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Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 20222023

 

OR

 

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______________to______________________

 

Commission file number: 001-38229

 

FIDELITY D & D BANCORP, INC.

 

STATE OF INCORPORATION:IRS EMPLOYER IDENTIFICATION NO:
Pennsylvania23-3017653

 

Address of principal executive offices:

Blakely & Drinker St.

Dunmore, Pennsylvania 18512

TELEPHONE: 570-342-8281

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

Title of each class

Trading Symbols(s)

Name of each exchange on which registered

Common stock, without par value

FDBC

The NASDAQ Stock Market, LLC

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subjected to such filing requirements for the past 90 days. ☒ Yes ☐ No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐

Non-accelerated filer ☒

Accelerated filer ☐

 

Smaller reporting company ☒

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No

 

The number of outstanding shares of Common Stock of Fidelity D & D Bancorp, Inc. on July 31, 2022,2023, the latest practicable date, was w5,632,344 as 5,687,162 shashares.res.

 

 

 

 

FIDELITY D & D BANCORP, INC.

 

Form 10-Q June 30, 20222023

 

Index

 

Part I. Financial Information

 

Page

Item 1.

Financial Statements (unaudited):

 
 

Consolidated Balance Sheets as of June 30, 20222023 and December 31, 20212022

3

 

Consolidated Statements of Income for the three and six months ended June 30, 20222023 and 20212022

4

 

Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 20222023 and 20212022

5

 

Consolidated Statements of Changes in Shareholders’ Equity for the three and six months ended June 30, 20222023 and 20212022

6

 

Consolidated Statements of Cash Flows for the six months ended June 30, 20222023 and 20212022

8

 

Notes to Consolidated Financial Statements (Unaudited)

10

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

3836

Item 3.

Quantitative and Qualitative Disclosure about Market Risk

5855

Item 4.

Controls and Procedures

6461

   

Part II. Other Information

  

Item 1.

Legal Proceedings

6562

Item 1A.

Risk Factors

6562

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

6562

Item 3.

Defaults upon Senior Securities

6562

Item 4.

Mine Safety Disclosures

6562

Item 5.

Other Information

6562

Item 6.

Exhibits

6663

Signatures

 

6865

 

 

2

 

 

PART I Financial Information

Item 1: Financial Statements

Fidelity D & D Bancorp, Inc. and Subsidiary

Consolidated Balance Sheets                

(Unaudited) 

(Unaudited)

 

(dollars in thousands)

 

June 30, 2022

  

December 31, 2021

  

June 30, 2023

  

December 31, 2022

 

Assets:

  

Cash and due from banks

 $39,831  $27,317  $35,294  $3,542 

Interest-bearing deposits with financial institutions

 69,294  69,560  34,338  25,549 

Total cash and cash equivalents

 109,125  96,877  69,632  29,091 

Available-for-sale securities

 452,822  738,980  380,785  420,862 

Held-to-maturity securities (fair value of $199,446 in 2022; $0 in 2021)

 222,011 0 

Held-to-maturity securities (fair value of $192,084 in 2023; $187,280 in 2022)

 223,479 222,744 

Restricted investments in bank stock

 3,622  3,206  3,728  5,268 

Loans and leases, net (allowance for loan losses of $16,590 in 2022; $15,624 in 2021)

 1,473,715  1,417,504 

Loans held-for-sale (fair value $4,061 in 2022; $32,013 in 2021)

 4,011  31,727 

Loans and leases, net (allowance for credit losses of $18,350 in 2023; $17,149 in 2022)

 1,611,314  1,547,025 

Loans held-for-sale (fair value $1,851 in 2023; $1,660 in 2022)

 1,808  1,637 

Foreclosed assets held-for-sale

 128  434  87  168 

Bank premises and equipment, net

 30,855  29,310  31,329  31,307 

Leased property under finance leases, net

 1,210  1,307  969  1,089 

Right-of-use assets

 8,800  9,006  8,411  8,642 

Cash surrender value of bank owned life insurance

 53,383  52,745  53,892  54,035 

Accrued interest receivable

 7,909  7,526  8,343  8,487 

Goodwill

 19,628  19,628  19,628  19,628 

Core deposit intangible, net

 1,732  1,942  1,353  1,540 

Other assets

 25,989  8,912  26,474  26,849 

Total assets

 $2,414,940  $2,419,104  $2,441,232  $2,378,372 

Liabilities:

  

Deposits:

  

Interest-bearing

 $1,606,637  $1,579,582  $1,569,519  $1,564,305 

Non-interest-bearing

 610,987  590,283  582,473  602,608 

Total deposits

 2,217,624  2,169,865  2,151,992  2,166,913 

Accrued interest payable and other liabilities

 16,248  15,943  16,442  17,434 

Allowance for credit losses on off-balance sheet credit exposures

 1,284 49 

Finance lease obligation

 1,226  1,320  991  1,110 

Operating lease liabilities

 9,477  9,627  9,170  9,357 

Short-term borrowings

 10 0  76,111 12,940 

Secured borrowings

 7,736  10,620  7,498  7,619 

Total liabilities

 2,252,321  2,207,375  2,263,488  2,215,422 

Shareholders' equity:

  

Preferred stock authorized 5,000,000 shares with no par value; none issued

 0  0  -  - 

Capital stock, no par value (10,000,000 shares authorized; shares issued and outstanding; 5,651,777 at June 30, 2022; and 5,645,687 at December 31, 2021)

 115,079  114,108 

Capital stock, no par value (10,000,000 shares authorized; shares issued and outstanding; 5,681,260 at June 30, 2023; and 5,630,794 at December 31, 2022)

 116,959  115,611 

Retained earnings

 108,848  97,442  126,711  119,754 

Accumulated other comprehensive (loss) income

 (60,920) 179 

Treasury stock, at cost (10,342 shares at June 30, 2022 and no shares at December 31, 2021)

 (388) 0 

Accumulated other comprehensive loss

 (65,268) (71,152)

Treasury stock, at cost (16,473 shares at June 30, 2023 and 32,663 shares at December 31, 2022)

 (658) (1,263)

Total shareholders' equity

 162,619  211,729  177,744  162,950 

Total liabilities and shareholders' equity

 $2,414,940  $2,419,104  $2,441,232  $2,378,372 

 

See notes to unaudited consolidated financial statements

 

3

 

 

Fidelity D & D Bancorp, Inc. and Subsidiary

Consolidated Statements of Income

(Unaudited)

 

Three months ended

 

Six months ended

  

Three months ended

 

Six months ended

 

(dollars in thousands except per share data)

 

June 30, 2022

 

June 30, 2021

 

June 30, 2022

 

June 30, 2021

  

June 30, 2023

 

June 30, 2022

 

June 30, 2023

 

June 30, 2022

 

Interest income:

  

Loans and leases:

  

Taxable

 $15,043  $11,621  $29,409  $23,809  $18,875  $15,043  $36,994  $29,409 

Nontaxable

 457  329  866  649  828  457  1,727  866 

Interest-bearing deposits with financial institutions

 80  39  113  60  121  80  152  113 

Restricted investments in bank stock

 33  36  64  68  75  33  181  64 

Investment securities:

  

U.S. government agency and corporations

 1,614  854  3,123  1,554  1,475  1,614  2,995  3,123 

States and political subdivisions (nontaxable)

 1,388  1,033  2,769  1,887  1,160  1,388  2,377  2,769 

States and political subdivisions (taxable)

 450  255  900  480  445  450  891  900 

Total interest income

 19,065  14,167  37,244  28,507  22,979  19,065  45,317  37,244 

Interest expense:

  

Deposits

 950  841  1,772  1,705  6,607  950  11,225  1,772 

Secured borrowings

 (31) 0  34  0  118  (31) 229  34 

Other short-term borrowings

 1 0 1 0  772  1  1,356  1 

FHLB advances

 0  0  0  26 

Total interest expense

 920  841  1,807  1,731  7,497  920  12,810  1,807 

Net interest income

 18,145  13,326  35,437  26,776  15,482  18,145  32,507  35,437 

Provision for loan losses

 525  300  1,050  1,100 

Net interest income after provision for loan losses

 17,620  13,026  34,387  25,676 

Provision for credit losses on loans

 675  525  855  1,050 

Provision (credit) for credit losses on unfunded loan commitments

 (50) (7) 175 (18)

Net interest income after provision for credit losses

 14,857  17,627  31,477  34,405 

Other income:

  

Service charges on deposit accounts

 836  565  1,634  1,130  1,001  836  1,922  1,634 

Interchange fees

 1,114  1,153  2,289  2,103  1,168  1,114  2,419  2,289 

Service charges on loans

 317  518  758  1,029  284  317  582  758 

Fees from trust fiduciary activities

 613  542  1,230  1,036  718  613  1,413  1,230 

Fees from financial services

 246  217  513  392  227  246  450  513 

Fees and other revenue

 312  176  692  353  734  312  1,352  692 

Earnings on bank-owned life insurance

 319  276  638  573  324  319  645  638 

Gain (loss) on write-down, sale or disposal of:

  

Loans

 477  1,136  1,190  3,483  242  477  406  1,190 

Available-for-sale debt securities

 -  -  (1) - 

Premises and equipment

 22  (6) (134) (6) (163) 22  (165) (134)

Total other income

 4,256  4,577  8,810  10,093  4,535  4,256  9,023  8,810 

Other expenses:

  

Salaries and employee benefits

 6,941  5,366  13,655  10,592  6,430  6,941  12,945  13,655 

Premises and equipment

 1,893  1,588  3,818  3,230  2,250  1,893  4,377  3,818 

Data processing and communication

 618  640  1,331  1,242  699  618  1,376  1,331 

Advertising and marketing

 489  255  1,270  1,157  478  489  1,371  1,270 

Professional services

 826  830  1,545  1,767  1,074  826  1,999  1,545 

Merger-related expenses

 0  419  0  942 

Automated transaction processing

 440  377  809  669  476  440  905  809 

Office supplies and postage

 178  161  357  274  197  178  378  357 

PA shares tax

 441  366  601  416  324  441  291  601 

Loan collection

 30  31  65  81  46  30  59  65 

Other real estate owned

 29  (7) 3  18  1  29  2  3 

FDIC assessment

 136  124  373  235  393  136  561  373 

FHLB prepayment fee

 0  0  0  369 

Other

 779  701  1,627  1,315  1,057  786  2,017  1,645 

Total other expenses

 12,800  10,851  25,454  22,307  13,425  12,807  26,281  25,472 

Income before income taxes

 9,076  6,752  17,743  13,462  5,967  9,076  14,219  17,743 

Provision for income taxes

 1,412  1,056  2,556  2,099  605  1,412  1,817  2,556 

Net income

 $7,664  $5,696  $15,187  $11,363  $5,362  $7,664  $12,402  $15,187 

Per share data:

  

Net income - basic

 $1.35  $1.14  $2.68  $2.28  $0.95  $1.35  $2.19  $2.68 

Net income - diluted

 $1.35  $1.13  $2.67  $2.26  $0.94  $1.35  $2.18  $2.67 

Dividends

 $0.33  $0.30  $0.66  $0.60  $0.36  $0.33  $0.72  $0.66 

 

See notes to unaudited consolidated financial statements

 

4

 

 

Fidelity D & D Bancorp, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income

 

Three months ended

 

Six months ended

  

Three months ended

 

Six months ended

 

(Unaudited)

 

June 30,

 

June 30,

  

June 30,

 

June 30,

 

(dollars in thousands)

 

2022

 

2021

 

2022

 

2021

  

2023

 

2022

 

2023

 

2022

 
  

Net income

 $7,664  $5,696  $15,187  $11,363  $5,362  $7,664  $12,402  $15,187 
  

Other comprehensive (loss) gain, before tax:

 

Unrealized holding (loss) gain on available-for-sale debt securities

 7  5,276  (54,013) (4,583)

Reclassification adjustment for net gains realized in income

 0  0  0  0 

Other comprehensive gain (loss), before tax:

 

Unrealized holding gain (loss) on available-for-sale debt securities

 (3,517) 7  6,307  (54,013)

Reclassification adjustment for net losses realized in income

   -  1  - 

Reclassification of unrealized loss on securities transferred from available-for-sale to held-to-maturity

 (23,882) 0 (23,882) 0  - (23,882) - (23,882)

Amortization of unrealized loss on held-to-maturity securities

 555 0 555 0  568 555 1,140 555 

Net unrealized (loss) gain

 (23,320) 5,276  (77,340) (4,583)

Net unrealized gain (loss)

 (2,949) (23,320) 7,448  (77,340)

Tax effect

 4,897  (1,108) 16,241  962  619  4,897  (1,564) 16,241 

Unrealized (loss) gain, net of tax

 (18,423) 4,168  (61,099) (3,621)

Other comprehensive (loss) gain, net of tax

 (18,423) 4,168  (61,099) (3,621)

Total comprehensive (loss) income, net of tax

 $(10,759) $9,864  $(45,912) $7,742 

Unrealized gain (loss), net of tax

 (2,330) (18,423) 5,884  (61,099)

Other comprehensive income (loss), net of tax

 (2,330) (18,423) 5,884  (61,099)

Total comprehensive income (loss), net of tax

 $3,032  $(10,759) $18,286  $(45,912)

 

See notes to unaudited consolidated financial statements

 

5

 

 

Fidelity D & D Bancorp, Inc. and Subsidiary

Consolidated Statements of Changes in Shareholders' Equity

 

 

For the Six Months Ended June 30, 2022 and 2021

 

For the Six Months Ended June 30, 2023 and 2022

 

(Unaudited)

       

Accumulated

            

Accumulated

     
       

other

            

other

     
 

Capital stock

 

Retained

 

comprehensive

 

Treasury

    

Capital stock

  

Retained

  

comprehensive

  

Treasury

    

(dollars in thousands)

 

Shares

 

Amount

 

earnings

 

income (loss)

 

Stock

 

Total

  

Shares

  

Amount

  

earnings

  

income (loss)

  

Stock

  

Total

 

Balance, December 31, 2020

 4,977,750  $77,676  $80,042  $8,952     $166,670 

Net income

      11,363       11,363 

Other comprehensive loss

        (3,621)    (3,621)

Issuance of common stock through Employee Stock Purchase Plan

 4,738  270         270 

Issuance of common stock from vested restricted share grants through stock compensation plans

 11,225  0         0 

Issuance of common stock through exercise of SSARs

 2,000           0 

Stock-based compensation expense

    527         527 

Cash dividends declared

      (3,024)      (3,024)

Balance, June 30, 2021

 4,995,713  $78,473  $88,381  $5,331     $172,185 
 

Balance, December 31, 2021

 5,645,687  $114,108  $97,442  $179  $0  $211,729  5,645,687  $114,108  $97,442  $179  $-  $211,729 

Net income

          15,187           15,187       15,187       15,187 

Other comprehensive loss

              (61,099)      (61,099)        (61,099)    (61,099)

Issuance of common stock through Employee Stock Purchase Plan

  4,891   252               252  4,891  252         252 

Forfeited restricted dividend reinvestment shares

  (48)              0   0  (48)     - - 

Issuance of common stock from vested restricted share grants through stock compensation plans

  11,541   0               -  11,541  -         - 

Stock-based compensation expense

      719               719     719         719 

Common stock repurchased

  (10,294)              (388)  (388) (10,294)       (388) (388)

Cash dividends declared

          (3,781)          (3,781)      (3,781)      (3,781)

Balance, June 30, 2022

  5,651,777  $115,079  $108,848  $(60,920) $(388) $162,619  5,651,777  $115,079  $108,848  $(60,920) $(388) $162,619 
 

Balance, December 31, 2022

 5,630,794  $115,611  $119,754  $(71,152) $(1,263) $162,950 

Cumulative-effect adjustment for adoption of ASU 2016-13 (Footnote 1)

       (1,326)       (1,326)

Net income

       12,402        12,402 

Other comprehensive income

          5,884     5,884 

Issuance of common stock through Employee Stock Purchase Plan

 7,294  302           302 

Re-issuance of common stock through Dividend Reinvestment Plan

 17,576  135        673  808 

Issuance of common stock from vested restricted share grants through stock compensation plans

 24,283  -           - 

Issuance of common stock through exercise of SSARs

 2,699 -      - 

Stock-based compensation expense

    963           963 

Repurchase of shares to cover withholdings

 (1,386) (52)      (68) (120)

Cash dividends declared

       (4,119)       (4,119)

Balance, June 30, 2023

 5,681,260  $116,959  $126,711  $(65,268) $(658) $177,744 

See notes to unaudited consolidated financial statements

 

6

 

For the three months ended June 30, 2022 and 2021

 

For the Three Months Ended June 30, 2023 and 2022

 

(Unaudited)

       

Accumulated

            

Accumulated

     
       

other

            

other

     
 

Capital stock

 

Retained

 

comprehensive

 

Treasury

    

Capital stock

  

Retained

 

comprehensive

 

Treasury

   

(dollars in thousands)

 

Shares

 

Amount

 

earnings

 

income (loss)

 

Stock

 

Total

  

Shares

 

Amount

 

earnings

 

income (loss)

 

Stock

 

Total

 

Balance, March 31, 2021

 4,995,547  $78,222  $84,197  $1,163     $163,582 

Net income

      5,696       5,696 

Other comprehensive income

        4,168     4,168 

Issuance of common stock from vested restricted share grants through stock compensation plans

 166  0         0 

Stock-based compensation expense

    251         251 

Cash dividends declared

      (1,512)      (1,512)

Balance, June 30, 2021

 4,995,713  $78,473  $88,381  $5,331     $172,185 
 

Balance, March 31, 2022

 5,659,068  $114,666  $103,074  $(42,497) $0  $175,243  5,659,068  $114,666  $103,074  $(42,497) $-  $175,243 

Net income

          7,664           7,664       7,664       7,664 

Other comprehensive loss

              (18,423)      (18,423)        (18,423)    (18,423)

Forfeited restricted dividend reinvestment shares

  (48)              0   0  (48)     -  - 

Issuance of common stock from vested restricted share grants through stock compensation plans

  3,051   0               0  3,051  -         - 

Stock-based compensation expense

    413         413 

Common stock repurchased

  (10,294)              (388)  (388) (10,294) -     (388) (388)

Stock-based compensation expense

      413               413 

Cash dividends declared

          (1,890)          (1,890)      (1,890)      (1,890)

Balance, June 30, 2022

  5,651,777  $115,079  $108,848  $(60,920) $(388) $162,619  5,651,777  $115,079  $108,848  $(60,920) $(388) $162,619 
 

Balance, March 31, 2023

 5,665,255  $116,437  $123,416  $(62,938) $(1,028) $175,887 

Net income

          5,362           5,362 

Other comprehensive loss

            (2,330)     (2,330)

Re-issuance of common stock through Dividend Reinvestment Plan

  9,472   56           370   426 

Issuance of common stock from vested restricted share grants through stock compensation plans

  3,834   -               - 

Issuance of common stock through exercise of SSARs

  2,699   -            - 

Stock-based compensation expense

      518               518 

Repurchase of shares to cover withholdings

  -   (52)             (52)

Cash dividends declared

          (2,067)          (2,067)

Balance, June 30, 2023

  5,681,260  $116,959  $126,711  $(65,268) $(658) $177,744 

 

See notes to unaudited consolidated financial statements

 

7

 

 

Fidelity D & D Bancorp, Inc. and Subsidiary

Consolidated Statements of Cash Flows

(Unaudited)

 

Six months ended June 30,

  

Six months ended June 30,

 

(dollars in thousands)

 

2022

 

2021

  

2023

 

2022

 
  

Cash flows from operating activities:

        

Net income

 $15,187  $11,363  $12,402  $15,187 

Adjustments to reconcile net income to net cash provided by operating activities:

  

Depreciation, amortization and accretion

 2,495  2,895  2,552  2,495 

Provision for loan losses

 1,050  1,100 

Deferred income tax expense

 1,300  168 

Provision for credit losses on loans

 855  1,050 

Provision (credit) for credit losses on unfunded loan commitments

 175  (18)

Deferred income tax (benefit) expense

 (224) 1,300 

Stock-based compensation expense

 719  517  963  719 

Excess tax benefit from exercise of SSARs

 0  26  31 - 

Proceeds from sale of loans held-for-sale

 52,800  135,745  23,285  52,800 

Originations of loans held-for-sale

 (42,581) (107,127) (23,540) (42,581)

Earnings from bank-owned life insurance

 (638) (573) (645) (638)

Gain from bank-owned life insurance claim

 (142) - 

Net gain from sales of loans

 (1,190) (3,483) (406) (1,190)

Net loss from sales of investment securities

 1 - 

Net gain from sale and write-down of foreclosed assets held-for-sale

 (23) (32) -  (23)

Net loss from write-down and disposal of bank premises and equipment

 134  6  165  134 

Operating lease payments

 57  13  44  57 

Change in:

  

Accrued interest receivable

 (384) (314) 145  (384)

Other assets

 (1,430) 932  400  (1,430)

Accrued interest payable and other liabilities

 305  120  (992) 323 

Net cash provided by operating activities

 27,801  41,356  15,069  27,801 
  

Cash flows from investing activities:

        

Available-for-sale securities:

  

Proceeds from sales

 0  0  31,208  - 

Proceeds from maturities, calls and principal pay-downs

 23,561  27,826  13,356  23,561 

Purchases

 (39,183) (196,928) -  (39,183)

Increase in restricted investments in bank stock

 (416) (418)

Decrease (increase) in restricted investments in bank stock

 1,540  (416)

Net increase in loans and leases

 (40,733) (12,843) (66,711) (40,733)

Principal portion of lease payments received under direct finance leases

 2,859  2,266  2,803  2,859 

Purchases of bank premises and equipment

 (3,875) (1,146) (2,579) (3,875)

Proceeds from death benefits received on bank-owned life insurance

 931 - 

Proceeds from sale of bank premises and equipment

 466  0  22  466 

Proceeds from sale of foreclosed assets held-for-sale

 780  216  -  780 

Net cash used in investing activities

 (56,541) (181,027) (19,430) (56,541)
  

Cash flows from financing activities:

        

Net increase in deposits

 47,776  248,190 

Net decrease in other borrowings

 (2,755) 0 

Repayment of FHLB advances

 0  (5,000)

Net (decrease) increase in deposits

 (14,903) 47,776 

Net increase (decrease) in other borrowings

 63,052  (2,755)

Repayment of finance lease obligation

 (116) (47) (118) (116)

Purchase of treasury stock

 (388) 0  - (388)

Proceeds from employee stock purchase plan participants

 252  270  302  252 

Dividends paid

 (3,781) (3,024)

Repurchase of shares to cover withholdings

 (121) - 

Dividends paid, net of dividends reinvested

 (3,310) (3,781)

Net cash provided by financing activities

 40,988  240,389  44,902  40,988 

Net increase in cash and cash equivalents

 12,248  100,718  40,541  12,248 

Cash and cash equivalents, beginning

 96,877  69,346  29,091  96,877 
  

Cash and cash equivalents, ending

 $109,125  $170,064  $69,632  $109,125 

 

See notes to unaudited consolidated financial statements

 

8

 

Fidelity D & D Bancorp, Inc. and Subsidiary

Consolidated Statements of Cash Flows (continued)

 

(Unaudited)

 

Six months ended June 30,

  

Six months ended June 30,

 

(dollars in thousands)

 

2022

 

2021

  

2023

 

2022

 

Supplemental Disclosures of Cash Flow Information

        

Cash payments for:

  

Interest

 $1,838  $1,907  $11,881  $1,838 

Income tax

  900  1,150   1,700  900 

Supplemental Disclosures of Non-cash Investing Activities:

        

Net change in unrealized gains on available-for-sale securities

  (54,013) (4,583)

Net change in unrealized gains (losses) on available-for-sale securities

  6,308  (54,013)

Transfers of securities from available-for-sale to held-to-maturity

  245,536  0   -  245,536 

Unrealized losses on securities transferred from available-for-sale to held-to-maturity

  (23,327) 0   -  (23,882)

Transfers from loans to foreclosed assets held-for-sale

  450  293 

Cumulative-effect adjustment for adoption of ASU 2016-13

  (1,326) - 

Amortization of unrealized losses on securities transferred from available-for-sale to held-to-maturity

  1,140  555 

Transfers from/(to) loans to/(from) foreclosed assets held-for-sale

  (82) 450 

Transfers from/(to) loans to/(from) loans held-for-sale, net

  (17,129) 3,781   (205) (17,129)

Transfers from premises and equipment to other assets held-for-sale

  1,184  0   739  1,184 

Security settlement pending

  0  1,138 

Right-of-use asset

  24  0   -  24 

Lease liability

  24  0   -  24 

 

See notes to unaudited consolidated financial statements

 

9

 

FIDELITY D & D BANCORP, INC.

Notes to Consolidated Financial Statements

(Unaudited)

 

 

1. Nature of operations and critical accounting policies

 

Nature of operations

 

Fidelity D & D Bancorp, Inc. (the Company) is a bank holding company and the parent of The Fidelity Deposit and Discount Bank (the Bank). The Bank is a commercial bank and trust company chartered under the laws of the Commonwealth of Pennsylvania and a wholly-owned subsidiary of the Company. Having commenced operations in 1903, the Bank is committed to provide superior customer service, while offering a full range of banking products and financial and trust services to both our consumer and commercial customers from our main office located in Dunmore and other branches located throughout Lackawanna, Northampton and Luzerne Counties and Wealth Management offices in Schuylkill and Lebanon Counties.

On July 1, 2021, the Company completed its acquisition of Landmark Bancorp, Inc. (Landmark) and its wholly-owned subsidiary, Landmark Community Bank (Landmark Bank). At the time of the acquisition, Landmark merged with and into an acquisition subsidiary of the Company with the acquisition subsidiary Company surviving the merger. In addition, immediately thereafter Landmark Bank merged with and into the Bank with the Bank as the surviving bank.

On May 1, 2020, the Company completed its acquisition of MNB Corporation (MNB) and its wholly-owned subsidiary, Merchants Bank of Bangor. At the time of the acquisition, MNB merged with and into the Company with the Company surviving the merger. In addition, immediately thereafter Merchants Bank of Bangor merged with and into the Bank with the Bank as the surviving bank.

Further discussion of the acquisition of Landmark can be found in Footnote 9, “Acquisition”.

 

Principles of consolidation

 

The accompanying unaudited consolidated financial statements of the Company and the Bank have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and with the instructions to this Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnote disclosures required by GAAP for complete financial statements. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the financial condition and results of operations for the periods have been included. All significant inter-company balances and transactions have been eliminated in consolidation.

 

For additional information and disclosures required under U.S. GAAP, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 20212022.

 

Management is responsible for the fairness, integrity and objectivity of the unaudited financial statements included in this report. Management prepared the unaudited financial statements in accordance with U.S. GAAP. In meeting its responsibility for the financial statements, management depends on the Company's accounting systems and related internal controls. These systems and controls are designed to provide reasonable but not absolute assurance that the financial records accurately reflect the transactions of the Company, the Company’s assets are safeguarded and that the financial statements present fairly the financial condition and results of operations of the Company.

 

In the opinion of management, the consolidated balance sheets as of June 30, 20222023 and December 31, 20212022 and the related consolidated statements of income, consolidated statements of comprehensive income and consolidated statements of changes in shareholders’ equity for the three and six months ended June 30, 20222023 and 20212022 and consolidated statements of cash flows for the six months ended June 30, 20222023 and 20212022 present fairly the financial condition and results of operations of the Company. All material adjustments required for a fair presentation have been made. These adjustments are of a normal recurring nature. Certain reclassifications have been made to the 20212022 financial statements to conform to the 20222023 presentation.

 

In preparing these consolidated financial statements, the Company evaluated the events and transactions that occurred after June 30, 20222023 through the date these consolidated financial statements were issued.

 

This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 20212022, and the notes included therein, included within the Company’s Annual Report filed on Form 10-K.

 

Critical accounting policies

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates.

 

10

 

A material estimate that is particularly susceptible to significant change relates to the determination of the allowance for loancredit losses. Management believes that the allowance for loancredit losses at June 30, 20222023 is adequate and reasonable to cover incurredexpected losses. Given the subjective nature of identifying and estimating loan losses, it is likely that well-informed individuals could make different assumptions and could, therefore, calculate a materially different allowance amount. While management uses available information to recognize losses on loans, changes in current economic conditions and reasonable and supportable forecasts may necessitate revisions in the future. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loancredit losses. Such agencies may require the Company to recognize adjustments to the allowance based on their judgment of information available to them at the time of their examination.

 

Another material estimate is the calculation of fair values of the Company’s investment securities. Fair values of investment securities are determined by pricing provided by a third-party vendor, who is a provider of financial market data, analytics and related services to financial institutions. Based on experience, management is aware that estimated fair values of investment securities tend to vary among valuation services. Accordingly, when selling investment securities, price quotes may be obtained from more than one source. All of the Company’s debt securities are classified as available-for-sale (AFS) or held-to-maturity (HTM). AFS debt securities are carried at fair value on the consolidated balance sheets, with unrealized gains and losses, net of income tax, reported separately within shareholders’ equity as a component of accumulated other comprehensive income (AOCI).  Debt securities, for which the Company has the positive intent and ability to hold to maturity, are reported at cost. On occasion, the Company may transfer securities from AFS to HTM at fair value on the date of transfer.

 

The fair value of residential mortgage loans, classified as held-for-sale (HFS), is obtained from the Federal National Mortgage Association (FNMA) or the Federal Home Loan Bank (FHLB). Generally, the market to which the Company sells residential mortgages it originates for sale is restricted and price quotes from other sources are not typically obtained. On occasion, the Company may transfer loans from the loan portfolio to loans HFS. Under these circumstances, pricing may be obtained from other entities and the residential mortgage loans are transferred at the lower of cost or market value and simultaneously sold. For other loans transferred to HFS, pricing may be obtained from other entities or modeled and the other loans are transferred at the lower of cost or market value and then sold. As of June 30, 20222023 and December 31, 20212022, loans classified as HFS consisted of residential mortgage loans.

 

Financing of automobiles, provided to customers under lease arrangements of varying terms, are accounted for as direct finance leases. Interest income on automobile direct finance leasing is determined using the interest method to arrive at a level effective yield over the life of the lease. The lease residual and the lease receivable, net of unearned lease income, are recorded within loans and leases on the balance sheet.

 

Foreclosed assets held-for-sale includes other real estate acquired through foreclosure (ORE) and may, from time-to-time, include repossessed assets such as automobiles. ORE is carried at the lower of cost (principal balance at date of foreclosure) or fair value less estimated cost to sell. Any write-downs at the date of foreclosure are charged to the allowance for loancredit losses. Expenses incurred to maintain ORE properties, subsequent write downs to the asset’s fair value, any rental income received and gains or losses on disposal are included as components of other real estate owned expense in the consolidated statements of income.

 

The Company accounts for business combinations under the purchase method of accounting. The application of this method of accounting requires the use of significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price consideration between assets that are amortized, accreted or depreciated from those that are recorded as goodwill. Estimates of the fair values of assets acquired and liabilities assumed are based upon assumptions that management believes to be reasonable.

 

Goodwill is recorded on the consolidated balance sheets as the excess of liabilities assumed over identifiable assets acquired on the acquisition date. Goodwill is recorded at its net carrying value which represents estimated fair value. The goodwill is deductible for tax purposes over a 15-year period. Goodwill is tested for impairment on at least an annual basis. There was 0no goodwill impairment as of June 30, 20222023 and December 31, 20212022. Other acquired intangible assets that have finite lives, such as core deposit intangibles, are amortized over their estimated useful lives and subject to periodic impairment testing.

 

Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. The Company accounts for certain participation interests in commercial loans receivable (loan participation agreements) sold as a sale of financial assets pursuant to ASC 860, Transfers and Servicing. Loan participation agreements that meet the sale criteria under ASC 860 are derecognized from the Consolidated Balance Sheets at the time of transfer. If the transfer of loans does not meet the sale criteria or participating interest criteria under ASC 860, the transfer is accounted for as a secured borrowing and the loan is not de-recognized and a participating liability is recorded in the Consolidated Balance Sheets.

 

The Company holds separate supplemental executive retirement (SERP) agreements for certain officers and an amount is credited to each participant’s SERP account monthly while they are actively employed by the bank until retirement. A deferred tax asset is provided for the non-deductible SERP expense. The Company also entered into separate split dollar life insurance arrangements with 4four executives providing post-retirement benefits and accrues monthly expense for this benefit. The split dollar life insurance expense is not deductible for tax purposes. Monthly expenses for the SERP and post-retirement split dollar life benefit are recorded as components of salaries and employee benefit expense on the consolidated statements of income.

 

For purposes of the consolidated statements of cash flows, cash and cash equivalents includes cash on hand, amounts due from banks and interest-bearing deposits with financial institutions.

 

11

 
 

2. New accounting pronouncements

On January 1, 2023, the Company adopted ASU 2016-13 and all of the subsequent amendments using the modified-retrospective approach and recorded a cumulative-effect adjustment to retained earnings. The change in this accounting guidance could require the Company to record loan losses more rapidly. The Company has engaged the services of a qualified third-party service provider to assist management in estimating credit allowances under this standard. Starting in the 3rd quarter of 2022, the Company ran its CECL model parallel to the current allowance for loan losses calculation to gain a better understanding of the effects of the change. During the fourth quarter of 2022, a third-party service provider ran a model validation with no substantial findings. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Company recorded a net decrease to retained earnings of $1.3 million as of January 1, 2023 for the cumulative effect of adopting ASC 326. The transition adjustment includes a $0.5 million decrease for the allowance for credit losses on loans (ACL) and a $0.8 million decrease for the reserve for unfunded commitments, net of deferred tax. The Company has also run a quarterly CECL analysis on its held-to-maturity investment securities starting in 2023 and the estimated CECL reserve is immaterial. While the CECL model does not apply to available-for-sale securities, the ASU does require companies to record an allowance when recognizing credit losses for available-for-sale securities with unrealized losses, rather than reduce the amortized cost of the securities by direct write-offs. The guidance will require companies to recognize improvements to estimated credit losses immediately in earnings rather than in interest income over time.

The Company adopted the provisions of ASC 326 related to financial assets purchased with credit deterioration (PCD) that were previously classified as purchased credit impaired (PCI) and accounted for under ASC 310-30 using the prospective transition approach. In accordance with the standard, management did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. On January 1, 2023, the amortized cost basis of the PCD assets were adjusted to reflect the addition of $0.1 million of the ACL.

 

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2016-13, Financial Instruments Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments (CECL). The amendments in this update require financial assets measured at amortized cost basis to be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. Previously, when credit losses were measured under GAAP, an entity only considered past events and current conditions when measuring the incurred loss. The amendments in this update broaden the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgement in determining the relevant information and estimation methods that are appropriate under the circumstances. The amendments in this update also require that credit losses on available-for-sale debt securities be presented as an allowance for credit losses rather than a writedown.

 

In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, which clarifies that receivables arising from operating leases are not within the scope of Topic 326. In December 2018, regulators issued a final rule related to regulatory capital (Regulatory Capital Rule: Implementation and Transition of the Current Expected Credit Losses Methodology for Allowances and Related Adjustments to the Regulatory Capital Rule and Conforming Amendments to Other Regulations) which is intended to provide regulatory capital relief for entities transitioning to CECL. In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments Credit Losses, Topic 815, Derivatives and Hedging and Topic 825, Financial Instruments. As it relates to CECL, this guidance amends certain provisions contained in ASU 2016-13, particularly in regards to the inclusion of accrued interest in the definition of amortized cost, as well as clarifying that extension and renewal options that are not unconditionally cancelable by the entity that are included in the original or modified contract should be considered in the entity’s determination of expected credit losses.

 

The amendments in this update are effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2019 for public companies. Early adoption is permitted beginning after December 15, 2018, including interim periods within those fiscal years. An entity will apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption (modified-retrospective approach). Upon adoption, the change in this accounting guidance could result in an increase in the Company's allowance for loan losses and require the Company to record loan losses more rapidly. On October 16, 2019, the FASB decided to move forward with finalizing its proposal to defer the effective date for ASU 2016-13 for smaller reporting companies to fiscal years beginning after December 31, 2022, including interim periods within those fiscal periods. Since the Company currently meets the SEC definition of a smaller reporting company, the delay will be applicable to the Company. The Company has engaged the services of a qualified third-party service provider to assist management in estimating credit allowances under this standard and is currently evaluating the impact of ASU 2016-13 on its consolidated financial statements. The current allowance for loan losses calculation is expected to be run parallel with the CECL model in the 3rd and 4th quarters of 2022 to gain a better understanding of the effects of the change. The Company is in the process of engaging another third-party service provider to run a model validation.

In March 2022, the FASB issued ASU 2022-02, Financial Instruments-Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures. The amendments in this update eliminate the accounting guidance for TDRs by creditors in Subtopic 310-40, Receivables-Troubled Debt Restructurings by Creditors, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. The amendments in this update also require that an entity disclose current-period gross writeoffs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, Financial Instruments-Credit Losses-Measured at Amortized Cost. The amendments in this update arewere effective for the Company upon adoption of ASU 2016-13. The amendments in this update should be applied prospectively, except as provided in the next sentence. For the transition method related to the recognition and measurement of TDRs, the Company has the option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. The Company adopted ASU 2022-02 on January 1, 2023 and the adoption required additional quantitative and qualitative disclosures. There was not any significant effect on the Company's financial statements.

 

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848) Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The amendments in this update provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The amendments in this update are elective and apply to all entities that have contracts that reference LIBOR or another reference rate expected to be discontinued. The guidance includes a general principle that permits an entity to consider contract modifications due to reference rate reform to be an event that does not require contract remeasurement at the modification date or reassessment of a previous accounting determination. An optional expedient simplifies accounting for contract modifications to loans receivable and debt, by prospectively adjusting the effective interest rate. The amendments in ASU 2020-04 are effective as of March 12, 2020 through December 31, 2022.

In December 2022, the FASB issued ASU 2022-06,Reference Rate Reform (Topic 848) - Deferral of the Sunset Date of Topic 848. The amendments in this update defer the sunset date of Topic 848 from December 31, 2022, to December 31, 2024, after which entities will no longer be permitted to apply the relief in Topic 848.The Company expects to apply the amendments prospectively for applicable loan and other contracts within the effective period of ASU 20202022-04.06. As of June 30, 20222023, the Company no longer had approximatelanyy $43 million in loan loanss with rates tied to LIBOR. The Company is working on modifying each of these existing contracts.

