Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion and analysis provides an overview of the consolidated financial condition and results of operations of the Company for the years ended December 31, 2020 and 2019. This discussion should be read in conjunction with the consolidated financial statements and notes to consolidated financial statements appearing elsewhere in this report.
Critical Accounting Policies
Note 1 to the Company’s consolidated financial statements lists significant accounting policies used in the development and presentation of its financial statements. This discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of the Company and its results of operations.
The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”), which require the Company to make estimates and assumptions. The Company believes that its determination of the allowance for loan losses and the valuation of deferred tax assets involve a higher degree of judgment and complexity than the Company’s other significant accounting policies. Further, these estimates can be materially impacted by changes in market conditions or the actual or perceived financial condition of the Company’s borrowers, subjecting the Company to significant volatility of earnings.
Securities classified as available for sale are those securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Securities available for sale are carried at fair value. Any decision to sell a security classified as available for sale would be based on various factors, including significant movement in interest rates, changes in maturity mix of the Company’s assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Unrealized gains and losses are reported as increases or decreases in other comprehensive income. Realized gains or losses, determined on the basis of the cost of the specific securities sold, are included in earnings. Premiums and discounts are recognized in interest income using the interest method over the terms of the securities.
Other-than-temporary impairment accounting guidance specifies that (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. The Company recognized no other-than-temporary impairment charges during the years ended December 31, 2020 and 2019.
The allowance for loan losses is established through the provision for loan losses, which is a charge against earnings. Provision for loan losses is made to reserve for estimated probable losses on loans. The allowance for loan losses is a significant estimate and is regularly evaluated by the Company for adequacy by taking into consideration factors such as changes in the nature and volume of the loan portfolio, trends in actual and forecasted credit quality, including delinquency, charge-off and bankruptcy rates, and current economic conditions that may affect a borrower’s ability to pay. The use of different estimates or assumptions could produce different provision for loan losses. For additional discussion concerning the Company’s allowance for loan losses and related matters, see “Provision for Loan Losses” and “Allowance for Loan Losses.”
Real estate acquired through foreclosure, or deed-in-lieu of foreclosure is recorded at fair value less estimated selling costs at the date of acquisition or transfer, and subsequently at the lower of its new cost or fair value less estimated selling costs. Adjustments to the carrying value at the date of acquisition or transfer are charged to the allowance for loan losses. The carrying value of the individual properties is subsequently adjusted to the extent it exceeds estimated fair value less the estimated selling costs, at which time a provision for loan losses on such real estate is charged to operations. Appraisals are critical in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly affect the valuation of a property. The assumptions supporting such
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appraisals are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable.
Deferred taxes are provided on the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and net operating loss carryforwards and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Based upon the level of historical taxable income and projections for future taxable income over periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences.
GENERAL
The Company is a Pennsylvania corporation organized in 2008 and registered as a bank holding company pursuant to the BHC Act. The Company was formed for purposes of acquiring the Bank in connection with the reorganization of the Bank into a bank holding company structure, which was consummated on November 11, 2008. Accordingly, the Company owns all of the capital stock of the Bank, giving the organization more flexibility in meeting its capital needs as the Company continues to grow.
The Bank, which is the Company’s primary operating subsidiary, was originally incorporated as a Pennsylvania bank on May 11, 2001 and opened its doors on November 6, 2001. It was formed by a group of local business persons and professionals with significant prior experience in community banking in the Lehigh Valley area of Pennsylvania, the Bank’s primary market area.
Since its inception, the Board’s philosophy has been that, by running the Bank with a view toward the long term, only good things will happen for the Bank’s customers, team members, shareholders, and the Lehigh Valley community.
OVERVIEW
The Company’s assets grew $265.9 million from $1.2 billion at December 31, 2019 to $1.4 billion at December 31, 2020. The Company’s deposits grew $200.4 million from $1.0 billion at December 31, 2019 to $1.2 billion at December 31, 2020. The growth in the Company’s deposits resulted primarily from a relationship building, sales and marketing effort, which served to further increase the Company’s overall presence in the market it serves, deposit relationships developed as a result of cross-marketing efforts to its loan and other non-depository banking service customers along with an injection of federal stimulus money into the economy in 2020 from PPP funds and consumer stimulus payments. The Bank also continued to capitalize on opportunities created by merger announcements, name changes, and competitive branch closures in the Company’s market area, attracting customers looking to relocate to a local, reputable community bank. During the same period, loans receivable (not including PPP loans), net of the allowance for loan losses, increased $73.2 million to $1.1 billion at December 31, 2020 from $1.0 billion at December 31, 2019 and PPP loans had a balance of $54.3 million as of December 31, 2020. With the onset of the COVID-19 pandemic, the market continues to be very competitive and the Company is committed to maintaining a high-quality portfolio that returns a reasonable market rate. While the past and current economic and competitive conditions in the marketplace have created more competition for loans to credit-worthy customers, the Company continues to expand its market presence and continues to focus on developing a reputation as being a market leader in both commercial and consumer/mortgage lending. Management believes that this combination of relationship building, cross marketing and responsible underwriting will translate into continued long-term growth of a portfolio of quality loans and core deposit relationships, although there can be no assurance of this. The Company continues to monitor interest rate exposure of its interest-bearing assets and liabilities and believes that it is well positioned for any anticipated future market rate adjustments.
The Company’s net income increased $1.9 million, or 17.7%, to $12.8 million from $10.9 million in 2019. Diluted earnings per share increased to $1.70 in 2020 from $1.44 in 2019, and basic earnings per share increased to $1.71 in 2020 from $1.46 in 2019, respectively. The difference in net income for the year ended December 31, 2020 and December 31, 2019 resulted, in part, from an increase in net interest income due to the Company’s loan portfolio
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Embassy Bancorp, Inc.
growth, due to PPP loan interest and fee income, and a decrease in interest expense primarily due to a lower cost of funds. Also, contributing to the increase in net income is the increase in bank owned life insurance, gain on the sale of securities, gain on the sale of loans, a decrease in occupancy and equipment, a decrease in advertising and promotions, and a decrease in other expenses, offset by an increase in the provision for loan losses, a decrease in merchant processing and credit card processing fees, a decrease in other service fees, no gain on the sale of real estate owned, an increase in salary and employee benefits, an increase in data processing, an increase in professional fees, and an increase in FDIC insurance.
RESULTS OF OPERATIONS
Net Interest Income and Net Interest Margin
The majority of the Company’s earnings derives from net interest income, which is the difference between income earned on assets and the cost supporting those assets. The net interest margin is the ratio of net interest income to average earning assets. Earning assets are composed primarily of loans and investments, along with interest-bearing deposits with other banks. Interest-bearing deposits and borrowings make up the cost of funds. Non-interest bearing deposits and capital are other components representing funding sources. Changes in the volume and mix of assets and funding sources, along with the changes in yields earned and rates paid, determine changes in net interest income and net interest margin. The timing of deposit and loan growth also impact net interest income.
Generally, changes in net interest income are measured by net interest rate spread and net interest margin. Interest rate spread is the mathematical difference between the average interest earned on earning assets and interest paid on interest bearing liabilities. Interest margin represents the net interest yield on earning assets. The interest margin gives a reader a better indication of asset earning results when compared to peer groups or industry standards.
The Company determines interest rate spread and margin on both US GAAP and tax equivalent basis. The use of tax equivalent basis in determining interest rate spread and margin is considered a non-US GAAP measure. The Company believes use of this measure provides meaningful information to the reader of the consolidated financial statements when comparing taxable and non-taxable assets. However, it is supplemental to US GAAP which is used to prepare the Company’s consolidated financial statements and should not be read in isolation or relied upon as a substitute for US GAAP measures. In addition, the non-US GAAP measure may not be comparable to non-US GAAP measures reported by other companies. The tax rate used to calculate the tax equivalent adjustments was 21% for 2020, 2019, and 2018.
2020 Compared to 2019
Total interest income for the year ended December 31, 2020 was $44.3 million, compared to $42.9 million for the year ended December 31, 2019. Total interest expense for the year ended December 31, 2020 was $6.4 million, compared to $9.3 million for the year ended December 31, 2019. Net interest income increased 13.1% to $37.9 million for the year ended December 31, 2020 as compared to $33.5 million for the year ended December 31, 2019. The improvement in net interest income for the year ended December 31, 2020 is in part the result of a decrease in the balance and rates of certificates of deposit and FHLBank Pittsburgh (“FHLB”) short-term borrowings, and a decrease in the rates of interest bearing demand deposits, NOW, money market, savings accounts, and securities sold under agreement to repurchase. Also contributing to the improvement in net interest income for the year ended December 31, 2020 was an increase in the balances of taxable loans, taxable investments, interest bearing deposits with banks, and interest income and fees from PPP loans. The improvements were offset, in part, by a decrease in the rates of taxable and non-taxable loans, taxable and non-taxable investments, fed funds sold and interest bearing deposits with banks, a decrease in the balance of non-taxable loans and non-taxable investments, an increase in the balance of interest bearing demand deposits, NOW and money markets, savings, FHLB long-term borrowings, and interest expense from Paycheck Protection Program Liquidity Facility (“PPPLF”) borrowings. The Company’s net interest margin for the year ended December 31, 2020 was 3.01% on a US GAAP basis and 3.03% on a non-US GAAP basis, compared to 3.06% on a US GAAP basis and 3.09% on a non-US GAAP basis for the year ended December 31, 2019.
