ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements in this section and elsewhere in this Annual Report on Form 10-K are forward-looking statements. Citizens & Northern Corporation and its wholly-owned subsidiaries (collectively, the Corporation) intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995. Forward-looking statements, which are not historical facts, are based on certain assumptions and describe future plans, business objectives and expectations, and are generally identifiable by the use of words such as, "should", “likely”, "expect", “plan”, "anticipate", “target”, “forecast”, and “goal”. These forward-looking statements are subject to risks and uncertainties that are difficult to predict, may be beyond management’s control and could cause results to differ materially from those expressed or implied by such forward-looking statements. Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following:
● the effect of the novel coronavirus (COVID-19) and related events
●changes in general economic conditions
●legislative or regulatory changes
●downturn in demand for loan, deposit and other financial services in the Corporation’s market area
●increased competition from other banks and non-bank providers of financial services
● technological changes and increased technology-related costs
●changes in accounting principles, or the application of generally accepted accounting principles
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
CORONAVIRUS (COVID-19) OUTBREAK
The Corporation’s Pandemic Committee has been very active since March 2020, providing frequent communication with employees and clients by telephone, video conference, email and digital tools, while substantially limiting business travel. Since the pandemic
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began, the Committee instituted measures to protect the health of employees and clients, including temporarily operating branch locations on a drive-through only basis and transitioning a significant portion of the Corporation’s employees to remote work. Currently all branches have limited operations to drive-up and appointment-only services. No furloughs or layoffs of employees have been made to date.
Emergency restrictions on the activities of businesses and individuals have resulted in significant adverse economic effects and a significant number of layoffs and furloughs of employees nationwide and in the regions in which the Corporation operates. The ultimate effect of COVID-19 on the local or broader economy is not known nor is the ultimate length of the restrictions described and any accompanying effects. In 2020, the Corporation increased the allowance for loan losses $785,000 based on an increase in qualitative factors related to potential deterioration in economic conditions. Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its economic impact, the total impact on the Corporation’s loan portfolio is not determinable.
Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) provides that, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States under the National Emergencies Act terminates (the “applicable period”), the Corporation may elect to suspend U.S. GAAP for loan modifications related to the pandemic that would otherwise be categorized as troubled debt restructurings (TDRs) and suspend any determination of a loan modified as a result of the effects of the pandemic as being a TDR, including impairment for accounting purposes. The suspension is applicable for the term of the loan modification that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019. The suspension is not applicable to any adverse impact on the credit of a borrower that is not related to the pandemic.
On December 27, 2020, the President of the United States signed into law the Consolidated Appropriations Act, 2021 (the “CAA Act”), which both funds the federal government until September 30, 2021 and broadly addresses additional COVID-19 responses and relief. Among the additional relief measures included are certain extensions to elements of the CARES Act, including extension of temporary relief from troubled debt restructurings established under Section 4013 of the CARES Act to the earlier of a) January 1, 2022, or b) the date that is 60 days after the date on which the national COVID-19 emergency terminates.
In addition, the banking regulators and other financial regulators, on March 22, 2020 and revised April 7, 2020, issued a joint interagency statement titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of the COVID-19 pandemic. Pursuant to the interagency statement, loan modifications that do not meet the conditions of Section 4013 of the CARES Act may still qualify as a modification that does not need to be accounted for as a TDR. Specifically, the agencies confirmed with the Financial Accounting Standards Board (“FASB”) staff that short-term modifications made in good faith in response to the pandemic to borrowers who were current prior to any relief are not TDRs under U.S. GAAP. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. Appropriate allowances for loan and lease losses are expected to be maintained. With regard to loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to the pandemic as past due because of the deferral. The interagency statement also states that during short-term pandemic-related loan modifications, these loans generally should not be reported as nonaccrual.
To work with clients impacted by COVID-19, the Corporation is offering short-term loan modifications on a case-by-case basis to borrowers who were current in their payments at the inception of the loan modification program. Prior to merging with the Corporation on July 1, 2020, Covenant Financial Inc. (“Covenant”) had a similar program in place, and these modified loans have been incorporated into the Corporation’s program. These efforts have been designed to assist borrowers as they deal with the current crisis and help the Corporation mitigate credit risk. For loans subject to the program, each borrower is required to resume making regularly scheduled loan payments at the end of the modification period and the deferred amounts will be moved to the end of the loan term. Consistent with Section 4013 of the CARES Act and guidance from the joint interagency statement described in the preceding paragraphs, the modified loans have not been reported as past due, nonaccrual or as TDRs at December 31, 2020. Most of the modifications under the program became effective in March or the second quarter 2020 and provided a deferral of interest or principal and interest for 90-to-180 days. Accordingly, most of the loans for which deferrals were granted returned to full payment status prior to December 31, 2020. At December 31, 2020, there were 45 loans in deferral status with a total recorded investment of $37,397,000, including 27 commercial loans with a total recorded investment of $35,002,000. A breakdown of these commercial loans by industry is as follows:
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Deferrals Remaining
(Dollars In Thousands) Number
of Recorded
Commercial Loans Modified - Summary Loans Investment
Accommodation and food services - hotels 6 $ 25,090
Lessors of residential buildings & dwellings 4 3,108
Lessors of nonresidential buildings (except miniwarehouses) 2 2,471
Accommodation and food services - other 3 1,102
Transportation and warehousing 4 952
Real estate rental and leasing - other 2 927
Religious organizations 2 755
Golf courses and country clubs 1 380
Breweries 2 201
Personal care services 1 16
The Corporation began accepting and processing applications for loans under the Paycheck Protection Program (“PPP”) through the Small Business Administration (“SBA”) and Treasury Department on April 3, 2020. Covenant also engaged in PPP lending starting in early April 2020. Under the PPP, the Corporation provides SBA-guaranteed loans to small businesses to pay their employees, rent, mortgage interest, and utilities. PPP loans will be forgiven subject to clients providing documentation evidencing their compliant use of funds and otherwise complying with the terms of the program.
The maximum term of PPP loans is five years, though most of the Corporation’s PPP loans have two-year terms, and the Corporation will be repaid sooner to the extent the loans are forgiven. The interest rate on PPP loans is 1%, and the Corporation has received fees from the SBA ranging between 1% and 5% per loan, depending on the size of the loan. Fees on PPP loans, net of origination costs and a market rate adjustment on PPP loans acquired from Covenant, will be recognized in interest income as a yield adjustment over the term of the loans.
As of December 31, 2020, the recorded investment in PPP loans was $132,269,000, including contractual principal balances of $134,802,000, increased by a market rate adjustment on PPP loans acquired from Covenant of $504,000 and reduced by net deferred origination fees of $3,037,000. Accretion of fees received on PPP loans, net of amortization of the market rate adjustment on PPP loans acquired from Covenant, was $1,945,000 for the year ended December 31, 2020.