 

12

 
 

3. Accumulated other comprehensive income

 

The following tables illustrate the changes in accumulated other comprehensive income by component and the details about the components of accumulated other comprehensive income as of and for the periods indicated:

 

As of and for the six months ended June 30, 2022

 

As of and for the six months ended June 30, 2023

As of and for the six months ended June 30, 2023

 
 

Unrealized gains

      

Unrealized gains

     
 

(losses) on

 

Securities

    

(losses) on

 

Securities

   
 

available-for-sale

 

transferred to

    

available-for-sale

 

transferred to

   

(dollars in thousands)

 

debt securities

 

held-to-maturity

 

Total

  

debt securities

 

held-to-maturity

 

Total

 

Beginning balance

 $179  $0  $179  $(53,624) $(17,528) $(71,152)
  

Other comprehensive loss before reclassifications, net of tax

 (42,670) (18,429) (61,099)

Other comprehensive income before reclassifications, net of tax

 4,982  901  5,883 

Amounts reclassified from accumulated other comprehensive income, net of tax

 0  0  0  1  -  1 

Net current-period other comprehensive loss

 (42,670) (18,429) (61,099) 4,983  901  5,884 

Ending balance

 $(42,491) $(18,429) $(60,920) $(48,641) $(16,627) $(65,268)

 

As of and for the three months ended June 30, 2022

 

As of and for the three months ended June 30, 2023

As of and for the three months ended June 30, 2023

 
 

Unrealized gains

      

Unrealized gains

     
 

(losses) on

 

Securities

    

(losses) on

 

Securities

   
 

available-for-sale

 

transferred to

    

available-for-sale

 

transferred to

   

(dollars in thousands)

 

debt securities

 

held-to-maturity

 

Total

  

debt securities

 

held-to-maturity

 

Total

 

Beginning balance

 $(42,497) $0  $(42,497) $(45,862) $(17,076) $(62,938)
  

Other comprehensive income (loss) before reclassifications, net of tax

 6  (18,429) (18,423)

Other comprehensive loss before reclassifications, net of tax

 (2,779) 449  (2,330)

Amounts reclassified from accumulated other comprehensive income, net of tax

 0  0  0  -  -  - 

Net current-period other comprehensive income (loss)

 6  (18,429) (18,423)

Net current-period other comprehensive loss

 (2,779) 449  (2,330)

Ending balance

 $(42,491) $(18,429) $(60,920) $(48,641) $(16,627) $(65,268)

 

As of and for the six months ended June 30, 2021

 

As of and for the six months ended June 30, 2022

 
 

Unrealized gains

      

Unrealized gains

     
 

(losses) on

 

Securities

    

(losses) on

 

Securities

   
 

available-for-sale

 

transferred to

    

available-for-sale

 

transferred to

   

(dollars in thousands)

 

securities

 

held-to-maturity

 

Total

  

securities

 

held-to-maturity

 

Total

 

Beginning balance

 $8,952  $0  $8,952  $179  $-  $179 
  

Other comprehensive loss before reclassifications, net of tax

 (3,621) 0  (3,621) (42,670) (18,429) (61,099)

Amounts reclassified from accumulated other comprehensive income, net of tax

 0  0  0  -  -  - 

Net current-period other comprehensive loss

 (3,621) 0  (3,621) (42,670) (18,429) (61,099)

Ending balance

 $5,331  $0  $5,331  $(42,491) $(18,429) $(60,920)

 

As of and for the three months ended June 30, 2021

 

As of and for the three months ended June 30, 2022

As of and for the three months ended June 30, 2022

 
 

Unrealized gains

      

Unrealized gains

     
 

(losses) on

 

Securities

    

(losses) on

 

Securities

   
 

available-for-sale

 

transferred to

    

available-for-sale

 

transferred to

   

(dollars in thousands)

 

debt securities

 

held-to-maturity

 

Total

  

debt securities

 

held-to-maturity

 

Total

 

Beginning balance

 $1,163  $0  $1,163  $(42,497) $-  $(42,497)
  

Other comprehensive income before reclassifications, net of tax

 4,168  0  4,168 

Other comprehensive income (loss) before reclassifications, net of tax

 6  (18,429) (18,423)

Amounts reclassified from accumulated other comprehensive income, net of tax

 0  0  0  -  -  - 

Net current-period other comprehensive income

 4,168  0  4,168 

Net current-period other comprehensive income (loss)

 6  (18,429) (18,423)

Ending balance

 $5,331  $0  $5,331  $(42,491) $(18,429) $(60,920)

 

13

 

Details about accumulated other

                 

comprehensive income components

 

Amount reclassified from accumulated

 

Affected line item in the statement

(dollars in thousands)

 

other comprehensive income

 

where net income is presented

  

For the three months ended June 30,

  

For the six months ended June 30,

  
  

2023

  

2022

  

2023

  

2022

  
                  

Unrealized gains (losses) on AFS debt securities

 $-  $-  $(1) $- 

Gain (loss) on sale of investment securities

Income tax effect

  -   -   -   - 

Provision for income taxes

Total reclassifications for the period

 $-  $-  $(1) $- 

Net income

 

4. Investment securities

 

Agency – Government-sponsored enterprise (GSE) and Mortgage-backed securities (MBS) - GSE residential

 

Agency – GSE and MBS – GSE residential securities consist of short- to long-term notes issued by Federal Home Loan Mortgage Corporation (FHLMC), FNMA, FHLB and Government National Mortgage Association (GNMA). These securities have interest rates that are fixed, have varying short to long-term maturity dates and have contractual cash flows guaranteed by the U.S. government or agencies of the U.S. government.

 

Obligations of states and political subdivisions (municipal)

 

The municipal securities are general obligation and revenue bonds rated as investment grade by various credit rating agencies and have fixed rates of interest with mid- to long-term maturities. Fair values of these securities are highly driven by interest rates. Management performs ongoing credit quality reviews on these issues.

 

The Company did not record any allowance for credit losses on its available-for-sale or held-to-maturity securities. The amortized cost and fair value of investment securities at June 30, 20222023 and December 31, 20212022 are summarized as follows:

 

    

Gross

 

Gross

       

Gross

 

Gross

   
 

Amortized

 

unrealized

 

unrealized

 

Fair

  

Amortized

 

unrealized

 

unrealized

 

Fair

 

(dollars in thousands)

 

cost

 

gains

 

losses

 

value

  

cost

 

gains

 

losses

 

value

 

June 30, 2022

        

June 30, 2023

        

Held-to-maturity securities:

  

Agency - GSE

 $79,776  $0  $(4,101) $75,675  $80,838  $-  $(8,915) $71,923 

Obligations of states and political subdivisions

 142,235  0  (18,464) 123,771  142,641  -  (22,480) 120,161 
  

Total held-to-maturity securities

 $222,011 $0 $(22,565) $199,446  $223,479 $- $(31,395) $192,084 
  

Available-for-sale debt securities:

  

Agency - GSE

 $37,023 $3 $(3,270) $33,756  $31,131 $- $(4,185) $26,946 

Obligations of states and political subdivisions

 201,566 571 (22,837) 179,300  173,828 1 (21,842) 151,987 

MBS - GSE residential

 268,019  15  (28,268) 239,766  237,397  -  (35,545) 201,852 
  

Total available-for-sale debt securities

 $506,608  $589  $(54,375) $452,822  $442,356  $1  $(61,572) $380,785 

 

     

Gross

 

Gross

        

Gross

 

Gross

   
 

Amortized

 

unrealized

 

unrealized

 

Fair

  

Amortized

 

unrealized

 

unrealized

 

Fair

 

(dollars in thousands)

 

cost

 

gains

 

losses

 

value

  

cost

 

gains

 

losses

 

value

 

December 31, 2021

 

December 31, 2022

 

Held-to-maturity securities:

 

Agency - GSE

 $80,306  $-  $(9,243) $71,063 

Obligations of states and political subdivisions

 142,438  -  (26,221) 116,217 
 

Total held-to-maturity securities

 $222,744 $- $(35,464) $187,280 
 

Available-for-sale debt securities:

  

Agency - GSE

 $119,399  $204  $(2,600) $117,003  $36,076 $- $(4,543) $31,533 

Obligations of states and political subdivisions

 360,680  6,708  (2,678) 364,710  197,935 501 (26,542) 171,894 

MBS - GSE residential

 258,674  1,654  (3,061) 257,267  254,730  -  (37,295) 217,435 
  

Total available-for-sale debt securities

 $738,753  $8,566  $(8,339) $738,980  $488,741  $501  $(68,380) $420,862 

 

14

 

The amortized cost and fair value of debt securities at June 30, 20222023 by contractual maturity are summarized below:

 

 

Amortized

 

Fair

  

Amortized

 

Fair

 

(dollars in thousands)

 

cost

 

value

  

cost

 

value

 

Held-to-maturity securities:

  

Due in one year or less

 $0  $0  $-  $- 

Due after one year through five years

 4,682  4,568  18,777  17,246 

Due after five years through ten years

 60,702  57,603  71,172  62,607 

Due after ten years

 156,627  137,275  133,530  112,231 

Total held-to-maturity securities

 $222,011 $199,446  $223,479 $192,084 
  

Available-for-sale securities:

  

Debt securities:

  

Due in one year or less

 $1,997 $1,999  $751 $752 

Due after one year through five years

 18,726 17,823  21,252 18,951 

Due after five years through ten years

 45,806 39,964  36,879 30,903 

Due after ten years

 172,060 153,270  146,077 128,327 
  

MBS - GSE residential

 268,019  239,766  237,397  201,852 

Total available-for-sale debt securities

 $506,608 $452,822  $442,356 $380,785 

 

Actual maturities will differ from contractual maturities because issuers and borrowers may have the right to call or repay obligations with or without call or prepayment penalty. Agency – GSE and municipal securities are included based on their original stated maturity. MBS – GSE residential, which are based on weighted-average lives and subject to monthly principal pay-downs, are listed in total. Most of the securities have fixed rates or have predetermined scheduled rate changes and many have call features that allow the issuer to call the security at par before its stated maturity without penalty.

 

Securities pledged at June 30, 2023 had a carrying amount of $382.0 million and were pledged to secure public deposits and trust client deposits.

The following table presents the fair value and gross unrealized losses of debt securities aggregated by investment type, the length of time and the number of securities that have been in a continuous unrealized loss position as of June 30, 20222023 and December 31, 20212022:

 

 

Less than 12 months

 

More than 12 months

 

Total

  

Less than 12 months

 

More than 12 months

 

Total

 
 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

  

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

(dollars in thousands)

 

value

 

losses

 

value

 

losses

 

value

 

losses

  

value

 

losses

 

value

 

losses

 

value

 

losses

 
  

June 30, 2022

            

June 30, 2023

            

Agency - GSE

 $64,941  $(3,522) $44,490  $(3,849) $109,431  $(7,371) $-  $-  $98,869  $(13,100) $98,869  $(13,100)

Obligations of states and political subdivisions

 260,199  (36,487) 42,873  (4,814) 303,072  (41,301) 4,137  (252) 267,258  (44,070) 271,395  (44,322)

MBS - GSE residential

 203,983  (22,712) 35,783  (5,556) 239,766  (28,268) 3,605  (193) 198,247  (35,352) 201,852  (35,545)

Total

 $529,123  $(62,721) $123,146  $(14,219) $652,269  $(76,940) $7,742  $(445) $564,374  $(92,522) $572,116  $(92,967)

Number of securities

 410     60     470     18     419     437    
  

December 31, 2021

 

December 31, 2022

 

Agency - GSE

 $84,308  $(1,460) $26,516  $(1,140) $110,824  $(2,600) $9,285  $(377) $93,312  $(13,409) $102,597  $(13,786)

Obligations of states and political subdivisions

 193,124  (2,662) 12,796  (399) 205,920  (3,061) 170,484  (26,928) 112,353  (25,835) 282,837  (52,763)

MBS - GSE residential

 137,495  (2,351) 9,469  (327) 146,964  (2,678) 61,803  (6,018) 155,632  (31,277) 217,435  (37,295)

Total

 $414,927  $(6,473) $48,781  $(1,866) $463,708  $(8,339) $241,572  $(33,323) $361,297  $(70,521) $602,869  $(103,844)

Number of securities

 187     26     213     272     213     485    

 

15

 

The Company had 470437 debt securities in an unrealized loss position at June 30, 20222023, including 4946 agency-GSE securities, 140136 MBS – GSE residential securities and 281255 municipal securities. The severity of these unrealized losses based on their underlying cost basis was as follows at June 30, 20222023: 6.31%11.70% for agency - GSE, 10.55%14.97% for total MBS-GSE residential; and 12.01%14.04% for municipals. Sixty of these securities had been in an unrealized loss position in excess of 12 months. Management has no intent to sell any securities in an unrealized loss position as of June 30, 20222023.

 

During theThe Company reassessed classification of certain investments and effective secondApril 1, 2022, quarter of 2022,the Company transferred agency and municipal investment securities with a book value of $245.5 million from available-for-sale to held-to-maturity. The accounting for securities held-to-maturity on this transfer will mitigatewere transferred at their amortized cost basis, net of any remaining unrealized gain or loss reported in accumulated other comprehensive income. The market value of the effectsecurities on the date of the transfer was $221.7 million, after netting unrealized losses totaling $18.9 million. The $18.9 million, net of deferred taxes, will be accreted into other comprehensive income (OCI) componentover the life of stockholders’ equity from the price risk of rising interest rates which will result in further future unrealizedbonds. The allowance for credit losses inon these securities was evaluated under the available-for-sale portfolio.accounting policy for HTM debt securities.

 

ManagementUnrealized losses on available-for-sale securities have not been recognized into income because management believes the cause of the unrealized losses is related to changes in interest rates and is not directly related to credit quality. Quarterly, management conducts a formal review of investment securities for the presence of other than temporary impairment (OTTI). The accounting guidance related to OTTI requires the Company to assess whether OTTI is present when the fair value of a debt security is less than its amortized cost as of the balance sheet date. Under those circumstances, OTTI is considered to have occurred if:An allowance for credit losses has not been recognized on these securities in an unrealized loss position because: (1) the entity has the intentdoes not intend to sell the security; (2) more likely than not the entity willnot be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is notsufficient to recover the entire amortized cost. The accounting guidance requires that credit-related OTTI be recognized in earnings while non-credit-related OTTIissuer(s) continues to make timely principal and interest payments on securities notthe bonds. The fair value is expected to recover as the bond(s) approach maturity.

The Company has U.S. agency bonds and municipal securities classified as held-to-maturity. Management estimated no credit loss reserve will be sold be recognized in OCI. Non-credit-related OTTInecessary for agency bonds HTM given the strong credit history of GSE and other U.S. agency issued bonds and the involvement of the U.S. government. For municipal securities HTM, the Company utilized a third-party model to analyze whether a credit loss reserve is basedneeded for these bonds. The amount of credit loss reserve calculated using this model was immaterial to the Company's financial statements, therefore no reserve was recorded, but the Company will continue to evaluate these securities on other factors affecting market value, including illiquidity.a quarterly basis.

 

The Company’s OTTIother than temporary impairment (OTTI)/credit impairment evaluation process also follows the guidance set forth in topics related to debt securities. The guidance set forth in the pronouncements require the Company to take into consideration current market conditions, fair value in relationship to cost, extent and nature of changes in fair value, issuer rating changes and trends, volatility of earnings, current analysts’ evaluations, all available information relevant to the collectability of debt securities, the ability and intent to hold investments until a recovery of fair value which may be to maturity and other factors when evaluating for the existence of OTTI. The guidance requires that credit-relatedif OTTI be recognized asexists, a realized loss through earnings when there has been an adverse change incontra-asset is recorded for the holder’s expected cash flows suchOTTI on both HTM and AFS securities, limited by the amount that the full amount (principal and interest) will probablyfair value is less than the amortized cost basis. Any impairment that has not be received. This requirementbeen recorded through an allowance for credit losses is consistent with the impairment modelrecognized in the guidance for accounting for debt securities.other comprehensive income.

 

For all debt securities, as of June 30, 20222023, the Company applied the criteria provided in the recognition and presentation guidance related to OTTI. That is, management has no intent to sell the securities and nor any conditions were identified by management that, more likely than not, would require the Company to sell the securities before recovery of their amortized cost basis. The results indicated there was no presence of OTTI in the Company’s security portfolio. In addition, management believes the change in fair value is attributable to changes in interest rates.

 

 

5. Loans and leases

 

The classifications of loans and leases at June 30, 20222023 and December 31, 20212022 are summarized as follows:

 

(dollars in thousands)

 

June 30, 2022

 

December 31, 2021

  

June 30, 2023

 

December 31, 2022

 

Commercial and industrial

 $219,439  $236,304 

Commercial and industrial:

 

Commercial

 $135,164  $141,122 

Municipal

 77,018 72,996 

Commercial real estate:

  

Non-owner occupied

 317,884  312,848  314,838  318,296 

Owner occupied

 259,844  248,755  294,718  284,677 

Construction

 19,515  21,147  39,057  24,005 

Consumer:

  

Home equity installment

 51,883  47,571  58,623  59,118 

Home equity line of credit

 55,578  54,878  52,501  52,568 

Auto loans

 127,590  118,029 

Auto loans - Recourse

 11,924  12,929 

Auto loans - Non-recourse

 121,230 114,909 

Direct finance leases

 32,254  26,232  34,691  33,223 

Other

 7,450  8,013  13,882  11,709 

Residential:

  

Real estate

 364,957  325,861  429,816  398,136 

Construction

 35,677  34,919  48,087  42,232 

Total

 1,492,071  1,434,557  1,631,549  1,565,920 

Less:

  

Allowance for loan losses

 (16,590) (15,624)

Allowance for credit losses on loans

 (18,350) (17,149)

Unearned lease revenue

 (1,766) (1,429) (1,885) (1,746)

Loans and leases, net

 $1,473,715  $1,417,504  $1,611,314  $1,547,025 

 

As of June 30, 2022, total loans of $1.5 billionTotal unamortized net costs and premiums included in loan totals were reflected including deferred loan costs of $4.3 million, comprised of $4.4 million in deferred loan costs partially offset by $0.1 million in deferred fee income from Paycheck Protection Program (PPP) loans. As of December 31, 2021, total loans of $1.4 billion were reflected including deferred loan costs of $3.0 million, comprised of $4.2 million in deferred loan costs partially offset by $1.2 million in deferred fee income from PPP loans.as follows:

(dollars in thousands)

 

June 30, 2023

  

December 31, 2022

 

Net unamortized fair value mark discount on acquired loans

 $(7,369) $(9,064)

Net unamortized deferred loan origination costs

  4,919   4,630 

Total

 $(2,450) $(4,434)

 

16

 

CommercialBased on the adoption of ASU 2016-13, the Company updated the segmentation of its loan and lease portfolio to ensure that the risk characteristics within these segments were as similar as possible with financial asset type and collateral type as the primary factors used in this evaluation. Consequently, management decided to create a new segment called “Municipal,” which are loans and leases to states and political subdivisions in the U.S. based on the unique risk characteristics of this segment as expected credit losses are minimal. Additionally, the previous segment of “Auto Loans”, which included direct auto loans, indirect non-recourse auto loans, and indirect recourse auto loans, was broken out between “Auto Loans-Recourse” and “Auto Loans-Non-recourse” as substantially all the recourse portfolio is to a high credit quality dealer with the guaranty of the dealership and high net worth principal. Direct auto loans were included in the “Consumer Other” segment. Additionally, during 2023, the Company analyzed its commercial portfolio to ensure these loans were in the appropriate segment based on their purpose and collateral. Based on this analysis, a total of $25.4 million of commercial and industrial (C&I)loans were reclassified to other loan balances were $219.4segments including: $5.0 million at June 30, 2022to municipal, $1.4 million to commercial real estate non-owner occupied, $13.9 million to commercial real estate owner occupied, and $236.3$5.1 million to commercial real estate construction. The classifications of loans and leases at December 31, 2021.2022 were modified retroactively to enhance comparability between periods.

The decrease was due toCompany excludes accrued interest receivable from the decrease in PPPamortized cost basis of loans (net of deferred fees) which declined by $37.5 million to $2.4 million at June 30, 2022 due to standard forgiveness under the SBA program.disclosed throughout this footnote. As of June 30, 2023 and December 31, 2022, accrued interest receivable for loans totaled $4.6 million and $4.5 million, respectively, and is included in accrued interest receivable line in the Company increasedconsolidated balance sheets and is excluded from the balanceestimate of C&I loans by $20.5 million (excluding PPP loans) primarily from several large C&I loans originated during the first half of the year. credit losses.

 

Direct finance leases include the lease receivable and the guaranteed lease residual. Unearned lease revenue represents the difference between the lessor’s investment in the property and the gross investment in the lease. Unearned revenue is accrued over the life of the lease using the effective interest method.

 

The Company services real estate loans for investors in the secondary mortgage market which are not included in the accompanying consolidated balance sheets. The approximate unpaid principal balance of mortgages serviced for others amounted to $461.6$469.9 million as of June 30, 20222023 and $430.9$465.7 million as of December 31, 2021.2022. Mortgage servicing rights amounted to $1.8$1.5 million and $1.7$1.6 million as of June 30, 20222023 and December 31, 20212022, respectively.

 

Management is responsible for conducting the Company’s credit risk evaluation process, which includes credit risk grading of individual commercial and industrial and commercial real estate loans. Commercial and industrial and commercial real estate loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information, and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed. The credit risk grades may be changed at any time management feels an upgrade or downgrade may be warranted. The Company utilizes an external independent loan review firm that reviews and validates the credit risk program on at least an annual basis. Results of these reviews are presented to management and the boardBoard of directors.Directors. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

 

Paycheck Protection Program Loans

The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, was signed into law on March 27, 2020, and provided over $2.0 trillion in emergency economic relief to individuals and businesses impacted by the COVID-19 pandemic. The CARES Act authorized the Small Business Administration (SBA) to temporarily guarantee loans under a new 7(a) loan program called the Paycheck Protection Program (PPP).

As a qualified SBA lender, the Company was automatically authorized to originate PPP loans. The SBA guaranteed 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrowers’ PPP loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount under the PPP.

On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (Economic Aid Act) was enacted, extending the authority to make PPP loans through May 31, 2021, revising certain PPP requirements, and permitting second draw PPP loans. On March 11, 2021, the American Rescue Plan Act of 2021 (American Rescue Plan Act) was enacted expanding eligibility for first and second draw PPP loans and revising the exclusions from payroll costs for purposes of loan forgiveness.

Acquired loans

Acquired loans are marked to fair value on the date of acquisition. For detailed information on calculating the fair value of acquired loans, see Footnote 9, “Acquisition.”

The carryover of allowance for loan losses related to acquired loans is prohibited as any credit losses in the loans are included in the determination of the fair value of the loans at the acquisition date. The allowance for loan losses on acquired loans reflects only those losses incurred after acquisition and represents the present value of cash flows expected at acquisition that is no longer expected to be collected.

The Company reported fair value adjustments regarding the acquired MNB and Landmark loan portfolios. Therefore, the Company did not record an allowance on the acquired non-purchased credit impaired loans. In conjunction with the quarterly evaluation of the adequacy of the allowance for loan losses, the Company performs an analysis on acquired loans to determine whether there has been subsequent deterioration in relation to those loans. If deterioration has occurred, the Company will include these loans in the calculation of the allowance for loan losses after the initial valuation and provide reserves accordingly.

Upon acquisition, in accordance with U.S. GAAP, the Company has individually determined whether each acquired loan is within the scope of ASC 310-30 deemed as purchased credit impaired (PCI). As part of this process, the Company’s senior management and other relevant individuals reviewed the seller’s loan portfolio on a loan-by-loan basis to determine if any loans met the two-part definition of an impaired loan as defined by ASC 310-30:1) Credit deterioration on the loan from its inception until the acquisition date, and 2) It is probable that not all contractual cash flows will be collected on the loan.

With regards to ASC 310-30 loans, for external disclosure purposes, the aggregate contractual cash flows less the aggregate expected cash flows result in a credit related non-accretable yield amount. The aggregate expected cash flows less the acquisition date fair value result in an accretable yield amount. The accretable yield reflects the contractual cash flows management expects to collect above the loan's acquisition date fair value and will be recognized over the life of the loan on a level-yield basis as a component of interest income.

Over the life of the acquired ASC 310-30 loan, the Company continues to estimate cash flows expected to be collected. Decreases in expected cash flows, other than from prepayments or rate adjustments, are recognized as impairments through a charge to the provision for credit losses resulting in an increase in the allowance for credit losses. Subsequent improvements in cash flows result in first, reversal of existing valuation allowances recognized after acquisition, if any, and next, an increase in the amount of accretable yield to be subsequently recognized on a prospective basis over the loan’s remaining life.

Acquired ASC 310-30 loans that met the criteria for non-accrual of interest prior to acquisition are considered performing upon acquisition, regardless of whether the customer is contractually delinquent if the Company can reasonably estimate the timing and amount of expected cash flows on such loans. Accordingly, the Company does not consider acquired contractually delinquent loans to be non-accruing and continues to recognize accretable yield on these loans which is recognized as interest income on a level yield method over the life of the loan.

Acquired ASC 310-20 loans, which are loans that did not meet the criteria above, were pooled into groups of similar loans based on various factors including borrower type, loan purpose, and collateral type. For these pools, the Company used certain loan information, including outstanding principal balance, estimated expected losses, weighted average maturity, weighted average margin, and weighted average interest rate along with estimated prepayment rates, expected lifetime losses, and environment factors to estimate the expected cash flow for each loan pool.

Within the ASC 310-20 loans, the Company identified certain loans that have higher risk. Although performing at the time of acquisition and likely will continue making payments in accordance with contractual terms, management elected a higher credit adjustment on these loans to reflect the greater inherent risk that the borrower will default on payments. Risk factors used to identify these loans included: loans that received COVID-19 related forbearance consistent with the regulatory guidance, loans that were in industries determined to be at greater risk to economic disruption due to COVID-19, loans that had a prior history of delinquency greater than 60 days at any point in the lifetime of the loan; loans with a Special Mention or Substandard risk rating; and/or loans borrowers in the Gasoline Station industry due to the environmental risk potential of these loans.

The following table provides changes in accretable yield for all acquired loans accounted for under ASC 310-30. Loans accounted for under ASC 310-20 are not included in this table.

  

For the six months ended June 30,

 

(dollars in thousands)

 

2022

  

2021

 

Balance at beginning of period

 $1,088  $563 

Accretable yield on acquired loans

  0   0 

Reclassification from non-accretable difference

  543   162 

Accretion of accretable yield

  (274)  (193)

Balance at end of period

 $1,357  $532 

The above table excludes the $269 thousand in non-accretable yield accreted to interest income for the six months ended June 30, 2021.

During the six months ended June 30, 2022, management performed an analysis of all loans acquired from mergers, consistent with and applicable to ASC 310-30 (Purchased Credit Impaired loans – PCI). Five loans had actual payments exceed estimates and 1 loan had a positive change in collateral value resulting in a $543 thousand reclassification from non-accretable discount to accretable discount. During the six months ended June 30, 2021, 2 loans had actual payments exceed estimates and 3 loans had a positive change in collateral value resulting in a $162 thousand reclassification from non-accretable discount to accretable discount.

Expected cash flows on acquired loans are estimated quarterly by incorporating several key assumptions. These key assumptions include probability of default and the number of actual prepayments after the acquisition date. Prepayments affect the estimated life of the loans and could change the amount of interest income, and possibly principal expected to be collected. In reforecasting future estimated cash flows, credit loss expectations are adjusted as necessary. Improved cash flow expectations for loans or pools are recorded first as a reversal of previously recorded impairment, if any, and then as an increase in prospective yield when all previously recorded impairment has been recaptured.

17

 

Non-accrual loans

 

Non-accrual loans and loans past due over 89 days still accruing, segregated by class, at June 30, 20222023 and December 31, 20212022, were as follows:

 

(dollars in thousands)

 

June 30, 2022

 

December 31, 2021

  

Nonaccrual With No Allowance for Credit Loss

  

Nonaccrual With Allowance for Credit Loss

  

Total Nonaccrual

  

Loans Past Due Over 89 Days Still Accruing

 

Commercial and industrial

 $791  $154 

At June 30, 2023

        

Commercial and industrial:

 

Commercial

 $619  $17  $636  $- 

Municipal

 -  -  -  - 

Commercial real estate:

  

Non-owner occupied

 717  478  168  -  168  - 

Owner occupied

 1,285  1,570  1,841  296  2,137  - 

Consumer:

  

Home equity installment

 0  0  54  48  102  - 

Home equity line of credit

 167  97  90  -  90  - 

Auto loans

 204  78 

Auto loans - Recourse

 9  -  9  - 

Auto loans - Non-recourse

 39  45  84  - 

Direct finance leases

 -  -  -  47 

Other

 1  -  1  - 

Residential:

  

Real estate

 42  572  83  183  266  - 

Total

 $3,206  $2,949  $2,904  $589  $3,493  $47 

 

The table above excludes $4.7 million and $4.7 million in purchased credit impaired loans, net of unamortized fair value adjustments as of June 30, 2022 and December 31, 2021, respectively.

(dollars in thousands)

 

Nonaccrual With No Allowance for Credit Loss

  

Nonaccrual With Allowance for Credit Loss

  

Total Nonaccrual

  

Loans Past Due Over 89 Days Still Accruing

 

At December 31, 2022

                

Commercial and industrial:

                

Commercial

 $580  $139  $719  $- 

Municipal

  -   -   -   - 

Commercial real estate:

                

Non-owner occupied

  168   215   383   - 

Owner occupied

  716   350   1,066   - 

Consumer:

                

Home equity installment

  -   -   -   - 

Home equity line of credit

  211   -   211   - 

Auto loans - Recourse

  135   18   153   - 

Auto loans - Non-recourse

  -   -   -   16 

Direct finance leases

  -   -   -   17 

Other

  -   -   -   - 

Residential:

                

Real estate

  3   -   3   - 

Total

 $1,813  $722  $2,535  $33 

 

The decision to place loans on non-accrual status is made on an individual basis after considering factors pertaining to each specific loan. C&I and CRE loans are placed on non-accrual status when management has determined that payment of all contractual principal and interest is in doubt or the loan is past due 90 days or more as to principal and interest, unless well-secured and in the process of collection. Consumer loans secured by real estate and residential mortgage loans are placed on non-accrual status at 90 days past due as to principal and interest and unsecured consumer loans are charged-off when the loan is 90 days or more past due as to principal and interest. The Company considers all non-accrual loans to be impaired loans.

 

Troubled Debt Restructuring (TDR)Loan modifications to borrowers experiencing financial difficulty

 

A modification of a loan constitutes a TDR when a borrower is experiencingOccasionally, the Company modifies loans to borrowers in financial difficulty and the modification constitutes a concession. The Company considers all TDRs to be impaired loans. The Company typically considers the following concessions when modifying a loan, which may include loweringdistress by providing lower interest rates below the market rate, temporary interest-only payment periods, term extensions at interest rates lower than the current market rate for new debt with similar risk and/or converting revolving credit lines to term loans. The Company typically does not forgive principal when granting a TDR modification.modifying loans.

 

ThereIn some cases, the Company provides multiple types of concessions on one loan. Typically, one type of concession, such as a term extension, is granted initially. If the borrower continues to experience financial difficulty, another concession, such as lowering the interest rate, may be granted. For the loans included in the "combination" columns below, multiple types of modifications have been made on the same loan within the current reporting period.

The following table presents the amortized cost basis of loans at June 30, 2023 that were 0 loansboth experiencing financial difficulty and modified in a TDR forduring thethree and six months ended June 30, 2022 and 2021. Of the TDRs outstanding as of June 30, 2022 and 20212023, whenby class and type of modification. The percentage of the amortized cost basis of loans that were modified to borrowers in financial distress as compared to the concessions granted consistedamortized cost basis of temporary interest-only payments, extensionseach class of maturity date, or a reductionfinancing receivable is also presented below:

  

Loans modified for the six months ended:

 

(dollars in thousands)

 

June 30, 2023

 
  

Principal Forgiveness

  

Payment Delay

  

Term Extension

  

Interest Rate Reduction

  

Combination Term Extension and Principal Forgiveness

  

Combination Term Extension Interest Rate Reduction

  

Total Class of Financing Receivable

 

Commercial and industrial:

                            

Commercial

 $-  $46  $-  $-  $-  $-   0.03

%

Commercial real estate:

                            

Non-owner occupied

  -   -   915   3,191   -   -   1.30

%

Total

 $-  $46  $915  $3,191  $-  $-    

The Company has not committed to lend additional amounts to the borrowers included in the rate of interest to a below-market rate for a contractual period of time. Other than the TDRs that were placed on non-accrual status, the TDRs were performing in accordance with their modified terms.previous table.

 

Loans modified in a TDRto borrowers experiencing financial difficulty are closely monitored for delinquency as an early indicatorto understand the effectiveness of possible future default. Ifits modification efforts. None of the loans that have been modified in a TDR subsequently default, the Company evaluateslast 12 months to borrowers experiencing financial difficulty were past due at June 30, 2023.

The following table presents the financial effect of the loan modifications presented above to borrowers experiencing financial difficulty for possible further impairment. There were 0 loans modified as a TDR within the previous twelve months that subsequently defaulted (i.e. 90 days or more past due following a modification) during the three and six months ended June 30, 2022 2023:

(dollars in thousands)

 

June 30, 2023

 
  

Principal Forgiveness

  

Weighted-Average Interest Rate Reduction

  

Weighted-Average Term Extension (Months)

 
             

Commercial real estate:

            

Non-owner occupied

 $-   6.13

%

  8.8 

Total

 $-   6.13

%

  8.8 

There were no loans that had a payment default during the six months ended June 30, 2023and were modified in the 2021twelve. months prior to that default to borrowers experiencing financial difficulty.

 

Upon the Company's determination that a modified loan (or portion of a loan) has subsequently been deemed uncollectible, the loan (or a portion of the loan) is written off. Therefore, the amortized cost basis of the loan is reduced by the uncollectible amount and the allowance for credit losses is adjusted by the same amount. The allowance for loancredit losses (allowance)(ACL) may be increased, adjustments may be made in the allocation of the allowanceACL or partial charge-offs may be taken to further write-down the carrying value of the loan. An allowance for impaired loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s observable market price. If the loan is collateral dependent, the estimated fair value of the collateral is used to establish the allowance.

As of June 30, 2022 and 2021, the balance of outstanding TDRs was $1.7 million and $3.1 million, respectively. As of June 30, 2022 and 2021, the allowance for impaired loans that have been modified in a TDR was $49 thousand and $0.7 million, respectively.

 

18

 

Past due loans

 

Loans are considered past due when the contractual principal and/or interest is not received by the due date. For loans reported 30-59 days past due, certain categories of loans are reported past due as and when the loan is in arrears for two payments or billing cycles. An aging analysis of past due loans, segregated by class of loans, as of the period indicated is as follows (dollars in thousands):

 

               

Recorded

                

Recorded

 
     

Past due

         

investment past

      

Past due

         

investment past

 
 

30 - 59 Days

 

60 - 89 Days

 

90 days

 

Total

   

Total

   

due ≥ 90 days

  

30 - 59 Days

 

60 - 89 Days

 

90 days

 

Total

   

Total

   

due ≥ 90 days

 

June 30, 2022

 

past due

  

past due

  

or more (1)

  

past due

  

Current

  

loans (3)

   

and accruing

 

June 30, 2023

 

past due

 

past due

 

or more (1)

 

past due

 

Current

 

loans (3)

   

and accruing

 
                              

Commercial and industrial

 $0  $39  $791  $830  $218,609  $219,439   $0 

Commercial and industrial:

               

Commercial

 $11  -  636  $647  $134,517  $135,164   $- 

Municipal

 -  -  -  -  77,018  77,018     

Commercial real estate:

                              

Non-owner occupied

  0   0   717   717   317,167   317,884    0  91  -  168  259  314,579  314,838   - 

Owner occupied

  0   0   1,285   1,285   258,559   259,844    0  104  -  2,137  2,241  292,477  294,718   - 

Construction

  0   0   0   0   19,515   19,515    0  -  -  -  -  39,057  39,057   - 

Consumer:

                              

Home equity installment

  61   16   0   77   51,806   51,883    0  136  -  102  238  58,385  58,623   - 

Home equity line of credit

  41   0   167   208   55,370   55,578    0  172  199  90  461  52,040  52,501   - 

Auto loans

  615   79   253   947   126,643   127,590    49 

Auto loans - Recourse

 46  4  9  59  11,865  11,924   - 

Auto loans - Non-recourse

 90  27  84  201  121,029  121,230   - 

Direct finance leases

  305   0   0   305   30,183   30,488 (2)  0  170  33  47  250  32,556  32,806 

(2)

 47 

Other

  7   5   0   12   7,438   7,450    0  28  5  1  34  13,848  13,882   - 

Residential:

                              

Real estate

  0   0   42   42   364,915   364,957    0  32  -  266  298  429,518  429,816   - 

Construction

  0   0   0   0   35,677   35,677    0  -  -  -  -  48,087  48,087   - 

Total

 $1,029  $139  $3,255  $4,423  $1,485,882  $1,490,305   $49  $880  $268  $3,540  $4,688  $1,624,976  $1,629,664   $47 

(1) Includes non-accrual loans. (2) Net of unearned lease revenue of $1.8$1.9 million. (3) Includes net deferred loan costs of $4.3$4.9 million.

 

               

Recorded

               

Recorded

 
     

Past due

         

investment past

      

Past due

        

investment past

 
 

30 - 59 Days

 

60 - 89 Days

 

90 days

 

Total

   

Total

   

due ≥ 90 days

  

30 - 59 Days

 

60 - 89 Days

 

90 days

 

Total

   

Total

  

due ≥ 90 days

 

December 31, 2021

 

past due

 

past due

 

or more (1)

 

past due

 

Current

 

loans (3)

   

and accruing

 

December 31, 2022

 

past due

 

past due

 

or more (1)

 

past due

 

Current

 

loans (3)

  

and accruing

 
                              

Commercial and industrial

 $0  $4  $154  $158  $236,146  $236,304   $0                

Commercial

 $-  $-  $719  $719  $140,403  $141,122  $- 

Municipal

 - - - - 72,996 72,996  - 

Commercial real estate:

                              

Non-owner occupied

 0  675  478  1,153  311,695  312,848   0  -  -  383  383  317,913  318,296  - 

Owner occupied

 0  0  1,570  1,570  247,185  248,755   0  42  -  1,066  1,108  283,569  284,677  - 

Construction

 0  0  0  0  21,147  21,147   0  -  -  -  -  24,005  24,005  - 

Consumer:

                              

Home equity installment

 87  32  0  119  47,452  47,571   0  239  -  -  239  58,879  59,118  - 

Home equity line of credit

 0  0  97  97  54,781  54,878   0  110  151  211  472  52,096  52,568  - 

Auto loans

 410  45  78  533  117,496  118,029   0 

Auto loans - Recourse

 152  115  11  278  12,651  12,929  - 

Auto loans - Non-recourse

 411 86 158 655 114,254 114,909  16 

Direct finance leases

 173  38  64  275  24,528  24,803 (2) 64  186  -  17  203  31,274  31,477

(2)

 17 

Other

 49  17  0  66  7,947  8,013   0  12  7  -  19  11,690  11,709  - 

Residential:

                              

Real estate

 0  452  572  1,024  324,837  325,861   0  -  327  3  330  397,806  398,136  - 

Construction

 0  0  0  0  34,919  34,919   0  -  -  -  -  42,232  42,232  - 

Total

 $719  $1,263  $3,013  $4,995  $1,428,133  $1,433,128   $64  $1,152  $686  $2,568  $4,406  $1,559,768  $1,564,174  $33 

(1) Includes non-accrual loans. (2) Net of unearned lease revenue of $1.4$1.7 million. (3) Includes net deferred loan costs of $3.0$4.6 million.

 

19

 

Pre-Adoption of ASC 326 - Impaired loans

 

ImpairedFor periods prior to the adoption of CECL, loans segregated by class, as of the period indicated are detailed below:

      

Recorded

  

Recorded

         
  

Unpaid

  

investment

  

investment

  

Total

     
  

principal

  

with

  

with no

  

recorded

  

Related

 

(dollars in thousands)

 

balance

  

allowance

  

allowance

  

investment

  

allowance

 

June 30, 2022

                    

Commercial and industrial

 $822  $791  $0  $791  $211 

Commercial real estate:

                    

Non-owner occupied

  1,102   126   976   1,102   5 

Owner occupied

  2,877   1,202   1,056   2,258   367 

Consumer:

                    

Home equity installment

  33   0   0   0   0 

Home equity line of credit

  211   0   167   167   0 

Auto loans

  255   145   59   204   23 

Residential:

                    

Real estate

  89   0   42   42   0 

Total

 $5,389  $2,264  $2,300  $4,564  $606 

      

Recorded

  

Recorded

         
  

Unpaid

  

investment

  

investment

  

Total

     
  

principal

  

with

  

with no

  

recorded

  

Related

 

(dollars in thousands)

 

balance

  

allowance

  

allowance

  

investment

  

allowance

 

December 31, 2021

                    

Commercial and industrial

 $218  $18  $136  $154  $18 

Commercial real estate:

                    

Non-owner occupied

  2,470   1,674   796   2,470   474 

Owner occupied

  3,185   1,802   762   2,564   763 

Consumer:

                    

Home equity installment

  33   0   0   0   0 

Home equity line of credit

  137   0   97   97   0 

Auto loans

  98   10   68   78   4 

Residential:

                    

Real estate

  699   0   572   572   0 

Total

 $6,840  $3,504  $2,431  $5,935  $1,259 

At June 30, 2022, impaired loans totaled $4.6 million consisting of $1.4 million in accruing TDRs and $3.2 million in non-accrual loans. At December 31, 2021, impaired loans totaled $5.9 million consisting of $3.0 million in accruing TDRs and $2.9 million in non-accrual loans. As of June 30, 2022, the non-accrual loans included 1 TDR totaling $0.4 million compared with 3 TDRs to two unrelated borrowers totaling $0.6 million as of December 31, 2021.

A loan iswere considered impaired when, based on current information and events;events, it iswas probable that the Company willwould be unable to collect the payments in accordance with the contractual terms of the loan. Factors considered in determining impairment include payment status, collateral value, and the probability of collecting payments when due. The significance of payment delays and/or shortfalls iswas determined on a case-by-case basis. All circumstances surrounding the loan arewere considered. Such factors include the length of the delinquency, the underlying reasons and the borrower’s prior payment record. Impairment iswas measured on these loans on a loan-by-loan basis. Impaired loans includeincluded non-accrual loans, TDRs and other loans deemed to be impaired based on the aforementioned factors.

Impaired loans, segregated by class, as of December 31, 2022 prior to the adoption of CECL are detailed below:

      

Recorded

  

Recorded

         
  

Unpaid

  

investment

  

investment

  

Total

     
  

principal

  

with

  

with no

  

recorded

  

Related

 

(dollars in thousands)

 

balance

  

allowance

  

allowance

  

investment

  

allowance

 

December 31, 2022

                    

Commercial and industrial

 $942  $139  $580  $719  $48 

Commercial real estate:

                    

Non-owner occupied

  762   215   547   762   42 

Owner occupied

  2,347   1,304   716   2,020   70 

Consumer:

                    

Home equity installment

  33   -   -   -   - 

Home equity line of credit

  255   -   211   211   - 

Auto loans

  213   18   135   153   1 

Residential:

                    

Real estate

  50   -   3   3   - 

Total

 $4,602  $1,676  $2,192  $3,868  $161 

At December 31, 2022, impaired loans totaled $3.9 million consisting of $1.4 million in accruing TDRs and $2.5 million in non-accrual loans. The non-accrual loans included one TDR totaling $0.2 million as of December 31, 2022.

