Citizens Financial Services, Inc.
PART I
CITIZENS FINANCIAL SERVICES, INC.
Citizens Financial Services, Inc. (the “Company”), a Pennsylvania corporation, was incorporated on April 30, 1984 to be the holding company for First Citizens Community Bank (the “Bank”), a Pennsylvania-chartered bank and trust company. During 2020, CZFS Acquisition Company, LLC (CZFS) was formed as a wholly owned subsidiary of the Company, and subsequently the Company’s interest in the Bank was transferred to CZFS to facilitate the merger with MidCoast Community Bancorp, Inc. (MidCoast) and its wholly owned subsidiary, MidCoast Community Bank (“MC Bank”), which was completed on April 17, 2020. The Company is primarily engaged in the ownership and management of CZFS, its subsidiary, the Bank and the Bank’s wholly owned subsidiaries, First Citizens Insurance Agency, Inc. (“First Citizens Insurance”) and 1st Realty of PA LLC (“Realty”). Realty was formed in March of 2019 to manage and sell properties acquired by the Bank in the settlement of a bankruptcy filing with a commercial customer, as well as other properties the Bank obtains in foreclosure.
AVAILABLE INFORMATION
A copy of the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current events reports on Form 8-K, and amendments to these reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are made available free of charge through the Company’s web site at www.firstcitizensbank.com as soon as reasonably practicable after such reports are filed with or furnished to the Securities and Exchange Commission. Copies of the reports the Company files electronically with the Securities and Exchange Commission are also available through the Securities and Exchange Commission’s website at www.sec.gov. Information on our website shall not be considered as incorporated by reference into this Form 10-K.
FIRST CITIZENS COMMUNITY BANK
The Bank is a full-service bank engaged in a broad range of banking activities and services for individual, business, governmental and institutional customers. These activities and services principally include checking, savings, and time deposit accounts; residential, commercial and agricultural real estate, commercial and industrial, state and political subdivision and consumer loans; and a variety of other specialized financial services. The Trust and Investment division of the Bank offers a full range of client investment, estate, mineral management and retirement services.
The Bank’s main office is located at 15 South Main Street, Mansfield (Tioga County), Pennsylvania. In addition to the main office in Mansfield, the Bank operates 29 full service offices and one limited branch office in its market areas. The Bank’s north central, Pennsylvania market area consists of the Pennsylvania Counties of Bradford, Clinton, Potter and Tioga in north central Pennsylvania. It also includes Allegany, Steuben, Chemung and Tioga Counties in Southern New York. The south central Pennsylvania market consists of Lebanon county and portions of Berks, Lancaster and Schuylkill Counties in Pennsylvania. The Central Pennsylvania market consists of our offices in Centre, Clinton and Union counties and the surrounding communities. Our Delaware market consists of Wilmington and Dover, Delaware and portions of Chester County, Pennsylvania and was due to the MidCoast acquisition, completed in April 2020, which added two offices in Wilmington, Delaware and one office in Dover, Delaware. In November of 2020, the Bank opened a full-service branch in Chester County, Pennsylvania. We have received regulatory approval to open a full service branch in Ephrata, Pennsylvania, which is expected to open in the second half of 2022.
The economy of the Bank’s market areas are diversified and include manufacturing industries, wholesale and retail trade, service industries, agricultural and the production of natural resources of gas and timber. We are dependent geographically upon the economic conditions in north central, central and south central Pennsylvania, the southern tier of New York and the cities and surrounding areas of Wilmington and Dover, Delaware.
COMPETITION
The banking industry in the Bank’s service areas are intensely competitive, with competitors including local community banks, larger regional banks, and financial service providers such as consumer finance companies, thrifts, investment firms, mutual funds, insurance companies, credit unions, mortgage banking firms, financial companies, financial affiliates of industrial companies, FinTech and internet entities, and government sponsored agencies, such as Freddie Mac, Fannie Mae and Farm Credit. Competitive pressures continue to increase in our service areas as entities seek both loan and deposit growth, as well as geographic expansion. The Bank is generally competitive with all competing financial institutions in its service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.
Additional information related to our business and competition is included in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
HUMAN CAPITAL RESOURCES
At December 31, 2021, we had a total of 306 employees, including 22 part-time employees and of which approximately 75% are women. The full-time equivalent of our total employees at December 31, 2021 was 293. As a financial institution, approximately 48% of our employees are employed at our branch and loan production offices, and another 1.3% are employed at our customer care call center. The success of our business is highly dependent on our employees, who provide value to our customers and communities through their dedication to our mission. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be good.
We encourage and support the growth and development of our associates and, wherever possible, seek to fill positions by promotion and transfer from within the organization. Continual learning and career development are advanced through internally developed training programs and specialty education within banking, using universities that offer Banking Management programs. We believe our ability to attract and retain employees is a key to our success. Accordingly, we strive to offer competitive salaries and employee benefits to all employees and monitor salaries in our market areas. At December 31, 2021, 24% of our current staff had been with us for fifteen years or more.
The safety, health and wellness of our employees is a top priority. The COVID-19 pandemic continues to present a unique challenge with regard to maintaining employee safety while continuing successful operations. All employees are asked not to come to work when they experience signs or symptoms of a possible COVID-19 illness and have been provided additional paid time off to cover compensation during such absences. On an ongoing basis, we further promote the health and wellness of our associates by strongly encouraging work-life balance and sponsoring various wellness programs, whereby associates are compensated for incorporating healthy habits into their daily routines.
SUPERVISION AND REGULATION
GENERAL
The Bank is subject to extensive regulation, examination and supervision by the Pennsylvania Department of Banking (“PDB”) and, as a member of the Federal Reserve System, by the Board of Governors of the Federal Reserve System (the “FRB”). Federal and state banking laws and regulations govern, among other things, the scope of a bank’s business, the investments a bank may make, the reserves against deposits a bank must maintain, terms of deposit accounts, loans a bank makes, the interest rates a bank charges and collateral a bank takes, the activities of a bank with respect to mergers and consolidations and the establishment of branches. The Company is registered as a bank holding company and is subject to supervision and regulation by the FRB under the Bank Holding Company Act of 1956, as amended (the “BHCA”).
CARES ACT
In response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law on March 27, 2020. Among other things, the CARES Act includes the following provisions impacting financial institutions like the Bank:
Community Bank Leverage Ratio (CBLR). The CARES Act directs the federal banking agencies to adopt interim final rules to lower the threshold under the CBLR from 9% to 8% and to provide a reasonable grace period for a community bank that falls below the threshold to regain compliance, in each case until the earlier of the termination date of the national emergency or December 31, 2020. In April 2020, the federal bank regulatory agencies issued two interim final rules implementing this directive. One interim final rule provides that, as of the second quarter 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework. It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement.
Temporary Troubled Debt Restructurings Relief. The CARES Act allows banks to elect to suspend requirements under accounting principles generally accepted in the United States of America (“GAAP”) for loan modifications related to the COVID-19 pandemic (for loans that were not more than 30 days past due as of December 31, 2019) that would otherwise be categorized as a TDR, including impairment for accounting purposes, until the earlier of 60 days after the termination date of the national emergency or December 31, 2020. Federal banking agencies are required to defer to the determination of the banks making such suspension.
Small Business Administration Paycheck Protection Program. The CARES Act authorizes the SBA’s Paycheck Protection Program (“PPP”). The PPP authorizes for small business loans to pay payroll and group health costs, salaries and commissions, mortgage and rent payments, utilities, and interest on other debt. The loans are provided through participating financial institutions, such as the Bank, that process loan applications and service the loans.
PENNSYLVANIA BANKING LAWS
The Pennsylvania Banking Code (“Banking Code”) contains detailed provisions governing the organization, location of offices, rights and responsibilities of directors, officers, and employees, as well as corporate powers, savings and investment operations and other aspects of the Bank and its affairs. The Banking Code delegates extensive rule-making power and administrative discretion to the PDB so that the supervision and regulation of state chartered banks may be flexible and readily responsive to changes in economic conditions and in savings and lending practices.
Pennsylvania law also provides Pennsylvania state chartered institutions elective parity with the power of national banks, federal thrifts, and state-chartered institutions in other states as authorized by the FDIC, subject to a required notice to the PDB. The Federal Deposit Insurance Corporation Act (“FDIA”), however, prohibits state chartered banks from making new investments, loans, or becoming involved in activities as principal and equity investments which are not permitted for national banks unless (1) the FDIC determines the activity or investment does not pose a significant risk of loss to the Deposit Insurance Fund and (2) the bank meets all applicable capital requirements. Accordingly, the additional operating authority provided to the Bank by the Banking Code is restricted by the FDIA.
In April 2008, banking regulators in the States of New Jersey, New York, and Pennsylvania entered into a Memorandum of Understanding (the “Interstate MOU”) to clarify their respective roles, as home and host state regulators, regarding interstate branching activity on a regional basis pursuant to the Riegle-Neal Amendments Act of 1997. The Interstate MOU establishes the regulatory responsibilities of the respective state banking regulators regarding bank regulatory examinations and is intended to reduce the regulatory burden on state chartered banks branching within the region by eliminating duplicative host state compliance exams. Under the Interstate MOU, the activities of branches we established in New York would be governed by Pennsylvania state law to the same extent that federal law governs the activities of the branch of an out-of-state national bank in such host states. Issues regarding whether a particular host state law is preempted are to be determined in the first instance by the PDB. In the event that the PDB and the applicable host state regulator disagree regarding whether a particular host state law is pre-empted, the PDB and the applicable host state regulator would use their reasonable best efforts to consider all points of view and to resolve the disagreement.
COMMUNITY REINVESTMENT ACT
The Community Reinvestment Act, (“CRA”), as implemented by FRB regulations, provides that the Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the FRB, in connection with its examination of the Bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain corporate applications by such institution, such as mergers and branching. The Bank���s most recent rating was “Satisfactory.” Various consumer laws and regulations also affect the operations of the Bank. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the FRB as it attempts to control the money supply and credit availability in order to influence the economy.
CURRENT CAPITAL REQUIREMENTS
Federal regulations require FDIC-insured depository institutions, including state-chartered, FRB-member banks, to meet several minimum capital standards. These capital standards were effective January 1, 2015, and result from a final rule implementing regulatory amendments based on recommendations of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).
The capital standards require the maintenance of common equity Tier 1 capital, Tier 1 capital and total capital to risk-weighted assets of at least 4.5%, 6.0% and 8.0%, respectively, and a leverage ratio of at least 4% of Tier 1 capital. Common equity Tier 1 capital is generally defined as common stockholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and Additional Tier 1 capital. Additional Tier 1 capital generally includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus Additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of Accumulated Other Comprehensive Income (“AOCI”), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. The Company has exercised the AOCI opt-out option and therefore AOCI is not incorporated into common equity Tier 1 capital. Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.
In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, residual interests) are multiplied by a risk weight factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien one- to four-family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans and a risk weight of between 0% to 600% is assigned to permissible equity interests, depending on certain specified factors.
In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions by the institution and certain discretionary bonus payments to management if an institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement was phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increased each year until fully implemented at 2.5% on January 1, 2019.
The FRB has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of the particular risks or circumstances.
As permitted by applicable federal regulation, the Bank has opted to use the community bank leverage ratio (the “CBLR”) framework for determining its capital adequacy, as discussed above. If a qualifying community bank fails to maintain the applicable minimum CBLR during the grace period, or if it is unable to restore compliance with the CBLR within the grace period, then it will revert to the Basel III capital framework and the normal Prompt Corrective Action capital categories will apply. At December 31, 2021, the Bank was considered “well-capitalized” under the CBLR framework, with a leverage ratio of 8.94%.
PROMPT CORRECTIVE ACTION RULES
Federal law establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. The law requires that certain supervisory actions be taken against undercapitalized institutions, the severity of which depends on the degree of undercapitalization. The FRB has adopted regulations to implement the prompt corrective action legislation as to state member banks. The regulations were amended to incorporate the previously mentioned increased regulatory capital standards that were effective January 1, 2015. An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a leverage ratio of 5.0% or greater and a common equity Tier 1 ratio of 6.5% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, a leverage ratio of 4.0% or greater and a common equity Tier 1 ratio of 4.5% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0%, a leverage ratio of less than 4.0% or a common equity Tier 1 ratio of less than 4.5%. An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 4.0%, a leverage ratio of less than 3.0% or a common equity Tier 1 ratio of less than 3.0%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2.0%.
Subject to a narrow exception, a receiver or conservator must be appointed for an institution that is “critically undercapitalized” within specified time frames. The regulations also provide that a capital restoration plan must be filed with the FRB within 45 days of the date an institution is deemed to have received notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Compliance with the capital restoration plan must be guaranteed by any parent holding company up to the lesser of 5% of the depository institution’s total assets when it was deemed to be undercapitalized or the amount necessary to achieve compliance with applicable capital requirements. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The FRB could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Significantly and critically undercapitalized institutions are subject to additional mandatory and discretionary measures.
STANDARDS FOR SAFETY AND SOUNDNESS
The federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness in various areas such as internal controls and information systems, internal audit, loan documentation and credit underwriting, interest rate exposure, asset growth and quality, earnings and compensation, fees and benefits. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the FRB determines that a state member bank fails to meet any standard prescribed by the guidelines, the FRB may require the institution to submit an acceptable plan to achieve compliance with the standard.
ENFORCEMENT
The PDB maintains enforcement authority over the Bank, including the power to issue cease and desist orders and civil money penalties and remove directors, officers or employees. The PDB also has the power to appoint a conservator or receiver for a bank upon insolvency, imminent insolvency, unsafe or unsound condition or certain other situations. The FRB has primary federal enforcement responsibility over FRB-member state banks and has authority to bring actions against the institution and all institution-affiliated parties, including shareholders, who knowingly or recklessly participate in wrongful actions likely to have an adverse effect on the bank. Formal enforcement action may range from the issuance of a capital directive or a cease and desist order, to removal of officers and/or directors. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The FDIC, as deposit insurer, has the authority to recommend to the FRB that enforcement action be taken with respect to a member bank. If the FRB does not take action, the FDIC has authority to take such action under certain circumstances. In general, regulatory enforcement actions occur with respect to situations involving unsafe or unsound practices or conditions, violations of law or regulation or breaches of fiduciary duty. Federal and Pennsylvania law also establish criminal penalties for certain violations.
REGULATORY RESTRICTIONS ON BANK DIVIDENDS
The Bank may not declare a dividend without approval of the FRB, unless the dividend to be declared by the Bank’s Board of Directors does not exceed the total of: (i) the Bank’s net profits for the current year to date, plus (ii) its retained net profits for the preceding two years, less any required transfers to surplus.
Under Pennsylvania law, the Bank may only declare and pay dividends from its accumulated net earnings. In addition, the Bank may not declare and pay dividends from the surplus funds that Pennsylvania law requires that it maintain. Under these policies and subject to the restrictions applicable to the Bank, the Bank could have declared, during 2021, without prior regulatory approval, aggregate dividends of approximately $20.6 million, plus net profits earned to the date of such dividend declaration.
BANK SECRECY ACT
Under the Bank Secrecy Act (BSA), banks and other financial institutions are required to retain records to assure that the details of financial transactions can be traced if investigators need to do so. Banks are also required to report most cash transactions in amounts exceeding $10,000 made by or on behalf of their customers. Failure to meet BSA requirements may expose the Bank to statutory penalties, and a negative compliance record may affect the willingness of regulating authorities to approve certain actions by the Bank requiring regulatory approval, including acquisition and opening new branches.
INSURANCE OF DEPOSIT ACCOUNTS
The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund (DIF) of the FDIC. Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned, and certain adjustments specified by FDIC regulations.
As required by the Dodd-Frank Act, the FDIC has issued final rules implementing changes to the assessment rules. The rules change the assessment base used for calculating deposit insurance assessments from deposits to total assets, less tangible (Tier 1) capital. Since the new base is larger than the previous base, the FDIC also lowered assessment rates so that the rule would not significantly alter the total amount of revenue collected from the industry. The range of adjusted assessment rates is now 2.5 to 45 basis points of the new assessment base. The rule is expected to benefit smaller financial institutions, which typically rely more on deposits for funding, and shift more of the burden for supporting the insurance fund to larger institutions, which are thought to have greater access to nondeposit funding. No institution may pay a dividend if it is in default of its assessments. As a result of the Dodd-Frank Act, deposit insurance per account owner is $250,000 for all types of accounts.
The Dodd-Frank Act increased the minimum target DIF ratio from 1.15% to 1.35% of estimated insured deposits. The FDIC was required to seek to achieve the 1.35% ratio by September 30, 2020, and insured institutions with assets of $10 billion or more were supposed to fund the increase. On September 30, 2018, the 1.35% ratio was exceeded, reaching 1.36%. Insured institutions of less than $10 billion of assets received credits for the portion of their assessments that contributed to raising the reserve ratio between 1.15% and 1.35% effective when the fund rate achieves 1.38%. The fund rate achieved 1.40% as of June 30, 2019, and the FDIC first applied small bank credits on the September 30, 2019 assessment invoice (for the second quarter of 2019). The FDIC remitted the final small bank credits in 2020 as the ratio remained above 1.35%. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the FDIC to establish a maximum fund ratio. The FDIC has exercised that discretion by establishing a long range fund ratio of 2%.
The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or regulatory condition imposed in writing. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
FEDERAL RESERVE SYSTEM
Under FRB regulations, the Bank is required to maintain reserves against its transaction accounts (primarily NOW and regular checking accounts). These reserve requirements are subject to annual adjustment by the FRB. For 2021, the Bank would have been required to maintain average daily reserves equal to 3% on aggregate transaction accounts of up to and including $640.6 million, plus 10% on the remainder, and the first $32.4 million of otherwise reservable balances will be exempt. In March 2020, the FRB reduced all reserve requirements to zero in response to the COVID-19 pandemic.
PROHIBITIONS AGAINST TYING ARRANGEMENTS
State-chartered banks are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
OTHER REGULATIONS
Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s operations are also subject to federal and state laws applicable to credit transactions, such as the:
| • | Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers; |
| • | Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves; |
| • | Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit; |
| • | Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies; |
| • | Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; |
| • | Truth in Savings Act; and |
| • | Rules and regulations of the various federal and state agencies charged with the responsibility of implementing such laws. |
The Bank’s operations also are subject to the:
| • | Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; |
| • | Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; |
| • | Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check; |
| • | The USA PATRIOT Act, which requires banks operating to, among other things, establish broadened anti-money laundering compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and |
| • | The Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of certain personal financial information with unaffiliated third parties. |
HOLDING COMPANY REGULATION
The Company, as a bank holding company, is subject to examination, supervision, regulation, and periodic reporting under the BHCA, as administered by the FRB. The Company is required to obtain the prior approval of the FRB to acquire all, or substantially all, of the assets of any bank or bank holding company. Prior FRB approval is also required for the Company to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if it would, directly or indirectly, own or control more than 5% of any class of voting shares of the bank or bank holding company.
A bank holding company is generally prohibited from engaging in, or acquiring, direct or indirect control of more than 5% of the voting securities of any company engaged in nonbanking activities. One of the principal exceptions to this prohibition is for activities found by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the principal activities that the FRB has determined by regulation to be closely related to banking are: (i) making or servicing loans; (ii) performing certain data processing services; (iii) providing securities brokerage services; (iv) acting as fiduciary, investment or financial advisor; (v) leasing personal or real property under certain conditions; (vi) making investments in corporations or projects designed primarily to promote community welfare; and (vii) acquiring a savings association.
A bank holding company that meets specified conditions, including that its depository institutions subsidiaries are “well capitalized” and “well managed,” can opt to become a “financial holding company.” A “financial holding company” may engage in a broader array of financial activities than permitted a typical bank holding company. Such activities can include insurance underwriting and investment banking. The Company does not anticipate opting for “financial holding company” status at this time.
The Company is exempt from the FRB’s consolidated capital adequacy guidelines for bank holding companies because the Company’s consolidated assets are less than $3.0 billion. The FRB consolidated capital adequacy guidelines are at least as stringent as those required for the subsidiary depository institutions.
A bank holding company is generally required to give the FRB prior written notice of any purchase or redemption of then outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the Company’s consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, FRB order or directive, or any condition imposed by, or written agreement with, the FRB. The FRB has adopted an exception to that approval requirement for well-capitalized bank holding companies that meet certain other conditions.
The FRB has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the FRB’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. The FRB’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by using available resources to provide capital funds during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. The Dodd-Frank Act codified the source of strength policy and requires the promulgation of implementing regulations. Under the prompt corrective action laws, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.
The Federal Deposit Insurance Act makes depository institutions liable to the Federal Deposit Insurance Corporation for losses suffered or anticipated by the insurance fund in connection with the default of a commonly controlled depository institution or any assistance provided by the Federal Deposit Insurance Corporation to such an institution in danger of default. That law would have potential applicability if the Company ever held as a separate subsidiary a depository institution in addition to the Bank.
The status of the Company as a registered bank holding company under the Bank Holding Company Act will not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws.
ACQUISITION OF THE HOLDING COMPANY
Under the Change in Bank Control Act (the “CIBCA”), a federal statute, a notice must be submitted to the FRB if any person (including a company), or group acting in concert, seeks to acquire 10% or more of the Company’s shares of outstanding common stock, unless the FRB has found that the acquisition will not result in a change in control of the Company. Under the CIBCA, the FRB generally has 60 days within which to act on such notices, taking into consideration certain factors, including the financial and managerial resources of the acquirer, the convenience and needs of the communities served by the Company and the Bank, and the anti-trust effects of the acquisition. Under the BHCA, any company would be required to obtain prior approval from the FRB before it may obtain “control” of the Company within the meaning of the BHCA. Control generally is defined to mean the ownership or power to vote 25% or more of any class of voting securities of the Company or the ability to control in any manner the election of a majority of the Company’s directors. An existing bank holding company would be required to obtain the FRB’s prior approval under the BHCA before acquiring more than 5% of the Company’s voting stock.
EFFECT OF GOVERNMENT MONETARY POLICIES
The earnings and growth of the banking industry are affected by the credit policies of monetary authorities, including the Federal Reserve System. An important function of the Federal Reserve System is to regulate the national supply of bank credit in order to control recessionary and inflationary pressures. Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are open market activities in U.S. government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These operations are used in varying combinations to influence overall economic growth and indirectly, bank loans, securities, and deposits. These variables may also affect interest rates charged on loans or paid on deposits. The monetary policies of the Federal Reserve authorities have had a significant effect on the operating results of commercial banks in the past and are expected to continue to have such an effect in the future.
