FNCB BANCORP, INC. This Quarterly Report on Form 10-Q 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 novel Coronavirus Disease 2019 ("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 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" 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 nine months ended September 30, 2020 and 2019 within the
consolidated statements of income.
Refer to Note 3, "Securities," 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 ofSeptember 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 endedSeptember 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 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, the Bank's 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. As ofSeptember 30, 2020 , FNCB did not face any material resource constraints through the implementation of its pandemic preparedness plan. Through the nine months endedSeptember 30, 2020 , FNCB incurred COVID-19-related expenses including stay-at-home pay, computer-related costs, cleaning and sanitizing facilities and safety supplies which are included in non-interest expense in the consolidated statements of income. Additionally, FNCB has not tested for and 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 the continued 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, the Bank actively participated in PPP loans assisting our small business community in securing this important funding. As ofSeptember 30, 2020 , FNCB was able to serve 1,002 small business customers with PPP loans totaling$118.6 million . The PPP closed onAugust 8, 2020 , and the SBA is no longer accepting applications for funding under this program. Subsequent to the closing of the program, the SBA began accepting applications for forgiveness. FNCB notified and began providing assistance to customers with the forgiveness application process. As ofSeptember 30, 2020 , FNCB had submitted 84 forgiveness applications to the SBA for PPP loans totaling$31.1 million . As ofSeptember 30, 2020 , FNCB had not received approval or funding from the SBA for the forgiveness associated with these loans. It is FNCB's understanding that loans funded through the PPP are fully guaranteed bythe United States government. Should those circumstances change, FNCB could be required to increase its allowance for loan and lease losses related to these loans resulting in an increase in the provision for loan and lease losses. 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 ofSeptember 30, 2020 , FNCB assisted 860 customers under our payment deferral program, with the aggregate principal balance of loans modified totaling$173.6 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 had suspended certain deposit service charges related to debit card usage. 32
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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 . The Bank has received approval from theFederal Reserve Bank as a participating lender in the Main Street Lending Program. As ofSeptember 30, 2020 , 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 . 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$4.1 million , or$0.20 per basic and diluted common share, for the three months endedSeptember 30, 2020 , an increase of$1.7 million , or 70.9%, compared to$2.4 million , or$0.12 per basic and diluted common share, for the three months endedSeptember 30, 2019 . Net income for the nine months endedSeptember 30, 2020 totaled$10.2 million , or$0.50 per basic and diluted share, an increase of$2.6 million , or 34.3%, compared to$7.6 million , or$0.39 per basic and diluted share, for the same nine months of 2019. The increase in third quarter 2020 earnings over the same quarter of 2019 was primarily due to increases in net interest income and non-interest income, coupled with a reduction in the provision for loan and lease losses. The increase in net income comparing the nine months endedSeptember 30, 2020 and 2019 primarily reflected increases in net interest income and non-interest income and a decrease in non-interest expense. Partially offsetting these positive factors comparing the year-to-date periods was an increase in the provision for loan and lease losses, which reflected continued uncertainty brought on by the COVID-19 global pandemic. Additionally, the results for the third quarter and year-to-date periods of 2020 include the effect on interest income of$118.6 million in PPP loans. For the three and nine months endedSeptember 30, 2020 , the annualized return on average assets was 1.15% and 1.03%, respectively, and 0.80% and 0.84%, respectively, for the same periods of 2019. The annualized return on average equity was 11.05% and 9.63%, respectively, for the three and nine months endedSeptember 30, 2020 , compared to 7.30% and 8.32%, respectively, for the comparable periods of 2019. FNCB declared and paid dividends to holders of common stock of$0.055 per share for the third quarter and$0.165 per share for the nine months endedSeptember 30, 2020 , a 10.0% increase compared to$0.05 per share and$0.15 per share for the same periods of 2019. The dividend pay-out ratio was 32.7% for the nine months endedSeptember 30, 2020 compared to 39.8% for the comparable period of 2019. Total assets increased$239.7 million , or 19.9%, to$1.443 billion atSeptember 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$128.4 million , or 15.7%, to$947.9 million atSeptember 30, 2020 from$819.5 million atDecember 31, 2019 . Excluding the$118.6 million in PPP loans outstanding atSeptember 30, 2020 , net loans increased$9.8 million , or 1.2%, fromDecember 31, 2019 . Cash and cash equivalents increased$70.4 million , or 203.8%, to$105.0 million atSeptember 30, 2020 from$34.6 million atDecember 31, 2019 . Also contributing to the balance sheet expansion was a$48.6 million , or 17.8%, increase in available-for-sale debt securities to$321.4 million atSeptember 30, 2020 from$272.8 million atDecember 31, 2019 . FNCB experienced unprecedented deposit demand during the first nine months of 2020 as total deposits increased$270.5 million , or 27.0%, to$1.272 billion atSeptember 30, 2020 from$1.002 billion atDecember 31, 2019 . Total borrowed funds decreased$46.9 million , or 82.0%, to$10.3 million atSeptember 30, 2020 from$57.2 million atDecember 31, 2019 . The decrease in borrowed funds reflected a decrease in advances through the FHLB ofPittsburgh as FNCB had no borrowings through the FHLB ofPittsburgh outstanding as ofSeptember 30, 2020 . 33
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Total shareholders' equity increased$16.4 million , or 12.3%, to$150.0 million atSeptember 30, 2020 from$133.6 million atDecember 31, 2019 . Contributing to the increase in capital was net income for the nine months endedSeptember 30, 2020 of$10.2 million and a$9.1 million increase in accumulated other comprehensive income related primarily to appreciation in the fair value of FNCB's available-for-sale debt securities, net of deferred taxes. Partially offsetting these increases were dividends declared and paid of$3.3 million for the nine months endedSeptember 30, 2020 .FNCB Bank's total risk-based capital and Tier 1 leverage ratios were 16.09% and 10.17% atSeptember 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. In response to the significant disruption and uncertainty in the economic environment brought on by COVID-19, theFOMC lowered the federal funds target rate 150 basis points in two emergency actions inMarch 2020 . As a result, the target range for federal funds fell from 1.50%-1.75% atDecember 31, 2019 to 0.00%-0.25% atMarch 31, 2020 and has remained at that level throughSeptember 30, 2020 . 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. TheFOMC actions, along with decreases in general market interest rates, has resulted in decreases in both the tax-equivalent yield on earnings assets and the rate paid on interest-bearing liabilities comparing the three and nine months endedSeptember 30, 2020 and 2019. Additionally, net interest income, earning asset yields and the net interest margin were impacted by the origination and funding of$118.6 million in PPP loans at an interest rate of 1.0%. Net interest income on a tax-equivalent basis increased$927 thousand , or 10.1%, to$10.1 million for the three months endedSeptember 30, 2020 from$9.1 million for the comparable period of 2019. The improvement in tax-equivalent net interest income for the third quarter of 2020 primarily reflected a decrease in interest expense of$1.0 million , or 40.7%, to$1.5 million from$2.5 million for the same period of 2019. The reduction in interest expense was slightly offset by a decrease in tax-equivalent interest income of$72 thousand , or 0.6%, to$11.5 million for the three months endedSeptember 30, 2020 from$11.6 million for the same period of 2019. For the nine months endedSeptember 30, 2020 , tax-equivalent net interest income increased$1.9 million , or 6.9%, to$29.2 million from$27.3 million for the same nine months of 2019. Similarly, the improvement in tax-equivalent net interest income comparing the year-to-date period endedSeptember 30, 2020 and 2019 was due to a$2.6 million , or 34.0%, reduction in interest expense, partially offset by a$699 thousand , or 2.0%, 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 third quarter tax-equivalent net interest income, FNCB's tax-equivalent net interest margin contracted 28 basis points to 3.04% for the third quarter of 2020 from 3.32% for the same quarter of 2019. The margin compression was due primarily to a$224.7 million , or 20.4%, increase in average earning asset levels, coupled with the impact of a 74-basis point reduction in the tax-equivalent yield on earning assets. 