CITIZENS FINANCIAL SERVICES, INC. CAUTIONARY STATEMENT
We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of the Company, the Bank,First Citizens Insurance , Realty or the Company on a consolidated basis. When we use words such as "believes," "expects," "anticipates," or similar expressions, we are making forward-looking statements. Forward-looking statements may prove inaccurate. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements:
• The scope, duration and severity of the COVID-19 pandemic and may have an
adverse effect on our business and operations, our customers, including their
ability to make timely loan payments, our service providers, and on the economy
and financial markets more significant that we expect.
• Interest rates could change more rapidly or more significantly than we expect.
• The economy could change significantly in an unexpected way, which would cause
the demand for new loans and the ability of borrowers to repay outstanding
loans to change in ways that our models do not anticipate.
• The financial markets could suffer a significant disruption, which may have a
negative effect on our financial condition and that of our borrowers, and on
our ability to raise money by issuing new securities.
• It could take us longer than we anticipate implementing strategic initiatives,
including expansions, designed to increase revenues or manage expenses, or we
may be unable to implement those initiatives at all.
• Acquisitions and dispositions of assets could affect us in ways that management
has not anticipated.
• We may become subject to new legal obligations or the resolution of litigation
may have a negative effect on our financial condition or operating results.
• We may become subject to new and unanticipated accounting, tax, regulatory or
compliance practices or requirements. Failure to comply with any one or more of
these requirements could have an adverse effect on our operations.
• We could experience greater loan delinquencies than anticipated, adversely
affecting our earnings and financial condition.
• We could experience greater losses than expected due to the ever increasing
volume of information theft and fraudulent scams impacting our customers and
the banking industry.
• We could lose the services of some or all of our key personnel, which would
negatively impact our business because of their business development skills,
financial expertise, lending experience, technical expertise and market area
knowledge.
• The agricultural economy is subject to extreme swings in both the costs of
resources and the prices received from the sale of products as a result of
weather, government regulations, international trade agreements and consumer
tastes, which could negatively impact certain of our customers.
• Loan concentrations in certain industries could negatively impact our results,
if financial results or economic conditions deteriorate.
• A budget impasse in the
values, liquidity and profitability as a result of either delayed or reduced
funding to school districts and municipalities who are customers of the bank.
• Companies providing support services related to the exploration and drilling of
the natural gas reserves in our market area may be affected by federal, state
and local laws and regulations such as restrictions on production, permitting,
changes in taxes and environmental protection, which could negatively impact
our customers and, as a result, negatively impact our loan and deposit volume
and loan quality. Additionally, the activities the companies providing support
services related to the exploration and drilling of the natural gas reserves
may be dependent on the market price of natural gas. As a result, decreases in
the market price of natural gas could also negatively impact these companies,
our customers.
Additional factors are discussed in this Annual Report on Form 10-K under "Item
1A. Risk Factors." These risks and uncertainties should be considered in
evaluating forward-looking statements and undue reliance should not be placed on
such statements. Forward-looking statements speak only as of the date they are
made and the Company does not undertake to update forward-looking statements to
reflect circumstances or events that occur after the date of the forward-looking
statements or to reflect the occurrence of unanticipated events. Accordingly,
past results and trends should not be used by investors to anticipate future
results or trends.
