fair value has deteriorated below the carrying value of the loan, the difference between the fair value and the principal balance is charged off. For impaired loans for which the value of the collateral less costs to sell exceeds the loan value, the impairment is determined to be zero.
The following table presents information about non-performing assets and
accruing TDRs at
Non-performing Assets and Accruing TDRs
June 30, December 31,
(dollars in thousands) 2020 2019
Non-accrual loans $ 6,740 $ 9,084
Loans past due 90 days or more and still accruing - -
Total non-performing loans 6,740 9,084
Other real estate owned 85 289
Other non-performing assets 1,900 1,900
Total non-performing assets $ 8,725 $ 11,273
Accruing TDRs $ 8,592 $ 7,745 Non-performing loans as a percentage of gross loans 0.71 %
1.10 % Total non-performing assets decreased$2.5 million , or 22.6%, to$8.7 million atJune 30, 2020 from$11.3 million atDecember 31, 2019 . The improvement was attributable to a decrease in non-accrual loans, primarily reflecting the return of two large commercial loan relationships that returned to accrual status, coupled with a decrease in OREO. FNCB's ratio of non-performing loans to total gross loans decreased to 0.71% atJune 30, 2020 from 1.10% atDecember 31, 2019 . FNCB's ratio of non-performing assets as a percentage of shareholders' equity improved to 6.0% atJune 30, 2020 from 8.4% atDecember 31, 2019 , due to primarily to an increase in FNCB's capital position, coupled with the reduction in non-performing assets. 42
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Other non-performing assets atJune 30, 2020 andDecember 31, 2019 was comprised solely of a classified account receivable secured by an evergreen letter of credit in the amount of$1.9 million , received in 2011 as part of a settlement agreement for a large construction, land acquisition and development loan for a residential development project in thePocono region ofMonroe County, Pennsylvania . The agreement provides for payment to FNCB as real estate building lots are sold. The project was stalled due to a decline in real estate values in this area following the financial crisis of 2008. In 2019, economic development in this market area started to improve and management had confirmed that the developer for this project had resumed construction activity, including the completion of substantial infrastructure, and had increased marketing and sales initiatives related to the project. As ofJune 30, 2020 , no single-unit lots have been sold, however, construction of a four-unit building is in process. Management continues to monitor this project closely. Due to the current economic disruption and uncertainty related to the COVID-19 pandemic, it is difficult to predict the timing of sales at this time. While credit quality metrics of FNCB's loan portfolio improved comparingJune 30, 2020 andDecember 31, 2019 , management believes the COVID-19 pandemic may have an adverse effect on asset quality during the remainder of 2020 and beyond. Prolonged disruption to FNCB's customers could result in increased loan delinquencies, defaults and collateral devaluations. Management actively manages problem credits through workout efforts focused on developing strategies to resolve borrower difficulties through liquidation of collateral and other appropriate means. Additionally, management continues to monitor non-accrual loans, delinquency trends and economic conditions within FNCB's market area on an on-going basis in order to proactively address any collection-related issues and mitigate any potential losses. There were three commercial and industrial loans and one residential mortgage loan modified as TDRs during the three and six months endedJune 30, 2020 . The three commercial and industrial loans were modified under forbearance agreements and had an aggregate pre- and post-modification recorded investment of$196 thousand . The one residential mortgage loan that was modified as a TDR involved an extension of terms and the loan had a pre- and post-modification recorded investment of$88 thousand . There was one residential loan modified as a TDR during the three and six months endedJune 30, 2019 . The modification involved an extension of terms and the loan had a pre-and post-modification balance of$24 thousand . There were no TDRs modified within the previous 12 months that defaulted during the three and six months endedJune 30, 2020 and 2019. There was one consumer TDR that was modified within the previous 12 months in the amount of$103 thousand that defaulted (defined as past 90 days or more) during the three and six months endedJune 30, 2019 . TDRs at bothJune 30, 2020 andDecember 31, 2019 were$9.1 million . Accruing and non-accruing TDRs were$8.6 million and$0.5 million , respectively atJune 30, 2020 and$7.7 million and$1.4 million , respectively atDecember 31, 2019 . FNCB was not committed to lend additional funds to any loan classified as a TDR atJune 30, 2020 .