 

20

 

The following table presents the average recorded investments in impaired loans and related amount of interest income recognized during the periods indicated below. The average balances are calculated based on the quarter-end balances of impaired loans. Payments received from non-accruing impaired loans are first applied against the outstanding principal balance, then to the recovery of any charged-off amounts. Any excess is treated as a recovery of interest income. Payments received from accruing impaired loans are applied to principal and interest, as contractually agreed upon.

 

  For the six months ended 
  

June 30, 2022

  

June 30, 2021

 
          

Cash basis

          

Cash basis

 
  

Average

  

Interest

  

interest

  

Average

  

Interest

  

interest

 
  

recorded

  

income

  

income

  

recorded

  

income

  

income

 

(dollars in thousands)

 

investment

  

recognized

  

recognized

  

investment

  

recognized

  

recognized

 
                         

Commercial and industrial

 $329  $0  $0  $454  $2  $0 

Commercial real estate:

                        

Non-owner occupied

  1,958   52   0   2,703   61   0 

Owner occupied

  2,043   53   0   1,766   20   0 

Construction

  0   0   0   0   0   0 

Consumer:

                        

Home equity installment

  11   0   0   39   4   0 

Home equity line of credit

  133   0   0   325   20   0 

Auto loans

  108   3   0   40   0   0 

Direct finance leases

  0   0   0   0   0   0 

Other

  0   0   0   0   0   0 

Residential:

                        

Real estate

  430   39   0   708   0   0 

Construction

  0   0   0   0   0   0 

Total

 $5,012  $147  $0  $6,035  $107  $0 

AverageIn the table below, average recorded investment refers to the five (5) quarter average of impaired loans preceding the reporting period.

 

 

For the three months ended

  For the six months ended 
 

June 30, 2022

 

June 30, 2021

  

June 30, 2022

 
     

Cash basis

     

Cash basis

      

Cash basis

 
 

Average

 

Interest

 

interest

 

Average

 

Interest

 

interest

  

Average

 

Interest

 

interest

 
 

recorded

 

income

 

income

 

recorded

 

income

 

income

  

recorded

 

income

 

income

 

(dollars in thousands)

 

investment

 

recognized

 

recognized

 

investment

 

recognized

 

recognized

  

investment

 

recognized

 

recognized

 
  

Commercial and industrial

 $420  $0  $0  $449  $2  $0  $329  $-  $- 

Commercial real estate:

  

Non-owner occupied

  983   6   0  2,789  39  0  1,958  52  - 

Owner occupied

  2,270   27   0  1,827  16  0  2,043  53  - 

Construction

  0   0   0  0  0  0  -  -  - 

Consumer:

  

Home equity installment

  2   0   0  27  0  0  11  -  - 

Home equity line of credit

  169   0   0  209  16  0  133  -  - 

Auto loans

  188   1   0  26  0  0  108  3  - 

Direct finance leases

  0   0  0  0  0  0  -  -  - 

Other

  0   0   0  0  0  0  -  -  - 

Residential:

  

Real estate

  89   14   0  709  0  0  430  39  - 

Construction

  0   0   0  0  0  0  -  -  - 

Total

 $4,121  $48  $0  $6,036  $73  $0  $5,012  $147  $- 

Average

In the table below, average recorded investment refers to the two (2) quarter average of impaired loans preceding the reporting period.

  

For the three months ended

 
  

June 30, 2022

 
          

Cash basis

 
  

Average

  

Interest

  

interest

 
  

recorded

  

income

  

income

 

(dollars in thousands)

 

investment

  

recognized

  

recognized

 
             

Commercial and industrial

 $420  $-  $- 

Commercial real estate:

            

Non-owner occupied

  983   6   - 

Owner occupied

  2,270   27   - 

Construction

  -   -   - 

Consumer:

            

Home equity installment

  2   -   - 

Home equity line of credit

  169   -   - 

Auto loans

  188   1   - 

Direct finance leases

  -   -    

Other

  -   -   - 

Residential:

            

Real estate

  89   14   - 

Construction

  -   -   - 

Total

 $4,121  $48  $- 

 

Credit Quality Indicators

 

Commercial and industrial and commercial real estate

 

The Company utilizes a loan grading system and assigns a credit risk grade to its loans in the C&I and CRE portfolios. The grading system provides a means to measure portfolio quality and aids in the monitoring of the credit quality of the overall loan portfolio. The credit risk grades are arrived at using a risk rating matrix to assign a grade to each of the loans in the C&I and CRE portfolios.

These loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed. The credit risk grades may be changed at any time management feels an upgrade or downgrade may be warranted.

 

The following is a description of each risk rating category the Company uses to classify each of its C&I and CRE loans:

 

Pass

 

Loans in this category have an acceptable level of risk and are graded in a range of one to five. Secured loans generally have good collateral coverage. Current financial statements reflect acceptable balance sheet ratios, sales and earnings trends. Management is competent, and a reasonable succession plan is evident. Payment experience on the loans has been good with minor or no delinquency experience. Loans with a grade of one are of the highest quality in the range. Those graded five are of marginally acceptable quality.

 

Special Mention

 

Loans in this category are graded a six and may be protected but are potentially weak. They constitute a credit risk to the Company but have not yet reached the point of adverse classification. Some of the following conditions may exist: little or no collateral coverage; lack of current financial information; delinquency problems; highly leveraged; available financial information reflects poor balance sheet ratios and profit and loss statements reflect uncertain trends; and document exceptions. Cash flow may not be sufficient to support total debt service requirements.

 

Substandard

 

Loans in this category are graded a seven and have a well-defined weakness which may jeopardize the ultimate collectability of the debt. The collateral pledged may be lacking in quality or quantity. Financial statements may indicate insufficient cash flow to service the debt; and/or do not reflect a sound net worth. The payment history indicates chronic delinquency problems. Management is weak. There is a distinct possibility that the Company may sustain a loss. All loans on non-accrual are rated substandard. Other loans that are included in the substandard category can be accruing, as well as loans that are current or past due. Loans 90 days or more past due, unless otherwise fully supported, are classified substandard. Also, borrowers that are bankrupt or have loans categorized as TDRsmodifications experiencing financial difficulty can be graded substandard.

 

21

 

Doubtful

 

Loans in this category are graded an eight and have a better than 50% possibility of the Company sustaining a loss, but the loss cannot be determined because of specific reasonable factors which may strengthen credit in the near-term. Many of the weaknesses present in a substandard loan exist. Liquidation of collateral, if any, is likely. Any loan graded lower than an eight is considered to be uncollectible and charged-off.

 

Consumer and residential

 

The consumer and residential loan segments are regarded as homogeneous loan pools and as such are not risk rated. For these portfolios, the Company utilizes payment activity and history in assessing performance. Non-performing loans are comprised of non-accrual loans and loans past due 90 days or more and accruing. All loans not classified as non-performing are considered performing.

 

The following table presentstables present loans including $4.3$4.9 million and $3.0$4.6 million of deferred costs, segregated by class, categorized into the appropriate credit quality indicator category as of June 30, 20222023 and December 31, 20212022, respectively:

 

Commercial credit exposure

Credit risk profile by creditworthiness category

As of June 30, 2023

  June 30, 2022 

(dollars in thousands)

 

Pass

  

Special mention

  

Substandard

  

Doubtful

  

Total

 
                     

Commercial and industrial

 $217,450  $288  $1,701  $0  $219,439 

Commercial real estate - non-owner occupied

  297,420   16,592   3,872   0   317,884 

Commercial real estate - owner occupied

  246,289   5,728   7,827   0   259,844 

Commercial real estate - construction

  19,515   0   0   0   19,515 

Total commercial

 $780,674  $22,608  $13,400  $0  $816,682 

 

(dollars in thousands)

 

2023

  

2022

  

2021

  

2020

  

2019

  

Prior

  

Revolving Loans Amortized Cost Basis

  

Revolving Loans Converted to Term

  

Total

 

Commercial and industrial

                                    

Risk Rating

                                    

Pass

 $10,316  $21,350   25,623   8,841   8,863   13,049   43,383  $-  $131,425 

Special Mention

  -   695   342   -   -   72   96   -   1,205 

Substandard

  -   171   16   24   67   295   1,961   -   2,534 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total commercial and industrial

 $10,316  $22,216  $25,981  $8,865  $8,930  $13,416  $45,440  $-  $135,164 

Commercial and industrial:

                                    

Current period gross write-offs

 $-  $-  $300  $20  $-  $-  $-  $-  $320 

Commercial and industrial - municipal

                                    

Risk Rating

                                    

Pass

 $3,310  $20,621  $19,175  $13,498  $1,450  $18,964  $-  $-  $77,018 

Special Mention

  -   -   -   -   -   -   -   -   - 

Substandard

  -   -   -   -   -   -   -   -   - 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total commercial and industrial - municipal

 $3,310  $20,621  $19,175  $13,498  $1,450  $18,964  $-  $-  $77,018 

Commercial and industrial - municipal:

                                    

Current period gross write-offs

 $-  $-  $-  $-  $-  $-  $-  $-  $- 

Commercial real estate - non-owner occupied

                                    

Risk Rating

                                    

Pass

 $19,532  $36,420  $78,793   45,289   17,938   94,378  $9,040  $-  $301,390 

Special Mention

  -   65   1,659   324   493   2,220   -   -   4,761 

Substandard

  -   -   478   136   86   7,987   -   -   8,687 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total commercial real estate - non-owner occupied

 $19,532  $36,485  $80,930  $45,749  $18,517  $104,585  $9,040  $-  $314,838 

Commercial real estate - non-owner occupied:

                                    

Current period gross write-offs

 $-  $-  $-  $-  $-  $32  $-  $-  $32 

Commercial real estate - owner occupied

                                    

Risk Rating

                                    

Pass

 $20,866   54,992   49,403   31,605   26,078   87,995  $9,985  $-  $280,924 

Special Mention

  -   237   611   27   -   306   125   -   1,306 

Substandard

  702   -   331   -   -   10,838   617   -   12,488 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total commercial real estate - owner occupied

 $21,568  $55,229  $50,345  $31,632  $26,078  $99,139  $10,727  $-  $294,718 

Commercial real estate - owner occupied:

                                    

Current period gross write-offs

 $-  $-  $-  $-  $-  $-  $-  $-  $- 

Commercial real estate - construction

                                    

Risk Rating

                                    

Pass

 $4,064  $28,673  $861  $-  $-  $2,335  $3,124  $-  $39,057 

Special Mention

  -   -   -   -   -   -   -   -   - 

Substandard

  -   -   -   -   -   -   -   -   - 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total commercial real estate - construction

 $4,064  $28,673  $861  $-  $-  $2,335  $3,124  $-  $39,057 

Commercial real estate - construction:

                                    

Current period gross write-offs

 $-  $-  $-  $-  $-  $-  $-  $-  $- 

22

Consumer & Mortgage lending credit exposure

Credit risk profile based on payment activity

As of June 30, 2023

  June 30, 2022 

(dollars in thousands)

  Performing   Non-performing   Total 

Consumer

            

Home equity installment

 $51,883  $0  $51,883 

Home equity line of credit

  55,411   167   55,578 

Auto loans

  127,337   253   127,590 

Direct finance leases (1)

  30,488   0   30,488 

Other

  7,450   0   7,450 

Total consumer

  272,569   420   272,989 

Residential

            

Real estate

  364,915   42   364,957 

Construction

  35,677   0   35,677 

Total residential

  400,592   42   400,634 

Total consumer & residential

 $673,161  $462  $673,623 

(dollars in thousands)

 

2023

  

2022

  

2021

  

2020

  

2019

  

Prior

  

Revolving Loans Amortized Cost Basis

  

Revolving Loans Converted to Term

  

Total

 

Home equity installment

                                    

Payment performance

                                    

Performing

 $5,192  $19,134  $10,606  $9,386  $4,302  $9,901  $-  $-  $58,521 

Non-performing

  -   -   -   -   -   102   -   -   102 

Total home equity installment

 $5,192  $19,134  $10,606  $9,386  $4,302  $10,003  $-  $-  $58,623 

Home equity installment

                                    

Current period gross write-offs

 $-  $-  $-  $-  $-  $-  $-  $-  $- 

Home equity line of credit

                                    

Payment performance

                                    

Performing

 $-  $-  $-  $-  $-  $-  $41,542  $10,869  $52,411 

Non-performing

  -   -   -   -   -   -   90   -   90 

Total home equity line of credit

 $-  $-  $-  $-  $-  $-  $41,632  $10,869  $52,501 

Home equity line of credit

                                    

Current period gross write-offs

 $-  $-  $-  $-  $-  $-  $-  $-  $- 

Auto loans - recourse

                                    

Payment performance

                                    

Performing

 $2,034  $2,431  $3,587  $2,451  $1,079  $333  $-  $-  $11,915 

Non-performing

  -   -   -   -   -   9   -   -   9 

Total auto loans - recourse

 $2,034  $2,431  $3,587  $2,451  $1,079  $342  $-  $-  $11,924 

Auto loans - recourse

                                    

Current period gross write-offs

 $-  $-  $-  $-  $-  $-  $-  $-  $- 

Auto loans - non-recourse

                                    

Payment performance

                                    

Performing

 $29,298  $50,112  $21,359  $10,670  $6,356  $3,351  $-  $-  $121,146 

Non-performing

  -   -   -   70   -   14   -   -   84 

Total auto loans - non-recourse

 $29,298  $50,112  $21,359  $10,740  $6,356  $3,365  $-  $-  $121,230 

Auto loans - non-recourse

                                    

Current period gross write-offs

 $-  $-  $78  $17  $13  $-  $-  $-  $108 

Direct finance leases (1)

                                    

Payment performance

                                    

Performing

 $7,103  $13,310  $9,036  $2,997  $266  $47  $-  $-  $32,759 

Non-performing

  -   31   16   -   -   -   -   -   47 

Total direct finance leases

 $7,103  $13,341  $9,052  $2,997  $266  $47  $-  $-  $32,806 

Direct finance leases

                                    

Current period gross write-offs

 $-  $-  $-  $-  $-  $-  $-  $-  $- 

Consumer - other

                                    

Payment performance

                                    

Performing

 $3,686  $4,003  $2,228  $899  $634  $1,029  $1,402  $-  $13,881 

Non-performing

  -   -   -   -   -   1   -   -   1 

Total consumer - other

 $3,686  $4,003  $2,228  $899  $634  $1,030  $1,402  $-  $13,882 

Consumer - other

                                    

Current period gross write-offs

 $49  $53  $6  $5  $11  $13  $-  $-  $137 

Residential real estate

                                    

Payment performance

                                    

Performing

 $29,359  $62,556  $136,270  $52,384  $31,128  $117,853  $-  $-  $429,550 

Non-performing

  -   -   -   -   -   266   -   -   266 

Total residential real estate

 $29,359  $62,556  $136,270  $52,384  $31,128  $118,119  $-  $-  $429,816 

Residential real estate

                                    

Current period gross write-offs

 $-  $-  $-  $-  $-  $-  $-  $-  $- 

Residential - construction

                                    

Payment performance

                                    

Performing

 $2,227  $28,031  $12,749  $4,218  $422  $440  $-  $-  $48,087 

Non-performing

  -   -   -   -   -   -   -   -   - 

Total residential - construction

 $2,227  $28,031  $12,749  $4,218  $422  $440  $-  $-  $48,087 

Residential - construction

                                    

Current period gross write-offs

 $-  $-  $-  $-  $-  $-  $-  $-  $- 

 

(1)Net of unearned lease revenue of $1.8$1.9 million.

 

Commercial credit exposure

Credit risk profile by creditworthiness category

 

 December 31, 2021  December 31, 2022 

(dollars in thousands)

 Pass Special mention Substandard Doubtful Total  Pass Special mention Substandard Doubtful Total 
  

Commercial and industrial

 $233,565  $339  $2,400  $0  $236,304  $231,614  $229  $2,635  $-  $234,478 

Commercial real estate - non-owner occupied

 289,679  16,614  6,555  0  312,848  301,386  4,227  11,254  -  316,867 

Commercial real estate - owner occupied

 230,146  7,089  11,520  0  248,755  255,921  803  14,086  -  270,810 

Commercial real estate - construction

 21,147  0  0  0  21,147  18,941  -  -  -  18,941 

Total commercial

 $774,537  $24,042  $20,475  $0  $819,054  $807,862  $5,259  $27,975  $-  $841,096 

 

2223

 

Consumer & Mortgage lending credit exposure

Credit risk profile based on payment activity

 

 December 31, 2021     December 31, 2022 

(dollars in thousands)

 

Performing

 

Non-performing

 

Total

  

Performing

 

Non-performing

 

Total

 
              

Consumer

              

Home equity installment

 $47,571  $0  $47,571  $59,118  $-  $59,118 

Home equity line of credit

 54,781  97  54,878  52,357  211  52,568 

Auto loans

 117,951  78  118,029  131,767  169  131,936 

Direct finance leases (2)

 24,739  64  24,803  31,460  17  31,477 

Other

 8,013  0  8,013  7,611  -  7,611 

Total consumer

 253,055  239  253,294  282,313  397  282,710 

Residential

              

Real estate

 325,289  572  325,861  398,133  3  398,136 

Construction

 34,919  0  34,919  42,232  -  42,232 

Total residential

 360,208  572  360,780  440,365  3  440,368 

Total consumer & residential

 $613,263  $811  $614,074  $722,678  $400  $723,078 

(2)Net of unearned lease revenue of $1.4$1.7 million.

Collateral dependent loans

Loans that do not share risk characteristics are evaluated on an individual basis. For loans that are individually evaluated and collateral dependent, financial loans where we have determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and we expect repayment of the financial asset to be provided substantially through the operation or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date. The following table presents the individually evaluated, collateral dependent loans as of June 30, 2023:

(dollars in thousands)

 

Real Estate

  

Other

  

Total Collateral-Dependent Non-Accrual Loans

 

At June 30, 2023

            

Commercial and industrial:

            

Commercial

 $-  $636  $636 

Municipal

  -   -   - 

Commercial real estate:

            

Non-owner occupied

  167   -   167 

Owner occupied

  2,138   -   2,138 

Consumer:

            

Home equity installment

  102   -   102 

Home equity line of credit

  90   -   90 

Auto loans - Recourse

  -   9   9 

Auto loans - Non-recourse

  -   84   84 

Direct finance leases

  -   -   - 

Other

  -   1   1 

Residential:

            

Real estate

  266   -   266 

Total

 $2,763  $730  $3,493 

 

Allowance for loancredit losses

 

Management continually evaluates the credit quality of the Company’s loan portfolio and performs a formal review of the adequacy of the allowance for credit losses (ACL) on a quarterly basis. The allowance reflects management’s best estimate of the amount of credit losses in the loan portfolio. Management’s judgment is based onWhen estimating the evaluation of individual loans, experience, the assessment of current economic conditions and other relevant factors including the amounts and timing of cash flowsnet amount expected to be received on impaired loans.collected, management considers the effects of past events, current conditions, and reasonable and supportable forecasts of the collectability of the Company’s financial assets. Those estimates may be susceptible to significant change. LoanCredit losses are charged directly against the allowance when loans are deemed to be uncollectible. Recoveries from previously charged-off loans are added to the allowance when received.

 

Management applies two primary components during the loan review process to determine proper allowance levels. The two components are a specific loan loss allocation for loans that are deemed impaired and a general loan loss allocation for those loans not specifically allocated. The methodology to analyze the adequacy of the allowance for loan lossesACL is as follows:based on seven primary components:

 

Data: The quality of the Company’s data is critically important as a foundation on which the ACL estimate is generated. For its estimate, the Company uses both internal and external data with a preference toward internal data where possible. Data is complete, accurate, and relevant, and subjected to appropriate governance and controls.

identificationSegmentation: Financial assets are segmented based on similar risk characteristics.

Contractual term of specific impaired loans by loan category;financial assets: The contractual term of financial assets is a significant driver of ACL estimates. Financial assets or pools of financial assets with shorter contractual maturities typically result in a lower reserve than those with longer contractual maturities. As the average life of a financial asset or pool of assets increases, there generally is a corresponding increase to the ACL estimate because the likelihood of default is considered over a longer time frame. As such, pool-based assumptions for a pool’s contractual term (i.e., average life) are based on the contractual maturity of the financial assets within the pool and adjusted in accordance with GAAP, if appropriate.

Credit loss measurement method: Multiple measurement methods for estimating ACLs are allowable per ASC Topic 326. The Company applies different estimation methods to different groups of financial assets. The discounted cash flow method is used for the Commercial & Industrial, Commercial Real Estate Non Owner Occupied, Commercial Real Estate Owner Occupied, Commercial Construction, Home Equity Installment Loan, Home Equity Line of Credit, Residential Real Estate, and Residential Construction pools. The weighted average remaining maturity (WARM) method is used for the Municipal, Non-Recourse Auto, Recourse Auto, Direct Finance Lease, and Consumer Other pools.

Reasonable and supportable forecasts: ASC Topic 326 requires Management to consider reasonable and supportable forecasts that affect expected collectability of financial assets. As such, the Company’s forecasts incorporate anticipated changes in the economic environment that may affect credit loss estimates over a time horizon when Management can reasonably support and document expectations. Forward-looking information may reflect positive or negative expectations relative to the current environment. As of the reporting date, management is using the median Federal Open Market Committee (FOMC) National Gross Domestic Product (GDP) and Unemployment Rate forecasts as well as the Federal Housing Finance Agency (FHFA) House Price Index (HPI) for its reasonable and supportable forecasts. The Company currently uses a 12 month (4 quarter) reasonable and supportable forecast period.

Reversion period: ASC Topic 326 does not require Management to estimate a reasonable and supportable forecast for the entire contractual life of financial assets. Management may apply reversion techniques for the contractual life remaining after considering the reasonable and supportable forecast period, which allows Management to apply a historical loss rate to latter periods of the financial asset’s life. The Company currently uses a 12 month (4 quarter) straight-line reversion period.
 

identificationQualitative factor adjustments: The Company’s ACL estimate considers all significant factors relevant to the expected collectability of specific loans that areits financial assets as of the reporting date; Qualitative factors reflect the impact of conditions not impaired, but have an identified potential for loss;

calculation of specific allowances where required forcaptured elsewhere, such as the impaired loans based on collateral and other objective and quantifiable evidence;

determination of loans with similar credit characteristics within each class of the loan portfolio segment and eliminating the impaired loans;

application of historical loss percentages (trailing twelve-quarter average) to pools to determinedata or within the allowance allocation;

application ofeconomic forecast. The qualitative factor adjustment percentages to historical losses for trendsconsiderations can be captured directly within measurement models or changesas additional components in the loan portfolio.

Qualitative factor adjustments include:

overall ACL methodologies. Currently, the Company uses the following qualitative factors:

 

o

levels of and trends in delinquencies and non-accrual loans;

 

o

levels of and trends in charge-offs and recoveries;

 

o

trends in volume and terms of loans;

 

o

changes in risk selection and underwriting standards;

 

o

changes in lending policies and legal and regulatory requirements;

 

o

experience, ability and depth of lending management;

 

o

national and local economic trends and conditions; and

 

o

changes in credit concentrations.concentrations; and

ochanges in underlying collateral.

 

AllocationAssets are evaluated on a collective (or pool) basis or individually, as applicable consistent with ASC Topic 326. In accordance with ASC Topic 326, the Company will evaluate individual instruments for expected credit losses when those instruments do not share similar risk characteristics with instruments evaluated using a collective (pooled) basis. In contrast to legacy accounting standards, this criterion is broader than the “impairment” concept as management may evaluate assets individually even when no specific expectation of collectability is in place. Instruments will not be included in both collective and individual analysis. Individual analysis will establish a specific reserve for instruments in scope.

For individually evaluated assets, an ACL is determined separately for each financial asset. Management therefore measures the expected credit losses based on an appropriate method per ASC Subtopic 326-20, similar to collectively evaluated financial assets. As of the allowancereporting date, the Company is using the collateral and cash flow methods.

ASC Topic 326 defines a collateral-dependent asset as a financial asset for different categorieswhich the repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower, based on Management’s assessment, is experiencing financial difficulty. The ACL for a collateral-dependent loan is measured using the fair value of collateral, regardless of whether foreclosure is probable. The fair value of collateral must be adjusted for estimated costs to sell if repayment or satisfaction of the asset depends on the sale of the collateral. If repayment is dependent only on the operation of the collateral, and not on the sale of the collateral, the fair value of the collateral would not be adjusted for estimated costs to sell. If the fair value of the collateral, adjusted for costs to sell if applicable, is less than the amortized cost basis of the collateral-dependent asset, the difference is recorded as an ACL.

The Company’s policy is to charge-off unsecured consumer loans when they become 90 days or more past due as to principal and interest. In the other portfolio segments, amounts are charged-off at the point in time when the Company deems the balance, or a portion thereof, to be uncollectible.

If the individually evaluated asset is determined to not be collateral dependent, the ACL is measured based on the expected cash flows. This measurement is based on the methodology as explained above. A key elementamount and timing of cash flows; the effective interest rate (EIR) used to discount the cash flows; and the basis for the determination of cash flows, including consideration of past events, current conditions, and reasonable and supportable forecasts about the future. These cash flows are discounted back by the EIR and compared to the amortized cost basis of the methodologyasset. If the present value of cash flows is less than the amortized cost, an ACL is recorded. When the present value of cash flows is equal to determineor greater than the allowanceamortized cost, no ACL is the Company’s credit risk evaluation process, which includes credit risk grading of individual C&I and CRE loans. C&I and CRE loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed. The credit risk grades may be changed at any time management feels an upgrade or downgrade may be warranted. The credit risk grades for the C&I and CRE loan portfolios are considered in the reserve methodology and loss factors are applied based upon the credit risk grades. The loss factors applied are based upon the Company’s historical experience as well as what we believe to be best practices and common industry standards. Historical experience reveals there is a direct correlation between the credit risk grades and loan charge-offs. The changes in allocations in the C&I and CRE loan portfolio from period to period are based upon the credit risk grading system and from periodic reviews of the loan portfolio. recorded.

An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies.

 

2324

 

Each quarter, management performs an assessment ofA key control related to the allowance. Theallowance is the Company’s Special Assets CommitteeCommittee. This committee meets quarterly, and the applicable lenders discuss each relationship under review and reach a consensus on the appropriate estimated loss amount, if applicable, based on current accounting guidance. The Special Assets Committee’s focus is on ensuring the pertinent facts are considered regarding not only loans considered for specific reserves, but also the collectability of loans that may be past due in payment. The assessment process also includes the review of all loans on a non-accruing basis as well as a review of certain loans to which the lenders or the Company’s Credit Administration function have assigned a criticized or classified risk rating.

 

The Company’s policy is to charge-off unsecured consumer loans when they become 90 days or more past due as to principal and interest. In the other portfolio segments, amounts are charged-off at the point in time when the Company deems the balance, or a portion thereof, to be uncollectible.

Information related to the change in the allowance and the Company’s recorded investment in loans by portfolio segment as of the period indicated is as follows:

 

As of and for the six months ended June 30, 2022

                    

As of and for the six months ended June 30, 2023

As of and for the six months ended June 30, 2023

                
 

Commercial &

 

Commercial

     

Residential

      

Commercial &

 

Commercial

     

Residential

     

(dollars in thousands)

 

industrial

 

real estate

 

Consumer

   

real estate

 

Unallocated

 

Total

  

industrial

 

real estate

 

Consumer

   

real estate

 

Unallocated

 

Total

 

Allowance for Loan Losses:

             

Allowance for Credit Losses:

              

Beginning balance

 $2,204  $7,422  $2,404   $3,508  $86  $15,624  $2,924  $7,162  $2,827   $4,169  $67  $17,149 

Impact of adopting ASC 326

 278 756 (547)  198 (67) 618 

Initial allowance on loans purchased with credit deterioration

 - 126 -   - - 126 

Charge-offs

  (31)  (1)  (136)   0   0   (168) (320) (32) (245)  -  -  (597)

Recoveries

  4   28   50    2   0   84  22  41  126   10  -  199 

Provision

  568   (486)  452    527   (11)  1,050 

Provision (credit) for loan losses

 (543) 525  353   470  50  855 

Ending balance

 $2,745  $6,963  $2,770   $4,037  $75  $16,590  $2,361  $8,578  $2,514   $4,847  $50  $18,350 

Ending balance: individually evaluated for impairment

 $211  $372  $23   $0  $0  $606 

Ending balance: collectively evaluated for impairment

 $2,534  $6,591  $2,747   $4,037  $75  $15,984 

Ending balance: individually evaluated

 $16  $219  $56   $4  $-  $295 

Ending balance: collectively evaluated

 $2,345  $8,359  $2,458   $4,843  $50  $18,055 

Loans Receivables:

                           

Ending balance (2)

 $219,439  $597,243  $272,989 (1) $400,634  $0  $1,490,305  $212,182  $648,613  $290,966 

(1)

 $477,903  $-  $1,629,664 

Ending balance: individually evaluated for impairment

 $791  $3,360  $371   $42  $0  $4,564 

Ending balance: collectively evaluated for impairment

 $218,648  $593,883  $272,618   $400,592  $0  $1,485,741 

Ending balance: individually evaluated

 $668  $7,000  $286   $609  $-  $8,563 

Ending balance: collectively evaluated

 $211,514  $641,613  $290,680   $477,294  $-  $1,621,101 

(1) Net of unearned lease revenue of $1.8$1.9 million. (2) Includes $4.3$4.9 million of net deferred loan costs.

 

As of and for the three months ended June 30, 2022

               

As of and for the three months ended June 30, 2023

As of and for the three months ended June 30, 2023

               
 

Commercial &

 

Commercial

   

Residential

      

Commercial &

 

Commercial

   

Residential

     

(dollars in thousands)

 

industrial

 

real estate

 

Consumer

 

real estate

 

Unallocated

 

Total

  

industrial

 

real estate

 

Consumer

 

real estate

 

Unallocated

 

Total

 

Allowance for Loan Losses:

                          

Beginning balance

 $2,780  $6,822  $2,547  $3,851  $81  $16,081  $2,550  $8,157  $2,448  $4,683  $72  $17,910 

Charge-offs

 (31) 0  (42) 0  0  (73) (150) -  (143) -  -  (293)

Recoveries

 2  19  36  0  0  57  1  2  55  -  -  58 

Provision

 (6) 122  229  186  (6) 525  (40) 419  154  164  (22) 675 

Ending balance

 $2,745  $6,963  $2,770  $4,037  $75  $16,590  $2,361  $8,578  $2,514  $4,847  $50  $18,350 

 

As of and for the year ended December 31, 2021

             

As of and for the year ended December 31, 2022

              
 

Commercial &

 

Commercial

     

Residential

      

Commercial &

 

Commercial

     

Residential

     

(dollars in thousands)

 

industrial

 

real estate

 

Consumer

   

real estate

 

Unallocated

 

Total

  

industrial

 

real estate

 

Consumer

   

real estate

 

Unallocated

 

Total

 

Allowance for Loan Losses:

                           

Beginning balance

 $2,407  $6,383  $2,552   $2,781  $79  $14,202  $2,204  $7,422  $2,404   $3,508  $86  $15,624 

Charge-offs

 (130) (491) (206)  (162) 0  (989) (371) (67) (377)  -  -  (815)

Recoveries

 23  250  138   0  0  411  11  153  74   2  -  240 

Provision

 (96) 1,280  (80)  889  7  2,000  1,080  (346) 726   659  (19) 2,100 

Ending balance

 $2,204  $7,422  $2,404   $3,508  $86  $15,624  $2,924  $7,162  $2,827   $4,169  $67  $17,149 

Ending balance: individually evaluated for impairment

 $18  $1,237  $4   $0  $0  $1,259  $48  $112  $1   $-  $-  $161 

Ending balance: collectively evaluated for impairment

 $2,186  $6,185  $2,400   $3,508  $86  $14,365  $2,876  $7,050  $2,826   $4,169  $67  $16,988 

Loans Receivables:

                           

Ending balance (2)

 $236,304  $582,750  $253,294 (1) $360,780  $0  $1,433,128  $234,478  $606,618  $282,710 

(1)

 $440,368  $-  $1,564,174 

Ending balance: individually evaluated for impairment

 $154  $5,034  $175   $572  $0  $5,935  $719  $2,782  $364   $3  $-  $3,868 

Ending balance: collectively evaluated for impairment

 $236,150  $577,716  $253,119   $360,208  $0  $1,427,193  $233,759  $603,836  $282,346   $440,365  $-  $1,560,306 

(1) Net of unearned lease revenue of $1.4$1.7 million. (2) Includes $3.0$4.6 million of net deferred loan costs.

 

As of and for the six months ended June 30, 2022

                     
  

Commercial &

  

Commercial

      

Residential

         

(dollars in thousands)

 

industrial

  

real estate

  

Consumer

  

real estate

  

Unallocated

  

Total

 

Allowance for Loan Losses:

                        

Beginning balance

 $2,204  $7,422  $2,404  $3,508  $86  $15,624 

Charge-offs

  (31)  (1)  (136)  -   -   (168)

Recoveries

  4   28   50   2   -   84 

Provision

  568   (486)  452   527   (11)  1,050 

Ending balance

 $2,745  $6,963  $2,770  $4,037  $75  $16,590 

2425

 

As of and for the six months ended June 30, 2021

           

As of and for the three months ended June 30, 2022

As of and for the three months ended June 30, 2022

           
 

Commercial &

 

Commercial

   

Residential

      

Commercial &

 

Commercial

   

Residential

     

(dollars in thousands)

 

industrial

 

real estate

 

Consumer

 

real estate

 

Unallocated

 

Total

  

industrial

 

real estate

 

Consumer

 

real estate

 

Unallocated

 

Total

 

Allowance for Loan Losses:

                          

Beginning balance

 $2,407  $6,383  $2,552  $2,781  $79  $14,202  $2,780  $6,822  $2,547  $3,851  $81  $16,081 

Charge-offs

 (106) (132) (82) (43) 0  (363) (31) -  (42) -  -  (73)

Recoveries

 15  235  56  0  0  306  2  19  36  -  -  57 

Provision

 8  742  (29) 332  47  1,100  (6) 122  229  186  (6) 525 

Ending balance

 $2,324  $7,228  $2,497  $3,070  $126  $15,245  $2,745  $6,963  $2,770  $4,037  $75  $16,590 

 

As of and for the three months ended June 30, 2021

                     
  

Commercial &

  

Commercial

      

Residential

         

(dollars in thousands)

 

industrial

  

real estate

  

Consumer

  

real estate

  

Unallocated

  

Total

 

Allowance for Loan Losses:

                        

Beginning balance

 $2,342  $7,080  $2,415  $2,915  $87  $14,839 

Charge-offs

  (99)  (8)  (54)  0   0   (161)

Recoveries

  11   224   32   0   0   267 

Provision

  70   (68)  104   155   39   300 

Ending balance

 $2,324  $7,228  $2,497  $3,070  $126  $15,245 

Unfunded commitments

In accordance with ASC Topic 326, the Company estimates expected credit losses for off-balance-sheet credit exposures over the contractual period during which the Company is exposed to credit risk. The estimate of expected credit losses takes into consideration the likelihood that funding will occur (i.e., funding rate) as well as the amount expected to be collected over the estimated remaining contractual term of the off-balance-sheet credit exposures (i.e., loss rate). The Company does not record an estimate of expected credit losses for off-balance-sheet exposures that are unconditionally cancellable. On a quarterly basis, Management evaluates expected credit losses for off-balance-sheet credit exposures.

The Company's allowance for credit losses on unfunded commitments is recognized as a liability on the consolidated balance sheets, with adjustments to the reserve recognized in the provision for credit losses on unfunded commitments on the consolidated statements of income. The Company's activity in the allowance for credit losses on unfunded commitments for the period was as follows:

(dollars in thousands)

 

For the Six Months Ended June 30, 2023

  

For the Six Months Ended June 30, 2022

 

Beginning balance

 $49  $63 

Impact of adopting ASC 326

  1,060   - 

Provision (credit) for loan losses

  175   (18)

Ending balance

 $1,284  $45 

 

Direct finance leases

On January 1, 2019, the Company adopted ASU 2016-02,Leases (Topic 842), and subsequent related updates to revise the accounting for leases. Lessor accounting was largely unchanged as a result of the standard. Additional disclosures required under the standard are included in this section and in Footnote 12, “Leases”.

 

The Company originates direct finance leases through two automobile dealerships. The carrying amount of the Company’s lease receivables, net of unearned income, was $8.8$6.9 million and $7.7$7.9 million as of June 30, 20222023 and December 31, 20212022, respectively. The residual value of the direct finance leases is fully guaranteed by the dealerships. Residual values amounted to $21.7$25.6 million and $17.1$23.6 million at June 30, 20222023 and December 31, 20212022, respectively, and are included in the carrying value of direct finance leases. As of June 30, 2023, there was also $242 thousand in deferred lease expense included in the carrying value of direct finance leases that is not included in the table below.

 

The undiscounted cash flows to be received on an annual basis for the direct finance leases are as follows:

 

(dollars in thousands)

 

Amount

  

Amount

 
  

2022

 $3,794 

2023

 9,446  $6,253 

2024

 9,521  12,652 

2025

 8,612  11,351 

2026

 881  3,657 

2027 and thereafter

 0 

2027

 485 

2028 and thereafter

 51 

Total future minimum lease payments receivable

 32,254  34,449 

Less: Unearned income

 (1,766) (1,885)

Undiscounted cash flows to be received

 $30,488  $32,564 

 

 

6. Earnings per share

 

Basic earnings per share (EPS) is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS is computed in the same manner as basic EPS but also reflects the potential dilution that could occur from the grant of stock-based compensation awards. The Company maintains one active share-based compensation plan that may generate additional potentially dilutive common shares. For granted and unexercised stock-settled stock appreciation rights (SSARs), dilution would occur if Company-issued SSARs were exercised and converted into common stock. As of the three and six months ended June 30, 20222023, there were 17,09417,725 and 20,40618,983 potentially dilutive shares related to issued and unexercised SSARs compared to 29,71817,094 and 30,82820,406 for the same 20212022 periods, respectively. The calculation did not include 50,01446,423 weighted average unexercised SSARs that could potentially dilute earnings per share but their effect was antidilutive as of the three and six months ended June 30, 20222023. For restricted stock, dilution would occur from the Company’s previously granted but unvested shares. There were 10,36015,978 and 12,04218,882 potentially dilutive shares related to unvested restricted share grants as of the three and six months ended June 30, 20222023 compared to 10,35110,360 and 10,70012,042 for the same 20212022 periods, respectively.  The calculation did not include 41,14843,177 and 25,22123,726 weighted average unvested restricted shares that could potentially dilute earnings per share but their effect was antidilutive as of the three and six months ended June 30, 20222023.

 

In the computation of diluted EPS, the Company uses the treasury stock method to determine the dilutive effect of its granted but unexercised stock options and SSARs and unvested restricted stock. Under the treasury stock method, the assumed proceeds, as defined, received from shares issued in a hypothetical stock option exercise or restricted stock grant, are assumed to be used to purchase treasury stock. Proceeds include amounts received from the exercise of outstanding stock options and compensation cost for future service that the Company has not yet recognized in earnings. The Company does not consider awards from share-based grants in the computation of basic EPS.

 

2526

 

The following table illustrates the data used in computing basic and diluted EPS for the periods indicated:

 

 

Three months ended June 30,

 

Six months ended June 30,

  

Three months ended June 30,

 

Six months ended June 30,

 
 

2022

 

2021

 

2022

 

2021

  

2023

 

2022

 

2023

 

2022

 

(dollars in thousands except per share data)

  

Basic EPS:

  

Net income available to common shareholders

 $7,664  $5,696  $15,187  $11,363  $5,362  $7,664  $12,402  $15,187 

Weighted-average common shares outstanding

 5,658,854  4,995,658  5,657,033  4,993,226  5,670,769  5,658,854  5,660,255  5,657,033 

Basic EPS

 $1.35  $1.14  $2.68  $2.28  $0.95  $1.35  $2.19  $2.68 
  

Diluted EPS:

  

Net income available to common shareholders

 $7,664  $5,696  $15,187  $11,363  $5,362  $7,664  $12,402  $15,187 

Weighted-average common shares outstanding

 5,658,854  4,995,658  5,657,033  4,993,226  5,670,769  5,658,854  5,660,255  5,657,033 

Potentially dilutive common shares

 27,454  40,069  32,448  41,528  33,703  27,454  37,865  32,448 

Weighted-average common and potentially dilutive shares outstanding

 5,686,308  5,035,727  5,689,481  5,034,754  5,704,472  5,686,308  5,698,120  5,689,481 

Diluted EPS

 $1.35  $1.13  $2.67  $2.26  $0.94  $1.35  $2.18  $2.67 

 

 

7. Stock plans

 

The Company has one stock-based compensation plan (the stock compensation plan) from which it can grant stock-based compensation awards and applies the fair value method of accounting for stock-based compensation provided under current accounting guidance. The guidelines require the cost of share-based payment transactions (including those with employees and non-employees) be recognized in the financial statements. The Company’s stock compensation plan was shareholder-approved and permits the grant of share-based compensation awards to its employees and directors. The Company believes that the stock-based compensation plan will advance the development, growth and financial condition of the Company by providing incentives through participation in the appreciation in the value of the Company’s common stock. In return, the Company hopes to secure, retain and motivate the employees and directors who are responsible for the operation and the management of the affairs of the Company by aligning the interest of its employees and directors with the interest of its shareholders. In the stock compensation plan, employees and directors are eligible to be awarded stock-based compensation grants which can consist of stock options (qualified and non-qualified), stock appreciation rights (SARs) and restricted stock.