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 22 basis points to 2.89% for the three months endedSeptember 30, 2020 from 3.11% for the same period of 2019. The tax-equivalent net interest margin and rate spread compressed 8 basis points and 4 basis points, respectively, comparing the nine months endedSeptember 30, 2020 and 2019. Comparing the three months endedSeptember 30, 2020 , the$1.0 million , or 40.7%, decrease in interest expense was entirely due to a 52-basis point reduction in the cost of funds. Specifically, the average rate paid for interest-bearing deposits decreased 41 basis points to 0.55% for the third quarter of 2020 from 0.96% for the same period of 2019, resulting in a decrease to interest expense of$806 thousand . The average rates paid for interest-bearing demand and time deposits, which reflected the reduction in market interest rates, decreased 40 basis points and 43 basis points, respectively, comparing the three months endedSeptember 30, 2020 and 2019. The decrease in interest expense due to changes in deposit rates was coupled with a 130 basis point reduction in the cost of borrowed funds comparing the three months endedSeptember 30, 2020 to the same period of 2019, which resulted in a$217 thousand decrease in interest expense. FNCB experienced significant demand for its deposit products, as changing customer deposit preferences and higher balances due to the reduction in economic activity and uncertainty related to the COVID-19 pandemic, were the primary factors driving a$114.5 million , or 13.0%, increase in average interest-bearing liabilities. Specifically, average interest-bearing deposits increased$148.8 million , or 18.7%, to$943.8 million for the third quarter of 2020 compared to$795.0 million for the same quarter of 2019. The strong growth in deposit volumes had little impact on interest expense, as FNCB used the excess liquidity to repay higher-costing borrowed funds. Average borrowed funds decreased by$34.3 million or 39.9% to$51.6 million for the third quarter of 2020 from$85.9 million for the same quarter of 2019. Overall, changes in volumes of average interest-bearing liabilities resulted in a slight increase in interest expense of$24 thousand comparing the third quarters of 2020 and 2019. 34
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Partially offsetting the lower amount of interest expense was a$72 thousand , or 0.6%, decrease in tax-equivalent interest income to$11.5 million for the third 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, almost entirely offset by an increase in average earning asset levels. The tax-equivalent yield on earning assets decreased 74 basis points to 3.48% for the third quarter of 2020 from 4.22% for the same quarter of 2019, which resulted in a corresponding decrease in tax-equivalent interest income of$1.8 million . Accounting for the majority of the decrease was an 82 basis point decrease in the tax-equivalent yield on the loan portfolio to 3.85% for the three months endedSeptember 30, 2020 from 4.67% for the same three months of 2019, which resulted in a corresponding decrease in tax-equivalent interest income of$1.8 million . With regard to earning asset volumes, average earning assets increased$224.7 million , or 20.4%, to$1.326 billion for the three months endedSeptember 30, 2020 from$1.101 billion for the same three months of 2019. The origination of$118.6 million in PPP loans was the predominant factor causing an increase in average loans of$133.3 million , or 16.3%, to$952.9 million for the third quarter of 2020 from$819.6 million for the same quarter of 2019, which caused a corresponding increase in interest income of$1.4 million . Additionally, comparing the third quarters of 2020 and 2019, average securities increased$30.8 million , or 11.4%, to$302.1 million from$271.3 million , respectively, which resulted in an increase to interest income of$289 thousand . Furthermore, average interest-bearing deposits in other banks and federal funds sold increased$60.6 million to$70.6 million for the three months endedSeptember 30, 2020 , from$10.0 million for the same three months of 2019, which caused tax-equivalent interest income to increase$26 thousand . Overall, the increase in average earning assets resulted in a corresponding increase to tax-equivalent interest income of$1.7 million , which was more than offset by the$1.8 million decrease in tax-equivalent interest income due to the decline in yield. For the nine months endedSeptember 30, 2020 , tax-equivalent net interest income increased$1.9 million , or 6.9%, which was mainly attributable to a$2.6 million , or 34.0% reduction in interest expense, which was partially offset by the decline in tax-equivalent interest income of$699 thousand , or 2.0%. The decrease in interest expense for the year-to-date period was primarily caused by decreases in funding costs due to lower market rates, coupled with changes in volumes of average interest-bearing liabilities. FNCB's total cost of funds decreased 39 basis points to 0.72% for the nine months endedSeptember 30, 2020 from 1.11% for the same period of 2019, resulting in a decrease to interest expense of$2.4 million . Specifically, comparing the nine months endedSeptember 30, 2020 and 2019, the cost of interest-bearing deposits decreased 33 basis points, while the cost of borrowed funds declined 128 basis points, resulting in corresponding decreases to interest expense of$1.7 million and$625 thousand , respectively. For the nine months endedSeptember 30, 2020 , interest-bearing liabilities averaged$937.1 million , an increase of$21.8 million , or 2.4%, from$915.3 million for the same nine-month period of 2019. Despite the increase, changes in volumes of interest-bearing liabilities resulted in a$228 thousand decrease in interest expense, driven by changes in volumes of interest-bearing deposits. Specifically, average balances of higher-costing time deposits decreased$57.9 million , or 22.8% comparing the nine months endedSeptember 30, 2020 and 2019 which caused a corresponding decrease to interest expense of$629 thousand . The decline in average time deposit balances largely reflected maturing retail certificates of deposit, the majority of which were transferred into a non-maturity deposit product. Volumes of average interest-bearing demand deposits and average savings deposits increased by$73.5 million and$6.7 million , respectively, comparing the nine months endedSeptember 30, 2020 and 2019 which resulted in corresponding increases to interest expense of$406 thousand and$7 thousand , respectively, comparing the year-to-date periods of 2020 and 2019. Average borrowed funds decreased$602 thousand , or 0.9%, to$65.0 million for the nine months endedSeptember 30, 2020 , compared to$65.6 million for the same period in 2019, resulting in a small decrease in interest expense of$12 thousand . The$699 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 44 basis point decrease in the yield on earning assets to 3.70% for the nine months endedSeptember 30, 2020 from 4.14% for the same nine months of 2019, which resulted in a$3.6 million decrease in tax-equivalent interest income. The reduction in market interest rates, coupled with the origination of lower-yielding PPP loans had the greatest impact on loan yields. Specifically, the tax-equivalent yield on loans declined 53 basis points to 4.08% for the nine months endedSeptember 30, 2020 from 4.61% for the same nine months of 2019, causing a$3.5 million decline in tax-equivalent interest income. PPP loans averaged$69.5 million for the nine months endedSeptember 30, 2020 , with an average yield of 0.99%. Additionally, yields earned on average interest-bearing deposits in other banks and federal funds sold decreased 174 basis points to 0.09% for the nine months endedSeptember 30, 2020 from 1.83% for the same period of 2019, which resulted in a corresponding decrease to tax-equivalent interest income of$244 thousand . Partially offsetting the reduction in tax-equivalent interest income due to yield decline was a$107.6 million , or 9.6%, increase in average earning assets to$1.231 billion for the nine months endedSeptember 30, 2020 , compared to$1.124 billion for the same nine months of 2019, which resulted in a$2.9 million increase in tax-equivalent interest income. Specifically, comparing the first nine months of 2020 and 2019, average loans increased$75.3 million , or 9.1%, which caused a$2.5 million increase in tax-equivalent interest income. In addition, comparing the nine months endedSeptember 30, 2020 and 2019, the average balance of securities increased$7.8 million , or 2.8%, while the average interest-deposits in other banks and federal funds sold increased$24.4 million , or 216.1%, resulting in additional tax-equivalent interest income of$330 thousand and$114 thousand , respectively. 35