In view of the changing conditions in the national economy and in the money markets, as well as the effect of actions by monetary and fiscal authorities including the Federal Reserve System, no prediction can be made as to possible changes in interest rates, deposit levels, loan demand or their effect on the business and earnings of the Company and the Bank. Additional information is included under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in this Annual Report on Form 10-K.
The following discussion sets forth the material risk factors that could affect the Company’s consolidated financial condition and results of operations. Readers should not consider any descriptions of these factors to be a complete set of all potential risks that could affect the Company. Any risk factor discussed below could by itself, or combined with other factors, materially and adversely affect the Company’s business, results of operations, financial condition, capital position, liquidity, competitive position or reputation, including by materially increasing expenses or decreasing revenues, which could result in material losses or a decrease in earnings.
RISKS RELATED TO THE COVID-19 PANDEMIC
The COVID-19 pandemic has impacted our business and financial results and that of many of our customers, and the ultimate impact will depend on future developments, which are highly uncertain, cannot be predicted and outside of our control, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.
The COVID-19 pandemic has created extensive disruptions to the global economy and to the lives of individuals throughout the world. Governments, businesses, and the public are taking unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal and monetary stimulus, and legislation designed to deliver financial aid and other relief. While the scope, duration, and full effects of COVID-19 are not fully known, the pandemic and the efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted market interest rates, increased economic and market uncertainty, and disrupted trade and supply chains. If these effects continue for a significantly longer term and result in further economic stress or a return to a recession, the effects of COVID-19 could have a material adverse impact on us in a number of ways as described in more detail below.
Credit Risk – Our risks of timely loan repayment and the value of collateral supporting the loans are affected by the strength of our borrowers’ businesses. Concern about the spread of COVID-19 has caused and is likely to continue to cause business shutdowns, limitations on commercial activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and commercial property vacancy rates, reduced profitability and ability for property owners to make mortgage payments, and overall economic and financial market instability, all of which may cause our customers to be unable to make scheduled loan payments. Hotel and restaurant operators and others in the leisure, hospitality and travel industries and the agricultural industry, among other industries, have been particularly hurt by COVID-19. If the effects of COVID-19 result in widespread and sustained repayment shortfalls on loans in our portfolio, we could incur significant delinquencies, foreclosures and credit losses, particularly if the available collateral is insufficient to cover our credit exposure. The future effects of COVID-19 on economic activity could negatively affect the collateral values associated with our existing loans, the ability to liquidate the real estate collateral securing our residential and commercial real estate loans, our ability to maintain loan origination volume and to obtain additional financing, the future demand for or profitability of our lending and services, and the financial condition and credit risk of our customers. Further, in the event of delinquencies, regulatory changes and policies designed to protect borrowers may slow or prevent us from making our business decisions or may result in a delay in our taking certain remediation actions, such as foreclosure. In addition, we have unfunded commitments to extend credit to customers. During a challenging economic environment like now, our customers depend more on our credit commitments and increased borrowings under these commitments could adversely impact our liquidity. Furthermore, in an effort to support our communities during the pandemic, we participated in the Paycheck Protection Program under the CARES Act whereby loans to small businesses were made and those loans were subject to the regulatory requirements that would require forbearance of loan payments for a specified time or that would limit our ability to pursue all available remedies in the event of a loan default. If the borrower under the PPP loan fails to qualify for loan forgiveness, we are at the heightened risk of holding these loans at unfavorable interest rates as compared to the loans to customers that we would have otherwise extended credit.
Strategic Risk – Our success may be affected by a variety of external factors that may affect the price or marketability of our products and services, changes in interest rates that may increase our funding costs, reduced demand for our financial products due to economic conditions and the various response of governmental and nongovernmental authorities. The COVID-19 pandemic has significantly increased economic and demand uncertainty and has led to disruption and volatility in the global capital markets. Furthermore, governmental actions have been directed toward curtailing household and business activity to contain COVID-19. The future effects of COVID-19 on economic activity could negatively affect the future banking products we provide, including a decline in originating loans.
Operational Risk – Current and future restrictions on our workforce’s access to our facilities could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations. We rely on business processes and branch activity that largely depend on people and technology, including access to information technology systems as well as information, applications, payment systems and other services provided by third parties. In response to COVID-19, at times, we have modified our business practices with a portion of our employees working remotely from their homes to have our operations uninterrupted as much as possible. Further, technology in employees’ homes may not be as robust as in our offices and could cause the networks, information systems, applications, and other tools available to employees to be more limited or less reliable than in our offices. The continuation of these work-from-home measures also introduces additional operational risk, including increased cybersecurity risk from phishing, malware, and other cybersecurity attacks, all of which could expose us to risks of data or financial loss and could seriously disrupt our operations and the operations of any impacted customers.
Moreover, we rely on many third parties in our business operations, including the appraisal of the real property collateral, vendors that supply essential services such as loan servicers, providers of financial information, systems and analytical tools and providers of electronic payment and settlement systems, and local and federal government agencies, offices, and courthouses. In light of the developing measures responding to the pandemic, many of these entities may limit the availability and access of their services. If the third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.
Interest Rate Risk/Market Value Risk – Our net interest income, lending and investment activities, deposits and profitability could be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19. In March 2020, the Federal Reserve lowered the target range for the federal funds rate to a range from 0% to 0.25%, citing concerns about the impact of COVID-19 on financial markets and market stress in the energy sector. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income and a decrease in prevailing fair market values of our investment securities and other assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition.
Because there have been no comparable recent global pandemics that resulted in similar global impact, we do not yet know the full extent of COVID-19’s effects on our business, operations, or the global economy as a whole. Any future development will be highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the effectiveness of our work-from-home arrangements, third party providers’ ability to support our operations, and any actions taken by governmental authorities and other third parties in response to the pandemic. The uncertain future development of this crisis could materially and adversely affect our business, operations, operating results, financial condition, liquidity or capital levels.
RISKS RELATED TO CHANGES IN MARKET INTEREST RATES
Changing interest rates may decrease our earnings and asset values.
Our net interest income is the interest we earn on loans and investments less the interest we pay on our deposits and borrowings. Our net interest margin is the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding. Changes in interest rates—up or down—could adversely affect our net interest margin and, as a result, our net interest income. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract. Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract until the asset yields catch up. Changes in the slope of the “yield curve”—or the spread between short-term and long-term interest rates—could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets.
Changes in interest rates also affect the value of the Bank’s interest-earning assets, and in particular the Bank’s securities portfolio. Generally, the value of fixed-rate securities fluctuates inversely with changes in interest rates. Unrealized gains and losses on securities available for sale are reported as a separate component of shareholder equity, net of tax, while unrealized gains and losses on equity securities directly impact earnings. Decreases in the fair value of securities available for sale resulting from increases in interest rates could have an adverse effect on shareholders’ equity or net income.
The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the growth of total assets, it believes that it is difficult to assess the overall impact. Management believes this to be the case due to the fact that generally neither the timing nor the magnitude of the inflationary changes in the CPI coincides with changes in interest rates. The price of one or more of the components of the CPI may fluctuate considerably and thereby influence the overall CPI without having a corresponding effect on interest rates or upon the cost of those goods and services normally purchased by us. In years of high inflation and high interest rates, intermediate and long-term interest rates tend to increase, thereby adversely impacting the market values of investment securities, mortgage loans and other long-term fixed rate loans. In addition, higher short-term interest rates caused by inflation tend to increase the cost of funds. In other years, the opposite may occur.
RISKS RELATED TO OUR LENDING ACTIVITIES
Activities related to the drilling for natural gas in the in the Marcellus and Utica Shale formations impacts certain customers of the Bank.
Our north central Pennsylvania market area is predominately centered in the Marcellus and Utica Shale natural gas exploration and drilling area, and as a result, the economy in north central Pennsylvania is influenced by the natural gas industry. Loan demand, deposit levels and the market value of local real estate are impacted by this activity. While the Company does not lend to the various entities directly engaged in exploration, drilling or production activities, many of our customers provide transportation and other services and products that support natural gas exploration and production activities. Therefore, our customers are impacted by changes in the market price for natural gas, as a significant downturn in this industry could impact the ability of our borrowers to repay their loans in accordance with their terms. Additionally, exploration and drilling activities may be affected by federal, state and local laws and regulations such as restrictions on production, permitting, changes in taxes and environmental protection. Regulatory and market pricing of natural gas could also impact and/or reduce demand for loans and deposit levels or loan collateral values. These factors could have a material adverse effect on our business, prospects, financial condition and results of operations.
Higher loan losses could require us to increase our allowance for loan losses through a charge to earnings.
When we loan money, we incur the risk that our borrowers do not repay their loans. We reserve for loan losses by establishing an allowance through a charge to earnings. The amount of this allowance is based on our assessment of loan losses inherent in our loan portfolio. The process for determining the amount of the allowance is critical to our financial results and condition. It requires subjective and complex judgments about the future, including forecasts of economic or market conditions that might impair the ability of our borrowers to repay their loans. We might underestimate the loan losses inherent in our loan portfolio and have loan losses in excess of the amount reserved. We might increase the allowance because of changing economic conditions. For example, in a rising interest rate environment, borrowers with adjustable-rate loans could see their payments increase. There may be a significant increase in the number of borrowers who are unable or unwilling to repay their loans, resulting in our charging off more loans and increasing our allowance. In addition, when real estate values decline, the potential severity of loss on a real estate-secured loan can increase significantly, especially in the case of loans with high combined loan-to-value ratios. A decline in the national economy and the local economies of the areas in which the loans are concentrated could result in an increase in loan delinquencies, foreclosures or repossessions resulting in increased charge-off amounts and the need for additional loan loss allowances in future periods. In addition, bank regulators may require us to make a provision for loan losses or otherwise recognize further loan charge-offs following their periodic review of our loan portfolio, our underwriting procedures, and our loan loss allowance. Any increase in our allowance for loan losses or loan charge-offs as required by such regulatory authorities could have a material adverse effect on our financial condition and results of operations.
Our allowance for loan losses amounted to $17.3 million, or 1.20% of total loans outstanding and 225.8% of nonperforming loans, at December 31, 2021. Our allowance for loan losses at December 31, 2021 may not be sufficient to cover future loan losses. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would decrease our earnings. In addition, at December 31, 2021 the top 40 relationships of the Bank had an outstanding balance of $393.8 million. These loans represent approximately 27.3% of our entire outstanding loan portfolio as of December 31, 2021 and the deterioration of one or more of these loans could result in a significant increase in our nonperforming loans and our provision for loan losses, which would negatively impact our results of operations.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be affected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. On October 16, 2019, the FASB voted to defer the effective date for ASC 326, Financial Instruments – Credit Losses, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. The implementation of this standard may result in significant changes to the balance in the allowance for loan losses and may result in significant costs being expended to implement.
Our emphasis on commercial real estate, agricultural real estate, construction and municipal lending may expose us to increased lending risks.
At December 31, 2021, we had $687.3 million in loans secured by commercial real estate, $312.0 million in agricultural real estate loans, $55.0 million in construction loans and $45.8 million in municipal loans. Commercial real estate loans, agricultural real estate, construction and municipal loans represented 47.7%, 21.6%, 3.8% and 3.1%, respectively, of our loan portfolio. At December 31, 2021, we had $13.5 million of reserves specifically allocated to these loan types. While commercial real estate, agricultural real estate, construction and municipal loans are generally more interest rate sensitive and carry higher yields than do residential mortgage loans, these types of loans generally expose a lender to greater risk of non-payment and loss than single-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property, the income stream of the borrowers and, for construction loans, the accuracy of the estimate of the property’s value at completion of construction and the estimated cost of construction. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to single-family residential mortgage loans. We monitor loan concentrations on an individual relationship and industry wide basis to monitor the amount of risk we have in our loan portfolio.
Agricultural loans are dependent for repayment on the successful operation and management of the farm property, the health of the agricultural industry broadly, and on the location of the borrower in particular, and other factors outside of the borrower’s control.
At December 31, 2021, our agricultural loans, consisting primarily of agricultural real estate loans and other agricultural loans totaled $351.9 million, representing 24.4% of our total loan portfolio. The primary activities of our agricultural customers include dairy and beef farms, poultry and swine operations, crops and support businesses. Agricultural markets are highly sensitive to real and perceived changes in the supply and demand of agricultural products. Weaker prices could reduce the value of agricultural land in our local markets and thereby increase the risk of default by our borrowers or reduce the foreclosure value of agricultural land, animals and equipment that serves as collateral for certain of our loans. At December 31, 2021, the Company had a loan concentration to the dairy industry totaling $127,392,000, or 8.8% of total loans and 36.2% of total agricultural loans compared to 9.90% of total loans and 38.2% of total agricultural loans at December 31, 2020.
Our agricultural loans are dependent on the profitable operation and management of the farm property securing the loan and its cash flows. The success of a farm property may be affected by many factors outside the control of the borrower, including:
| • | The COVID-19 pandemic and its impact to supply and demand constraints |
| • | adverse weather conditions (such as hail, drought and floods), restrictions on water supply or other conditions that prevent the planting or harvesting of a crop or limit crop yields; |
| • | loss of crops or livestock due to disease or other factors; |
| • | declines in the market prices or demand for agricultural products (both domestically and internationally), for any reason; |
| • | increases in production costs (such as the costs of labor, rent, feed, fuel and fertilizer); |
| • | the impact of domestic and international government policies and regulations (including changes in price supports, subsidies, government-sponsored crop insurance, minimum ethanol content requirements for gasoline, tariffs, trade barriers, trade agreements and health and environmental regulations); |
| • | access to technology and the successful implementation of production technologies; and |
| • | changes in the general economy that could affect the availability of off-farm sources of income and prices of real estate for borrowers. |
| • | Disruptions in the supply chain and the processing of product and delivery to the final retail channel |
Lower prices for agricultural products may cause farm revenues to decline and farm operators may be unable to reduce expenses as quickly as their revenues decline. In addition, many farms are dependent on a limited number of key individuals whose injury or death could significantly affect the successful operation of the farm. If the cash flow from a farming operation is diminished, the borrower’s ability to repay the loan may be impaired. Consequently, agricultural loans may involve a greater degree of risk than residential mortgage lending, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as farm equipment (some of which is highly specialized with a limited or no market for resale) or perishable assets such as livestock or crops. In such cases, any repossessed collateral for a defaulted agricultural operating loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation or because the assessed value of the collateral exceeds the eventual realization value.
Loan participations comprise a portion of our loan portfolio and a decline in loan participation volume could hurt profits and slow loan growth.
We have actively engaged in loan participations whereby we are invited to participate in loans, primarily commercial real estate and municipal loans, originated by another financial institution known as the lead lender. We have participated with other financial institutions in both our primary markets and out of market areas. We underwrite any loan we participate in as if we are originating the loan. The primary difference is that financial information is received from the participating financial institution and not the borrower. The loans we participate in totaled $58.3 million and $63.3 million at December 31, 2021 and 2020, respectively. As a percent of total loans, participation purchased loans were 4.0%, 4.5% and 5.6% as of December 31, 2021, 2020 and 2019. Our profits and loan growth could be significantly and adversely affected if the volume of loan participations would materially decrease, whether because loan demand declines, loan payoffs, lead lenders may come to perceive us as a potential competitor in their respective market areas, or otherwise.
Environmental liability associated with lending activities could result in losses.
In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances were discovered on any of these properties, we could be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit use of properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.
RISKS RELATED TO OUR INVESTMENT SECURITIES
If we conclude that the decline in value of any of our investment securities is other than temporary, we are required to write down the value of that security through a charge to earnings.
We review our investment securities portfolio monthly and at each quarter-end reporting period to determine whether the fair value is below the current carrying value. When the fair value of any of our investment securities has declined below its carrying value, we are required to assess whether the decline is other than temporary. If we conclude that the decline is other than temporary, we are required to write down the value of that security through a charge to earnings. As of December 31, 2021, our investment portfolio included available for sale investment securities with an amortized cost of $412.0 million and a fair value of $412.4 million, which included unrealized losses on 138 securities totaling $3,997,000. Changes in the expected cash flows of these securities and/or prolonged price declines may result in our concluding in future periods that the impairment of these securities is other than temporary, which would require a charge to earnings to write down these securities to their fair value. Any charges for other-than-temporary impairment would not impact cash flow, tangible capital or liquidity.
RISKS RELATED TO OUR SECONDARY MORTGAGE OPERATIONS
Income from secondary mortgage market operations is volatile, and we may incur losses or charges with respect to our secondary mortgage market operations which would negatively affect our earnings.
We generally sell in the secondary market the longer term fixed-rate residential mortgage loans that we originate, earning non-interest income in the form of gains on sale. When interest rates rise, the demand for mortgage loans tends to fall and may reduce the number of loans available for sale. In addition to interest rate levels, weak or deteriorating economic conditions also tend to reduce loan demand. Although we sell loans in the secondary market without recourse, we are required to give customary representations and warranties to the buyers. If we breach those representations and warranties, the buyers can require us to repurchase the loans and we may incur a loss on the repurchase. Because we generally retain the servicing rights on the loans we sell in the secondary market, we are required to record a mortgage servicing right asset, which we test annually for impairment. The value of mortgage servicing rights tends to increase with rising interest rates, which occurred in 2021, and to decrease with falling interest rates, with activity increasing in falling rate environments. If we are required to take an impairment charge on our mortgage servicing rights our earnings would be adversely affected.
As a result of the acquisition in 2015, the Bank acquired a portfolio of loans sold to the FHLB, which were sold under the Mortgage Partnership Finance Program (“MPF”). While the Bank was not an active participant in the MPF program in 2021, we continue to evaluate the program to see if it would be beneficial to our customers and our performance. The MPF portfolio balance was $12,140,000 at December 31, 2021. The FHLB maintains a first-loss position for the MPF portfolio that totals $157,000. Should the FHLB exhaust its first-loss position, recourse to the Bank’s credit enhancement would be up to the next $590,000 of losses. The Bank has not experienced any losses for the MPF portfolio.
RISKS RELATED TO OUR MARKET AREA
The Company’s financial condition and results of operations are dependent on the economy in the Bank’s market area.
The Bank’s primary market area consists of the Pennsylvania Counties of Bradford, Clinton, Potter, and Tioga in north central Pennsylvania, Lebanon, Schuylkill, Berks and Lancaster in south central, Pennsylvania, Centre and Clinton in central Pennsylvania, and Allegany, Steuben, Chemung and Tioga Counties in southern New York. With the acquisition of MidCoast, we consider the cities and surrounding areas of Wilmington and Dover, Delaware, as well as Kennett Square, Pennsylvania in Chester County, as primary market areas. The majority of the Bank’s loan and deposits come from households and businesses whose primary address is located in the Bank’s primary market areas. Because of the Bank’s concentration of business activities in its market area, the Company’s financial condition and results of operations depend upon economic conditions in its market areas. Adverse economic conditions in our market areas could reduce our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations. Conditions such as inflation, recession, unemployment, high interest rates and short money supply and other factors beyond our control may adversely affect our profitability. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in the States of Pennsylvania, New York and Delaware could adversely affect the value of our assets, revenues, results of operations and financial condition. Moreover, we cannot give any assurance we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.
RISKS RELATED TO LAWS AND REGULATIONS
Regulation of the financial services industry is significant, and future legislation could increase our cost of doing business or harm our competitive position.
We are subject to extensive regulation, supervision and examination by the FRB and the PDB, our primary regulators, and by the FDIC, as insurer of our deposits. Such regulation and supervision governs the activities in which an institution and its holding company may engage and are intended primarily for the protection of the insurance fund and the depositors and borrowers of the Bank rather than for holders of our common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our profitability and operations. Future legislative changes could require changes to business practices or force us to discontinue businesses and potentially expose us to additional costs, liabilities, enforcement action and reputational risk.
Our ability to pay dividends is limited by law.
Our ability to pay dividends to our shareholders largely depends on our receipt of dividends from the Bank. The amount of dividends that the Bank may pay to us is limited by federal and state laws and regulations. We also may decide to limit the payment of dividends even when we have the legal ability to pay them in order to retain earnings for use in our business.
Federal and state banking laws, our articles of incorporation and our by-laws may have an anti-takeover effect.
Federal law imposes restrictions, including regulatory approval requirements, on persons seeking to acquire control over us. Pennsylvania law also has provisions that may have an anti-takeover effect. These provisions may serve to entrench management or discourage a takeover attempt that shareholders consider to be in their best interest or in which they would receive a substantial premium over the current market price.
RISKS RELATED TO COMPETITION
Strong competition within the Bank’s market areas could hurt profits and slow growth.
The Bank faces intense competition both in making loans and attracting deposits. This competition has made it more difficult for the Bank to make new loans and at times has forced the Bank to offer higher deposit rates. Price competition for loans and deposits might result in the Bank earning less on loans and paying more on deposits, which would reduce net interest income. Competition also makes it more difficult to increase the volume of our loan and deposit portfolios. As of June 30, 2021, which is the most recent date for which information is available, we held 34.2% of the FDIC insured deposits in Bradford, Potter and Tioga Counties, Pennsylvania, which was the second largest share of deposits out of eight financial institutions with offices in the area, and 6.0% of the FDIC insured deposits in Allegany County, New York, which was the third largest share of deposits out of three financial institutions with offices in this area. As of June 30, 2021, we held 7.6% of the FDIC insured deposits in Lebanon County, Pennsylvania, which was the fourth largest share out of the 14 financial institutions with offices in the County. As of June 30, 2021, we held 3.6% of the FDIC insured deposits in Clinton County, Pennsylvania, which was the eighth largest share out of the eight financial institutions with offices in the County. Our offices in Berks, Centre, Chester, Lancaster and Schuylkill Counties of Pennsylvania and our offices in Wilmington and Dover, Delaware all have less than 3% of the FDIC insured deposits of the corresponding County as of June 30, 2021. This data does not include deposits held by credit unions. Competition also makes it more difficult to hire employees and more expensive to retain experienced employees. Some of the institutions with which the Bank competes have substantially greater resources and lending limits than the Bank has and may offer services that the Bank does not provide. Management expects competition to increase in the future as a result of legislative, regulatory and technological changes (fintech) and the continuing trend of consolidation in the financial services industry. The Bank’s profitability depends upon its continued ability to compete successfully in its market area.