In response to the COVID-19 outbreak, the Federal Reserve Board in mid-March 2020 reduced by 150 basis points the benchmark fed funds rate to a target range of 0% to 0.25%, and the yields on 10 year and 30 year Treasury notes
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Embassy Bancorp, Inc.
have declined to historic lows. As a result of the decline in the Federal Reserve Board’s target federal funds rate and yields on Treasury notes, the Company’s future net interest margin and spread may be further reduced. The Company’s net interest margin was also affected by the PPP loans, which bear interest at a rate of 1.0%, and the PPPLF borrowings added during the year. The net interest margin on a non-US GAAP basis excluding PPP loans and PPP interest income and PPPLF borrowings interest expense for the year ended December 31, 2020 was 3.04%.
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Embassy Bancorp, Inc.
The following table includes the average balances, interest income and expense and the average rates earned and paid for assets and liabilities for the periods presented. All average balances are daily average balances.
Average Balances, Rates and Interest Income and Expense
Average Tax Equivalent Average Tax Equivalent Average Tax Equivalent
Balance Interest Yield Balance Interest Yield Balance Interest Yield
(Dollars in Thousands)
ASSETS
LIABILITIES AND STOCKHOLDERS' EQUITY
TOTAL LIABILITIES AND
Tax equivalent adjustments:
Net interest spread (US GAAP basis) 2.84% 2.83% 3.03%
Net interest margin (US GAAP basis) 3.01% 3.06% 3.19%
Net interest spread (non-US GAAP basis) (3) 2.86% 2.86% 3.07%
Net interest margin (non-US GAAP basis) (3) 3.03% 3.09% 3.23%
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Embassy Bancorp, Inc.
The table below demonstrates the relative impact on net interest income of changes in the volume of interest-earning assets and interest-bearing liabilities and changes in rates earned and paid by the Company on such assets and liabilities.
Increase (decrease) due to changes in: Increase (decrease) due to changes in:
(In Thousands)
Volume Rate Total Volume Rate Total
Interest-earning assets:
Loans - Paycheck Protection Program 1,307 - 1,307 - - -
Total net change in income on
Interest-bearing liabilities:
Interest bearing demand deposits,
Securities sold under agreements to
Paycheck Protection Program
Liquidity Facility borrowings 129 - 129 - - -
Total net change in expense on
Provision for Loan Losses
The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is maintained at a level management considers to be adequate to provide for losses that can be reasonably anticipated. Management’s periodic evaluation of the adequacy of the allowance is based on known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant change. The Company has determined, because of the 100% SBA guarantee, that no allowance for loan losses is required on PPP loans.
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Embassy Bancorp, Inc.
The allowance consists of general, specific, qualitative, and unallocated components. The general component covers non-classified loans and classified loans not considered impaired, and is based on historical loss experience adjusted for qualitative factors. The specific component relates to loans that are classified as impaired and/or restructured. For loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. An allowance for loan losses is not maintained on loans designated as held for sale.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and/or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral-dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and home equity loans for impairment disclosures, unless such loans are the subject of a restructuring agreement or there is a possible loss expected.
For the year ended December 31, 2020, the provision for loan losses was $2.5 million, compared to $605 thousand for the year ended December 31, 2019. Gross loans, excluding PPP loans, grew $76.3 million, or 7.5%, in 2020 over 2019. There were no charge-offs in 2020 or 2019. There were recoveries of $28 thousand and $5 thousand for the years ended December 31, 2020 and December 31, 2019. The provision for loan losses is a function of the allowance for loan loss methodology that the Bank uses to determine the appropriate level of the allowance for inherent loan losses after net charge-offs have been deducted. During the year ending December 31, 2020, the Bank adjusted the economic risk factor and loan modifications risk factor methodologies to incorporate the current economic implications, unemployment rate and amount of loan modifications due to the COVID-19 pandemic. See further discussion following in the “Credit Risk and Loan Quality” section of the Bank’s considerations of its December 31, 2020 allowance for loan loss levels. The allowance for loan losses as of December 31, 2020 was $10.6 million representing 0.97% of outstanding loans receivable (not including PPP loans), as compared to $8.0 million as of December 31, 2019, representing 0.79% of outstanding loans receivable. Based principally on economic conditions, asset quality, and loan-loss experience, including that of comparable institutions in the Bank’s market area, the allowance is believed to be adequate to absorb any losses inherent in the portfolio. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate, or that material increases will not be necessary should the quality of the loans deteriorate. The Bank has not participated in any sub-prime lending activity.
Non-interest Income
Non-interest income is derived from the Company’s operations and represents primarily credit card processing fees, debit card interchange fees, service fees on deposit and loan relationships and income from bank owned life insurance. Non-interest income also may include net gains and losses from the sale of available for sale securities, loans, and other real estate owned.
Total non-interest income was $2.4 million for the year ended December 31, 2020 compared to $2.2 million for the year ended December 31, 2019. The increase is attributable to an increase in bank owned life insurance of $239 thousand, the gain on the sale of securities of $128 thousand, and the gain on the sale of loans of $59 thousand; offset by a decrease of $75 thousand in merchant processing and credit card processing fees due, in part, to less merchant
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Embassy Bancorp, Inc.
processing activity resulting from the COVID-19 pandemic and less credit card activity due to the credit card portfolio being sold in the second quarter of 2020, a decrease in other service fees of $89 thousand in part due to the Company waiving overdraft fees during part of the second quarter due to the COVID-19 pandemic, and the gain on the sale of real estate owned of $45 thousand during the year ended December 31, 2019. The increase in the bank owned life insurance was driven by the effect market conditions had on underlying life insurance assets, particularly the separate account life insurance assets as well as the purchase of $4.0 million in bank owned life insurance in 2020. As the deposit customer account base continues to grow and the Company continues to mature and develop additional sources of fee income, non-interest income is expected to become a more significant contributor to the overall profitability of the Company. Currently, and unlike many in the industry, the Company does not derive additional non-interest fee income by selling its mortgages in the secondary market, nor does it offer trust or investment/brokerage services to its customers.
Non-interest Expense
Non-interest expenses represent the normal operating expenses of the Company. These expenses include salaries, employee benefits, occupancy, equipment, data processing, advertising and other expenses related to the overall operation of the Company.
Non-interest expenses for the year ended December 31, 2020 was $22.1 million, compared to $21.7 million for the year ended December 31, 2019. The increase in non-interest expenses is primarily due to an increase of $634 thousand, or 6.1%, over 2019, in salaries and employee benefits primarily due to the number of employees, the annual increases in salaries and benefits, increase in health insurance cost, and increase in non-qualified pension expense; offset by an increase in deferred compensation costs primarily associated with PPP loan originations. At December 31, 2020, the Company had ninety-six (96) full-time equivalent employees compared to ninety-five (95) at December 31, 2019. Additional increases in non-interest expenses are attributable to an increase of $246 thousand, or 10.5%, in data processing due primarily to e-commerce and the expanding customer base, an increase of $56 thousand, or 7.1%, in professional fees primarily due to an increase in auditing and legal costs, and an increase of $190 thousand, or 95.5%, in FDIC insurance premiums primarily due to FDIC assessment credits of $206 thousand applied in 2019 compared to credits of $44 thousand applied in 2020. These increases in non-interest expenses were offset by a decrease of $77 thousand, or 2.3%, in occupancy and equipment due, in part, to fewer leasehold improvements and utility expenses, a decrease of $617 thousand, or 36.0%, in advertising and promotions from shifts in marketing strategies and less promotional items resulting in part from the COVID-19 pandemic, and a decrease of $80 thousand, or 4.8%, in other expenses in part due to less postage expenses, less fraud losses, and less employee, customer, and shareholder expenses primarily due to restrictions from the COVID-19 pandemic.
A breakdown of other non-interest expenses is included in the Consolidated Statements of Income in the Consolidated Financial Statements included in Item 8 of this Report.
Income Taxes
The provision for income taxes was $2.9 million and $2.5 million for December 31, 2020 and December 31, 2019. The effective rate on income taxes for the years ended December 31, 2020 and 2019 was 18.6%, respectively.
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FINANCIAL CONDITION
Securities
The Company’s securities portfolio is classified, in its entirety, as “available for sale.” Management believes that a portfolio classification of available for sale allows complete flexibility in the management of the investment portfolio. Using this classification, the Company intends to hold these securities for an indefinite amount of time, but not necessarily to maturity. Such securities are carried at fair value with unrealized gains or losses reported as a separate component of stockholders’ equity. The portfolio is structured to provide maximum return on investments while providing a consistent source of liquidity and meeting strict risk standards. The Company holds no high-risk, non-investment grade, securities or derivatives as of December 31, 2020.