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Net interest income depends upon the relative amount of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them. The following tables present certain information about FNCB's consolidated statements of financial condition and consolidated statements of income for the three- and nine-month periods endedSeptember 30, 2020 and 2019, and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are calculated by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are derived from average daily balances. The yields include amortization of fees which are considered adjustments to yields. Three Months Ended September 30, 2020 September 30, 2019 Average Yield/ Average Yield/ (dollars in thousands) Balance Interest Cost Balance Interest Cost Assets Earning assets (2)(3) Loans-taxable (4)$ 908,095 $ 8,688 3.83 %$ 781,963 $ 9,170 4.69 % Loans-tax free (4) 44,826 494 4.41 % 37,638 403 4.28 % Total loans (1)(2) 952,921 9,182 3.85 % 819,601 9,573 4.67 % Securities-taxable 232,081 1,760 3.03 % 266,653 1,951 2.93 % Securities-tax free 69,973 586 3.35 % 4,611 47 4.08 % Total securities (1)(5) 302,054 2,346 3.11 % 271,264 1,998 2.95 % Interest-bearing deposits in other banks 70,601 1 0.01 % 10,007 30 1.20 % Total earning assets 1,325,576 11,529 3.48 % 1,100,872 11,601 4.22 % Non-earning assets 108,587
99,888
Allowance for loan and lease losses (11,865 ) (9,081 ) Total assets$ 1,422,298 $ 1,191,679 Liabilities and Shareholders' Equity Interest-bearing liabilities Interest-bearing demand deposits$ 638,070 705 0.44 %$ 480,277 1,011 0.84 % Savings deposits 105,394 24 0.09 % 93,369 31 0.13 % Time deposits 200,290 562 1.12 % 221,325 859 1.55 %
Total interest-bearing deposits 943,754 1,291 0.55 %
794,971 1,901 0.96 %
Borrowed funds and other
interest-bearing liabilities 51,629 165 1.28 % 85,927 554 2.58 %
Total interest-bearing
liabilities 995,383 1,456 0.59 % 880,898 2,455 1.11 %
Demand deposits 267,636 169,416
Other liabilities 11,384 10,730
Shareholders' equity 147,895 130,635
Total liabilities and
shareholder's equity $ 1,422,298 $ 1,191,679
Net interest income/interest
rate spread (6) 10,073 2.89 % 9,146 3.11 %
Tax equivalent adjustment (227 ) (95 )
Net interest income as reported $ 9,846 $ 9,051
Net interest margin (7) 3.04 % 3.32 %
(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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Nine Months Ended
September 30, 2020 September 30, 2019
Average Yield/ Average Yield/
(dollars in thousands) Balance Interest Cost Balance Interest Cost
Assets
Earning assets (2)(3)
Loans-taxable (4) $ 854,885 $ 26,042 4.06 % $ 781,612 $ 27,194 4.64 %
Loans-tax free (4) 48,080 1,564 4.34 % 46,019 1,417 4.11 %
Total loans (1)(2) 902,965 27,606 4.08 % 827,631 28,611 4.61 %
Securities-taxable 247,848 5,426 2.92 % 280,114 5,997 2.85 %
Securities-tax free 44,723 1,149 3.43 % 4,624 142 4.09 %
Total securities (1)(5) 292,571 6,575 3.00 % 284,738 6,139 2.87 %
Interest-bearing deposits in
other banks 35,746 25 0.09 % 11,309 155 1.83 %
Total earning assets 1,231,282 34,206 3.70 % 1,123,678 34,905 4.14 %
Non-earning assets 101,773 95,412
Allowance for loan and lease losses (10,321 ) (9,344 ) Total assets$ 1,322,734 $ 1,209,746 Liabilities and Shareholders' Equity Interest-bearing liabilities Interest-bearing demand deposits$ 577,012 2,363 0.55 %$ 503,483 3,095 0.82 % Savings deposits 99,627 75 0.10 % 92,893 96 0.14 % Time deposits 195,456 1,889 1.29 % 253,306 3,092 1.63 % Total interest-bearing deposits 872,095 4,327 0.66 % 849,682 6,283 0.99 % Borrowed funds and other interest-bearing liabilities 65,046 706 1.45 % 65,648 1,343 2.73 % Total interest-bearing liabilities 937,141 5,033 0.72 % 915,330 7,626 1.11 % Demand deposits 232,920 161,036 Other liabilities 11,361 11,406 Shareholders' equity 141,312 121,974 Total liabilities and shareholder's equity$ 1,322,734 $ 1,209,746 Net interest income/interest rate spread (6) 29,173 2.99 % 27,279 3.03 % Tax equivalent adjustment (570 ) (328 ) Net interest income as reported$ 28,603 $ 26,951 Net interest margin (7) 3.16 % 3.24 %
(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 September 30, Nine Months Ended September 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 $ 1,352 $ (1,834 ) $ (482 ) $ 2,413 $ (3,565 ) $ (1,152 )
Loans - tax free 79 12 91 65 82 147
Total loans 1,431 (1,822 ) (391 ) 2,478 (3,483 ) (1,005 )
Securities - taxable (260 ) 69 (191 ) (704 ) 133 (571 )
Securities - tax free 549 (10 ) 539 1,034 (27 ) 1,007
Total securities 289 59 348 330 106 436
Interest-bearing
deposits in other
banks 26 (55 ) (29 ) 114 (244 ) (130 )
Total interest income 1,746 (1,818 ) (72 ) 2,922 (3,621 ) (699 )
Interest expense:
Interest-bearing
demand deposits 268 (574 ) (306 ) 406 (1,138 ) (732 )
Savings deposits 4 (11 ) (7 ) 7 (28 ) (21 )
Time deposits (76 ) (221 ) (297 ) (629 ) (574 ) (1,203 )
Total
interest-bearing
deposits 196 (806 ) (610 ) (216 ) (1,740 ) (1,956 )
Borrowed funds and
other
interest-bearing
liabilities (172 ) (217 ) (389 ) (12 ) (625 ) (637 )
Total interest
expense 24 (1,023 ) (999 ) (228 ) (2,365 ) (2,593 )
Net interest income $ 1,722 $ (795 ) $ 927 $ 3,150 $ (1,256 ) $ 1,894 Provision for Loan and Lease Losses
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. 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. During 2020, management took into consideration the potential adverse impact the COVID-19 pandemic has had on economic conditions in its application of FNCB's methodology on the allowance for loan and lease losses. Specifically, management has tried to address this adverse impact by adjusting the qualitative factor associated with changes in national, local and business economic conditions and developments, which has resulted in higher credit provisioning during the nine months endedSeptember 30, 2020 . FNCB recorded a provision for loan and lease losses of$74 thousand for the three-month period endedSeptember 30, 2020 compared to$637 thousand for the three months endedSeptember 30, 2019 . The$563 thousand decrease in the provision for loan and lease losses was directly attributable to substantial recoveries related to two large commercial credits received in the third quarter of 2020, partially offset by additional credit provisioning related to economic disruption and uncertainty related to the COVID-19 pandemic. The provision for loan losses amounted to$2.0 million for the nine months endedSeptember 30, 2020 , an increase of$1.2 million , from$830 thousand for the same nine months of 2019. Non-interest Income Non-interest income increased significantly for the third quarter and year-to-date periods, which was primarily due to increases in net gains on equity securities, net gains on the sale of mortgage loans held for sale and net gains on available-for-sale debt securities. Non-interest income increased$1.1 million , or 62.2%, to$2.9 million for the three months endedSeptember 30, 2020 from$1.8 million for the same three months of 2019. Net gains on equity securities increased$841 thousand to$846 thousand for the third quarter of 2020 compared to$5 thousand for the same quarter of 2019. FNCB realized a gain of$1.1 million on the conversion of an equity security of a bank holding company that was part of a merger and acquisition that was completed in the third quarter of 2020. Partially offsetting this gain was a net unrealized loss on equity securities held of$287 thousand . FNCB realized net gains on the sale of mortgage loans of$186 thousand for the three months endedSeptember 30, 2020 , a$117 thousand or 169.6%, increase compared to$69 thousand in net gains realized for the same three-month period of 2019. In addition, FNCB realized net gains on the sales of available-for-sale securities of$433 thousand , an increase of$54 thousand , or 14.2%, compared to$379 thousand for the same quarter of 2019. For the nine months endedSeptember 30, 2020 , non-interest income increased$2.3 million , or 45.5%, to$7.2 million from$4.9 million for the same period of 2019. Net gains on equity securities increased$833 thousand to$864 thousand for the nine months endedSeptember 30, 2020 compared to$31 thousand for the same period of 2019, which was primarily related to the bank holding company stock transaction mentioned above, partially offset by unrealized losses on equity securities held of$269 thousand . For the first nine months of 2020, net gains on the sale of mortgage loans amounted to$465 thousand , an increase of$267 thousand , or 134.7%, compared to$198 thousand for the period of 2019. For the nine months endedSeptember 30, 2020 , net gains on the sale of available-for-sale securities amounted to$1.5 million , an increase of$802 thousand , or 114.2%, compared to$702 thousand for the same nine months of 2019. 38