Capital Strength
While it is difficult to estimate the future impact of COVID-19, the Corporation, including the principal subsidiary, Citizens & Northern Bank (“C&N Bank”), entered the crisis from a position of strength. This is especially apparent in the capital ratios, which are at levels that demonstrate the capacity to absorb significant losses if they arise while continuing to meet the requirements to be considered well capitalized.
C&N Bank’s leverage ratio (Tier 1 capital to average assets) at December 31, 2020 of 10.12% is significantly higher than the well-capitalized threshold of 5%, an excess capital amount of $113.9 million. Similarly, the total capital to risk-weighted assets ratio at December 31, 2020 is 15.98%, which exceeds the well-capitalized threshold of 10%, an excess capital amount of $88.7 million.
Additional details regarding the Corporation’s and C&N Bank’s regulatory capital position are provided in the “Stockholders’ Equity and Capital Adequacy” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”).
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ACQUISITIONS OF COVENANT FINANCIAL, INC. AND MONUMENT BANCORP, INC
The Corporation’s acquisition of Covenant was completed July 1, 2020. Covenant was the parent company of Covenant Bank, a commercial bank which operated a community bank office in Bucks County, Pennsylvania and another in Chester County, Pennsylvania. Pursuant to the transaction, Covenant merged with and into the Corporation and Covenant Bank merged with and into C&N Bank. Total purchase consideration was $63.3 million, including common stock with a fair value of $41.6 million and cash of $21.7 million. Holders of Covenant common stock prior to the consummation of the merger held approximately 12.9% of the Corporation’s common stock outstanding immediately following the merger.
In connection with the acquisition, effective July 1, 2020, the Corporation recorded goodwill of $24.1 million and a core deposit intangible asset of $3.1 million. Assets acquired included loans valued at $464.2 million, cash and due from banks of $97.8 million, bank-owned life insurance valued at $11.2 million and securities valued at $10.8 million. Liabilities assumed included deposits valued at $481.8 million, borrowings valued at $64.0 million and subordinated debt valued at $10.1 million. The assets purchased and liabilities assumed in the acquisition were recorded at their preliminary estimated fair values at the time of closing and may be adjusted for up to one year subsequent to the acquisition.
The acquisition of Covenant follows the acquisition of Monument Bancorp, Inc. (“Monument”) on April 1, 2019. Monument was the parent company of Monument Bank, with two community banking offices and a lending office in Bucks County, Pennsylvania. Monument merged with and into the Corporation and Monument Bank merged with and into C&N Bank. The total transaction value of the Monument acquisition was $42.7 million.
In 2020, the Corporation incurred pre-tax merger-related expenses related to the Covenant transaction of $7.7 million. Merger-related expenses include severance and similar expenses as well as expenses related to conversion of Covenant’s core customer system data into the Corporation’s core system and legal and other professional expenses. Management expects additional merger-related expenses associated with the Covenant acquisition will be insignificant.
Merger-related expenses associated with the Monument transaction totaled $3.8 million for the year ended December 31, 2019.
EARNINGS OVERVIEW
Net income for the year ended December 31, 2020 was $19,222,000, or $1.30 per diluted share as compared to 2019 net income of $19,504,000 or $1.46 per share. Earnings for the year ended December 31, 2020 were significantly impacted by the Covenant acquisition, including the effects of merger-related expenses described earlier. Earnings for the year ended December 31, 2020 included a pre-tax loss of $1.6 million on prepayment of long-term borrowings (Federal Home Loan Bank of Pittsburgh advances) with outstanding balances totaling $48.0 million. The borrowings included several advances maturing in 2022 through 2024 with a weighted-average interest rate of 1.77% and a weighted-average duration of 2.3 years. Management estimated the use of excess cash to prepay borrowings would generate an improvement in the net interest margin of approximately 0.11% in 2021 over previous internal projections, and that the loss would be recovered through higher future earnings in approximately two years. Excluding the impact of merger-related expenses, loss on prepayment of borrowings and net securities gains, adjusted (non-U.S. GAAP) earnings for 2020 would be $26,514,000 or $1.79 per share as compared to similarly adjusted (non-GAAP) earnings of $22,756,000 or $1.70 per share for 2019.
The following table provides a reconciliation of the Corporation’s 2020 earnings results under U.S. generally accepted accounting principles (U.S. GAAP) to comparative non-U.S. GAAP results excluding merger-related expenses, loss on prepayment of borrowings and net securities gains. Management believes disclosure of 2020 and 2019 earnings results, adjusted to exclude the impact of these items, provides useful information to investors for comparative purposes.
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RECONCILIATION OF NET INCOME AND
DILUTED EARNINGS PER SHARE TO NON-U.S.
GAAP MEASURE
(Dollars In Thousands, Except Per Share Data)
Income Diluted Income Diluted
Before Earnings Before Earnings
Income Income per Income Income per
Tax Tax Net Common Tax Tax Net Common
In 2020, interest income on loans acquired from Covenant, partially offset by interest expense on deposits, borrowings and subordinated debt assumed, contributed to growth in net interest income, while costs associated with the expansion contributed to an increase in noninterest expenses. Results for 2019 were significantly impacted by the Monument acquisition.
Other significant variances were as follows:
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More detailed information concerning the Corporation’s earnings results are provided in other sections of Management’s Discussion and Analysis.
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CRITICAL ACCOUNTING POLICIES
The presentation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates.
Allowance for Loan Losses – A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. Management believes the allowance for loan losses is adequate and reasonable. Notes 1 and 8 to the consolidated financial statements provide an overview of the process management uses for evaluating and determining the allowance for loan losses, and additional discussion of the allowance for loan losses is provided in a separate section later in Management’s Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.
Business Combinations – We account for business combinations under the purchase method of accounting. The application of this method of accounting requires the use of significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price consideration between assets that are amortized, accreted or depreciated from those that are recorded as goodwill. Our estimates of the fair values of assets acquired and liabilities assumed are based upon assumptions that we believe to be reasonable.
Goodwill – Goodwill is tested at least annually at December 31 for impairment, or more often if events or circumstances indicate there may be impairment. In 2020, the COVID-19 pandemic led to government-imposed emergency restrictions that have had significant adverse effects on macroeconomic conditions. The ultimate effect of COVID-19 on the local or broader economy is not known nor is the ultimate length of the restrictions described and any accompanying effects.
In testing goodwill for impairment at December 31, 2020, the Corporation by-passed performing a qualitative assessment and performed a quantitative assessment based on comparison of the Corporation’s market capitalization to its stockholders’ equity, resulting in the determination that the fair value of its reporting unit, its community banking operation, exceeded its carrying amount. Accordingly, there was no goodwill impairment at December 31, 2020.