Modifications Related to COVID-19
In lateMarch 2020 , the federal banking regulators issued guidance that short-term modifications made to a borrower affected by the COVID-19 pandemic and governmental shutdown orders do not need to be identified as a TDR if the loan was current at the time a modification plan was implemented. Section 4013 of the CARES Act also addressed COVID-19-related modifications and specified that such modifications made on loans that were current as ofDecember 31, 2019 are not TDRs. As ofJune 30, 2020 , FNCB has applied this guidance and made 905 such modifications with principal balances totaling$176.6 million . Management is closely monitoring all loans for which a payment deferral has been granted and will continue to follow guidance issued by the banking regulators in making any TDR determinations. The following table presents the number, and aggregate recorded investment, of COVID-19 related loan modifications by major loan category that were outstanding atJune 30, 2020 . Deferrals Remaining (in thousands) As of June 30, 2020 Recorded COVID -19 related loan modifications: Number of Loans Investment Residential real estate 213$ 20,338 Commercial real estate 160 108,100 Construction, land acquisition and development 16 16,340 Commercial and industrial 110 23,880 Consumer 406 7,920 State and political subdivisions - - Total 905$ 176,578 As ofJuly 30, 2020 , there were 128 loans with an aggregate recorded investment of$17.1 million that were still in deferment. There were 777 loans, with an aggregate recorded investment of$159.5 million , as ofJuly 30, 2020 for which the deferral period had expired and the borrower had not requested any additional deferral. The average balance of impaired loans was$14.8 million and$15.0 million , respectively, for the three and six months endedJune 30, 2020 and 2019, compared to$12.7 million and$12.8 million , respectively for the three and six months endedJune 30, 2019 . FNCB recognized$98 thousand and$189 thousand of interest income on impaired loans for the three and six months endedJune 30, 2020 , respectively and$101 thousand and$205 thousand for the respective periods of 2019. The following table presents the changes in non-performing loans for the three and six months endedJune 30, 2020 and 2019. Loan foreclosures represent recorded investment at time of foreclosure not including the effect of any guarantees. There were no loans foreclosed upon during the three and six months endedJune 30, 2020 and 2019.
Changes in Non-Performing Loans
Three Months Ended June 30, Six Months Ended June 30,
(in thousands) 2020 2019 2020 2019
Balance, beginning of period $ 8,576 $ 6,175 $ 9,084 $ 4,696
Loans newly placed on non-accrual 717 816 1,436 3,094
Loans returned to performing status (1,521 ) (4 ) (1,569 ) (27 )
Loan foreclosures - - - -
Loans charged-off (310 ) (1,120 ) (624 ) (1,567 )
Loan payments received (722 ) (565 ) (1,587 ) (894 )
Balance, end of period $ 6,740 $ 5,302 $ 6,740 $ 5,302
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The additional interest income that would have been earned on non-accrual and restructured loans had the loans been performing in accordance with their original terms for the three and six months endedJune 30, 2020 approximated$94 thousand and$205 thousand , respectively and$95 thousand and$177 thousand for the respective periods of 2019.
The following table presents accruing loan delinquencies and non-accrual loans
as a percentage of gross loans at
Loan Delinquencies and Non-Accrual Loans
June 30, December 31,
2020 2019
Accruing:
30-59 days 0.16 % 0.26 %
60-89 days 0.03 % 0.10 %
90+ days 0.00 % 0.00 %
Non-accrual 0.71 % 1.10 %
Total delinquencies 0.90 % 1.46 %
Total delinquencies as a percent of gross loans were 0.90% at
Allowance for Loan and Lease Losses
The ALLL represents management's estimate of probable loan losses inherent in the loan portfolio. The ALLL is analyzed in accordance with GAAP and is maintained at a level that is based on management's evaluation of the adequacy of the ALLL in relation to the risks inherent in the loan portfolio.