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Also impacting non-interest income levels for the third quarter and year-to-date periods were increases in loan referral fees and deposit service charges. 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$22 thousand , to$76 thousand for the three months endedSeptember 30, 2020 , compared to$54 thousand for the same period of 2019. Loan referral fees totaled$338 thousand for the nine months endedSeptember 30, 2020 , an increase of$264 thousand , or 357.4%, compared to$74 thousand for the nine months endedSeptember 30, 2019 . With regard to deposit service charges, 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. As a result, deposit service charges increased$47 thousand , or 5.9%, to$844 thousand for the third quarter of 2020 from$797 thousand for the same quarter of 2019. For the nine months endedSeptember 30 , deposit service charges increased$174 thousand or 7.9%, to$2.4 million in 2020 compared to$2.2 million in 2019. Non-interest Expense Non-interest expense increased$514 thousand , or 7.0%, to$7.8 million for the three months endedSeptember 30, 2020 from$7.3 million for the three months endedSeptember 30, 2019 . The increase primarily reflected increases in other operating expenses, regulatory assessments, professional fees and bank shares tax, partially offset by a reduction in salaries and benefits. Other operating expenses in the third quarter increased$288 thousand , or 35.3%, to$1.1 million in 2020 from$815 thousand in 2019. The increase was largely due to$399 thousand in FHLB penalties paid in the third quarter of 2020 related to the decision to prepay high-costing FHLB term advances. Comparing the three months endedSeptember 30, 2020 and 2019, regulatory assessments increased$102 thousand , or 485.7%, professional fees increased$90 thousand , or 47.6%, and bank shares tax increased$58 thousand or 28.3%. The increase in regulatory assessments reflected the full utilization of theFDIC's Small Bank Assessment Credit during the prior quarter, coupled with an increase in FNCB's assessment base due to strong balance sheet growth. The increase in professional fees reflected the timing of certain services performed coupled with a contract renegotiation credit received in third quarter of 2019, while the increase in bank shares tax was due to the increase inFNCB Bank's capital. Slightly offsetting these increases was a$76 thousand , or 1.9% decrease in salaries and employee benefits, due primarily to staff reductions resulting from open positions that have not been filled. For the nine months endedSeptember 30, 2020 , non-interest expense decreased$404 thousand , or 1.8%, to$21.5 million compared to$21.9 million for the same nine-month period of 2019, primarily due to the decline in salaries and employee benefits, data processing expenses, other operating expenses and professional fees. Salaries and employee benefits declined$372 thousand , or 3.2%, to$11.3 million atSeptember 30, 2020 , compared to$11.6 million atSeptember 30, 2019 , reflecting an increase in deferred loan origination costs associated with the origination of PPP loans and reductions to staff, partially offset by merit increases. Data processing expenses and professional fees declined$124 thousand , or 5.4%, and$64 thousand , or 8.9%, respectively comparing the year-to-date periods of 2020 and 2019. In addition, other operating expenses decreased$117 thousand , or 5.2%, comparing the nine months endedSeptember 30, 2020 to 2019. The reduction in data processing costs and professional fees reflected more efficient utilization of third-party services. These decreases were partially offset by the$144 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. Bank shares tax increased$118 thousand , or 15.5%, to$878 thousand atSeptember 30, 2020 , compared to$760 thousand atSeptember 30, 2019 . For the nine months endedSeptember 30, 2020 , FNCB incurred$199 thousand in 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, which is included in non-interest expense. Provision for Income Taxes FNCB recorded income tax expense of$2.0 million for the nine months endedSeptember 30, 2020 , an increase of$467 thousand , or 29.5%, compared to income tax expense of$1.6 million for the same period of 2019. The increase in income tax expense primarily reflected an increase in pre-tax net income of$3.1 million , or 33.5%, when comparing the nine months endedSeptember 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 atSeptember 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 atSeptember 30, 2020 . FINANCIAL CONDITION Assets Total assets increased$239.7 million , or 19.9%, to$1.443 billion atSeptember 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$128.4 million , or 15.7%, to$947.9 million atSeptember 30, 2020 from$819.5 million atDecember 31, 2019 , primarily reflecting the origination and funding of PPP loans, of which$118.6 million were outstanding atSeptember 30, 2020 . Available-for-sale debt securities increased$48.6 million , or 17.8%, to$321.4 million atSeptember 30, 2020 from$272.8 million atDecember 31, 2019 as security purchases outpaced sales and repayments. FNCB experienced unprecedented demand for its deposit products during the nine months endedSeptember 30, 2020 , which was the driving factor leading to an increase in total deposits of$270.5 million , or 27.0%, to$1.272 billion atSeptember 30, 2020 from$1.002 billion atDecember 31, 2019 . Meanwhile, borrowed funds decreased$46.9 million , or 82.0%, to$10.3 million atSeptember 30, 2020 as compared to$57.2 million atDecember 31, 2019 , as FNCB used excess liquidity to prepay certain higher-costing term advances through the FHLB ofPittsburgh . 39
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Table of Contents Cash and Cash Equivalents Cash and cash equivalents increased$70.4 million , or 203.8%, to$105.0 million atSeptember 30, 2020 from$34.6 million atDecember 31, 2019 . The increase was primarily due to the increase in total deposits and cash generated through bank operations, partially offset by increases in available-for-sale debt securities and gross loans. FNCB paid dividends of$0.055 per share and$0.165 per share for the three and nine months endedSeptember 30, 2020 and 2019, respectively, an increase of 10% compared to dividends of$0.05 per share and$0.15 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. AtSeptember 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. AtSeptember 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 atSeptember 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 atSeptember 30, 2020 andDecember 31, 2019 :
Composition of the Investment Portfolio
September 30, December 31,
(in thousands) 2020 2019
Available-for-sale debt securities:
Obligations of state and political subdivisions $ 191,963 $ 117,763
U.S. government/government-sponsored agencies: Collateralized mortgage obligations - residential 54,494
80,294
Collateralized mortgage obligations - commercial 2,198
17,723
Mortgage-backed securities 11,123
18,485
Private collateralized mortgage obligations 32,729 25,075 Corporate debt securities 19,000 7,182 Asset-backed securities 9,892 5,621 Negotiable certificates of deposit -
696