 

At the 2022 annual shareholders' meeting, the Company's shareholders approved and the Company adopted the 2022 Omnibus Stock Incentive Plan which replaced the 2012 Omnibus Stock Incentive Plan and the 2012 Director Stock Incentive Plan (collectively, the 2012 stock incentive plans). The 2012 stock incentive plans expired in 2022.Unless terminated by the Company’s board of directors, the 2022 stock incentive plansOmnibus Stock Incentive Plan will expire on and no stock-based awards shall be granted after the year 2032.

 

In the 2022 stock incentive plan,Omnibus Stock Incentive Plan, the Company has reserved 500,000 shares of its 0-parno-par common stock for future issuance. The Company recognizes share-based compensation expense over the requisite service or vesting period. Since 2019, the Company has approved a Long-Term Incentive Plan (LTIP) each year that awarded restricted stock and/or stock-settled stock appreciation rights (SSARs) to senior officers and managers based on the attainment of performance goals. The SSAR awards have a ten year-year term from the date of each grant.

During the first quarter of 2023, the Company approved a LTIP and awarded restricted stock to senior officers and managers in February 2023 based on 2022 performance. During the second quarter of 2023, the Company awarded 1,000 shares of restricted stock to one new employee.

 

During the first quarter of 2022, the Company approved a LTIP and awarded restricted stock to senior officers and managers in February 2022 based on 2021 performance.

 

During the first quarter of 2021, the Company approved a LTIP and awarded restricted stock to senior officers and managers in February and March 2021 based on 2020 performance.

2627

 

The following table summarizes the weighted-average fair value and vesting of restricted stock grants awarded during the periods ended June 30, 20222023 and 20212022 under the 2022 and 2012 stock incentive plans:

 

 

June 30, 2022

 

June 30, 2021

  

June 30, 2023

 

June 30, 2022

 
     

Weighted-

     

Weighted-

      

Weighted-

     

Weighted-

 
 

Shares

  

average grant

 

Shares

  

average grant

  

Shares

   

average grant

 

Shares

   

average grant

 
 

granted

  

date fair value

 

granted

  

date fair value

  

granted

   

date fair value

 

granted

   

date fair value

 
          

Director plan

  18,000(2) $49.85  12,500(2) $52.00  -   $-  18,000 

(2)

 $49.85 

Omnibus plan

  16,520(3)  49.85  13,552(3) 52.00  18,000 

(2)

 49.43  16,520 

(3)

 49.85 

Omnibus plan

  50(1)  35.91  50(1) 58.17  17,684 

(3)

 49.43 50 

(1)

 35.91 

Omnibus plan

  0  0  36(3) 58.17  50 

(1)

 49.43 -   - 

Omnibus plan

 1,000 

(3)

 44.06 -   - 

Total

  34,570  $49.83  26,138  $52.02  36,734   $49.28  34,570   $49.83 

(1) Vest after 1 year (2) Vest after 3 years – 33% each year (3) Vest fully after 3 years

 

The fair value of the shares granted in 20222023 and 20212022 was calculated using the grant date closing stock price.

 

A summary of the status of the Company’s non-vested restricted stock as of and changes during the period indicated are presented in the following table:

 

 

2012 Stock incentive plans

  

2012 & 2022 Stock incentive plans

 
 

Director

 

Omnibus

 

Total

 Weighted- average grant date fair value  

Director

 

Omnibus

 

Total

 Weighted- average grant date fair value 

Non-vested balance at December 31, 2021

 14,920  28,123  43,043  53.20 

Non-vested balance at December 31, 2022

 23,872 38,614 62,486 $51.46 

Granted

 18,000  16,570  34,570  49.83  -  36,734  36,734  49.28 

Forfeited

 0  (1,533) (1,533) 52.26  -  -  -  - 

Vested

 (9,048) (2,493) (11,541) 52.84  (11,353) (12,930) (24,283) 52.57 

Non-vested balance at June 30, 2022

 23,872  40,667  64,539  $51.48 

Non-vested balance at June 30, 2023

 12,519  62,418  74,937  $50.04 

 

A summary of the status of the Company’s SSARs as of and changes during the period indicated are presented in the following table:

 

 

Awards

 Weighted-average grant date fair value Weighted-average remaining contractual term (years)  

Awards

 Weighted-average grant date fair value Weighted-average remaining contractual term (years) 

Outstanding December 31, 2021

 94,332  9.66  5.5 

Outstanding December 31, 2022

 87,133 $9.69 4.5 

Granted

 0       -      

Exercised

 0       (7,665)     

Forfeited

 0       -      

Outstanding June 30, 2022

 94,332  $9.66  5.0 

Outstanding June 30, 2023

 79,468  $10.18  4.1 

Of the SSARs outstanding at June 30, 20222023, all SSARs vested and were exercisable.

 

There were 0 SSARs exercised during the first half of 2022.During the first half of 2021,2023, there were 2,9327,665 SSARs exercised. The intrinsic value recorded for these SSARs was $10,190.$35,370. The tax deduction realized from the exercise of these SSARs was $125,810$149,886 resulting in a tax benefit of $26,420.$31,476. There were no SSARs exercised during the first half of 2022.

 

Share-based compensation expense is included as a component of salaries and employee benefits in the consolidated statements of income. The following tables illustrate stock-based compensation expense recognized on non-vested equity awards during the three and six months ended June 30, 20222023 and 20212022 and the unrecognized stock-based compensation expense as of June 30, 20222023:

 

  

Three months ended June 30,

  

Six months ended June 30,

 

(dollars in thousands)

 

2022

  

2021

  

2022

  

2021

 

Stock-based compensation expense:

                

Director stock incentive plan

 $263  $94  $372  $169 

Omnibus stock incentive plan

  150   157   315   314 

Employee stock purchase plan

  0   0   32   44 

Total stock-based compensation expense

 $413  $251  $719  $527 

In addition, during the six months ended June 30, 2021, the Company reversed accruals of ($10 thousand) in stock-based compensation expense for restricted stock and SSARs awarded under the Omnibus Plan.

  

Three months ended June 30,

  

Six months ended June 30,

 

(dollars in thousands)

 

2023

  

2022

  

2023

  

2022

 

Stock-based compensation expense:

                

2012 Director stock incentive plan

 $173  $263  $287  $372 

2012 Omnibus stock incentive plan

  118   150   259   315 

2022 Omnibus stock incentive plan

  227   -   383   - 

Employee stock purchase plan

  -   -   34   32 

Total stock-based compensation expense

 $518  $413  $963  $719 

 

2728

 
 

As of

  

As of

 

(dollars in thousands)

 

June 30, 2022

  

June 30, 2023

 

Unrecognized stock-based compensation expense:

  

Director plan

 $1,024 

Omnibus plan

 1,212 

2012 Director stock incentive plan

 $486 

2012 Omnibus stock incentive plan

 552 

2022 Omnibus stock incentive plan

 1,428 

Total unrecognized stock-based compensation expense

 $2,236  $2,466 

The unrecognized stock-based compensation expense as of June 30, 20222023 will be recognized ratably over the periods ended February 2025, and February 2025 and June 2026for the 2012Director Stock Incentive Plan, 2012 Omnibus Stock Incentive Plan and the2022 Omnibus Stock Incentive Plan, respectively.

 

In addition to the 20122022 stock incentive plans,plan, the Company established the 2002 Employee Stock Purchase Plan (the ESPP) and reserved 165,000 shares of its un-issued capital stock for issuance under the plan. The ESPP was designed to promote broad-based employee ownership of the Company’s stock and to motivate employees to improve job performance and enhance the financial results of the Company. Under the ESPP, participation is voluntary whereby employees use automatic payroll withholdings to purchase the Company’s capital stock at a discounted price based on the fair market value of the capital stock as measured on either the commencement or termination dates, as defined. As of June 30, 20222023, 94,533 shares101,827 shares have been issued under the ESPP. The ESPP is considered a compensatory plan and is required to comply with the provisions of current accounting guidance. The Company recognizes compensation expense on its ESPP on the date the shares are purchased, and it is included as a component of salaries and employee benefits in the consolidated statements of income.

 

During the second quarter of 2022, the Company announced that the Board of Directors approved a plan to purchase, in open market and privately negotiated transactions, up to 3% of its outstanding common stock. As of June 30, 2022,2023, the Company had repurchased 10,29432,554 shares of common stock at an average price of $37.68$38.81 under the treasury stock repurchase plan.

 

8. Fair value measurements

 

The accounting guidelines establish a framework for measuring and disclosing information about fair value measurements. The guidelines of fair value reporting instituted a valuation hierarchy for disclosure of the inputs used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:

 

Level 1 - inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities;

 

Level 2 - inputs are quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument;

 

Level 3 - inputs are unobservable and are based on the Company’s own assumptions to measure assets and liabilities at fair value. Level 3 pricing for securities may also include unobservable inputs based upon broker-traded transactions.

 

A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

 

The Company uses fair value to measure certain assets and, if necessary, liabilities on a recurring basis when fair value is the primary measure for accounting. Thus, the Company uses fair value for AFS securities. Fair value is used on a non-recurring basis to measure certain assets when adjusting carrying values to market values, such as impaired loans, other real estate owned (ORE) and other repossessed assets.

 

The following table represents the carrying amount and estimated fair value of the Company’s financial instruments as of the periods indicated:

 

June 30, 2022

 

June 30, 2023

June 30, 2023

 
       

Quoted prices

 

Significant

 

Significant

        

Quoted prices

 

Significant

 

Significant

 
       

in active

 

other

 

other

        

in active

 

other

 

other

 
 

Carrying

 

Estimated

 

markets

 

observable inputs

 

unobservable inputs

  

Carrying

 

Estimated

 

markets

 

observable inputs

 

unobservable inputs

 

(dollars in thousands)

 

amount

 

fair value

 

(Level 1)

 

(Level 2)

 

(Level 3)

  

amount

 

fair value

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Financial assets:

                      

Cash and cash equivalents

 $109,125  $109,125  $109,125  $0  $0  $69,632  $69,632  $69,632  $-  $- 

Held-to-maturity securities

 222,011 199,446 0 199,446 0  223,479 192,084 - 192,084 - 

Available-for-sale debt securities

 452,822  452,822  0  452,822  0  380,785  380,785  -  380,785  - 

Restricted investments in bank stock

 3,622  3,622  0  3,622  0  3,728  3,728  -  3,728  - 

Loans and leases, net

 1,473,715  1,391,043  0  0  1,391,043  1,611,314  1,476,610  -  -  1,476,610 

Loans held-for-sale

 4,011  4,061  0  4,061  0  1,808  1,851  -  1,851  - 

Accrued interest receivable

 7,909  7,909  0  7,909  0  8,343  8,343  -  8,343  - 

Interest rate swaps

 111  111  0  111  0  203  203  -  203  - 

Financial liabilities:

                      

Deposits with no stated maturities

 2,092,516  2,092,516  0  2,092,516  0  1,971,520  1,971,520  -  1,971,520  - 

Time deposits

 125,108  122,042  0  122,042  0  180,472  176,501  -  176,501  - 

Short-term borrowings

 10 10 0 10 0  76,111 76,114 - 76,114 - 

Secured borrowings

 7,736  7,135  0  0  7,135  7,498  7,632  -  -  7,632 

Accrued interest payable

 123  123  0  123  0  1,378  1,378  -  1,378  - 

Interest rate swaps

 111  111  0  111  0  203  203  -  203  - 

 

2829

 

December 31, 2021

 
          

Quoted prices

  

Significant

  

Significant

 
          

in active

  

other

  

other

 
  

Carrying

  

Estimated

  

markets

  

observable inputs

  

unobservable inputs

 

(dollars in thousands)

 

amount

  

fair value

  

(Level 1)

  

(Level 2)

  

(Level 3)

 

Financial assets:

                    

Cash and cash equivalents

 $96,877  $96,877  $96,877  $0  $0 

Available-for-sale debt securities

  738,980   738,980   0   738,980   0 

Restricted investments in bank stock

  3,206   3,206   0   3,206   0 

Loans and leases, net

  1,417,504   1,404,103   0   0   1,404,103 

Loans held-for-sale

  31,727   32,013   0   32,013   0 

Accrued interest receivable

  7,526   7,526   0   7,526   0 

Financial liabilities:

                    

Deposits with no stated maturities

  2,031,072   2,031,072   0   2,031,072   0 

Time deposits

  138,793   138,291   0   138,291   0 

Secured borrowings

  10,620   10,690   0   0   10,690 

Accrued interest payable

  155   155   0   155   0 

December 31, 2022

 
          

Quoted prices

  

Significant

  

Significant

 
          

in active

  

other

  

other

 
  

Carrying

  

Estimated

  

markets

  

observable inputs

  

unobservable inputs

 

(dollars in thousands)

 

amount

  

fair value

  

(Level 1)

  

(Level 2)

  

(Level 3)

 

Financial assets:

                    

Cash and cash equivalents

 $29,091  $29,091  $29,091  $-  $- 

Held-to-maturity securities

  222,744   187,280   -   187,280   - 

Available-for-sale debt securities

  420,862   420,862   -   420,862   - 

Restricted investments in bank stock

  5,268   5,268   -   5,268   - 

Loans and leases, net

  1,547,025   1,440,151   -   -   1,440,151 

Loans held-for-sale

  1,637   1,660   -   1,660   - 

Accrued interest receivable

  8,487   8,487   -   8,487   - 

Interest rate swaps

  213   213   -   213   - 

Financial liabilities:

                    

Deposits with no stated maturities

  2,049,689   2,049,689   -   2,049,689   - 

Time deposits

  117,224   113,252   -   113,252   - 

Short-term borrowings

  12,940   12,940   -   12,940   - 

Secured borrowings

  7,619   7,275   -   -   7,275 

Accrued interest payable

  448   448   -   448   - 

Interest rate swaps

  213   213   -   213   - 

 

The carrying value of short-term financial instruments, as listed below, approximates their fair value. These instruments generally have limited credit exposure, no stated or short-term maturities, carry interest rates that approximate market and generally are recorded at amounts that are payable on demand:

 

 

Cash and cash equivalents;

 

Non-interest bearing deposit accounts;

 

Savings, interest-bearing checking and money market accounts and

 

Short-term borrowings.

 

Securities: Fair values on investment securities are determined by prices provided by a third-party vendor, who is a provider of financial market data, analytics and related services to financial institutions.

 

OriginatedAccruing loans and leases: The fair value of accruing loans is estimated by calculating the net present value of the future expected cash flows discounted using the exit price notion. The discount rate is based uponat current offering rates with an additional discount for expected potential charge-offs. Additionally, an environmental generalsimilar loans. Current offering rates consider, among other things, credit risk adjustment is subtracted from the net present value to arrive at the total estimated fair value of the accruing loan portfolio.risk. 

 

The carrying value that fair value is compared to is net of the allowance for loancredit losses and since there is significant judgment included in evaluating credit quality, loans are classified within Level 3 of the fair value hierarchy.

 

Non-accrual loans: Loans which the Company has measured as non-accruing are generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties. These loans are classified within Level 3 of the fair value hierarchy. The fair value consists of loan balances less the valuation allowance.

Acquired loans: Acquired loans (performing and non-performing) are initially recorded at their acquisition-date fair values using Level 3 inputs. For more information on the calculation of the fair value of acquired loans, see Footnote 9, “Acquisition.”

 

Loans held-for-sale: The fair value of loans held-for-sale is estimated using rates currently offered for similar loans and is typically obtained from the Federal National Mortgage Association (FNMA) or the Federal Home Loan Bank of Pittsburgh (FHLB).

 

Interest rate swaps: Fair values on investment securities are determined by prices provided by a third-party vendor, who is a provider of financial market data, analytics and related services to financial institutions.

 

Certificates of deposit: The fair value of certificates of deposit is based on discounted cash flows using rates which approximate market rates for deposits of similar maturities.

 

Secured borrowings: The fair value for these obligations uses an income approach based on expected cash flows on a pooled basis.

 

2930

 

The following tables illustrate the financial instruments measured at fair value on a recurring basis segregated by hierarchy fair value levels as of the periods indicated:

 

 

Total carrying value

 Quoted prices in active markets Significant other observable inputs 

Significant other unobservable inputs

  

Total carrying value

 Quoted prices in active markets Significant other observable inputs 

Significant other unobservable inputs

 

(dollars in thousands)

 

June 30, 2022

 

(Level 1)

 

(Level 2)

 

(Level 3)

  

June 30, 2023

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Available-for-sale securities:

                  

Agency - GSE

 $33,756  $0  $33,756  $0  $26,946  $-  $26,946  $- 

Obligations of states and political subdivisions

 179,300  0  179,300  0  151,987  -  151,987  - 

MBS - GSE residential

 239,766  0  239,766  0  201,852  -  201,852  - 

Total available-for-sale debt securities

 $452,822  $0  $452,822  $0  $380,785  $-  $380,785  $- 

 

 

Total carrying value

 Quoted prices in active markets Significant other observable inputs Significant other unobservable inputs  

Total carrying value

 Quoted prices in active markets Significant other observable inputs Significant other unobservable inputs 

(dollars in thousands)

 

December 31, 2021

 

(Level 1)

 

(Level 2)

 

(Level 3)

  

December 31, 2022

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Available-for-sale securities:

                  

Agency - GSE

 $117,003  $0  $117,003  $0  $31,533  $-  $31,533  $- 

Obligations of states and political subdivisions

 364,710  0  364,710  0  171,894  -  171,894  - 

MBS - GSE residential

 257,267  0  257,267  0  217,435  -  217,435  - 

Total available-for-sale debt securities

 $738,980  $0  $738,980  $0  $420,862  $-  $420,862  $- 

 

Debt securities in the AFS portfolio are measured at fair value using market quotations provided by a third-party vendor, who is a provider of financial market data, analytics and related services to financial institutions. Assets classified as Level 2 use valuation techniques that are common to bond valuations. That is, in active markets whereby bonds of similar characteristics frequently trade, quotes for similar assets are obtained.

 

There were 0no changes in Level 3 financial instruments measured at fair value on a recurring basis as of and for the periods ending June 30, 20222023 and December 31, 20212022, respectively.

 

The following table illustrates the financial instruments newly measured at fair value on a non-recurring basis segregated by hierarchy fair value levels as of the periods indicated:

 

    

Quoted prices in

 

Significant other

 

Significant other

      

Quoted prices in

 

Significant other

 

Significant other

 
 

Total carrying value

 

active markets

 

observable inputs

 

unobservable inputs

   

Total carrying value

 

active markets

 

observable inputs

 

unobservable inputs

 

(dollars in thousands)

 

at June 30, 2022

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Valuation techniques

 

at June 30, 2023

 

(Level 1)

 

(Level 2)

 

(Level 3)

 
          

Impaired loans

 $1,658  $0  $0  $1,658 

Individually evaluated loans

Fair value of collateral appraised value

 $311  $-  $-  $311 

Individually evaluated loans

Discount cash flow

 405     405 

Other real estate owned

 128  0  0  128 

Fair value of asset less selling costs

 1  -  -  1 

Total

 $1,786  $0  $0  $1,786 

Total

 $717  $-  $-  $717 

 

   

Quoted prices in

 

Significant other

 

Significant other

    

Quoted prices in

 

Significant other

 

Significant other

 
 

Total carrying value

 

active markets

 

observable inputs

 

unobservable inputs

  

Total carrying value

 

active markets

 

observable inputs

 

unobservable inputs

 

(dollars in thousands)

 

at December 31, 2021

 

(Level 1)

 

(Level 2)

 

(Level 3)

  

at December 31, 2022

 

(Level 1)

 

(Level 2)

 

(Level 3)

 
                  

Impaired loans

 $2,245  $0  $0  $2,245  $1,515  $-  $-  $1,515 

Other real estate owned

 198  0  0  198  168  -  -  168 

Total

 $2,443  $0  $0  $2,443  $1,683  $-  $-  $1,683 

 

From time-to-time, the Company may be required to record at fair value financial instruments on a non-recurring basis, such as impaired loans, ORE and other repossessed assets. These non-recurring fair value adjustments involve the application of lower-of-cost-or-market accounting on write downs of individual assets. The fair value of impaired loans was calculated using the value of the impaired loans with an allowance less the related allowance.

 

The following describes valuation methodologies used for financial instruments measured at fair value on a non-recurring basis. ImpairedIndividually evaluated loans that are collateral dependent are written down to fair value through the establishment of specific reserves, a component of the allowance for loancredit losses, and as such are carried at the lower of net recorded investment or the estimated fair value. Estimates of fair value of the collateral are determined based on a variety of information, including available valuations from certified appraisers for similar assets, present value of discounted cash flows and inputs that are estimated based on commonly used and generally accepted industry liquidation advance rates and estimates and assumptions developed by management.

 

Valuation techniques for impairedindividually evaluated, collateral dependent loans are typically determined through independent appraisals of the underlying collateral or may be determined through present value of discounted cash flows. Both techniques include various Level 3 inputs which are not identifiable. The valuation technique may be adjusted by management for estimated liquidation expenses and qualitative factors such as economic conditions. If real estate is not the primary source of repayment, present value of discounted cash flows and estimates using generally accepted industry liquidation advance rates and other factors may be utilized to determine fair value.

 

At June 30, 20222023 and December 31, 20212022, the range of liquidation expenses and other valuation adjustments applied to impairedindividually evaluated, collateral dependent loans ranged from -23.02%-27.56% and -23.02%-32.02% and from -33.08%-19.61% to -47.66%-29.58%, respectively. The weighted average of liquidation expenses and other valuation adjustments applied to impairedindividually evaluated, collateral dependent loans amounted to -23.02%-30.02% as of June 30, 20222023 and -44.50%-21.77% as of December 31, 20212022, respectively. Due to the multitude of assumptions, many of which are subjective in nature, and the varying inputs and techniques used to determine fair value, the Company recognizes that valuations could differ across a wide spectrum of techniques employed. Accordingly, fair value estimates for impairedindividually evaluated, collateral dependent loans are classified as Level 3.

 

For ORE, fair value is generally determined through independent appraisals of the underlying properties which generally include various Level 3 inputs which are not identifiable. Appraisals form the basis for determining the net realizable value from these properties. Net realizable value is the result of the appraised value less certain costs or discounts associated with liquidation which occurs in the normal course of business. Management’s assumptions may include consideration of the location and occupancy of the property, along with current economic conditions. Subsequently, as these properties are actively marketed, the estimated fair values may be periodically adjusted through incremental subsequent write-downs. These write-downs usually reflect decreases in estimated values resulting from sales price observations as well as changing economic and market conditions. At June 30, 20222023 and December 31, 20212022, the discounts applied to the appraised values of ORE ranged from -24.61%-77.60% to -77.60% and from -20.16%-39.07% to -77.60%, respectively. As of June 30, 20222023 and December 31, 20212022, the weighted average of discount to the appraisal values of ORE amounted to -34.85%-77.60% and -28.21%-39.61%, respectively.

 

At June 30, 20222023 and December 31, 20212022, there were 0no other repossessed assets. The Company refers to the National Automobile Dealers Association (NADA) guide to determine a vehicle’s fair value.

9. Acquisition

On July 1, 2021, the Company completed its previously announced acquisition of Landmark. Landmark was a 1-bank holding company organized under the laws of the Commonwealth of Pennsylvania and was headquartered in Pittston, PA. Its wholly owned subsidiary, Landmark Community Bank, was an independent community bank chartered under the laws of the Commonwealth of Pennsylvania. Landmark Community Bank conducted full-service commercial banking services through 5 bank centers located in Lackawanna and Luzerne Counties, Pennsylvania. The acquisition expanded Fidelity Deposit and Discount Bank’s full-service footprint in Luzerne County, Pennsylvania. The Company transacted the acquisition to complement the Company’s existing operations, while consistent with the Company’s strategic plan of enhancing long-term shareholder value. The fair value of total assets acquired as a result of the merger totaled $375.5 million (net of cash consideration), loans totaled $298.9 million and deposits totaled $308.5 million. Goodwill recorded in the merger was $12.6 million.

In accordance with the terms of the Reorganization Agreement, on July 1, 2021 each share of Landmark common stock was converted into the right to receive 0.272 shares of the Company’s common stock and $3.26 in cash. As a result of the acquisition, the Company issued 647,990 shares of its common stock, valued at $35.1 million, and $7.8 million in cash based upon $54.10, the determined market price of the Company’s common stock in accordance with the Reorganization Agreement. The results of the combined entity’s operations are included in the Company’s Consolidated Financial Statements from the date of acquisition. The acquisition of Landmark was accounted for as a business combination using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration paid were recorded at estimated fair values on the acquisition date.

Effective July 1, 2021, in connection with the acquisition and pursuant to the terms of the Reorganization Agreement, Paul C. Woelkers was appointed as a Class C Director of Fidelity’s Board of Directors. Mr. Woelkers was also appointed as a Director of Fidelity Bank’s Board of Directors.

30

The following table summarizes the consideration paid for Landmark and the fair value of assets acquired, and liabilities assumed as of the acquisition date:

Purchase Price Consideration in Common Stock

    

Landmark shares settled for stock

  2,382,695 

Exchange ratio

  0.272 

Total FDBC shares issued

  647,990 

Value assigned to FDBC common share (6/30/2021 closing price)

 $54.10 
     

Purchase price assigned to Landmark common shares exchanged for FDBC common shares

 $35,056,259 
     

Purchase Price Consideration - Cash for Common Stock

    

Landmark shares exchanged for cash, excluding fractional shares

  2,382,695 

Cash consideration (per Landmark share)

 $3.26 

Cash portion of purchase price

 $7,767,586 
     

Cash portion of purchase price (cash paid fractional shares)

 $5,559 
     

Cash for outstanding Landmark stock options

 $69,250 
     

Total consideration paid

 $42,898,654 

Allocation of Purchase Price

 

In thousands

     

Total Purchase Price

     $42,899 
         

Estimated Fair Value of Assets Acquired

        

Cash and cash equivalents

  4,090     

Investment securities

  49,430     

Loans

  298,860     

Restricted investments in bank stock

  1,186     

Premises and equipment

  3,405     

Lease property under finance leases

  1,188     

Core deposit intangible asset

  597     

Other real estate owned

  488     

Other assets

  11,629     

Total assets acquired

  370,873     
         

Estimated Fair Value of Liabilities Assumed

        

Non-interest bearing deposits

  100,472     

Interest bearing deposits

  208,057     

Short-term borrowings

  2,224     

FHLB borrowings

  4,602     

Secured borrowings

  20,619     

Finance lease obligation

  1,188     

Other liabilities

  3,387     

Total liabilities assumed

  340,549     
         

Net Assets Acquired

      30,324 

Goodwill Recorded in Acquisition

     $12,575 

Pursuant to the accounting requirements, the Company assigned a fair value to the assets acquired and liabilities assumed of Landmark. ASC 820 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

31

The assets acquired and liabilities assumed in the acquisition of Landmark were recorded at their estimated fair values based on management’s best estimates using information available at the date of the acquisition and are subject to adjustment for up to one year after the closing date of the acquisition. While the fair values are not expected to be materially different from the estimates, any material adjustments to the estimates will be reflected, retroactively, as of the date of the acquisition. The items most susceptible to adjustment are the fair value adjustments on loans, core deposit intangible and the deferred income tax assets resulting from the acquisition. Fair values of the major categories of assets acquired and liabilities assumed were determined as follows:

Investment securities available-for-sale

The estimated fair values of the investment securities available for sale, primarily comprised of U.S. Government agency mortgage-backed securities, U.S. government agencies and municipal bonds, were determined using Level 1 and Level 2 inputs in the fair value hierarchy. The fair values were determined using executable market bids or independent pricing services. The Company’s independent pricing service utilized matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific security but rather relying on the security’s relationship to other benchmark quoted prices. Management reviewed the data and assumptions used in pricing the securities.

Loans

Acquired loans (performing and non-performing) are initially recorded at their acquisition-date fair values using Level 3 inputs. Fair values are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, expected lifetime losses, environmental factors, collateral values, discount rates, expected payments and expected prepayments. Specifically, the Company has prepared three separate loan fair value adjustments that it believed a market participant might employ in estimating the entire fair value adjustment necessary under ASC 820-10 for the acquired loan portfolio. The three-separate fair valuation methodology employed are: 1) an interest rate loan fair value adjustment, 2) a general credit fair value adjustment, and 3) a specific credit fair value adjustment for purchased credit impaired loans subject to ASC 310-30 procedures. The acquired loans were recorded at fair value at the acquisition date without carryover of Landmark’s previously established allowance for loan losses. The fair value of the financial assets acquired included loans receivable with a gross amortized cost basis of $309.8 million.

The table below illustrates the fair value adjustments made to the amortized cost basis in order to present the fair value of the loans acquired. The credit adjustment on purchased credit impaired loans is derived in accordance with ASC 310-30 and represents the portion of the loan balances that has been deemed uncollectible based on the Company’s expectations of future cash flows for each respective loan.

Dollars in thousands

 

Gross amortized cost basis at June 30, 2021

 $309,767 

Interest rate fair value adjustment on pools of homogeneous loans

  (1,855)

Credit fair value adjustment on pools of homogeneous loans

  (7,915)

Credit fair value adjustment on purchased credit impaired loans

  (1,137)

Fair value of acquired loans at June 30, 2021

 $298,860 

For loans acquired without evidence of credit quality deterioration, the Company prepared the interest rate loan fair value and credit fair value adjustments. Loans were grouped into homogeneous pools by characteristics such as loan type, term, collateral, and rate. Market rates for similar loans were obtained from various internal and external data sources and reviewed by management for reasonableness. The average of these rates was used as the fair value interest rate a market participant would utilize. A present value approach was utilized to calculate the interest rate fair value discount of $1.9 million. Additionally, for loans acquired without credit deterioration, a credit fair value adjustment was calculated using a two-part credit fair value analysis: 1) expected lifetime credit migration losses; and 2) estimated fair value adjustment for certain qualitative factors. The expected lifetime losses were calculated using historical losses observed by the Company, Landmark and peer banks. The Company also estimated an environmental factor to apply to each loan type. The environmental factor represents the potential discount which may arise due to general credit and economic factors. A credit fair value discount of $7.9 million was determined. Both the interest rate and credit fair value adjustments relate to loans acquired with evidence of credit quality deterioration will be substantially recognized as interest income on a level yield amortization method over the expected life of the loans.

The following table presents the acquired purchased credit impaired loans receivable at the acquisition date:

Dollars in thousands

 

Contractual principal and interest at acquisition

 $5,306 

Non-accretable difference

  (1,691)

Expected cash flows at acquisition

  3,615 

Accretable yield

  (588)

Fair value of purchased impaired loans

 $3,027 

32

Premises and Equipment

The Company assumed leases on 2 branch facilities of Landmark. The Company compared the lease contract obligations to comparable market rental rates determined by third-party licensed appraisers. The Company believed that the leased contract rates were in a reasonable range of market rental rates and concluded that no fair market value adjustment related to leasehold interest was necessary. The fair value of Landmark’s premises, including land, buildings and improvements, was determined based upon independent third-party appraisals performed by licensed appraisers or sales agreements.

Core Deposit Intangible

The fair value of the core deposit intangible was determined based on a discounted cash flow (present value) analysis using a discount rate commensurate with market participants. To calculate cash flows, deposit account servicing costs (net of deposit fee income) and interest expense on deposits were compared to the higher cost of alternative funding sources available through national brokered CD offering rates and FHLB advance rates. The projected cash flows were developed using projected deposit attrition rates based on the average rate experienced by both institutions. The core deposit intangible will be amortized over ten years using the sum-of-years digits method.

Time Deposits

The fair value adjustment for time deposits represents a discount from the value of the contractual repayments of fixed maturity deposits using prevailing market interest rates for similar-term time deposits. The time deposit premium is being amortized into income on a level yield amortization method over the contractual life of the deposits.

Secured Borrowings

The Company identified 19 sold participations acquired from Landmark that did not meet the criteria for sales treatment under ASC 860-10-40 and should be recorded as obligations from secured borrowing arrangements. The Company has estimated the fair value of these obligations using an income approach based on the expected cash flows method on a pooled basis using Level 3 assumptions.

FHLB Borrowings

The Company assumed FHLB borrowings in connection with the merger. The fair value of FHLB Borrowings was determined by using FHLB prepayment penalty as a proxy for the fair value adjustment. The Company decided to pay off the borrowing post acquisition date therefore no amortization is warranted.

Merger-related expenses

The Company did not incur any merger-related expenses for the three and six months ended June 30, 2022. For the three and six months ended June 30, 2021, the Company incurred $0.4 million and $0.9 million in merger-related expenses related to the merger with Landmark, primarily consisting of professional fee expenses.

 

 

10.9. Employee Benefits

 

Bank-Owned Life Insurance (BOLI)

 

The Company has purchased single premium BOLI policies on certain officers. The policies are recorded at their cash surrender values. Increases in cash surrender values are included in non-interest income in the consolidated statements of income. As a result of the acquisition of Landmark, the Company added BOLI with a value of $7.2 million during 2021.The policies’ cash surrender value totaled $53.4$53.9 million and $52.7$54.0 million, respectively, as of June 30, 20222023 and December 31, 20212022 and is reflected as an asset on the consolidated balance sheets. During the first quarter of 2023, the Company received $0.9 million in proceeds from a BOLI death claim, of which $0.8 million was return of cash surrender value and $0.1 million was additional income which was recorded in fees and other revenue on the consolidated statements of income. For the six months ended June 30, 20222023 and 20212022, the Company has recorded income of $645 thousand and $638 thousand, and $573 thousand, respectively.respectively, due to an increase in cash surrender values.

 

Officer Life Insurance

 

In 2017, the Bank entered into separate split dollar life insurance arrangements (Split Dollar Agreements) with 11eleven officers. This plan provides each officer a specified death benefit should the officer die while in the Bank’s employ. The Bank paid the insurance premiums in March 2017 and the arrangements were effective in March 2017. In March 2019, the Bank entered into a new Split Dollar Agreement with 1one officer. In January 2021, the Bank entered into Split Dollar Agreements with 15fifteen officers. The Bank owns the policies and all cash values thereunder. Upon death of the covered employee, the agreed-upon amount of death proceeds from the policies will be paid directly to the insured’s beneficiary. As of June 30, 20222023, the policies had total death benefitsbenefits of $53.4$53.9 million of which $7.8of which $8.8 million wouldwould have been paid to the officer’s beneficiaries and the remaining $45.6remaining $45.1 million wouldwould have been paid to the Bank. In addition, 4four executive officers have the opportunity to retain a split dollar benefit equal to two times their highest base salary after separation from service if the vesting requirements are met. As of June 30, 20222023 and December 31, 20212022, the Company had a balance in accrued expenses of $235$310 thousand and $200$269 thousand for the split dollar benefit.

 

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Supplemental Executive Retirement plan (SERP)

 

On March 29, 2017, the Bank entered into separate supplemental executive retirement agreements (individually the “SERP Agreement”) with 5five officers, pursuant to which the Bank will credit an amount to a SERP account established on each participant’s behalf while they are actively employed by the Bank for each calendar month from March 1, 2017 until retirement. On March 20, 2019, the Bank entered into a SERP Agreement with 1one officer, pursuant to which the Bank will credit an amount to a SERP account established for the participant’s behalf while they are actively employed by the Bank for each calendar month from March 1, 2019 until normal retirement age. As a result of the acquisition of Landmark, the Company added $1.0 million in accruedacquired a SERP expenses to the consolidated balance sheets.agreement with one former employee. As of June 30, 20222023 and December 31, 20212022, the Company had a balance in accrued expenses of $3.8$4.2 million and $3.6$4.0 million in connection with the SERP.

 

 

11.10. Revenue Recognition

 

As of January 1, 2018, theThe Company adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606) and all subsequent ASUs that modified Topic 606. The Company has elected to use the modified retrospective approach with prior period financial statements unadjusted and presented with historical revenue recognition methods. The implementation of the new standard had no material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary.

 

The majority of the Company’s revenues are generated through interest earned on securities and loans, which is explicitly excluded from the scope of the guidance. In addition, certain non-interest income streams such as fees associated with mortgage servicing rights, loan service charges, life insurance earnings, rental income and gains/losses on the sale of loans and securities are not in the scope of the new guidance. The main types of contracts with customers that are in the scope of the new guidance are:

 

 

Service charges on deposit accounts – Deposit service charges represent fees charged by the Company for the performance obligation of providing services to a customer’s deposit account. The transaction price for deposit services includes both fixed and variable amounts based on the Company’s fee schedules. Revenue is recognized and payment is received either at a point in time for transactional fees or on a monthly basis for non-transactional fees.

 

 

Interchange fees – Interchange fees represent fees charged by the Company for customers using debit cards. The contract is between the Company and the processor and the performance obligation is the ability of customers to use debit cards to make purchases at a point in time. The transaction price is a percentage of debit card usage and the processor pays the Company and revenue is recorded throughout the month as the performance obligations are being met.

 

 

Fees from trust fiduciary activities – Trust fees represent fees charged by the Company for the management, custody and/or administration of trusts. These are mostly monthly fees based on the market value of assets in the trust account at the prior month end. Payment is generally received a few weeks after month end through a direct charge to customers’ accounts. Estate fees are recognized and charged as the Company reaches each of six different stages of the estate administration process.

 

 

Fees from financial services – Financial service fees represent fees charged by the Company for the performance obligation of providing various services for an investment account. Revenue is recognized twice monthly for fees on sales transactions and on a monthly basis for advisory fees and quarterly for trail fees.

 

 

Gain/loss on ORE sales – Gain/loss on the sale of ORE is recognized at the closing date when the sales proceeds are received. In seller-financed ORE transactions, the contract is made subject to our normal underwriting standards and pricing. The Company does not have any obligation or right to repurchase any sales of ORE.

 

Contract balances

 

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before the payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity already received payment (or payment is due) from the customer. The Company’s non-interest income streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company typically does not enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of June 30, 20222023 and December 31, 20212022, the Company did not have any significant contract balances.

 

Remaining performance obligations

 

The Company’s performance obligations have an original expected duration of less than one year and follow the relevant guidance for recognizing revenue over time. There is no variable consideration subject to constraint that is not included in information about transaction price.

 

Contract acquisition costs

 

An entity is required to capitalize and subsequently amortize into expense, certain incremental costs of obtaining a contract if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less.

 

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12.11. Leases

 

ASU 2016-02 Leases (Topic 842) became effective for the Company on January 1, 2019. For all operating lease contracts where the Company is lessee, a right-of-use (ROU) asset and lease liability were recorded as of the effective date. The Company assumed all renewal terms will be exercised when calculating the ROU assets and lease liabilities. For leases existing at the transition date, any prepaid or deferred rent was added to the ROU asset to calculate the lease liability. The discount rate used to calculate the present value of future payments at the transition date was the Company’s incremental borrowing rate. The Company used the FHLB fixed rate borrowing rates as the discount rates. For all classes of underlying assets, the Company has elected not to record short-term leases (leases with a term of 12 months or less) on the balance sheet when the Company is lessee. Instead, the Company will recognize the lease payment on a straight-line basis over the lease term and variable lease payments in the period in which the obligation for those payments is incurred. For all asset classes, the Company has elected, as a lessee, not to separate nonlease components from lease components and instead to account for each separate lease component and nonlease components associated with that lease component as a single lease component.

 

Management determines if an arrangement is or contains a lease at contract inception. If an arrangement is determined to be or contains a lease, the Company recognizes a ROU asset and a lease liability when the asset is placed in service.

 

The Company’s operating leases, where the Company is lessee, include property, land and equipment. As of June 30, 20222023, 10ten of the Company’s branch properties and 1 future branchone administrative office were leased under operating leases. In 4four of the branch leases, the Company leases the land from an unrelated third party, and the buildings are the Company’s own capital improvement. The Company also leases 3two standalone ATMs under operating leases. Additionally, the Company has 1one property lease and 4four equipment leases classified as finance leases. The Company acquired a leased property classified as a finance lease with a fair value of $1.2 million from the Landmark merger during 2021.