The Company’s securities portfolio was $130.9 million at December 31, 2020, a $40.1 million increase from securities of $90.8 million at December 31, 2019. The Company’s securities have increased primarily due to purchases in the amount of $144.7 million and an increase in unrealized gains of $2.0 million, offset by a combination of investment principal pay-downs, maturities, calls, and proceeds from sales totaling $106.3 million. The carrying value of the securities portfolio as of December 31, 2020 and December 31, 2019, includes a net unrealized gain of $3.7 million and $1.7 million, respectively, which is recorded to accumulated other comprehensive income in stockholders’ equity. This increase in the unrealized gain is due primarily to changes in market conditions from 2019 to 2020. No securities are deemed to be other than temporarily impaired.
The following table sets forth the composition of the securities portfolio at fair value as of December 31, 2020, 2019 and 2018.
(In Thousands)
U.S. Treasury securities $ 9,998 $ - $ -
U.S. Government agency obligations 39,036 - 2,997
U.S. Government sponsored enterprise (GSE)
- Mortgage-backed securities - commercial 543 - -
U.S. Government sponsored enterprise (GSE)
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Embassy Bancorp, Inc.
The following table presents the maturities and average weighted yields of the debt securities portfolio as of December 31, 2020. Maturities of mortgage-backed securities are based on estimated life. Yields are based on amortized cost.
Securities by Maturities
1 year or Less 1-5 Years 5-10 Years Over 10 Years Total
Average Average Average Average Average
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
(Dollars In Thousands)
U.S. Government agency
U.S. GSE - Mortgage-
backed securities-
U.S. GSE - Mortgage-
backed securities-
Loans
On May 1, 2020, the Company sold its entire $689 thousand commercial credit card loan portfolio to an unrelated third party for a gain of $59 thousand. These commercial credit cards were unsecured. The Company does not anticipate retaining a credit card loan portfolio by originating and selling commercial credits cards in the future, but will continue to utilize the third party vendor to offer the product.
The loan portfolio comprises a major component of the Bank’s earning assets. All of the Bank’s loans are to domestic borrowers. Total net loans receivable (not including PPP loans) at December 31, 2020 increased $73.2 million to $1.08 billion from $1.01 billion December 31, 2019. The gross loan-to-deposit ratio (not including PPP loans) decreased from 98% at December 31, 2019 to 88% at December 31, 2020. The Bank’s loan portfolio at December 31, 2020, was comprised of residential real estate and consumer loans of $577.1 million, an increase of $58.1 million from December 31, 2019, and commercial loans of $512.5 million, an increase of $18.2 million from December 31, 2019. The Bank has not originated, nor does it intend to originate, sub-prime mortgage loans. As described in Note 2 to the consolidated financial statements, the Bank is participating in the SBA PPP program to support the needs of its small business clients. PPP loans receivable at December 31, 2020 were $54.3 million. Including PPP loans receivable, the gross loan-to-deposit ratio was 93%.
Payment accommodations related to COVID-19 assistance were in the form of short-term (six months or less) principal and/or interest deferrals and the loans were considered current at the time of the accommodation. These payment accommodations were done in accordance with Section 4013 of the CARES Act and the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus and the Company did not categorize these modifications as troubled debt restructurings. Through December 31, 2020, the Company had provided payment accommodations on two hundred fifty-five (255) loans with balances of $151.3 million. Included in these totals are two hundred forty-three (243) loans totaling $133.0 million in which the payment accommodation period has ended and the loan payments have resumed under their original contractual terms. Also included in the totals above are six (6) loans totaling $984 thousand that are in their first short-term payment accommodation period, one (1) loan totaling $25 thousand that is in its second short-term payment accommodation period and five (5) loans totaling $17.3 million that are in their third short-term payment accommodation period. At December 31, 2020, Management has not changed its classification of these loans due to the quality knowledge our loan officers have obtained from their discussions with the borrowers and due to the strength of the collateral and guarantors. Management continues to carefully monitor those borrowers who remain on payment deferral for additional signs of distress that would result in a downgrade in loan classification. All loans under a modification period are considered current for payment status. All loans that have the CARES Act Section
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Embassy Bancorp, Inc.
4013 modification, regardless of whether original contractual payment terms have resumed, are provided additional qualitative reserve in the Company’s allowance for loan loss calculation. None of the loans that remain in payment accommodation status at December 31, 2020 are considered impaired by Management at December 31, 2020 as, at this time, Management does not feel it probable that the Company will be unable to collect all amounts according to the contractual terms of the loan agreement.
The following table sets forth information on the composition of the loan portfolio by type at December 31, 2020. All of the Company’s loans are to domestic borrowers.
Percentage of Percentage of Percentage of
Balance total Loans Balance total Loans Balance total Loans
(Dollars in Thousands)
Percentage of Percentage of
Balance total Loans Balance total Loans
(Dollars in Thousands)
Unearned origination costs 458 144
Allowance for loan losses (7,040) (6,517)
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Embassy Bancorp, Inc.
The following table shows the maturities of the commercial loan portfolio and the loans subject to interest rate fluctuations at December 31, 2020.
One year or Less After One Year Through Five Years After Five Years Total
(In Thousands)
Credit Risk and Loan Quality
The allowance for loan losses increased $2.5 million to $10.6 million at December 31, 2020 from $8.0 million at December 31, 2019. At December 31, 2020 and December 31, 2019, the allowance for loan losses represented 0.97% and 0.79%, respectively, of total loans (not including PPP loans which are guaranteed by the SBA). In 2020, the Bank adjusted the economic risk factor and loan modifications risk factor methodologies to incorporate the current economic implications, unemployment rate and amount of loan modifications due to the COVID-19 pandemic, leading to the increase in the allowance for loan losses as a percentage of total loans. In determining its allowance for loan loss level for the year ending December 31, 2020, the Bank considered the health and composition of its loan portfolio going into and during the COVID-19 pandemic. At December 31, 2020, approximately 94% of the Bank’s loan portfolio is collateralized by real estate. Less than 6% of the Bank’s loan portfolio is to borrowers in the more particularly hard-hit industries (including the travel and hotel industry, the full-service and limited-service restaurant industries, and the assisted living facilities industry) and the Bank has no direct international exposure. The Bank was not required to adopt the Current Expected Credit Losses (“CECL”) FASB accounting standard in 2020, as this guidance will not be effective for the Bank until 2023. Based upon current economic conditions, the composition of the loan portfolio, the perceived credit risk in the portfolio and loan-loss experience of the Bank and comparable institutions in the Bank’s market area, management feels the allowance is adequate to absorb reasonably anticipated losses.
At December 31, 2020, aggregate balances on non-performing loans (not including PPP loans) equaled $2.8 million compared to $2.7 million at December 31, 2019, representing 0.26% of total loans (not including PPP loans) at December 31, 2020 and December 31, 2019, respectively. In certain circumstances in which the Company has deemed it prudent for reasons related to a borrower’s financial condition, the Company has agreed to restructure certain loans (referred to as troubled debt restructurings). Troubled debt restructuring loans, which are considered non-performing loans, outstanding at December 31, 2020 and 2019 totaled $2.6 million and $2.7 million, respectively. Generally, a loan is classified as nonaccrual when it is determined that the collection of all or a portion of interest or principal is doubtful or when a default of interest or principal has existed for 90 days or more, unless the loan is well secured and in the process of collection. A non-performing loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. Non-accrual loans outstanding as of December 31, 2020 and December 31, 2019 totaled $274 thousand and $18 thousand, respectively. At December 31, 2020 and December 31, 2019, the Company had no recorded investment in consumer mortgage loans collateralized by residential real estate property that is in the process of foreclosure. The Bank had no charge-offs for the years ended December 31, 2020 and December 31, 2019.
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Embassy Bancorp, Inc.
As of December 31, 2020 and 2019, the Company had no foreclosed assets. The details for the non-performing loans and assets are included in the following table:
December 31,
(Dollars In Thousands)
Non-accrual - commercial $ - $ - $ - $ 104 $ 280
Loans past due 90 or more days, accruing interest - - - - 55
Nonperforming loans to total loans (not
Allowance for Loan Losses
Based upon current economic conditions, the composition of the loan portfolio and loan loss experience of comparable institutions in the Company’s market areas, an allowance for loan losses has been provided at 0.97% of outstanding loans receivable (excluding PPP loans). Based on its knowledge of the portfolio and current economic conditions, management believes that, as of December 31, 2020, the allowance is adequate to absorb reasonably anticipated losses. As of December 31, 2020, the Company had $3.6 million of impaired loans (defined as a loan that management feels probable the Company will be unable to collect all amounts according to the contractual terms of the loan agreement or loans considered to be troubled debt restructurings) compared to $3.5 million at December 31, 2019. Most of the Company’s impaired loans required no specific reserves due to adequate collateral. As of December 31, 2020, the Company had impaired loans of $1.5 million requiring a specific reserve of $169 thousand. As of December 31, 2019, the Company had impaired loans of $1.1 million requiring a specific reserve of $202 thousand.
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Embassy Bancorp, Inc.