Total available-for-sale debt securities$ 321,399 $ 272,839 Available-for-sale debt securities increased$48.6 million , or 17.8%, to$321.4 million atSeptember 30, 2020 from$272.8 million atDecember 31, 2019 . Management took advantage of market opportunities during the nine months endedSeptember 30, 2020 to sell lower-yielding investments within the available-for-sale portfolio and replace them and add to the portfolio with higher-yielding securities that were within FNCB's risk tolerance. During the nine months endedSeptember 30, 2020 , FNCB sold 28 available-for-sale debt securities which included 15 U.S. government/government sponsored agency CMOs, 12 taxable obligations of state and political subdivisions and 1 tax exempt obligation of state and political subdivisions. The securities sold had an aggregate amortized cost of$61.3 million with a weighted-average yield of 1.68%. For the nine months endedSeptember 30, 2020 , gross proceeds received totaled$62.8 million , with a net gain of$1.5 million realized upon the sales and included in non-interest income. During the nine months endedSeptember 30, 2020 , FNCB purchased 64 available-for-sale debt securities including 36 tax-exempt obligations of state and political subdivisions, 15 taxable obligations of state and political subdivisions, 6 corporate debt securities, 3 private asset-backed securities, 3 private CMOs and one agency CMO with an aggregate cost of$113.2 million and a weighted-average yield of 2.71%. Due to tax planning strategies designed to utilize NOL carryovers, management previously minimized holdings of tax-exempt obligations. However, market volatility during the first nine months 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. These actions resulted in increases in the tax-equivalent yield on the investment portfolio of 16 basis points to 3.11% from 2.95%, respectively, comparing the third quarters of 2020 and 2019 and 13 basis points to 3.00% from 2.87%, respectively, comparing the nine months endedSeptember 30, 2020 and 2019. Management continuously monitors FNCB's investment portfolio for credit worthiness. With regard to FNCB's holding of municipal securities, in the second quarter of 2020, management engaged an independent third party consultant to perform a semiannual credit review of FNCB's investments in obligations of state and political subdivisions as ofJune 30, 2020 . The review included a comparison of each security to the consultant's "Portfolio Credit Benchmark" to identify any securities that may contain more than a minimal risk of payment default. Based on this review all obligations of state and political subdivision held within the portfolio atJune 30, 2020 either met or exceeded the Portfolio Credit Benchmark and there were no such securities that required further review. The next third party review is scheduled forDecember 31, 2020 . We also monitor municipal securities monthly in the Municipal Surveillance Report. The following table presents the maturities of available-for-sale debt securities, based on carrying value atSeptember 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. 40
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Maturity Distribution of the Investment Portfolio
September 30, 2020
Collateralized
Mortgage
Obligations,
Mortgage-Backed
and Asset-Backed
(dollars in thousands) < 1 Year >1 - 5 Years 6 - 10 Years Over 10 Years Securities Total
Available-for-sale debt securities:
Obligations of state and political
subdivisions $ 4,573 $ 60,632 $ 25,604 $ 101,154 $ - $ 191,963
Yield 2.31 % 2.95 % 2.95 % 2.92 % 2.92 %
U.S. government/government-sponsored
agencies:
Collateralized mortgage obligations -
residential - - - - 54,494 54,494
Yield 2.88 % 2.88 %
Collateralized mortgage obligations -
commercial - - - - 2,198 2,198
Yield 2.81 % 2.81 %
Mortgage-backed securities - - - - 11,123 11,123
Yield 3.54 % 3.54 %
Private collateralized mortgage
obligations - - - - 32,729 32,729
Yield 2.63 % 2.63 %
Corporate debt securities - - 19,000 - - 19,000
Yield 5.44 % 5.44 %
Asset-backed securities - - - - 9,892 9,892
Yield 1.47 % 1.47 %
Negotiable certificates of deposit - - - - - -Yield
Total available-for-sale debt securities$ 4,573 $ 60,632 $ 44,604 $ 101,154 $ 110,436$ 321,399 Weighted average yield 2.31 % 2.95 % 4.01 % 2.92 % 2.75 % 3.01 % OTTI Evaluation There was no OTTI recognized during the nine months endedSeptember 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, atSeptember 30, 2020 andDecember 31, 2019 : September 30, December 31, (in thousands) 2020 2019
Stock in
10 10
Total restricted securities, at cost $ 1,791$ 3,804
Management noted no indicators of impairment for the
AtDecember 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. Because the common stock of this bank holding company was not traded on any established market, FNCB accounted for this transaction as an equity security without a readily determinable fair value. Under GAAP, an equity security without a readily determinable fair value shall be carried at cost and written down to fair value if a qualitative assessment indicates that the investment is impaired and the fair value is less than its carrying value. The$1.7 million investment was included in other assets atDecember 31, 2019 . OnDecember 18, 2019 , this privately held bank holding company entered into an Agreement and Plan Merger ("Merger Agreement") with a publicly traded bank holding company. The Merger Agreement provided for the privately held bank holding company to merge with and into the publicly traded bank holding company, the company surviving the merger ("surviving company"). The surviving company's common stock trades on Nasdaq. The acquisition was completed onJuly 1, 2020 with FNCB receiving$1.2 million in cash for 74,113 of its shares with the remaining 122,178 shares converted into 78,822 shares of the surviving company's common stock that had a fair value of$19.90 per share onJuly 1, 2020 or$1.6 million in aggregate. FNCB realized a gain of$1.1 million on the completion of this acquisition. OnSeptember 15, 2020 , FNCB purchased 20,000 shares of fixed-rate non-cumulative perpetual preferred stock of another publicly traded bank holding company pursuant to an underwritten public offering at an offering price of$25.00 per share or$500 thousand in aggregate. The preferred stock pays a quarterly dividend at a rate of 7.50%. FNCB considers its investments in common and preferred shares of the bank holding companies discussed above to be equity securities with readily determinable fair values and therefore reports these securities at fair value on the consolidated statements of financial condition with unrealized gains and losses recognized in non-interest income in the consolidated statements of income. AtSeptember 30, 2020 , the common shares had a fair value of$1.3 million , resulting in an unrealized loss of$288 thousand included in non-interest income for the three and nine months endedSeptember 30, 2020 . FNCB's investment in the preferred stock had a fair value of$503 thousand atSeptember 30, 2020 , resulting in an unrealized gain of$3 thousand included in non-interest income for three and nine months endedSeptember 30, 2020 . 41
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Also included in equity securities at
Loans Total loans, gross, increased$137.0 million , or 16.6%, to$963.3 million atSeptember 30, 2020 from$826.3 million atDecember 31, 2019 , which was predominantly due to the origination and funding of$118.6 million in PPP loans. Excluding PPP loans, FNCB saw modest growth in loans within the commercial sector, loans to state and political subdivisions and residential real estate loans. The increases in these major loan categories was partially offset by a reduction in consumer loans. Historically, commercial lending activities represented a significant portion of FNCB's loan portfolio. Excluding PPP loans, commercial loans including commercial and industrial loans, commercial real estate loans and construction, land acquisition and development loans, as a percentage of total loans, gross, increased to 60.9% atSeptember 30, 2020 from 57.3% atDecember 31, 2019 . 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$24.8 million , or 4.8%, to$538.5 million atSeptember 30, 2020 from$513.7 million atDecember 31, 2019 . The increase was concentrated in commercial real estate loans. Real estate secured loans represented 55.9% and 62.2% of total loans atSeptember 30, 2020 andDecember 31, 2019 , respectively. Commercial real estate loans increased$17.9 million , or 6.4%, to$296.3 million atSeptember 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$138.1 million , or 93.6%, to$285.7 million atSeptember 30, 2020 from$147.6 million atDecember 31, 2019 . Excluding PPP loans, commercial and industrial loans increased$19.5 million , or 13.2%. Construction, land acquisition and development loans increased$3.4 million , or 7.2%, to$50.9 million atSeptember 30, 2020 from$47.5 million atDecember 31, 2019 . Residential real estate loans totaled$174.0 million atSeptember 30, 2020 , an increase of$3.3 million , or 1.9%, 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$27.6 million , or 20.0%, to$110.6 million atSeptember 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$1.9 million , or 4.3%, to$45.8 million atSeptember 30, 2020 from$43.9 million atDecember 31, 2019 .