Fair Value of Debt Securities – Another material estimate is the calculation of fair values of the Corporation’s debt securities. For most of the Corporation’s debt securities, the Corporation receives estimated fair values of debt securities from an independent valuation service, or from brokers. In developing fair values, the valuation service and the brokers use estimates of cash flows, based on historical performance of similar instruments in similar interest rate environments. Based on experience, management is aware that estimated fair values of debt securities tend to vary among brokers and other valuation services.
NET INTEREST INCOME
The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense. Tables I, II and III include information regarding the Corporation’s net interest income in 2020 and 2019. In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis. Accordingly, the net interest income amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the tables.
Fully taxable equivalent net interest income was $68,545,000 in 2020, $13,013,000 (23.4%) higher than in 2019. Interest income was $12,325,000 higher in 2020 as compared to 2019; interest expense was lower by $688,000 in comparing the same periods. As presented in Table II, the Net Interest Margin was 3.69% in 2020 as compared to 3.86% in 2019, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) decreased to 3.49% in 2020 from 3.56% in 2019.
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Income from purchase accounting-related adjustments in 2020 had a positive effect on net interest income of $3,272,000, including an increase in income on loans of $1,888,000 and reductions in interest expense on time deposits of $928,000 and on borrowed funds of $456,000. The positive impact to the net interest margin from purchase accounting adjustments was 0.18% in 2020 and 0.04% in 2019.
INTEREST INCOME AND EARNING ASSETS
Interest income totaled $78,140,000 in 2020, an increase of 18.7% from 2019. Interest and fees on loans receivable increased $13,881,000, or 24.9%, to $69,606,000 in 2020 from $55,725,000 in 2019. Table III shows the increase in interest on loans includes $17,713,000 attributable to an increase in volume and a decrease of $3,832,000 related to a decrease in average yield. The average balance of loans receivable increased $387,539,000 (36.6%) to $1,445,098,000 in 2020 from $1,057,559,000 in 2019. The increase in average balance reflects the Corporation’s purchase of Covenant on July 1, 2020. The average balance of loans outstanding in 2020 attributable to the former Covenant operations totaled $234,062,000, including PPP loans of $32,279,000. Excluding Covenant, average loans outstanding increased $153,477,000, including PPP loans of $66,187,000. The increase in average loans outstanding includes the effect of loans acquired from Monument, effective April 1, 2019, as well as subsequent loan growth over the last three quarters of 2019. The average yield on loans in 2020 was 4.82% compared to 5.27% in 2019.
Interest income on available-for-sale debt securities totaled $8,203,000 in 2020, a reduction of $1,328,000 from the total for 2019. As indicated in Table II, average available-for-sale debt securities (at amortized cost) totaled $328,445,000 in 2020, a decrease of $28,839,000 (8.1%) from 2019. The average yield on available-for-sale debt securities decreased to 2.50% in 2020 from 2.67% in 2019.
Interest income from interest-bearing deposits in banks totaled $251,000 in 2020, a decrease of $263,000 from the total for 2019. The most significant categories of assets within this category include interest-bearing balances held with the Federal Reserve and investments in certificates of deposit issued by other banks. The average balance increased $58,876,000, partly due to cash received in the Covenant transaction that was not fully deployed. The average yield on interest-bearing deposits with banks fell to 0.31% in 2020 from 2.37% in 2019, which is a result of the decreases to the rates paid on balances held at the Federal Reserve.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
Interest expense decreased $688,000, or 6.7%, to $9,595,000 in 2020 from $10,283,000 in 2019. Table II shows that the overall cost of funds on interest-bearing liabilities decreased to 0.72% in 2020 from 1.02% in 2019.
Total average deposit balances (interest-bearing and noninterest-bearing) increased $372,722,000 to $1,586,409,000 in 2020 from $1,213,687,000 in 2019. The average balance of deposits from the former Covenant operations totaled $225,541,000. Excluding Covenant average deposits for 2020, deposits increased $147,181,000 over the comparative amount for 2019, reflecting the inclusion of deposits assumed from Monument for all of 2020 as compared to nine months in 2019 as well as increases in deposits related to PPP and other government stimulus programs.
Interest expense on deposits decreased $959,000 in 2020 over 2019. The average rate on interest-bearing deposits decreased to 0.60% in 2020 from 0.89% in 2019, consistent with the reduction in market rates in 2020.
Interest expense on borrowed funds increased $271,000 in 2020 as compared to 2019. Total average borrowed funds increased $46,553,000 to $129,265,000 in 2020 from $82,712,000 in 2019. The increase in average borrowed funds includes the impact of borrowings originated to fund loan growth in the last three quarters of 2019 and borrowings assumed from Covenant. The average rate on total borrowed funds was 1.83% in 2020 compared to 2.53% in 2019. The decrease in the average rate on borrowed funds in 2020 reflects the impact of a reduction in market rates.
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TABLE I - ANALYSIS OF INTEREST INCOME AND EXPENSE
Year Ended
December 31, Increase/
INTEREST INCOME
Interest-bearing due from banks $ 251 $ 514 $ (263)
Available-for-sale debt securities:
Total available-for-sale debt securities 8,203 9,531 (1,328)
Loans receivable:
Paycheck Protection Program (Taxable) 2,924 0 2,924
Other earning assets 80 45 35
INTEREST EXPENSE
Interest-bearing deposits:
Borrowed funds:
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TABLE II - ANALYSIS OF AVERAGE DAILY BALANCES AND RATES
(Dollars In Thousands) Year Year
Ended Rate of Ended Rate of
Average Cost of Average Cost of
Balance Funds% Balance Funds%
EARNING ASSETS
Available-for-sale securities,
at amortized cost:
Loans receivable:
Paycheck Protection Program (Taxable) 98,466 2.97 % 0 0.00 %
Unrealized gain/loss on securities 12,487 1,347
Allowance for loan losses (11,018) (8,876)
Bank-owned life insurance 24,415 18,543
Bank premises and equipment 19,826 15,914
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Borrowed funds:
Other liabilities 20,800 14,624
Stockholders' equity, excluding accumulated
other comprehensive income/loss 263,253 228,103
Accumulated other comprehensive income/loss 10,098 1,343
Total Stockholders' Equity 273,351 229,446
Interest Rate Spread 3.49 % 3.56 %
Net Interest Income/Earning Assets 3.69 % 3.86 %
Total Deposits (Interest-bearing
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TABLE III - ANALYSIS OF VOLUME AND RATE CHANGES
Change in Change in Total
Volume Rate Change
EARNING ASSETS
Interest-bearing due from banks $ 477 $ (740) $ (263)
Available-for-sale debt securities:
Total available-for-sale debt securities (548) (780) (1,328)
Loans receivable:
Paycheck Protection Program (Taxable) 2,924 0 2,924
Other earning assets 31 4 35
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Total interest-bearing deposits 1,669 (2,628) (959)
Borrowed funds:
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NONINTEREST INCOME
TABLE IV - COMPARISON OF NONINTEREST INCOME
(Dollars in Thousands) Years Ended
December 31, $ %
Trust and financial management revenue $ 6,321 $ 6,106 $ 215 3.5 %
Insurance commissions, fees and premiums 184 167 17 10.2 %
Service charges on deposit accounts 4,231 5,358 (1,127) (21.0) %
Service charges and fees 304 332 (28) (8.4) %
Loan servicing fees, net (61) 100 (161) (161.0) %
Total noninterest income, excluding realized gains and losses on securities, increased $5,060,000 (26.2%) in 2020 compared to 2019. Changes of significance are discussed in the Earnings Overview section of Management’s Discussion and Analysis.