RISKS RELATED TO OUR OPERATIONS
We rely on our management and other key personnel, and the loss of any of them may adversely affect our operations.
We are and will continue to be dependent upon the services of our executive management team. In addition, we will continue to depend on our ability to retain and recruit key commercial and agricultural loan officers. The unexpected loss of services of any key management personnel or commercial and agricultural loan officers could have an adverse effect on our business and financial condition because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
We are periodically subject to examination and scrutiny by a number of banking agencies and, depending upon the findings and determinations of these agencies, we may be required to make adjustments to our business that could adversely affect us.
Federal and state banking agencies periodically conduct examinations of our business, including compliance with applicable laws and regulations. If, as a result of an examination, a banking agency was to determine that the financial condition, capital resources, asset quality, asset concentration, earnings prospects, management, liquidity, sensitivity to market risk or other aspects of any of our operations has become unsatisfactory, or that we or our management is in violation of any law or regulation, it could take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to change the composition of our assets or liabilities, to assess civil monetary penalties against us and/or our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance. If we become subject to such regulatory actions, our business, results of operations and reputation may be negatively impacted.
We are subject to certain risks in connection with our use of technology.
Communications and information systems are essential to the conduct of our business, as we use such systems to manage our customer relationships, our general ledger, our deposits, our loans, and to deliver on-line and electronic banking services. Our operations rely on the secure processing, storage, and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems, software, and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses, or other malicious code and cyber attacks that could have a security impact.
In addition, breaches of security may occur through intentional or unintentional acts by those having authorized or unauthorized access to our confidential or other information or the confidential or other information of our customers, clients, or counterparties. If one or more of such events were to occur, the confidential and other information processed and stored in, and transmitted through, our computer systems and networks could potentially be jeopardized, or could otherwise cause interruptions or malfunctions in our operations or the operations of our customers, clients, or counterparties. This could cause us significant reputational damage or result in our experiencing significant losses from fraud or otherwise.
Furthermore, we may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures arising from operational and security risks. Also, we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance we maintain.
We routinely transmit and receive personal, confidential, and proprietary information by e-mail and other electronic means. We have discussed and worked with our customers, clients, and counterparties to develop secure transmission capabilities, but we do not have, and may be unable to put in place, secure capabilities with all of these constituents, and we may not be able to ensure that these third parties have appropriate controls in place to protect the confidentiality of such information. Any interception, misuse, or mishandling of personal, confidential, or proprietary information being sent to or received from a customer, client, or counterparty could result in legal liability, regulatory action, and reputational harm, and could have a significant adverse effect on our competitive position, financial condition, and results of operations.
Our risk management framework may not be effective in mitigating risks and/or losses to us.
We have implemented a risk management framework to manage our risk exposure. This framework is comprised of various processes, systems and strategies, and is designed to manage the types of risk to which we are subject, including, among others, credit, market, liquidity, interest rate and compliance. Our framework also includes financial or other modeling methodologies which involve management assumptions and judgment. There is no assurance that our risk management framework will be effective under all circumstances or that it will adequately mitigate any risk or loss to us. If our framework is not effective, we could suffer unexpected losses and our business, financial condition, results of operations or prospects could be materially and adversely affected. We may also be subject to potentially adverse regulatory consequences.
RISKS RELATED TO LIBOR
Changes in the method pursuant to which benchmark rates, including LIBOR, are calculated and their potential discontinuance could adversely impact our business operations and financial results.
Many of our lending products, securities and derivatives utilize a benchmark rate to determine the applicable interest rate or payment amount. As the Company has grown and developed relationships with larger and more sophisticated borrowers, the benchmarks utilized by the Company have changed with an increased usage of LIBOR. In July 2017, the Chief Executive of the U.K. Financial Conduct Authority (“FCA”) announced that the FCA intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR after 2021. This announcement indicates that the continuation of LIBOR cannot and will not be guaranteed after 2021. Instruments associated with LIBOR have been identified by the Company, and transition procedures to a revised benchmark are being developed.
The discontinuation of a benchmark rate, changes in a benchmark rate, or changes in market perceptions of the acceptability of a benchmark rate, including LIBOR, could, among other things, adversely affect the value of and return on certain of our financial instruments or products, result in changes to our risk exposures, or require renegotiation of previous transactions. In addition, any such discontinuation or changes, whether actual or anticipated, could result in market volatility, adverse tax or accounting effects, increased compliance, legal and operational costs, and risks associated with customer disclosures and contract negotiations. The transition to using a new rate could also expose us to risks associated with disputes with customers and other market participants in connection with interpreting and implementing fallback provisions.
Various regulators, industry bodies and other market participants in the U.S. are engaged in initiatives to develop, introduce and encourage the use of alternative rates to replace certain benchmarks. Despite progress made to date by regulators and industry participants, such as us, to prepare for the anticipated discontinuation of LIBOR, significant uncertainties still remain. Such uncertainties relate to, for example, whether replacement benchmark rates may become accepted alternatives to LIBOR for different types of transactions and financial instruments, how the terms of any transaction or financial instrument may be adjusted to account for differences between LIBOR and any alternative rate selected, how any replacement would be implemented across the industry, and the effect any changes in industry views or movement to alternative benchmarks would have on the markets for LIBOR-linked financial instruments.
RISKS RELATED TO OUR MERGER AND ACQUISITION ACTIVITY
Impairment of goodwill could require charges to earnings, which could result in a negative impact on our results of operations.
Our goodwill could become impaired in the future. If goodwill were to become impaired, it could limit the ability of the Bank to pay dividends to the Company, adversely impacting the Company’s liquidity and ability to pay dividends. The most significant assumptions affecting our goodwill impairment evaluation are variables including the market price of our Common Stock, projections of earnings, and the control premium above our current stock price that an acquirer would pay to obtain control of us. We are required to test goodwill for impairment at least annually or when impairment indicators are present. If an impairment determination is made in a future reporting period, our earnings and book value of goodwill will be reduced by the amount of the impairment. If an impairment loss is recorded, it will have little or no impact on the tangible book value of our Common Stock, or our regulatory capital levels, but such an impairment loss could significantly reduce the Bank’s earnings and thereby restrict the Bank’s ability to make dividend payments to us without prior regulatory approval, because Federal Reserve policy states the bank holding company dividends should be paid from current earnings. At December 31, 2021, the book value of our goodwill was $31.4 million, all of which was recorded at the Bank.
We may fail to realize all of the anticipated benefits of entering new markets.
As a result of completed and proposed acquisitions and the hiring of additional agricultural and commercial lending teams, the Company enters new banking market areas. The success of entering these new markets depends upon, in part, the Company’s ability to realize the anticipated benefits and cost savings from combining the businesses of the Company and the acquisition, as well as organically growing loans and deposits. To realize these anticipated benefits and cost savings, the businesses and individuals must be successfully combined and operated. If the Company is not able to achieve these objectives, the anticipated benefits, including growth and cost savings related to the combined businesses, may not be realized at all or may take longer to realize than expected. If the Company fails to realize the anticipated benefits of the acquisitions and the new employee hiring’s, the Company’s results of operations could be adversely affected.
ITEM 1B – UNRESOLVED STAFF COMMENTS.
Not applicable.
The headquarters of the Company and Bank are located at 15 South Main Street, Mansfield, Pennsylvania. The building contains the central offices of the Company and Bank. Our bank owns twenty three banking facilities and leases eleven other facilities.
The net book value of owned banking facilities and leasehold improvements totaled $16,323,000 as of December 31, 2021. The properties are adequate to meet the needs of the employees and customers. We have equipped all of our facilities with current technological improvements for data processing.
ITEM 3 - LEGAL PROCEEDINGS.
The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings in the aggregate are believed by management to be immaterial to the Company’s consolidated financial condition or results of operations.
ITEM 4 – MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
The Company’s stock is not listed on any stock exchange, but it is quoted on the OTC Pink Market under the trading symbol CZFS. Prices presented in the table below are bid prices between broker-dealers published by the OTC Pink Market and the Pink Sheets Electronic Quotation Service. The prices do not include retail markups or markdowns or any commission to the broker-dealer. The bid prices do not necessarily reflect prices in actual transactions. For 2021 and 2020, cash dividends were declared on a quarterly basis and are summarized in the table below:
| | | | Dividends declared per share | | | | | | Dividends declared per share | |
| | 2021 | 2020 |
| High | | | Low | High | | | Low |
| First quarter | | $ | 58.42 | | | $ | 53.96 | | | $ | 0.465 | | | $ | 64.85 | | | $ | 37.62 | | | $ | 0.555 | |
| Second quarter | | | 62.50 | | | | 58.42 | | | | 0.465 | | | | 56.47 | | | | 48.66 | | | | 0.455 | |
| Third quarter | | | 64.00 | | | | 61.10 | | | | 0.470 | | | | 49.56 | | | | 43.25 | | | | 0.460 | |
| Fourth quarter | | | 61.50 | | | | 59.00 | | | | 0.470 | | | | 55.00 | | | | 43.00 | | | | 0.460 | |
The Company has paid dividends since April 30, 1984, the effective date of our formation as a bank holding company. The Company’s Board of Directors expects that comparable cash dividends will continue to be paid by the Company in the future; however, future dividends necessarily depend upon earnings, financial condition, appropriate legal restrictions and other factors in existence at the time the Board of Directors considers a dividend distribution. Cash available for dividend distributions to stockholders of the Company comes primarily from dividends paid to the Company by the Bank. Therefore, restrictions on the ability of the Bank to make dividend payments are directly applicable to the Company. Under the Pennsylvania Business Corporation Law of 1988, the Company may pay dividends only if, after payment, the Company would be able to pay debts as they become due in the usual course of our business and total assets will be greater than the sum of total liabilities. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions. Also see “Supervision and Regulation – Regulatory Restrictions on Bank Dividends,” “Supervision and Regulation – Holding Company Regulation,” and “Note 15 – Regulatory Matters” to the consolidated financial statements.
As of March 1, 2022, the Company had 1,876 stockholders of record. The computation of stockholders of record excludes investors whose shares were held for them by a bank or broker at that date. The following table presents information regarding the Company’s stock repurchases during the three months ended December 31, 2021:
| 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 of Programs | | | Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs (1) | |
| | | | | | | | | | | | | |
| 10/1/21 to 10/31/21 | | | - | | | $ | 0.00 | | | | - | | | | 142,986 | |
| 11/1/21 to 11/30/21 | | | 2,634 | | | $ | 61.43 | | | | 2,634 | | | | 140,352 | |
| 12/1/21 to 12/31/21 | | | 5,263 | | | $ | 60.46 | | | | 5,263 | | | | 135,089 | |
| Total | | | 7,897 | | | $ | 60.78 | | | | 7,897 | | | | 135,089 | |
| (1) | On April 21, 2020, the Company announced that the Board of Directors authorized the Company to repurchase up to an additional 150,000 shares at an aggregate purchase price not to exceed $12.0 million over a period of 36 months. The repurchases will be conducted through open-market purchases or privately negotiated transactions and will be made from time to time depending on market conditions and other factors. No time limit was placed on the duration of the share repurchase program. Any repurchased shares will be held as treasury stock and will be available for general corporate purposes. |
ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
CAUTIONARY STATEMENT
We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of the Company, the Bank, First Citizens Insurance, Realty or the Company on a consolidated basis. When we use words such as “believes,” “expects,” “anticipates,” or similar expressions, we are making forward-looking statements. Forward-looking statements may prove inaccurate. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements:
| • | The scope, duration and severity of the COVID-19 pandemic and may have an adverse effect on our business and operations, our customers, including their ability to make timely loan payments, our service providers, and on the economy and financial markets more significant that we expect. |
| • | Interest rates could change more rapidly or more significantly than we expect. |
| • | The economy could change significantly in an unexpected way, which would cause the demand for new loans and the ability of borrowers to repay outstanding loans to change in ways that our models do not anticipate. |
| • | The financial markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities. |
| • | It could take us longer than we anticipate implementing strategic initiatives, including expansions, designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all. |
| • | Acquisitions and dispositions of assets could affect us in ways that management has not anticipated. |
| • | We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition or operating results. |
| • | We may become subject to new and unanticipated accounting, tax, regulatory or compliance practices or requirements. Failure to comply with any one or more of these requirements could have an adverse effect on our operations. |
| • | We could experience greater loan delinquencies than anticipated, adversely affecting our earnings and financial condition. |
• We could experience greater losses than expected due to the ever increasing volume of information theft and fraudulent scams impacting our customers and the banking industry.
| • | We could lose the services of some or all of our key personnel, which would negatively impact our business because of their business development skills, financial expertise, lending experience, technical expertise and market area knowledge. |
| • | The agricultural economy is subject to extreme swings in both the costs of resources and the prices received from the sale of products as a result of weather, government regulations, international trade agreements and consumer tastes, which could negatively impact certain of our customers. |
| • | Loan concentrations in certain industries could negatively impact our results, if financial results or economic conditions deteriorate. |
| • | A budget impasse in the Commonwealth of Pennsylvania could impact our asset values, liquidity and profitability as a result of either delayed or reduced funding to school districts and municipalities who are customers of the bank. |
| • | Companies providing support services related to the exploration and drilling of the natural gas reserves in our market area may be affected by federal, state and local laws and regulations such as restrictions on production, permitting, changes in taxes and environmental protection, which could negatively impact our customers and, as a result, negatively impact our loan and deposit volume and loan quality. Additionally, the activities the companies providing support services related to the exploration and drilling of the natural gas reserves may be dependent on the market price of natural gas. As a result, decreases in the market price of natural gas could also negatively impact these companies, our customers. |
Additional factors are discussed in this Annual Report on Form 10-K under “Item 1A. Risk Factors.” These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Forward-looking statements speak only as of the date they are made and the Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date of the forward-looking statements or to reflect the occurrence of unanticipated events. Accordingly, past results and trends should not be used by investors to anticipate future results or trends.
INTRODUCTION
The following is management’s discussion and analysis of the significant changes in financial condition, the results of operations, capital resources and liquidity presented in the accompanying consolidated financial statements for the Company. The Company’s consolidated financial condition and results of operations consist almost entirely of the Bank’s financial condition and results of operations. Management’s discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes. Except as noted, tabular information is presented in thousands of dollars.
The Company currently engages in the general business of banking throughout its service area of Bradford, Tioga, Clinton, Potter and Centre counties in north central Pennsylvania, Lebanon, Berks, Schuylkill and Lancaster counties in south central Pennsylvania and Allegany County in southern New York. We also have a limited branch office in Union county, Pennsylvania, which primarily serves agricultural customers in the central Pennsylvania market. We maintain our main office in Mansfield, Pennsylvania. Presently we operate 34 banking facilities, 31 of which operate as bank branches. In Pennsylvania, the Company has full service offices located in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, Rome, the Mansfield Wal-Mart Super Center, Mill Hall, Schuylkill Haven, Friedensburg, Mt. Aetna, Fredericksburg, Mount Joy, Fivepointville, State College and two branches near the city of Lebanon, Pennsylvania. In November of 2020, we opened a full service branch in Kennett Square, Pennsylvania. We also have a limited branch office in Winfield, Pennsylvania. In New York, our office is in Wellsville. There are two branches in Wilmington Delaware, one branch in Dover Delaware, and a corporate administration building in Wilmington, Delaware, which were acquired as part of the MidCoast acquisition in April 2020.
Risk identification and management are essential elements for the successful management of the Company. In the normal course of business, the Company is subject to various types of risk, including interest rate, credit, liquidity, reputational and regulatory risk.
Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates. Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company. The Company uses its asset/liability and funds management policies to control and manage interest rate risk.
Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from loans with customers and the purchasing of securities. The Company’s primary credit risk is in the loan portfolio. The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for loan losses. Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio.
Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Company has established guidelines within its asset/liability and funds management policy to manage liquidity risk. These guidelines include, among other things, contingent funding alternatives.
Reputational risk, or the risk to our business, earnings, liquidity, and capital from negative public opinion, could result from our actual or alleged conduct in a variety of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, ethical issues, or inadequate protection of customer information, which could include identify theft, or theft of customer information through third parties. We expend significant resources to comply with regulatory requirements. Failure to comply could result in reputational harm or significant legal or remedial costs. Damage to our reputation could adversely affect our ability to retain and attract new customers, and adversely impact our earnings and liquidity.
Regulatory risk represents the possibility that a change in law, regulations or regulatory policy may have a material effect on the business of the Company and its subsidiary. We cannot predict what legislation might be enacted or what regulations might be adopted, or if adopted, the effect thereof on our operations.
Readers should carefully review the risk factors described in other documents the Company files with the SEC, including the annual reports on Form 10-K, the quarterly reports on Form 10-Q and any current reports on Form 8-K filed by us.
SELECTED FINANCIAL DATA
The following table sets forth certain financial data as of and for each of the years in the five year period ended December 31, 2021:
| (in thousands, except per share data) | | 2021 | | | 2020 | | | 2019 | | | 2018 | | | 2017 | |
| Interest and dividend income | | $ | 73,217 | | | $ | 70,296 | | | $ | 61,980 | | | $ | 56,758 | | | $ | 48,093 | |
| Interest expense | | | 7,105 | | | | 8,105 | | | | 12,040 | | | | 9,574 | | | | 5,839 | |
| Net interest income | | | 66,112 | | | | 62,191 | | | | 49,940 | | | | 47,184 | | | | 42,254 | |
| Provision for loan losses | | | 1,550 | | | | 2,400 | | | | 1,675 | | | | 1,925 | | | | 2,540 | |
| Net interest income after provision for loan losses | | | 64,562 | | | | 59,791 | | | | 48,265 | | | | 45,259 | | | | 39,714 | |
| Non-interest income | | | 11,754 | | | | 11,158 | | | | 8,242 | | | | 7,754 | | | | 7,621 | |
| Investment securities gains (losses), net | | | 551 | | | | 264 | | | | 144 | | | | (19 | ) | | | 1,035 | |
| Non-interest expenses | | | 41,550 | | | | 40,847 | | | | 33,341 | | | | 31,557 | | | | 29,314 | |
| Income before provision for income taxes | | | 35,317 | | | | 30,366 | | | | 23,310 | | | | 21,437 | | | | 19,056 | |
| Provision for income taxes | | | 6,199 | | | | 5,263 | | | | 3,820 | | | | 3,403 | | | | 6,031 | |
| Net income | | $ | 29,118 | | | $ | 25,103 | | | $ | 19,490 | | | $ | 18,034 | | | $ | 13,025 | |
| | | | | | | | | | | | | | | | | | | | | |
| Per share data: | | | | | | | | | | | | | | | | | | | | |
| Net income - Basic (1) | | $ | 7.38 | | | $ | 6.53 | | | $ | 5.42 | | | $ | 4.99 | | | $ | 3.59 | |
| Net income - Diluted (1) | | | 7.38 | | | | 6.53 | | | | 5.41 | | | | 4.98 | | | | 3.59 | |
| Cash dividends declared (1) | | | 1.86 | | | | 1.90 | | | | 1.74 | | | | 1.69 | | | | 1.60 | |
| Stock dividend | | | 1 | % | | | 1 | % | | | 1 | % | | | 1 | % | | | 5 | % |
| Book value (1) (2) | | | 53.91 | | | | 48.40 | | | | 43.14 | | | | 39.59 | | | | 36.45 | |
| | | | | | | | | | | | | | | | | | | | | |
| End of Period Balances: | | | | | | | | | | | | | | | | | | | | |
| Total assets | | $ | 2,143,863 | | | $ | 1,891,674 | | | $ | 1,466,339 | | | $ | 1,430,712 | | | $ | 1,361,886 | |
| Available for sale securities | | | 412,402 | | | | 295,189 | | | | 240,706 | | | | 241,010 | | | | 254,782 | |
| Loans | | | 1,441,533 | | | | 1,405,281 | | | | 1,115,569 | | | | 1,081,883 | | | | 1,000,525 | |
| Allowance for loan losses | | | 17,304 | | | | 15,815 | | | | 13,845 | | | | 12,884 | | | | 11,190 | |
| Total deposits | | | 1,836,511 | | | | 1,588,858 | | | | 1,211,118 | | | | 1,185,156 | | | | 1,104,943 | |
| Total borrowings | | | 73,977 | | | | 88,838 | | | | 85,117 | | | | 91,194 | | | | 114,664 | |
| Stockholders’ equity | | | 212,492 | | | | 194,259 | | | | 157,774 | | | | 139,229 | | | | 129,011 | |
| | | | | | | | | | | | | | | | | | | | | |
| Key Ratios | | | | | | | | | | | | | | | | | | | | |
| Return on assets (net income to average total assets) | | | 1.45 | % | | | 1.46 | % | | | 1.34 | % | | | 1.29 | % | | | 1.03 | % |
| Return on equity (net income to average total equity) | | | 14.26 | % | | | 14.21 | % | | | 13.00 | % | | | 13.00 | % | | | 10.04 | % |
| Equity to asset ratio (average equity to average total assets, excluding other comprehensive income) | | | 10.20 | % | | | 10.27 | % | | | 10.31 | % | | | 9.90 | % | | | 10.31 | % |
| Net interest margin (tax equivalent) (3) | | | 3.52 | % | | | 3.92 | % | | | 3.72 | % | | | 3.66 | % | | | 3.80 | % |
| Efficiency (4) | | | 51.57 | % | | | 53.62 | % | | | 54.27 | % | | | 55.04 | % | | | 54.82 | % |
| Dividend payout ratio (dividends declared divided by net income) | | | 25.36 | % | | | 29.32 | % | | | 32.40 | % | | | 34.08 | % | | | 44.97 | % |
| Tier 1 leverage (5) | | | 9.31 | % | | | 9.16 | % | | | 9.77 | % | | | 9.15 | % | | | 9.18 | % |
| Common equity risk based capital (5) | | | 12.03 | % | | | 11.22 | % | | | 12.11 | % | | | 11.47 | % | | | 11.27 | % |
| Tier 1 risk-based capital (5) | | | 12.53 | % | | | 11.75 | % | | | 12.79 | % | | | 12.18 | % | | | 12.04 | % |
| Total risk-based capital (5) | | | 14.35 | % | | | 12.86 | % | | | 14.04 | % | | | 13.42 | % | | | 13.21 | % |
| Nonperforming assets/total loans | | | 0.61 | % | | | 0.93 | % | | | 1.38 | % | | | 1.33 | % | | | 1.18 | % |
| Nonperforming loans/total loans | | | 0.53 | % | | | 0.80 | % | | | 1.08 | % | | | 1.27 | % | | | 1.07 | % |
| Allowance for loan losses/total loans | | | 1.20 | % | | | 1.13 | % | | | 1.24 | % | | | 1.19 | % | | | 1.12 | % |
| Net (recoveries)charge-offs/average loans | | | 0.00 | % | | | 0.03 | % | | | 0.06 | % | | | 0.02 | % | | | 0.03 | % |
(1) Amounts were adjusted to reflect stock dividends.