As part of its evaluation, management considers qualitative and environmental factors, including, but not limited to:
• changes in national, local, and business economic conditions and developments,
including the condition of various market segments;
• changes in the nature and volume of the loan portfolio;
• changes in lending policies and procedures, including underwriting standards,
collection, charge-off and recovery practices and results;
• changes in the experience, ability and depth of lending management and staff;
• changes in the quality of the loan review system and the degree of oversight by
the Board of Directors;
• changes in the trend of the volume and severity of past due and classified
loans, including trends in the volume of non-accrual loans, TDRs and other loan
modifications;
• the existence and effect of any concentrations of credit and changes in the
level of such concentrations;
• the effect of external factors such as competition and legal and regulatory
requirements on the level of estimated credit losses in the current loan
portfolio; and
• analysis of customers' credit quality, including knowledge of their operating
environment and financial condition.
Evaluations are intrinsically subjective, as the results are estimated based on management knowledge and experience and are subject to interpretation and modification as information becomes available or as future events occur. Management monitors the loan portfolio on an ongoing basis with emphasis on weakness in both the real estate market and the economy in general and its effect on repayment. Adjustments to the ALLL are made based on management's assessment of the factors noted above.
For purposes of management's analysis of the ALLL, all loan relationships with an aggregate balance greater than$100 thousand that are rated substandard and non-accrual, identified as doubtful or loss, and all TDRs are considered impaired and are analyzed individually to determine the amount of impairment. Circumstances such as construction delays, declining real estate values, and the inability of the borrowers to make scheduled payments have resulted in these loan relationships being classified as impaired. FNCB utilizes the fair value of collateral method for collateral-dependent loans and TDRs for which repayment depends on the sale of collateral. For non-collateral-dependent loans and TDRs, FNCB measures impairment based on the present value of expected future cash flows discounted at the loan's original effective interest rate. With regard to collateral-dependent loans, appraisals are received at least annually to ensure that impairment measurements reflect current market conditions. Should a current appraisal not be available at the time of impairment analysis, other valuation sources including current letters of intent, broker price opinions or executed agreements of sale may be used. Only downward adjustments are made based on these supporting values. Included in all impairment calculations is a cost to sell adjustment of approximately 10%, which is based on typical cost factors, including a 6% broker commission, 1% transfer taxes and 3% various other miscellaneous costs associated with the sales process. Sales costs are periodically reviewed and revised based on actual experience. The ALLL analysis is adjusted for subsequent events that may arise after the end of the reporting period but before the financial reports are filed. The ALLL equaled$11.0 million , or 1.16% of total loans atJune 30, 2020 , an increase of$2.1 million , or 23.2%, from$8.9 million atDecember 31, 2019 . The increase resulted from$2.0 million in provisions for loan and lease losses for the six months endedJune 30, 2020 , offset by$92 thousand in net recoveries for the same time period. The increase in the ALLL was primarily related to economic disruption and uncertainty caused by the COVID-19 pandemic. Management adjusted the qualitative factors for the potential effect of economic and employment uncertainty and disruption due to the global pandemic into its evaluation. The ALLL consists of both specific and general components. The component of the ALLL that is related to impaired loans that are individually evaluated for impairment, the guidance for which is provided by ASC 310 "Impairment of a Loan" ("ASC 310"), was$513 thousand , or 4.7%, of the total ALLL atJune 30, 2020 , compared to$473 thousand , or 5.3%, of the total ALLL atDecember 31, 2019 . A general allocation of$10.5 million was calculated for loans analyzed collectively under ASC 450 "Contingencies" ("ASC 450"), which represented 95.3% of the total ALLL of$11.0 million . Comparatively, atDecember 