NONINTEREST EXPENSE
TABLE V - COMPARISON OF NONINTEREST EXPENSE
(Dollars in Thousands) Year Ended
December 31, $ %
Automated teller machine and interchange expense 1,231 1,103 128 11.6 %
Loss on prepayment of borrowings 1,636 0 1,636
Total noninterest expenses increased $15,416,000 (31.1%) in 2020 as compared to 2019. Total noninterest expenses excluding merger-related expenses and loss on prepayment of borrowings increased $10,171,000 (22.4%) in 2020 as compared to 2019. Merger-related expenses are discussed in the Acquisitions of Covenant Financial Inc. and Monument Bancorp, Inc. section of Management’s Discussion
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and Analysis. Loss on prepayment of borrowings and other changes of significance are discussed in the Earnings Overview section of Management’s Discussion and Analysis.
INCOME TAXES
The effective income tax rate was 17.2% of pre-tax income in 2020, up from 16.7% in 2019. The Corporation’s effective tax rates differed from the statutory rate of 21% mainly because of the effects of tax-exempt interest income. The higher effective income tax rate in 2020 as compared to 2019 resulted mainly from a reduction in tax-exempt interest income and an increase in nondeductible penalties.
The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. At December 31, 2020, the net deferred tax asset was $2,705,000, up from the balance at December 31, 2019 of $2,618,000. The most significant changes in temporary difference components included a net increase of $2,170,000 in the deferred tax liability resulting from appreciation in available-for-sale debt securities attributable to lower interest rates as well as Covenant acquisition-related adjustments to loans, a net operating loss carryforward, core deposit intangibles, bank premises and equipment and operating leases.
The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income, including taxable income in prior carryback years, as well as future taxable income. Further, the value of the benefit from realization of deferred tax assets would be impacted if income tax rates were changed from currently enacted levels.
Management believes the recorded net deferred tax asset at December 31, 2020 is fully realizable; however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings.
Additional information related to income taxes is presented in Note 14 to the consolidated financial statements.
SECURITIES
The objectives of the Corporation’s available-for-sale debt securities (investment) portfolio are to maintain high credit quality, achieve good portfolio balance, support liquidity needs, maximize return on earning assets within reasonable risk parameters, provide an adequate amount of pledgeable securities, support local communities by purchasing securities they issue for public projects and programs, provide a means to hedge the Corporation’s interest rate risk exposure, and minimize taxes. Management continually evaluates the size and mix of securities held in the available-for-sale debt securities portfolio while considering these objectives.
Table VI shows the composition of the available-for-sale debt securities portfolio at December 31, 2020 and 2019. The amortized cost of available-for-sale debt securities was $334,552,000 at December 31, 2020 and $342,278,000 at December 31, 2019. Within the securities portfolio, mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies decreased to 40.5% of the amortized cost basis of the portfolio at December 31, 2020 from 64.8% at December 31, 2019. Investments in tax-exempt and taxable municipal bonds increased to 48.3% of the portfolio at December 31, 2020 from 30.5% at December 31, 2019. These changes in portfolio mix were based on changes in liquidity and interest rate risk management needs and current market yields for various categories of securities.
As reflected in Table VI, the fair value of available-for-sale securities as of December 31, 2020 was $14,780,000, or 4.4%, greater than the total amortized cost basis. In comparison, the aggregate unrealized gain position at December 31, 2019 was $4,445,000, or 1.3% of the total amortized cost basis. The unrealized appreciation in the portfolio in 2020 resulted mainly from a decrease in interest rates.
Management has reviewed the Corporation’s holdings as of December 31, 2020 and concluded that unrealized losses on all of the securities in an unrealized loss position are considered temporary. Note 7 to the consolidated financial statements provides more detail concerning the Corporation’s processes for evaluating securities for other-than-temporary impairment.
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TABLE VI - INVESTMENT SECURITIES
Amortized Fair Amortized Fair
(In Thousands) Cost Value Cost Value
AVAILABLE-FOR-SALE DEBT SECURITIES:
Obligations of the U.S. Treasury $ 12,184 $ 12,182 $ 0 $ 0
Obligations of states and political subdivisions:
The following table presents the contractual maturities and the weighted-average yields (calculated based on amortized cost) of investment securities as of December 31, 2020. Yields on tax-exempt securities are presented on a fully taxable-equivalent basis. For callable securities, yields on securities purchased at a discount are based on yield-to-maturity, while yields on securities purchased at a premium are based on yield to the first call date. Yields on mortgage-backed securities are estimated and include the effects of prepayment assumptions. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.
Within One- Five- After
One Five Ten Ten
Residential pass-through securities 36,853 1.93 %
Residential collateralized mortgage obligations 56,048 1.73 %
Commercial mortgage-backed securities 42,461 2.45 %
The Corporation’s mortgage-backed securities and collateralized mortgage obligations have stated maturities that may differ from actual maturities due to borrowers’ ability to prepay obligations. Cash flows from such investments are dependent upon the performance of the underlying mortgage loans and are generally influenced by the level of interest rates. As rates increase, cash flows generally decrease as prepayments on the underlying mortgage loans decrease. As rates decrease, cash flows generally increase as prepayments increase due to increased refinance activity and other factors. In the table above, the entire balances and weighted-average rates for mortgage-backed securities and collateralized mortgage obligations are shown in one period.
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FINANCIAL CONDITION
This section includes information regarding the Corporation’s lending activities or other significant changes or exposures that are not otherwise addressed in Management’s Discussion and Analysis. Significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the Net Interest Income section of Management’s Discussion and Analysis. Other significant balance sheet items, including securities, the allowance for loan losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis. There are no significant concerns that have arisen related to the Corporation’s off-balance sheet loan commitments or outstanding letters of credit at December 31, 2020, and management does not expect the amount of purchases of bank premises and equipment to have a material, detrimental effect on the Corporation’s financial condition in 2021.