 

The following is an analysis of the leased property under finance leases:

 

(dollars in thousands)

 

June 30, 2022

 

December 31, 2021

  

June 30, 2023

 

December 31, 2022

 
  

Property and equipment

 $1,695  $1,673  $1,695  $1,695 

Less accumulated depreciation and amortization

 (485) (366) (726) (606)

Leased property under finance leases, net

 $1,210  $1,307  $969  $1,089 

 

The following is a schedule of future minimum lease payments under finance leases together with the present value of the net minimum lease payments as of June 30, 20222023:

 

(dollars in thousands)

 

Amount

  

Amount

 
  

2022

 $127 

2023

 227  $100 

2024

 171  171 

2025

 161  161 

2026

 150  150 

2027 and thereafter

 462 

2027

 150 

2028 and thereafter

 312 

Total minimum lease payments (a)

 1,298  1,044 

Less amount representing interest (b)

 (72) (53)

Present value of net minimum lease payments

 $1,226  $991 

 

 

(a)

The future minimum lease payments have not been reduced by estimated executory costs (such as taxes and maintenance) since this amount was deemed immaterial by management.

 

(b)

Amount necessary to reduce net minimum lease payments to present value calculated at the Company’s incremental borrowing rate upon lease inception.

 

3533

 

As of June 30, 20222023, the Company leased its Green Ridge, Pittston, Peckville, Back Mountain, Mountain Top, Abington, Nazareth, Easton, Bethlehem and Wyoming branches under the terms of operating leases. During 2021,2022, the Company entered into a new lease for the Bethlehem branch which will be relocatedof administrative office space in 2022.Scranton.  Common area maintenance is included in variable lease payments in the table below. The Abington branch has variable lease payments which are calculated as a percentage of the national prime rate of interest and are expensed as incurred. The Bethlehem and Easton branches have variable lease payments that increase annually and are expensed as incurred.

 

(dollars in thousands)

 

June 30, 2022

 

June 30, 2021

  

June 30, 2023

 

June 30, 2022

 

Lease cost

        

Finance lease cost:

  

Amortization of right-of-use assets

 $119  $47  $120  $119 

Interest on lease liabilities

 11  3  9  11 

Operating lease cost

 366  291  384  366 

Short-term lease cost

 74  16  38  74 

Variable lease cost

 15  2  32  15 

Total lease cost

 $585  $359  $583  $585 
  

Other information

        

Cash paid for amounts included in the measurement of lease liabilities

  

Operating cash flows from finance leases

 $11  $3  $9  $11 

Operating cash flows from operating leases (Fixed payments)

 $303  $269  $352  $303 

Operating cash flows from operating leases (Liability reduction)

 $152  $147  $187  $152 

Financing cash flows from finance leases

 $116  $47  $118  $116 

Right-of-use assets obtained in exchange for new finance lease liabilities

 $0  $0  $-  $- 

Right-of-use assets obtained in exchange for new operating lease liabilities

 $0  $0  $-  $- 

Weighted-average remaining lease term - finance leases (in years)

 6.82 2.65  6.28  6.82 

Weighted average remaining lease term - operating leases (in years)

 21.08 20.94  20.33  21.08 

Weighted-average discount rate - finance leases

 1.75% 2.48% 1.68% 1.75%

Weighted-average discount rate - operating leases

 3.39% 3.57% 3.39% 3.39%

 

During the firstsix months of 2023, $571 thousand of the total lease cost was included in premises and equipment expense and $12 thousand was included in other expenses on the consolidated statements of income. During the first six months of 2022, $568 thousand of the total lease cost iswas included in premises and equipment expense and $17 thousand iswas included in other expenses on the consolidated statements of income. Operating lease expense is recognized on a straight-line basis over the lease term. We recognized both the interest expense and amortization expense for finance leases in premises and equipment expense since the interest expense portion was immaterial.

 

The future minimum lease payments for the Company’s branch network and equipment under operating leases that have lease terms in excess of one year as of June 30, 20222023 are as follows:

 

(dollars in thousands)

 

Amount

  

Amount

 
  

2022

 $311 

2023

 618  $347 

2024

 614  659 

2025

 622  639 

2026

 630  646 

2027 and thereafter

 10,590 

2027

 655 

2028 and thereafter

 10,195 

Total future minimum lease payments

 13,385  13,141 

Plus variable payment adjustment

 184 

Less variable payment adjustment

 (192)

Less amount representing interest

 (4,092) (3,779)

Present value of net future minimum lease payments

 $9,477  $9,170 

 

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The Company leases several properties,one property, where the Company is lessor, under an operating leaseslease to an unrelated parties. Some of these properties are residential properties surrounding the Main Branch that the Company leases on a month-to-month basis and are considered short-term leases.party. The undiscounted cash flows to be received on an annual basis for the remaining 2 properties under long-term operating leasesproperty are as follows:

 

(dollars in thousands)

 

Amount

  

Amount

 
  

2022

 $67 

2023

 48  $24 

2024

 51  51 

2025

 54  54 

2026

 54  54 

2027 and thereafter

 27 

2027

 27 

2028 and thereafter

 - 

Total lease payments to be received

 $301  $210 

 

The Company also indirectly originates automobile leases classified as direct finance leases. See Footnote 5, “Loans and leases”, for more information about the Company’s direct finance leases.

 

Lease income recognized from direct finance leases was included in interest income from loans and leases on the consolidated statements of income. Lease income related to operating leases is included in fees and other revenue on the consolidated statements of income. The Company only receives a variable payment for taxes from one of its lessees, but the amount is immaterial and excluded from rental income. The amount of lease income recognized on the consolidated statements of income was as follows for the periods indicated:

 

  

For the three months ended June 30,

  

For the six months ended June 30,

 

(dollars in thousands)

 

2022

  

2021

  

2022

  

2021

 

Lease income - direct finance leases

                

Interest income on lease receivables

 $267  $205  $491  $395 
                 

Lease income - operating leases

  62   77   120   128 

Total lease income

 $329  $282  $611  $523 

  

For the three months ended June 30,

  

For the six months ended June 30,

 

(dollars in thousands)

 

2023

  

2022

  

2023

  

2022

 

Lease income - direct finance leases

                

Interest income on lease receivables

 $275  $267  $595  $491 
                 

Lease income - operating leases

  12   62   24   120 

Total lease income

 $287  $329  $619  $611 
 

13.12. Derivative Instruments

 

The Company is a party to interest rate derivatives that are not designated as hedging instruments. The Company enters into interest rate swaps that allow certain commercial loan customers to effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. These interest rate swaps with customers are simultaneously offset by interest rate swaps that the Company executes with a third-party financial institution, such that the Company minimizes its net interest rate risk exposure resulting from such transactions. The interest rate swap agreements are free-standing derivatives and are recorded at fair value in the Company’s consolidated balance sheets (asset positions are included in other assets and liability positions are included in other liabilities). As the interest rate swaps are structured to offset each other, changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in an impact to earnings; however there may be fair value adjustments related to credit-quality variations between counterparties, which may impact earnings as required by FASB ASC 820. There was no effect on earnings in any periods presented. The Company had $1 million in investment securities pledged as collateral on its interest rate swaps with a third-party financial institution as of June 30, 20222023There were 0 interest rate swaps as of December 31, 2021.

 

   

Weighted

          

Weighted

       
 

Notional

 

Average Maturity

 

Interest Rate

 

Interest Rate

    

Notional

 

Average Maturity

 

Interest Rate

 

Interest Rate

   

(dollars in thousands)

 

Amount

 

(Years)

 

Paid

 

Received

 

Fair Value

  

Amount

 

(Years)

 

Paid

 

Received

 

Fair Value

 

June 30, 2022

      

June 30, 2023

      

Classified in Other assets:

  

Customer interest rate swaps

 $2,000  15.42  

30 Day SOFR + Margin

 

Fixed

 $111  $1,945  14.42  

30 Day SOFR + Margin

 

Fixed

 $203 

Classified in Accrued interest payable and other liabilities:

  

Third party interest rate swaps

 $2,000  15.42  

Fixed

 

30 Day SOFR + Margin

 $111  $1,945  14.42  

Fixed

 

30 Day SOFR + Margin

 $203 

 

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Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations

 

The following is management's discussion and analysis of the significant changes in the consolidated financial condition of the Company as of June 30, 20222023 compared to December 31, 20212022 and a comparison of the results of operations for the three and six months ended June 30, 20222023 and 2021.2022. Current performance may not be indicative of future results. This discussion should be read in conjunction with the Company’s 20212022 Annual Report filed on Form 10-K.

 

Forward-looking statements

 

Certain of the matters discussed in this Quarterly Report on Form 10-Q may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. The words “expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate,” and similar expressions are intended to identify such forward-looking statements.

 

The Company’s actual results may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation:

 

 local, regional and national economic conditions and changes thereto;
 

the short-term and long-term effects of inflation, and rising costs to the Company, its customers and on the economy;

 

the effects of economic conditions particularly with regard to the negative impact of severe, wide-ranging and continuing disruptions caused by the spread of Coronavirus Disease 2019 (COVID-19) and any other pandemic, epidemic or other health-related crisis and responses thereto on current customers and the operations of the Company, specifically the effect of the economy on loan customers’ ability to repay loans;

the costs and effects of litigation and of unexpected or adverse outcomes in such litigation;

the impact of new or changes in existing laws and regulations, including laws and regulations concerning taxes, banking, securities and insurance and their application with which the Company and its subsidiaries must comply;

impacts of the capital and liquidity requirements of the Basel III standards and other regulatory pronouncements, regulations and rules;

governmental monetary and fiscal policies, as well as legislative and regulatory changes;

effects of short- and long-term federal budget and tax negotiations and their effect on economic and business conditions;

the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Financial Accounting Standards Board and other accounting standard setters;

the risks of changes and volatility of interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities and interest rate protection agreements, as well as interest rate risks;

securities markets and monetary fluctuations and volatility;
disruption of credit and equity markets;
 

impacts of the capital and liquidity requirements of the Basel III standards and other regulatory pronouncements, regulations and rules;

governmental monetary and fiscal policies, as well as legislative and regulatory changes;
effects of short- and long-term federal budget and tax negotiations and their effect on economic and business conditions;

the costs and effects of litigation and of unexpected or adverse outcomes in such litigation;

the impact of new or changes in existing laws and regulations, including laws and regulations concerning taxes, banking, securities and insurance and their application with which the Company and its subsidiaries must comply;

the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Financial Accounting Standards Board and other accounting standard setters;

the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in our market area and elsewhere, including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the internet;

the effects of economic conditions of any pandemic, epidemic or other health-related crisis such as COVID-19 and responses thereto on current customers and the operations of the Company, specifically the effect of the economy on loan customers’ ability to repay loans;
the effects of bank failures, banking system instability, deposit fluctuations, loan and securities value changes;
 

technological changes;

 

the interruption or breach in security of our information systems, continually evolving cybersecurity and other technological risks and attacks resulting in failures or disruptions in customer account management, general ledger processing and loan or deposit updates and potential impacts resulting therefrom including additional costs, reputational damage, regulatory penalties, and financial losses;

 

acquisitions and integration of acquired businesses;

 

the failure of assumptions underlying the establishment of reserves for loan losses and estimations of values of collateral and various financial assets and liabilities;

inflation, securities markets and monetary fluctuations and volatility;

 

acts of war or terrorism;

disruption of credit and equity markets; and

 

the risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

 

The Company cautions readers not to place undue reliance on forward-looking statements, which reflect analyses only as of the date of this document. The Company has no obligation to update any forward-looking statements to reflect events or circumstances after the date of this document.

 

Readers should review the risk factors described in other documents that we file or furnish, from time to time, with the Securities and Exchange Commission, including Annual Reports to Shareholders, Annual Reports filed on Form 10-K and other current reports filed or furnished on Form 8-K.

 

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Executive Summary

 

The Company is a Pennsylvania corporation and a bank holding company, whose wholly-owned state chartered commercial bank and trust company is The Fidelity Deposit and Discount Bank. The Company is headquartered in Dunmore, Pennsylvania. We consider Lackawanna, Northampton, Lehigh and Luzerne Counties our primary marketplace.

 

As a leading Northeastern and Eastern Pennsylvania community bank, our goals are to enhance shareholder value while continuing to build a full-service community bank. We focus on growing our core business of retail and business lending and deposit gathering while maintaining strong asset quality and controlling operating expenses. We continue to implement strategies to diversify earning assets (see “Funds Deployed” section of this management’s discussion and analysis) and to increase the amount of low-costrelationship core deposits (see “Funds Provided” section of this management’s discussion and analysis). These strategies include a greater level of commercial lending and the ancillary business products and services supporting our commercial customers’ needs as well as residential lending strategies and an array of consumer products. We focus on developing a full banking relationship with existing, as well as new business prospects. The Bank has a personal and corporate trust department and also provides alternative financial and insurance products with asset management services. In addition, we explore opportunities to selectively expand and optimize our franchise footprint, consisting presently of our 22-branch20-branch network.

 

We are impacted by both national and regional economic factors, with commercial, commercial real estate and residential mortgage loans concentrated in Northeastern Pennsylvania, primarily in Lackawanna and Luzerne counties, and Eastern Pennsylvania, primarily Northampton County.and Lehigh counties. The Federal Open Market Committee (FOMC) increased interest rates by 425 basis points during 2022 and another 25 basis points each in February, March, 2022 in the first “tightening” move since December 2018 followed by increases of 50 basis pointsMay and 75 basis points in May 2022 and June 2022, respectively. The FOMC increased interest rates another 75 basis points in July 2022, totaling 225 basis points increase thus far during 2022, and communicated inflation fighting expectations of further increases during the remainder of this year.2023. According to the U.S. Bureau of Labor Statistics, the national unemployment rate for June 20222023 was 3.6%, down 0.3up 0.1 percentage pointspoint from December 2021. However, the2022. The unemployment rates in the Scranton - Wilkes-Barre – Hazleton (market area north) and the Allentown – Bethlehem – Easton (market area south) Metropolitan Statistical Areas (local) increased and have remained at a higher levelslevel than the national unemployment rate. The local unemployment rates at June 30, 20222023 were 5.5% 4.4% in market area north and 4.4% and 4.0% in market area south, respectively, a decrease of 0.1 percentage point and an increaseincrease of 0.20.3 percentage points and 0.1 percentage point from the 5.3%4.5% and 4.3%3.7%, respectively, at December 31, 2021. Stimulus payments2022. The rising rate environment and enhanced unemployment benefits supportedhistorically low inventory has reduced the economy throughout 2020 and 2021 and it is uncertain if the government could continue to provide this support in the future.amount of home purchases below 2022 levels. The median home values in the Scranton-Wilkes-Barre-Hazleton metro and Allentown-Bethlehem-Easton metro increased 19.7%5.3% and 15.6%4.8%, respectively, from a year ago, according to Zillow, an online database advertising firm providing access to its real estate search engines to various media outlets.outlets, and values are expected to grow 6.2% and 6.2% in the next year. In light of these expectations, we are uncertain if real estate values could continue to increase at these levels with the risingcurrent elevated rate environment, however we will continue to monitor the economic climate in our region and scrutinize growth prospects with credit quality as a principal consideration.

On July 1, 2021, the Company completed its previously announced acquisition of Landmark Bancorp, Inc. (“Landmark”) and its wholly-owned bank subsidiary. Non-recurring costs to facilitate the merger and integrate systems of $3.0 million were incurred during 2021.

On May 1, 2020, the Company completed its previously announced acquisition of MNB Corporation (“MNB”) and its wholly-owned bank subsidiary. The merger expanded the Company’s full-service footprint into Northampton County, PA and the Lehigh Valley. Non-recurring costs to facilitate the merger and integrate systems of $2.5 million were incurred during 2020.

 

For the six months ended June 30, 2022,2023, net income was $15.2$12.4 million, or $2.67$2.18 diluted earnings per share, compared to $11.4$15.2 million, or $2.26$2.67 diluted earnings per share, for the six months ended June 30, 2021. Non-recurring merger-related costs and Federal Home Loan Bank (FHLB) prepayment penalties incurred are not a part of the Company’s normal operations. If these expenses had not occurred, adjusted net income (non-GAAP) for the six months ended June 30, 2022 and 2021 would have been $15.2 million and $12.5 million, respectively. Adjusted diluted EPS (non-GAAP) would have been $2.67 and $2.49 for the six months ended June 30, 2022 and 2021, respectively.2022. 

 

As of June 30, 20222023 and December 31, 2021,June 30, 2022, tangible common book value per share (non-GAAP) was $24.99$27.59 and $33.68,$24.99, respectively. The decreaseincrease in tangible book value was due primarily to the declineimprovement in tangible common equity resulting within AOCI from the after tax net unrealized losses on available-for-sale securities. These non-GAAP measures should be reviewed in connection with the reconciliation of these non-GAAP ratios. See “Non-GAAP Financial Measures” located below within this management’s discussion and analysis.

 

Branch managers, relationship bankers, mortgage originators and our business service partners are all focused on developing a mutually profitable full banking relationship.relationship with our clients. We understand our markets, offer products and services along with financial advice that is appropriate for our community, clients and prospects. The Company continues to focus on the trusted financial advisor model by utilizing the team approach of experienced bankers that are fully engaged and dedicated towards maintaining and growing profitable relationships.

 

In addition to the challenging economic environment in which we compete, the regulation and oversight of our business has changed significantly in recent years. As described more fully in Part II, Item 1A, “Risk Factors” below, as well as Part I, Item 1A, “Risk Factors,” and in the “Supervisory and Regulation” section of management’s discussion and analysis of financial condition and results of operations in our 20212022 Annual Report filed on Form 10-K, certain aspects of the Dodd-Frank Wall Street Reform Act (Dodd-Frank Act) continue to have a significant impact on us.

 

3937

 

Non-GAAP Financial Measures

 

The following are non-GAAP financial measures which provide useful insight to the reader of the consolidated financial statements but should be supplemental to GAAP used to prepare the Company’s financial statements and should not be read in isolation or relied upon as a substitute for GAAP measures. In addition, the Company’s non-GAAP measures may not be comparable to non-GAAP measures of other companies. The Company’s tax rate used to calculate the fully-taxable equivalent (FTE) adjustment was 21% at June 30, 20222023 and 2021.2022.

 

The following table reconciles the non-GAAP financial measures of FTE net interest income:

 

 

Three months ended

  

Six months ended

  

Three months ended

 

Six months ended

 

(dollars in thousands)

 

June 30, 2022

 

June 30, 2021

 

June 30, 2022

 

June 30, 2021

  

June 30, 2023

 

June 30, 2022

 

June 30, 2023

 

June 30, 2022

 

Interest income (GAAP)

 $19,065  $14,167  $37,244  $28,507  $22,979  $19,065  $45,317  $37,244 

Adjustment to FTE

 682  487  1,350  903  725  682  1,485  1,350 

Interest income adjusted to FTE (non-GAAP)

 19,747  14,654  38,594  29,410  23,704  19,747  46,802  38,594 

Interest expense (GAAP)

 920  841  1,807  1,731  7,497  920  12,810  1,807 

Net interest income adjusted to FTE (non-GAAP)

 $18,827  $13,813  $36,787  $27,679  $16,207  $18,827  $33,992  $36,787 

 

The efficiency ratio is non-interest expenses as a percentage of FTE net interest income plus non-interest income. The following table reconciles the non-GAAP financial measures of the efficiency ratio to GAAP:

 

 

Three months ended

  

Six months ended

  

Three months ended

 

Six months ended

 

(dollars in thousands)

 

June 30, 2022

 

June 30, 2021

 

June 30, 2022

 

June 30, 2021

  

June 30, 2023

 

June 30, 2022

 

June 30, 2023

 

June 30, 2022

 

Efficiency Ratio (non-GAAP)

                        

Non-interest expenses (GAAP)

 $12,800  $10,851  $25,454  $22,307  $13,425  $12,807  $26,281  $25,472 
          

Net interest income (GAAP)

  18,145  13,326   35,437  26,776   15,482  18,145   32,507  35,437 

Plus: taxable equivalent adjustment

  682  487   1,350  903   725  682   1,485  1,350 

Non-interest income (GAAP)

  4,256  4,577   8,810  10,093   4,535  4,256   9,023  8,810 

Net interest income (FTE) plus non-interest income (non-GAAP)

 $23,083  $18,390  $45,597  $37,772  $20,742  $23,083  $43,015  $45,597 

Efficiency ratio (non-GAAP)

  55.45% 59.01%  55.82% 59.06%  64.72% 55.49%  61.10% 55.86%

  

The following table provides a reconciliation of the tangible common equity (non-GAAP) and the calculationcalculations of tangible book value per share:share and tangible common equity ratio:

 

(dollars in thousands)

 

June 30, 2022

  

June 30, 2021

 

Tangible Book Value per Share (non-GAAP)

        

Total assets (GAAP)

 $2,414,940  $1,949,233 

Less: Intangible assets, primarily goodwill

  (21,360)  (8,613)

Tangible assets

  2,393,580   1,940,620 

Total shareholders' equity (GAAP)

  162,619   172,185 

Less: Intangible assets, primarily goodwill

  (21,360)  (8,613)

Tangible common equity

 $141,259  $163,572 
         

Common shares outstanding, end of period

  5,651,777   4,995,713 

Tangible Common Book Value per Share

 $24.99  $32.74 

40

(dollars in thousands)

 

June 30, 2023

  

June 30, 2022

 

Tangible Book Value per Share (non-GAAP)

        

Total assets (GAAP)

 $2,441,232  $2,414,940 

Less: Intangible assets, primarily goodwill

  (20,981)  (21,360)

Tangible assets

  2,420,251   2,393,580 

Total shareholders' equity (GAAP)

  177,744   162,619 

Less: Intangible assets, primarily goodwill

  (20,981)  (21,360)

Tangible common equity

 $156,763  $141,259 
         

Common shares outstanding, end of period

  5,681,260   5,651,777 

Tangible Common Book Value per Share (non-GAAP)

 $27.59  $24.99 

Tangible Common Equity Ratio (non-GAAP)

  6.48%  5.90%

Unrealized losses on held-to-maturity securities, net of tax

  (24,802)  (17,826)

Adjusted tangible common equity ratio (non-GAAP)

  5.45%  5.16%

 

The following table provides a reconciliation of the Company’s earnings results under GAAPpre-provision net revenue (PPNR) to comparative non-GAAP results excluding merger-related expenses:average assets (non-GAAP):

 

  

Six months ended

 
  

June 30, 2022

  

June 30, 2021

 

(dollars in thousands except per share data)

 

Income before income taxes

  

Provision for income taxes

  

Net income

  

Diluted earnings per share

  

Income before income taxes

  

Provision for income taxes

  

Net income

  

Diluted earnings per share

 

Results of operations (GAAP)

 $17,743  $2,556  $15,187  $2.67  $13,462  $2,099  $11,363  $2.26 

Add: Merger-related expenses

  -   -   -   -   942   52   890   0.17 

Add: FHLB prepayment penalty

  -   -   -   -   369   78   291   0.06 

Adjusted earnings (non-GAAP)

 $17,743  $2,556  $15,187  $2.67  $14,773  $2,229  $12,544  $2.49 
  

Three months ended

  

Six months ended

 

(dollars in thousands)

 

June 30, 2023

  

June 30, 2022

  

June 30, 2023

  

June 30, 2022

 

Pre-Provision Net Revenue to Average Assets

                

Income before taxes (GAAP)

 $5,967  $9,076  $14,219  $17,743 

Plus: Provision for credit losses

  625   518   1,030   1,032 

Total pre-provision net revenue (non-GAAP)

  6,592   9,594   15,249   18,775 

Total (annualized) (non-GAAP)

 $26,441  $38,481  $30,751  $37,861 
                 

Average assets

 $2,407,600  $2,378,584  $2,403,455  $2,398,890 

Pre-Provision Net Revenue to Average Assets (non-GAAP)

  1.10%  1.62%  1.28%  1.58%

 

  

Three months ended

 
  

June 30, 2022

  

June 30, 2021

 

(dollars in thousands except per share data)

 

Income before income taxes

  

Provision for income taxes

  

Net income

  

Diluted earnings per share

  

Income before income taxes

  

Provision for income taxes

  

Net income

  

Diluted earnings per share

 

Results of operations (GAAP)

 $9,076  $1,412  $7,664  $1.35  $6,752  $1,056  $5,696  $1.13 

Add: Merger-related expenses

  -   -   -   -   419   44   375   0.08 

Adjusted earnings (non-GAAP)

 $9,076  $1,412  $7,664  $1.35  $7,171  $1,100  $6,071  $1.21 
38

 

General

 

The Company’s earnings depend primarily on net interest income. Net interest income is the difference between interest income and interest expense. Interest income is generated from yields earned on interest-earning assets, which consist principally of loans and investment securities. Interest expense is incurred from rates paid on interest-bearing liabilities, which consist of deposits and borrowings. Net interest income is determined by the Company’s interest rate spread (the difference between the yields earned on its interest-earning assets and the rates paid on its interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. Interest rate spread is significantly impacted by: changes in interest rates and market yield curves and their related impact on cash flows; the composition and characteristics of interest-earning assets and interest-bearing liabilities; differences in the maturity and re-pricing characteristics of assets compared to the maturity and re-pricing characteristics of the liabilities that fund them and by the competition in the marketplace.

 

The Company’s earnings are also affected by the level of its non-interest income and expenses and by the provisions for loan losses and income taxes. Non-interest income mainly consists of: service charges on the Company’s loan and deposit products; interchange fees; trust and asset management service fees; increases in the cash surrender value of the bank owned life insurance and from net gains or losses from sales of loans and securities. Non-interest expense consists of: compensation and related employee benefit costs; occupancy; equipment; data processing; advertising and marketing; FDIC insurance premiums; professional fees; loan collection; net other real estate owned (ORE) expenses; supplies and other operating overhead.

 

Net interest income, net interest rate margin, net interest rate spread and the efficiency ratio are presented in the MD&A on a fully-taxable equivalent (FTE) basis. The Company believes this presentation to be the preferred industry measurement of net interest income as it provides a relevant comparison between taxable and non-taxable amounts.

 

Comparison of the results of operations

three and six months ended June 30, 20222023 and 20212022

 

Overview

 

For the second quarter of 2022,2023, the Company generated net income of $7.7$5.4 million, or $1.35$0.94 per diluted share, compared to $5.7$7.7 million, or $1.13$1.35 per diluted share, for the second quarter of 2021.2022. The $2.0$2.3 million, increaseor 30%, decrease in net income was primarily the result of $4.8$2.7 million lower net interest income and $0.6 million higher net interest income. This increase wasnon-interest expenses partially offset by $1.9a $0.8 million more non-interest expenses, $0.3 million less in non-interest income and a $0.2 million increasedecrease in the provision for loan losses. Non-interest expenses increased quarter over-quarter primarily due to the increased bank scale following the Landmark merger.income taxes and $0.3 million increase in non-interest income. In the year-to-date comparison, net income increaseddecreased by $3.8$2.8 million to $12.4 million, or $2.18 per diluted share, from $15.2 million, or $2.67 per diluted share, from $11.4 million, or $2.26 per diluted share. The $8.7decline was primarily caused by a reduction of $2.9 million growth in net interest income. An increase of $0.8 million in non-interest expenses was offset by a $0.7 million decrease in the provision for income was enough to offset $3.1taxes and $0.2 million higher non-interest expenses and $1.3 million lower non-interest income year-over-year.

 

Return on average assets (ROA) was 1.29%0.89% and 1.20%1.29% for the second quarters of 20222023 and 2021,2022, respectively, and 1.28%1.04% and 1.24%1.28% for the six months ended June 30, 20222023 and 2021,2022, respectively. During the same time periods, return on average shareholders’ equity (ROE) was 18.16%12.19% and 13.63%18.16%, respectively, and 16.45%14.52% and 13.68%16.45%, respectively. ROA and ROE both increaseddecreased due to the growthdecline in net income relative to the increase in average assets and equity for the quarterquarter-over-quarter and year-to-dateyear-over-year comparisons. ROE decreased primarily due to the net income decreases over the same time periods. Pre-provision net revenue to average assets (non-GAAP) was 1.10% and 1.62% for the three months ended June 30, 2023 and 2022, respectively, and 1.28% and 1.58% for the six months ended June 30, 2023, respectively. The decreases were due to a decline in income before taxes quarter-over-quarter and year-over-year.

 

Net interest income and interest sensitive assets / liabilities

 

For the second quarter of 2022,2023, net interest income increased $4.8decreased $2.7 million, or 36%15%, to $18.1$15.5 million from $13.3$18.2 million for the second quarter of 20212022 due to increasedinterest expense growing faster than interest income. The $4.9$3.9 million growth in interest income was produced by the addition of $472.8$47.4 million in average interest-earning assets supplemented byand the effect of a 2162 basis point increase in FTE yields earned on those assets. The loan portfolio contributed the most to this growth by providing $3.6$4.3 million more in FTE interest income, which absorbed $0.6$0.5 million lower fees earned under the Paycheck Protection Program (PPP), and $0.3 million less from fair value purchase accounting accretion, due to $332.3$142.9 million more in average loans. Interest income on loans also included $0.5 millionand a 69 basis point increase in additional fair value purchase accounting accretion.the FTE yields earned thereon. In the investment portfolio, an increase in the average balances of each type of securities was the biggest driver of interest income growth. The average balance of total securities grew $249.0declined $64.7 million earning nine basis points higher FTE yields which produced $1.5$0.4 million less in additional FTE interest income.  On the liability side, total interest-bearing liabilities grew $339.5$44.5 million, on average, with a four161 basis point decreaseincrease in rates paid thereon. A $329.8 million higher average balance of interest-bearing deposits offset the threeThe 146 basis point decreaseincrease in rates paid on deposits resultingresulted in $0.1$5.7 million more interest expense on deposits for the second quarter of 20222023 compared to the 20212022 like period. The Company also utilized $64.4 million more in average short-term borrowings during the second quarter of 2023 which added $0.8 million in interest expense.

 

Net interest income increased $8.7decreased $2.9 million, or 32%8%, from $26.7 million for the six months ended June 30, 2021 to $35.4 million for the six months ended June 30, 2022 to $32.5 million for the six months ended June 30, 2023, due to $8.7$11.0 million higher interest income whileexpense partially offset by the $8.1 million increase in interest expense remained relatively flat.income.  Total average interest-earning assets increased $551.2$32.6 million and FTE yields earned on these assets rose 67 basis points resulting in $9.2$8.2 million of growth in FTE interest income.  In the loan portfolio, the Company experienced average balance growth of $318.9$142.6 million and an additional 71 basis point in FTE yields which had the effect of producing $5.8$8.7 million more FTE interest income, despite $1.7$1.2 million less in fees earned under the Paycheck Protection Program (PPP) and a 13 basis point reduction in FTE yields during the first half of 2022.  Interest income on loans also included $0.9 million in additional fair value purchase accounting accretion during the first half of 2022.2023. The average balance of the investment portfolio grew $296.3declined $64.3 million supplemented by a five basis point increase in yields which resulted in $3.3$0.6 million in additionallower FTE interest income. On the liability side, total interest-bearing liabilities grew $393.1$28.8 million on average with a six136 basis point decreaseincrease in rates paid on these interest-bearing liabilities.  Growth in average interest-bearing deposits of $384.8 million was partially offset by a sixThe 122 basis point decreaseincrease in the rates paid on interest-bearing deposits increasingresulted in interest expense by less than $0.1growth of $9.5 million. An additional $1.4 million in interest expense was incurred from the utilization of $56.7 million more in average short-term borrowings.

 

4139

 

The FTE net interest rate spread increaseddecreased by 2599 and 469 basis points and margin increaseddecreased by 2452 and 229 basis points, respectively, for the three and six months ended June 30, 20222023 compared to the same 20212022 periods. In the quarter-over-quarter comparison, the spread and margin increaseddecreased due to the higherrise in rates paid on interest-bearing liabilities which increased faster than the yields earned on interest-earning assets combined with the lower rates paid on interest-bearing liabilities.assets. In the year-to-date comparison, the reductionincrease in rates paid on interest-bearing liabilities outpaced the lowerhigher yields on interest-earning assets resulting in the higherlower spread and margin. The overall 17137 and 117 basis pointpoints cost of funds for both the three and six months ended June 30, 2022,2023, which includes the impact of non-interest bearing deposits, decreased threeincreased 120 and four100 basis points compared to the same 20212022 periods. The primary reason for the declineincrease was the reduction inhigher rates paid on deposits coupled with the increased average balances of non-interest bearing deposits compared to the same 2021 periods.2022 periods due to the increases in market interest rates during the period.

 

For the remainder of 2022,2023, the Company expects to operate in a risingis uncertain about the expected interest rate environment. A rate environment with rising interest rates positionsHowever, management is primarily reliant on the Company to improve itsFederal Open Market Committee's statements and forecast.  The Company’s net interest income performance from new and repricing earning assets. For the remainderhas been reduced by assetyields being outpaced by higher cost of 2022, the Company anticipatesfunds compressing net interest spread. The risk to net interest income to improve as growthimprovement is rapid acceleration of deposit rates in interest-earning assets would help mitigate an adverse impact of rate movements on the cost of funds.Company's market area. The FOMC began increasingincreased the federal funds rate by 425 basis points during 2022 and another 25 basis points in each of the first halfmonths of 2022, the first moves since they cut rates during the first quarter of 2020,February, March, May and July 2023, which did not havehad a significantdisproportional effect on rates paid on interest-bearing liabilities.liabilities in 2023. On the asset side, the primePrime interest rate, the benchmark rate that banks use as a base rate for adjustable rate loans was also increased 150425 basis points during the first half of 2022. At the2022 and another 100 basis points through July 2022 meeting, the FOMC increased the federal funds rate another 75 basis points.2023. Consensus economic forecasts are predicting a gradual increases in short-term ratesrate increases throughout the rest of 2022.2023. The 20222023 focus is to manage net interest income and control deposit costs through a rising forecasted short-term rate cycle for primarily overnightby exercising disciplined and proactive loan pricing and managing deposit costs to 12 month rates. Interest income is projectedmaintain a reasonable spread, to increase more than interest expensethe extent possible, in 2022. order to mitigate further margin compression.

Continued growth in the loan portfolios complemented with the achieved investment security growth is expected to boost interest income, and when coupled with a proactive relationship approach to deposit cost setting strategies shouldshould help stopmitigate spread compression and contain the interest rate margin, preventing further reductions below acceptable levels.

 

The Company’s cost of interest-bearing liabilities was 0.23%1.84% and 1.59% for both the three and six months ended June 30, 2022,2023, or four161 and six136 basis points lowerhigher than the cost for the same 20212022 periods. For the month of July 2023, the cost of interest-bearing liabilities was 43 basis points higher than the first half of 2023 at 2.02% which shows the higher costs are expected to continue. The decreaseincrease in interest paid on deposits contributed to the lowerhigher cost of interest-bearing liabilities. Management currently believesliabilities supplemented by the short-term borrowings utilized during the first half of 2023. The FOMC is expected to continue to raisegradually increase the federal funds rate in the immediate future, sobut the Company may continue to experience pressure to further increase rates paid on deposits. To help mitigate the impact of the imminent change to the economic landscape, the Company has successfully developed and will continue to strengthen its association with existing customers, develop new business relationships, generate new loan volumes, and retain and generate higher levels of average non-interest bearing deposit balances. Strategically deploying no-non-interest bearing and low-costrelationship deposits into interest earning-assets is an effective margin-preserving strategy that the Company expects to continue to pursue and expand to help stabilize net interest margin.

 

The Company’s Asset Liability Management (ALM) team meets regularly to discuss among other things, interest rate risk and when deemed necessary adjusts interest rates. ALM is actively addressing the Company's sensitivity to a changing rate environment to ensure interest rate risks are contained within acceptable levels. ALM also discusses revenue enhancing strategies to help combat the potential for a decline in net interest income. The Company’s marketing department, together with ALM, and service-driven branch and relationship managers, continue to develop prudent strategies that will grow the loan portfolio and accumulate low-costrelationship driven deposits at costs lower than borrowing costs to improve net interest income performance.