31, 2019 , the general allocation for loans collectively analyzed for impairment amounted to$8.5 million , or 94.7%, of the total ALLL. Included in the general component of the ALLL atJune 30, 2020 was an unallocated reserve of$1.0 million , compared to$426 thousand atDecember 31, 2019 . The increase in the unallocated reserve was directly related to the increase in credit provisioning due to the economic disruption caused by the COVID-19 pandemic. Based on its evaluations, management may establish an unallocated component to cover any inherent losses that exist as of the evaluation date, but which may not have been identified under the methodology. The ratio of the ALLL to total loans increased to 1.16% of total loans, net of net deferred loan fees and unearned income, of$948.4 million atJune 30, 2020 from 1.08% of total loans, net of net deferred loan costs and unearned income, of$828.5 million atDecember 31, 2019 . Excluding PPP loans, the ALLL as a percentage of gross loans equaled 1.32% atJune 30, 2020 . 44
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The following table presents an allocation of the ALLL by major loan category and percent of loans in each category to total loans atJune 30, 2020 andDecember 31, 2019 : Allocation of the ALLL June 30, 2020 December 31, 2019 Percentage Percentage of Loans of Loans in Each in Each Category Category Allowance to Total Allowance to Total (dollars in thousands) Amount Loans Amount Loans Residential real estate$ 1,351 17.93 %$ 1,147 20.66 % Commercial real estate 3,942 29.65 % 3,198 33.69 % Construction, land acquisition and development 360 5.38 % 271 5.75 % Commercial and industrial 2,343 29.48 % 1,997 17.86 % Consumer 1,689 12.68 % 1,658 16.73 % State and political subdivision 337 4.88 % 253 5.31 % Unallocated 1002 0.00 % 426 0.00 % Total$ 11,024 100.00 %$ 8,950 100.00 %
The following table presents an analysis of the ALLL by loan category for the
three and six months ended
Reconciliation of the ALLL
For the Three Months Ended June 30, For the Six Months Ended June 30,
(dollars in thousands) 2020 2019 2020 2019
Balance at beginning of period $ 9,907 $ 9,253 $ 8,950 $ 9,519
Charge-offs:
Residential real estate - 27 - 27
Commercial real estate - - 56 -
Construction, land acquisition and
development - 18 - 18
Commercial and industrial 92 621 127 760
Consumer 224 457 462 772
State and political subdivisions - - - -
Total charge-offs 316 1,123 645 1,577
Recoveries of charged-off loans:
Residential real estate 37 2 39 6
Commercial real estate 1 14 1 14
Construction, land acquisition and
development - - - 81
Commercial and industrial 425 123 484 207
Consumer 139 329 213 502
State and political subdivisions - - - -
Total recoveries 602 468 737 810
Net (recoveries) charge-offs (286 ) 655 (92 ) 767
Provision for loan and lease losses 831 347 1,982 193
Balance at end of period $ 11,024 $ 8,945 $ 11,024 $ 8,945
Net charge-offs as a percentage of
average loans (0.03 )% 0.01 % (0.01 )% 0.09 %
Allowance for loan and lease losses as a
percentage of gross loans outstanding at
period end 1.16 % 1.10 % 1.16 % 1.10 %
Allowance for loan and lease losses as a
percentage of gross loans outstanding at
period end, excluding PPP Loans 1.32 % - 1.32 % -
Other Real Estate Owned
There was one piece of commercial land with a carrying value of $85 thousand
held in OREO at June 30, 2020 . There were two properties with an aggregate
carrying value of $289 thousand at December 31, 2019 , including the piece of
commercial land and a single family residential real estate property with
carrying values of $85 thousand and $204 thousand , respectively. The residential
real estate property was sold during the six months ended June 30, 2020 . The
property sold was collateral supporting an investor-owned residential mortgage
loan. The agreement with the investor requires FNCB to take title to the
property upon foreclosure and FNCB is responsible for the property liquidation
on behalf of the investor after foreclosure. FNCB did not realize any gain or
loss upon the sale. There were no properties foreclosed upon during the
six months ended June 30, 2020 . There was one property with a fair value less
cost to sell of $52 thousand that was foreclosed upon during the six months
ended June 30, 2019 . The property foreclosed upon was the collateral supporting
an investor-owned residential mortgage loan. There were three OREO properties,
with an aggregate carrying value of $411 thousand , sold during the six months
ended June 30, 2019 . FNCB realized a net gain of $9 thousand upon the sales,
which is included in non-interest income for the six months ended June 30, 2019 .