Table VII shows the composition of the loan portfolio as of the end of the years 2016 through 2020. From December 31, 2016 through December 31, 2018, total loans outstanding increased $75.7 million (10.1%) and the overall mix by segment remained fairly constant, with residential mortgage loans of approximately 55% to 56% of the portfolio at each year-end, and commercial loans of 42% to 43% of the portfolio. At December 31, 2019, gross loans outstanding totaled $1,182,222,000, an increase of $354.7 million (42.9%) from December 31, 2018. At December 31, 2020, gross loans outstanding totaled $1,644,209,000, an increase of $462.0 million (39.1%) from December 31, 2019. A significant portion of the Corporation’s loan growth in 2019 was attributable to the Monument acquisition, while, similarly, growth in 2020 is attributable to the Covenant acquisition as well as due to new loans originated in the southeastern and southcentral Pennsylvania markets. At December 31, 2020, commercial loans represented approximately 61% of the portfolio while residential mortgage loans totaled 38% of the portfolio.
While the Corporation’s lending activities are primarily concentrated in its market areas, a portion of the Corporation’s commercial loan segment consists of participation loans. Participation loans represent portions of larger commercial transactions for which other institutions are the “lead banks”. Although not the lead bank, the Corporation conducts detailed underwriting and monitoring of participation loan opportunities. Participation loans are included in the “Commercial and industrial,” “Commercial loans secured by real estate”, “Political subdivisions” and “Other commercial” classes in the loan tables presented in this Form 10-K. Total participation loans outstanding amounted to $65,741,000 at December 31, 2020, up slightly from $64,633,000 at December 31, 2019. At December 31, 2020, the balance of participation loans outstanding includes a total of $40,009,000 to businesses located outside of the Corporation’s market areas. Also, included within participation loans are “leveraged loans,” meaning loans to businesses with minimal tangible book equity and for which the extent of collateral available is limited, though typically at the time of origination the businesses have demonstrated strong cash flow performance in their recent histories. Leveraged participation loans totaled $8,437,000 at December 31, 2020 and $9,947,000 at December 31, 2019.
Table VIII presents loan maturity data as of December 31, 2020. Fixed-rate loans are shown in Table VIII based on their contractually scheduled principal repayments, and variable-rate loans are shown based on the date of the next change in rate. Table VIII shows that fixed-rate loans are approximately 43% of the loan portfolio and approximately 34% of the portfolio are variable-rate loans that re-price after more than one year. Variable-rate loans re-pricing after more than one year include residential and commercial real estate secured loans. The Corporation’s substantial investment in long-term, fixed-rate loans and variable-rate loans with extended periods until re-pricing is one of the concerns management attempts to address through interest rate risk management practices.
Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Xtra program consist primarily of conforming, prime loans sold to the Federal National Mortgage Association (Fannie Mae), a quasi-government entity. In 2014, the Corporation began to originate and sell residential mortgage loans to the secondary market through the MPF Original program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Original program consist primarily of conforming, prime loans sold to the Federal Home Loan Bank of Pittsburgh. In late 2019, the Corporation began to originate and sell larger-balance, nonconforming mortgages under the MPF Direct Program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. The Corporation does not retain servicing rights for loans sold under the MPF Direct Program. In 2020, the Corporation’s activity under the MPF Direct Program was minimal.
For loan sales originated under the MPF programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received or reimburse the investor for a credit loss incurred on a loan, if it
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is determined that the representations and warranties have not been met. Such repurchases or reimbursements generally result from an underwriting or documentation deficiency. At December 31, 2020, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,714,000, and the corresponding total outstanding balance of repurchased loans at December 31, 2019 was $1,770,000.
At December 31, 2020, outstanding balances of loans sold and serviced through the MPF Xtra and Original programs totaled $278,857,000, including loans sold through the MPF Xtra program of $149,463,000 and loans sold through the Original program of $129,394,000. At December 31, 2019, outstanding balances of loans sold and serviced through the two programs totaled $178,446,000, including loans sold through the MPF Xtra program of $104,707,000 and loans sold through the Original Program of $73,739,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of December 31, 2020 and December 31, 2019.
For loans sold under the Original program, the Corporation provides a credit enhancement whereby the Corporation would assume credit losses in excess of a defined First Loss Account (“FLA”) balance, up to specified amounts. The FLA is funded by the Federal Home Loan Bank of Pittsburgh based on a percentage of the outstanding balance of loans sold. At December 31, 2020, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $6,766,000, and the Corporation has recorded a related allowance for credit losses in the amount of $500,000 which is included in accrued interest and other liabilities in the accompanying consolidated balance sheets. At December 31, 2019, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $4,618,000, and the related allowance for credit losses was $333,000. Income related to providing the credit enhancement (included in other noninterest income in the consolidated statements of income) totaled $227,000 in 2020 and $90,000 in 2019. A provision for losses related to the credit enhancement obligation (included in other noninterest expense in the consolidated statements of income) of $167,000 was recorded in 2020 with no corresponding charge in 2019. The Corporation does not provide a credit enhancement for loans sold through the Xtra program.
The Corporation is a participating SBA lender. Under the terms of its arrangements with the SBA, the Corporation may originate loans to commercial borrowers, with full-or-partial guarantees by the SBA, subject to the SBA’s underwriting and documentation requirements. Covenant had also been a participating SBA lender. Pursuant to the Covenant acquisition, the Corporation acquired loans with partial SBA guarantees, or in some cases, loans where the SBA-guaranteed portion of the loans had been sold back to the SBA subject to ongoing compliance with SBA underwriting and documentation requirements. As part of its due diligence, the Corporation reviewed all the loans originated through the various SBA loan programs acquired from Covenant as of July 1, 2020 and recorded an allowance for SBA claim adjustments of $800,000. Determination of the allowance was subjective in nature and was based on the Corporation’s assessment of the credit quality of the loans and the quality of the documentation supporting compliance with SBA requirements. The Corporation’s total exposure related to SBA guarantees on loans originated by Covenant was $17,041,000 at December 31, 2020. In the fourth quarter 2020, the Corporation recorded a reduction in other noninterest expense of $70,000 resulting from better collection experience on certain claims than had been estimated in determining the allowance at July 1, 2020. At December 31, 2020, the allowance for SBA claim adjustments (included in accrued interest and other liabilities in the consolidated balance sheets) had a balance of $730,000.
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TABLE VII – Five-year Summary of Loans by Type
Residential mortgage:
Commercial:
TABLE VIII – LOAN MATURITY DISTRIBUTION
Fixed-Rate Loans Variable- or Adjustable-Rate Loans
1 Year 1-5 >5 1 Year 1-5 >5
(In Thousands) or Less Years Years Total or Less Years Years Total
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. Notes 1 and 8 to the consolidated financial statements provide an overview of the process management uses for evaluating and determining the allowance for loan losses.
While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.
The allowance for loan losses was $11,385,000 at December 31, 2020, up from $9,836,000 at December 31, 2019. Table X shows that the collectively determined portion of the allowance increased $1,675,000 across all loan classes, including an increase in the collectively determined portion of the allowance related to commercial loans of $1,632,000. This increase was primarily due to increases in qualitative factors related to economic conditions in 2020 and an increase in the historical loss factor on commercial loans.