The activity in the allowance for loan losses is shown in the following table, as well as period end loans receivable and the allowance for loan losses as a percent of the total loan portfolio (not including PPP loans):
December 31,
(Dollars In Thousands)
Allowance for loan losses:
Loans charged off:
Commercial real estate - - - (217) (35)
Commercial construction - - - - -
Residential real estate - - (23) (206) (207)
Consumer - - - - (4)
Recoveries of loans previously charged-off:
Commercial real estate 24 - 12 13 -
Commercial construction - - - - -
Commercial - 4 - - -
Residential real estate 4 1 8 - -
Consumer - - - - -
Allowance for loan losses to loans
Allocation of the Allowance for Loan Losses
The following table details the allocation of the allowance for loan losses to various loan categories (excluding PPP loans) and the related percent of total loans in each category. While allocations have been established for particular loan categories, management considers the entire allowance to be available to absorb losses in any category.
(Dollars in Thousands)
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Embassy Bancorp, Inc.
Deposits
As growth continues, the Company expects that the principal sources of its funds will be deposits, consisting of demand deposits, NOW accounts, money market accounts, savings accounts, and certificates of deposit from the local market areas surrounding the Company’s offices. These accounts provide the Company with a source of fee income and a relatively stable source of funds.
Total deposits at December 31, 2020 were $1.2 billion, an increase of $200.4 million, or 19.4%, over total deposits of $1.0 billion as of December 31, 2019. The growth in total deposits was due to organic growth of new and existing customers. Management believes the increase in deposits was from expansion of the Company’s online banking platform, competitive offered rates, the addition of a permanent branch office in Macungie, the continued convenience and efficiency of our branch network and branch personnel, along with an injection of federal stimulus money into the economy in 2020 from PPP funds and consumer stimulus payments and changing consumer and commercial spending as a result of the COVID-19 pandemic. The shift in time deposits was primarily due to prior year time deposit promotions rolling off and current time deposits yielding lower rates in the current rate environment. The funds were primarily used to fund new loan growth and purchase securities.The following table reflects the Company’s deposits by category for the periods indicated. All deposits are domestic deposits.
(In Thousands)
The following table sets forth the average balance of the Company’s deposits and the average rates paid on those deposits:
Average Average Average Average Average Average
Amount Rate Amount Rate Amount Rate
(Dollars In Thousands)
Demand, NOW and money market,
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Embassy Bancorp, Inc.
The following table displays the maturities and the amounts of the Company’s certificates of deposit of $250,000 or more:
(In Thousands)
As a FDIC member institution, the Company’s deposits are insured to a maximum of $250,000 per depositor through the DIF that is administered by the FDIC and each institution is required to pay quarterly deposit insurance premium assessments to the FDIC.
Liquidity
Liquidity is a measure of the Company’s ability to meet the demands required for the funding of loans and to meet depositors’ requirements for use of their funds. The Company’s sources of liquidity are cash balances, due from banks, and federal funds sold. Cash and cash equivalents were $131.9 million at December 31, 2020, compared to $40.0 million at December 31, 2019. There are other sources of liquidity that are available to the Company, as well, including those described below.
Additional asset liquidity sources include principal and interest payments from the investment security, unpledged investment securities, and loan portfolios. Long-term liquidity needs may be met by selling unpledged securities available for sale, selling or participating loans, or raising additional capital. At December 31, 2020, the Company had $130.9 million of available for sale securities, compared to $90.8 million at December 31, 2019. Securities with carrying values of approximately $98.7 million and $74.0 million at December 31, 2020 and December 31, 2019, respectively, were pledged as collateral to secure securities sold under agreements to repurchase, public deposits, and for other purposes required or permitted by law.
At December 31, 2020, the Bank had a maximum borrowing capacity for short-term and long-term advances of approximately $682.6 million. This borrowing capacity with the FHLB includes a line of credit of $150.0 million. There were no short-term FHLB advances outstanding as of December 31, 2020 and $18.1 million in short-term FHLB advances outstanding as of December 31, 2019. There were $14.7 million in long-term FHLB advances outstanding as of December 31, 2020 and none outstanding at December 31, 2019. All FHLB borrowings are secured by qualifying assets of the Bank.
The Bank has a federal funds line of credit with the Atlantic Community Bankers Bank (“ACBB”) of $10.0 million, of which none was outstanding at December 31, 2020 and December 31, 2019. Advances from this line are unsecured.
As described in Note 2, the Bank has long-term PPPLF borrowings through the Federal Reserve Bank of Philadelphia of $50.8 million, at an interest rate of 0.35%, as of December 31, 2020 and none as of December 31, 2019. All PPPLF borrowings are secured by PPP loans. As of February 3, 2021, the PPPLF borrowings have been repaid in full.
Because of the composition of the Company’s balance sheet, its strong capital base, deposit growth, and borrowing capacity, the Company believes that it remains well positioned with respect to liquidity. While it is desirable to be liquid, it has the effect of a lower interest margin. The majority of the Company’s funds are invested in loans; however, a portion is invested in investment securities that generally carry a lower yield.
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Embassy Bancorp, Inc.
Contractual Obligations
The following table represents the Company’s contractual obligations to make future payments as of the year ended December 31, 2020:
(In Thousands)
As of February 3, 2021, the PPPLF borrowings have been paid off in full.
Off-Balance Sheet Arrangements
The Company’s consolidated financial statements do not reflect various off-balance sheet arrangements that are made in the normal course of business, which may involve some liquidity risk. These commitments consist of unfunded loans, lines of credit, and letters of credit made under the same standards as on-balance sheet loan instruments. These off-balance sheet arrangements at December 31, 2020 and December 31, 2019 totaled $140.8 million and $142.4 million, respectively. Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Company. The Bank also issued standby letters of credit commitments for the benefit of a third party, which secure public deposits in the Bank through the FHLB. These deposit letters of credit are secured by qualifying assets of the Bank. The Company, through the Bank, had $7.6 million of FHLB deposit letters of credit outstanding as of December 31, 2019 and none as of December 31, 2020. For further information see Note 5.
Management believes that any amounts actually drawn upon can be funded in the normal course of operations. The Company has no investment in or financial relationship with any unconsolidated entities that are reasonably likely to have a material effect on liquidity or the availability of capital resources. Management will continue to evaluate the Company’s liquidity position for changes caused by the COVID-19 pandemic.
Capital Resources and Adequacy
Total stockholders’ equity was $112.2 million as of December 31, 2020, representing a net increase of $12.6 million from December 31, 2019. The increase in capital was primarily the result of the net income of $12.8 million, an increase of $1.6 million in unrealized gains on available for sale securities, and an increase in surplus of $468 thousand due to stock grants, stock options, and employee stock purchases with compensation expense, offset by dividends paid of $1.6 million and treasury stock repurchases of $765 thousand.
The Company and the Bank are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain actions by regulators that could have a material adverse effect on the consolidated financial statements.
The regulations require that banks maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and Tier 1 capital to average assets (as defined). As of December 31, 2020, the Bank met the minimum requirements. In addition, the Bank’s capital ratios exceeded the amounts required to be considered “well capitalized” as defined in the regulations.
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Embassy Bancorp, Inc.
The following table provides a comparison of the Bank’s risk-based capital ratios and leverage ratios:
(Dollars In Thousands)
Tier 2, allowable portion of allowance for loan losses 10,570 8,022
Common equity tier 1 capital ratio 11.9% 12.0%
Tier 1 risk based capital ratio 11.9% 12.0%
Total risk based capital ratio 13.1% 13.0%
Tier 1 leverage ratio 8.1% 8.4%
In July 2013, the FDIC and the Federal Reserve approved a new rule that substantially amended the regulatory risk based capital rules applicable to the Bank and the Company. The final rule implements the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act.
In addition to the risk-based capital guidelines, the federal banking regulators established minimum leverage ratio (Tier 1 capital to total assets) guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of 3% for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a leverage ratio of at least 4%.
The capital ratios to be considered “well capitalized” under the new capital rules are: common equity of 6.5%, Tier 1 leverage of 5%, Tier 1 risk-based capital of 8%, and Total Risk-Based capital of 10%.
The Company qualifies as a small bank holding company and is not subject to the Federal Reserve’s consolidated capital rules, although an institution that so qualifies may continue to file reports that include such capital amounts and ratios. The Company has elected to continue to report those amounts and ratios.
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Embassy Bancorp, Inc.
The following table provides the Company’s risk-based capital ratios and leverage ratios:
(Dollars In Thousands)
Tier 2, allowable portion of allowance for loan losses 10,570 8,022
Common equity tier 1 capital ratio 12.0% 12.0%
Tier 1 risk based capital ratio 12.0% 12.0%
Total risk based capital ratio 13.1% 13.0%
Tier 1 leverage ratio 8.1% 8.4%
Interest Rate Risk Management
A principal objective of the Company’s asset/liability management policy is to minimize the Company’s exposure to changes in interest rates by an ongoing review of the maturity and repricing of interest-earning assets and interest-bearing liabilities. The Asset Liability Committee (ALCO), which meets as part of the Board of Directors meeting, oversees this review, which establishes policies to control interest rate sensitivity. Interest rate sensitivity is the volatility of a company’s earnings resulting from a movement in market interest rates. The Company monitors rate sensitivity in order to reduce vulnerability to interest rate fluctuations while maintaining adequate capital levels and acceptable levels of liquidity. The Company’s asset/liability management policy, monthly and quarterly financial reports, along with simulation modeling, supplies management with guidelines to evaluate and manage rate sensitivity.