(2) Calculation excludes accumulated other comprehensive income.
(3) Tax adjusted net interest income to average interest-earning assets. Tax adjusted net Interest income is a non-gaap measure and is reconciled to the GAAP equivalent measure on page 26 of this 10k.
(4) Bank non-interest expenses to tax adjusted net interest income and non-interest income, excluding security gains. Tax adjusted net Interest income is a non-gaap measure and is reconciled to the GAAP equivalent measure on page 30 of this 10k. The efficiency ratio calculated using non-tax effected net interest income was 52.21%, 54.50%, 55.36%, 56.26% and 57.68%, for the years ended 2021, 2020, 2019, 2018 and 2017, respectively.
(5) Ratio calculated on consolidated level
TRUST AND INVESTMENT SERVICES; OIL AND GAS SERVICES
Our Investment and Trust Division is committed to helping our customers meet their financial goals. The Trust Division offers professional trust administration, investment management services, estate planning and administration, custody of securities and individual retirement accounts. In addition to traditional trust and investment services offered, we assist our customers through various oil and gas specific leasing matters from lease negotiations to establishing a successful approach to personal wealth management. Assets held by the Bank in a fiduciary or agency capacity for its customers are not included in the consolidated financial statements since such items are not assets of the Bank. As of December 31, 2021 and 2020, assets owned and invested by customers of the Bank through the Bank’s investment representatives totaled $282.1 million and $241.0 million, respectively. Additionally, as summarized in the table below, the Trust Department had assets under management as of December 31, 2021 and 2020 of $154.8 million and $150.3 million, respectively. During the year ended December 31, 2021, $1.3 million of new trust accounts were opened, $9.5 million of additional contributions to trust accounts, $9.6 million distributed from trust accounts, and $13.2 million of accounts were closed. As a result of market fluctuations, the fair value of the trust accounts increased approximately $16.6 million during the year ended December 31, 2021. The following table reflects trust accounts by investment type and structure:
| (market values - in thousands) | | 2021 | | | 2020 | |
| INVESTMENTS: | | | | | | |
| Bonds | | $ | 8,640 | | | $ | 11,777 | |
| Stock | | | 22,099 | | | | 30,867 | |
| Savings and Money Market Funds | | | 11,587 | | | | 13,427 | |
| Mutual Funds | | | 105,233 | | | | 86,141 | |
| Mineral interests | | | 2,959 | | | | 2,738 | |
| Mortgages | | | 856 | | | | 956 | |
| Real Estate | | | 2,099 | | | | 1,560 | |
| Miscellaneous | | | 942 | | | | 625 | |
| Cash | | | 425 | | | | 2,257 | |
| TOTAL | | $ | 154,840 | | | $ | 150,348 | |
| ACCOUNTS: | | | | | | | | |
| Trusts | | | 46,953 | | | | 40,234 | |
| Guardianships | | | 443 | | | | 2,817 | |
| Employee Benefits | | | 62,149 | | | | 58,751 | |
| Investment Management | | | 45,293 | | | | 48,462 | |
| Custodial | | | 2 | | | | 84 | |
| TOTAL | | $ | 154,840 | | | $ | 150,348 | |
Our financial consultants offer full service brokerage and financial planning services throughout the Bank’s market areas. Appointments can be made at any Bank branch. Products such as mutual funds, annuities, health and life insurance are made available through our insurance subsidiary, First Citizens Insurance Agency, Inc.
RESULTS OF OPERATIONS
Net income for the year ended December 31, 2021 was $29,118,000, which represents an increase of $4,015,000, or 16.0%, when compared to 2020. Net income for the year ended December 31, 2020 was $25,103,000, which represents an increase of $5,613,000, or 28.8%, when compared to 2019. Basic earnings per share were $7.38, $6.53 and $5.42 for 2021, 2020 and 2019, respectively, while diluted earnings per share were $7.38, $6.53 and $5.41, for 2021, 2020 and 2019, respectively.
Net income is influenced by five key components: net interest income, provision for loan losses, non-interest income, non-interest expenses, and the provision for income taxes.
Net Interest Income
The most significant source of revenue is net interest income; the amount by which interest earned on interest-earning assets exceeds interest paid on interest-bearing liabilities. Factors that influence net interest income are changes in volume of interest-earning assets and interest-bearing liabilities as well as changes in the associated interest rates.
The following table sets forth the Company’s average balances of, and the interest earned or incurred on, each principal category of assets, liabilities and stockholders’ equity, the related rates, net interest income and rate “spread” created. The acquisition of MidCoast, which closed on April 17, 2020, impacted the average balances and rates for 2020 when compared to 2019:
| Analysis of Average Balances and Interest Rates | |
| | | 2021 | | | 2020 | | | 2019 | |
| (dollars in thousands) | |
| Balance (1) $ | | | Interest $
| | |
| Rate % | | |
| | | | Interest $
| | |
| | | |
| Average Balance (1) $ | | | Interest $
| | |
| % | |
| ASSETS | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Short-term investments: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing deposits at banks | | | 108,872 | | | | 124 | | | | 0.11 | | | | 41,330 | | | | 37 | | | | 0.09 | | | | 9,693 | | | | 23 | | | | 0.24 | |
| Total short-term investments | | | 108,872 | | | | 124 | | | | 0.11 | | | | 41,330 | | | | 37 | | | | 0.09 | | | | 9,693 | | | | 23 | | | | 0.24 | |
| Interest bearing time deposits at banks | | | 12,527 | | | | 323 | | | | 2.57 | | | | 14,139 | | | | 364 | | | | 2.57 | | | | 15,085 | | | | 384 | | | | 2.55 | |
| Investment securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Taxable | | | 252,470 | | | | 4,198 | | | | 1.66 | | | | 188,241 | | | | 4,488 | | | | 2.38 | | | | 188,697 | | | | 5,170 | | | | 2.74 | |
| Tax-exempt (3) | | | 104,379 | | | | 2,786 | | | | 2.67 | | | | 80,131 | | | | 2,366 | | | | 2.95 | | | | 58,637 | | | | 1,889 | | | | 3.22 | |
| Total investment securities | | | 356,849 | | | | 6,984 | | | | 1.96 | | | | 268,372 | | | | 6,854 | | | | 2.55 | | | | 247,334 | | | | 7,059 | | | | 2.85 | |
| Loans: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential mortgage loans | | | 203,062 | | | | 9,867 | | | | 4.86 | | | | 210,696 | | | | 11,161 | | | | 5.30 | | | | 215,749 | | | | 11,473 | | | | 5.32 | |
| Construction loans | | | 56,315 | | | | 2,292 | | | | 4.07 | | | | 26,343 | | | | 1,288 | | | | 4.89 | | | | 19,085 | | | | 984 | | | | 5.16 | |
| Commercial Loans | | | 739,000 | | | | 36,215 | | | | 4.90 | | | | 590,469 | | | | 31,087 | | | | 5.26 | | | | 415,681 | | | | 22,741 | | | | 5.47 | |
| Agricultural Loans | | | 349,951 | | | | 15,079 | | | | 4.31 | | | | 357,201 | | | | 16,022 | | | | 4.49 | | | | 344,586 | | | | 15,879 | | | | 4.61 | |
| Loans to state & political subdivisions | | | 52,804 | | | | 1,871 | | | | 3.54 | | | | 86,143 | | | | 3,458 | | | | 4.01 | | | | 97,780 | | | | 3,845 | | | | 3.93 | |
| Other loans | | | 24,125 | | | | 1,385 | | | | 5.74 | | | | 20,986 | | | | 1,185 | | | | 5.65 | | | | 9,684 | | | | 740 | | | | 7.64 | |
| Loans, net of discount (2)(3)(4) | | | 1,425,257 | | | | 66,709 | | | | 4.68 | | | | 1,291,838 | | | | 64,201 | | | | 4.97 | | | | 1,102,565 | | | | 55,662 | | | | 5.05 | |
| Total interest-earning assets | | | 1,903,505 | | | | 74,140 | | | | 3.89 | | | | 1,615,679 | | | | 71,456 | | | | 4.42 | | | | 1,374,677 | | | | 63,128 | | | | 4.59 | |
| Cash and due from banks | | | 6,525 | | | | | | | | | | | | 7,487 | | | | | | | | | | | | 6,168 | | | | | | | | | |
| Bank premises and equipment | | | 17,194 | | | | | | | | | | | | 17,286 | | | | | | | | | | | | 16,074 | | | | | | | | | |
| Other assets | | | 75,410 | | | | | | | | | | | | 79,305 | | | | | | | | | | | | 57,038 | | | | | | | | | |
| Total non-interest earning assets | | | 99,129 | | | | | | | | | | | | 104,078 | | | | | | | | | | | | 79,280 | | | | | | | | | |
| Total assets | | | 2,002,634 | | | | | | | | | | | | 1,719,757 | | | | | | | | | | | | 1,453,957 | | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW accounts | | | 457,189 | | | | 1,387 | | | | 0.30 | | | | 383,931 | | | | 1,102 | | | | 0.29 | | | | 331,906 | | | | 2,282 | | | | 0.69 | |
| Savings accounts | | | 290,376 | | | | 322 | | | | 0.11 | | | | 241,429 | | | | 476 | | | | 0.20 | | | | 218,240 | | | | 814 | | | | 0.37 | |
| Money market accounts | | | 257,937 | | | | 684 | | | | 0.27 | | | | 205,142 | | | | 1,012 | | | | 0.49 | | | | 164,872 | | | | 1,978 | | | | 1.20 | |
| Certificates of deposit | | | 351,265 | | | | 3,444 | | | | 0.98 | | | | 345,397 | | | | 4,261 | | | | 1.23 | | | | 277,946 | | | | 4,145 | | | | 1.49 | |
| Total interest-bearing deposits | | | 1,356,767 | | | | 5,837 | | | | 0.43 | | | | 1,175,899 | | | | 6,851 | | | | 0.58 | | | | 992,964 | | | | 9,219 | | | | 0.93 | |
| Other borrowed funds | | | 84,621 | | | | 1,268 | | | | 1.50 | | | | 93,237 | | | | 1,254 | | | | 1.34 | | | | 109,041 | | | | 2,821 | | | | 2.59 | |
| Total interest-bearing liabilities | | | 1,441,388 | | | | 7,105 | | | | 0.49 | | | | 1,269,136 | | | | 8,105 | | | | 0.64 | | | | 1,102,005 | | | | 12,040 | | | | 1.09 | |
| Demand deposits | | | 341,604 | | | | | | | | | | | | 257,285 | | | | | | | | | | | | 187,991 | | | | | | | | | |
| Other liabilities | | | 15,420 | | | | | | | | | | | | 16,662 | | | | | | | | | | | | 14,074 | | | | | | | | | |
| Total non-interest-bearing liabilities | | | 357,024 | | | | | | | | | | | | 273,947 | | | | | | | | | | | | 202,065 | | | | | | | | | |
| Stockholders’ equity | | | 204,222 | | | | | | | | | | | | 176,674 | | | | | | | | | | | | 149,887 | | | | | | | | | |
| Total liabilities & stockholders’ equity | | | 2,002,634 | | | | | | | | | | | | 1,719,757 | | | | | | | | | | | | 1,453,957 | | | | | | | | | |
| Net interest income | | | | | | | 67,035 | | | | | | | | | | | | 63,351 | | | | | | | | | | | | 51,088 | | | | | |
| Net interest spread (5) | | | | | | | | | | | 3.40 | % | | | | | | | | | | | 3.78 | % | | | | | | | | | | | 3.50 | % |
Net interest income as a percentage of average interest-earning assets | | | | | | | | | | | 3.52 | % | | | | | | | | | | | 3.92 | % | | | | | | | | | | | 3.72 | % |
Ratio of interest-earning assets to interest-bearing liabilities | | | | | | | | | | | 1.32 | | | | | | | | | | | | 1.27 | | | | | | | | | | | | 1.25 | |
| (1) | Averages are based on daily averages. |
| (2) | Includes loan origination and commitment fees. |
| (3) | Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using a statutory federal income tax rate of 21% for 2021, 2020 and 2019. |
| (4) | Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets. |
| (5) | Interest rate spread represents the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. |
For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Federal statutory rate for the corresponding year. Accordingly, tax equivalent adjustments for investments and loans have been made accordingly to the previous table for the years ended December 31, 2021, 2020 and 2019, respectively (in thousands):
| | | 2021 | | | 2020 | | | 2019 | |
Interest and dividend income from investment securities, interest bearing time deposits and short-term investments (non-tax adjusted) (GAAP) | | $ | 6,846 | | | $ | 6,758 | | | $ | 7,069 | |
| Tax equivalent adjustment | | | 585 | | | | 497 | | | | 397 | |
| | | | | | | | | | | | |
Interest and dividend income from investment securities, interest bearing time deposits and short-term investments (tax equivalent basis) (Non-GAAP) | | $ | 7,431 | | | $ | 7,255 | | | $ | 7,466 | |
| | | | | | | | | | | | | |
| | | | 2021 | | | | 2020 | | | | 2019 | |
| Interest and fees on loans (non-tax adjusted) (GAAP) | | $ | 66,371 | | | $ | 63,538 | | | $ | 54,911 | |
| Tax equivalent adjustment | | | 338 | | | | 663 | | | | 751 | |
| Interest and fees on loans (tax equivalent basis) (Non-GAAP) | | $ | 66,709 | | | $ | 64,201 | | | $ | 55,662 | |
| | | | | | | | | | | | | |
| | | | 2021 | | | | 2020 | | | | 2019 | |
| Total interest income | | $ | 73,217 | | | $ | 70,296 | | | $ | 61,980 | |
| Total interest expense | | | 7,105 | | | | 8,105 | | | | 12,040 | |
| Net interest income (GAAP) | | | 66,112 | | | | 62,191 | | | | 49,940 | |
| Total tax equivalent adjustment | | | 923 | | | | 1,160 | | | | 1,148 | |
| Net interest income (tax equivalent basis) (Non-GAAP) | | $ | 67,035 | | | $ | 63,351 | | | $ | 51,088 | |
The following table shows the tax-equivalent effect of changes in volume and rates on interest income and expense (in thousands):
| Analysis of Changes in Net Interest Income on a Tax-Equivalent Basis |
| | | 2021 vs. 2020 (1) | | | 2020 vs. 2019 (1) | |
| | | | | | | | | | | | | | | | | | Total Change | |
| Interest Income: | | | | | | | | | | | | | | | | | | |
| Short-term investments: | | | | | | | | | | | | | | | | | | |
| Interest-bearing deposits at banks | | $ | 73 | | | $ | 14 | | | $ | 87 | | | $ | 16 | | | $ | (2 | ) | | $ | 14 | |
| Interest bearing time deposits at banks | | | (41 | ) | | | - | | | | (41 | ) | | | (24 | ) | | | 4 | | | | (20 | ) |
| Investment securities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Taxable | | | 1,287 | | | | (1,577 | ) | | | (290 | ) | | | (13 | ) | | | (669 | ) | | | (682 | ) |
| Tax-exempt | | | 615 | | | | (195 | ) | | | 420 | | | | 615 | | | | (138 | ) | | | 477 | |
| Total investment securities | | | 1,902 | | | | (1,772 | ) | | | 130 | | | | 602 | | | | (807 | ) | | | (205 | ) |
| Total investment income | | | 1,934 | | | | (1,758 | ) | | | 176 | | | | 594 | | | | (805 | ) | | | (211 | ) |
| Loans: | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential mortgage loans | | | (394 | ) | | | (900 | ) | | | (1,294 | ) | | | (263 | ) | | | (49 | ) | | | (312 | ) |
| Construction loans | | | 1,177 | | | | (173 | ) | | | 1,004 | | | | 353 | | | | (49 | ) | | | 304 | |
| Commercial Loans | | | 7,074 | | | | (1,946 | ) | | | 5,128 | | | | 9,164 | | | | (818 | ) | | | 8,346 | |
| Agricultural Loans | | | (321 | ) | | | (622 | ) | | | (943 | ) | | | 524 | | | | (381 | ) | | | 143 | |
| Loans to state & political subdivisions | | | (1,218 | ) | | | (369 | ) | | | (1,587 | ) | | | (471 | ) | | | 84 | | | | (387 | ) |
| Other loans | | | 180 | | | | 20 | | | | 200 | | | | 573 | | | | (128 | ) | | | 445 | |
| Total loans, net of discount | | | 6,498 | | | | (3,990 | ) | | | 2,508 | | | | 9,880 | | | | (1,341 | ) | | | 8,539 | |
| Total Interest Income | | | 8,432 | | | | (5,748 | ) | | | 2,684 | | | | 10,474 | | | | (2,146 | ) | | | 8,328 | |
| Interest Expense: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW accounts | | | 219 | | | | 66 | | | | 285 | | | | 444 | | | | (1,624 | ) | | | (1,180 | ) |
| Savings accounts | | | 133 | | | | (287 | ) | | | (154 | ) | | | 91 | | | | (429 | ) | | | (338 | ) |
| Money Market accounts | | | 410 | | | | (738 | ) | | | (328 | ) | | | 686 | | | | (1,652 | ) | | | (966 | ) |
| Certificates of deposit | | | 73 | | | | (890 | ) | | | (817 | ) | | | 416 | | | | (300 | ) | | | 116 | |
| Total interest-bearing deposits | | | 835 | | | | (1,849 | ) | | | (1,014 | ) | | | 1,637 | | | | (4,005 | ) | | | (2,368 | ) |
| Other borrowed funds | | | (60 | ) | | | 74 | | | | 14 | | | | (360 | ) | | | (1,207 | ) | | | (1,567 | ) |
| Total interest expense | | | 775 | | | | (1,775 | ) | | | (1,000 | ) | | | 1,277 | | | | (5,212 | ) | | | (3,935 | ) |
| Net interest income | | $ | 7,657 | | | $ | (3,973 | ) | | $ | 3,684 | | | $ | 9,197 | | | $ | 3,066 | | | $ | 12,263 | |
(1) The portion of the total change attributable to both volume and rate changes during the year has been allocated to volume and rate components based upon the absolute dollar amount of the change in each component prior to allocation.
2021 vs. 2020
Tax equivalent net interest income for 2021 was $67,035,000 compared to $63,351,000 for 2020, an increase of $3,684,000 or 5.8%. Total interest income increased $2,684,000, as loan interest income increased $2,508,000, and total investment income increased $176,000. Interest expense decreased $1,000,000 from 2020.
Total tax equivalent interest income from investment securities increased $130,000 in 2021 from 2020. The average balance of investment securities increased $88.5 million, which had an effect of increasing interest income by $1,902,000 due to volume. The majority of the increase in volume was in tax-exempt securities, which experienced an increase in the average balance of $64.2 million. The average tax-effected yield on our investment portfolio decreased from 2.55% in 2020 to 1.96% in 2021. The decrease in the tax-effected yield is attributable to purchases made in a lower rate environment. As a result of the yield on investment securities decreasing 59 basis points (bps) to 1.96%, interest income on investment securities decreased $1,772,000, with the decrease primarily related to taxable securities. The investment strategy for 2021 has been to utilize cashflows from the investment portfolio and deposit inflows to purchase U.S. treasury securities, mortgage backed securities issued by government sponsored entities and obligations of state and political securities. The increase in the investment portfolio was in response to the deposit inflows that occurred in 2021. We continually monitor interest rate trading ranges and try to focus purchases to times when rates are in the top of the trading range. The Bank believes its investment strategy has appropriately mitigated its interest rate risk exposure for various rate environments, while providing sufficient cashflows to meet liquidity needs.