Table X shows total specific allowances on impaired loans decreased $126,000 to $925,000 at December 31, 2020 from $1,051,000 at December 31, 2019. This net decrease included the impact of the elimination of a specific allowance of $678,000 at December 31, 2019 on a commercial loan that was repaid for less than the full principal balance resulting in a charge-off of $107,000 in the second quarter of 2020 as well as the elimination of $125,000 in specific allowances on loans no longer considered impaired at December 31, 2020.
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This reduction in specific allowances on impaired loans was partially offset by allowances totaling $701,000 at December 31, 2020 related to three commercial loan relationships with an aggregate recorded investment of $7,312,000 that management identified as impaired in the second quarter 2020 and that were still considered impaired at December 31, 2020.
Loans acquired from Covenant that were identified as having a deterioration in credit quality (purchased credit impaired, or PCI), were valued at $6,648,000 at July 1, 2020 and $6,537,000 at December 31, 2020. The remainder of the portfolio was deemed to be the performing component of the portfolio. The calculation of the fair value of performing loans included a discount for credit losses of $7,219,000 reduced by accretion of $1,857,000 in the third and fourth quarters of 2020 to $5,362,000 at December 31, 2020. The discount recorded in the acquisition represented an estimate of the present value of credit losses based on market expectations at the date of acquisition.
Loans acquired from Monument that were identified as having a deterioration in credit quality (PCI) were valued at $441,000 at April 1, 2019 and $304,000 at December 31, 2020. The remainder of the portfolio was deemed to be the performing component of the portfolio. Performing loans acquired from Monument are presented net of a discount for credit losses of $617,000 at December 31, 2020 and $1,216,000 at December 31, 2019. This discount reflects an estimate of the present value of credit losses based on market expectations at the date of acquisition of $1,914,000, subsequently reduced as accretion has been recognized based on estimated and actual principal pay-downs.
Table XI shows the allowance for loan losses totaled 0.69% of gross loans outstanding at December 31, 2020, down from 0.83% at December 31, 2019 and down from levels in excess of 1.00% from 2016 to 2018. Table XI also shows that the total of the allowance and the credit adjustment on purchased non-impaired loans, as a percentage of total loans plus the credit adjustment, was 1.05% at December 31, 2020, in line with ratios from the previous years.
The provision for loan losses by segment for 2020 and 2019 is as follows:
Residential mortgage $ 27 $ 374
Unallocated 0 86
The provision for loan losses is further detailed as follows:
Residential mortgage segment
Loan (reduction) growth (240) 171
Changes in historical loss experience factors (88) 47
Changes in qualitative factors 413 (82)
Total provision for loan losses - Residential mortgage segment $ 27 $ 374
Commercial segment
Changes in historical loss experience factors 831 (371)
Changes in qualitative factors 369 157
Total provision for loan losses - Commercial segment $ 3,847 $ 197
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Consumer segment
Loan reduction (30) (3)
Changes in historical loss experience factors (15) 31
Changes in qualitative factors 3 20
Total provision for loan losses - Consumer segment $ 39 $ 192
Total – All segments
Changes in historical loss experience factors 728 (293)
Changes in qualitative factors 785 95
Unallocated 0 86
Total provision for loan losses - All segments $ 3,913 $ 849
For the periods shown in the tables immediately above, the provision related to increases or decreases in specific allowances on impaired loans was affected by changes in the results of management’s assessment of the amount of probable or actual (charged-off) losses associated with a small number of larger, individual loans. This line item also includes net charge-offs or recoveries from smaller loans that had not been individually evaluated for impairment prior to charge-off.
In the tables immediately above, the portion of the net change in the collectively determined allowance attributable to loan growth was determined by applying the historical loss experience and qualitative factors used in the allowance calculation at the end of the preceding period to the net increase in loans outstanding (excluding purchased loans and loans specifically evaluated for impairment) for the period.
The effect on the provision of changes in historical loss experience and qualitative factors, as shown in the tables above, was determined by: (1) calculating the net change in each factor used in determining the allowance at the end of the period as compared to the preceding period, and (2) applying the net change in each factor to the outstanding balance of loans at the end of the preceding period (excluding loans specifically evaluated for impairment).
In 2020, net charge-offs were $2,364,000, including charge-offs of $2,465,000 and recoveries of $101,000. The Corporation’s overall net charge-off experience in 2020 was elevated compared to results over the past several years due to the impact of a charge-off of $2,219,000 on a commercial loan with an outstanding balance of $3,500,000 in the third quarter 2020. Table XII shows the average rate of net charge-offs as a percentage of loans was 0.16% in 2020, with an annual average over the five-year period ended December 31, 2020 of 0.08%, and annual average rates ranging from a high of 0.16% in 2020 to a low of 0.02% in 2018.
Table XI presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs). Total nonperforming loans as a percentage of outstanding loans was 1.42% at December 31, 2020, up from 0.88% at December 31, 2019, and nonperforming assets as a percentage of total assets was 1.10% at December 31, 2020, up from 0.80% at December 31, 2019. Table XI presents data at the end of each of the years ended December 31, 2016 through 2020. Table XI shows that total nonperforming loans as a percentage of loans of 1.42% at December 31, 2020, though up from December 31, 2019, was lower than the corresponding year-end ratio from 2016 through 2018. Similarly, the December 31, 2020 ratio of total nonperforming assets as a percentage of assets of 1.10% was lower than the corresponding ratio from 2016 through 2018.
Total impaired loans of $17,818,000 at December 31, 2020 are up $12,332,000 from the corresponding amount at December 31, 2019 of $5,486,000. The increase in impaired loans includes the net impact of classification as impaired of the commercial loans referred to above in the discussion of specific allowances and the loans purchased with credit impairment from Covenant. Table XI shows that the
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total balance of impaired loans at December 31, 2020 was higher than the year-end amounts over the period 2016-2019, which ranged from a low of $9,511,000 in 2017 to the high of $17,818,000 at December 31, 2020.
Total nonperforming assets of $24,729,000 at December 31, 2020 are $11,418,000 higher than the corresponding amount at December 31, 2019, summarized as follows:
As reflected in Table XI, total loans past due 30-89 days and still accruing interest amounted to $5,918,000 at December 31, 2020, down from $8,889,000 at December 31, 2019. This variance includes the effect of fluctuations in 30-89 day past due residential mortgage loans, which totaled $5,084,000 at December 31, 2020, down from $7,816,000 at December 31, 2019. Management monitors the status of delinquent residential mortgage loans on an ongoing basis and has considered delinquency trends, which were generally favorable throughout most of 2020, in evaluating the allowance for loan losses at December 31, 2020.