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Embassy Bancorp, Inc.
GAP, a measure of the difference in volume between interest bearing assets and interest bearing liabilities, is a means of monitoring the sensitivity of a financial institution to changes in interest rates. The chart below provides an indicator of the rate sensitivity of the Company. NOW and savings accounts are categorized by their respective estimated decay rates. The Company is liability sensitive, which means that if interest rates fall, interest income will fall slower than interest expense and net interest income will likely increase. If interest rates rise, interest income will rise slower than interest expense and net interest income will likely decrease. The Company continues to monitor interest rate exposure of its interest bearing assets and liabilities and believes that it is well positioned for any future market rate adjustments.
Over 3 Over 1 Over 4
0 to 3 Months to Year to Years to Over 5
Months 12 Months 3 Years 5 Years Years Total
(In Thousands)
Interest-earning assets
Federal funds sold and interest-
Interest-bearing liabilities
Repurchase agreements
GAP TO INTEREST EARNING
CUMULATIVE GAP TO
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Embassy Bancorp, Inc.
Based on a twelve-month forecast of the balance sheet, the following table sets forth our interest rate risk profile at December 31, 2020. For income simulation purposes, personal and business savings accounts reprice every three months, personal and business NOW accounts reprice every four months and personal and business money market accounts reprice every two months. The impact on net interest income, illustrated in the following table, would vary if different assumptions were used or if actual experience differs from that indicated by the assumptions.
Change in Interest Rates Percentage Change in Net Interest Income
Down 100 basis points -2.0%
Down 200 basis points -4.7%
Return on Assets and Equity
For the year ended December 31, 2020, the return on average assets was 0.98%, the return on average equity was 12.07%, and the ratio of average shareholders’ equity to average total assets was 8.13%.
For the year ended December 31, 2019, the return on average assets was 0.95%, the return on average equity was 11.54%, and the ratio of average shareholders’ equity to average total assets was 8.28%.
Dividend Payout Ratio
For the years ended December 31, 2020 and 2019 the dividend payout ratio was 12.83% and 13.74%, respectively.
Effects of Inflation
The majority of assets and liabilities of the Company are monetary in nature, and therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. The precise impact of inflation upon the Company is difficult to measure. Inflation may affect the borrowing needs of consumers, thereby impacting the growth rate of the Company’s assets. Inflation may also affect the general level of interest rates, which can have a direct bearing on the Company.
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Embassy Bancorp, Inc.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not required.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Table of Contents
PageNumber
Management Report on Internal Controls Over Financial Reporting 51
Report of Independent Registered Public Accounting Firm 52
Consolidated Balance Sheets 54
Consolidated Statements of Income 55
Consolidated Statements of Comprehensive Income 56
Consolidated Statements of Stockholders’ Equity 57
Consolidated Statement of Cash Flows 58
Notes to Financial Statements 60
50
Embassy Bancorp, Inc.
Management Report on Internal Controls Over Financial Reporting
The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures, as defined in SEC Rules 13a-15(e) and 15d-15(e). Based upon the evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2020, the Company’s disclosure controls and procedures are effective. Disclosure controls and procedures are designed to ensure that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness of future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) Internal Control-Integrated Framework (2013). Based on this assessment, management concluded that, as of December 31, 2020, the Company’s internal control over financial reporting is effective based on those criteria.
/s/
/s/ David M. Lobach, Jr. /s/ Judith A. Hunsicker
David M. Lobach, Jr. Judith A. Hunsicker
Chairman, President and First Executive Officer, Chief Operating
Chief Executive Officer Officer, Secretary and Chief Financial
51
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Embassy Bancorp, Inc. and Subsidiary:
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Embassy Bancorp, Inc. and Subsidiary (Company) as of December 31, 2020 and 2019, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for the years then ended, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Loan Losses – General Component Qualitative Factors
As discussed in Note 1 to the consolidated financial statements, the allowance for loan losses is established through a provision for loan losses and represents an amount, which, in management’s judgment, will be adequate to absorb losses in the loan portfolio. The Company’s allowance for loan losses was $10.6 million at December 31, 2020 and consists of specific and general components of $169 thousand and $10.4 million, respectively. Management develops the general component based on historical loan loss experience adjusted for qualitative factors not reflected in the historical loss experience. Historical loss ratios are measured using the average charge-off ratio for the most recent rolling four years plus current year to date. The qualitative factors used by the Company include factors such as national and local economic conditions, levels of and trends in delinquency rates and nonaccrual loans, trends in volumes and terms of loans, changes in lending policies, lending personnel, and collateral, as well as concentrations in loan types, industry, and geography. The
52
adjustments for qualitative factors require a significant amount of judgment by management and involve a high degree of estimation uncertainty.
We identified the qualitative factor component of the allowance for loan losses as a critical audit matter as auditing the underlying qualitative factors required significant auditor judgment as amounts determined by management rely on analysis that is highly subjective and includes significant estimation uncertainty.
Our audit procedures related to the qualitative factor component of the allowance for loan losses included the following, among others:
Obtaining an understanding of the relevant controls related to the allowance for loan losses and testing such controls for design and operating effectiveness, including controls related to management’s establishment, review, and approval of the qualitative factors, and the completeness and accuracy of data used in determining qualitative factors.
Evaluation of the appropriateness of management’s methodology for estimating the allowance for loan losses.
Testing of the completeness and accuracy of data used by management in determining qualitative factor adjustments by agreeing them to internal and external source data.
Testing of management’s conclusions regarding the appropriateness of the qualitative factor adjustments and agreement of any changes therein to the allowance for loan losses calculation.
/s/ Baker Tilly US, LLP
We have served as the Company’s auditor since 2001.
Baker Tilly US, LLP (formerly known as Baker Tilly Virchow Krause, LLP)
Allentown, Pennsylvania
March 12, 2021
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Embassy Bancorp, Inc.
Consolidated Balance Sheets
December 31, December 31,
(In Thousands, Except Share Data)
Interest bearing demand deposits with banks 116,379 33,161
Restricted investment in bank stock 1,330 1,478
Paycheck Protection Program loans receivable 54,334 -
Premises and equipment, net of accumulated depreciation 3,346 2,123
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Securities sold under agreements to repurchase 13,612 7,208
Short-term borrowings - 18,067
Long-term borrowings 14,651 -
Paycheck Protection Program Liquidity Facility borrowings 50,794 -
Stockholders' Equity:
Common stock, $1 par value; authorized 20,000,000 shares;
Accumulated other comprehensive income 2,937 1,340
See notes to consolidated financial statements.
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Embassy Bancorp, Inc.
Consolidated Statements of Income
Year Ended December 31,
INTEREST INCOME (In Thousands, Except Per Share Data)
Paycheck Protection Program loans, including fees 1,307 -
Securities, non-taxable 826 990
Short-term investments, including federal funds sold 160 622
INTEREST EXPENSE
Securities sold under agreements to repurchase and
federal funds purchased 18 74
Short-term borrowings 51 275
Long-term borrowings 90 -
Paycheck Protection Program Liquidity Facility borrowings 129 -
Net Interest Income after Provision for Loan Losses 35,396 32,928
OTHER NON-INTEREST INCOME
Merchant and credit card processing fees 265 340
Debit card interchange fees 647 612
Bank owned life insurance 930 691
Gain on sale of securities 128 -
Gain on sale of other real estate owned - 45
Gain on sale of loans 59 -
Total Other Non-Interest Income 2,445 2,193
OTHER NON-INTEREST EXPENSES
Merchant and credit card processing 50 85
Charitable contributions 869 864
BASIC EARNINGS PER SHARE $ 1.71 $ 1.46
DILUTED EARNINGS PER SHARE $ 1.70 $ 1.44
DIVIDENDS PER SHARE $ 0.22 $ 0.20
See notes to consolidated financial statements.
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Embassy Bancorp, Inc.
Consolidated Statements of Comprehensive Income
Year Ended December 31,
(In Thousands)
Change in Accumulated Other Comprehensive Income:
Unrealized holding gain
on securities available for sale 2,149 3,275
Less: reclassification adjustment
for realized gains (128) -
Other comprehensive income, net of tax 1,597 2,587
See notes to consolidated financial statements.
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Embassy Bancorp, Inc.