The expenses related to maintaining OREO, not including adjustments to property
values subsequent to foreclosure, and net of any income from operation of the
properties, amounted to $35 thousand and $90 thousand for the three and six
months ended June 30, 2020 , respectively, compared to $14 thousand and $65
thousand for the respective periods of 2019.
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FNCB actively markets OREO properties for sale through a variety of channels including internal marketing and the use of outside brokers/realtors. The carrying value of OREO is generally calculated at an amount not greater than 90% of the most recent fair market appraised value unless specific conditions warrant an exception. A 10% factor is generally used to estimate costs to sell, which is based on typical cost factors, such as 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process. This fair value is updated on an annual basis or more frequently if new valuation information is available. Deterioration in the real estate market could result in additional losses on these properties. There were no valuation adjustments recorded on OREO properties during the three and six months endedJune 30, 2020 and 2019. Liabilities Total liabilities, which consist primarily of total deposits and borrowed funds, were$1.273 billion atJune 30, 2020 , an increase of$202.9 million , or 19.0%, from$1.070 billion atDecember 31, 2019 . The increase was primarily attributable to an increase in total deposits, coupled with an increase in borrowed funds. Total deposits increased$167.9 million to$1.170 billion atJune 30, 2020 from$1.002 billion atDecember 31, 2019 . FNCB experienced increases in both non-interest-bearing and interest-bearing deposits. Non-interest-bearing demand deposits increased$87.3 million , or 48.7%, to$266.8 million atJune 30, 2020 from$179.5 million atDecember 31, 2019 , while interest-bearing deposits increased$80.6 million , or 9.8%, to$902.8 million atJune 30, 2020 from$822.2 million atDecember 31, 2019 . The increases were due primarily to higher balances of non-maturity deposits and reflected funds disbursed for PPP loans into customer demand deposit accounts. Total time deposits decreased$0.9 million , or 0.5%, to$192.1 million atJune 30, 2020 from$193.0 million atDecember 31, 2019 . The decrease was due to certificates of deposit that were not renewed in the current low interest rate environment almost entirely offset by an increase of$10.0 million brokered certificates of deposit. Borrowed funds increased$32.2 million , or 56.2%, to$89.4 million atJune 30, 2020 from$57.2 million atDecember 31, 2019 . The increase included a$36 million advance through the Federal Reserve Discount Window under the PPPLF. This was slightly offset by the$4.1 decrease in FHLB ofPittsburgh advances to$42.8 million atJune 30, 2020 from$46.9 million atDecember 31, 2019 , which included a$14.1 repayment of a FHLB ofPittsburgh overnight advance and a$10.0 million term advance as part of an interest rate swap transaction. There were no outstanding overnight advances through FHLB ofPittsburgh atJune 30, 2020 . Management regularly monitors wholesale funding sources taking into consideration the cost of funds, diversification between funding sources and asset/liability management strategies. FNCB utilizes brokered deposits, including one-way purchases through thePromontory Interfinancial Network , deposits acquired through a national listing service, as well as overnight and term advances through the FHLB ofPittsburgh as wholesale sources of funds to supplement its deposit gathering initiatives. Equity Total shareholders' equity increased$11.8 million , or 8.8%, to$145.4 million atJune 30, 2020 from$133.6 million atDecember 31, 2019 . The improvement in capital resulted primarily from net income for the six months endedJune 30, 2020 of$6.1 million and a$7.7 million increase in accumulated other comprehensive income related primarily to appreciation in the fair value of available-for-sale debt securities, net of deferred taxes. These improvements were partially offset by dividends declared and paid for the six months endedJune 30, 2020 of$2.2 million . FNCB's tangible book value per common share improved$0.57 , or 8.6% to$7.19 atJune 30, 2020 , compared to$6.62 per share atDecember 31, 2019 .FNCB Bank's total regulatory capital increased$14.6 million to$148.0 million atJune 30, 2020 from$133.4 million atDecember 31, 2019 . The Bank's total risk-based capital and Tier 1 leverage ratios improved to 15.68% and 