In total, loan interest income increased $2,508,000 in 2021 from 2020. The average balance of our loan portfolio increased by $133.4 million in 2021 compared to 2020, which resulted in an increase in interest income of $6,498,000 due to volume. The increase in the average balance of loans was driven by the MidCoast acquisition from 2020, which was outstanding for the entire year and loan growth that occurred primarily in the Delaware market. The average tax-effected yield on our loan portfolio decreased 29 basis points to 4.68% in 2021, resulting in a decrease in loan interest income of $3,990,000. The decrease in the tax-effected yield was due to the lower rate environment promoted by the Federal Reserve in response to the COVID-19 pandemic.
| • | Interest income on residential mortgage loans decreased $1,294,000. The average balance of residential mortgage loans decreased $7.6 million, resulting in a decrease of $394,000 due to volume. The decrease in loans is due to loans being refinanced and sold on the secondary market. The change due to rate was a decrease of $900,000 as the average yield on residential mortgages decreased from 5.30% in 2020 to 4.86% in 2021 as a result of the lower rate environment during the year as a result of COVID-19 pandemic. |
| • | The average balance of construction loans increased $30.0 million from 2020 to 2021 as a result of projects in our south central Pennsylvania market and Delaware market, which resulted in an increase of $1,177,000 in interest income. The average yield on construction loans decreased from 4.89% to 4.07%, which correlated to a $173,000 decrease in interest income. |
| • | Interest income on commercial loans increased $5,128,000 from 2020 to 2021. The increase in the average balance of commercial loans of $148.5 million is attributable to the MidCoast acquisition and growth in the Delaware market. The increase in the average balance of these loans resulted in an increase in interest income due to volume of $7,074,000. Our lenders have been able to attract and retain loan relationships in their markets by providing excellent customer service and having attractive products. We believe our lenders are adept at customizing and structuring loans to customers that meet their needs and satisfy our commitment to credit quality. In many cases, the Bank works with the Small Business Administration (SBA) guaranteed loan programs to offset credit risk and to further promote economic growth in our market area. The average yield on commercial loans decreased 36 basis points to 4.90% in 2021, resulting in a decrease in interest income due to rate of $1,946,000. |
| • | Interest income on agricultural loans decreased $943,000 from 2020 to 2021. The decrease in the average balance of agricultural loans of $7.3 million is primarily attributable to the south central Pennsylvania market. The decrease in the average balance of these loans resulted in a decrease in interest income due to volume of $321,000. The average yield on agricultural loans decreased from 4.49% in 2020 to 4.31% in 2021 due to a general decrease in rates, resulting in a decrease in interest income due to rate of $622,000. We believe our lenders are adept at customizing, understanding and have the expertise to structure loans for customers that meet their needs and satisfy our commitment to credit quality. In many cases, the Bank works with the United States Department of Agriculture’s (USDA) guaranteed loan programs to offset credit risk and to further promote economic growth in our market area. |
| • | The average balance of loans to state and political subdivisions decreased $33.3 million from 2020 to 2021 which had a negative impact of $1,218,000 on total interest income due to volume was due to customers refinancing through the municipal bond market. The average tax equivalent yield on loans to state and political subdivisions decreased from 4.01% in 2020 to 3.54% in 2021, decreasing interest income by $369,000. |
| • | The average balance of other loans increased $3.1 million as a result of an increase in outstanding student loans. This resulted in an increase of $180,000 on total interest income due to volume. The average tax equivalent yield on other loans increased from 5.65% in 2020 to 5.74% in 2021, increasing interest income by $20,000 in other loans |
Total interest expense decreased $1,000,000 in 2021 compared to 2020. The majority of the decrease was due to a decrease in the average rate paid on interest bearing deposits of 15 basis points to 0.43%. This decrease resulted in a decrease in interest expense of $1,849,000. The decrease in rates was driven by the Federal Reserve’s response to the COVID-19 pandemic. The average rate on certificates of deposit decreased from 1.23% to 0.98% resulting in a decrease in interest expense of $890,000. The average rate on money markets decreased from 0.49% to 0.27% resulting in a decrease in interest expense of $738,000. The average rate paid on savings accounts decreased 9 bps and resulted in a decrease in interest expense of $287,000. The average rate paid on other borrowed funds increased from 1.34% to 1.50% resulting in an increase in interest expense of $74,000 and was due to interest expense on debt issued in 2021.
Average interest-bearing liabilities increased $172.3 million in 2021, with average interest-bearing deposits increasing $180.9 million and average other borrowings decreasing $8.6 million. As a result of the increase in average deposits, interest expense increased $835,000 as result of the change in volume. Increases in average deposits, which were primarily driven by organic growth across all markets of the Bank, included NOW accounts of $73.3 million, savings accounts of $48.9 million, money market accounts of $52.8 million and certificates of deposits of $5.9 million The combined impact to interest expense of these increases was $835,000. The average balance of other borrowed funds decreased $8.6 million, which corresponds to a decrease in interest expense of $60,000.
Our tax equivalent net interest margin for 2021 was 3.52% compared to 3.92% for 2020, with the change attributable to the yield of interest-earning assets decreasing more than the cost from interest-bearing liabilities during 2021. Interest rates rose in 2021 in response to shifting expectations for fiscal policy and an enduring pandemic that continued to hamper economic activity, strengthening and prolonging unusually strong inflationary pressures and altering the expected path of monetary policy. The moves up for interest rates, however, unfolded across the maturity spectrum at different times during the year. Longer yields peaked at the end of the first quarter, propelled higher by the rollout of vaccines and expectations for more stimulative fiscal policy. Federal Reserve officials abandoned in the second half of the year their belief that higher inflation would prove transitory and had shifted to a notably more aggressive posture by year’s end. The central bank’s official forecast from March 2021 for rates to remain near zero for the next several years gave way to a call by December to raise the federal funds target rate range by 1.50% by the end of 2023. Federal funds futures contracts, which began the year flat across the forecast horizon, reflected a presumption for three 25-basis point rate hikes in 2022 and two more in 2023. The 2-year Treasury yield traded within a range of 0.10% to 0.19% from January 1 through the Federal Reserve’s June 15 meeting, was bounded between 0.17% and 0.27% from mid-June to the September 22 meeting, but climbed steeply in the fourth quarter to 0.73% by year’s end. Along a similar timeline, the 5-year Treasury yield rose from a low of 0.35% in early January to 1.26% by the end of the year. Despite historic inflation readings in the second half of the year, concerns that the abrupt policy shift by the Federal Reserve to fight inflation raised the risk of a policy error that could disrupt the recovery kept longer yields in check. The 10-year yield failed to eclipse its March high and finished the year at 1.51%. The timing differences of rate changes across the curve had a noticeable and informative impact on the shape of the curve throughout the year. The spread between the 2-year and 10-year Treasury yields expanded from 0.79% on January 1, 2021 to a peak of 1.58% on March 31, 2021. Stepping lower in stages for the remainder of the year, the spread tightened back to 0.77% by the end of 2021.
2020 vs. 2019
Tax equivalent net interest income for 2020 was $63,351,000 compared to $51,088,000 for 2019, an increase of $12,263,000 or 24.0%. Total interest income increased $8,328,000, as loan interest income increased $8,539,000, and total investment income decreased $211,000. Interest expense decreased $3,935,000 in 2020 from 2019.
Total tax equivalent interest income from investment securities decreased $205,000 in 2020 from 2019. The average balance of investment securities increased $21.0 million, which had an effect of increasing interest income by $602,000 due to volume. The majority of the increase in volume was in tax-exempt securities, which experienced an increase in the average balance of $21.5 million. The average tax-effected yield on our investment portfolio decreased from 2.85% in 2019 to 2.55% in 2020. The decrease in the tax-effected yield is attributable to purchases made in a lower rate environment and calls in the third quarter of 2019 of securities purchased at a discount. As a result of the yield on investment securities decreasing 30 basis points (bps) to 2.55%, interest income on investment securities decreased $807,000, with the decrease primarily related to taxable securities. The increase in the investment portfolio was in response to growth in deposits that exceeded organic loan opportunities in 2019. The Covid-19 pandemic did provide opportunities for the Company to purchase high quality municipal securities and mortgage backed securities with relatively high spreads in the first and second quarters of 2020. Purchases in the second half of 2020 were reflective of tighter spreads and lower yields due government stimulus and its impact on bond markets and deposit levels.
In total, loan interest income increased $8,539,000 in 2020 from 2019. The average balance of our loan portfolio increased by $189.3 million in 2020 compared to 2019, which resulted in an increase in interest income of $9,880,000 due to volume. The increase in the average balance of loans was driven by the MidCoast acquisition in the first quarter of 2020 and the PPP program authorized by the SBA in response to the COVID-19 pandemic. Organic growth in the first three quarters of 2020, excluding the PPP program was limited, but did increase in the fourth quarter of 2020, primarily in our Delaware market. The average tax-effected yield on our loan portfolio decreased 8 basis points to 4.97% in 2020, resulting in a decrease in loan interest income of $1,341,000. The decrease in the tax-effected yield was due to the lower rate environment promoted by the Federal Reserve in 2020 in response to the COVID-19 pandemic.
| • | Interest income on residential mortgage loans decreased $312,000. The average balance of residential mortgage loans decreased $5.1 million, resulting in a decrease of $263,000 due to volume. The decrease in loans is due to loans being refinanced and sold on the secondary market. The change due to rate was a decrease of $49,000 as the average yield on residential mortgages decreased from 5.32% in 2019 to 5.30% in 2020 as a result of the lower rate environment during the year as a result of COVID-19 pandemic. |
| • | The average balance of construction loans increased $7.3 million from 2019 to 2020 as a result of the acquisition and projects in our south central Pennsylvania market, which resulted in an increase of $353,000 in interest income. The average yield on construction loans decreased from 5.16% to 4.89%, which correlated to a $49,000 decrease in interest income. |
| • | Interest income on commercial loans increased $8,346,000 from 2019 to 2020. The increase in the average balance of commercial loans of $174.8 million is attributable to the MidCoast acquisition and PPP loans originated in the second and third quarters of 2020. The increase in the average balance of these loans resulted in an increase in interest income due to volume of $9,164,000. The average yield on commercial loans decreased 21 basis points to 5.26% in 2020, resulting in a decrease in interest income due to rate of $818,000. |
| • | Interest income on agricultural loans increased $143,000 from 2019 to 2020. The increase in the average balance of agricultural loans of $12.6 million is primarily attributable to the central and south central markets as well as the acquisition. The increase in the average balance of these loans resulted in an increase in interest income due to volume of $524,000. The average yield on agricultural loans decreased from 4.61% in 2019 to 4.49% in 2020 due to a general decrease in rates, resulting in a decrease in interest income due to rate of $381,000. |
| • | The average balance of loans to state and political subdivisions decreased $11.6 million from 2019 to 2020 which had a negative impact of $471,000 on total interest income due to volume. The average tax equivalent yield on loans to state and political subdivisions increased from 3.93% in 2019 to 4.01% in 2020, increasing interest income by $84,000. |
| • | The average balance of other loans increased $11.3 million as a result of an increase in outstanding student loans. This resulted in an increase of $573,000 on total interest income due to volume. The average tax equivalent yield on other loans decreased from 7.64% in 2019 to 5.65% in 2020 as a result of the growth in student loans, decreasing interest income by $128,000 in student loans |
Total interest expense decreased $3,935,000 in 2020 compared to 2019. The majority of the decrease was due to a decrease in the average rate paid on interest bearing liabilities of 45 basis points to 0.64%. This decrease resulted in a decrease in interest expense of $5,212,000. The decrease in rates was driven by the Federal Reserve decreasing rates in the second half of 2019 as a result of a slowing economy and in the first quarter of 2020 in response to the COVID-19 pandemic. The average rate on certificates of deposit decreased from 1.49% to 1.23% resulting in a decrease in interest expense of $300,000. The average rate paid on other borrowed funds decreased from 2.59% to 1.34% resulting in a decrease in interest expense of $1,207,000. The average rate paid on money market accounts decreased from 1.20% to 0.49% resulting in a decrease in interest expense of $1,652,000. The average rate paid on NOW accounts decreased from 0.69% in 2019 to 0.29% in 2020 resulting in a decrease in interest expense of $1,624,000. The average rate paid on savings accounts decreased 17 bps and resulted in a decrease in interest expense of $429,000.
Average interest-bearing liabilities increased $167.1 million in 2020, with average interest-bearing deposits increasing $182.9 million and average other borrowings decreasing $15.8 million. As a result of the increase in average deposits, interest expense increased $1,277,000 as result of the change in volume. Increases in average deposits, which were primarily driven by the MidCoast acquisition, included NOW accounts of $52.0 million, savings accounts of $23.2 million, money market accounts of $40.3 million and certificates of deposits of $67.5 million The combined impact to interest expense of these increases was $1,637,000. The average balance of other borrowed funds decreased $15.8 million, which corresponds to a decrease in interest expense of $360,000.
Our tax equivalent net interest margin for 2020 was 3.92% compared to 3.72% for 2019, with the change attributable to the cost of interest-bearing liabilities decreasing more than income from interest earning assets during 2020.
PROVISION FOR LOAN LOSSES
For the year ended December 31, 2021, we recorded a provision for loan losses of $1,550,000. The provision for 2021 was $850,000, or 35.4%, lower than the provision in 2020. The decrease in the provision for loan losses was primarily the result of the impact the COVID-19 pandemic had on the economy in 2020 and limited organic growth in 2021 compared to 2020. (see also “Financial Condition – Allowance for Loan Losses and Credit Quality Risk”).
For the year ended December 31, 2020, we recorded a provision for loan losses of $2,400,000. The provision for 2020 was $725,000, or 43.3%, higher than the provision in 2019. The increase in the provision for loan losses was primarily the result of the COVID-19 pandemic and its impact on our economy as well as organic growth attributable to the Delaware market primarily in the fourth quarter of 2020 (see also “Financial Condition – Allowance for Loan Losses and Credit Quality Risk”).
NON-INTEREST INCOME
The following table reflects non-interest income by major category for the years ended December 31 (dollars in thousands):
| | 2021 | | | 2020 | | | 2019 | |
Service charges | | | 4,755 | | | $ | 4,221 | | | $ | 4,687 | |
Trust | | | 865 | | | | 803 | | | | 750 | |
Brokerage and insurance | | | 1,625 | | | | 1,297 | | | | 1,141 | |
Equity security gains (losses), net | | | 339 | | | | (41 | ) | | | 120 | |
Available for sale security gains, net | | | 212 | | | | 305 | | | | 24 | |
Gains on loans sold | | | 1,283 | | | | 2,168 | | | | 473 | |
Earnings on bank owned life insurance | | | 1,828 | | | | 695 | | | | 623 | |
Other | | | 1,398 | | | | 1,974 | | | | 568 | |
Total | | $ | 12,305 | | | $ | 11,422 | | | $ | 8,386 | |
| | | | | | |
| | Amount | | | % | | | Amount | | | % | |
Service charges | | $ | 534 | | | | 12.7 | | | $ | (466 | ) | | | (9.9 | ) |
Trust | | | 62 | | | | 7.7 | | | | 53 | | | | 7.1 | |
Brokerage and insurance | | | 328 | | | | 25.3 | | | | 156 | | | | 13.7 | |
Equity security gains (losses), net | | | 380 | | | | (926.8 | ) | | | (161 | ) | | | (134.2 | ) |
Available for sale security gains (losses), net | | | (93 | ) | | | (30.5 | ) | | | 281 | | | | 1,170.8 | |
Gains on loans sold | | | (885 | ) | | | (40.8 | ) | | | 1,695 | | | | 358.4 | |
Earnings on bank owned life insurance | | | 1,133 | | | | 163.0 | | | | 72 | | | | 11.6 | |
Other | | | (576 | ) | | | (29.2 | ) | | | 1,406 | | | | 247.5 | |
Total | | $ | 883 | | | | 7.7 | | | $ | 3,036 | | | | 36.2 | |
2021 vs. 2020
Non-interest income increased $883,000 in 2021 from 2020, or 7.7%. We experienced a $212,000 net gain on available for sale securities in 2021 compared to net gains totaling $305,000 in 2020. During 2021, we sold $17.2 million of US treasury securities for a pre-tax gain of $177,000 and $12.0 million of US Agency securities for a pre-tax gain of $35,000 to take advantage of market conditions at the time of the sales. During 2020, we sold 19 mortgage backed securities for a net gain of $305,000 to lock in gains that benefitted from the Federal Reserve investment purchase program in response to the COVID-19 pandemic. During 2021, net equity security gains amounted to $339,000 as a result of market gains experienced in 2021 compared to losses of $41,000 last year associated with the Covid-19 pandemic.
Gains on loans sold decreased $885,000 compared to last year. The decrease in gains on loans sold is attributable to a $20.2 million, or 26.6% decrease in the proceeds from the sale of residential mortgages loans. The increase in service charges of $534,000 for 2021 is attributable to the Bank’s response to the COVID-19 pandemic in 2020 and an increase in customer spending in 2021 compared to 2020 which was impacted by mandatory stay at home orders as customers ate out less and spent less on discretionary items. The decrease in other income is due to fees on offering derivative contracts for certain customers, that provided the customer with fixed rate loans, which generated fee income of $494,000 in 2021 compared to $1,373,000 in 2020. The increase in earnings on bank owned life insurance is due to two former employees of the Company passing during the first quarter of 2021, which generated a death benefit payable to the Company of $1,155,000. The increase in brokerage and insurance commissions was attributable to growth in our south central and north central, Pennsylvania markets.
2020 vs. 2019
Non-interest income increased $3,036,000 in 2020 from 2019, or 36.2%. We experienced a $305,000 net gain on available for sale securities in 2020 compared to net gains totaling $24,000 in 2019. During 2020, we sold 19 mortgage backed securities for a net gain of $305,000 to lock in gains that benefitted from the Federal Reserve investment purchase program in response to the COVID-19 pandemic. During 2019, we sold 3 agency securities for a net gain of $1,000 and 4 US Treasury securities for a gain of $23,000 to fund loan growth and to restructure the investment portfolio to improve performance in the current rate environment. During 2020, net equity security losses amounted to $41,000 as a result of market losses associated with the Covid-19 pandemic compared to gains of $120,000 in 2019.
Gains on loans sold increased $1,695,000 compared to 2019. The increase in gains on loans sold was attributable to a $54.0 million, or 248.1% increase in the proceeds from the sale of residential mortgages loans as a result of the low rate environment, which has significantly increased residential refinancings. The decrease in service charges of $466,000 for 2020 is attributable to the Bank’s response to the COVID-19 pandemic and a decrease in customer spending as a result of mandatory stay at home orders as customers ate out less and spent less on discretionary items. The increase in other income is due to fees on offering derivative contracts for certain customers, that provided the customer with fixed rate loans, which generated fee income of $1,373,000 in 2020. The increase in brokerage and insurance commissions was primarily attributable to growth in our south central market.
Non-interest Expenses
The following tables reflect the breakdown of non-interest expense by major category for the years ended December 31 (dollars in thousands):
| | | 2021 | | | 2020 | | | 2019 | |
| Salaries and employee benefits | | | 25,902 | | | $ | 24,190 | | | $ | 20,456 | |
| Occupancy | | | 2,966 | | | | 2,557 | | | | 2,174 | |
| Furniture and equipment | | | 519 | | | | 757 | | | | 674 | |
| Professional fees | | | 1,526 | | | | 1,517 | | | | 1,423 | |
| FDIC insurance | | | 522 | | | | 476 | | | | 75 | |
| Pennsylvania shares tax | | | 880 | | | | 868 | | | | 808 | |
| Amortization of intangibles | | | 192 | | | | 216 | | | | 259 | |
| Merger and acquisition | | | - | | | | 2,179 | | | | 466 | |
| ORE expenses | | | 439 | | | | 451 | | | | 376 | |
| Software expenses | | | 1,321 | | | | 1,155 | | | | 948 | |
| Other | | | 7,283 | | | | 6,481 | | | | 5,682 | |
| Total | | $ | 41,550 | | | $ | 40,847 | | | $ | 33,341 | |
| | | | | | |
| | Amount | | | % | | | Amount | | | % | |
| Salaries and employee benefits | | $ | 1,712 | | | | 7.1 | | | $ | 3,734 | | | | 18.3 | |
| Occupancy | | | 409 | | | | 16.0 | | | | 383 | | | | 17.6 | |
| Furniture and equipment | | | (238 | ) | | | (31.4 | ) | | | 83 | | | | 12.3 | |
| Professional fees | | | 9 | | | | 0.6 | | | | 94 | | | | 6.6 | |
| FDIC insurance | | | 46 | | | | 9.7 | | | | 401 | | | | 534.7 | |
| Pennsylvania shares tax | | | 12 | | | | 1.4 | | | | 60 | | | | 7.4 | |
| Amortization of intangibles | | | (24 | ) | | | (11.1 | ) | | | (43 | ) | | | (16.6 | ) |
| Merger and acquisition | | | (2,179 | ) | | | (100.0 | ) | | | 1,713 | | | | 367.6 | |
| ORE expenses | | | (12 | ) | | | (2.7 | ) | | | 75 | | | | 19.9 | |
| Software expenses | | | 166 | | | | 14.4 | | | | 207 | | | | 21.8 | |
| Other | | | 802 | | | | 12.4 | | | | 799 | | | | 14.1 | |
| Total | | $ | 703 | | | | 1.7 | | | $ | 7,506 | | | | 22.5 | |
2021 vs. 2020
Non-interest expenses for 2021 totaled $41,550,000, which represents an increase of $703,000, compared to 2020 expenses of $40,847,000. Salaries and employee benefits increased $1,712,000 or 7.1%. The increase was due to merit increases effective at the beginning of 2021, additional headcount as part of the MidCoast acquisition and servicing the Delaware market and increased profit sharing expenses due to increased profitability of the Company. Employee commissions related to brokerage and insurance commissions increased due to the increased sales in 2021 compared to 2020.
The increase in occupancy expenses is due to the additional branches acquired as part of the MidCoast acquisition and the Kennett Square branch as they are included for a full year in 2021. The decrease in merger and acquisition costs was due to costs associated with the MidCoast acquisition that closed in April 2020. The decrease in furniture and fixtures is due to a decrease in non-capitalized items that were purchased in 2020 to support the acquisition. The increase in other expenses is due to charitable contributions made in our south central Pennsylvania and Delaware markets the Delaware franchise tax due to the performance of the Delaware market, advertising and promotions associated with the Delaware markets.
2020 vs. 2019
Non-interest expenses for 2020 totaled $40,847,000, which represents an increase of $7,506,000, compared to 2019 expenses of $33,341,000. The primary cause of the total increase was the MidCoast acquisition costs, as well as the additional salaries and benefits costs of the acquired employees. Salary and benefit costs increased $3,734,000, or 18.3%. Base salaries and related payroll taxes increased $3,081,000 as a result of merit increases and additional headcount associated with the acquisition. Full time equivalent staffing was 281 and 259 for 2020 and 2019, respectively. Profit sharing expenses increased $829,000 compared to 2019, as a result of the employee mix and increased profitability, which resulted in higher bonuses to employees.
The increase in occupancy and furniture and equipment expenses was due to the additional branches acquired as part of the MidCoast acquisition. The increase in merger and acquisition expenses was due to costs associated with the MidCoast acquisition that closed in April 2020. The increase in FDIC insurance in 2020 was due to credits received from the FDIC in 2019 as the Deposit Insurance Fund exceeded 1.38% as well as organic and acquisition growth that occurred in 2020. The increase in software expenses is due to new systems implemented in the second half of 2020 for our tellers and image capture and review. The largest drivers of the increase in other expenses was the termination of a pension plan in 2019 for a gain that was acquired as of the FNB acquisition in 2015, ATM and data processing expenses as a result of fraud prevention, contributions in response to the COVID-19 pandemic, supplies for the additional branches and the Delaware franchise fee. The increase in ORE expenses is the result of net losses on the disposal of ORE properties in 2020 compared to a net gain in 2019.
Provision for Income Taxes
The provision for income taxes was $6,199,000, $5,263,000 and $3,820,000 for 2021, 2020 and 2019, respectively. The effective tax rates for 2021, 2020 and 2019 were 17.6%, 17.3% and 16.4%, respectively.
The increase in income tax expense of $936,000 in 2021 was due to the increase of $4,951,000 in income before the provision for income taxes, which accounts for an increase in tax expense of $1,040,000 at a 21% tax rate.