Consolidated Statements of Stockholders’ Equity
Years Ended December 31, 2020 and 2019
(In Thousands, Except Share and Per Share Data)
Other comprehensive income, net of tax - - - 2,587 - 2,587
Dividend declared and paid, $0.20 per share - - (1,495) - - (1,495)
Compensation expense recognized on stock options - 4 - - - 4
Common stock grants to directors,
Compensation expense recognized on
stock grants, net of unearned compensation
Shares issued under employee stock purchase plan, 3,158 shares 4 48 - - - 52
Other comprehensive income, net of tax - - - 1,597 - 1,597
Dividend declared and paid, $0.22 per share - - (1,644) - - (1,644)
Stock tendered for funding exercise of
Common stock grants to directors,
Common stock grants to officers, 34,429 shares
and compensation expense recognized on
stock grants, net of unearned compensation
Shares issued under employee stock purchase plan, 5,039 shares 5 58 - - - 63
Purchase treasury stock, 40,000 shares
See notes to consolidated financial statements.
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Embassy Bancorp, Inc.
Consolidated Statements of Cash Flows
Year Ended December 31,
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Amortization of deferred loan costs 269 262
Accretion of deferred Paycheck Protection Program loan fees (862) -
Net amortization of investment security premiums and discounts 492 172
Stock compensation expense 286 367
Net realized gain on sale of other real estate owned - (45)
Income on bank owned life insurance (930) (691)
Deferred income taxes (558) (238)
Realized gain on sale of securities available for sale (128) -
Loans originated for sale (689) -
Proceeds from sale of loans 748 -
Realized gain on sale of loans (59) -
(Increase) decrease in accrued interest receivable (1,088) 130
(Decrease) increase in accrued interest payable (1,641) 1,592
Increase (decrease) in other liabilities 800 (1,008)
Net Cash Provided by Operating Activities 13,634 14,303
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (144,744) (20,429)
Proceeds from sales of securities available for sale 4,023 -
Net increase in Paycheck Protection Program loans (53,472) -
Net redemption of restricted investment in bank stock 148 1,316
Purchase of bank owned life insurance (4,000) -
Proceeds from sale of other real estate owned - 180
Purchases of premises and equipment (1,983) (778)
Net Cash Used in Investing Activities (173,772) (53,300)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from Employee Stock Purchase Plan 63 52
Decrease in short-term borrowed funds (18,067) (35,928)
Proceeds from long-term borrowed funds 14,651 -
Purchase of treasury stock (765) -
Exercise of stock options, net of payment for stock tendered 212 -
Net Cash Provided by Financing Activities 252,059 51,407
Net Increase in Cash and Cash Equivalents 91,921 12,410
CASH AND CASH EQUIVALENTS - BEGINNING 39,986 27,576
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Embassy Bancorp, Inc.
Consolidated Statements of Cash Flows
SUPPLEMENTARY CASH FLOWS INFORMATION
Non-cash Investing and Financing Activities:
Recognition of operating lease right of use assets $ - $ 10,921
Recognition of operating lease liabilities $ - $ 11,027
See notes to consolidated financial statements.
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Embassy Bancorp, Inc.
Notes to Consolidated Financial Statements
Note 1 – Summary of Significant Accounting Policies
Principles of Consolidation and Nature of Operations
Embassy Bancorp, Inc. (the “Company”) is a Pennsylvania corporation organized in 2008 and registered as a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Company was formed for purposes of acquiring Embassy Bank For The Lehigh Valley (the “Bank”) in connection with the reorganization of the Bank into a bank holding company structure, which was consummated on November 11, 2008. Accordingly, the Company owns all of the capital stock of the Bank, giving the organization more flexibility in meeting its capital needs as the Company continues to grow.
The Bank, which is the Company’s principal operating subsidiary, was originally incorporated as a Pennsylvania bank on May 11, 2001 and opened its doors on November 6, 2001. It was formed by a group of local business persons and professionals with significant prior experience in community banking in the Lehigh Valley area of Pennsylvania, the Bank’s primary market area.
Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of other-than-temporary impairment on available for sale debt securities, the determination of the allowance for loan losses, the valuation of other real estate owned, and the valuation of deferred tax assets.
Concentrations of Credit Risk
Most of the Company’s activities are with customers located in the Lehigh Valley area of Pennsylvania. Note 3 discusses the types of securities in which the Company invests. The concentrations of credit by type of loan are set forth in Note 4. The Company does not have any significant concentrations to any one specific industry or customer, with the exception of lending activity to a broad range of lessors of residential and non-residential real estate within the Lehigh Valley. Although the Company has a diversified loan portfolio, its debtors’ ability to honor their contracts is influenced by the region’s economy.
Presentation of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing demand deposits with bank, and federal funds sold. Generally, federal funds are purchased or sold for less than one week periods.
Securities
Securities classified as available for sale are those securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Securities available for sale are carried at fair value. Any decision to sell a security classified as available for sale would be based on various factors, including significant movement in interest rates, changes in maturity mix of the Company’s assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Unrealized gains and losses are reported as increases or decreases in other comprehensive income. Realized gains or losses, determined on the basis of the cost of the specific securities sold, are included in earnings. Premiums and discounts are recognized in interest income using the interest method over the terms of the securities.
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Embassy Bancorp, Inc.
Other-than-temporary accounting guidance specifies that (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. The Company recognized no other-than-temporary impairment charges during the years ended December 31, 2020 and 2019.
Restricted Investments in Bank Stock
Restricted investments in bank stock consist of FHLBank Pittsburgh (“FHLB”) stock and Atlantic Community Bankers Bank (“ACBB”) stock. The restricted stocks have no quoted market value and are carried at cost. Federal law requires a member institution of the FHLB to hold stock of its district FHLB according to a predetermined formula.
Management evaluates the FHLB and ACBB restricted stock for impairment. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the issuer as compared to the capital stock amount for the issuer and the length of time this situation has persisted, (2) commitments by the issuer to make payments required by law or regulation and the level of such payments in relation to the operating performance of the issuer, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the issuer.
Management believes no impairment charge is necessary related to the FHLB or ACBB restricted stock as of December 31, 2020. No impairment charge was taken related to the FHLB or ACBB restricted stock as of December 31, 2019.
Loans Receivable
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield using the effective interest method. Premiums and discounts on purchased loans are amortized as adjustments to interest income using the effective interest method. Delinquency fees are recognized in income when collected.
As described in Note 2, the Company originates Paycheck Protection Program (“PPP”) loans as part of the Coronavirus Aid, Relief and Economic Security (“CARES”) Act. The non-PPP loans receivable portfolio is segmented into commercial and consumer loans. Commercial loans consist of the following classes: commercial real estate, commercial construction and commercial. Consumer loans consist of the following classes: residential real estate and other consumer loans.
The Company makes commercial loans for real estate development and other business purposes required by the customer base. The Company’s credit policies determine advance rates against the different forms of collateral that can be pledged against commercial loans. Typically, the majority of loans will be limited to a percentage of their underlying collateral values such as real estate values, equipment, eligible accounts receivable and inventory. Individual loan advance rates may be higher or lower depending upon the financial strength of the borrower and/or term of the loan. The assets financed through commercial loans are used within the business for its ongoing operation. Repayment of these kinds of loans generally comes from the cash flow of the business or the ongoing conversion of assets. Commercial real estate loans include long-term loans financing commercial properties. Repayments of these loans are dependent upon either the ongoing cash flow of the borrowing entity or the resale of or lease of the subject property. Commercial real estate loans typically require a loan to value ratio of not greater than 80% and vary in terms.
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Residential mortgages and home equity loans are secured by the borrower’s residential real estate in either a first or second lien position. Residential mortgages and home equity loans have varying interest rates (fixed or variable) depending on the financial condition of the borrower and the loan to value ratio. Residential mortgages may have amortizations up to 30 years and home equity loans may have maturities up to 25 years. Other consumer loans include installment loans, car loans, and overdraft lines of credit. Some of these loans may be unsecured.
For all classes of loans receivable, the accrual of interest may be discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed. Interest received on nonaccrual loans, including impaired loans, generally is applied against principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments.
Allowance for Loan Losses
The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans, or portions of loans, determined to be confirmed losses are charged against the allowance account and subsequent recoveries, if any, are credited to the account. A loss is considered confirmed when information available at the balance sheet date indicates the loan, or a portion thereof, is uncollectible. As further described in Note 2, because of the 100% SBA guarantee, the Company has determined that no allowance for loan losses is required on PPP loans.
Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.
Management maintains the allowance for loan losses at a level it believes adequate to absorb probable credit losses related to specifically identified loans, as well as probable incurred losses inherent in the remainder of the loan portfolio as of the balance sheet dates. The allowance for loan losses account consists of specific and general reserves.
For the specific portion of the allowance for loan losses, a loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest and principal payments of a loan will be collected as scheduled in the loan agreement. Factors considered by management in determining impairment include payment status, ability to pay and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Loans considered impaired are measured for impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. If the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral, if the loan is collateral dependent, is less than the recorded investment in the loan, including accrued interest and net deferred loan fees or costs, the Company will recognize the impairment by adjusting the allowance for loan losses account through charges to earnings as a provision for loan losses.
For loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of
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the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.
For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.