10.42%, respectively atJune 30, 2020 from 14.77% and 10.36%, respectively, atDecember 31, 2019 . The Bank's risk-based capital ratios exceeded the minimum regulatory capital ratios required for well capitalized under prompt corrective action regulations. Based on the most recent notification from its primary regulator, the Bank was considered well capitalized atJune 30, 2020 andDecember 31, 2019 . There were no conditions or events since that notification that management believes would have changed this capital designation. Liquidity The term liquidity refers to the ability to generate sufficient amounts of cash to meet cash flow needs. Liquidity is required to fulfill the borrowing needs of FNCB's credit customers and the withdrawal and maturity requirements of its deposit customers, as well as to meet other financial commitments. FNCB's liquidity position is impacted by several factors, which include, among others, loan origination volumes, loan and investment maturity structure and cash flows, deposit demand and time deposit maturity structure and retention. FNCB has liquidity and contingent funding policies in place that are designed with controls in place to provide advanced detection of potentially significant funding shortfalls, establish methods for assessing and monitoring risk levels, and institute prompt responses that may alleviate a potential liquidity crisis. Management monitors FNCB's liquidity position and fluctuations daily, forecasts future liquidity needs, performs periodic stress tests on its liquidity levels and develops strategies to ensure adequate liquidity at all times. The statements of cash flows present the change in cash and cash equivalents from operating, investing and financing activities. Cash and due from banks and interest-bearing deposits in other banks, which comprise cash and cash equivalents, are FNCB's most liquid assets. AtJune 30, 2020 , cash and cash equivalents totaled$101.5 million , an increase of$66.9 million compared to$34.5 million atDecember 31, 2019 . For the six months endedJune 30, 2020 net cash provided by operating and financing activities were partially offset by net cash used in investing activities during that same time frame. Operating activities, net of reconciling adjustments for the six months endedJune 30, 2020 provided net cash of$11.3 million . Financing activities provided$197.8 million in net cash flow for the six months endedJune 30, 2020 , which resulted primarily from the net increase in deposits and net proceeds on advances from the Federal Reserve Bank Discount Window PPPLF of$36.2 million . Partially offsetting these net cash inflows, was$142.2 million in net cash used by FNCB's investing activities for the six months endedJune 30, 2020 , which resulted primarily from the cash used of$120.0 million for new loan funding, coupled with the purchases of available-for-sale securities of$83.1 million . This was partially offset by cash received from sales and repayments of available-for-sale debt securities of$60.9 million . 46
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Management believes the COVID-19 pandemic could pose potential stresses on liquidity management. FNCB could experience an increase in the utilization of existing lines of credit as customers manage their own liquidity needs during this time of economic uncertainty. Management believes FNCB's current liquidity position and available sources of liquidity were sufficient to meet its cash flow needs and fulfill its obligations atJune 30 2020 . In addition cash and cash equivalents of$101.5 million atJune 30, 2020 , FNCB had ample sources of additional liquidity including approximately$266.7 million in available borrowing capacity from the FHLB ofPittsburgh , and available borrowing capacity through the Federal Reserve Discount Window of$80.8 million under the PPPLF and$14.4 million under the borrower-in-custody program. FNCB also has available unsecured federal funds lines of credit totaling$40.0 million atJune 30, 2020 . Interest Rate Risk Interest Rate Sensitivity Market risk is the risk to earnings and/or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. FNCB's exposure to market risk is primarily interest rate risk associated with our lending, investing and deposit gathering activities, all of which are other than trading. Changes in interest rates affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. In addition, variations in interest rates affect the underlying economic value of our assets, liabilities and off-balance sheet items.