The increase in income tax expense of $1,443,000 in 2020 was due to the increase of $7,056,000 in income before the provision for income taxes, which accounts for an increase in tax expense of $1,482,000 at a 21% tax rate.
We are involved in five limited partnership agreements that operate low-income housing projects in our market areas, one of which we entered into during 2021. During 2021, 2020 and 2019, we recognized tax credits related to one of the five partnerships. The 2021 partnership started in 2021 and credits are expected to be available in 2022. Tax credits associated with three of the partnerships were fully utilized by December 2016. We anticipate recognizing an aggregate of $3.1 million of tax credits over the next twelve years.
FINANCIAL CONDITION
The following table presents ending balances (dollars in millions), the dollar amount of change and the percentage change during the past two years:
| | | | | | Increase | | | | | | | |
| Total assets | | $ | 2,143.9 | | | $ | 252.2 | | | | 13.3 | | | $ | 1,891.7 | |
| Total investments | | | 412.4 | | | | 117.2 | | | | 39.7 | | | | 295.2 | |
| Total loans, net | | | 1,424.2 | | | | 34.7 | | | | 2.5 | | | | 1,389.5 | |
| Total deposits | | | 1,836.2 | | | | 247.3 | | | | 15.6 | | | | 1,588.9 | |
| Total borrowings | | | 74.0 | | | | (14.8 | ) | | | (16.7 | ) | | | 88.8 | |
| Total stockholders’ equity | | | 212.5 | | | | 18.2 | | | | 9.4 | | | | 194.3 | |
Cash and Cash Equivalents
Cash and cash equivalents totaled $172.8 million at December 31, 2021 compared to $68.7 million at December 31, 2020. Management actively measures and evaluates its liquidity through our Asset – Liability committee and believes its liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, Federal Home Loan Bank financing, federal funds lines with correspondent banks, brokered certificates of deposit and the portion of the investment and loan portfolios that mature within one year. Management expects that these sources of funds will permit us to meet cash obligations and off-balance sheet commitments as they come due.
Investments
The following table shows the year-end composition of the investment portfolio, at fair value, for the two years ended December 31 (dollars in thousands):
| | | | | | | | | | | | | |
| Available-for-sale: | | | | | | | | | | | | |
| U. S. Agency securities | | $ | 73,945 | | | | 17.8 | | | $ | 81,416 | | | | 27.4 | |
| U.S. Treasuries | | | 115,347 | | | | 27.8 | | | | 28,043 | | | | 9.4 | |
Obligations of state & political subdivisions | | | 112,021 | | | | 27.0 | | | | 102,972 | | | | 34.7 | |
| Corporate obligations | | | 10,333 | | | | 2.5 | | | | 6,509 | | | | 2.2 | |
| Mortgage-backed securities | | | 100,756 | | | | 24.3 | | | | 76,249 | | | | 25.7 | |
| Equity securities (a) | | | 2,270 | | | | 0.6 | | | | 1,931 | | | | 0.6 | |
| Total | | $ | 414,672 | | | | 100.0 | | | $ | 297,120 | | | | 100.0 | |
| (a) | As of January 1, 2018, the Company adopted ASU 2016-01 resulting in the reclassification of equity securities from available for sale securities to equity securities in the Consolidated Balance Sheet. |
2021
The Company’s investment portfolio increased during 2021 by $117.6 million. This growth was fueled by increases in deposits that were driven by customers held more cash and government stimulus efforts that occurred during 2021. During 2021, we purchased $108.4 million of U.S. Treasuries, $20.6 million of U.S. agencies, $56.6 million of mortgage backed securities, $18.6 million of state and local obligations and $7.0 million of corporate obligations, which helped to offset the $28.8 million of principal repayments and $26.7 million of calls and maturities that occurred during the year. We also sold $29.2 million of bonds at a net gain of $212,000. The fair value of our investment portfolio decreased approximately $7.3 million in 2021 due to interest rate fluctuations, net of equity market gains. Excluding our short term investments consisting of monies held primarily at the Federal Reserve, the effective yield on our investment portfolio for 2021 was 1.96% compared to 2.55% for 2020 on a tax equivalent basis.
Interest rates rose during 2021 in response to shifting expectations for fiscal policy and an enduring pandemic that continued to hamper economic activity, strengthening and prolonging unusually strong inflationary pressures and altering the expected path of monetary policy. The upper movement in interest rates, however, unfolded across the maturity spectrum at different times during the year. Longer yields peaked at the end of the first quarter, propelled higher by the rollout of vaccines and expectations for more stimulative fiscal policy. The central bank’s official forecast from March 2021 for rates to remain near zero for the next several years gave way to a call by December to raise the federal funds target rate range by 1.50% by the end of 2023. Federal funds futures contracts, which began the year flat across the forecast horizon, reflected a presumption for three 25-basis point rate hikes in 2022 and two more in 2023. The 2-year Treasury yield traded within a range of 0.10% to 0.19% from January 1 through the Federal Reserve’s June 15 meeting, was bounded between 0.17% and 0.27% from mid-June to the September 22 meeting, but climbed steeply in the fourth quarter to 0.73% by year’s end. Along a similar timeline, the 5-year Treasury yield rose from a low of 0.35% in early January to 1.26% by the end of the year. Despite historic inflation readings in the second half of the year, concerns that the abrupt policy shift by the Federal Reserve to fight inflation raised the risk of a policy error that could disrupt the recovery kept longer yields in check. The 10-year yield failed to eclipse its March high and finished the year at 1.51%. The timing differences of rate changes across the curve had a noticeable and informative impact on the shape of the curve throughout the year. The spread between the 2-year and 10-year Treasury yields expanded from 0.79% on January 1, 2021 to a peak of 1.58% on March 31, 2021. Stepping lower in stages for the remainder of the year, the spread tightened back to 0.77% by the end of 2021. The investment strategy for 2021 has been to utilize cashflows from the investment portfolio and deposit inflows to purchase US treasury securities, mortgage backed securities in government sponsored entities and obligations of state and political securities, as well as US agency securities. The increase in the investment portfolio was in response to growth in deposits that exceeds organic loan opportunities. We continually monitor interest rate trading ranges and try to focus purchases to times when rates are in the top third of the trading range. The Company believes its investment strategy has appropriately mitigated its interest rate risk exposure if rates rise while providing sufficient cashflows for the Company’s liquidity needs.
At December 31, 2021, the Company did not own any securities, other than government-sponsored and government-guaranteed mortgage-backed securities, that had an aggregate book value in excess of 10% of its consolidated stockholders’ equity at that date.
The expected principal repayments at amortized cost and average weighted yields for the investment portfolio (excluding equity securities) as of December 31, 2021, are shown below (dollars in thousands). Expected principal repayments, which include prepayment speed assumptions for mortgage-backed securities, are significantly different than the contractual maturities detailed in Note 4 of the consolidated financial statements. Yields on tax-exempt securities are presented on a fully taxable equivalent basis, assuming a 21% tax rate, which was the rate in effect at December 31, 2021.
| | | One Year or Less | | | After One Year to Five years | | | After Five Years to Ten Years | | | After Ten Years | | | Total | |
| | | | | | | | | Amortized Cost | | | Yield % | | | Amortized Cost | | | Yield % | | | Amortized Cost | | | Yield % | | | | | | | |
| Available-for-sale securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. agency securities | | $ | 22,706 | | | | 1.5 | | | $ | 35,145 | | | | 2.1 | | | $ | 15,952 | | | | 1.3 | | | $ | - | | | | - | | | $ | 73,803 | | | | 1.7 | |
| U.S. treasuries | | | 8,491 | | | | 2.1 | | | | 64,808 | | | | 0.8 | | | | 43,444 | | | | 1.1 | | | | - | | | | - | | | | 116,743 | | | | 1.0 | |
Obligations of state & political subdivisions | | | 8,173 | | | | 2.9 | | | | 53,597 | | | | 2.1 | | | | 47,597 | | | | 1.9 | | | | - | | | | - | | | | 109,367 | | | | 2.0 | |
| Corporate obligations | | | - | | | | - | | | | 10,378 | | | | 3.6 | | | | - | | | | - | | | | - | | | | - | | | | 10,378 | | | | 3.6 | |
| Mortgage-backed securities | | | 24,439 | | | | 1.0 | | | | 35,965 | | | | 1.5 | | | | 31,142 | | | | 1.4 | | | | 10,181 | | | | 1.4 | | | | 101,727 | | | | 1.3 | |
| Total available-for-sale | | $ | 63,809 | | | | 1.6 | | | $ | 199,893 | | | | 1.6 | | | $ | 138,135 | | | | 1.4 | | | $ | 10,181 | | | | 1.4 | | | $ | 412,018 | | | | 1.6 | |
At December 31, 2021, approximately 64.0% of the amortized cost of debt securities is expected to mature, call or pre-pay within five years or less. The Company expects that earnings from operations, the levels of cash held at the Federal Reserve and other correspondent banks, the high liquidity level of the available-for-sale securities, growth of deposits and the availability of borrowings from the Federal Home Loan Bank and other third party banks will be sufficient to meet future liquidity needs.
Loans Held for Sale
Loans held for sale decreased $10.1 million to $4.6 million as of December 31, 2021 from December 31, 2020. The decrease in loans held for sale was due to the amount of refinancings occurring due to the low rate environment in the fourth quarter of 2020 compared to 2021.
Loans
The Bank’s lending efforts have historically focused on north central Pennsylvania and southern New York. With the acquisition of FNB and the opening of offices in Lancaster County, this focus has grown to include Lebanon, Schuylkill, Berks and Lancaster County markets of south central, Pennsylvania. We have a limited branch office in Union County that is staffed by a lending team to primarily support agricultural opportunities and offices in State College and Mill Hall to support commercial opportunities in central Pennsylvania, especially Centre and Clinton Counties. In April 2020, we completed the MidCoast acquisition, which expanded our markets into the State of Delaware with activity centered around the cities of Wilmington and Dover, Delaware. In November of 2020, we opened a branch in Kennett Square, Pennsylvania, to further serve customers obtained as part of the MidCoast acquisition, as well as to expand operations into Chester County, Pennsylvania.
We originate loans primarily through direct loans to our existing customer base, with new customers generated through the strong relationships that our lending teams have with their customers, as well as by referrals from real estate brokers, building contractors, attorneys, accountants, corporate and advisory board members, existing customers and the Bank’s website. The Bank offers a variety of loans, although historically most of our lending has focused on real estate loans including residential, commercial, agricultural, and construction loans. As of December 31, 2021, approximately 87.1% of our loan portfolio consisted of real estate loans. All lending is governed by a lending policy that is developed and administered by management and approved by the Board of Directors.
The Bank primarily offers fixed rate residential mortgage loans with terms of up to 25 years and adjustable rate mortgage loans (with amortization schedules up to 30 years) with interest rates and payments that adjust based on one, three, five and 15 year fixed periods. Loan to value ratios are usually 80% or less with exceptions for individuals with excellent credit and low debt to income and/or high net worth. Adjustable rate mortgages are tied to a margin above the comparable Federal Home Loan Bank of Pittsburgh borrowing rate. Home equity loans are written with terms of up to 15 years at fixed rates. Home equity lines of credit are variable rate loans tied to the Prime Rate generally with a ten year draw period followed by a ten year repayment period. Home equity loans are typically written with a maximum 80% loan to value.
Commercial real estate loan terms are generally 20 years or less, with one to five year adjustable interest rates. The adjustable rates are typically tied to a margin above the comparable Federal Home Loan Bank of Pittsburgh borrowing rate with a typical loan to value ratio of 80% or less. During 2021 and 2020, the Bank offered certain customers derivative contracts that allowed the customer to obtain a fixed interest rate for a period up to 10 years. Where feasible, the Bank participates in the United States Department of Agriculture’s (USDA) and Small Business Administration (SBA) guaranteed loan programs to offset credit risk and to further promote economic growth in our market area.
Agriculture is an important industry throughout our market areas. Therefore, the Bank has not only developed an agriculture lending team with significant experience that has a thorough understanding of this industry, but also continually looks for additional employees with a thorough understanding of agriculture. We have an agricultural loan policy to assist in underwriting agricultural loans. Agricultural loans are made to a diversified customer base that include dairy, swine and poultry farmers and their support businesses. Agricultural loans focus on character, cash flow and collateral, while also considering the particular risks of the industry. Loan terms are generally 20 years or less, with one to five year adjustable interest rates. The adjustable rates are typically tied to a margin above the comparable Federal Home Loan Bank of Pittsburgh borrowing rate with a typical loan to value of less than 80%. We evaluate the financial strength of the integrators we have exposure to with our poultry and swine agricultural customers. The Bank is a preferred lender under the USDA’s Farm Service Agency (FSA) and participates in the FSA guaranteed loan program.
The Bank, as part of its commitment to the communities it serves, is an active lender for projects by our local municipalities and school districts. These loans range from short term bridge financing to 20 year term loans for specific projects. These loans are typically written at rates that adjust at least every five years. Due to the size of certain municipal loans, we have developed participation lending relationships with other community banks that allow us to meet regulatory compliance issues, while meeting the needs of the customer. At December 31, 2021, the aggregate balance of our participation loans, in which a portion was sold to other lender’s totaled $157.5 million, of which $90.9 million was sold.
Activity associated with exploration for natural gas in 2021 was slightly higher than 2020. Certain entities drilled new wells and created new pad sites and pipelines, while other companies only maintained their existing wells. Natural gas prices increased during 2021, but still experienced significant volatility in 2021. While the Bank has loaned to companies that service the exploration activities, the Bank did not originate any loans to companies performing the actual drilling and exploration activities. Loans made by the Company were to service industry customers which included trucking companies, stone quarries and other support businesses. We also originated loans to businesses and individuals for restaurants, hotels and apartment rentals that were developed and expanded to meet the housing and living needs of the gas workers. Due to our understanding of the industry and its cyclical nature, the loans made for natural gas-related activities were originated in a prudent and cautious manner and were subject to specific policies and procedures for lending to these entities, which included lower loan to value thresholds, shortened amortization periods, and expansion of our monitoring of loan concentrations associated with this activity.
The following table shows the year-end composition of the loan portfolio for the five years ended December 31 (dollars in thousands):
| | 2021 | | | 2020 | |
| | Amount | | | % | | | Amount | | | % | |
| Real estate: | | | | | | | | | | | | |
| Residential | | $ | 201,097 | | | | 14.0 | | | $ | 201,911 | | | | 14.4 | |
| Commercial | | | 687,338 | | | | 47.7 | | | | 596,255 | | | | 42.4 | |
| Agricultural | | | 312,011 | | | | 21.6 | | | | 315,158 | | | | 22.4 | |
| Construction | | | 55,036 | | | | 3.8 | | | | 35,404 | | | | 2.5 | |
| Consumer | | | 25,858 | | | | 1.8 | | | | 30,277 | | | | 2.2 | |
| Other commercial loans | | | 74,585 | | | | 5.2 | | | | 114,169 | | | | 8.1 | |
| Other agricultural loans | | | 39,852 | | | | 2.8 | | | | 48,779 | | | | 3.5 | |
| State & political subdivision loans | | | 45,756 | | | | 3.1 | | | | 63,328 | | | | 4.5 | |
| Total loans | | | 1,441,533 | | | | 100.0 | | | | 1,405,281 | | | | 100.0 | |
| Less allowance for loan losses | | | 17,304 | | | | | | | | 15,815 | | | | | |
| Net loans | | $ | 1,424,229 | | | | | | | $ | 1,389,466 | | | | | |
| | | |
| | Amount | | | % | |
| Real estate: | | | | | | | |
| Residential | | $ | (814 | ) | | | (0.4 | ) |
| Commercial | | | 91,083 | | | | 15.3 | |
| Agricultural | | | (3,147 | ) | | | (1.0 | ) |
| Construction | | | 19,632 | | | | 55.5 | |
| Consumer | | | (4,419 | ) | | | (14.6 | ) |
| Other commercial loans | | | (39,584 | ) | | | (34.7 | ) |
| Other agricultural loans | | | (8,927 | ) | | | (18.3 | ) |
| State & political subdivision loans | | | (17,572 | ) | | | (27.7 | ) |
| Total loans | | $ | 36,252 | | | | 2.6 | |
2021
Total loans grew $36.3 million in 2021 and total $1.44 billion at the end of 2021. The primary driver of growth during 2021 was growth in commercial real estate in the Delaware market. This growth was offset by a decrease in other commercial loans of $39.6 million due to a decrease in PPP loans due to forgiveness and repayments of $30.4 million and $17.6 million in state and political subdivision loans due to customers refinancing on the bond market due to the low interest rate environment.
Residential real estate loans decreased $814,000 even as refinancing activity remained high in 2021, some of which met the requirements of the secondary market and were subsequently sold. During 2021, $44.7 million of residential real estate loans were originated for sale on the secondary market, which compares to $88.0 million for 2020. For loans sold on the secondary market, the Company recognizes fee income for servicing these sold loans, which is included in non-interest income.
The following table presents the maturity distribution of our loan portfolio as of December 31, 2021 (in thousands). The table does not include any estimate of prepayments which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.
| | | Due in One year or less | | | After one year but within five years | | | After five years through fifteen years | | | After fifteen years | | | Total | |
| Real estate: | | | | | | | | | | | | | | | |
| Residential | | $ | 509 | | | $ | 6,807 | | | $ | 80,496 | | | $ | 113,285 | | | $ | 201,097 | |
| Commercial | | | 28,666 | | | | 151,485 | | | | 331,361 | | | | 175,826 | | | | 687,338 | |
| Agricultural | | | 4,128 | | | | 18,871 | | | | 135,297 | | | | 153,715 | | | | 312,011 | |
| Construction | | | 983 | | | | 16,488 | | | | 26,954 | | | | 10,611 | | | | 55,036 | |
| Consumer | | | 20,724 | | | | 1,868 | | | | 3,110 | | | | 156 | | | | 25,858 | |
| Other commercial loans | | | 2,304 | | | | 38,973 | | | | 8,975 | | | | 24,333 | | | | 74,585 | |
| Other agricultural loans | | | 1,673 | | | | 15,557 | | | | 4,112 | | | | 18,510 | | | | 39,852 | |
| State & political subdivision loans | | | 732 | | | | 1,742 | | | | 16,977 | | | | 26,305 | | | | 45,756 | |
| | | $ | 59,719 | | | $ | 251,791 | | | $ | 607,282 | | | $ | 522,741 | | | $ | 1,441,533 | |
The following table presents the portion of loans that have fixed interest rates or variable interest rates that fluctuate over the life of loans in accordance with changes in the interest rate index that mature after December 31, 2022.
Sensitivity of loans to changes in interest rates - loans due after December 31, 2022: | | Predetermined
interest rate | | | Floating or adjustable interest rate | | | Total | |
| Real estate: | | | | | | | | | |
| Residential | | $ | 110,252 | | | $ | 90,336 | | | $ | 200,588 | |
| Commercial | | | 259,144 | | | | 399,528 | | | | 658,672 | |
| Agricultural | | | 15,907 | | | | 291,976 | | | | 307,883 | |
| Construction | | | 23,167 | | | | 30,886 | | | | 54,053 | |
| Consumer | | | 4,839 | | | | 295 | | | | 5,134 | |
| Other commercial loans | | | 30,358 | | | | 41,923 | | | | 72,281 | |
| Other agricultural loans | | | 10,109 | | | | 28,070 | | | | 38,179 | |
| State & political subdivision loans | | | 29,893 | | | | 15,131 | | | | 45,024 | |
| | | $ | 483,669 | | | $ | 898,145 | | | $ | 1,381,814 | |
Allowance for Loan Losses and Credit Quality Risk
The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb probable future loan losses inherent in the loan portfolio. The provision for loan losses is charged against current income. Loans deemed not collectable are charged-off against the allowance while subsequent recoveries increase the allowance. The allowance for loan losses was $17,304,000 or 1.20% of total loans as of December 31, 2021 as compared to $15,815,000 or 1.13% of loans as of December 31, 2020. The $1,489,000 increase is a result of a $1,550,000 provision for loan losses less net charge-offs of $61,000. During 2021, net charge-offs were low with no significant charge-offs occurring. The following table shows the distribution of the allowance for loan losses and the percentage of loans compared to total loans by loan category (dollars in thousands) as of December 31:
| | | 2021 | | | 2020 | |
| | | Amount | | | % | | | Amount | | | % | |
| Real estate loans: | | | | | | | | | | | | |
| Residential | | $ | 1,147 | | | | 14.0 | | | $ | 1,174 | | | | 14.4 | |
| Commercial | | | 8,099 | | | | 47.7 | | | | 6,216 | | | | 42.4 | |
| Agricultural | | | 4,729 | | | | 21.6 | | | | 4,953 | | | | 22.4 | |
| Construction | | | 434 | | | | 3.8 | | | | 122 | | | | 2.5 | |
| Consumer | | | 262 | | | | 1.8 | | | | 321 | | | | 2.2 | |
| Other commercial loans | | | 1,023 | | | | 5.2 | | | | 1,226 | | | | 8.1 | |
| Other agricultural loans | | | 558 | | | | 2.8 | | | | 864 | | | | 3.5 | |
| State & political subdivision loans | | | 281 | | | | 3.1 | | | | 479 | | | | 4.5 | |
| Unallocated | | | 771 | | | | N/A | | | | 460 | | | | N/A | |
| Total allowance for loan losses | | $ | 17,304 | | | | 100.0 | | | $ | 15,815 | | | | 100.0 | |
The following table provides information related to credit loss experience and net (charge-offs) recoveries for 2021, 2020 and 2019.