The following table presents loans receivable, net by major category at
Loan Portfolio Detail
September 30, December 31,
(in thousands) 2020 2019
Residential real estate $ 174,020 $ 170,723
Commercial real estate 296,281 278,379
Construction, land acquisition and development 50,934 47,484
Commercial and industrial 285,693 147,623
Consumer 110,636 138,239
State and political subdivisions 45,738 43,908
Total loans, gross 963,302 826,356
Unearned income (118 ) (69 )
Net deferred loan costs (2,955 ) 2,192
Allowance for loan and lease losses (12,269 ) (8,950 )
Loans, net $ 947,960 $ 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 September 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
September 30, 2020 December 31, 2019
(in thousands) Amount % of Gross Loans Amount % of Gross Loans
1-4 family residential
investment properties $ 53,757 5.58 % $ 38,122 4.61 %
Retail space/shopping centers 45,214 4.69 % 43,865 5.31 %
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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. Management has identified and is continually monitoring exposures to borrowers and industries that may be impacted more immediately and acutely than others. Of particular concern are credit exposures to businesses within the hospitality industry including hotels and motels, full and limited-service restaurants and drinking establishments, among others. In many instances, management has directly reached out to specific borrowers to provide guidance and assistance as appropriate. AtSeptember 30, 2020 , FNCB had an aggregate exposure of$15.5 million in outstanding loan balances to borrowers in the hotel industry and$23.6 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. During the three months endedSeptember 30, 2020 , management provided a modification under the Cares Act to a significant commercial loan relationship involving three commercial real estate loans totaling$5.1 million that is secured by a hotel in FNCB's market area. AtSeptember 30, 2020 the loans were current and performing under the terms of the modification agreement. Management applied the provisions of the Cares Act and does not consider this modification to be a TDR as the three loans were current as ofDecember 31, 2019 and the borrower's business was directly impacted adversely by the COVID-19 pandemic. Management is closely monitoring this relationship and will appropriately address any changes in the borrower's status. Additionally, management is monitoring unfunded commitments such as lines of credit and overdraft protection to determine liquidity and funding issues that may arise with FNCB's 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, 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. 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
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Non-performing Assets and Accruing TDRs
September 30, December 31,
(dollars in thousands) 2020 2019
Non-accrual loans $ 6,176 $ 9,084
Loans past due 90 days or more and still accruing - -
Total non-performing loans 6,176 9,084
Other real estate owned 58 289
Other non-performing assets 1,900 1,900
Total non-performing assets $ 8,134 $ 11,273
Accruing TDRs $ 7,216 $ 7,745
Non-performing loans as a percentage of gross loans 0.64 % 1.10 %
Total non-performing assets decreased $3.2 million , or 27.8%, to $8.1 million at
September 30, 2020 from $11.3 million at December 31, 2019 . The improvement was
attributable to a decrease in non-accrual loans, primarily reflecting the return
of two large commercial loan relationships to accrual status, coupled with a
decrease in OREO. FNCB's ratio of non-performing loans to total gross loans
decreased to 0.64% at September 30, 2020 from 1.10% at December 31, 2019 . FNCB's
ratio of non-performing assets as a percentage of shareholders' equity improved
to 5.4% at September 30, 2020 from 8.4% at December 31, 2019 , due primarily to
an increase in FNCB's capital position, coupled with the reduction in
non-performing assets.
Other non-performing assets at September 30, 2020 and December 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 the Pocono region of Monroe
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 of September 30, 2020 , no
single-unit lots have been sold, however, the construction of a seven-unit
building is nearing completion and general business activity appears to be
increasing. Management continues to monitor this project closely and is in
regular contact with the Developer. However, uncertainty and economic
volatility associated with the COVID-19 pandemic are unknown and could
negatively impact the timing of sales and payments.
While credit quality metrics of FNCB's loan portfolio improved comparing
September 30, 2020 and December 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 no loans modified as TDRs during the three months ended September 30,
2020 . Loans modified as TDRs for the nine months ended September 30, 2020
included three commercial and industrial loans and one residential mortgage
loan. The three commercial and industrial loans were modified under forbearance
agreements with an aggregate pre- and post-modification recorded investment of
$196 thousand . The modification of the residential mortgage loan involved an
extension of terms and the loan had a pre- and post-modification recorded
investment of $88 thousand .
During the three months ended September 30, 2019 , there were three residential
mortgage loans modified as TDRs. The modifications involved either forbearance
or capitalization of taxes and had pre- and post-modification recorded
investments that totaled $250 thousand and $261 thousand respectively. For the
nine months ended September 30, 2019 , TDRs also included one residential
mortgage loan for which the terms were extended. This TDR had a pre- and
post-modification balance of $24 thousand .
During the three and nine months ended September 30, 2020 , there were no loans
modified as a TDR within the previous 12 months that subsequently defaulted,
defined as 90 days or more past due. There were no loans that were modified as a
TDR within the previous 12 months that subsequently defaulted during the three
months ended September 30, 2019 . For the nine months ended September 30, 2019 ,
subsequent defaults of TDRs modified within the previous 12 months included one
consumer loan with a recorded investment of $103 thousand .