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INTRODUCTION
The following is management's discussion and analysis of the significant changes in financial condition, the results of operations, capital resources and liquidity presented in the accompanying consolidated financial statements for the Company. The Company's consolidated financial condition and results of operations consist almost entirely of the Bank's financial condition and results of operations. Management's discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes. Except as noted, tabular information is presented in thousands of dollars. The Company currently engages in the general business of banking throughout its service area ofBradford ,Tioga ,Clinton ,Potter andCentre counties in north centralPennsylvania ,Lebanon ,Berks ,Schuylkill andLancaster counties in south centralPennsylvania and Allegany County in southernNew York . We also have a limited branch office inUnion county ,Pennsylvania , which primarily serves agricultural customers in the centralPennsylvania market. We maintain our main office inMansfield, Pennsylvania . Presently we operate 33 banking facilities, 31 of which operate as bank branches after closing a facility in the first quarter of 2020 and opening a facility in the fourth quarter of 2020. InPennsylvania , the Company has full service offices located inMansfield ,Blossburg ,Ulysses ,Genesee ,Wellsboro ,Troy ,Sayre ,Canton ,Gillett ,Millerton ,LeRaysville ,Towanda ,Rome , the Mansfield Wal-Mart Super Center,Mill Hall ,Schuylkill Haven ,Friedensburg ,Mt. Aetna ,Fredericksburg ,Mount Joy , Fivepointville,State College and two branches near the city ofLebanon, Pennsylvania after closing a third branch inJanuary 2020 . We also have a limited branch office inWinfield, Pennsylvania . In November of 2020, we opened a full service branch inKennett Square, Pennsylvania . InNew York , our office is inWellsville . There are two branches inWilmington Delaware , one branch inDover Delaware , and a corporate administration building inWilmington, Delaware , which were acquired as part of the MidCoast acquisition inApril 2020 . Risk identification and management are essential elements for the successful management of the Company. In the normal course of business, the Company is subject to various types of risk, including interest rate, credit, liquidity, reputational and regulatory risk. Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates. Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company. The Company uses its asset/liability and funds management policies to control and manage interest rate risk. Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from loans with customers and the purchasing of securities. The Company's primary credit risk is in the loan portfolio. The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for loan losses. Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio. Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Company has established guidelines within its asset/liability and funds management policy to manage liquidity risk. These guidelines include, among other things, contingent funding alternatives. 25
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Reputational risk, or the risk to our business, earnings, liquidity, and capital from negative public opinion, could result from our actual or alleged conduct in a variety of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, ethical issues, or inadequate protection of customer information, which could include identify theft, or theft of customer information through third parties. We expend significant resources to comply with regulatory requirements. Failure to comply could result in reputational harm or significant legal or remedial costs. Damage to our reputation could adversely affect our ability to retain and attract new customers, and adversely impact our earnings and liquidity. Regulatory risk represents the possibility that a change in law, regulations or regulatory policy may have a material effect on the business of the Company and its subsidiary. We cannot predict what legislation might be enacted or what regulations might be adopted, or if adopted, the effect thereof on our operations. Readers should carefully review the risk factors described in other documents the Company files with theSEC , including the annual reports on Form 10-K, the quarterly reports on Form 10-Q and any current reports on Form 8-K filed by us.
TRUST AND INVESTMENT SERVICES; OIL AND GAS SERVICES
Our Investment and Trust Division is committed to helping our customers meet their financial goals. The Trust Division offers professional trust administration, investment management services, estate planning and administration, custody of securities and individual retirement accounts. In addition to traditional trust and investment services offered, we assist our customers through various oil and gas specific leasing matters from lease negotiations to establishing a successful approach to personal wealth management. Assets held by the Bank in a fiduciary or agency capacity for its customers are not included in the consolidated financial statements since such items are not assets of the Bank. As ofDecember 31, 2020 and 2019, assets owned and invested by customers of the Bank through the Bank's investment representatives totaled$241.0 million and$215.4 million , respectively. Additionally, as summarized in the table below, the Trust Department had assets under management as ofDecember 31, 2020 and 2019 of$150.3 million and$134.3 million , respectively. During the year endedDecember 31, 2020 ,$14.0 million of new trust accounts were opened,$4.0 million of additional contributions to trust accounts,$10.6 million distributed from trust accounts, and$5.8 million of accounts were closed. As a result of market fluctuations, the fair value of the trust accounts increased approximately$14.4 million during the year endedDecember 31, 2020 . The following table reflects trust accounts by investment type and structure: (fair values - in thousands) 2020 2019 INVESTMENTS: Bonds$ 11,777 $ 17,349 Stock 30,867 18,632 Savings and Money Market Funds 13,427 16,085 Mutual Funds 86,141 75,158 Mineral interests 2,738 4,982 Mortgages 956 696 Real Estate 1,560 1,045 Miscellaneous 625 351 Cash 2,257 - TOTAL$ 150,348 $ 134,298 ACCOUNTS: Trusts 40,234 34,975 Guardianships 2,817 5,929 Employee Benefits 58,751 51,870 Investment Management 48,462 41,520 Custodial 84 4 TOTAL$ 150,348 $ 134,298 Our financial consultants offer full service brokerage and financial planning services throughout the Bank's market areas. Appointments can be made at any Bank branch. Products such as mutual funds, annuities, health and life insurance are made available through our insurance subsidiary,First Citizens Insurance Agency, Inc. 26
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RESULTS OF OPERATIONS
Net income for the year endedDecember 31, 2020 was$25,103,000 , which represents an increase of$5,613,000 , or 28.8%, when compared to 2019. Net income for the year endedDecember 31, 2019 was$19,490,000 , which represents an increase of$1,456,000 , or 8.1%, when compared to 2018. Basic earnings per share were$6.60 ,$5.48 and$5.04 for 2020, 2019 and 2018, respectively, while diluted earnings per share were$6.59 ,$5.47 and$5.04 , for 2020, 2019 and 2018, respectively. Net income is influenced by five key components: net interest income, provision for loan losses, non-interest income, non-interest expenses, and the provision for income taxes. Net Interest Income The most significant source of revenue is net interest income; the amount by which interest earned on interest-earning assets exceeds interest paid on interest-bearing liabilities. Factors that influence net interest income are changes in volume of interest-earning assets and interest-bearing liabilities as well as changes in the associated interest rates. The following table sets forth the Company's average balances of, and the interest earned or incurred on, each principal category of assets, liabilities and stockholders' equity, the related rates, net interest income and rate "spread" created. The acquisition of MidCoast, which closed onApril 17, 2020 , impacted the average balances and rates for 2020 when compared to 2019: 27
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Analysis of Average Balances and Interest Rates
2020 2019 2018
Average Interest Average Average Interest Average Average Interest Average
Balance (1) $ Rate Balance (1) $ Rate Balance (1) $ Rate
(dollars in thousands) $ % $ % $ %
ASSETS
Short-term investments:
Interest-bearing deposits at banks 41,330 37 0.09 9,693 23 0.24 8,929 20 0.22
Total short-term investments 41,330 37 0.09 9,693 23 0.24 8,929 20 0.22
Interest bearing time deposits at banks 14,139 364 2.57 15,085 384 2.55 12,734 299 2.35
Investment securities:
Taxable 188,241 4,488 2.38 188,697 5,170 2.74 191,991 4,237 2.21
Tax-exempt (3) 80,131 2,366 2.95 58,637 1,889 3.22 64,728 2,208 3.41
Total investment securities 268,372 6,854 2.55 247,334 7,059 2.85 256,719 6,445 2.51
Loans:
Residential mortgage loans 210,696 11,161 5.30 215,749 11,473 5.32 214,458 11,205 5.22
Construction loans 26,343 1,288 4.89 19,085 984 5.16 25,698 1,235 4.80
Commercial Loans 590,469 31,087 5.26 415,681 22,741 5.47 388,037 20,611 5.31
Agricultural Loans 357,201 16,022 4.49 344,586 15,879 4.61 305,003 13,638 4.47 Loans to state & political subdivisions
86,143 3,458 4.01 97,780 3,845 3.93 101,496 3,759 3.70 Other loans 20,986 1,185 5.65 9,684 740 7.64 9,558 737 7.71 Loans, net of discount (2)(3)(4) 1,291,838 64,201 4.97 1,102,565 55,662 5.05 1,044,250 51,185 4.90 Total interest-earning assets 1,615,679 71,456 4.42 1,374,677 63,128 4.59 1,322,632 57,949 4.38 Cash and due from banks 7,487 6,168 6,807 Bank premises and equipment 17,286 16,074 16,338 Other assets 79,305 57,038 54,722 Total non-interest earning assets 104,078 79,280 77,867 Total assets 1,719,757 1,453,957 1,400,499 LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: NOW accounts 383,931 1,102 0.29 331,906 2,282 0.69 326,040 1,642 0.50 Savings accounts 241,429 476 0.20 218,240 814 0.37 192,727 323 0.17 Money market accounts 205,142 1,012 0.49 164,872 1,978 1.20 164,916 1,618 0.98 Certificates of deposit 345,397 4,261 1.23 277,946 4,145
1.49 276,213 3,327 1.20 Total interest-bearing deposits
1,175,899 6,851 0.58 992,964 9,219 0.93 959,896 6,910 0.72 Other borrowed funds 93,237 1,254 1.34 109,041 2,821
2.59 117,912 2,664 2.26 Total interest-bearing liabilities
1,269,136 8,105 0.64 1,102,005 12,040 1.09 1,077,808 9,574 0.89 Demand deposits 257,285 187,991 171,353 Other liabilities 16,662 14,074 12,647 Total non-interest-bearing liabilities 273,947 202,065 184,000 Stockholders' equity 176,674 149,887 138,691 Total liabilities & stockholders' equity 1,719,757 1,453,957 1,400,499 Net interest income 63,351 51,088 48,375 Net interest spread (5) 3.78 % 3.50 % 3.49 %
Net interest income as a percentage of average interest-earning assets
3.92 % 3.72 % 3.66 %
Ratio of interest-earning assets to interest-bearing liabilities 1.27 1.25 1.23
(1) Averages are based on daily averages.