| 2021 | | Credit Loss Expense (Benefit) | | | Net (charge-offs) Recoveries | | | Average Loans | | | Ratio of net (charge-offs) recoveries to
Average loans | | | Allowance to total loans | | | Non-
accrual loans as a percent of loans | | | Allowance to total non- accrual loans | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | |
| Residential | | $ | (27 | ) | | | - | | | $ | 203,062 | | | | 0.00 | % | | | 0.57 | % | | | 0.30 | % | | | 192.77 | % |
| Commercial | | | 1,848 | | | | 35 | | | | 639,161 | | | | 0.01 | % | | | 1.18 | % | | | 0.43 | % | | | 275.01 | % |
| Agricultural | | | (224 | ) | | | - | | | | 312,770 | | | | 0.00 | % | | | 1.52 | % | | | 1.00 | % | | | 150.94 | % |
| Construction | | | 312 | | | | - | | | | 56,315 | | | | 0.00 | % | | | 0.79 | % | | | 0.00 | % | | NA | |
| Consumer | | | (53 | ) | | | (6 | ) | | | 24,125 | | | | (0.02 | %) | | | 1.01 | % | | | 0.00 | % | | NA | |
| Other commercial loans | | | (113 | ) | | | (90 | ) | | | 99,839 | | | | (0.09 | %) | | | 1.37 | % | | | 0.19 | % | | | 730.71 | % |
| Other agricultural loans | | | (306 | ) | | | - | | | | 37,181 | | | | 0.00 | % | | | 1.40 | % | | | 2.01 | % | | | 69.49 | % |
| State & political subdivision loans | | | (198 | ) | | | - | | | | 52,804 | | | | 0.00 | % | | | 0.61 | % | | | 0.00 | % | | NA | |
| Unallocated | | | 311 | | | | - | | | | - | | | NA | | | NA | | | NA | | | NA | |
| Total | | $ | 1,550 | | | $ | (61 | ) | | $ | 1,425,257 | | | | 0.00 | % | | | 1.20 | % | | | 0.53 | % | | | 227.21 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2020 | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential | | $ | 46 | | | | 14 | | | $ | 210,696 | | | | 0.01 | % | | | 0.58 | % | | | 0.40 | % | | | 144.58 | % |
| Commercial | | | 2,065 | | | | (398 | ) | | | 478,415 | | | | (0.08 | %) | | | 1.04 | % | | | 0.76 | % | | | 137.25 | % |
| Agricultural | | | (84 | ) | | | 15 | | | | 311,100 | | | | 0.00 | % | | | 1.57 | % | | | 0.99 | % | | | 158.09 | % |
| Construction | | | 79 | | | | - | | | | 26,343 | | | | 0.00 | % | | | 0.34 | % | | | 0.00 | % | | NA | |
| Consumer | | | 238 | | | | (29 | ) | | | 20,986 | | | | (0.14 | %) | | | 1.06 | % | | | 0.00 | % | | NA | |
| Other commercial loans | | | 3 | | | | (32 | ) | | | 112,054 | | | | (0.03 | %) | | | 1.07 | % | | | 1.12 | % | | | 95.48 | % |
| Other agricultural loans | | | (97 | ) | | | - | | | | 46,101 | | | | 0.00 | % | | | 1.77 | % | | | 2.00 | % | | | 88.71 | % |
| State & political subdivision loans | | | (57 | ) | | | - | | | | 86,143 | | | | 0.00 | % | | | 0.76 | % | | | 0.00 | % | | NA | |
| Unallocated | | | 207 | | | | - | | | | - | | | NA | | | NA | | | NA | | | NA | |
| Total | | $ | 2,400 | | | $ | (430 | ) | | $ | 1,291,838 | | | | (0.03 | %) | | | 1.13 | % | | | 0.76 | % | | | 147.36 | % |
| 2019 | | Credit Loss Expense (Benefit) | | | Net (charge-offs) Recoveries | | | Average Loans | | | Ratio of net (charge-offs) recoveries to Average loans | | | Allowance to total loans | | | Non- accrual loans as a percent of loans | | | Allowance to total non-a ccrual loans | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | |
| Residential | | $ | 41 | | | | (32 | ) | | $ | 215,749 | | | | (0.01 | %) | | | 0.51 | % | | | 0.44 | % | | | 115.80 | % |
| Commercial | | | 1,012 | | | | (578 | ) | | | 340,695 | | | | (0.17 | %) | | | 1.33 | % | | | 1.49 | % | | | 89.55 | % |
| Agricultural | | | 758 | | | | - | | | | 298,996 | | | | 0.00 | % | | | 1.61 | % | | | 0.83 | % | | | 194.80 | % |
| Construction | | | (15 | ) | | | 0 | | | | 19,085 | | | | 0.00 | % | | | 0.28 | % | | | 0.00 | % | | NA | |
| Consumer | | | 8 | | | | (16 | ) | | | 9,684 | | | | (0.17 | %) | | | 1.13 | % | | | 0.06 | % | | | 1866.67 | % |
| Other commercial loans | | | (71 | ) | | | (28 | ) | | | 74,986 | | | | (0.04 | %) | | | 1.79 | % | | | 2.63 | % | | | 68.32 | % |
| Other agricultural loans | | | 269 | | | | (60 | ) | | | 45,590 | | | | (0.13 | %) | | | 1.74 | % | | | 1.95 | % | | | 89.56 | % |
| State & political subdivision loans | | | (226 | ) | | | - | | | | 97,780 | | | | 0.00 | % | | | 0.57 | % | | | 0.00 | % | | NA | |
| Unallocated | | | (101 | ) | | | - | | | | - | | | NA | | | NA | | | NA | | | NA | |
| Total | | $ | 1,675 | | | $ | (714 | ) | | $ | 1,102,565 | | | | (0.06 | %) | | | 1.24 | % | | | 1.03 | % | | | 120.02 | % |
The Company believes it utilizes a disciplined and thorough loan review process based upon its internal loan policy approved by the Company’s Board of Directors. The purpose of the review is to assess loan quality, analyze delinquencies, identify problem loans, evaluate potential charge-offs and recoveries, and assess general overall economic conditions in the markets served. An external independent loan review is performed on our commercial portfolio at least semi-annually for the Company. The external consultant is engaged to 1) review a minimum of 50% of the dollar volume of the commercial loan portfolio on an annual basis, 2) new loans originated for over $1.0 million in the last year, 3) a majority of borrowers with commitments greater than or equal to $1.0 million, 4) selected loan relationships over $750,000 which are over 30 days past due, or classified Special Mention, Substandard, Doubtful, or Loss, and 5) such other loans which management or the consultant deems appropriate. As part of this review, our underwriting process and loan grading system is evaluated.
Management believes it uses the best information available to make such determinations and that the allowance for loan losses is adequate as of December 31, 2021. However, future adjustments could be required if circumstances differ substantially from assumptions and estimates used in making the initial determination. A prolonged downturn in the economy, changes in the economies of various segments of our agricultural and commercial portfolios, high unemployment rates, significant changes in the value of collateral and delays in receiving financial information from borrowers could result in increased levels of non-performing assets, charge-offs, loan loss provisions and reduction in income. Additionally, bank regulatory agencies periodically examine the Bank’s allowance for loan losses. The banking agencies could require the recognition of additions to the allowance for loan losses based upon their judgment of information available to them at the time of their examination.
On a monthly basis, problem loans are identified and updated primarily using internally prepared past due reports. Based on data surrounding the collection process of each identified loan, the loan may be added or deleted from the monthly watch list. The watch list includes loans graded special mention, substandard, doubtful, and loss, as well as additional loans that management may choose to include. Watch list loans are continually monitored going forward until satisfactory conditions exist that allow management to upgrade and remove the loan from the watchlist. In certain cases, loans may be placed on non-accrual status or charged-off based upon management’s evaluation of the borrower’s ability to pay. All commercial loans, which include commercial real estate, agricultural real estate, state and political subdivision loans, other commercial loans and other agricultural loans, on non-accrual are evaluated quarterly for impairment.
The adequacy of the allowance for loan losses is subject to a formal, quarterly analysis by management of the Company. In order to better analyze the risks associated with the loan portfolio, the entire portfolio is divided into several categories. As stated above, loans on non-accrual status are specifically reviewed for impairment and given a specific reserve, if appropriate. Loans evaluated and not found to be impaired are included with other performing loans, by category, by their respective homogenous pools. Three year average historical loss factors were calculated for each pool and applied to the performing portion of the loan category for each year presented. The historical loss factors for both reviewed and homogeneous pools are adjusted based upon the following qualitative factors:
| • | Level of and trends in delinquencies, impaired/classified loans |
| ◾ | Change in volume and severity of past due loans |
| ◾ | Volume of non-accrual loans |
| ◾ | Volume and severity of classified, adversely or graded loans |
| • | Level of and trends in charge-offs and recoveries |
| • | Trends in volume, terms and nature of the loan portfolio |
| • | Effects of any changes in risk selection and underwriting standards and any other changes in lending and recovery policies, procedures and practices |
| • | Changes in the quality of the Bank’s loan review system |
| • | Experience, ability and depth of lending management and other relevant staff |
| • | National, state, regional and local economic trends and business conditions |
| ◾ | General economic conditions |
| ◾ | Changes in values of underlying collateral for collateral-dependent loans |
| • | Industry conditions including the effects of external factors such as competition, legal, and regulatory requirements on the level of estimated credit losses. |
| • | Existence and effect of any credit concentrations, and changes in the level of such concentrations |
| • | Any change in the level of board oversight |
See also “Note 5 – Loans and Related Allowance for Loan Losses” to the consolidated financial statements.
As a result of previous loss experiences and other risk factors utilized in determining the allowance, the Bank’s allocation of the allowance does not directly correspond to the actual balances of the loan portfolio. While commercial and agricultural real estate loans total 69.3% of the loan portfolio at December 31 2021, 74.1% of the allowance is assigned to these portions of the loan portfolio as these loans have more inherent risks than residential real estate or loans to state and political subdivisions. Residential real estate loans comprise 14.0% of the loan portfolio as of December 31, 2021 and 6.6% of the allowance is assigned to this segment as generally there are less inherent risks then commercial and agricultural loans.
The following table is a summary of our non-performing assets for the years ended December 31, 2021 and 2020. All non-accruing troubled debt restructurings (TDRs) are also included the non-accruing loans totals.
| | | 2021 | | | 2020 | |
| Non-performing assets: | | | | | | |
| Non-accruing loans | | $ | 7,616 | | | $ | 10,732 | |
| Accrual loans - 90 days or more past due | | | 46 | | | | 525 | |
| Total non-performing loans | | $ | 7,662 | | | $ | 11,257 | |
| Foreclosed assets held for sale | | | 1,180 | | | | 1,836 | |
| Total non-performing assets | | $ | 8,842 | | | $ | 13,093 | |
| | | | | | | | | |
| Troubled debt restructurings (TDR) | | | | | | | | |
| Non-accruing TDRs | | $ | 4,295 | | | $ | 7,026 | |
| Accrual TDRs | | | 6,810 | | | | 5,240 | |
| Total troubled debt restructurings | | $ | 11,105 | | | $ | 12,266 | |
The following table identifies amounts of loans contractually past due 30 to 90 days and non-performing loans by loan category, as well as the change from December 31, 2020 to December 31, 2021 in non-performing loans (in thousands). Non-performing loans include those accruing loans that are contractually past due 90 days or more and non-accrual loans. Interest does not accrue on non-accrual loans. Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management’s assessment of its ultimate ability to collect principal and interest.
| | | December 31, 2021 | | | December 31, 2020 | |
| | | | | | Non-Performing Loans | | | | | | Non-Performing Loans | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential | | $ | 492 | | | $ | 13 | | | $ | 595 | | | $ | 608 | | | $ | 1,351 | | | $ | 275 | | | $ | 812 | | | $ | 1,087 | |
| Commercial | | | 243 | | | | 33 | | | | 2,945 | | | | 2,978 | | | | 1,247 | | | | 70 | | | | 4,529 | | | | 4,599 | |
| Agricultural | | | 31 | | | | - | | | | 3,133 | | | | 3,133 | | | | 366 | | | | 150 | | | | 3,133 | | | | 3,283 | |
| Construction | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
| Consumer | | | 163 | | | | - | | | | - | | | | - | | | | 155 | | | | 30 | | | | - | | | | 30 | |
| Other commercial loans | | | 28 | | | | - | | | | 140 | | | | 140 | | | | 930 | | | | - | | | | 1,284 | | | | 1,284 | |
| Other agricultural loans | | | 10 | | | | - | | | | 803 | | | | 803 | | | | 71 | | | | - | | | | 974 | | | | 974 | |
| Total nonperforming loans | | $ | 967 | | | $ | 46 | | | $ | 7,616 | | | $ | 7,662 | | | $ | 4,120 | | | $ | 525 | | | $ | 10,732 | | | $ | 11,257 | |
| | | Change in Non-Performing Loans | |
| | | Amount | | | % | |
| Real estate: | | | | | | | |
| Residential | | $ | (479 | ) | | | (44.1 | ) |
| Commercial | | | (1,621 | ) | | | (35.2 | ) |
| Agricultural | | | (150 | ) | | | (4.6 | ) |
| Construction | | | - | | | | - | |
| Consumer | | | (30 | ) | | | (100.0 | ) |
| Other commercial loans | | | (1,144 | ) | | | (89.1 | ) |
| Other agricultural loans | | | (171 | ) | | | (17.6 | ) |
| Total nonperforming loans | | $ | (3,595 | ) | | | (31.9 | ) |
The Company has worked with customers directly affected by the COVID-19 pandemic. The Company has offered assistance in accordance with regulator guidelines. As a result of the current COVID-19 pandemic, the Company is engaging in more frequent communication with borrowers to better understand their situation and the challenges faced, allowing it to respond proactively as needs and issues arise. Should economic conditions worsen, the Company could experience increases in non-performing loans and further increases in its required allowance for loan losses and record additional provision expense. It is possible that the Company’s asset quality measures could worsen at future measurement periods if the effects of the COVID-19 pandemic are prolonged.
For the year ended December 31, 2021, we recorded a provision for loan losses of $1,550,000 which compares to $2,400,000 for the same period in 2020, a decrease of $850,000. The decrease is primarily attributable to the impact that the COVID-19 pandemic had in 2020 on the national and local economies compared to 2021, as well as a decrease in organic loan growth in 2021 compared to 2020. Non-performing loans decreased $3.6 million from December 31, 2020 to December 31, 2021 with the decrease being primarily due to two customer relationships that paid off a $1.5 million of their relationships and additional relationships that returned to accrual status during 2021. At December 31, 2021, approximately 61.4% of the Bank’s non-performing loans are associated with the following three customer relationships:
| • | A commercial loan relationship with $1.3 million outstanding, and additional letters of credit of $1.7 million available, secured by undeveloped land, stone quarries and equipment, was on non-accrual status as of December 31, 2021. The Company services the natural gas industry, as well as local municipalities. As a result, the reduced exploration for natural gas in north central Pennsylvania has significantly impacted the cash flows of the customer, who provides excavation services and stone for pad construction related to these activities. During 2019, the Company had the underlying equipment collateral appraised. The 2019 appraisal indicated a decrease in collateral values compared to the appraisal ordered for the loan origination and an appraisal performed in 2017, however, the loan was still considered well secured on a loan to value basis at December 31, 2021. In 2021, the customer has liquidated some excess equipment and the funds have been utilized to pay down a portion of the loans. Management determined that no specific reserve was required as of December 31, 2021.The slowdown in the exploration for natural gas has significantly impacted the cash flows of the customer, who provides excavation services and stone for pad construction related to these activities. During 2019, the Company had the underlying equipment collateral appraised. The 2019 appraisal indicated a decrease in collateral values compared to the appraisal ordered for the loan origination and an appraisal performed in 2017, however, the loan is still considered well secured on a loan to value basis. In the fourth quarter of 2020, a forbearance agreement was signed with this customer. Management determined that no specific reserve was required as of December 31, 2021. |
| • | An agricultural loan customer with a total loan relationship of $2.2 million, secured by real estate, equipment and cattle, was on non-accrual status as of December 31, 2021. The customer declared bankruptcy during the fourth quarter of 2018 and developed a workout plan that was approved by the bankruptcy court in the fourth quarter of 2019 and resulted in monthly payments resuming in late 2019 that continued in 2020 and 2021. Included within these loans to this customer are $792,000 of loans which are subject to Farm Service Agency guarantees. Depressed milk prices and the pandemic have created cash flow difficulties for this customer. Absent a sizable and sustained increase in milk prices, which is not assured, we will need to rely upon the collateral for repayment of interest and principal. During 2020, the Company had the underlying collateral appraised. Management determined that no specific reserve was required as of December 31, 2021. |
| • | An agricultural loan customer with a total loan relationship of $1.2 million, secured by real estate was on non-accrual status as of December 31, 2021. The COVID-19 pandemic has escalated the cash flow difficulties this customer was experiencing. We expect that we will need to rely upon the collateral for repayment of interest and principal. Management reviewed the collateral and determined that no specific reserve was required as of December 31, 2021. |
Management believes that the allowance for loan losses at December 31, 2021 was adequate at that date, which was based on the following factors:
| • | Three loan relationships comprise 61.4% of the non-performing loan balance, which did not require any specific reserves as of December 31, 2021. |
| • | The Company has a history of low charge-offs, which were 0.00% and 0.03% of average loans for 2021 and 2020, respectively. |
Bank Owned Life Insurance
The Company holds bank owned life insurance policies to offset current and future employee benefit costs. These policies provide the Bank with an asset that generates earnings to partially offset the current costs of benefits, and eventually (at the death of the insureds) provide partial recovery of cash outflows associated with the benefits. As of December 31, 2021 and 2020, the cash surrender value of the life insurance was $38.5 million and $32.6 million, respectively. The primary cause of the increase was the Bank purchased $7.8 million of additional insurance during 2021. During the first quarter of 2021, the Company received proceeds of $3,714,000, which included death benefits of $1,155,000 on two former employees of the Company. The change in cash surrender value, net of purchases and amounts acquired through acquisitions, is recognized in the results of operations. The amounts recorded as non-interest income totaled $1,828,000, $695,000 and $623,000 in 2021, 2020 and 2019, respectively with the increase due to the death benefits received in 2021. The Company evaluates annually the risks associated with the life insurance policies, including limits on the amount of coverage and an evaluation of the various carriers’ credit ratings.
Effective January 1, 2015, the Company restructured its agreements so that any death benefits received from a policy while the insured person is an active employee of the Bank will be split with the beneficiary of the policy. Under the restructured agreements, the employee’s beneficiary will be entitled to receive 50% of the net amount at risk from the proceeds. The policies acquired as part of the acquisition of MidCoast are only for the benefit of the Bank. The net amount at risk is the total death benefit payable less the cash surrender value of the policy as of the date of death. The policies acquired as part of the acquisition of FNB, provide a fixed dollar benefit for the beneficiary’s’ estate, which is dependent on several factors including whether the covered individual was a Director of FNB or an employee of FNB and their salary level. As of December 31, 2021 and 2020, included in other liabilities on the Consolidated Balance sheet is a liability of $696,000 and $687,000, respectively, for the obligation under the split-dollar benefit agreements.
Other Assets
2021
Other assets increased $3.4 million in 2021 to $22.8 million from $19.4 million in 2020. As a result of derivative transactions for the Company and customers, other assets increased $3.7 million. We extended several leases during the year, which resulted in the right of use asset for facilities increasing $978,000. As a result of the discount rates utilized for the pension plan, a pension asset was recorded of $792,000. Due to lower borrowing levels with FHLB of Pittsburgh, regulatory stock decreased $1.3 million during 2021. Foreclosed properties were sold during 2021, which resulted in a decrease to other assets of $656,000 million.
Deposits
The following table shows the breakdown of deposits by deposit type (dollars in thousands) at December 31:
| | 2021 | | | 2020 | | | 2019 | |
| | Amount | | | % | | | Amount | | | % | | | Amount | | | % | |
| Non-interest-bearing deposits | | $ | 358,073 | | | | 19.5 | | | $ | 303,762 | | | | 19.1 | | | $ | 203,793 | | | | 16.9 | |
| NOW accounts | | | 485,292 | | | | 26.4 | | | | 422,083 | | | | 26.6 | | | | 340,273 | | | | 28.1 | |
| Savings deposits | | | 313,048 | | | | 17.0 | | | | 255,853 | | | | 16.1 | | | | 224,456 | | | | 18.5 | |
| Money market deposit accounts | | | 350,122 | | | | 19.1 | | | | 225,968 | | | | 14.2 | | | | 169,865 | | | | 14.0 | |
| Certificates of deposit | | | 329,616 | | | | 18.0 | | | | 381,192 | | | | 24.0 | | | | 272,731 | | | | 22.5 | |
| Total | | $ | 1,836,151 | | | | 100.0 | | | $ | 1,588,858 | | | | 100.0 | | | $ | 1,211,118 | | | | 100.0 | |
| | | | | | | | | | | | | | | | | | | | �� | | | | | |
| | | | | | 2020/2019 Change | | | | | | | | | |
| | | Amount | | | % | | | Amount | | | % | | | | | | | | | |
| Non-interest-bearing deposits | | $ | 54,311 | | | | 17.9 | | | $ | 99,969 | | | | 49.1 | | | | | | | | | |
| NOW accounts | | | 63,209 | | | | 15.0 | | | | 81,810 | | | | 24.0 | | | | | | | | | |
| Savings deposits | | | 57,195 | | | | 22.4 | | | | 31,397 | | | | 14.0 | | | | | | | | | |
| Money market deposit accounts | | | 124,154 | | | | 54.9 | | | | 56,103 | | | | 33.0 | | | | | | | | | |
| Certificates of deposit | | | (51,576 | ) | | | (13.5 | ) | | | 108,461 | | | | 39.8 | | | | | | | | | |
| Total | | $ | 247,293 | | | | 15.6 | | | $ | 377,740 | | | | 31.2 | | | | | | | | | |
2021
Total deposits increased $247.3 million in 2021, or 15.6%. The driver of the increase was government stimulus funds in response to the COVID 19 pandemic, which included individuals, businesses and municipalities and all markets of Company. We continue to enhance our cash management services to improve our customer services and to grow deposits through our current customers. Brokered certificates of deposit decreased $23.8 million as maturing certificates were not replaced in 2021. As a percentage of total deposits, non-interest-bearing deposits totaled 19.5% as of the end of 2021, which compares to 19.1% at the end of 2020. The rates paid on certificates of deposit by the Company remain competitive with rates paid by our competition.
2020
Total deposits increased $377.7 million in 2020, or 31.2%. The primary driver of the growth was the MidCoast acquisition, in which $208.8 million of deposits were acquired. The remaining growth was driven by customers holding more cash as a result of the COVID-19 pandemic, and was experienced across all markets, which was facilitated by various government stimulus plans. As a percentage of total deposits, non-interest-bearing deposits totaled 19.1% as of the end of 2020, which compares to 16.9% at the end of 2019. As a result of market conditions in the first half of 2020, we issued long term brokered CD’s and had a balance of $23.8 million of brokered CD’s outstanding as of December 31, 2020 compared to $15.0 million as of December 31, 2019.