Modifications Related to COVID-19
In lateMarch 2020 , the federal banking regulators issued guidance and are encouraging banks to work prudently with, and provide short-term payment accommodations to, borrowers affected by COVID-19. Additionally, Section 4013 of the CARES Act addressed COVID-19-related modifications and specified that such modifications made on loans that were current as ofDecember 31, 2019 do not need to be classified as TDRs. FNCB had applied this guidance and made 916 such modifications, with 860 loans having an aggregate recorded investment of$173.6 million outstanding atSeptember 30, 2020 . These initial modifications provided borrowers with a short-term, typically three months, interest-only period or full payment deferral. Of the 860 loans, 71 loans with an aggregate recorded investment of$21.4 million were provided a second deferral. As ofSeptember 30, 2020 , there were 16 loans with an aggregate recorded investment of$8.0 million , or 0.83% of total loans, that were still under deferral. Included in loans still under deferral was a modification provided to a significant commercial loan relationship involving three commercial real estate loans totaling$5.1 million that are secured by a hotel in FNCB's market area. AtSeptember 30, 2020 the loans were current and performing under the terms of the modification agreement. In applying the provisions of the CARES Act, management does not consider this modification to be a TDR as the three loans were current as ofDecember 31, 2019 and the borrower's business was directly impacted adversely by the COVID-19 pandemic. Management is closely monitoring this relationship, as well as all loans for which modifications under the CARES Act have been granted, and will appropriately address any changes in the status of any of the borrowers. Additionally, management will continue to follow regulatory guidance when working with borrowerswho have been impacted by COVID-19 and apply the CARES Act guidance in making any TDR determinations. 44 --------------------------------------------------------------------------------
The following table presents information about COVID-19 related loan
modifications by major loan category as of
As of September 30, 2020
Total Loans Modified Total Number of Loans Still Under Deferral
Recorded % of Loan Recorded % of Loan
(in thousands) Number of Loans Investment Category Number of Loans Investment Category
COVID-19 related loan
modifications:
Residential real
estate 201 $ 18,951 10.89 % 2 $ 54 0.03 %
Commercial real
estate 159 113,245 38.22 % 7 7,860 2.65 %
Construction, land
acquisition and
development 12 11,340 22.26 % - - -
Commercial and
industrial 101 22,748 7.96 % - - -
Consumer 387 7,283 6.58 % 7 107 0.10 %
State and political
subdivision - - - - - -
Total 860 $ 173,567 18.02 % 16 8,021 0.83 %
The following table presents the changes in non-performing loans for the three
and nine months ended September 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 nine months
ended September 30, 2020 and 2019.
Changes in Non-Performing Loans
Three Months Ended September 30, Nine Months Ended September 30,
(in thousands) 2020 2019 2020 2019
Balance, beginning of period $ 6,740 $ 5,302 $ 9,084 $ 4,696 Loans newly placed on non-accrual
329 1,707 1,765 4,801
Loans returned to performing status (4 ) - (1,573 ) (27 )
Loan foreclosures - - - -
Loans charged-off (567 ) (411 ) (1,191 ) (1,978 )
Loan payments received (322 ) (479 ) (1,909 ) (1,373 )
Balance, end of period $ 6,176 $ 6,119 $ 6,176 $ 6,119
The average balance of impaired loans was $12.8 million and $14.3 million ,
respectively, for the three and nine months ended September 30, 2020 and 2019,
compared to $12.3 million and $12.6 million , respectively, for the three and
nine months ended September 30, 2019 . FNCB recognized $83 thousand and
$272 thousand of interest income on impaired loans for the three and nine months
ended September 30, 2020 , respectively and $97 thousand and $302 thousand for
the respective periods of 2019.
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 nine months ended September 30, 2020
approximated $76 thousand and $282 thousand , respectively and $90 thousand and
$267 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
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Loan Delinquencies and Non-Accrual Loans
September 30, December 31,
2020 2019
Accruing:
30-59 days 0.14 % 0.26 %
60-89 days 0.03 % 0.10 %
90+ days 0.00 % 0.00 %
Non-accrual 0.64 % 1.10 %
Total delinquencies 0.81 % 1.46 %
Total delinquencies as a percent of gross loans were 0.81% 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$12.3 million , or 1.28% of total loans atSeptember 30, 2020 , an increase of$3.3 million , or 37.1%, from$8.9 million atDecember 31, 2019 . The increase resulted from$2.0 million in provisions for loan and lease losses for the nine months endedSeptember 30, 2020 , offset by$1.3 million 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$409 thousand , or 3.3%, of the total ALLL atSeptember 30, 2020 , compared to$473 thousand , or 5.3%, of the total ALLL atDecember 31, 2019 . A general allocation of$11.9 million was calculated for loans analyzed collectively under ASC 450 "Contingencies" ("ASC 450"), which represented 96.7% of the total ALLL of$12.3 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 atSeptember 30, 2020 was an unallocated reserve of$1.1 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 1.28% of total loans, net of net deferred loan origination fees and unearned income, of$960.2 million atSeptember 30, 2020 from 1.08% of total loans, net of net deferred loan costs and unearned income, of$828.5 million atDecember 31, 2019 . Excluding PPP loans, the ALLL as a percentage of gross loans equaled 1.45% atSeptember 30, 2020 . 46
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The following table presents an allocation of the ALLL by major loan category and percent of loans in each category to total loans atSeptember 30, 2020 andDecember 31, 2019 : Allocation of the ALLL September 30, 2020 December 31, 2019 Percentage Percentage of Loans of Loans in Each in Each Category Category Allowance to Total Allowance to Total (dollars in thousands) Amount Loans Amount Loans Residential real estate$ 1,547 18.06 %$ 1,147 20.66 % Commercial real estate 4,814 30.75 % 3,198 33.69 % Construction, land acquisition and development 413 5.29 % 271 5.75 % Commercial and industrial 2,354 29.66 % 1,997 17.86 % Consumer 1,649 11.49 % 1,658 16.73 % State and political subdivision 377 4.75 % 253 5.31 % Unallocated 1,115 0.00 % 426 0.00 % Total$ 12,269 100.00 %$ 8,950 100.00 %
The following table presents an analysis of the ALLL by loan category for the
three and nine months ended
Reconciliation of the ALLL
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
(dollars in thousands) 2020 2019 2020 2019
Balance at beginning of period $ 11,024 $ 8,945 $ 8,950 $ 9,519
Charge-offs:
Residential real estate - - - 27
Commercial real estate 280 - 336 -
Construction, land acquisition and
development - - - 18
Commercial and industrial 81 216 208 976
Consumer 221 201 683 973
State and political subdivisions - - - -
Total charge-offs 582 417 1,227 1,994
Recoveries of charged-off loans:
Residential real estate 3 1 42 7
Commercial real estate 845 - 846 14
Construction, land acquisition and
development - 1 - 82
Commercial and industrial 726 58 1,210 265
Consumer 179 90 392 592
State and political subdivisions - - - -
Total recoveries 1,753 150 2,490 960
Net (recoveries) charge-offs (1,171 ) 267 (1,263 ) 1,034
Provision for loan and lease losses 74 637 2,056 830
Balance at end of period $ 12,269 $ 9,315 $ 12,269 $ 9,315
Net charge-offs as a percentage of
average loans (0.12 )% 0.03 % (0.14 )% 0.13 %
Allowance for loan and lease losses as a
percentage of gross loans outstanding at
period end 1.28 % 1.11 % 1.28 % 1.11 %
Allowance for loan and lease losses as a
percentage of gross loans outstanding at
period end, excluding PPP Loans 1.45 % - 1.45 % -
Other Real Estate Owned
There was one piece of commercial land with a carrying value of $58 thousand
held in OREO at September 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. FNCB recorded a
valuation adjustment to the carrying value of the piece of commercial land of
$27 thousand during the nine months ended September 30, 2020 . The residential
real estate property, which was the collateral supporting an investor-owned
residential mortgage loan, was sold during the nine months ended September 30,
2020 . The agreement with the investor requires FNCB to take title to the
property upon foreclosure and liquidate the property 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 nine months ended September 30,
2020 .