Asset and Liability Management
FNCB manages these objectives through its
The major objectives of ALCO are to:
? manage exposure to changes in the interest rate environment by limiting the
changes in net interest margin to an acceptable level within a reasonable
range of interest rates;
? ensure adequate liquidity and funding;
? maintain a strong capital base; and
? maximize net interest income opportunities.
FNCB utilizes the pricing and structure of loans and deposits, the size and
duration of the investment securities portfolio, the size and duration of the
wholesale funding portfolio, and off-balance sheet interest rate contracts to
manage interest rate risk. The off-balance sheet interest rate contracts may
include interest rate swaps, caps and floors. These interest rate contracts
involve, to varying degrees, credit risk and interest rate risk. Credit risk is
the possibility that a loss may occur if a counterparty to a transaction fails
to perform according to terms of the contract. The notional amount of the
interest rate contracts is the amount upon which interest and other payments are
based. The notional amount is not exchanged, and therefore, should not be taken
as a measure of credit risk. See Note 6, "Derivative and Hedging
Transactions," to the notes to consolidated financial statements for additional
information about FNCB's derivative transactions.
ALCO monitors FNCB's exposure to changes in net interest income over both a
one-year planning horizon and a longer-term strategic horizon. ALCO uses net
interest income simulations and economic value of equity ("EVE") simulations as
the primary tools in measuring and managing FNCB's position and considers
balance sheet forecasts, FNCB's liquidity position, the economic environment,
anticipated direction of interest rates and FNCB's earnings sensitivity to
changes in these rates in its modeling. In addition, ALCO has established policy
tolerance limits for acceptable negative changes in net interest income.
Furthermore, as part of its ongoing monitoring, ALCO requires quarterly back
testing of modeling results, which involves after-the-fact comparisons of
projections with FNCB's actual performance to measure the validity of
assumptions used in the modeling techniques.
Earnings at Risk and Economic Value at Risk Simulations
Earnings at Risk Earnings-at-risk simulation measures the change in net interest income and net income under various interest rate scenarios. Specifically, given the current market rates, ALCO looks at "earnings at risk" to determine anticipated changes in net interest income from a base case scenario with scenarios of +200, +400, and -100 basis points for simulation purposes. The simulation takes into consideration that not all assets and liabilities re-price equally and simultaneously with market rates (i.e., savings rate). Economic Value at Risk While earnings-at-risk simulation measures the short-term risk in the balance sheet, economic value (or portfolio equity) at risk measures the long-term risk by finding the net present value of the future cash flows from FNCB's existing assets and liabilities. ALCO examines this ratio regularly, and given the current rate environment, has utilized rate shocks of +200, +400, and -100 basis points for simulation purposes. Management recognizes that, in some instances, this ratio may contradict the "earnings at risk" ratio.
While ALCO regularly performs a wide variety of simulations under various strategic balance sheet and treasury yield curve scenarios, the following results reflect FNCB's sensitivity over the subsequent twelve months based on the following assumptions:
? asset and liability levels usingJune 30, 2020 as a starting point;
? cash flows are based on contractual maturity and amortization schedules with
applicable prepayments derived from internal historical data and external
sources; and
? cash flows are reinvested into similar instruments so as to keep
interest-earning asset and interest-bearing liability levels constant.