Remaining maturities of certificates of deposit in excess of FDIC insurance limits are as follows for December 31, 2021 (dollars in thousands):
| 3 months or less | | $ | 9,464 | |
| Over 3 months through 6 months | | | 7,424 | |
| Over 6 months through 12 months | | | 27,422 | |
| Over 12 months | | | 33,801 | |
| Total | | $ | 78,111 | |
As a percent of total certificates of deposit | | | 23.70 | % |
Uninsured deposits as of December 31, 2021 and 2020, are estimated based on regulatory reporting requirements to be $742,304,000 and $536,383,000, respectively.
Deposits by type of depositor are as follows (dollars in thousands) at December 31:
| | 2021 | | | 2020 | | | 2019 | |
| | Amount | | | % | | | Amount | | | % | | | Amount | | | % | |
| Individuals | | $ | 938,331 | | | | 51.1 | | | $ | 865,041 | | | | 54.4 | | | $ | 664,065 | | | | 54.8 | |
| Businesses and other organizations | | | 534,402 | | | | 29.1 | | | | 467,159 | | | | 29.4 | | | | 306,873 | | | | 25.3 | |
| State & political subdivisions | | | 363,418 | | | | 19.8 | | | | 256,658 | | | | 16.2 | | | | 240,180 | | | | 19.9 | |
| Total | | $ | 1,836,151 | | | | 100.0 | | | $ | 1,588,858 | | | | 100.0 | | | $ | 1,211,118 | | | | 100.0 | |
Borrowed Funds
2021
Borrowed funds decreased $14.9 million during 2021 as a result of maturities and prepayments that occurred in 2021 that were not replaced due to deposit growth in 2021. Short term borrowings from the FHLB remained steady and totaled $25.0 million as of December 31, 2021 and 2020. Long term borrowings from the FHLB decreased $26.8 million and total $14.7 million. Term loans from the FHLB totaled $14.7 million and $41.5 million as of December 31, 2021 and 2020, respectively. The change in term loans was due to $21.8 million of term loans maturing during 2021 and prepaying an additional $5.0 million of term loans during 2021. In the second quarter of 2021, we issued $10.0 million of subordinated notes. (see Note 10 of the consolidated financial statements for additional information). Management continually monitors interest rates in order to minimize interest rate risk in future years and as part of this may extend some of the short term borrowings via term notes. The Bank has five interest rate swap agreements outstanding to convert floating-rate debt to fixed rate debt on notional amounts of $15.0 million, $10.0 million and three agreements of $6.0 million. The $15.0 million and $10.0 million were originated on April 1, 2020 and expire on April 1, 2025 and April 1, 2027. The three $6.0 million agreements originated on May 14, 2020 with a two year forward start date and expire on May 14, 2027, 2029 and 2032 The Company has an interest rate swap agreement outstanding that was entered into on April 13, 2020, to convert floating-rate debt to fixed rate debt on a notional amount of $7.5 million. The interest rate swap agreement expires on June 17, 2027. The interest rate swap instruments involve an agreement to receive a floating rate and pay a fixed rate, at specified intervals, calculated on the agreed-upon notional amounts. The differentials paid or received on interest rate swap agreements are recognized as adjustments to interest expense in the period. The fair value of the interest rate swaps at December 31, 2021 was $ 1,910,000 and is included within other assets on the consolidated balance sheets.
Other Liabilities
2021
Other liabilities increased $1.8 million to $20.5 million during 2021. We extended several leases during the year, which resulted in the right of use asset for facilities increasing $971,000. As a result of derivative transactions for the Company and customers, other liabilities increased $1.1 million. As a result of the discount rates utilized for the pension plan, the pension liability decreased $773,000. Employee benefit accruals, including profit sharing increased $624,000.
Stockholders’ Equity
We evaluate stockholders’ equity in relation to total assets and the risk associated with those assets. The greater our capital resources, the greater the likelihood of meeting our cash obligations and absorbing unforeseen losses. For these reasons, capital adequacy has been, and will continue to be, of paramount importance. Due to its importance, we develop a capital plan and stress test capital levels using various techniques and assumptions annually to ensure that in the event of unforeseen circumstances, we would remain in compliance with our capital plan approved by the Board of Directors and regulatory requirement levels.
Our Board of Directors determines our cash dividend rate after considering our capital requirements, current and projected net income, and other factors. In 2021 and 2020, the Company paid out 25.36% and 29.32% of net income in cash dividends, respectively.
As of December 31, 2021, the total number of common shares outstanding was 3,944,420. For comparative purposes, outstanding shares for prior periods were adjusted for the June 2021 stock dividend in computing earnings and cash dividends per share as detailed in Note 1 of the consolidated financial statements. During 2021, we purchased 23,390 shares of treasury stock at a weighted average cost of $58.74 per share. The Company awarded 4,660 shares of restricted stock to employees at a weighted average cost per share of $60.73 under an equity incentive plan. The Board of Directors was awarded 1,800 shares at a cost of $60.90 per share under an incentive plan.
2021
Stockholders’ equity increased 9.4% in 2021 to $212.5 million. Excluding accumulated other comprehensive income (loss), stockholders’ equity increased $21.0 million, or 10.9%., Net income for 2021 was $29.1 million, offset by net cash dividends of $7,383,000 and net treasury stock activity of $934,000. All of the Company’s debt investment securities are classified as available-for-sale, making this portion of the Company’s balance sheet more sensitive to the changing market value of investments. Accumulated other comprehensive income decreased $2,742,000 from December 31, 2020, primarily as result of the decrease in the fair market value of the investment portfolio. Total stockholders’ equity was approximately 9.9% of total assets as of December 31, 2021, compared to 10.27% of total assets as of December 31, 2020.
LIQUIDITY
Liquidity is a measure of the Company’s ability to efficiently meet normal cash flow requirements of both borrowers and depositors. Liquidity is needed to meet depositors’ withdrawal demands, extend credit to meet borrowers’ needs, provide funds for normal operating expenses and cash dividends, and fund future capital expenditures.
To maintain proper liquidity, we use funds management policies along with our investment and asset liability policies to assure we can meet our financial obligations to depositors, credit customers and stockholders. Management monitors liquidity by reviewing loan demand, investment opportunities, deposit pricing and the cost and availability of borrowing funds. Additionally, the bank has established various limits and ratios to monitor liquidity. On a quarterly basis, we stress test our liquidity position to ensure that the Bank has the capability of meeting its cash flow requirements in the event of unforeseen circumstances. The Company’s historical activity in this area can be seen in the Consolidated Statement of Cash Flows from investing and financing activities.
Cash generated by operating activities, investing activities and financing activities influences liquidity management. The most important source of funds is the deposits that are primarily core deposits (deposits from customers with other relationships). Short-term debt from the Federal Home Loan Bank supplements the Company’s availability of funds as well as a line of credit arrangement with a corresponding bank. Other sources of short-term funds include brokered CDs and the sale of loans, if needed.
The Company’s use of funds is shown in the investing activity section of the Consolidated Statement of Cash Flows, where the net loan activity is detailed. Other significant uses of funds are capital expenditures, purchase of loans and acquisition premiums. Surplus funds are then invested in investment securities.
Capital expenditures, including software purchases in 2021 totaled $1,105,000, which included:
| ▪ | Operations building in Wellsboro, Pennsylvania totaling $753,000 |
| ▪ | Vehicle purchases totaling $82,000 |
| ▪ | ATM upgrades totaling $124,000 |
| ▪ | Building and ground improvements totaling $96,000 |
Capital expenditures, including software purchases in 2020 totaled $942,000, which included:
| ▪ | Teller and imaging software totaling $709,000 |
| ▪ | Leasehold improvements and certain equipment for an office opened in 2020 totaling $73,000 |
| ▪ | Building and ground improvements totaling $73,000 |
| ▪ | Computer, network and copier upgrades totaling $76,000 |
We expect these expenditures will support our initiatives and will create operating efficiencies, while providing quality customer service.
In addition to the Bank’s cash balances, the Bank achieves additional liquidity primarily from its investment in the FHLB of Pittsburgh and the resulting borrowing capacity obtained through this investment, investments that mature in less than one year and expected principal repayments from mortgage backed securities. The Bank has a maximum borrowing capacity at the Federal Home Loan Bank of approximately $756.2 million, inclusive of any outstanding amounts, as a source of liquidity. The Bank also has two federal funds line with third party providers in the total amount of $34.0 million as of December 31, 2021, which is unsecured and a borrower in custody agreement was established with the FRB in the amount of $1.1 million, which is collateralized by $1.7 million of municipal loans.
The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders. The Company also has repurchased shares of its common stock. The Company’s primary source of income is dividends received from the Bank. The Bank may not declare a dividend without approval of the FRB, unless the dividend to be declared by the Bank’s Board of Directors does not exceed the total of: (i) the Bank’s net profits for the current year to date, plus (ii) its retained net profits for the preceding two current years, less any required transfers to surplus. In addition, the Bank can only pay dividends to the extent that its retained net profits (including the portion transferred to surplus) exceed its bad debts. The FRB, the OCC, the PDB and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions. The Prompt Corrective Action Rules, described above, further limit the ability of banks to pay dividends, because banks which are not classified as well capitalized or adequately capitalized may not pay dividends and no dividend may be paid which would make the Bank undercapitalized after the dividend. At December 31, 2021, the Company (unconsolidated basis) had liquid assets of $15.0 million.
CONTRACTUAL OBLIGATIONS
The Company has various financial obligations, including contractual obligations which may require cash payments. The following table (in thousands) presents as of December 31, 2021, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the obligations can be found in Notes 9, 10 and 18 to the Consolidated Financial Statements.
| Contractual Obligations | | | | | | | | | | | | | | Total | |
| Deposits without a stated maturity | | $ | 1,506,535 | | | $ | - | | | $ | - | | | $ | - | | | $ | 1,506,535 | |
| Time deposits | | | 184,857 | | | | 110,741 | | | | 28,251 | | | | 5,767 | | | | 329,616 | |
| FHLB Advances | | | - | | | | - | | | | - | | | | - | | | | - | |
| Term borrowings - FHLB | | | 29,725 | | | | - | | | | 10,000 | | | | - | | | | 39,725 | |
| Note Payable | | | - | | | | - | | | | - | | | | 7,500 | | | | 7,500 | |
| Subordinated Debt | | | - | | | | - | | | | - | | | | 10,000 | | | | 10,000 | |
| Repurchase agreements | | | 16,872 | | | | - | | | | - | | | | - | | | | 16,872 | |
| Operating leases | | | 672 | | | | 1,117 | | | | 824 | | | | 851 | | | | 3,464 | |
Total
| | $ | 1,738,661 | | | $ | 111,858 | | | $ | 39,075 | | | $ | 24,118 | | | $ | 1,913,712 | |
OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, unused lines of credit and letters of credit. For information about our loan commitments, unused lines of credit and letters of credit, see Note 16 of the notes to consolidated financial statements.
For the year ended December 31, 2021, we did not engage in any off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.
INTEREST RATE AND MARKET RISK MANAGEMENT
The objective of interest rate sensitivity management is to maintain an appropriate balance between the stable growth of income and the risks associated with maximizing income through interest sensitivity imbalances and the market value risk of assets and liabilities.
Because of the nature of our operations, we are not subject to foreign currency exchange or commodity price risk and, since the Company has no trading portfolio, it is not subject to trading risk.
At December 31, 2021, the Company had equity securities that represent only 0.6% of our investment portfolio, and therefore market risk related to equity securities is not significant.
The primary factors that make assets interest-sensitive include adjustable-rate features on loans and investments, loan repayments, investment maturities and money market investments. The primary components of interest-sensitive liabilities include maturing certificates of deposit, IRA certificates of deposit, repurchase agreements and short-term borrowings. Savings deposits, NOW accounts and money market investor accounts, with the exception of top interest tier money market and NOW accounts, are considered core deposits and are not short-term interest sensitive and therefore are included in the table below in the over five year column. Top interest tier money market and NOW accounts are included in the table below in the within three month column. Borrowings subject to swap arrangements are included in the table below based on the swap arrangement maturity.
The following table shows the cumulative static gap (at amortized cost) for various time intervals (dollars in thousands):
| Maturity or Re-pricing of Company Assets and Liabilities as of December 31, 2021 | |
| | | Three Months | | | Months | | | Years | | | Years | | | Years | | | Years | | | Total | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing deposits at banks | | $ | 159,776 | | | $ | 6,950 | | | $ | 2,832 | | | $ | 250 | | | $ | - | | | $ | - | | | $ | 169,808 | |
| Investment securities | | | 24,969 | | | | 38,751 | | | | 36,358 | | | | 50,385 | | | | 117,923 | | | | 143,632 | | | | 412,018 | |
| Residential mortgage loans | | | 35,868 | | | | 48,987 | | | | 40,557 | | | | 28,468 | | | | 29,979 | | | | 17,238 | | | | 201,097 | |
| Construction loans | | | 15,505 | | | | 19,404 | | | | 20,127 | | | | - | | | | - | | | | - | | | | 55,036 | |
| Commercial and farm loans | | | 261,250 | | | | 202,084 | | | | 182,913 | | | | 121,197 | | | | 264,803 | | | | 81,539 | | | | 1,113,786 | |
| Loans to state & political subdivisions | | | 8,077 | | | | 3,920 | | | | 3,563 | | | | 4,277 | | | | 13,496 | | | | 12,423 | | | | 45,756 | |
| Other loans | | | 3,062 | | | | 4,845 | | | | 4,969 | | | | 3,589 | | | | 4,394 | | | | 4,999 | | | | 25,858 | |
| Total interest-earning assets | | $ | 508,507 | | | $ | 324,941 | | | $ | 291,319 | | | $ | 208,166 | | | $ | 430,595 | | | $ | 259,831 | | | $ | 2,023,359 | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW accounts | | $ | 314,959 | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 170,333 | | | $ | 485,292 | |
| Savings accounts | | | - | | | | - | | | | - | | | | - | | | | - | | | | 313,048 | | | | 313,048 | |
| Money Market accounts | | | 324,189 | | | | - | | | | - | | | | - | | | | - | | | | 25,933 | | | | 350,122 | |
| Certificates of deposit | | | 53,247 | | | | 131,610 | | | | 68,192 | | | | 42,549 | | | | 28,251 | | | | 5,767 | | | | 329,616 | |
| Long-term borrowing | | | 21,598 | | | | - | | | | - | | | | 10,000 | | | | 24,879 | | | | 17,500 | | | | 73,977 | |
| Total interest-bearing liabilities | | $ | 713,993 | | | $ | 131,610 | | | $ | 68,192 | | | $ | 52,549 | | | $ | 53,130 | | | $ | 532,581 | | | $ | 1,552,055 | |
Excess interest-earning assets (liabilities) | | $ | (205,486 | ) | | $ | 193,331 | | | $ | 223,127 | | | $ | 155,617 | | | $ | 377,465 | | | $ | (272,750 | ) | | | | |
| Cumulative interest-earning assets | | $ | 508,507 | | | $ | 833,448 | | | $ | 1,124,767 | | | $ | 1,332,933 | | | $ | 1,763,528 | | | $ | 2,023,359 | | | | | |
| Cumulative interest-bearing liabilities | | | 713,993 | | | | 845,603 | | | | 913,795 | | | | 966,344 | | | | 1,019,474 | | | | 1,552,055 | | | | | |
| Cumulative gap | | $ | (205,486 | ) | | $ | (12,155 | ) | | $ | 210,972 | | | $ | 366,589 | | | $ | 744,054 | | | $ | 471,304 | | | | | |
Cumulative interest rate sensitivity ratio (1) | | | 0.71 | | | | 0.99 | | | | 1.23 | | | | 1.38 | | | | 1.73 | | | | 1.30 | | | | | |
The previous table and the simulation models discussed below are presented assuming money market investment accounts and NOW accounts in the top interest rate tier are re-priced within the first three months. The loan amounts reflect the principal balances expected to be re-priced as a result of contractual amortization and anticipated early payoffs.
Gap analysis, one of the methods used by us to analyze interest rate risk, does not necessarily show the precise impact of specific interest rate movements on the Bank’s net interest income because the re-pricing of certain assets and liabilities is discretionary and is subject to competition and other pressures. In addition, assets and liabilities within the same period may, in fact, be repaid at different times and at different rate levels. We have not experienced the kind of earnings volatility that might be indicated from gap analysis.
The Bank currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. We use the model as part of our risk management and asset liability management processes that we believe will effectively identify, measure, and monitor the Bank’s risk exposure. In this analysis, the Bank examines the results of movements in interest rates with additional assumptions made concerning the timing of interest rate changes, prepayment speeds on mortgage loans and mortgage securities and deposit pricing movements. Shock scenarios, which assume a parallel shift in interest rates and is instantaneous, typically have the greatest impact on net interest income. The following is a rate shock analysis and the impact on net interest income as of December 31, 2021 (dollars in thousands):
| Changes in Rates | | Prospective One-Year Net Interest Income | | | Change in Prospective Net Interest Income | | | % Change in Prospective Net Interest Income | |
| -100 Shock | | | 61,171 | | | | (1,093 | ) | | | (1.76 | ) |
| Base | | | 62,264 | | | | - | | | | - | |
| +100 Shock | | | 62,260 | | | | (4 | ) | | | (0.01 | ) |
| +200 Shock | | | 63,644 | | | | 1,380 | | | | 2.22 | |
| +300 Shock | | | 64,512 | | | | 2,248 | | | | 3.61 | |
| +400 Shock | | | 65,184 | | | | 2,920 | | | | 4.69 | |
The model makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage backed securities, call activity of other investment securities, and deposit selection, re-pricing and maturity structure. Because of these assumptions, actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change on net interest income. Additionally, the changes above do not necessarily represent the level of change under which management would undertake specific measures to realign its portfolio in order to reduce the projected level of change. The projections above utilize a static balance sheet and do not include any changes that may result from the growth of the Bank. Management has developed policy limits for acceptable changes in net interest income for multiple scenarios, including shock scenarios. As of December 31, 2021, changes in net interest income projected for all scenarios, including the shock scenarios noted above are in line with Bank policy limits for interest rate risk.
CRITICAL ACCOUNTING POLICIES; CRITICAL ACCOUNTING ESTIMATES
The Company’s accounting policies are integral to understanding the results reported. The accounting policies are described in detail in Note 1 of the consolidated financial statements. Our most complex accounting policies require management’s judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. We have established detailed policies and control procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief description of our current accounting policies involving significant management valuation judgments and critical accounting estimates.
Other than Temporary Impairment
All securities are evaluated periodically to determine whether a decline in their value is other than temporary and is a matter of judgment. For debt securities, management considers whether the present value of cash flows expected to be collected are less than the security’s amortized cost basis (the difference defined as the credit loss), the magnitude and duration of the decline, the reasons underlying the decline and the Company’s intent to sell the security or whether it is more likely than not that the Company would be required to sell the security before its anticipated recovery in market value, to determine whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, if the Company does not intend to sell the security, and it is more-likely-than-not that it will not be required to sell the security, before recovery of the security’s amortized cost basis, the charge to earnings is limited to the amount of credit loss. Any remaining difference between fair value and amortized cost (the difference defined as the non-credit portion) is recognized in other comprehensive income, net of applicable taxes. Otherwise, the entire difference between fair value and amortized cost is charged to earnings.
Allowance for Loan Losses
Arriving at an adequate level of allowance for loan losses involves a high degree of judgment. The Company’s allowance for loan losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio.
Management uses historical information to assess the adequacy of the allowance for loan losses as well as the prevailing business environment; as it is affected by changing economic conditions and various external factors, which may impact the portfolio in ways currently unforeseen. This evaluation is inherently subjective as it requires significant estimates that may be susceptible to significant change, subjecting the Bank to volatility of earnings. The allowance is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off. For a full discussion of the Company’s methodology of assessing the adequacy of the allowance for loan losses, refer to Note 1 of the consolidated financial statements.
Goodwill and Other Intangible Assets
As discussed in Note 1 of the consolidated financial statements, the Company performs an evaluation of goodwill for impairment on an annual basis, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company performed a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value. Based on the fair value of the reporting unit, no impairment of goodwill was recognized in 2021, 2020 or 2019.
Pension Benefits
Pension costs and liabilities are dependent on assumptions used in calculating such amounts. These assumptions include discount rates, benefits earned, interest costs, expected return on plan assets, mortality rates, and other factors. In accordance with GAAP, actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense and the recorded obligation of future periods. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect the Company’s pension obligations and future expense. Our pension benefits are described further in Note 11 of the “Notes to Consolidated Financial Statements.”
Deferred Tax Assets
We use an estimate of future earnings to support our position that the benefit of our deferred tax assets will be realized. If future income should prove non-existent or less than the amount of the deferred tax assets within the tax years to which they may be applied, the asset may not be realized and our net income will be reduced. Management also evaluates deferred tax assets to determine if it is more likely than not that the deferred tax benefit will be utilized in future periods. If not, a valuation allowance is recorded. Our deferred tax assets are described further in Note 12 of the consolidated financial statements.
Business combinations are accounted for by applying the acquisition method. As of acquisition date, the identifiable assets acquired and liabilities assumed are measured at fair value and recognized separately from goodwill. Results of operations of the acquired entities are included in the consolidated statement of income from the date of acquisition. The calculation of intangible assets including core deposits and the fair value of loans are based on significant judgements. Core deposits intangibles are calculated using a discounted cash flow model based on various factors including discount rate, attrition rate, interest rate, cost of alternative funds and net maintenance costs.
Loans acquired in connection with acquisitions are recorded at their acquisition-date fair value with no carryover of related allowance for credit losses. Any allowance for loan loss on these pools reflect only losses incurred after the acquisition (meaning the present value of all cash flows expected at acquisition that ultimately are not to be received). Determining the fair value of the acquired loans involves estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. Management considers a number of factors in evaluating the acquisition-date fair value including the remaining life of the acquired loans, delinquency status, estimated prepayments, payment options and other loan features, internal risk grade, estimated value of the underlying collateral and interest rate environment.
ITEM 7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
This information is included under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate and Market Risk Management”, appearing in this Annual Report on Form 10-K.