At September 30, 2019 , OREO consisted of four properties with an aggregate value
of $412 thousand . There were two properties with an aggregate fair value less
cost to sell of $256 thousand that were foreclosed upon during the nine months
ended September 30, 2019 . The properties foreclosed upon were the collateral
supporting investor-owned residential mortgage loans. There were four OREO
properties, with an aggregate carrying value of $749 thousand , sold during the
nine months ended September 30, 2019 . FNCB realized net gains of $20 thousand
upon the sales, which was included in non-interest income for the nine months
ended September 30, 2019 .
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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$65 thousand and$155 thousand for the three and nine months endedSeptember 30, 2020 , respectively, and$62 thousand and$127 thousand for the respective periods of 2019. 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. As mentioned above, FNCB recorded valuation adjustments to the carrying value of the property held in OREO of$27 thousand for the three and nine months endedSeptember 30, 2020 . There were no valuation adjustments recorded to the carrying value of OREO properties during the three and nine months endedSeptember 30, 2019 . Liabilities Total liabilities, which consist primarily of total deposits and borrowed funds, were$1.293 billion atSeptember 30, 2020 , an increase of$223.2 million , or 20.9%, from$1.070 billion atDecember 31, 2019 . The increase primarily reflected strong deposit growth experienced during 2020. Changing customer deposit preferences and higher balances due to the reduction in consumer and business spending due to uncertainty related to the COVID-19 pandemic, coupled with cyclical deposit trends of public funds, were the the primary factors contributing to an increase in total deposits of$270.5 million , or 27.0%, to$1.272 billion atSeptember 30, 2020 from$1.002 billion atDecember 31, 2019 . FNCB experienced strong demand for both non-interest-bearing and interest-bearing deposits. Non-interest-bearing demand deposits increased$94.6 million , or 52.7%, to$274.1 million atSeptember 30, 2020 from$179.5 million atDecember 31, 2019 , while interest-bearing deposits increased$175.9 million , or 21.4%, to$998.1 million atSeptember 30, 2020 from$822.2 million atDecember 31, 2019 . Interest-bearing demand deposits increased$158.3 million , or 29.6%, to$693.0 million atSeptember 30, 2020 from$534.7 million atDecember 31, 2019 , while savings deposits increased$13.4 million , or 14.1%, to$107.9 million atSeptember 30, 2020 from$94.5 million atDecember 31, 2019 . Total time deposits increased$4.1 million , or 2.1%, to$197.2 million atSeptember 30, 2020 from$193.0 million atDecember 31, 2019 primarily due to an increase in brokered certificates of deposit of$20.0 million , partially offset by maturing certificates of deposit that were primarily redirected into non-maturity interest-bearing deposits. As a result of strong increase in deposits, FNCB was able to reduce its reliance on borrowed funds as a source of liquidity. Specifically, FNCB prepaid two higher-costing term advances during the three months endedSeptember 30, 2020 . Additionally, FNCB prepaid a$36 million advance through the Federal Reserve Discount Window under the PPPLF during the three months endedSeptember 30, 2020 . There were no Discount Window advances or any FHLB ofPittsburgh overnight or term advances outstanding atSeptember 30, 2020 . Total borrowed funds decreased$46.9 million , or 82.0%, to$10.3 million atSeptember 30, 2020 from$57.2 million atDecember 31, 2019 . 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$16.4 million , or 12.3%, to$150.0 million atSeptember 30, 2020 from$133.6 million atDecember 31, 2019 . The improvement in capital resulted primarily from net income for the nine months endedSeptember 30, 2020 of$10.2 million and a$9.1 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 nine months endedSeptember 30, 2020 of$3.3 million . FNCB's tangible book value per common share improved$0.79 , or 12.0%, to$7.41 atSeptember 30, 2020 , compared to$6.62 per share atDecember 31, 2019 . The Bank's total regulatory capital increased$19.1 million to$152.5 million atSeptember 30, 2020 from$133.4 million atDecember 31, 2019 . The Bank's total risk-based capital and Tier 1 leverage ratios were 16.09% and 10.17%, respectively atSeptember 30, 2020 compared to 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 atSeptember 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. AtSeptember 30, 2020 , cash and cash equivalents totaled$105.0 million , an increase of$70.4 million compared to$34.6 million atDecember 31, 2019 . For the nine months endedSeptember 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 nine months endedSeptember 30, 2020 provided net cash of$15.1 million . Financing activities provided$220.3 million in net cash flow for the nine months endedSeptember 30, 2020 , which resulted primarily from the net increase in deposits of$270.5 million . Partially offsetting these net cash inflows, was$165.0 million in net cash used by FNCB's investing activities for the nine months endedSeptember 30, 2020 , which resulted primarily from the cash used of$130.8 million for new loan funding, coupled with the purchases of available-for-sale securities of$113.2 million . These investing cash outflows were partially offset by cash received from sales, maturities, calls and repayments of available-for-sale debt securities totaling$77.2 million . 48
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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 atSeptember 30, 2020 . In addition to cash and cash equivalents of$105.0 million atSeptember 30, 2020 , FNCB had ample sources of additional liquidity including approximately$350.9 million in available borrowing capacity from the FHLB ofPittsburgh , and available borrowing capacity through the Federal Reserve Discount Window of$82.4 million under the PPPLF and$17.3 million under the borrower-in-custody program. FNCB also has available unsecured federal funds lines of credit totaling$40.0 million atSeptember 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 using
? 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 theSeptember 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 (1.8 )% (12.5 )% (1.1 )% (20.0 )% 2.1 % (10.0 )% Economic value at risk: Percent change in economic value of equity 10.5 % (20.0 )% 17.0 % (35.0 )% (28.3 )% (10.0 )% Model results atSeptember 30, 2020 indicated that FNCB was liability sensitive and had minor exposure to rising rates in the near term moving to an asset sensitive position within approximately 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 atSeptember 30, 2020 indicated that FNCB's net interest income is expected to decrease 1.8% under a +200-basis point interest rate shock. Additionally, model results indicated that FNCB's economic value of equity is expected toincrease 10.5%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 2.1%, while the economic value of equity would decrease 28.3%, 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 atSeptember 30, 2020 . Comparatively, model results atJune 30, 2020 exhibited similar results and indicated net interest income would be expected to decrease 1.6% and economic value of equity would be expected to increase 11.0% given a +200-basis point rate shock. Conversely, given a -100 basis point rate shock atJune 30, 2020 , net interest income would be expected to increase 3.4% and the economic value of equity would decrease 32.2%. 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 endedSeptember 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 endedSeptember 30, 2020 of approximately$1.1 million , or 12.6%. The variance primarily reflected a difference in the assumption for the volume and timing of the forgiveness of PPP loans used in the model with that actually experienced. TheJune 30, 2020 simulation assumed approximately 75.0% of PPP loans would be forgiven and paid off within six months, and the proceeds used to repay borrowings with the remainder re-invested into higher-yielding assets. As ofSeptember 30, 2020 , there were no PPP loans that were forgiven and paid off. 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 nine months endedSeptember 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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