 

4240

 

The table that follows sets forth a comparison of average balances of assets and liabilities and their related net tax equivalent yields and rates for the periods indicated. Within the table, interest income was FTE adjusted, using the corporate federal tax rate of 21% for June 30, 20222023 and 20212022 to recognize the income from tax-exempt interest-earning assets as if the interest was taxable. See “Non-GAAP Financial Measures” within this management’s discussion and analysis for the FTE adjustments. This treatment allows a uniform comparison among yields on interest-earning assets. Loans include loans held-for-sale (HFS) and non-accrual loans but exclude the allowance for loancredit losses. Home equity lines of credit (HELOC) are included in the residential real estate category since they are secured by real estate. Net deferred loan (cost amortization)/fee accretion of $0.2 million($0.2 million) and $0.8$0.2 million during the second quarters of 20222023 and 2021 ,2022, respectively, and $0.6 million($0.5 million) and $2.1$0.6 million for the six months ended June 30, 20222023 and 2021,2022, respectively, are included in interest income from loans. MNB and Landmark loan fair value purchase accounting adjustments of $1.0$0.7 million and $0.5$1.0 million are included in interest income from loans and $115$10 thousand and $6$115 thousand reduced interest expense on deposits and borrowings for the three months ended June 30, 20222023 and 2021.2022. MNB and Landmark loan fair value purchase accounting adjustments of $1.8$1.6 million and $0.9$1.8 million are included in interest income from loans and $136$21 thousand and $36$136 thousand reduced interest expense on deposits and borrowings for the six months ended June 30, 20222023 and 2021.2022. Average balances are based on amortized cost and do not reflect net unrealized gains or losses. Residual values for direct finance leases are included in the average balances for consumer loans. Net interest margin is calculated by dividing net interest income-FTE by total average interest-earning assets. Cost of funds includes the effect of average non-interest bearing deposits as a funding source:

 

 

Three months ended

  

Three months ended

 

(dollars in thousands)

 

June 30, 2022

 

June 30, 2021

  

June 30, 2023

 

June 30, 2022

 
 

Average

   

Yield /

 

Average

   

Yield /

  

Average

   

Yield /

 

Average

   

Yield /

 

Assets

 

balance

 

Interest

 

rate

 

balance

 

Interest

 

rate

  

balance

 

Interest

 

rate

 

balance

 

Interest

 

rate

 
              

Interest-earning assets

                              

Interest-bearing deposits

 $40,554  $80  0.79

%

 $149,522  $39  0.11

%

 $9,454  $121  5.13% $40,554  $80  0.79

%

Restricted investments in bank stock

 3,538  33  3.78  3,152  36  4.56  3,834  75  7.88  3,538  33  3.78 

Investments:

              

Agency - GSE

 116,625  443  1.52  76,614  257  1.35  111,797  404  1.45  116,625  443  1.52 

MBS - GSE residential

 272,801  1,171  1.72  168,387  597  1.42  241,246  1,071  1.78  272,801  1,171  1.72 

State and municipal (nontaxable)

 258,728  1,951  3.02  185,061  1,434  3.11  230,657  1,666  2.90  258,728  1,951  3.02 

State and municipal (taxable)

 86,230  450  2.09  55,287  255  1.85  85,991  445  2.08  86,230  450  2.09 

Total investments

 734,384  4,015  2.19  485,349  2,543  2.10  669,691  3,586  2.15  734,384  4,015  2.19 

Loans and leases:

              

C&I and CRE (taxable)

 753,969  9,175  4.88  639,756  7,375  4.62  757,786  10,902  5.77  753,969  9,175  4.88 

C&I and CRE (nontaxable)

 70,739  576  3.27  42,504  415  3.92  104,855  1,047  4.01  70,739  576  3.27 

Consumer

 210,034  2,013  3.85  162,333  1,548  3.82  239,985  2,589  4.33  210,034  2,013  3.85 

Residential real estate

 447,886  3,855  3.45  305,693  2,698  3.54  522,883  5,384  4.13  447,886  3,855  3.45 

Total loans and leases

 1,482,628  15,619  4.23  1,150,286  12,036  4.20  1,625,509  19,922  4.92  1,482,628  15,619  4.23 

Total interest-earning assets

 2,261,104  19,747  3.50

%

 1,788,309  14,654  3.29

%

 2,308,488  23,704  4.12% 2,261,104  19,747  3.50

%

Non-interest earning assets

 117,480       112,730       99,112       117,480      

Total assets

 $2,378,584       $1,901,039       $2,407,600       $2,378,584      
              

Liabilities and shareholders' equity

                              
              

Interest-bearing liabilities

                              

Deposits:

              

Interest-bearing checking

 $710,692  $503  0.28

%

 $549,364  $418  0.31

%

 $651,384  $2,424  1.49% $710,692  $503  0.28

%

Savings and clubs

 246,242  26  0.04  200,386  31  0.06  223,298  165  0.30  246,242  26  0.04 

MMDA

 493,481  318  0.26  391,439  251  0.26  517,622  2,978  2.31  493,481  318  0.26 

Certificates of deposit

 128,736  103  0.32  108,158  141  0.52  169,108  1,040  2.47  128,736  103  0.32 

Total interest-bearing deposits

 1,579,151  950  0.24  1,249,347  841  0.27  1,561,412  6,607  1.70  1,579,151  950  0.24 

Secured borrowings

 9,644  (31) (1.29) -  -  -  7,529  118  6.30  9,644  (31) (1.29)

Short-term borrowings

 206  1  1.09  177  -  0.27  64,558  772  4.80  206  1  1.09 

Total interest-bearing liabilities

 1,589,001  920  0.23

%

 1,249,524  841  0.27

%

 1,633,499  7,497  1.84% 1,589,001  920  0.23

%

Non-interest bearing deposits

 593,120       464,818       568,202       593,120      

Non-interest bearing liabilities

 27,164       19,026       29,479       27,164      

Total liabilities

 2,209,285       1,733,368       2,231,180       2,209,285      

Shareholders' equity

 169,299       167,671       176,420       169,299      

Total liabilities and shareholders' equity

 $2,378,584       $1,901,039       $2,407,600       $2,378,584      

Net interest income - FTE

    $18,827       $13,813        $16,207       $18,827    
              

Net interest spread

       3.27

%

      3.02

%

       2.28%      3.27

%

Net interest margin

       3.34

%

      3.10

%

       2.82%      3.34

%

Cost of funds

       0.17

%

      0.20

%

       1.37

%

      0.17

%

 

4341

 

 

Six months ended

  

Six months ended

 

(dollars in thousands)

 

June 30, 2022

 

June 30, 2021

  

June 30, 2023

  

June 30, 2022

 
 

Average

   

Yield /

 

Average

   

Yield /

  

Average

   

Yield /

 

Average

   

Yield /

 

Assets

 

balance

 

Interest

 

rate

 

balance

 

Interest

 

rate

  

balance

  

Interest

  

rate

  

balance

  

Interest

  

rate

 
                          

Interest-earning assets

                                    

Interest-bearing deposits

 $53,620  $113  0.43

%

 $117,929  $60  0.10

%

 $6,669  $152  4.60

%

 $53,620  $113  0.43

%

Restricted investments in bank stock

 3,384  64  3.83  3,023  68  4.56  4,622  181  7.89  3,384  64  3.83 

Investments:

                          

Agency - GSE

 118,630  863  1.47  64,906  438  1.36  112,358  818  1.47  118,630  863  1.47 

MBS - GSE residential

 270,652  2,260  1.68  157,498  1,116  1.43  245,101  2,177  1.79  270,652  2,260  1.68 

State and municipal (nontaxable)

 263,457  3,894  2.98  171,360  2,620  3.08  234,619  3,407  2.93  263,457  3,894  2.98 

State and municipal (taxable)

 89,657  900  2.02  52,367  480  1.85  86,033  891  2.09  89,657  900  2.02 

Total investments

 742,396  7,917  2.15  446,131  4,654  2.10  678,111  7,293  2.17  742,396  7,917  2.15 

Loans and leases:

                          

C&I and CRE (taxable)

 757,641  17,959  4.78  642,660  15,180  4.76  759,483  21,571  5.73  757,641  17,959  4.78 

C&I and CRE (nontaxable)

 68,973  1,091  3.19  42,399  819  3.89  106,760  2,182  4.12  68,973  1,091  3.19 

Consumer

 204,056  3,886  3.84  162,329  3,122  3.88  237,784  5,013  4.25  204,056  3,886  3.84 

Residential real estate

 444,368  7,564  3.43  308,778  5,507  3.60  513,599  10,410  4.09  444,368  7,564  3.43 

Total loans and leases

 1,475,038  30,500  4.17  1,156,166  24,628  4.30  1,617,626  39,176  4.88  1,475,038  30,500  4.17 

Total interest-earning assets

 2,274,438  38,594  3.42% 1,723,249  29,410  3.44

%

 2,307,028  46,802  4.09

%

 2,274,438  38,594  3.42

%

Non-interest earning assets

 124,452       117,246       96,427        124,452       

Total assets

 $2,398,890       $1,840,495       $2,403,455        $2,398,890       
                          

Liabilities and shareholders' equity

                                    
                          

Interest-bearing liabilities

                                    

Deposits:

                          

Interest-bearing checking

 $719,153  $952  0.27% $516,985  $794  0.31

%

 $646,320  $3,745  1.17

%

 $719,153  $952  0.27

%

Savings and clubs

 244,779  52  0.04  193,468  63  0.07  228,666  339  0.30  244,779  52  0.04 

MMDA

 490,357  546  0.22  376,525  517  0.28  530,474  5,529  2.10  490,357  546  0.22 

Certificates of deposit

 131,337  222  0.34  113,892  331  0.59  154,858  1,612  2.10  131,337  222  0.34 

Total interest-bearing deposits

 1,585,626  1,772  0.23  1,200,870  1,705  0.29  1,560,318  11,225  1.45  1,585,626  1,772  0.23 

Secured borrowings

 10,111  34  0.68  -  -  -  7,538  229  6.13  10,111  34  0.68 

Short-term borrowings

 104  1  1.09  161  -  0.38  56,791  1,356  4.82  104  1  1.09 

FHLB advances

 -  -  -  1,685  26  3.12 

Total interest-bearing liabilities

 1,595,841  1,807  0.23

%

 1,202,716  1,731  0.29

%

 1,624,647  12,810  1.59

%

 1,595,841  1,807  0.23

%

Non-interest bearing deposits

 589,760       451,354       577,045       589,760      

Non-interest bearing liabilities

 27,087       18,985       29,565        27,087       

Total liabilities

 2,212,688       1,673,055       2,231,257       2,212,688      

Shareholders' equity

 186,202       167,440       172,198        186,202       
             

Total liabilities and shareholders' equity

 $2,398,890       $1,840,495       $2,403,455        $2,398,890       

Net interest income - FTE

    $36,787       $27,679        $33,992        $36,787    
                          

Net interest spread

       3.19

%

      3.15

%

       2.50

%

       3.19

%

Net interest margin

       3.26

%

      3.24

%

       2.97

%

       3.26

%

Cost of funds

       0.17

%

      0.21

%

       1.17

%

       0.17

%

 

4442

 

Changes in net interest income are a function of both changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities. The following table presents the extent to which changes in interest rates and changes in volumes of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to (1) the changes attributable to changes in volume (changes in volume multiplied by the prior period rate), (2) the changes attributable to changes in interest rates (changes in rates multiplied by prior period volume) and (3) the net change. The combined effect of changes in both volume and rate has been allocated proportionately to the change due to volume and the change due to rate. Tax-exempt income was not converted to a tax-equivalent basis on the rate/volume analysis:

 

 

Six months ended June 30,

  

Six months ended June 30,

 

(dollars in thousands)

 

2022 compared to 2021

 

2021 compared to 2020

  

2023 compared to 2022

 

2022 compared to 2021

 
 

Increase (decrease) due to

  

Increase (decrease) due to

 
 

Volume

 

Rate

 

Total

 

Volume

 

Rate

 

Total

  

Volume

 

Rate

 

Total

 

Volume

 

Rate

 

Total

 

Interest income:

  

Interest-bearing deposits

 $(48) $101  $53  $57  $(47) $10  $(179) $218  $39  $(48) $101  $53 

Restricted investments in bank stock

 8  (12) (4) (7) (11) (18) 30  87  117  8  (12) (4)

Investments:

  

Agency - GSE

 388  37  425  377  (45) 332  (46) 1  (45) 388  37  425 

MBS - GSE residential

 916  228  1,144  209  (698) (489) (222) 139  (83) 916  228  1,144 

State and municipal

 1,345  (43) 1,302  1,790  (402) 1,388  (333) (68) (401) 1,345  (43) 1,302 

Other

 - - - (3) - (3)

Total investments

 2,649  222  2,871  2,373  (1,145) 1,228  (601) 72 (529) 2,649 222 2,871 

Loans and leases:

  

Residential real estate

 2,318  (262) 2,056  899  (573) 326  1,280  1,566  2,846  2,318  (262) 2,056 

C&I and CRE

 3,227  (231) 2,996  5,087  106  5,193  937  3,536  4,473  3,227  (231) 2,996 

Consumer

 795  (30) 765  (92) (101) (193) 684  443  1,127  795  (30) 765 

Total loans and leases

 6,340  (523) 5,817  5,894  (568) 5,326  2,901  5,545  8,446  6,340  (523) 5,817 

Total interest income

 8,949  (212) 8,737  8,317  (1,771) 6,546  2,151 5,922 8,073 8,949 (212) 8,737 
  

Interest expense:

  

Deposits:

  

Interest-bearing checking

 279  (121) 158  392  (298) 94  (106) 2,898  2,792  279  (121) 158 

Savings and clubs

 14  (24) (10) 24  (14) 10  (4) 291  287  14  (24) (10)

Money market

 138  (109) 29  406  (854) (448) 48  4,935  4,983  138  (109) 29 

Certificates of deposit

 45  (155) (110) (108) (554) (662) 47  1,344  1,391  45  (155) (110)

Total deposits

 476  (409) 67  714  (1,720) (1,006) (15) 9,468  9,453  476  (409) 67 

Secured borrowings

 34  -  34  -  -  -  (11) 206  195  34  -  34 

Overnight borrowings

 -  1  1  (136) (59) (195) 1,353 2 1,355 - 1 1 

FHLB advances

 (26) -  (26) (224) 22  (202) - - - (26) - (26)

Total interest expense

 484  (408) 76  354  (1,757) (1,403) 1,327 9,676 11,003 484 (408) 76 

Net interest income

 $8,465  $196  $8,661  $7,963  $(14) $7,949  $824 $(3,754) $(2,930) $8,465 $196 $8,661 

 

Provision for loancredit losses

 

The provision for loancredit losses represents the necessary amount to charge against current earnings, the purpose of which is to increase the allowance for loancredit losses (the allowance) to a level that represents management’s best estimate of known and inherentexpected credit losses in the Company’s loan portfolio. Loans determined to be uncollectible are charged off against the allowance. The required amount of the provision for loancredit losses, based upon the adequate level of the allowance, is subject to the ongoing analysis of the loan portfolio. The Company’s Special Assets Committee meets periodically to review problem loans. The committee is comprised of management, including credit administration officers, loan officers, loan workout officers and collection personnel. The committee reports quarterly to the Credit Administration Committee of the board of directors.

 

Management continuously reviews the risks inherent in the loan portfolio. Specific factors used to evaluate the adequacyThe determination of the loanamounts of the allowance for credit losses and the provision for credit losses is based on management’s current judgments about the credit quality of the Company’s financial assets and known and expected relevant internal and external factors that significantly affect collectability such as historical loss provision during the formal process include:

•         specific loans that could have loss potential;

•         levels ofinformation. current conditions, and trends in delinquenciesreasonable and non-accrual loans;

•         levels of and trends in charge-offs and recoveries;

•         trends in volume and terms of loans;supportable forecasts, including significant qualitative factors.

 

4543

 

•         changesOn January 1, 2023, the Company adopted Accounting Standard Update 2016-13, Financial Instruments - Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments (CECL) and recorded an increase of $0.7 million in risk selectionthe allowance for credit losses on loans and underwriting standards;

•         changesan increase of $1.1 million in lending policies and legal and regulatory requirements;

•         experience, ability and depth of lending management;

•         national and local economic trends and conditions; and

•         changesthe allowance for credit losses on unfunded loan commitments. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in credit concentrations.accordance with previously applicable GAAP.

 

For the three months ended June 30, 2022,2023, the provision for loancredit losses on loans was $0.5$0.7 million due to a $0.2reduction of $33.1 million increase compared to $0.3 million for the same period in 2021.  The increase in the provision compared to the three months ended June 30, 2021, was due to the higher provisioning required for loanbalance of municipal loans which were replaced by $22.9 million in commercial real estate and $12.8 in residential mortgage growth in the secondloan portfolio. The provision for credit losses on unfunded loan commitments decreased due to a reduction in the level of unfunded commitments during the quarter, of 2022 comparedwhich resulted in a $0.1 million credit to the year earlier period.that provision.

 

For the six months ended June 30, 2022,2023, the provision for loancredit losses on loans was $1.1$0.9 million relatively unchanged from the same period in 2021, despite loandue to $65.6 million of growth in 2022.the loan portfolio for the first half of 2023. The provision was $0.4for credit losses on unfunded loan commitments increased by $0.2 million higher in 2021 from a specific reserve which keptdue to six large unfunded commercial loan commitments originated during the provision stable in 2022.year.

 

This amountDue to the Company’s adoption of provisioning reflected what management deemed necessary, given experienced loan growth, to maintainASU 2016-13 on January 1, 2023, comparability of the allowance for loan and lease losses at an adequate level.prior period provision is not considered relevant.

 

The provision for loancredit losses derives from the reserve required from the allowance for loancredit losses calculation. The Company continued provisioning for the three and six months ended June 30, 20222023 to maintain an allowance level that management deemed adequate.

 

For a discussion on the allowance for loancredit losses, see “Allowance for loancredit losses,” located in the comparison of financial condition section of management’s discussion and analysis contained herein.

 

Other income

 

For the second quarter of 2022,2023, non-interest income amounted to $4.3$4.5 million, a decreasean increase of $0.3 million, or 7%, compared to $4.6$4.2 million recorded for the same 20212022 period. The decreaseincrease was due to $0.7$0.3 million in fees from commercial loans with interest rate hedges, $0.2 million higher service charges on deposits, $0.1 million more trust fees and $0.1 million in recoveries from acquired charged-off loans. Partially offsetting these increases were $0.2 million lower gains on loan sales from less mortgage activity during the second quarter of 20222023 compared to the second quarter of 2021.  Service charges on loans were2022. The Company also downhad a $0.2 million quarter-over-quarter duewrite-down from a branch closure with the property moved to lower mortgage and commercial loan service charges. Partially offsetting these decreases was $0.3 million higher deposit service charges and higher wealth management fees (fees from trust fiduciary activities and financial services)held-for-sale during the second quarter of $0.1 million.2023.  

 

Non-interest income totaled $8.8$9.0 million for the six months ended June 30, 2022, a decrease2023, an increase of $1.3$0.2 million, or 13%2%, from the $10.1$8.8 million recorded for the six months ended June 30, 2021.2022.  The decreaseincrease was primarily due to $2.3$0.3 million in recoveries from acquired charged-off loans, $0.3 million higher deposit service charges, $0.2 million in additional commercial loans fees from interest rate hedges, $0.2 million higher trust fiduciary fees, $0.1 million recorded for a death claim on BOLI and $0.1 million more debit card interchange fees. Partially offsetting these increases were $0.8 million lower gains on loan sales and $0.3$0.2 million less loan service charges due to scaled back demand for mortgages.  Partially offsetting these decreases was $0.5 million in additional depositmortgages and less service charges, $0.3 million more in wealth management fees and $0.2 million increase in debit card interchange fees.recorded on commercial loans. 

 

Operating expenses

 

For the quarter ended June 30, 2022,2023, total non-interest expenses were $12.8$13.4 million, an increase of $1.9$0.6 million, or 18%5%, compared to $10.9$12.8 million for the same 20212022 quarter. Non-interestPremises and equipment expenses would have increased $0.4 million, more ifor 19%, primarily due to higher equipment maintenance and rental expenses from investments in new technology. The FDIC assessment expense increased $0.3 million due to the Company had not incurred merger-relatedhigher assessment rate for 2023 that was approved during 2022. Other increases in non-interest expenses duringare as follows: $0.2 million in fraud losses and $0.2 million in professional services. Partially offsetting these increases, salary and employee benefits declined $0.5 million, or 7%, to $6.4 million for the second quarter of 2021.  Salary and employee benefits rose $1.5 million, or 29%, to2023 from $6.9 million for the second quarter of 2022 from $5.4 million for the second quarter of 2021.2022. The increasedecrease was primarily due to higher salaries, incentives and insurance costs from 14 additional full-time equivalent employees. Premises and equipment expenses increased $0.3 million, or 19%, primarily due to property and equipment added from the merger with Landmark. Advertising and marketing expenses were $0.2 million higher due to more advertising costs incurred during the second quarter of 2022.lower employee incentives. 

 

For the six months ended June 30, 2022,2023, non-interest expenses increased $3.1$0.8 million, or 14%3%, compared to the six months ended June 30, 2021,2022, from $22.3$25.5 million to $25.4$26.3 million.  Non-interest expenses would have increased $1.3 million more if the Company had not incurred $0.9 million in merger-related expenses and a $0.3 million FHLB prepayment penalty during the six months ended June 30, 2021.  Salaries and employee benefit expenses grew $3.1 million, or 29%.  The increase was primarily due to less deferred loan origination costs reducing salaries and employee benefits expense from a lower volume of originations from mortgages and PPP loans.  Additionally, salaries and employee benefits were higher from more employees.  Premises and equipment expenses increased $0.6 million, or 18%15%, due primarily to higher expenses for lease payments, depreciationequipment maintenance and otherrentals. Professional service expenses relatedgrew $0.5 million due to premisesadditional consulting, legal and equipment acquired from the merger with Landmark.audit expenses. Fraud losses increased $0.3 million due to more counterfeit checks. Partially offsetting these increases, professional services were $0.2salaries and employee benefit expenses declined $0.7 million, lower for the first six months of 2022 compared to the same 2021 periodor 5%.  The decrease was primarily due to less legal expenses and other non-recurring professional fees incurred during the first quarter of 2021.incentive expense. PA shares tax expense was also $0.3 million lower from declines in shareholders' equity.  

 

The ratios of non-interest expense less non-interest income to average assets, known as the expense ratio, were 1.40%1.45% and 1.34%1.40% for the six months ended June 30, 20222023 and 2021.2022. The expense ratio increased because of increasedhigher non-interest expenses and decreased non-interest income.expenses. The efficiency ratio (non-GAAP) decreasedincreased from 59.06% at June 30, 2021 to 55.82%55.86% at June 30, 2022 to 61.10% at June 30, 2023 due to revenuenon-interest expenses increasing faster than expenses.as net interest income declined. For more information on the calculation of the efficiency ratio, see “Non-GAAP Financial Measures” located within this management’s discussion and analysis.

 

Provision for income taxes

 

The provision for income taxes increased $0.5decreased $0.7 million for the six months ended June 30, 20222023 compared to the same 20212022 period due to higher pre-tax income.tax credits from plug-in hybrid electric vehicles and lower income before taxes. The Company's effective tax rate was 12.8% at June 30, 2023 compared to 14.4% at June 30, 2022 compared to 15.6% at June 30, 2021.2022. The difference between the effective rate and the enacted statutory corporate rate of 21% is due mostly to the effect of tax-exempt income in relation to the level of pre-tax income. The decrease in the effective tax rate was primarily due to higher tax-exempt interest income.lower pre-tax income and the aforementioned tax credits. Due to challenges relating to current market conditions, the Company may not have the ability to make a reliable estimate of all or part of its ordinary income which could cause volatility in the effective tax rate. If the federal corporate tax rate is increased, the Company’s net deferred tax liabilities and deferred tax assets will be re-valued upon adoption of the new tax rate. A federal tax rate increase will decreaseincrease net deferred tax assets with a corresponding decrease to provision for income taxes.

 

4644

 

Comparison of financial condition at

 June 30, 20222023 and December 31, 20212022

 

Overview

 

Consolidated assets decreased $4.2increased $62.9 million to $2.4 billion as of June 30, 2022 relatively unchanged from2023 approximately the same as December 31, 2021.2022. The decreaseincrease in assets occurred primarily in the investmentloan portfolio which was partially offset by loan portfolio growth.a decline in the investment portfolio.  The declinereduction in the investment portfolio was primarily caused by net unrealized losses which were partially offset by the related deferred tax asset which is a componentsale of other assets on the consolidated balance sheets.securities in order to pay down short-term borrowings.  Loan portfolio increases were funded by growth in deposits. As explained in greater detail below, growth in deposits occurred because of various wealth managed trust accounts accepted into a bank pledged money market account.short-term borrowings. 

 

Funds Deployed:

 

Investment securities

 

At the time of purchase, management classifies investment securities into one of three categories: trading, available-for-sale (AFS) or held-to-maturity (HTM). To date, management has not purchased any securities for trading purposes. Some of the securities the Company purchases are classified as AFS even though there is no immediate intent to sell them. The AFS designation affords management the flexibility to sell securities and position the balance sheet in response to capital levels, liquidity needs or changes in market conditions. Debt securities AFS are carried at fair value on the consolidated balance sheets with unrealized gains and losses, net of deferred income taxes, reported separately within shareholders’ equity as a component of accumulated other comprehensive income (AOCI). Securities designated as HTM are carried at amortized cost and represent debt securities that the Company has the ability and intent to hold until maturity. For the six months ended June 30, 2023, AOCI improved by $5.0 million due to the change in fair value of the Company's investment securities.

 

Effective April 1, 2022, the Company transferred agency and municipal bonds with a book value of $245.5 million from AFS to HTM in order to apply the accounting for securities HTM to mitigate the effect AFS accounting has on the balance sheet. The bonds that were transferred had the highest price volatility and consisted of fixed-rate securities representing 70% of the agency portfolio, 70% of the taxable municipal portfolio each laddered out on the short to intermediate part of the yield curve and 35% of the tax-exempt municipal portfolio on the long end of the yield curve were identified as the best candidates given the Company’s ability to hold those bonds to maturity. The market value of the securities on the date of the transfer was $221.7 million, after netting unrealized losses totaling $18.9 million. The $18.9 million, net of deferred taxes, will be accreted againstinto other comprehensive income over the life of the bonds. As of June 30, 2023, the carrying value of held-to-maturity securities was $223.5 million, net of $16.6 million in remaining transferred after-tax unrealized losses.

 

As of June 30, 2022,2023, the carrying value of investment securities amounted to $674.8$604.3 million, or 28%25% of total assets, compared to $739.0$643.6 million, or 31%27% of total assets, as of December 31, 2021.2022. On June 30, 2022, 36%2023, 33% of the carrying value of the investment portfolio was comprised of U.S. Government Sponsored Enterprise residential mortgage-backed securities (MBS – GSE residential or mortgage-backed securities) that amortize and provide monthly cash flow that the Company can use for reinvestment, loan demand, unexpected deposit outflow, facility expansion or operations. The mortgage-backed securities portfolio includes only pass-through bonds issued by Fannie Mae, Freddie Mac and the Government National Mortgage Association (GNMA).

 

The Company’s municipal (obligations of states and political subdivisions) portfolio is comprised of tax-free municipal bonds with a book value of $257.5$238.8 million and taxable municipal bonds with a book value of $86.3$92.2 million. The overall credit ratings of these municipal bonds was as follows: 36%38% AAA, 62%61% AA, 1% A and 1% escrowed.A. For municipal securities HTM, the Company utilized a third-party model to analyze whether a credit loss reserve is needed for these bonds. The amount of the credit loss reserve calculated was immaterial because of the underlying strong credit quality of the municipal portfolio.

 

During the first six months of 2022,2023, the carrying value of total investments decreased $64.2$39.3 million, or 9%6%. Purchases forDuring January 2023 with the 10-year U.S. Treasury yield declining, $31.2 million of securities were able to be sold yielding 3.62% (FTE yield of 4.33%) at a breakeven level. These proceeds were used to pay down FHLB overnight borrowings costing 4.80% at that time. Additionally, principal reductions during the first halfsix months of 20222023 totaled $39.2 million, while principal reductions totaled $23.6 million and$13.4 million. Partially offsetting the declinedecreases, was an improvement in the unrealized gain/loss was $54.0position of $6.3 million in the AFS portfolio and $23.9 million in unrealized losses were transferred to the HTM portfolio. The purchases were funded principally by cash flow generated from the portfolio and excess overnight liquidity. The Company attempts to maintain a well-diversified and proportionate investment portfolio that is structured to complement the strategic direction of the Company. Its growth typically supplements the lending activities but also considers the current and forecasted economic conditions, the Company’s liquidity needs and interest rate risk profile.

 

A comparison of investment securities at June 30, 20222023 and December 31, 20212022 is as follows:

 

 

June 30, 2022

 

December 31, 2021

  

June 30, 2023

 

December 31, 2022

 

(dollars in thousands)

 

Amount

  % 

Book yield

 

Reprice term

 

Amount

  % 

Book yield

 

Reprice term

  

Amount

 

%

 

Book yield

 

Reprice term

 

Amount

 

%

 

Book yield

 

Reprice term

 
 

HTM securities:

                 

Obligations of states & political subdivisions - tax exempt

 $83,453 13.8% 2.1% 21.3 $83,426 13.0% 3.8% 21.8 

Obligations of states & political subdivisions - taxable

 59,188  9.8  2.1  11.8  59,012  9.1  3.1  12.3 

Agency - GSE

 80,838  13.4  1.4  6.9  80,306  12.5  2.6  7.4 

Total HTM securities

 $223,479 37.0% 1.8% 13.6 $222,744 34.6% 3.2% 14.1 

AFS debt securities:

                 

MBS - GSE residential

 $239,766  35.5

%

 1.8

%

 6.4  $257,267  34.8

%

 1.6

%

 5.1  $201,852  33.3

%

 1.8

%

 6.5  $217,435  33.8

%

 1.8

%

 6.4 

Obligations of states & political subdivisions

 321,535  47.7  2.9  14.3  364,710  49.4  2.3  7.5 

Obligations of states & political subdivisions - tax exempt

 129,110 21.4 2.1 11.5 149,131 23.2 2.6 11.4 

Obligations of states & political subdivisions - taxable

 22,877 3.8 1.6 6.1 22,763 3.5 1.6 6.6 

Agency - GSE

 113,532  16.8  2.3  7.0  117,003  15.8  1.4  5.2  26,946 4.5 1.2 4.8 31,533 4.9 1.4 4.6 

Total

 $674,833  100.0

%

 2.4

%

 10.2  $738,980  100.0

%

 1.9

%

 6.3 

Total AFS debt securities

 $380,785 63.0% 1.9% 8.0 $420,862 65.4% 2.0% 8.0 

Total securities

 $604,264  100.0

%

 1.9

%

 10.0  $643,606  100.0

%

 2.4

%

 9.9 

 

The investment securities portfolio contained no private label mortgage-backed securities, collateralized mortgage obligations, collateralized debt obligations, or trust preferred securities, and no off-balance sheet derivatives were in use. The portfolio had no adjustable-rate instruments as of June 30, 20222023 and December 31, 2021.2022. However, management is currently evaluating, with a third-party derivative expert company, an opportunity to utilize fair value hedge portfolio layer method to designate and swap a portion of the fixed rate AFS portfolio. The Company has an approved Derivative Policy that requires Board pre-approval on such balance sheet hedging activates as well as ongoing reporting to its ALCO Committee.

 

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Investment securities were comprised of AFS and HTM securities as of June 30, 20222023 and AFS securities as of December 31, 2021.2022. The AFS securities were recorded with a net unrealized loss of $53.8$61.6 million and a net unrealized gainloss of $0.2$67.9 million as of June 30, 20222023 and December 31, 2021,2022, respectively. Of the $6.3 million net decline in the unrealized gain position of $54.0 million: $26.3improvement; $4.2 million was attributable to municipal securities; $26.8$1.7 million was attributable to mortgage-backed securities and $0.9$0.4 million was attributable to agency securities. During the second quarter of 2022, securities with net unrealized losses totaling $23.9 million were transferred to HTM of which subsequently $0.6and for the six months ended June 30, 2023 $1.1 million was accreted against other comprehensive income. The direction and magnitude of the change in value of the Company’s investment portfolio is attributable to the direction and magnitude of the change in interest rates along the treasury yield curve. Generally, the values of debt securities move in the opposite direction of the changes in interest rates. As interest rates along the treasury yield curve rise, especially at the intermediate and long end, the values of debt securities tend to decline. Whether or not the value of the Company’s investment portfolio will change above or below its amortized cost will be largely dependent on the direction and magnitude of interest rate movements and the duration of the debt securities within the Company’s investment portfolio. Management does not consider the reduction in value attributable to changes in credit quality. Correspondingly, when interest rates decline, the market values of the Company’s debt securities portfolio could be subject to market value increases.

 

As of June 30, 2022,2023, the Company had $367.7had $291.7 million in public deposits, or 17%14% of total deposits. As of June 30, 2023, trust deposits were $96.7 million, or 4% of total deposits. Pennsylvania state law requires the Company to maintain pledged securities on these public and trust deposits or otherwise obtain a FHLB letter of credit or FDIC insurance for these customers. As of June 30, 2022,2023, the balance of pledged securities required for public and trust deposits was $415.0$382.0 million, or 61%63% of total securities.

 

Quarterly, management performs a review of the investment portfolio to determine the causes of declines in the fair value of each security. The Company uses inputs provided by independent third parties to determine the fair value of its investment securities portfolio. Inputs provided by the third parties are reviewed and corroborated by management. Evaluations of the causes of the unrealized losses are performed to determine whether impairment exists and whether the impairment is temporary or other-than-temporary. Considerations such as the Company’s intent and ability to hold the securities until or sell prior to maturity, recoverability of the invested amounts over the intended holding period, the length of time and the severity in pricing decline below cost, the interest rate environment, the receipt of amounts contractually due and whether or not there is an active market for the securities, for example, are applied, along with an analysis of the financial condition of the issuer for management to make a realistic judgment of the probability that the Company will be unable to collect all amounts (principal and interest) due in determining whether a security is other-than-temporarily impaired. If a decline in value is deemed to be other-than-temporary, a contra-asset is recorded for the OTTI on both HTM and AFS securities, limited by the amount that the fair value is less than the amortized cost of the security is reduced by the credit impairment amount and a corresponding charge to current earnings is recognized.basis. During the quarter ended June 30, 2022,2023, the Company did not incur other-than-temporary impairment charges from its investment securities portfolio.

 

Restricted investments in bank stock

 

Investment in Federal Home Loan Bank (FHLB) stock is required for membership in the organization and is carried at cost since there is no market value available. The amount the Company is required to invest is dependent upon the relative size of outstanding borrowings the Company has with the FHLB of Pittsburgh. Excess stock is repurchased from the Company at par if the amount of borrowings decline to a predetermined level. In addition, the Company earns a return or dividend based on the amount invested. Atlantic Community Bankers Bank (ACBB) stock totaled $82 thousand as of June 30, 20222023 and December 31, 2021.2022. The balance in FHLB stock was $3.5$3.6 million and $3.1$5.2 million as of June 30, 20222023 and December 31, 2021,2022, respectively.  The dividends received from the FHLB totaled $66$161 thousand and $70$66 thousand for the six months ended June 30, 20222023 and 2021,2022, respectively.

 

Loans held-for-sale (HFS)

 

Upon origination, most residential mortgages and certain Small Business Administration (SBA) guaranteed loans may be classified as held-for-sale (HFS). In the event of market rate increases, fixed-rate loans and loans not immediately scheduled to re-price would no longer produce yields consistent with the current market. In declining interest rate environments, the Company would be exposed to prepayment risk as rates on fixed-rate loans decrease, and customers look to refinance loans. Consideration is given to the Company’s current liquidity position and projected future liquidity needs. To better manage prepayment and interest rate risk, loans that meet these conditions may be classified as HFS. Occasionally, residential mortgage and/or business loans may be transferred from the loan portfolio to HFS. The carrying value of loans HFS is based on the lower of cost or estimated fair value. If the fair values of these loans decline below their original cost, the difference is written down and charged to current earnings. Subsequent appreciation in the portfolio is credited to current earnings but only to the extent of previous write-downs.

 

As of June 30, 20222023 and December 31, 2021,2022, loans HFS consisted of residential mortgages with carrying amounts of $4.0$1.8 million and $31.7$1.6 million, respectively, which approximated their fair values. During the six months ended June 30, 2022,2023, residential mortgage loans with principal balances of $52.3$23.2 million were sold into the secondary market and the Company recognized net gains of $1.2$0.4 million, compared to $133.6$52.3 million and $3.5$1.2 million, respectively, during the six months ended June 30, 2021.

Management completed $17.1 million in transfers of mortgages HFS to the held-for-investment portfolio during the first half of 2022.

 

The Company retains mortgage servicing rights (MSRs) on loans sold into the secondary market. MSRs are retained so that the Company can foster personal relationships. At June 30, 20222023 and December 31, 2021,2022, the servicing portfolio balance of sold residential mortgage loans was $461.6$469.9 million and $430.9$465.7 million, respectively, with mortgage servicing rights of $1.8$1.5 million and $1.7$1.6 million for the same periods, respectively.

 

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Loans and leases

 

As of June 30, 2022,2023, the Company had gross loans and leases including originated and acquired loans and leases, totaling $1.5over $1.6 billion, an increase of $65.6 million, or 4%, compared to $1.4almost $1.6 billion at December 31, 2021, an increase of $57.5 million, or 4%.2022.

 

GrowthDuring the six months ended June 30, 2023, the growth in the portfolio was primarily attributed toa $19.7 million increase in the $39.9commercial portfolio and a $37.5 million increase in the residential portfolio, including $13 million in mortgage loans originatedthe result of a higher percentage of adjustable rate mortgages recorded as held-for-investment during 2021 as available-for-sale but reclassified to the held-for-investment portfolio during the first quarter 2022.  The Company elected to reclassify the mortgage loans, which meet FNMA underwriting guidelines and are considered high quality, to realize the better yields than those alternately available during the first quarter of 2022.  This growth was supplemented by a $20.0 million increase in the consumer portfolio during the first half of 2022.this period.

 

The composition of the loan portfolio at June 30, 20222023 and December 31, 20212022 is summarized as follows:

 

 

June 30, 2022

 

December 31, 2021

  

June 30, 2023

 

December 31, 2022

 

(dollars in thousands)

 

Amount

  % 

Amount

  % 

Amount

 

%

 

Amount

 

%

 

Commercial and industrial

 $219,439  14.7

%

 $236,304  16.5

%

Commercial and industrial:

 

Commercial

 $135,164  8.3

%

 $141,122  9.0

%

Municipal

 77,018 4.7 72,996 4.7 

Commercial real estate:

  

Non-owner occupied

 317,884  21.3  312,848  21.8  314,838  19.3  318,296  20.3 

Owner occupied

 259,844  17.4  248,755  17.3  294,718  18.1  284,677  18.2 

Construction

 19,515  1.3  21,147  1.5  39,057  2.4  24,005  1.5 

Consumer:

  

Home equity installment

 51,883  3.5  47,571  3.3  58,623  3.6  59,118  3.8 

Home equity line of credit

 55,578  3.7  54,878  3.8  52,501  3.2  52,568  3.4 

Auto

 127,590  8.5  118,029  8.2 

Auto loans - Recourse

 11,924  0.7  12,929  0.8 

Auto loans - Non-recourse

 121,230 7.4 114,909 7.3 

Direct finance leases

 32,254  2.2  26,232  1.8  34,691  2.1  33,223  2.1 

Other

 7,450  0.5  8,013  0.6  13,882  0.9  11,709  0.7 

Residential:

  

Real estate

 364,957  24.5  325,861  22.8  429,816  26.4  398,136  25.5 

Construction

 35,677  2.4  34,919  2.4  48,087  2.9  42,232  2.7 

Gross loans

 1,492,071   100.0

%

 1,434,557   100.0

%

 1,631,549   100.0

%

 1,565,920   100.0

%

Less:

  

Allowance for loan losses

 (16,590)    (15,624)   

Allowance for credit losses

 (18,350)    (17,149)   

Unearned lease revenue

 (1,766)     (1,429)    (1,885)     (1,746)   

Net loans

 $1,473,715     $1,417,504     $1,611,314     $1,547,025    
  

Loans held-for-sale

 $4,011     $31,727     $1,808     $1,637    

 

Commercial & industrial (C&I) and commercial real estate (CRE)

 

As of June 30, 2022,2023, the commercial loan portfolio decreasedincreased by $2.4$19.7 million, or 2%, to $816.7$860.8 million compared to the December 31, 20212022 balance of $819.1$841.1 million due to a $37.4 million reductiontwo owner-occupied commercial real estate loans totaling $19.6 million.

Commercial and industrial loans are generally secured with short-term assets; however, in PPP loans (netmany cases, additional collateral such as real estate is provided as additional security for the loan. Loan-to-value maximum values have been established by the Company and are specific to the type of deferred fees). Excluding the reduction in PPP loans duringcollateral. Collateral values may be determined using invoices, inventory reports, accounts receivable aging reports, collateral appraisals, etc.

For the six months ended June 30, 2022, the2023, commercial portfolio grew $35.0and industrial loans decreased $5.9 million, with the growth stemmingor 4%, from the both the C&I and CRE portfolios.

Excluding PPP loans, C&I loans grew $20.5$141.1 million primarily due to three loans originated during the first half ofat December 31, 2022 to three unrelated borrowers consisting$135.2 million at June 30, 2023, which was the result of one commercial fixed term noteoriginations and two tax-free municipal loans.  Other C&I loan originations in various industries were offset byline advances not keeping pace with scheduled payments and unscheduled paydowns in the portfolio.

CRE loans increased $14.5 million with growth in owner occupied and non-owner occupied CRE offsetting a reduction in construction loan balances. 

line pay-downs/Paycheck Protection Program Loans

The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, was signed into law on March 27, 2020, and provided over $2.0 trillion in emergency economic reliefoffs, as most businesses utilized excess cash balances to individuals and businesses impacted by the COVID-19 pandemic. The CARES Act authorized the Small Business Administration (SBA) to temporarily guarantee loans under a new 7(a) loan program called the Paycheck Protection Program (PPP)repay floating-rate debt.

 

As a qualified SBA lender, the Company was automatically authorized to originate PPPMunicipal loans and during the second and third quarter of 2020, the Company originated 1,551 loans totaling $159 million under the Paycheck Protection Program.

Under the PPP, the entire principal amount of the borrower’s loan, including any accrued interest, is eligible to be reducedare secured by the loan forgiveness amount, so long asfull faith and credit of respective local government units located in the employer maintains or quickly rehires employees and maintains salary levels and 60%Commonwealth of the loan proceeds are used for payroll expenses,Pennsylvania authorized in accordance with the remaining 40%Local Government Unit Debt Act. These loans have a long history of the loan proceeds used for other qualifying expenses.

As part of the Economic Relief Act, which became law on December 27, 2020, an additional $284 billion of federal resources was allocated to a reauthorized and revised PPP. On January 19, 2021, the Company began processing and originating PPP loans for this second round, which subsequently ended on May 31, 2021, and during this round, the Company originated 1,022 loans totaling $77 million.performance within contractual terms with no defaults noted.

 

4947

 

Beginning in the fourth quarter of 2020 and continuing during 2022, the Company submitted PPP forgiveness applications to the SBA, and through June 30, 2022, the Company received forgiveness or paydowns of $234.2 million, or 99%, of the original PPP loan balances of $236.3 million with $31.0 million occurring duringFor the six months ended June 30, 2022.

As a PPP lender,2023, municipal loans increased $4.0 million, or 6%, from $73.0 million at December 31, 2022 to $77.0 million at June 30, 2023, which was attributed to $3.3 million in originations during the Company received fee income of approximately $9.9 million with $9.8 million recognized to date, including $0.7 million recognizedyear, excluding municipal loans originated and paid off during the first quarterhalf of 2023, along with advances on loan commitments.

Commercial real estate loans generally present a higher level of risk than other types of loans due primarily to the effect of general economic conditions and the complexities involved in valuing the underlying collateral whose values tend to move inversely with interest rates. These loans are generally secured with mortgages, or commercial real estate mortgages (CREM) against the subject property. In underwriting commercial real estate construction loans, the Company performs a robust analysis of the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the project using feasibility studies, market data, etc. Appraisals on properties securing commercial real estate loans originated by the Company are performed by independent appraisers consistent with Uniform Standards of Professional Appraisal Practice (USPAP) standards and compliant with Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA).

Non-owner occupied CRE loans are commercial loans not occupied by their owners and thus rely on income from third parties, including multi-family residential tenants and commercial tenants representing various industries. Underwriting on non-owner occupied CRE loans evaluates cash flow derived from the respective tenants and the industries they occupy. As such, management considers non-owner occupied CRE loans as having a higher risk profile than owner occupied CRE loans. In keeping with its risk appetite and relationship management strategy, the Company avoids speculative commercial office space and prefers loans to projects that have sufficient equity, or loan to value, and have either S&P rated tenants with long term leases, loans structured with personal guarantees of owners whose personal financial strength provides meaningful cash flow support to supplement rental income volatility, residential projects with stable rents in desirable locations, or projects with sufficient diversity and industries proven to provide lower risk over the long term.