Over the period 2016-2020, each period includes a few large commercial relationships that have required significant monitoring and workout efforts. As a result, a limited number of relationships may significantly impact the total amount of allowance required on impaired loans, and may significantly impact the amount of total charge-offs reported in any one period.
Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of December 31, 2020. Management continues to closely monitor its commercial loan relationships for possible credit losses, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.
Tables IX through XII present historical data related to the allowance for loan losses.
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TABLE IX - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(Dollars In Thousands)
Years Ended December 31,
Charge-offs:
Recoveries:
Residential mortgage 44 12 8 19 3
Net charge-offs as a % of average loans 0.16 % 0.03 % 0.02 % 0.05 % 0.09 %
TABLE X - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES
(In Thousands) As of December 31,
ASC 450 - Collective segments:
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TABLE XI - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS AND TROUBLED DEBT RESTRUCTURINGS (TDRs)
(Dollars In Thousands) As of December 31,
Purchased credit impaired loans 6,841 441 0 0 0
Nonperforming assets:
Purchased credit impaired loans $ 6,841 $ 441 $ 0 $ 0 $ 0
Loans subject to troubled debt restructurings (TDRs):
Total nonperforming loans as a % of loans 1.42 % 0.88 % 1.94 % 2.10 % 2.07 %
Total nonperforming assets as a % of assets 1.10 % 0.80 % 1.37 % 1.47 % 1.43 %
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TABLE XII – FIVE-YEAR HISTORY OF LOAN LOSSES
Allowance coverage of charge-offs 5 x 31 x 71 x 21 x 13 x 28 x
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The Corporation’s significant fixed and determinable contractual obligations as of December 31, 2020 include repayment obligations related to time deposits and borrowed funds. Information related to maturities of time deposits is provided in Note 11 to the consolidated financial statements. Information related to maturities of borrowed funds is provided in Note 12 to the consolidated financial statements. The Corporation’s operating lease commitments with terms of one year or less and other commitments at December 31, 2020 are immaterial. Information concerning operating lease commitments with terms greater than one year is provided in Note 17 to the consolidated financial statements. The Corporation’s significant off-balance sheet arrangements include commitments to extend credit and standby letters of credit. Off-balance sheet arrangements are described in Note 16 to the consolidated financial statements.
As described in more detail in the Financial Condition section of Management’s Discussion and Analysis, the Corporation sells residential mortgage loans for which the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met. At December 31, 2020, outstanding balances of such loans sold totaled $278,857,000.
Also, for loans sold under the MPF Original program, the Corporation provides a credit enhancement. At December 31, 2020, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $6,766,000, and the Corporation has recorded a related allowance for credit losses in the amount of $500,000 which is included in “Accrued interest and other liabilities” in the accompanying consolidated balance sheets.
As discussed in the Financial Condition section of Management’s Discussion and Analysis, the Corporation is a participating SBA lender and may originate loans to commercial borrowers, with full-or-partial guarantees by the SBA, subject to the SBA’s underwriting and documentation requirements. In some cases, the Corporation may sell the SBA-guaranteed portion of the loan back to the SBA subject to ongoing compliance with SBA underwriting and documentation requirements. If it is determined that the ongoing compliance requirements are not met, the Corporation could be subject to claim adjustments on SBA guaranteed loans. At December 31, 2020, the Corporation’s total exposure to SBA guarantees was $17,041,000 with a recorded claims adjustment allowance of $730,000, included in accrued interest and other liabilities in the consolidated balance sheets.
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LIQUIDITY
Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand. At December 31, 2020, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $71,237,000.
The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity. Also, the Corporation maintains borrowing facilities with the Federal Home Loan Bank of Pittsburgh, secured by various mortgage loans.
The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. Management intends to use this line of credit as a contingency funding source. As collateral for the line, the Corporation has pledged available-for-sale securities with a carrying value of $15,126,000 at December 31, 2020.
The Corporation’s outstanding, available, and total credit facilities at December 31, 2020 and 2019 are as follows:
Outstanding Available Total Credit
The significant increase in credit available from the Federal Home Loan Bank of Pittsburgh in 2020 resulted from an increase in the borrowing base created by the acquisition of real estate secured loans from Covenant. At December 31, 2020, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of short-term borrowings of $18,000,000, long-term borrowings of $53,822,000 and a $400,000 letter of credit. At December 31, 2019, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of overnight borrowings of $64,000,000, short-term borrowings of $20,297,000 and long-term borrowings with a total amount of $52,127,000.
Additionally, the Corporation uses “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis. If required to raise cash in an emergency situation, the Corporation could sell available-for-sale debt securities to meet its obligations. At December 31, 2019, the carrying value of available-for-sale debt securities in excess of amounts required to meet pledging or repurchase agreement obligations was $124,510,000.
Management believes the Corporation is well-positioned to meet its short-term and long-term obligations.
STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY
Details concerning capital ratios at December 31, 2020 and December 31, 2019 are presented in Note 18 to the consolidated financial statements. Management believes, as of December 31, 2020, that C&N Bank meets all capital adequacy requirements to which it is subject and maintains a capital conservation buffer (described in more detail below) that allows the Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Further, the Corporation’s and C&N Bank’s capital ratios at December 31, 2020 and December 31, 2019 exceed the Corporation’s Board policy threshold levels. Management expects C&N Bank to maintain capital levels that exceed the regulatory standards for well-capitalized institutions for the next 12 months and for the foreseeable future.
Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. In addition, the Corporation and C&N Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities. These restrictions are described in Note 18 to the consolidated financial statements. Further, although the Corporation is no longer subject to the specific consolidated capital requirements described herein, the Corporation’s ability
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to pay dividends, repurchase stock or engage in other activities may be limited by the Federal Reserve if the Corporation fails to hold sufficient capital commensurate with its overall risk profile.
To avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets. At December 31, 2020, the minimum risk-based capital ratios, and the capital ratios including the capital conservation buffer, are as follows:
Minimum common equity tier 1 capital ratio 4.5 %
Minimum tier 1 capital ratio 6.0 %
Minimum tier 1 capital ratio plus capital conservation buffer 8.5 %
Minimum total capital ratio 8.0 %
Minimum total capital ratio plus capital conservation buffer 10.5 %
A banking organization with a buffer greater than 2.5% would not be subject to additional limits on dividend payments or discretionary bonus payments; however, a banking organization with a buffer less than 2.5% would be subject to increasingly stringent limitations as the buffer approaches zero. The rule also prohibits a banking organization from making dividend payments or discretionary bonus payments if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% as of the beginning of that quarter. Eligible net income is defined as net income for the four calendar quarters preceding the current calendar quarter, net of any distributions and associated tax effects not already reflected in net income. A summary of payout restrictions based on the capital conservation buffer is as follows:
Capital Conservation Buffer Maximum Payout
(as a % of risk-weighted assets) (as a % of eligible retained income)
Greater than 2.5% No payout limitation applies
At December 31, 2020, C&N Bank’s Capital Conservation Buffer (determined based on the minimum total capital ratio) was 7.98%.