The general portion of the allowance for loan losses covers pools of loans by major loan class including commercial loans not considered impaired, as well as smaller balance homogeneous loans, such as residential real estate and other consumer loans. Loss contingencies for each of the major loan pools are determined by applying a total loss factor to the current balance outstanding for each individual pool. The total loss factor is comprised of a historical loss factor using the loss migration method plus a qualitative factor, which adjusts the historical loss factor for changes in trends, conditions and other relevant factors that may affect repayment of the loans in these pools as of the evaluation date. Loss migration involves determining the percentage of each pool that is expected to ultimately result in loss based on historical loss experience. Historical loss factors are based on the ratio of net loans charged-off to loans, net, for each of the major groups of loans. The historical loss factor for each pool, includes but is not limited to, an average of the Company’s historical net charge-off ratio for the most recent rolling four years plus current year to date.
In addition to these historical loss factors, management also uses a qualitative factor that represents a number of environmental risks that may cause estimated credit losses associated with the current portfolio to differ from historical loss experience. These environmental risks include: (i) changes in lending policies and procedures including underwriting standards and collection, charge-off and recovery practices; (ii) changes in the composition and volume of the portfolio; (iii) changes in national, local and industry conditions, including the effects of such changes on the value of underlying collateral for collateral-dependent loans; (iv) changes in the volume and severity of classified loans, including past due, nonaccrual, troubled debt restructures and other loan modifications; (v) changes in the levels of, and trends in, charge-offs and recoveries; (vi) the existence and effect of any concentrations of credit and changes in the level of such concentrations; (vii) changes in the experience, ability and depth of lending management and other relevant staff; (viii) changes in the quality of the loan review system and the degree of oversight by the board of directors; and (ix) the effect of external factors such as competition and regulatory requirements on the level of estimated credit losses in the current loan portfolio. Each environmental risk factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation. In 2020, the Bank adjusted the economic risk factor and loan modifications risk factor methodologies to incorporate the current economic implications, unemployment rate and amount of loan modifications due to the COVID-19 pandemic, leading to the increase in the allowance for loan losses as a percentage of total loans.
The unallocated component of the general allowance is used to cover inherent losses that exist as of the evaluation date, but which have not been identified as part of the allocated allowance using the above impairment evaluation methodology due to limitations in the process. One such limitation is the imprecision of accurately estimating the impact current economic conditions will have on historical loss rates. Variations in the magnitude of impact may cause estimated credit losses associated with the current portfolio to differ from historical loss experience, resulting in an allowance that is higher or lower than the anticipated level.
The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors, and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payment, for commercial and consumer loans. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans criticized as special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weakness may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness and borrowers are highly leveraged. They include loans that are inadequately protected by the current sound net worth and the paying capacity of the obligor or
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of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass.
Federal regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management’s comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.
Other Real Estate Owned
Other real estate owned is comprised of properties acquired through foreclosure proceedings or acceptance of a deed-in-lieu of foreclosure and loans classified as in-substance foreclosures. A loan is classified as an in-substance foreclosure when the Company has taken possession of the collateral, regardless of whether formal foreclosure proceedings take place. Other real estate owned is recorded at fair value less cost to sell at the time of acquisition. Any excess of the loan balance over the recorded value is charged to the allowance for loan losses at the time of acquisition. After foreclosure, valuations are periodically performed and the assets are carried at the lower of cost or fair value less cost to sell. Changes in the valuation allowance on foreclosed assets are included in other income. Costs to maintain the assets are included in other expenses. Any gain or loss realized upon disposal of other real estate owned is included in other income.
Bank Owned Life Insurance
The Company invests in bank owned life insurance (“BOLI”) as a tax deferred investment and a source of funding for employee benefit expenses. BOLI involves the purchasing of life insurance by the Company on certain of its employees and directors. The Company is the owner and primary beneficiary of the policies. This life insurance investment is carried at the cash surrender value of the underlying policies. Income from increases in cash surrender value of the policies is included in non-interest income and is not subject to income taxes unless surrendered. The Company does not intend to surrender these policies, and accordingly, no deferred taxes have been recorded on the earnings from these policies. The Company purchased $4.0 million of BOLI in 2020. There were no BOLI purchases in 2019.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the following estimated useful lives of the related assets: furniture, fixtures and equipment for five years to ten years, leasehold improvements for the life of the lease, building for forty years, computer equipment and data processing software for one year to five years, and automobiles for five years.
Transfers of Financial Assets
Transfers of financial assets, including sales of loan participations, are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Advertising Costs
The Company follows the policy of charging the costs of advertising to expense as incurred.
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Income Taxes
Income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to taxable income. Deferred income taxes are provided on the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and net operating loss carry forwards and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Earnings Per Share
Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period, as adjusted for stock dividends and splits. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustments to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.
Year Ended December 31,
(Dollars In Thousands, Except Per Share Data)
Dilutive effect of potential common
Diluted weighted average common
Basic earnings per share $ 1.71 $ 1.46
Diluted earnings per share $ 1.70 $ 1.44
There were no stock options not considered in computing diluted earnings per common share for the years ended December 31, 2020 and December 31, 2019.
Employee Benefit Plan
The Company has a 401(k) Plan (the “Plan”) for employees. All employees are eligible to participate after they have attained the age of 21 and have also completed 6 consecutive months of service during which at least 500 hours of service are completed. The employees may contribute up to the maximum percentage allowable by law of their compensation to the Plan, and the Company provides a match of fifty percent of the first 8% percent to eligible participating employees. Full vesting in the Plan is prorated equally over a four year period. The Company’s contributions to the Plan for the years ended December 31, 2020 and 2019 were $228 thousand and $210 thousand, respectively.
Off Balance Sheet Financial Instruments
In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit. Such financial instruments are recorded in the balance sheet when they are funded.
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Comprehensive Income
US GAAP require that recognized revenue, expenses, gains, and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
Stock-Based Compensation
The Company measures and records compensation expense for share-based payments based on the instrument's fair value on the date of grant. The fair value of each stock option grant is measured using the Black-Scholes option pricing model. The fair value of stock awards is based on the Company's stock price. Share-based compensation expense is recognized over the service period, generally defined as the vesting period.
Non-Interest Income
The majority of the Company’s revenue-generating transactions are not subject to ASU 2014-09 “Revenue from Contracts with Customers (Topic 606)”, including revenue generated from financial instruments, such as its loans and investment securities, as these activities are subject to other US GAAP discussed elsewhere within the Company’s disclosures. Descriptions of the Company’s revenue-generating activities that are within the scope of Topic 606, which are presented in the consolidated statement of income as components of non-interest income, are merchant processing and credit card processing fees, debit card interchange fees, other service fees on deposit accounts, and gains and losses on other real estate owned. Credit card processing fees include income from commercial credit cards and merchant processing income. Income for such performance obligations are generally received at the time the performance obligations are satisfied or within the monthly service period. Service fees on deposit accounts represent general service fees for monthly account maintenance and activity or transaction-based fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when the Company’s performance obligation is completed, which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). The Company recognizes debit card interchange fees daily from debit cardholder transactions conducted through the MasterCard payment network. The Company records a gain or loss from the sale of other real estate owned when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of other real estate owned to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction prices and related gain or loss on the sale if a significant financing component is present. The Company does not sell its mortgages on the secondary market, nor does it offer trust or investment brokerage services to its customers to generate fee income. On May 1, 2020, the Company sold its entire $689 thousand commercial credit card loan portfolio to an unrelated third party for a gain of $59 thousand. These loans were classified as held for sale at March 31, 2020 prior to the May 1, 2020 sale.
Subsequent Events
The Company has evaluated events and transactions occurring subsequent to the balance sheet date of December 31, 2020 through the date these consolidated financial statements were available for issuance for items that should potentially be recognized or disclosed in these consolidated financial statements. As of February 3, 2021, the Paycheck Protection Program Liquidity Facility (“PPPLF”) borrowings of $50.8 million were paid off in full. Refer to Note 2 for subsequent loan balances and activity related to the CARES Act.
Future Accounting Standards
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, “Financial Instruments - Credit Losses”. ASU 2016-13 requires entities to report “expected” credit losses on financial instruments and other commitments to extend credit rather than the current “incurred loss” model. These
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expected credit losses for financial assets held at the reporting date are to be based on historical experience, current conditions, and reasonable and supportable forecasts. This ASU will also require enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In November 2019, the FASB issued an update to defer the implementation date for smaller reporting companies from 2020 to 2023. The Company currently qualifies as a smaller reporting company under SEC Regulation S-K and, therefore, the guidance is effective for the Company in 2023. The Company has not yet determined the impact this standard will have on its financial statements or results of operations.
Reclassification
Certain amounts in the 2019 consolidated financial statements may have been reclassified to conform to 2020 presentation. These reclassifications had no effect on 2019 net income.
Note 2 – COVID-19
On March 11, 2020, the World Health Organization declared the outbreak of a novel coronavirus (“COVID-19”) as a global pandemic and on March 13, 2020 the United States government declared COVID-19 as a national emergency. The continuing effects of COVID-19 could adversely impact a broad range of industries in which the Company’s customers operate and impair their ability to fulfill their financial obligations to the Company. The economic effects of COVID-19 may adversely affect the Company’s financial condition and results of operations as further described below. The full future potential impact is unknown at this time.