For the six months ended June 30, 2023, non-owner occupied commercial real estate decreased $3.5 million, or 1%, from $318.3 million at December 31, 2022 to $314.8 million at June 30, 2023, which was attributed to scheduled monthly payments.

Owner occupied commercial real estate loans are occupied by their owners which rely on income generated from the respective owners’ businesses. Therefore, underwriting on owner occupied CRE loans emphasizes the owner’s cash flow and $0.5financial conditions while the real estate typically represents the owners' primary business location. As such, management considers owner occupied CRE loans as having a lower risk profile than non-owner occupied CRE loans.

For the six months ended June 30, 2023, owner occupied commercial real estate increased $10.0 million, or 4%, from $284.7 million at December 31, 2022 to $294.7 million at June 30, 2023, which was attributed to a $10 million CRE loan originated during the second quarterquarter.

Construction lending consists of 2022. Unearned fees attributedcommercial and residential site development loans, as well as commercial building construction and residential housing construction loans. Management prefers lending to PPP loans, net of fees paid to referral sources as prescribed bywell-established developers with a proven track record and strong business and guaranteed with owners’ personal financial conditions.

For the SBA under the PPP, were $0.1 million as ofsix months ended June 30, 2022.

The PPP loans originated by size were as follows as of2023, commercial construction increased $15.1 million, or 63%, from $24.0 million at December 31, 2022 to $39.1 million at June 30, 2022:

(dollars in thousands)

 Balance originated  

Current balance

  

Total SBA fee

  SBA fee recognized 

$150,000 or less

 $76,594  $614  $4,866  $4,820 

Greater than $150,000 but less than $2,000,000

  128,082   1,550   4,765   4,733 

$2,000,000 or higher

  31,656   -   316   316 

Total PPP loans originated

 $236,332  $2,164  $9,947  $9,869 

The table above does not include the $20.32023, which was primarily attributable to $10.8 million in PPPfundings on four large construction loans acquired because of the merger with Landmark during the third quarter of 2021. As of June 30, 2022, the balance of outstanding acquired PPP loans was $0.4 million.and $4.1 million in originations.

 

Consumer

 

The consumer loan portfolio consisted of home equity installment, home equity line of credit, automobile,non-recourse auto loans, recourse auto loans, direct finance leases and other consumer loans.

 

As of June 30, 2022,2023, the consumer loan portfolio increased by $20.0$8.4 million, or 8%3%, to $274.7$292.8 million compared to the December 31, 20212022 balance of $254.7$284.4 million, primarily due to growth in the non-recourse auto loan and lease portfolios.  Auto loans grew $9.6 millionportfolio from continued demand for higher priced automobiles and new dealer relationships. Direct finance leases increased $6.0 million primarily due to higher residual values and more automobile leases added than expired.  Home equity installment loans also grew $4.3 million from the spring home equity campaign.

 

Residential

 

As of June 30, 2022,2023, the residential loan portfolio increased by $39.9$37.5 million, or 11%9%, to $400.6$477.9 million compared to the December 31, 20212022 balance of $360.7$440.4 million. The increase was due in part to a strategic reclassification of $13 million in available-for-sale mortgages booked during 2021 to held-for-investment loans during the first quarter of 2022. The remainder of the increase was due to a shift from mortgage loans sold to loans held-for-investment due to increased jumbo loans, and the pricing of loans in the secondary market and $22.4 million more adjustable rateadjustable-rate mortgages which are not being sold in the secondary market.

 

The residential loan portfolio consisted primarily of held-for-investment residential loans for primary residences.residences, including approximately $363 million in fixed-rate and $67 million in adjustable-rate mortgages as of June 30, 2023. Management expects the sudden historic rise in interest rates to impact demand for residential mortgages throughoutfor the second halfremainder of 2022.2023.

The Company considers its portfolio segmentation, including the real estate secured portfolio, to be normal and reasonably diversified. The banking industry is affected by general economic conditions including, among other things, the effects of real estate values. The Company ensures that its mortgage lending adheres to standards of secondary market compliance. Furthermore, the Company’s credit function strives to mitigate the negative impact of economic conditions by maintaining strict underwriting principles for all loan types.

 

Allowance for loancredit losses

 

Management continually evaluates the credit quality of the Company’s loan portfolio and performs a formal review of the adequacy of the allowance for loancredit losses (allowance)(ACL) on a quarterly basis. The allowance reflects management’s best estimate of the amount of credit losses in the loan portfolio. Management’s judgment is based onWhen estimating the evaluation of individual loans, experience, the assessment of current economic conditions and other relevant factors including the amounts and timing of cash flowsnet amount expected to be received on impaired loans.collected, Management considers the effects of past events, current conditions, and reasonable and supportable forecasts of the collectability of the Company’s financial assets. Those estimates may be susceptible to significant change. The provision for loan losses represents the amount necessary to maintain an appropriate allowance. Loan losses are charged directly against the allowance when loans are deemed to be uncollectible. Recoveries from previously charged-off loans are added to the allowance when received.

 

Management applies two primary components during the loan review process to determine proper allowance levels. The two components are a specific loan loss allocation for loans that are deemed impaired and a general loan loss allocation for those loans not specifically allocated. The methodology to analyze the adequacy of the allowance for loan losses is as follows:

identification of specific impaired loans by loan category;

calculation of specific allowances where required for the impaired loans based on collateral and other objective and quantifiable evidence;

determination of loans with similar credit characteristics within each class of the loan portfolio segment and eliminating the impaired loans;

application of historical loss percentages (trailing twelve-quarter average) to pools to determine the allowance allocation; and

application of qualitative factor adjustment percentages to historical losses for trends or changes in the loan portfolio, regulations, and/or current economic conditions.

5048

 

The methodology to analyze the adequacy of the ACL is based on seven primary components:

Data: The quality of the Company’s data is critically important as a foundation on which the ACL estimate is generated. For its estimate, the Company uses both internal and external data with a preference toward internal data where possible. Data is complete, accurate, and relevant, and subjected to appropriate governance and controls.

Segmentation: Financial assets are segmented based on similar risk characteristics.

Contractual term of financial assets: The contractual term of financial assets is a significant driver of ACL estimates. Financial assets or pools of financial assets with shorter contractual maturities typically result in a lower reserve than those with longer contractual maturities. As the average life of a financial asset or pool of assets increases, there generally is a corresponding increase to the ACL estimate because the likelihood of default is considered over a longer time frame. As such, pool-based assumptions for a pool’s contractual term (i.e., average life) are based on the contractual maturity of the financial assets within the pool and adjusted in accordance with GAAP, if appropriate.

Credit loss measurement method: Multiple measurement methods for estimating ACLs are allowable per ASC Topic 326. The Company applies different estimation methods to different groups of financial assets. The discounted cash flow method is used for the commercial & industrial, commercial real estate non-owner occupied, commercial real estate owner occupied, commercial construction, home equity installment loan, home equity line of credit, residential real estate, and residential construction pools. The weighted average remaining maturity (WARM) method is used for the municipal, non-recourse auto, recourse auto, direct finance lease, and consumer other pools.

Reasonable and supportable forecasts: ASC Topic 326 requires management to consider reasonable and supportable forecasts that affect expected collectability of financial assets. As such, the Company’s forecasts incorporate anticipated changes in the economic environment that may affect credit loss estimates over a time horizon when management can reasonably support and document expectations. Forward-looking information may reflect positive or negative expectations relative to the current environment. As of the reporting date, management is using the median Federal Open Market Committee (FOMC) National Gross Domestic Product (GDP) and unemployment rate forecasts as well as the Federal Housing Finance Agency (FHFA) House Price Index (HPI) for its reasonable and supportable forecasts. The Company currently uses a 12-month (4 quarter) reasonable and supportable forecast period.

Reversion period: ASC Topic 326 does not require management to estimate a reasonable and supportable forecast for the entire contractual life of financial assets. Management may apply reversion techniques for the contractual life remaining after considering the reasonable and supportable forecast period, which allows management to apply a historical loss rate to latter periods of the financial asset’s life. The Company currently uses a 12 month (4 quarter) straight-line reversion period.

Qualitative factor adjustments: The Company’s ACL estimate considers all significant factors relevant to the expected collectability of its financial assets as of the reporting date; Qualitative factors reflect the impact of conditions not captured elsewhere, such as the historical loss data or within the economic forecast. The qualitative considerations can be captured directly within measurement models or as additional components in the overall ACL methodologies. Currently, the Company uses the following qualitative factors:

o

levels of and trends in delinquencies and non-accrual loans;

o

levels of and trends in charge-offs and recoveries;

o

trends in volume and terms of loans;

o

changes in risk selection and underwriting standards;

o

changes in lending policies and legal and regulatory requirements;

o

experience, ability and depth of lending management;

o

national and local economic trends and conditions;

o

changes in credit concentrations; and

o

changes in underlying collateral.

A key element of the methodologycontrol related to determine the allowance is the Company’s credit risk evaluation process, which includes credit risk grading of individual commercial loans. Commercial loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed. The credit risk grades may be changed at any time management determines an upgrade or downgrade may be warranted. The credit risk grades for the commercial loan portfolio are considered in the reserve methodology and loss factors are applied based upon the credit risk grades. The loss factors applied are based upon the Company’s historical experience as well as what management believes to be best practices and within common industry standards. Historical experience reveals there is a direct correlation between the credit risk grades and loan charge-offs. The changes in allocations in the commercial loan portfolio from period-to-period are based upon the credit risk grading system and from periodic reviews of the loan portfolio.

Acquired loans are initially recorded at their acquisition date fair values with no carryover of the existing related allowance for loan losses. Fair values are based on a discounted cash flow methodology that involves assumptions and judgements as to credit risk, expected lifetime losses, environmental factors, collateral values, discount rates, expected payments and expected prepayments. Upon acquisition, in accordance with GAAP, the Company has individually determined whether each acquired loan is within the scope of ASC 310-30. These loans are deemed purchased credit impaired loans and the excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non-accretable discount.

Acquired ASC 310-20 loans, which are loans that did not meet the criteria of ASC 310-30, were pooled into groups of similar loans based on various factors including borrower type, loan purpose, and collateral type. These loans are initially recorded at fair value and include credit and interest rate marks associated with purchase accounting adjustments. Purchase premiums or discounts are subsequently amortized as an adjustment to yield over the estimated contractual lives of the loans. There is no allowance for loan losses established at the acquisition date for acquired performing loans. An allowance for loan losses is recorded for any credit deterioration in these loans after acquisition.

Each quarter, management performs an assessment of the allowance for loan losses. The Company’s Special Assets CommitteeCommittee. This committee meets quarterly, and the applicable lenders discuss each relationship under review and reach a consensus on the appropriate estimated loss amount, if applicable, based on current accounting guidance. The Special Assets Committee’s focus is on ensuring the pertinent facts are considered regarding not only loans considered for specific reserves, but also the collectability of loans that may be past due.due in payment. The assessment process also includes the review of all loans on non-accrual statusa non-accruing basis as well as a review of certain loans to which the lenders or the Company’s Credit Administration function have assigned a criticized or classified risk rating.

 

5149

 

The following tables set forth the activity in the allowance for loancredit losses and certain key ratios for the period indicated:

 

 

As of and for the

 

As of and for the

 

As of and for the

  

As of and for the

 

As of and for the

 

As of and for the

 
 

six months ended

 

twelve months ended

 

six months ended

  

three months ended

 

twelve months ended

 

six months ended

 

(dollars in thousands)

 

June 30, 2022

 

December 31, 2021

 

June 30, 2021

  

June 30, 2023

 

December 31, 2022

 

June 30, 2022

 
  

Balance at beginning of period

 $15,624  $14,202  $14,202  $17,149  $15,624  $15,624 
  

Charge-offs:

  

Commercial and industrial

 (31) (130) (106) (320) (371) (31)

Commercial real estate

 (1) (491) (132) (32) (67) (1)

Consumer

 (136) (206) (82) (245) (377) (136)

Residential

 -  (162) (43) -  -  - 

Total

 (168) (989) (363) (597) (815) (168)
  

Recoveries:

  

Commercial and industrial

 4  23  15  22  11  4 

Commercial real estate

 28  250  235  41  153  28 

Consumer

 50  138  56  126  74  50 

Residential

 2  -  -  10  2  2 

Total

 84  411  306  199  240  84 

Net charge-offs

 (84) (578) (57) (398) (575) (84)

Provision for loan losses

 1,050  2,000  1,100 

Impact of adopting ASC 326

 618 - - 

Initial allowance on loans purchased with credit deterioration

 126 - - 

Provision for credit losses on loans

 855  2,100  1,050 

Balance at end of period

 $16,590  $15,624  $15,245  $18,350  $17,149  $16,590 
  

Allowance for loan losses to total loans

 1.11

%

 1.09

%

 1.35

%

Allowance for credit losses to total loans

 1.13

%

 1.10

%

 1.11

%

Net charge-offs to average total loans outstanding

 0.01

%

 0.04

%

 0.01

%

 0.05

%

 0.04

%

 0.01

%

Average total loans

 $1,475,038  $1,299,960  $1,156,166  $1,617,626  $1,500,796  $1,475,038 

Loans 30 - 89 days past due and accruing

 $1,168  $1,982  $5,072  $1,148  $1,838  $1,168 

Loans 90 days or more past due and accruing

 $49  $64  $24  $47  $33  $49 

Non-accrual loans

 $3,206  $2,949  $3,171  $3,493  $2,535  $3,206 

Allowance for loan losses to non-accrual loans

 5.17

x

 5.30

x

 4.81

x

Allowance for loan losses to non-performing loans

 5.10

x

 5.19

x

 4.77

x

Allowance for credit losses to non-accrual loans

 5.25

x

 6.76

x

 5.17

x

Allowance for credit losses to non-performing loans

 5.18

x

 6.68

x

 5.10

x

For the six months ended June 30, 2023, the allowance increased $1.2 million, or 7%, to $18.3 million from $17.1 million at December 31, 2022. The increase in the allowance was based on a $0.7 million adjustment related to the adoption of CECL on January 1, 2023 including a $0.1 million initial allowance on Purchase Credit Deteriorated (PCD) loans related to the reclassification of Purchase Credit Impaired (PCI) loans to PCD along with provisioning of $0.9 million partially offset by net charge-offs of $0.4 million.

 

The allowance increased $1.0 million, or 6%, to $16.6 million at June 30, 2022 from $15.6 million at December 31, 2021 due to provisioning of $1.1 million partially offset by $0.1 million in net charge-offs. The allowance for loan and leasecredit losses increased as a percentage of total loans at 1.11%increased to 1.13% as of June 30, 20222023 compared to 1.09% as of1.10% at December 31, 2021 because2022 as the growthincrease in the allowance (6%(7%) outpaced the growth in the total loansloan portfolio (4%) through June 30, 2022.

Loans acquired from the Merchants and Landmark mergers (performing and non-performing) were initially recorded at their acquisition-date fair values. Since there is no initial credit valuation allowance recorded under this method, the Company established a post-acquisition allowance for loan losses to record losses which may subsequently arise on the acquired loans.

PPP loans made to eligible borrowers have a 100% SBA guarantee. Given this guarantee, no allowance for loan and lease losses was recorded for these loans..

 

Management believes that the current balance in the allowance for loancredit losses is sufficient to meet the identified potential credit quality issues that may arise and other issues unidentified but inherent to the portfolio. Potential problem loans are those where there is known information that leads management to believe repayment of principal and/or interest is in jeopardy and the loans are currently neither on non-accrual status nor past due 90 days or more.

 

DuringAlthough key loss driver assumptions used in the first quarter of 2022, management increasedACL estimate remained largely stable from the qualitative factors associated with its commercial, consumer, and residential portfolios relatedday one estimate to the riseestimate as of June 30, 2023, the ACL estimate increased based on growth in the loan and lease portfolio and changes in the composition of the portfolio. Key loss driver assumptions included the median Federal Open Market Committee (FOMC) National Gross Domestic Product (GDP) and unemployment rate forecasts, the Federal Housing Finance Agency (FHFA) House Price Index (HPI), prepayment and curtailment rates, that occurred during the quarter, and the adverse impact that these increased rates are anticipated to have on estimated credit losses.remaining loan lives.

 

During the second quarter of 2022, management increased the qualitative factors associated with its commercial, consumer, and residential portfolios related to the rise in rates that occurred during the quarter, and the adverse impact that these increased rates are anticipated to have on estimated credit losses. These increases were partially offset by a reduction in the qualitativeQualitative factors for the owner occupied CRE and residential RE portfolios relatedACL estimate as of June 30, 2023 increased slightly compared to the historically lowday one estimate based on higher delinquency observed in these portfolios.  the HELOC portfolio and an increased weighted average risk rating in the commercial real estate portfolio.

 

5250

 

The allocation of net charge-offs among major categories of loans are as follows for the periods indicated:

 

(dollars in thousands)

 For the six months ended June 30, 2022 % of Total Net Charge-offs For the six months ended June 30, 2021 % of Total Net Charge-offs  For the six months ended June 30, 2023 % of Total Net Charge-offs For the six months ended June 30, 2022 % of Total Net Charge-offs 

Net charge-offs

                  

Commercial and industrial

 $(27) 32

%

 $(91) 160

%

 $(298) 75

%

 $(27) 32

%

Commercial real estate

 27  (32) 103  (181) 9  (2) 27  (32)

Consumer

 (86) 102  (26) 46  (119) 30  (86) 102 

Residential

 2  (2) (43) 75  10  (3) 2  (2)

Total net charge-offs

 $(84) 100

%

 $(57) 100

%

 $(398) 100

%

 $(84) 100

%

 

For the six months ended June 30, 2022,2023, net charge-offs against the allowance totaled $84$398 thousand compared with net charge-offs of $57$84 thousand for the six months ended June 30, 2021,2022, representing a $27$314 thousand or 47%, increase.increase due to an increase in commercial & industrial net charge-offs, which was driven by a $300 thousand charge-off to a single borrower. Net charge offs were stablecharge-offs increased as a percentage of the total loan portfolio at 0.05% for the six months ended June 30, 2023 compared to 0.01% for the six (6) months ended June 30, 2022 compared with the six (6) months ended June 30, 2021.2023.

 

For a discussion on the provision for loancredit losses, see the “Provision for loancredit losses,” located in the results of operations section of management’s discussion and analysis contained herein.

 

The allowance for loancredit losses can generally absorb losses throughout the loan portfolio. However, in some instances an allocation is made for specific loans or groups of loans. Allocation of the allowance for loancredit losses for different categories of loans is based on the methodology used by the Company, as previously explained. The changes in the allocations from period-to-period are based upon quarter-end reviews of the loan portfolio.

 

Allocation of the allowance among major categories of loans for the periods indicated, as well as the percentage of loans in each category to total loans, is summarized in the following table. This table should not be interpreted as an indication that charge-offs in future periods will occur in these amounts or proportions, or that the allocation indicates future charge-off trends. When present, the portion of the allowance designated as unallocated is within the Company’s guidelines:

 

 

June 30, 2022

 

December 31, 2021

 

June 30, 2021

  

June 30, 2023

 

December 31, 2022

 

June 30, 2022

 
    

Category

   

Category

   

Category

     

Category

   

Category

   

Category

 
    

% of

   

% of

   

% of

     

% of

   

% of

   

% of

 

(dollars in thousands)

 

Allowance

 

Loans

 

Allowance

 

Loans

 

Allowance

 

Loans

  

Allowance

 

Loans

 

Allowance

 

Loans

 

Allowance

 

Loans

 

Category

                          

Commercial real estate

 $6,963  40

%

 $7,422  41

%

 $7,228  36

%

 $8,578  40

%

 $7,162  39

%

 $6,963  40

%

Commercial and industrial

 2,745  15  2,204  16  2,324  22  2,361  13  2,924  15  2,745  15 

Consumer

 2,770  18  2,404  18  2,497  19  2,514  18  2,827  18  2,770  18 

Residential real estate

 4,037  27  3,508  25  3,070  23  4,847  29  4,169  28  4,037  27 

Unallocated

 75  -  86  -  126  -  50  -  67  -  75  - 

Total

 $16,590  100

%

 $15,624  100

%

 $15,245  100

%

 $18,350  100

%

 $17,149  100

%

 $16,590  100

%

 

As of June 30, 2022,2023, the commercial loan portfolio, consisting of CRE and C&I loans, comprised 59%60% of the total allowance for loancredit losses compared with 62%59% on December 31, 2021.2022. The commercial loan allowance allocation declined but remained higher thanincreased based on the commercial loan allocation (55%), dueadoption of CECL and changes in how reserves are estimated compared to the payoff of commercial real estate loans to a single borrower with a large specific impairment during the first quarter of 2022.previous incurred loss methodology.

 

As of June 30, 2022,2023, the consumer loan portfolio comprised 17%14% of the total allowance for loancredit losses compared with 15%17% on December 31, 2021. The two percentage point increase2022 due to the relative growth in the consumer portfolio. The consumer loan allowance allocation wasdecreased based on the resultadoption of growthCECL and changes in how reserves are estimated compared to the consumer portfolio during the first half of the year.previous incurred loss methodology.

 

As of June 30, 2022,2023, the residential loan portfolio comprised 24%26% of the total allowance for loancredit losses compared with 22%24% on December 31, 2021.2022. The two percentage point increase wasresidential loan allowance allocation increased based on the resultadoption of CECL and changes in how reserves are estimated compared to the relative increase in this loan category, which increased to 27% as of June 30, 2022 from 25% at December 31, 2021.previous incurred loss methodology.

 

As of June 30, 2022,2023, the unallocated reserve, representing the portion of the allowance not specifically identified with a loan or groups of loans, was less than 1% of the total allowance for loancredit losses, unchanged from December 31, 2021.2022.

 

Non-performing assets

 

The Company defines non-performing assets as accruing loans past due 90 days or more, non-accrual loans, troubled debt restructurings (TDRs), other real estate owned (ORE) and repossessed assets. Based on the Company’s adoption of ASU 2022-02, Financial Instruments-Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures, the recognition and measurement guidance related to troubled debt restructurings (TDR) has been eliminated. As such, TDRs were removed from non-performing assets at June 30, 2023, December 31, 2022, and June 30, 2022 in the following table to adhere to this standard and provide better comparability.

 

5351

 

The following table sets forth non-performing assets data as of the period indicated:

 

(dollars in thousands)

 

June 30, 2022

  

December 31, 2021

  

June 30, 2021

 
             

Loans past due 90 days or more and accruing

 $49  $64  $24 

Non-accrual loans *

  3,206   2,949   3,171 

Total non-performing loans

  3,255   3,013   3,195 

Troubled debt restructurings

  1,358   2,987   2,484 

Other real estate owned and repossessed assets

  128   434   365 

Total non-performing assets

 $4,741  $6,434  $6,044 
             

Total loans, including loans held-for-sale

 $1,494,316  $1,464,855  $1,134,157 

Total assets

 $2,414,940  $2,419,104  $1,949,233 

Non-accrual loans to total loans

  0.21%  0.20%  0.28%

Non-performing loans to total loans

  0.22%  0.21%  0.28%

Non-performing assets to total assets

  0.20%  0.27%  0.31%

* In the table above, the amount includes non-accrual TDRs of $0.4 million as of June 30, 2022, $0.6 million as of December 31, 2021 and $0.7 million as of June 30, 2021.

(dollars in thousands)

 

June 30, 2023

  

December 31, 2022

  

June 30, 2022

 
             

Loans past due 90 days or more and accruing

 $47  $33  $49 

Non-accrual loans

  3,493   2,535   3,206 

Total non-performing loans

  3,540   2,568   3,255 

Other real estate owned and repossessed assets

  87   168   128 

Total non-performing assets

 $3,627  $2,736  $3,383 
             

Total loans, including loans held-for-sale

 $1,631,472  $1,565,811  $1,494,316 

Total assets

 $2,441,232  $2,378,372  $2,414,940 

Non-accrual loans to total loans

  0.21%  0.16%  0.21%

Non-performing loans to total loans

  0.22%  0.16%  0.22%

Non-performing assets to total assets

  0.15%  0.12%  0.14%

 

Management routinely reviewscontinually monitors the loan portfolio to identify loans that are either delinquent or are otherwise deemed by management unable to repay in accordance with contractual terms. Generally, loans of all types are placed on non-accrual status if a loan of any type is past due 90 or more days or if collection of principal and interest is in doubt. Further, unsecured consumer loans are charged-off when the principal and/or interest is 90 days or more past due. Uncollected interest income accrued on all loans placed on non-accrual is reversed and charged to interest income.

 

Non-performing assets represented 0.20%0.15% of total assets at June 30, 20222023 compared with 0.27%0.12% at December 31, 2021.2022. The improvementincrease resulted from a $1.7$0.9 million, or 26%33%, increase in non-performing assets which outpaced the growth in total assets (3%) during this period. Non-performing assets increased due to recognition of $1.5 million in Purchase Credit Deteriorated (PCD) loans, now classified as non-accrual loans, consistent with the changes in financial reporting under ASC Topic 326 (CECL). This was partially offset by a $0.5 million decrease in non-performing assets. Non-performing assets decreased due tonon-PCD non-accrual loans as well as a $1.6$0.1 million reduction in accruing troubled debt restructurings and a $0.3 million reductiondecrease in other real estate owned and repossessed assets partially offset by the $0.2 million increase in non-accrual loans.

From December 31, 2021 to June 30, 2022, non-accrual loans increased $0.3 million, or 9%, from $2.9 million to $3.2 million. The $0.3 million increase in non-accrual loans was primarily the result of $1.6 million in additions partially offset by $0.8 million in payments, $0.4 million in moves to ORE, and $0.1 million in moves to accrual.owned.

 

At June 30, 2022,2023, there were a total of 40 loans to 30 unrelated borrowers with balances that ranged from less than $1 thousand to $0.8 million. At December 31, 2021, there were a total of 3133 non-accrual loans to 28 unrelated borrowers with balances that ranged from less than $1 thousand to $0.7 million.$1.3 million, or $3.5 million in the aggregate. At December 31, 2022, there were a total of 39 non-accrual loans to 29 unrelated borrowers with balances that ranged from less than $1 thousand to $0.6 million, or $2.5 million in the aggregate.

 

There were two full recourse auto loansdirect finance leases totaling $49$47 thousand that werewas over 90 days past due as of June 30, 20222023 compared to twoone direct finance leaseslease and one non-recourse auto loan totaling $64$33 thousand that were over 90 days past due as of December 31, 2021. The delinquent auto2022. All loans are fully guaranteed under a formal recourse agreement withwere well secured and in the originating auto dealer and were in process of orderly collection.

 

The Company seeks payments from all past due customers through an aggressive customer communication process. Unless well-secured and in the process of collection, past due loans will be placed on non-accrual at the 90-day point when it is deemed that a customer is non-responsive and uncooperative to collection efforts.

 

5452

 

The composition of non-performing loans as of June 30, 20222023 is as follows:

 

   

Past due

          

Past due

       
 

Gross

 

90 days or

 

Non-

 

Total non-

 

% of

  

Gross

 

90 days or

 

Non-

 

Total non-

 

% of

 
 

loan

 

more and

 

accrual

 

performing

 

gross

  

loan

 

more and

 

accrual

 

performing

 

gross

 

(dollars in thousands)

 

balances

 

still accruing

 

loans

 

loans

 

loans

  

balances

 

still accruing

 

loans

 

loans

 

loans

 

Commercial and industrial

 $219,439  $-  $791  $791  0.36%

Commercial and industrial:

 

Commercial

 $135,164  $-  $636  $636  0.47%

Municipal

 77,018 - -     

Commercial real estate:

  

Non-owner occupied

 317,884  -  717  717  0.23% 314,838  -  168  168  0.05%

Owner occupied

 259,844  -  1,285  1,285  0.49% 294,718  -  2,137  2,137  0.73%

Construction

 19,515  -  -  -  -  39,057  -  -  -  - 

Consumer:

  

Home equity installment

 51,883  -  -  -  -  58,623  -  102  102  0.17%

Home equity line of credit

 55,578  -  167  167  0.30% 52,501  -  90  90  0.17%

Auto loans

 127,590  49  204  253  0.20%

Auto loans-Recourse

 11,924  -  9  9  0.08%

Auto loans-Non Recourse

 121,230 - 84 84 0.07%

Direct finance leases *

 30,488  -  -  -  -  32,806  47  -  47  0.14%

Other

 7,450  -  -  -  -  13,882  -  1  1  0.01%

Residential:

  

Real estate

 364,957  -  42  42  0.01% 429,816  -  266  266  0.06%

Construction

 35,677  -  -  -  -  48,087  -  -  -  - 

Loans held-for-sale

 4,011  -  -  -  -  1,808  -  -  -  - 

Total

 $1,494,316  $49  $3,206  $3,255  0.22% $1,631,472  $47  $3,493  $3,540  0.22%

 

*Net of unearned lease revenue of $1.8$1.9 million.

 

Payments received from non-accrual loans are recognized on a cost recovery method. Payments are first applied to the outstanding principal balance, then to the recovery of any charged-off loan amounts. Any excess is treated as a recovery of interest income. If the non-accrual loans that were outstanding as of June 30, 20222023 had been performing in accordance with their original terms, the Company would have recognized interest income with respect to such loans of $92$195 thousand.

The following tables set forth the activity in TDRs for the periods indicated:

As of and for the six months ended June 30, 2022

         
  

Accruing

  

Non-accruing

     
  

Commercial

  

Commercial

  

Commercial

     

(dollars in thousands)

 

real estate

  

real estate

  

& industrial

  

Total

 

Troubled Debt Restructures:

                

Beginning balance

 $2,987  $419  $135  $3,541 

Additions

  -   -   -   - 

Pay downs / payoffs

  (1,629)  (61)  (135)  (1,825)

Charge offs

  -   -   -   - 

Ending balance

 $1,358  $358  $-  $1,716 

Number of loans

  6   1  ��-   7 

As of and for the year ended December 31, 2021

             
  

Accruing

  

Non-accruing

     
  

Commercial

  

Commercial

  

Commercial

     

(dollars in thousands)

 

real estate

  

real estate

  

& industrial

  

Total

 

Troubled Debt Restructures:

                

Beginning balance

 $2,571  $456  $206  $3,233 

Additions

  519   -   -   519 

Pay downs / payoffs

  (103)  (37)  (6)  (146)

Charge offs

  -   -   (65)  (65)

Ending balance

 $2,987  $419  $135  $3,541 

Number of loans

  8   1   2   11 

55

The Company, on a regular basis, reviews changes to loans to determine if they meet the definition of a TDR. TDRs arise when a borrower experiences financial difficulty and the Company grants a concession that it would not otherwise grant based on current underwriting standards to maximize the Company’s recovery.

From December 31, 2021 to June 30, 2022, TDRs declined $1.8 million, or 52%, primarily due to payoff of two commercial real estate TDRs to a single borrower totaling $1.6 million and the payoff of two C&I TDRs to a single borrower totaling $0.1 million. At December 31, 2021, there were a total of 11 TDRs by 8 unrelated borrowers with balances that ranged from $50 thousand to $1.3 million, and at June 30, 2022, there were a total of 7 TDRs by 6 unrelated borrowers with balances that ranged from $89 thousand to $0.5 million.

Loans modified in a TDR may or may not be placed on non-accrual status. At June 30, 2022, there was one TDR totaling $0.4 million that was on non-accrual status compared to three TDRs totaling $0.6 million at December 31, 2021.

 

Foreclosedassets held-for-sale

 

From December 31, 20212022 to June 30, 2022,2023, foreclosed assets held-for-sale (ORE) declined from $434$168 thousand to $128$87 thousand, a $306$81 thousand decrease, which was primarily attributed to twoone ORE properties totaling $283 thousand that were soldproperty being transferred to non-accrual due to administrative error during the first quarter. One property totaling $437$86 thousand was also added to ORE and sold during the first quarter.2023.

 

The following table sets forth the activity in the ORE component of foreclosed assets held-for-sale:

 

 

June 30, 2022

 

December 31, 2021

  

June 30, 2023

 

December 31, 2022

 

(dollars in thousands)

 

Amount

 

#

 

Amount

 

#

  

Amount

 

#

 

Amount

 

#

 
  

Balance at beginning of period

 $434  5  $256  6  $168  2  $434  5 
  

Additions

 437  1  969  7  86  1  762  3 

Pay downs

 (6)    -     -     (6)   

Write downs

 (17)    (16)    -     (17)   

Transfers

 (167) (1) -   

Sold

 (720) (3) (775) (8) -  -  (1,005) (6)

Balance at end of period

 $128  3  $434  5  $87  2  $168  2 

 

As of June 30, 2022,2023, ORE consisted of threetwo properties securing loans to threetwo unrelated borrowers totaling $128$87 thousand. Two propertiesOne property ($12786 thousand) to two unrelated borrowers werewas added in 20212023 and one property ($1 thousand) was added in 2017. Of the three properties, one property is under agreement of sale and twoBoth properties are listed for sale.

 

As of June 30, 20222023 and December 31, 2021,2022, the Company had no other repossessed assets held-for-sale.

 

Cash surrender value of bank owned life insurance

 

The Company maintains bank owned life insurance (BOLI) for a chosen group of employees at the time of purchase, namely its officers, where the Company is the owner and sole beneficiary of the policies. BOLI is classified as a non-interest earning asset. Increases in the cash surrender value are recorded as components of non-interest income. The BOLI is profitable from the appreciation of the cash surrender values of the pool of insurance and its tax-free advantage to the Company. This profitability is used to offset a portion of current and future employee benefit costs. As a result of the Landmark acquisition, the Company acquired $7.2 million in BOLI during the third quarter of 2021. The BOLI cash surrender value build-up can be liquidated if necessary, with associated tax costs. However, the Company intends to hold this pool of insurance, because it provides income that supports employee benefit cost increases which enhances the Company’s capital position. Therefore, the Company has not provided for deferred income taxes on the earnings from the increase in cash surrender value.  The Company received a death benefit claim on two owned policies and received $0.8 million in return of cash surrender value and $0.1 million in other income during the first quarter of 2023.

 

Premises and equipment

 

Net of depreciation, premises and equipment increased $1.5 millionwas relatively unchanged during the first six monthshalf of 2022.2023. The Company purchased $0.3$0.7 million in fixed assets and added $3.6$1.9 million in construction in process during the first half of 2022. The increase in construction in process was primarily due to the purchase of the Scranton Electric Building for a new headquarters in Scranton, PA.2023. These increases were partially offset by $1.1$1.2 million in depreciation expenseexpense. The Company closed the Hazle Township branch on March 31, 2023 and $1.2listed it for sale during the second quarter of 2023 resulting in a transfer of $0.7 million in transfersfrom premises and equipment to other assets held-for-sale. The Company expectsis planning to beginopen a new branch in Wilkes-Barre in 2023. The Company has recently begun remodeling the Main Branch located in Dunmore, PA and estimated costs for the project are currently $3.9 million. The Company began corporate headquarters planningheadquarters construction which may continue to increase construction in process and is evaluating its branch network looking for consolidation that makes sense for more efficient operations.

 

On December 23, 2020, the Commonwealth of Pennsylvania authorized the release of $2.0 million in Redevelopment Assistance Capital Program (RACP) funding for the Company’s headquarters project in Lackawanna County. On December 2, 2021, the Company announced it would be receiving an additional $2.0 million in RACP funding in support of the project. The $4.0 million in total RACP grant funds will be allocated to the renovation and rehabilitation of the historic building located in downtown Scranton which will be used for the new corporate headquarters. The Company currently expectsestimates net remaining costs for the corporate headquarters could range from $15 million to be $15.8 million$20 million. This range estimate may expand because it is subject to supply chain issues, commodities pricing and results of final planning over approximately two years beginning during the fourth quarter of 2022.through early 2025. In addition, the Company intends to pursuecurrently is in the process of pursuing a federal historic preservation tax credit which if it qualifies, would provide a 20% tax credit on qualified improvements on the historic property.

 

5653

 

The Company is planning to open a new branch and administrative office for Luzerne County in Wilkes-Barre in October and is currently renovating the new location for the Bethlehem branch.  The Company also plans to remodel the Main Branch located in Dunmore, PA which is expected to begin in August 2022 and estimated costs for the project are currently $3 million.

Other assets

 

During the first six monthshalf of 2022,2023, the $17.1$0.4 million increasedecrease in other assets was due mostly to a $16.2$1.1 million increasedecrease in deferred tax assets primarily from lower net unrealized losses in the investment portfolio partially offset by a $0.6 million increase in other assets held-for-sale and $0.5 million increase in prepaid dealer reserve.held-for-sale.

 

Funds Provided:

 

Deposits

 

The Company is a community based commercial depository financial institution, member FDIC, which offers a variety of deposit products with varying ranges of interest rates and terms. Generally, deposits are obtained from consumers, businesses and public entities within the communities that surround the Company’s 2220 branch offices and all deposits are insured by the FDIC up to the full extent permitted by law. Deposit products consist of transaction accounts including: savings; clubs; interest-bearing checking; money market and non-interest bearing checking (DDA). The Company also offers short- and long-term time deposits or certificates of deposit (CDs). CDs are deposits with stated maturities which can range from seven days to ten years. Cash flow from deposits is influenced by economic conditions, changes in the interest rate environment, pricing and competition. To determine interest rates on its deposit products, the Company considers local competition, spreads to earning-asset yields, liquidity position and rates charged for alternative sources of funding such as short-term borrowings and FHLB advances.

 

The following table represents the components of deposits as of the date indicated:

 

 

June 30, 2022

 

December 31, 2021

  

June 30, 2023

 

December 31, 2022

 

(dollars in thousands)

 

Amount

 

%

 

Amount

 

%

  

Amount

 

%

 

Amount

 

%

 
  

Interest-bearing checking

 $688,275  31.0

%

 $730,595  33.7

%

 $646,304  30.0

%

 $664,439  30.7

%

Savings and clubs

 245,297  11.1  234,747  10.8  218,903  10.2  238,174  11.0 

Money market

 547,957  24.7  475,447  21.9  523,840  24.3  544,468  25.1 

Certificates of deposit

 125,108  5.6  138,793  6.4  180,472  8.4  117,224  5.4 

Total interest-bearing

 1,606,637  72.4  1,579,582  72.8  1,569,519  72.9  1,564,305  72.2 

Non-interest bearing

 610,987  27.6  590,283  27.2  582,473  27.1  602,608  27.8 

Total deposits

 $2,217,624  100.0

%

 $2,169,865  100.0

%

 $2,151,992  100.0

%

 $2,166,913  100.0

%

 

Total deposits increased $47.8decreased $14.9 million, or 2%1%, remaining at approximatelyto $2.2 billion at June 30, 2022 and2023 from $2.2 billion at December 31, 2021.2022. During the second quarterfirst half of 2022, the Company accepted $522023, one relationship transferred approximately $35 million from various wealth managed trust accounts into a bank pledged money market account which increased total deposits.accounts to interest-bearing checking accounts at the bank. Money market accounts grew $72.5declined $20.6 million primarily due to the $51.8this transfer and shifting of funds to CD accounts partially offset by a $21.7 million increase in a trust sweep account, transfers in from trustnon-interest bearing checking accounts along with a $24.0 million transfer from an interest-bearing checking account. and other business account growth. Non-interest bearing checking accounts increased $20.7decreased $20.1 million including a $7.5 million seasonal temporary deposit from one business customer. The remaining growth in non-interest bearing checking balances wasprimarily due to increasesdeclines in personal and business checking accounts.accounts from shifts to interest-bearing products. Savings and clubsclub accounts also increased $10.5decreased $19.3 million primarily due to personal savings growth.  declines and shifts to CDs and money market accounts. Interest-bearing checking accounts decreased $42.3decreased $18.1 million during the first half of 2022. The decrease in interest-bearing checking accounts was2023 primarily due to the aforementioned $24.0 million transfer to money marketfrom outflow of public funds from municipalities withdrawing American Rescue Plan Act funds and seasonal activitydecline in publicschool district accounts. The Company focuses on obtaining a full-banking relationship with existing checking account customers as well as forming new customer relationships. The Company will continue to execute on its relationship development strategy, explore the demographics within its marketplace and develop creative programs for its customers.customers to maintain and grow core deposits. For the remainderfirst half of 2022,2023, the Company expectsexperienced deposit balances to declinebalance declines as clients transfertransferred their deposits to investments to earn higher interest.interest and pay down debts and consumer spending. We currently expect this trend of cash usage due to the impact of inflation on consumer and business spending and deposit mix shifts due to the high interest rate environment to continue throughout the second half of 2023. Seasonal public deposit fluctuations are expected to remain volatile and at times may partially offset future deposit growth.

 

Partially offsetting these non-maturing deposit increases,decreases, CDs decreased $13.7increased $63.2 million, or 54%, during the first half of 2022.2023. CD balances continuestarted to declineimprove as rates lagged capital market rate increases and CDs with promotional rates reached maturity. The majority ofincreased. Some maturing CDs were closed as customers could earn higher yields by investing the money elsewhere.into other products. The Company will continue to pursue strategies to grow and retain retail and business customers with an emphasis on deepening and broadening existing and creating new relationships.