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The following table illustrates the simulated impact of parallel and instantaneous interest rate shocks of +400 basis points, +200 basis points, and -100 basis points on net interest income and the change in economic value over a one-year time horizon from theJune 30, 2020 levels: Rates +200 Rates +400 Rates -100 Simulation Simulation Simulation Results Policy Limit Results Policy Limit Results Policy Limit Earnings at risk: Percent change in net interest income (1.6 )% (12.5 )% (0.6 )% (20.0 )% 3.4 % (10.0 )% Economic value at risk: Percent change in economic value of equity 11.0 % (20.0 )% 16.1 % (35.0 )% (32.2 )% (10.0 )% Model results atJune 30, 2020 indicated that FNCB was liability rate sensitive for the short term moving to an asset sensitive position in approximately within twelve months and then continuing in an asset-sensitive position for the remaining periods of the model. The liability rate sensitive position shortened as compared to model results atMarch 31, 2020 , which indicated a shift to an asset sensitive position in months 13 through 15 of the model. Model results atJune 30, 2020 indicated that FNCB's net interest income is expected to decrease 1.6% under a +200-basis point interest rate shock. Additionally, model results indicated that FNCB's economic value of equity is expected toincrease 11.0%under a parallel shift in interest rates of +200 basis points. Under a -100-basis point interest rate shock, model results indicated that FNCB's net interest income would increase 3.4%, while the economic value of equity would decrease 32.2%, respectively. Management does not believe that the modeled decrease in the economic value of equity, which exceeds the current policy limit of 10.0%, poses any undue interest rate risk atJune 30, 2020 . Comparatively, model results atMarch 31, 2020 indicated net interest income would be expected to decrease 4.4% and economic value of equity would be expected to decrease 1.5%given a +200-basis point rate shock. Conversely, given a -100 basis point rate shock atMarch 31, 2020 , net interest income would be expected to increase 2.7% and the economic value of equity would decrease 18.6%. This analysis does not represent a forecast for FNCB and should not be relied upon as being indicative of expected operating results. These simulations are based on numerous assumptions, including but not limited to: the nature and timing of interest rate levels, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacements of asset and liability cash flows, and other factors. While assumptions reflect current economic and local market conditions, FNCB cannot make any assurances as to the predictive nature of these assumptions, including changes in interest rates, customer preferences, competition and liquidity needs, or what actions ALCO might take in responding to these changes. In response to the economic disruption and uncertainty brought on by the COVID-19 pandemic, theFOMC lowered the federal funds target rate a total of 150 basis points in two emergency actions with an expectation that the Committee will maintain a low interest rate environment for the foreseeable future. Given FNCB's current asset/liability position, the significantly lower market interest rates may have a negative impact on FNCB's earning asset yields and variable-rate loans and securities indexed to prime and LIBOR will reprice downward. As previously mentioned, as part of its ongoing monitoring, ALCO requires quarterly back testing of modeling results, which involves after-the-fact comparisons of projections with FNCB's actual performance to measure the validity of assumptions used in the modeling techniques. As part of its quarterly review, management compared tax-equivalent net interest income recorded for the three months endedJune 30, 2020 with tax-equivalent net interest income that was projected for the same three-month period. There was a negative variance between actual and projected tax-equivalent net interest income for the three-month period endedJune 30, 2020 of$715 thousand , or 7.4%. The variance primarily reflected the decrease origination of$117.0 million in PPP loans at an interest rate of 1.00% during the second quarter of 2020, which was not included in the model atMarch 31, 2020 . ALCO performs a detailed rate/volume analysis between actual and projected results in order to continue to improve the accuracy of its simulation models.
Off-Balance Sheet Arrangements
In the ordinary course of operations, FNCB engages in a variety of financial transactions that, in accordance with GAAP, are not recorded in our consolidated financial statements or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions may be used for general corporate purposes or for customer needs. Corporate purpose transactions would be used to help manage credit, interest rate and liquidity risk or to optimize capital. Customer transactions are used to manage customers' requests for funding. For the three and six months endedJune 30, 2020 , FNCB did not engage in any off-balance sheet transactions that would have or would be reasonably likely to have a material effect on its consolidated financial condition.
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