For the year ended December 31, 2020, the Company provided certain borrowers affected in a variety of ways by COVID-19 with payment accommodations that facilitate their ability to work through the immediate impact of the virus. Payment accommodations were in the form of short-term principal and/or interest deferrals. These payment accommodations were made in accordance with Section 4013 of the CARES Act and the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus. Section 4013 of the CARES Act, enacted on March 27, 2020, provides that, from the period beginning March 1, 2020 until the earlier of December 31, 2020, subsequently extended until December 31, 2021, 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 Company may elect to suspend US GAAP for loan modifications related to the pandemic which would otherwise be categorized as troubled debt restructurings and suspend any determination of a loan modified as a result of the effects of the pandemic as being a troubled debt restructuring, including impairment for accounting purposes. Interest income is continuing to be recognized during the accommodation period. The following table presents COVID-19 payment accommodations based on loan type and amount at December 31, 2020:
Number of Loans Loan Amount
(In Thousands)
Included in the totals above are two hundred forty-three (243) loans totaling $133.0 million in which the payment accommodation period has ended and the loan payments have resumed under their original contractual terms. Also included in the totals above are six (6) loans totaling $984 thousand that are in their first short-term (three month) payment accommodation period, one (1) loan totaling $25 thousand that is in its second short-term (three month) payment accommodation period and five (5) loans totaling $17.3 million that are in their third short-term (three month) payment accommodation period. At December 31, 2020, Management has not changed its classification of
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these loans due to the quality knowledge our loan officers have obtained from their discussions with the borrowers and due to the strength of the collateral and guarantors. Management continues to carefully monitor those borrowers who remain on payment deferral for additional signs of distress that would result in a downgrade in loan classification. All loans under a modification period are considered current for payment status.
At February 28, 2021, the Company had two hundred forty-eight (248) Section 4013 loans totaling $149.5 million. Included in these totals are two hundred forty-three (243) loans totaling $132.6 million in which the payment accommodation period has ended and the loan payments have resumed under their original contractual terms. Also included in the totals are one (1) consumer loan totaling $418 thousand that is in its first short-term (three month) payment accommodation period and four (4) commercial loans totaling $16.5 million that have been given a fourth short-term (three month) payment accommodation period. Loans in the fourth short-term (three month) payment accommodation period consist of a $11.4 million loan to a borrower in the travel and hotel industry, a $3.8 million loan to a borrower in the assisted living facility industry and two (2) loans totaling $1.4 million to a borrower in the restaurant industry. Except for these four (4) loans being granted a fourth short-term (three month) payment accommodation, between January 1, 2021 and February 28, 2021, there were no new Section 4013 modifications made.
In order to participate in the SBA’s PPP program under the CARES Act, the Company made application for and was approved to be a PPP lender. The Company had not previously been an approved SBA 7(a) lender. The Company began accepting applications from qualified borrowers on April 3, 2020, and, as of December 31, 2020, the Company had a total of four hundred seventy (470) PPP loans with a receivable balance of $54.3 million, net of $1.2 million of unearned origination fees and costs. Through December 31, 2020, the Company had received forgiveness payments from the SBA on PPP loan principal balances of $13.2 million. From January 1, 2021 to February 28, 2021, the Company had received additional forgiveness payments from the SBA on PPP loan principal balances of $19.4 million.
These PPP loans are 100% guaranteed by the SBA, have a two year or up to five year maturity and an interest rate of 1% throughout the term of the loan, with payments deferred until forgiveness proceeds received from the SBA or ten months after the end of the covered period. The SBA may forgive the PPP loans if certain conditions are met by the borrower, including using at least 60% of the proceeds for payroll costs. The SBA also provided the Company with a processing fee for each loan, with the amount of such fee pre-determined by the SBA dependent upon the size of each loan. At December 31, 2020, the Company has recorded net deferred PPP loan fees and costs of $1.2 million, which will be recognized through interest income over the life of the related PPP loans. Because of the 100% SBA guarantee, the Company has determined that no allowance for loan losses is required on the PPP loans. All PPP loans have a pass rating and none are past due under their contractual terms.
On December 27, 2020 the 2021 Consolidated Appropriations Act (“CAA”) was signed into the law. The CAA included $284 billion in new PPP funding, and the Company is assisting its customers in applying for such funding. Through February 28, 2021, the Company originated new PPP loans under the CAA with a balance of $23.2 million, net of $922 thousand of unearned fees and costs.
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In April 2020, the Company applied and was approved by the Federal Reserve Board for both the ability to borrow under its PPPLF, as well as its Discount Window. The PPPLF provides term funding to depository institutions that originate loans to small businesses under the PPP. PPP loans that are pledged to secure PPPLF extensions of credit are excluded from leverage ratio calculations. The components of long-term borrowings with the PPPLF at December 31, 2020 were as follows:
(Dollars in Thousands)
Maturity Date Interest Rate Outstanding
Total PPPLF Outstanding Borrowings $ 50,794
As of February 3, 2021, the PPPLF borrowings have been paid off in full. The Company is approved to borrow under the PPPLF through June 30, 2021.
The Company’s allowance for loan losses increased $2.5 million to $10.6 million at December 31, 2020 from $8.0 million at December 31, 2019. At December 31, 2020 and December 31, 2019, the allowance for loan losses represented 0.97% and 0.79%, respectively, of total loans (not including PPP loans which are guaranteed by the SBA). In 2020, the Bank adjusted the economic risk factor and loan modifications risk factor methodologies to incorporate the current economic implications, unemployment rate and amount of loan modifications due to the COVID-19 pandemic, leading to the increase in the allowance for loan losses as a percentage of total loans. In determining its allowance for loan loss level for the year ending December 31, 2020, the Bank considered the health and composition of its loan portfolio going into and during the COVID-19 pandemic. At December 31, 2020, approximately 94% of the Bank’s loan portfolio is collateralized by real estate. Less than 6% of the Bank’s loan portfolio is to borrowers in the more particularly hard-hit industries (including the travel and hotel industry, the full-service and limited-service restaurant industries, and the assisted living facilities industry) and the Bank has no direct international exposure. The Bank was not required to adopt the Current Expected Credit Losses (“CECL”) FASB accounting standard in 2020, as this guidance will not be effective for the Bank until 2023. Based upon current economic conditions, the composition of the loan portfolio, the perceived credit risk in the portfolio and loan-loss experience of the Bank and comparable institutions in the Bank’s market area, management feels the allowance is adequate to absorb reasonably anticipated losses.
In response to the COVID-19 outbreak, the Federal Reserve Board in mid-March 2020 has reduced by 150 basis points the benchmark federal funds rate to a target range of 0% to 0.25%, and the yields on 10 year and 30 year Treasury notes have declined to historic lows. As a result of the decline in the Federal Reserve Board’s target federal funds rate and yields on Treasury notes, the Company’s future net interest margin and spread may be further reduced.
All loans that have the CARES Act Section 4013 modification, regardless of whether original contractual payment terms have resumed, are provided additional qualitative reserve in the Company’s allowance for loan loss calculation. None of the loans that remain in payment accommodation status at December 31, 2020 are considered impaired by Management at December 31, 2020 as, at this time, Management does not feel it probable that the Company will be unable to collect all amounts according to the contractual terms of the loan agreement.
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Note 3 – Securities Available For Sale
The amortized cost and approximate fair values of securities available-for-sale were as follows at December 31, 2020 and 2019, respectively:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
(In Thousands)
U.S. Treasury securities $ 9,998 $ - $ - $ 9,998
The amortized cost and fair value of securities as of December 31, 2020, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without any penalties.
Amortized Fair
Cost Value
(In Thousands)
Due after one year through five years 30,833 30,818
Due after five years through ten years 6,887 7,157
Gross gains of $128 thousand were realized on the sales of securities for the year ended December 31, 2020. There were no gross losses on the sales of securities for the year ended December 31, 2020. There were no sales of securities for the year ended December 31, 2019.
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The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2020 and December 31, 2019, respectively:
Less Than 12 Months 12 Months or More Total
December 31, 2020 : (In Thousands)
U.S. Government agency obligations $ 31,369 $ (24) $ - $ - $ 31,369 $ (24)
Total Temporarily Impaired Securities $ 31,369 $ (24) $ - $ - $ 31,369 $ (24)
Municipal bonds $ 1,295 $ (5) $ - $ - $ 1,295 $ (5)
The Company had five (5) securities in an unrealized loss position at December 31, 2020 and five (5) securities in an unrealized loss position at December 31, 2019. Unrealized losses are due only to market interest rate fluctuations. As of December 31, 2020, the Company either has the intent and ability to hold the securities until maturity or market price recovery or believes that it is more likely than not that it will not be required to sell such securities. Management believes that the unrealized loss only represents temporary impairment of the securities. None of the individual losses are significant.
Securities with a carrying value of $98.7 million and $74.0 million at December 31, 2020 and December 31, 2019, respectively, were subject to agreements to repurchase, pledged to secure public deposits, or pledged for other purposes required or permitted by law.
Note 4 – Loans Receivable and Credit Quality