 

The Company uses the Certificate of Deposit Account Registry Service (CDARS) reciprocal program and Insured Cash Sweep (ICS) reciprocal program to obtain FDIC insurance protection for customers who have large deposits that at times may exceed the FDIC maximum insured amount of $250,000. The Company did not have any CDARs as of June 30, 20222023 and December 31, 2021.2022. As of June 30, 20222023 and December 31, 2021,2022, ICS reciprocal deposits represented $25.3$81.0 million and $27.6$26.3 million, or 4% and 1% each,, of total deposits which are included in interest-bearing checking accounts in the table above. The $2.3$54.7 million decreaseincrease in ICS deposits is primarily due to one large business deposit transfers fromrelationship that transferred deposits to ICS accounts tofrom other interest-bearing checking accounts.

 

5754

 

As of June 30, 2022,2023, total uninsured deposits were estimated to be $995.5 million.$878.7 million, or 41% of total deposits. The estimate of uninsured deposits is based on the same methodologies and assumptions used for regulatory reporting requirements. The Company aggregates deposit products by taxpayer identification number and classifies into ownership categories to estimate amounts over the FDIC insurance limit. As of June 30, 2023, the ratio of uninsured and non-collateralized deposits to total deposits was approximately 23%. Collateralized deposits totaled $382.0 million, or 18%, of total deposits as of June 30, 2023.

 

The maturity distribution of certificates of deposit that meet or exceed the FDIC limit, by account, at June 30, 20222023 is as follows:

 

(dollars in thousands)

  

Three months or less

 $1,757  $3,955 

More than three months to six months

 9,656  4,387 

More than six months to twelve months

 3,220  21,501 

More than twelve months

 5,444  24,164 
 

Total

 $20,077  $54,007 

 

Approximately 44%22% of the CDs, with a weighted-average interest rate of 0.28%0.94%, are scheduled to mature in 2022the second half of 2023 and an additional 38%60%, with a weighted-average interest rate of 0.31%3.32%, are scheduled to mature in 2023.2024. Renewing CDs are currently expected to re-price to lowerhigher market rates depending on the rate on the maturing CD, the pace and direction of interest rate movements, the shape of the yield curve, competition, the rate profile of the maturing accounts and depositor preference for alternative, non-term products. The Company plans to continue to address repricing CDs in the ordinary course of business on a relationship pricing basis and is prepared to match rates when prudent to maintain relationships. Growth in CD accounts is challenged by the current and expected rate environment and clients’ preference for short-term rates. The Company will continue to develop CD promotional programs when the Company deems that it is economically feasible to do so or when demand exists. The Company will consider the needs of the customers and simultaneously be mindful of the liquidity levels, borrowing rates and the interest rate sensitivity exposure of the Company.

 

Short-term borrowings

 

Borrowings are used as a complement to deposit generation as an alternative funding source whereby the Company will borrow under advances from the FHLB of Pittsburgh and other correspondent banks for asset growth and liquidity needs.

 

Short-term borrowings may include overnight balances with FHLB line of credit and/or correspondent bank’s federal funds lines which the Company may require to fund daily liquidity needs such as deposit outflow, loan demand and operations. There was $10 thousandThe Company used $76.1 million in short-term borrowings as of June 30, 2022 and $0 as of December 31, 2021 as growth in deposits funded asset growth. If deposit balances decline, the Company may need to use short-term borrowings to fund loan growth for the secondfirst half of 2022.2023. The short-term borrowings included $32.0 million borrowed through the Federal Reserve Bank Term Funding Program (BTFP) up to one year costing 4.38% by pledging $32.0 million in securities. As of June 30, 2022,2023, the Company had the ability to borrow $111.6$172.9 million from the Federal Reserve borrower-in-custody program, $145.9 million in overnight borrowings with the FHLB open-repo line of credit and $31.0$20.0 million from lines of credit with correspondent banks.

 

Secured borrowings

 

As of June 30, 20222023 and December 31, 2021,2022, the Company had 98 secured borrowing agreements with third parties with a fair value of $7.7$7.5 million and $7.6 million, respectively, related to certain sold loan participations that did not qualify for sales treatment acquired from Landmark. Secured borrowings are expected to decrease in the second half of 2022for 2023 from scheduled amortization and, when possible, early pay-offs.

 

FHLB advances

 

The Company had no FHLB advances as of June 30, 20222023 and December 31, 2021. During the first quarter of 2021, the Company paid off $5 million in FHLB advances with a weighted average interest rate of 3.07%. During the third quarter of 2021, the Company acquired $4.5 million in FHLB advances from the Landmark merger that was subsequently paid off.2022. As of June 30, 2022,2023, the Company had the ability to borrow an additional $595.2additional $637.8 million from the FHLB, including any overnight borrowings. The Company does not expect to have any FHLB advances in 2022.the second half of 2023.

 

Item 3. Quantitative and Qualitative Disclosure About Market Risk

 

Management of interest rate risk and market risk analysis.

 

The adequacy and effectiveness of an institution’s interest rate risk management process and the level of its exposures are critical factors in the regulatory evaluation of an institution’s sensitivity to changes in interest rates and capital adequacy. Management believes the Company’s interest rate risk measurement framework is sound and provides an effective means to measure, monitor, analyze, identify and control interest rate risk in the balance sheet.

 

The Company is subject to the interest rate risks inherent in its lending, investing and financing activities. Fluctuations of interest rates will impact interest income and interest expense along with affecting market values of all interest-earning assets and interest-bearing liabilities, except for those assets or liabilities with a short term remaining to maturity. Interest rate risk management is an integral part of the asset/liability management process. The Company has instituted certain procedures and policy guidelines to manage the interest rate risk position. Those internal policies enable the Company to react to changes in market rates to protect net interest income from significant fluctuations. The primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on net interest income along with creating an asset/liability structure that maximizes earnings.

 

5855

 

Asset/Liability Management. One major objective of the Company when managing the rate sensitivity of its assets and liabilities is to stabilize net interest income. The management of and authority to assume interest rate risk is the responsibility of the Company’s Asset/Liability Committee (ALCO), which is comprised of senior management and members of the board of directors. ALCO meets quarterly to monitor the relationship of interest sensitive assets to interest sensitive liabilities. The process to review interest rate risk is a regular part of managing the Company. Consistent policies and practices of measuring and reporting interest rate risk exposure, particularly regarding the treatment of non-contractual assets and liabilities, are in effect. In addition, there is an annual process to review the interest rate risk policy with the board of directors which includes limits on the impact to earnings from shifts in interest rates.

 

Interest Rate Risk Measurement. Interest rate risk is monitored through the use of three complementary measures: static gap analysis, earnings at risk simulation and economic value at risk simulation. While each of the interest rate risk measurements has limitations, collectively, they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company and the distribution of risk along the yield curve, the level of risk through time and the amount of exposure to changes in certain interest rate relationships.

 

Static Gap. The ratio between assets and liabilities re-pricing in specific time intervals is referred to as an interest rate sensitivity gap. Interest rate sensitivity gaps can be managed to take advantage of the slope of the yield curve as well as forecasted changes in the level of interest rate changes.

 

To manage this interest rate sensitivity gap position, an asset/liability model commonly known as cumulative gap analysis is used to monitor the difference in the volume of the Company’s interest sensitive assets and liabilities that mature or re-price within given time intervals. A positive gap (asset sensitive) indicates that more assets will re-price during a given period compared to liabilities, while a negative gap (liability sensitive) indicates the opposite effect. The Company employs computerized net interest income simulation modeling to assist in quantifying interest rate risk exposure. This process measures and quantifies the impact on net interest income through varying interest rate changes and balance sheet compositions. The use of this model assists the ALCO to gaugein gauging the effects of the interest rate changes on interest-sensitive assets and liabilities in order to determine what impact these rate changes will have upon the net interest spread. At June 30, 2022,2023, the Company maintained a one-year cumulative gap of negative (liability sensitive) $34.4$181.6 million, or -1.4%-7%, of total assets. The effect of this negative gap position provided a mismatch of assets and liabilities which may expose the Company to interest rate risk during periods of rising interest rates. Conversely, in a decliningdecreasing interest rate environment, net interest income could be positively impacted because more liabilities than assets will re-price downward during the one-year period.

 

Certain shortcomings are inherent in the method of analysis discussed above and presented in the next table. Although certain assets and liabilities may have similar maturities or periods of re-pricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the table amounts. The ability of many borrowers to service their adjustable-rate debt may decrease in the event of an interest rate increase.

 

5956

 

The following table reflects the re-pricing of the balance sheet or “gap” position at June 30, 2022:2023:

 

   

More than three

 

More than

        

More than three

 

More than

     
 

Three months

 

months to

 

one year

 

More than

    

Three months

 

months to

 

one year

 

More than

   

(dollars in thousands)

 

or less

 

twelve months

 

to three years

 

three years

 

Total

  

or less

 

twelve months

 

to three years

 

three years

 

Total

 
  

Cash and cash equivalents

 $69,294  $-  $-  $39,831  $109,125  $34,338  $-  $-  $35,294  $69,632 

Investment securities (1)(2)

 8,426  22,826  62,358  584,845  678,455  6,279  16,992  47,790  536,931  607,992 

Loans and leases(2)

 346,250  228,438  399,774  503,264  1,477,726  311,595  236,362  457,003  608,162  1,613,122 

Fixed and other assets

 -  53,383  -  96,251  149,634  -  53,892  -  96,594  150,486 

Total assets

 $423,970  $304,647  $462,132  $1,224,191  $2,414,940  $352,212  $307,246  $504,793  $1,276,981  $2,441,232 

Total cumulative assets

 $423,970  $728,617  $1,190,749  $2,414,940     $352,212  $659,458  $1,164,251  $2,441,232    
  

Non-interest-bearing transaction deposits (3)

 $-  $61,159  $167,899  $381,929  $610,987  $-  $58,306  $160,064  $364,103  $582,473 

Interest-bearing transaction deposits (3)

 606,051  -  350,192  525,286  1,481,529  591,648  -  318,960  478,439  1,389,047 

Certificates of deposit

 25,488  63,995  27,155  8,470  125,108  17,551  91,211  66,165  5,545  180,472 

Secured borrowings

 6,358  -  1,378  -  7,736  6,213  -  1,285  -  7,498 

Short-term borrowings

 10 - -   10  76,111 - - - 76,111 

Other liabilities

 -  -  -  26,951  26,951  -  -  -  27,887  27,887 

Total liabilities

 $637,907  $125,154  $546,624  $942,636  $2,252,321  $691,523  $149,517  $546,474  $875,974  $2,263,488 

Total cumulative liabilities

 $637,907  $763,061  $1,309,685  $2,252,321     $691,523  $841,040  $1,387,514  $2,263,488    
  

Interest sensitivity gap

 $(213,937) $179,493  $(84,492) $281,555     $(339,311) $157,729  $(41,681) $401,007    

Cumulative gap

 $(213,937) $(34,444) $(118,936) $162,619     $(339,311) $(181,582) $(223,263) $177,744    
  

Cumulative gap to total assets

 (8.9)% (1.4)% (4.9)% 6.7%    (13.9)% (7.4)% (9.1)% 7.3%   

(1)

Includes restricted investments in bank stock and the net unrealized gains/losses on available-for-sale securities.

(2)

Investments and loans are included in the earlier of the period in which interest rates were next scheduled to adjust or the period in which they are due. In addition, loans were included in the periods in which they are scheduled to be repaid based on scheduled amortization. For amortizing loans and MBS – GSE residential, annual prepayment rates are assumed reflecting historical experience as well as management’s knowledge and experience of its loan products.

(3)

The Company’s demand and savings accounts were generally subject to immediate withdrawal. However, management considers a certain amount of such accounts to be core accounts having significantly longer effective maturities based on the retention experiences of such deposits in changing interest rate environments. The effective maturities presented are the recommended maturity distribution limits for non-maturing deposits based on historical deposit studies.

 

Earnings at Risk and Economic Value at Risk Simulations. The Company recognizes that more sophisticated tools exist for measuring the interest rate risk in the balance sheet that extend beyond static re-pricing gap analysis. Although it will continue to measure its re-pricing gap position, the Company utilizes additional modeling for identifying and measuring the interest rate risk in the overall balance sheet. The ALCO is responsible for focusing on “earnings at risk” and “economic value at risk”, and how both relate to the risk-based capital position when analyzing the interest rate risk.

 

Earnings at Risk. An earnings at risk simulation measures the change in net interest income and net income should interest rates rise and fall. The simulation recognizes that not all assets and liabilities re-price one-for-one with market rates (e.g., savings rate). The ALCO looks at “earnings at risk” to determine income changes from a base case scenario under an increase and decrease of 200 basis points in interest rate simulation models.

 

Economic Value at Risk. An 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 the Company’s existing assets and liabilities. The ALCO examines this ratio quarterly utilizing an increase and decrease of 200 basis points in interest rate simulation models. The ALCO recognizes that, in some instances, this ratio may contradict the “earnings at risk” ratio.

 

6057

 

The following table illustrates the simulated impact of an immediate 200 basis points upward or downward movement in interest rates on net interest income, net income and the change in the economic value (portfolio equity). This analysis assumed that the adjusted interest-earning asset and interest-bearing liability levels at June 30, 20222023 remained constant. The impact of the rate movements was developed by simulating the effect of the rate change over a twelve-month period from the June 30, 20222023 levels:

 

 

% change

  

% change

 
 

Rates +200

 

Rates -200

  

Rates +200

 

Rates -200

 

Earnings at risk:

  

Net interest income

 (3.0)% (7.4)% (8.4)% (0.1)%

Net income

 (5.0) (14.5) (18.8) (1.7)

Economic value at risk:

  

Economic value of equity

 (10.1) (12.6) (19.1) 7.7 

Economic value of equity as a percent of total assets

 (1.5) (1.9) (2.1) 0.9 

In the scenarios in the above table, the Board-approved policy has the following guidelines: net interest income within +/- 10%, net income within +/- 25%, economic value of equity within +/- 25%, economic value of equity as a percent of total assets within +/-5%.

 

Economic value has the most meaning when viewed within the context of risk-based capital. Therefore, the economic value may normally change beyond the Company’s policy guideline for a short period of time as long as the risk-based capital ratio (after adjusting for the excess equity exposure) is greater than 10%. At June 30, 2022,2023, the Company’s risk-based capital ratio was 14.30%14.71%.

Given the existing economic and interest rate conditions along with the recent increase in earnings at risk exposure to rising rates, management is evaluating to pursue balance sheet hedging opportunities on both sides of balance sheet with an independent third-party vendor with derivative expertise in response to mitigate these interest rate risks on net interest income. The Company has a derivative policy in place and any balance sheet hedges require Board pre-approval along with quarterly monitoring requirements by the Company's ALCO Committee.

 

The table below summarizes estimated changes in net interest income over a twelve-month period beginning July 1, 2022,2023, under alternate interest rate scenarios using the income simulation model described above:

 

 

Net interest

 

$

 

%

  

Net interest

 

$

 

%

 

(dollars in thousands)

 

income

 

variance

 

variance

  

income

 

variance

 

variance

 

Simulated change in interest rates

         

+200 basis points

 $74,786  $(2,325)    (3.0)% $63,178  $(5,816) (8.4)%

+100 basis points

 76,226  (885)    (1.1)% 66,491  (2,503) (3.6)%

Flat rate

 77,111  -     -% 68,994  -  -%

-100 basis points

 73,883  (3,228)    (4.2)% 68,953  (41) (0.1)%

-200 basis points

 71,405  (5,706)    (7.4)% 68,929  (65) (0.1)%

 

Simulation models require assumptions about certain categories of assets and liabilities. The models schedule existing assets and liabilities by their contractual maturity, estimated likely call date or earliest re-pricing opportunity. MBS – GSE residential securities and amortizing loans are scheduled based on their anticipated cash flow including estimated prepayments. For investment securities, the Company uses a third-party service to provide cash flow estimates in the various rate environments. Savings, money market and interest-bearing checking accounts do not have stated maturities or re-pricing terms and can be withdrawn or re-price at any time. This may impact the margin if more expensive alternative sources of deposits are required to fund loans or deposit runoff. Management projects the re-pricing characteristics of these accounts based on historical performance and assumptions that it believes reflect their rate sensitivity. The model reinvests all maturities, repayments and prepayments for each type of asset or liability into the same product for a new like term at current product interest rates. As a result, the mix of interest-earning assets and interest bearing-liabilities is held constant.

 

Liquidity

 

Liquidity management ensures that adequate funds will be available to meet customers’ needs for borrowings, deposit withdrawals and maturities, facility expansion and normal operating expenses. Sources of liquidity are cash and cash equivalents, asset maturities and pay-downs within one year, loans HFS, investments AFS, growth of core deposits, utilization of borrowing capacities from the FHLB, correspondent banks, IntraFi's ICS and CDARs,One-Way Buy program, the Discount Window of the Federal Reserve Bank of Philadelphia (FRB), Atlantic Community Bankers Bank (ACBB) and proceeds from the issuance of capital stock. Though regularly scheduled investment and loan payments are dependable sources of daily liquidity, sales of both loans HFS and investments AFS, deposit activity and investment and loan prepayments are significantly influenced by general economic conditions including the interest rate environment. During low and declining interest rate environments, prepayments from interest-sensitive assets tend to accelerate and provide significant liquidity that can be used to invest in other interest-earning assets but at lower market rates. Conversely, in periods of high or rising interest rates, prepayments from interest-sensitive assets tend to decelerate causing prepayment cash flows from mortgage loans and mortgage-backed securities to decrease. Rising interest rates may also cause deposit inflow but priced at higher market interest rates or could also cause deposit outflow due to higher rates offered by the Company’s competition for similar products. The Company closely monitors activity in the capital markets and takes appropriate action to ensure that the liquidity levels are adequate for funding, investing and operating activities.

 

6158

 

The Company’s contingency funding plan (CFP) sets a framework for handling liquidity issues in the event circumstances arise which the Company deems to be less than normal. The Company established guidelines for identifying, measuring, monitoring and managing the resolution of potentially serious liquidity crises. The CFP outlines required monitoring tools, acceptable alternative funding sources and required actions during various liquidity scenarios. Thus, the Company has implemented a proactive means for the measurement and resolution for handling potentially significant adverse liquidity conditions. At least quarterly, the CFP monitoring tools, current liquidity position and monthly projected liquidity sources and uses are presented and reviewed by the Company’s Asset/Liability Committee. As of June 30, 2022,2023, the Company had not experienced any adverse issues that would give rise to its inability to raise liquidity in an emergency situation.

 

During the six months ended June 30, 2022, 2023, the Company generated $12.2$40.5 million of cash. During the period, the Company’s operations provided approximately $27.8$15.1 million mostlymostly from $35.7 million$34.4 million of net cash inflow from the components of net interest income plus $10.2 million in proceeds over originations of loans HFS partially offset by net non-interest expense/income related paymentspayments of $17.2$17.4 million and $0.9$1.7 million in quarterly estimated tax payments. CashCash inflow from interest-earning assets, depositsthe sale of securities, short-term borrowings and loan payments were used to purchase investment securities and replace maturing and cash runoff of securities, fund the loan portfolio, invest in bank premises and equipment and make net dividend payments. The Company received a large amount of public deposits over the past six years. The seasonal nature of deposits from municipalities and other public funding sources requires the Company to be prepared for the inherent volatility and the unpredictable timing of cash outflow from this customer base, including maintaining the requirements to pledge investment securities. Accordingly, the use of short-term overnight borrowings could be used to fulfill funding gap needs. The CFP is a tool to help the Company ensure that alternative funding sources are available to meet its liquidity needs.

 

During 2020,January 2023, the Company sold $31.2 million in AFS securities at breakeven to generate liquidity in order to pay down overnight borrowings which will result in interest expense savings. Management will continue to execute strategies to generate liquidity when it makes sense for the Company's operations.

During 2021 and the first half of 2022, the Company also experienced deposit inflow resulting from businesses and municipalities that received relief from the CARES Act, American Rescue Plan Act ("ARPA") and other government stimulus. There is uncertainty about the length of time that these deposits will remain which could require the Company to maintain elevated cash balances.  During the first half of 2023, the Company experienced an outflow of $54.3 million in ARPA funds, or approximately 56% of the balance of these funds from the end 2022. The Company will continue to monitor deposit fluctuationfluctuations for other significant changes.

 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the financing needs of its customers and in connection with the overall interest rate management strategy. These instruments involve, to a varying degree, elements of credit, interest rate and liquidity risk. In accordance with GAAP, these instruments are either not recorded in the consolidated financial statements or are recorded in amounts that differ from the notional amounts. Such instruments primarily include lending commitments.

 

Lending commitments include commitments to originate loans and commitments to fund unused lines of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Unfunded commitments of existing loan facilities totaled $364.0 million, standby letters of credit totaled $17.0 million and the level of uninsured and non-collateralized deposits was $496.7 million at June 30, 2023Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

 

As of June 30, 20222023, the Company maintained $109.1$69.6 million in cash and cash equivalents and $456.8$382.6 million of investments AFS and loans HFS. Also as of June 30, 20222023the Company had approximately $595.2$637.8 million available to borrow from the FHLB, $31.0$20.0 million from correspondent banks, $111.6$172.9 million from the FRB and $363.1$366.2 million from the IntraFi Network One-Way Buy program. The combined total of $1.7 billion$1,649.1 million represented 69%68% of total assets at June 30, 20222023. The Company also has the ability to pledge securities to borrow at par from the Federal Reserve Bank Term Funding Program to gain liquidity. Management believes this level of liquidity to be strong and adequate to support current operations.

 

Capital

 

During the six months ended June 30, 2022,2023, total shareholders' equity decreased $49.1increased $14.8 million, or 23%9%, due principally to $12.4 million in net income added into retained earnings and $61.1$5.9 million after tax reductionimprovement in the net unrealized gain position to a net unrealized loss position in the Company’s investment portfolio, $3.8 million of cash dividends declared on the Company’s common stock and $0.4 million in treasury stock purchases. These items were partially offsetportfolio. Capital was enhanced by $15.2 million in net income added into retained earnings, $0.3 million from investments in the Company’s common stock via the Employee Stock Purchase Plan (ESPP) and $0.7, $1.0 million from stock-based compensation expense from the ESPP and restricted stock and SSARs.$0.8 million from the re-issuance of treasury stock for the dividend reinvestment plan. Partially offsetting these increases were $4.1 million of cash dividends declared on the Company’s common stock, a $1.3 million cumulative effect adjustment for adoption of CECL and $0.1 million in treasury stock purchases to cover employee withholdings. The Company’s dividend payout ratio, defined as the rate at which current earnings are paid to shareholders, was 25.1%33.2% for the six months ended June 30, 2022.2023. The balance of earnings is retained to further strengthen the Company’s capital position.

 

As of June 30, 2022,2023, the Company reported a net unrealized loss position of $60.9$65.3 million, net of tax, from the securities AFS portfolio compared to a net unrealized gainloss of $0.2$71.2 million as of December 31, 2021.2022. The $61.1$5.9 million reductionimprovement during the first six monthshalf of 20222023 was from the $42.7$5.0 million reductionimprovement in net unrealized gains to net unrealized losses on AFS securities, net of tax, and $18.4$0.9 million in accretion of net unrealized losses on HTM securities transferred from AFS, net of tax. Lower unrealized gains and higher unrealized losses on all types of securities contributed to the net unrealized lossesimprovement in investment portfolio. Management believes that changes in fair value of the Company’s securities are due to changes in interest rates and not in the creditworthiness of the issuers.

Generally, when U.S. Treasury rates rise, investment securities’ pricing declines and fair values of investment securities also decline. While volatilityVolatility has existed in the yield curve within the past twelve months a rising rate environment is expected and during the period of rising rates, the Company expects pricing inis uncertain about the bond portfolio to decline.expected rate environment. There is no assurance that future realized and unrealized losses will not be recognized from the Company’s portfolio of investment securities.

The tangible common equity (TCE) ratio (non-GAAP) was 6.48% and 5.90% for the six months ended June 30, 2023 and 2022, respectively. At June 30, 2023 and 2022, the held-to-maturity securities portfolio had $24.8 million and $17.8 million in unrealized losses, net of deferred taxes. If the TCE ratio was adjusted to include the unrealized losses on held-to-maturity securities, the adjusted TCE ratio (non-GAAP) would have been 5.45% and 5.16% at June 30, 2023 and 2022.

 

To help maintain a healthy capital position, the Company can issue stock to participants in the DRP and ESPP plans. The DRP affords the Company the option to acquire shares in open market purchases and/or issue shares directly from the Company to plan participants. During the first half of 2022,2023, the Company acquiredre-issued treasury shares in the open market to fulfill the needs of the DRP. Both the DRP and the ESPP plans have been a consistent source of capital from the Company’s loyal employees and shareholders and their participation in these plans will continue to help strengthen the Company’s balance sheet.

 

6259

 

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

 

Under these guidelines, assets and certain off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets. The guidelines require all banks and bank holding companies to maintain a minimum ratio of total risk-based capital to total risk-weighted assets (Total Risk Adjusted Capital) of 8%, including Tier I common equity to total risk-weighted assets (Tier I Common Equity) of 4.5%, Tier I capital to total risk-weighted assets (Tier I Capital) of 6% and Tier I capital to average total assets (Leverage Ratio) of at least 4%. A capital conservation buffer, comprised of common equity Tier I capital, is also established above the regulatory minimum capital requirements of 2.50%. As of June 30, 20222023 and December 31, 2021,2022, the Company and the Bank exceeded all capital adequacy requirements to which it was subject.

 

The Company continues to closely monitor and evaluate alternatives to enhance its capital ratios as the regulatory and economic environments change. The following table depicts the capital amounts and ratios of the Company, on a consolidated basis, and the Bank as of  June 30, 20222023 and December 31, 2021:2022:

 

         

For capital adequacy

 

To be well capitalized

          

For capital adequacy

 

To be well capitalized

 
     

For capital

 

purposes with capital

 

under prompt corrective

      

For capital

 

purposes with capital

 

under prompt corrective

 
 

Actual

 

adequacy purposes

 

conservation buffer

 

action provisions

 

Actual

 

adequacy purposes

 

conservation buffer

 

action provisions

 

(dollars in thousands)

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

Ratio

 

Amount

Ratio

 

Amount

Ratio

 

Amount

Ratio

 

As of June 30, 2022

                

As of June 30, 2023

        
  

Total capital (to risk-weighted assets)

  

Consolidated

 $218,813  14.3%

 $122,404  8.0%

 $160,655  10.5%  N/A  N/A $241,539 14.7%

$131,377 8.0%

$172,432 10.5%  N/A N/A 

Bank

 $218,438  14.3%

 $122,395  8.0%

 $160,643  10.5%

 $152,994  10.0%$240,569 14.7%

$131,370 8.0%

$172,423 10.5%

$164,212 10.0%
  

Tier 1 common equity (to risk-weighted assets)

  

Consolidated

 $202,179  13.2%

 $68,852  4.5%

 $107,104  7.0%  N/A  N/A $222,031 13.5%

$73,899 4.5%

$114,955 7.0%  N/A N/A 

Bank

 $201,804  13.2%

 $68,847  4.5%

 $107,096  7.0%

 $99,446  6.5%$221,061 13.5%

$73,895 4.5%

$114,949 7.0%

$106,738 6.5%
  

Tier I capital (to risk-weighted assets)

  

Consolidated

 $202,179  13.2%

 $91,803  6.0%

 $130,054  8.5%  N/A  N/A $222,031 13.5%

$98,533 6.0%

$139,588 8.5%  N/A N/A 

Bank

 $201,804  13.2%

 $91,796  6.0%

 $130,045  8.5%

 $122,395  8.0%$221,061 13.5%

$98,527 6.0%

$139,580 8.5%

$131,370 8.0%
  

Tier I capital (to average assets)

  

Consolidated

 $202,179  8.4%

 $95,934  4.0%

 $95,934  4.0%  N/A  N/A $222,031 9.1%

$97,852 4.0%

$97,852 4.0%  N/A N/A 

Bank

 $201,804  8.4%

 $95,934  4.0%

 $95,934  4.0%

 $119,918  5.0%$221,061 9.0%

$97,848 4.0%

$97,848 4.0%

$122,310 5.0%

 

6360

 

         

For capital adequacy

 

To be well capitalized

             

For capital adequacy

 

To be well capitalized

 
     

For capital

 

purposes with capital

 

under prompt corrective

      

For capital

  

purposes with capital

 

under prompt corrective

 
 

Actual

 

adequacy purposes

 

conservation buffer

 

action provisions

 

Actual

 

adequacy purposes

  

conservation buffer

 

action provisions

 

(dollars in thousands)

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

Ratio

 

Amount

Ratio

  

Amount

Ratio

 

Amount

Ratio

 

As of December 31, 2021

 

As of December 31, 2022

                       
                        

Total capital (to risk-weighted assets)

                        

Consolidated

 $205,667  14.5%

 $113,421  8.0%

 $148,866  10.5%  N/A  N/A $230,133 14.4%

$128,325 8.0%

$168,427 10.5%  N/A N/A 

Bank

 $205,726  14.5%

 $113,406  8.0%

 $148,845  10.5%

 $141,757  10.0%$229,803 14.3%

$128,308 8.0%

$168,405 10.5%

$160,385 10.0%
                        

Tier 1 common equity (to risk-weighted assets)

                        

Consolidated

 $189,980  13.4%

 $63,800  4.5%

 $99,244  7.0%  N/A  N/A $212,935 13.3%

$72,183 4.5%

$112,285 7.0%  N/A N/A 

Bank

 $190,039  13.4%

 $63,791  4.5%

 $99,230  7.0%

 $92,142  6.5%$212,605 13.3%

$72,173 4.5%

$112,270 7.0%

$104,251 6.5%
                          

Tier I capital (to risk-weighted assets)

                          

Consolidated

 $189,980  13.4%

 $85,066  6.0%

 $120,510  8.5%  N/A  N/A $212,935 13.3%

$96,244 6.0%

$136,346 8.5%  N/A N/A 

Bank

 $190,039  13.4%

 $85,054  6.0%

 $120,493  8.5%

 $113,406  8.0%$212,605 13.3%

$96,231 6.0%

$136,328 8.5%

$128,308 8.0%
                          

Tier I capital (to average assets)

                          

Consolidated

 $189,980  7.9%

 $95,688  4.0%

 $95,688  4.0%  N/A  N/A $212,935 8.7%

$97,960 4.0%

$97,960 4.0%  N/A N/A 

Bank

 $190,039  7.9%

 $95,680  4.0%

 $95,680  4.0%

 $119,600  5.0%$212,605 8.7%

$97,951 4.0%

$97,951 4.0%

$122,439 5.0%

 

The Company advises readers to refer to the Supervision and Regulation section of Management’s Discussion and Analysis of Financial Condition and Results of Operation, of its 20212022 Form 10-K for a discussion on the regulatory environment and recent legislation and rulemaking.

 

Item 4. Controls and Procedures

 

As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was carried out by the Company’s management, with the participation of its President and Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934. Based on such evaluation, the President and Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports the Company files or furnishes under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations, and are effective. The Company made no changes in its internal controls over financial reporting or in other factors that materially affected, or are reasonably likely to materially affect, these controls during the last fiscal quarter ended June 30, 2022.2023.

 

6461

 

PART II - Other Information

 

Item 1. Legal Proceedings

 

The nature of the Company’s business generates a certain amount of litigation involving matters arising in the ordinary course of business. However, in the opinion of the Company after consultation with legal counsel, no legal proceedings are pending, which, if determined adversely to the Company or the Bank, would have a material adverse effect on the Company’s undivided profits or financial condition, operations or the results of such operations. No legal proceedings are pending other than ordinary routine litigation incidental to the business of the Company and the Bank. In addition, to management’s knowledge, no governmental authorities have initiated or contemplated any material legal or regulatory actions against the Company or the Bank.

 

Item 1A. Risk Factors

 

Recent Negative Developments Affecting the Banking Industry, Including Recent Bank Failures or Concerns Regarding Liquidity, Have Eroded Customer Confidence in the Banking System and May Have a Material Adverse Effect on the Company.

During March and April 2023 three significant bank failures occurred (Silicon Valley Bank, Signature Bank, and First Republic Bank).  This was and continues to be accompanied by financial instability at various additional banks.  These bank failures and bank instabilities have created and may continue to create market and other risks, for all financial institutions and banks, including the Corporation.  These risks include, but are not limited to:

1.

market risk and a loss of confidence in the financial services sector, and/or specific banks;

2.

Deterioration of securities and loan portfolios;

3.

Deposit volatility and reductions with higher volumes and occurring over shorter periods of time;

4.

Increased liquidity demand and utilization of sources of liquidity; and

5.

Interest rate volatility and abrupt, sudden and greater than usual rate changes.

These factors individually, or in any combination, could materially and adversely affect our:

1.

Financial condition;

2.

Operations and results thereof; and

3.

Stock price.

In addition, the previously mentioned bank failures and instabilities, or future bank failures and instability, may result in an increase of FDIC deposit insurance premiums and/or result in special FDIC deposit insurance assessments, which also may adversely affect the Company’s financial condition, operations, results thereof or stock price.

The Company cannot predict the impact, timing or duration of such events.

Management of the Company does not believe there have been any other material changes to the risk factors that were disclosed in the 20212022 Form 10-K filed with the Securities and Exchange Commission on March 23, 2022.20, 2023.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

 

(a)

 

(b)

 

(c)

 

(d)

  

(a)

 

(b)

 

(c)

 

(d)

 

Period

 

Total number of shares (or units) purchased

  

Average price paid per share (or unit)

  

Total number of shares (or units) purchased as part of publicly announced plans or programs

  

Maximum number (or approximate dollar value) of shares (or units) that may yet be purchased under the plans or programs

  

Total number of shares (or units) purchased

 

Average price paid per share (or unit)

 

Total number of shares (or units) purchased as part of publicly announced plans or programs

 

Maximum number (or approximate dollar value) of shares (or units) that may yet be purchased under the plans or programs

 

June 1, 2022 to June 30, 2022

 10,294  $37.60  10,294  $4,612,084 

April 1, 2023 to April 30, 2023

 -  $-  -  $3,739,242 

May 1, 2023 to May 31, 2023

 -  -  -  3,739,242 

June 1, 2023 to June 30, 2023

 -  -  -  3,739,242 

Total

 -  $-  -  $3,739,242 

 

On May 18, 2022, the Company announced that the Board of Directors approved a plan to purchase, in open market and privately negotiated transactions, up to 3% of its outstanding common stock in accordance with all applicable securities laws and regulations, including Rule 10b-18 of the Exchange Act.  The plan shallis expected to terminate on the earlier of the date an aggregate of $5,000,000 of stock have been purchased or August 9, 2023.

 

Item 3. Default Upon Senior Securities

 

None

 

Item 4. Mine Safety Disclosures

 

Not applicable

 

Item 5. Other Information

 

None

 

6562

 

Item 6. Exhibits

The following exhibits are filed herewith or incorporated by reference as a part of this Form 10-Q:

 

3(i) Amended and Restated Articles of Incorporation of Registrant. Incorporated by reference to Annex B of the Proxy Statement/Prospectus included in Registrant’s Amendment 4 to its Registration Statement No. 333-90273 on Form S-4, filed with the SEC on April 6, 2000.

 

3(ii) Amended and Restated Bylaws of Registrant. Incorporated by reference to Exhibit 3.1 to Registrant’s Form 8-K filed with the SEC on April 16, 2020.

 

2.1 Agreement and Plan of Reorganization by and among Fidelity D & D Bancorp, Inc., The Fidelity Deposit and Discount Bank, MNB Corporation and Merchants Bank of Bangor dated as of December 9, 2019. Incorporated by reference to Annex A of the Registrant’s Registration Statement No. 333-236453 on Form S-4, filed with the Commission on February 14, 2020. (Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Registrant agrees to furnish supplementally to the SEC a copy of any omitted schedule upon request.)

 

2.2 Agreement and Plan of Reorganization by and among Fidelity D & D Bancorp, Inc., NEPA Acquisition Subsidiary, LLC, The Fidelity Deposit and Discount Bank, Landmark Bancorp, Inc. and Landmark Community Bank dated as of February 25, 2021. Incorporated by reference to Annex A of the Registrant’s Registration No. 333-255479 on Form S-4, filed with the Commission on April 23, 2021. (Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Registrant agrees to furnish supplementally to the SEC a copy of any omitted schedule upon request.)

 

*10.1 Registrants 2012 Dividend Reinvestment and Stock Repurchase Plan. Incorporated by reference to Exhibit 4.1 to Registrant’s Registration Statement No. 333-183216 on Form S-3 filed with the SEC on August 10, 2012 as amended February 3, 2014.

 

*10.2 Registrants 2002 Employee Stock Purchase Plan. Incorporated by reference to Appendix A to Definitive proxy Statement filed with the SEC on March 28, 2002.

 

*10.3 Amended and Restated Executive Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity Deposit and Discount Bank and Daniel J. Santaniello, dated March 23, 2011. Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SEC on March 29, 2011.

 

*10.4 2012 Omnibus Stock Incentive Plan. Incorporated by reference to Appendix A to Registrant’s Definitive Proxy Statement filed with the SEC on March 30, 2012.

 

*10.5 2012 Director Stock Incentive Plan. Incorporated by reference to Appendix B to Registrant’s Definitive Proxy Statement filed with the SEC on March 30, 2012.

 

*10.6 Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity Deposit and Discount Bank and Salvatore R. DeFrancesco, Jr. dated as of March 17, 2016. Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SEC on March 18, 2016.

 

*10.7 Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity Deposit and Discount Bank and Eugene J. Walsh dated as of March 29, 2017. Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SEC on April 4, 2017.

 

*10.8 Form of Supplemental Executive Retirement Plan – Applicable to Daniel J. Santaniello and Salvatore R. DeFrancesco, Jr. Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SEC on April 4, 2017.

 

*10.9 Form of Supplemental Executive Retirement Plan – Applicable to Eugene J. Walsh. Incorporated by reference to Exhibit 99.2 to Registrant’s Current Report on Form 8-K filed with the SEC on April 4, 2017.

 

*10.10 Form of Split Dollar Life Insurance Agreement – Applicable to Daniel J. Santaniello, Salvatore R. DeFrancesco, Jr. and Eugene J. Walsh. Incorporated by reference to Exhibit 99.3 to Registrant’s Current Report on Form 8-K filed with the SEC on April 4, 2017.

 

*10.11 Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity Deposit and Discount Bank and Michael J. Pacyna dated as of March 20, 2019. Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SEC on March 21, 2019.

 

*10.12 Form of Supplemental Executive Retirement Plan for Michael J. Pacyna. Incorporated by reference to Exhibit 99.2 to Registrant’s Current Report on Form 8-K filed with the SEC on March 21, 2019.

 

*10.13 Form of Split Dollar Life Insurance Agreement for Michael J. Pacyna. Incorporated by reference to Exhibit 99.3 to Registrant’s Current Report on Form 8-K filed with the SEC on March 21, 2019.

 

*10.14 2022 Omnibus Stock Incentive Plan. Incorporated by reference to Appendix A to Registrant’s Definitive Proxy Statement filed with the SEC on March 23, 2022.

 

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31.1 Rule 13a-14(a) Certification of Principal Executive Officer, filed herewith.

 

31.2 Rule 13a-14(a) Certification of Principal Financial Officer, filed herewith.

 

32.1 Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.herewith.

 

32.2 Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.

 

101 Interactive data files: The following, from Fidelity D&D Bancorp, Inc.’s. Quarterly Report on Form 10-Q for the quarter ended June 30, 2022,2023, is formatted in Inline XBRL (eXtensible Business Reporting Language): Consolidated Balance Sheets as of June 30, 20222023 and December 31, 2021;2022; Consolidated Statements of Income for the three and six months ended June 30, 20222023 and 2021;2022; Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 20222023 and 2021;2022; Consolidated Statements of Changes in Shareholders’ Equity for the three and six months ended June 30, 20222023 and 2021;2022; Consolidated Statements of Cash Flows for the six months ended June 30, 20222023 and 20212022  and the Notes to the Consolidated Financial Statements. **

 

104 Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).

* Management contract or compensatory plan or arrangement.

 

** Pursuant to Rule 406T of Regulation S-T, the interactive data files in Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

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Signatures

 

 

FIDELITY D & D BANCORP, INC.

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

Fidelity D & D Bancorp, Inc.

  

Date: August 15, 202211, 2023

/s/Daniel J. Santaniello

 

     Daniel J. Santaniello,

     President and Chief Executive Officer

  
 

Fidelity D & D Bancorp, Inc.

  

Date: August 15, 202211, 2023

/s/Salvatore R. DeFrancesco, Jr.

 

     Salvatore R. DeFrancesco, Jr.,

     Treasurer and Chief Financial Officer

 

 

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