The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale debt securities. The difference between amortized cost and fair value of available-for-sale debt securities, net of deferred income tax, is included in Accumulated Other Comprehensive Income within stockholders’ equity. The balance in Accumulated Other Comprehensive Income related to unrealized gains (losses) on available-for-sale debt securities, net of deferred income tax, amounted to $11,676,000 at December 31, 2020 and $3,511,000 at December 31, 2019. Changes in accumulated other comprehensive income (loss) are excluded from earnings and directly increase or decrease stockholders’ equity. If available-for-sale debt securities are deemed to be other-than-temporarily impaired, unrealized losses are recorded as a charge against earnings, and amortized cost for the affected securities is reduced. Note 7 to the consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale debt securities for other-than-temporary impairment at December 31, 2020.
Stockholders’ equity is also affected by the underfunded or overfunded status of defined benefit pension and postretirement plans. The balance in Accumulated Other Comprehensive Income related to defined benefit plans, net of deferred income tax, was $119,000 at December 31, 2020 and $180,000 at December 31, 2019.
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ITEM 8. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
(In Thousands, Except Share and Per Share Data) 2020 2019
ASSETS
Cash and due from banks:
Available-for-sale debt securities, at fair value 349,332 346,723
Marketable equity security 1,000 979
Loans held for sale 942 767
Allowance for loan losses (11,385) (9,836)
Accrued interest receivable 8,293 5,001
Foreclosed assets held for sale 1,338 2,886
Core deposit intangibles, net 3,851 1,247
LIABILITIES
Deposits:
Accrued interest and other liabilities 27,692 12,186
STOCKHOLDERS' EQUITY
preference per share; no shares issued 0 0
Common stock, par value $1.00 per share; authorized 20,000,000 shares;
Accumulated other comprehensive income 11,795 3,691
The accompanying notes are an integral part of the consolidated financial statements.
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Consolidated Statements of Income
Years Ended December 31,
(In Thousands Except Per Share Data) 2020 2019
INTEREST INCOME
Interest and fees on loans:
Interest on mortgages held for sale 62 22
Interest on balances with depository institutions 251 514
Income from available-for-sale debt securities:
Dividends on marketable equity security 18 23
Total interest and dividend income 77,160 64,771
INTEREST EXPENSE
Interest on short-term borrowings 367 733
Interest on long-term borrowings 1,291 1,013
Interest on subordinated debt 706 347
Provision for loan losses 3,913 849
Net interest income after provision for loan losses 63,652 53,639
NONINTEREST INCOME
Trust and financial management revenue 6,321 6,106
Insurance commissions, fees and premiums 184 167
Service charges on deposit accounts 4,231 5,358
Service charges and fees 304 332
Interchange revenue from debit card transactions 3,094 2,754
Net gains from sale of loans 5,403 924
Loan servicing fees, net (61) 100
Increase in cash surrender value of life insurance 515 402
Realized gains on available-for-sale debt securities, net 169 23
NONINTEREST EXPENSE
Pensions and other employee benefits 7,463 5,837
Furniture and equipment expense 1,451 1,289
Automated teller machine and interchange expense 1,231 1,103
Loss on prepayment of borrowings 1,636 0
Other noninterest expense 7,428 6,667
Income before income tax provision 23,212 23,409
EARNINGS PER COMMON SHARE - BASIC $ 1.30 $ 1.46
EARNINGS PER COMMON SHARE - DILUTED $ 1.30 $ 1.46
The accompanying notes are an integral part of consolidated financial statements.
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Consolidated Statements of Comprehensive Income
Years Ended December 31,
Unrealized gains on available-for-sale debt securities:
Reclassification adjustment for gains realized in income (169) (23)
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses (49) 87
Other comprehensive (loss) income on unfunded retirement obligations (78) 55
Other comprehensive income before income tax 10,257 9,952
Income tax related to other comprehensive income (2,153) (2,091)
Net other comprehensive income 8,104 7,861
The accompanying notes are an integral part of the consolidated financial statements.
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Consolidated Statements of Changes in Stockholders’ Equity
(In Thousands Except Share and Per Share Data)
Accumulated
Other
Shares Shares Stock Capital Earnings (Loss) Income Stock Total
Other comprehensive income, net 7,861 7,861
Restricted stock granted (48,137) (918) 918 0
Forfeiture of restricted stock 3,758 71 (71) 0
Stock-based compensation expense 798 798
Other comprehensive income, net 8,104 8,104
Forfeiture of restricted stock 5,290 100 (100) 0
Stock-based compensation expense 1,050 1,050
The accompanying notes are an integral part of the consolidated financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
CASH FLOWS FROM OPERATING ACTIVITIES:
Provision for loan losses 3,913 849
Loss on prepayment of borrowings 1,636 0
Realized gains on available-for-sale debt securities, net (169) (23)
Net amortization of securities 1,570 1,341
Increase in cash surrender value of life insurance (515) (402)
Depreciation and amortization of bank premises and equipment 1,981 1,749
Net accretion of purchase accounting adjustments (2,524) (375)
Stock-based compensation 1,050 798
Deferred income taxes (361) 172
Decrease in fair value of servicing rights 576 331
Gains on sales of loans, net (5,403) (924)
Origination of loans held for sale (158,909) (29,978)
Proceeds from sales of loans held for sale 163,149 30,144
Net Cash Provided by Operating Activities 24,784 22,461
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of certificates of deposit 740 580
Purchase of certificates of deposit (2,500) 0
Proceeds from sales of available-for-sale debt securities 28,941 96,148
Purchase of available-for-sale debt securities (105,354) (57,655)
Redemption of Federal Home Loan Bank of Pittsburgh stock 8,496 10,137
Purchase of Federal Home Loan Bank of Pittsburgh stock (5,146) (9,208)
Net decrease (increase) in loans 1,564 (96,628)
Proceeds from bank owned life insurance 0 796
Purchase of premises and equipment (3,137) (2,870)
Proceeds from sale of foreclosed assets 2,262 1,768
Net Cash Provided by Investing Activities 96,580 22,668
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits 86,941 (4,822)
Net decrease in short-term borrowings (99,969) (38,307)
Proceeds from long-term borrowings 25,891 48,500
Repayments of long-term borrowings and subordinated debt (54,831) (38,173)
Sale of treasury stock 131 198
Purchase of vested restricted stock for tax withholding (163) (189)
Net Cash Used in Financing Activities (56,469) (46,834)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 64,895 (1,705)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 31,122 32,827
CASH AND CASH EQUIVALENTS, END OF YEAR $ 96,017 $ 31,122