(2) Includes loan origination and commitment fees.
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper
comparison using a statutory federal income tax rate of 21% for 2020, 2019
and 2018. Tax equivalent income is considered a non-gaap measure. See
reconciliation to equivalent GAAP measure on page 30.
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan
balances are included in interest-earning assets.
(5) Interest rate spread represents the difference between the average rate
earned on interest-earning assets and the average rate paid on
interest-bearing liabilities.
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For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Federal statutory rate for the corresponding year. Accordingly, tax equivalent adjustments for investments and loans have been made accordingly to the previous table for the years endedDecember 31, 2020 , 2019 and 2018, respectively (in thousands): 2020 2019 2018
Interest and dividend income from investment securities, interest bearing time deposits and short-term investments (non-tax adjusted) (GAAP)
$ 6,758 $ 7,069 $ 6,300 Tax equivalent adjustment 497 397 464
Interest and dividend income from investment securities,
interest bearing time deposits and short-term investments (tax equivalent basis) (Non-GAAP)
2020 2019 2018
Interest and fees on loans (non-tax adjusted) (GAAP) $ 63,538 $ 54,911 $ 50,458
Tax equivalent adjustment 663 751 727
Interest and fees on loans (tax equivalent basis) (Non-GAAP) $ 64,201 $ 55,662 $ 51,185
2020 2019 2018
Total interest income $ 70,296 $ 61,980 $ 56,758
Total interest expense 8,105 12,040 9,574
Net interest income (GAAP) 62,191 49,940 47,184
Total tax equivalent adjustment 1,160
1,148 1,191
Net interest income (tax equivalent basis) (Non-GAAP)
The following table shows the tax-equivalent effect of changes in volume and rates on interest income and expense (in thousands):
Analysis of Changes in Net Interest Income on a Tax-Equivalent Basis
2020 vs. 2019 (1) 2019 vs. 2018 (1)
Change in Change Total Change in Change Total
Volume in Rate Change Volume in Rate Change
Interest Income:
Short-term investments:
Interest-bearing deposits at banks $ 16 $ (2 ) $ 14 $ 2 $ 1 $ 3
Interest bearing time deposits at banks (24 ) 4 (20 ) 58 27 85
Investment securities:
Taxable (13 ) (669 ) (682 ) (71 ) 1,004 933
Tax-exempt 615 (138 ) 477 (200 ) (119 ) (319 )
Total investment securities 602 (807 ) (205 ) (271 ) 885 614
Total investment income 594 (805 ) (211 ) (211 ) 913 702
Loans:
Residential mortgage loans (263 ) (49 ) (312 ) 68 200 268
Construction loans 353 (49 ) 304 (350 ) 99 (251 )
Commercial Loans 9,164 (818 ) 8,346 1,500 630 2,130
Agricultural Loans 524 (381 ) 143 1,814 427 2,241Loans to state & political subdivisions (471 ) 84 (387 ) (124 ) 210 86 Other loans
573 (128 ) 445 9 (6 ) 3
Total loans, net of discount 9,880 (1,341 ) 8,539 2,917 1,560 4,477
Total Interest Income 10,474 (2,146 ) 8,328 2,706 2,473 5,179
Interest Expense:
Interest-bearing deposits:
NOW accounts 444 (1,624 ) (1,180 ) 30 610 640
Savings accounts 91 (429 ) (338 ) 48 443 491
Money Market accounts 686 (1,652 ) (966 ) (1 ) 361 360
Certificates of deposit 416 (300 ) 116 21 797 818
Total interest-bearing deposits 1,637 (4,005 ) (2,368 ) 98 2,211 2,309
Other borrowed funds (360 ) (1,207 ) (1,567 ) (170 ) 327 157
Total interest expense 1,277 (5,212 ) (3,935 ) (72 ) 2,538 2,466
Net interest income $ 9,197 $ 3,066 $ 12,263 $ 2,778 $ (65 ) $ 2,713 (1) The portion of the total change attributable to both volume and rate changes
during the year has been allocated to volume and rate components based upon
the absolute dollar amount of the change in each component prior to
allocation.
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2020 vs. 2019
Tax equivalent net interest income for 2020 was$63,351,000 compared to$51,088,000 for 2019, an increase of$12,263,000 or 24.0%. Total interest income increased$8,328,000 , as loan interest income increased$8,539,000 , and total investment income decreased$211,000 . Interest expense decreased$3,935,000 from 2019. Total tax equivalent interest income from investment securities decreased$205,000 in 2020 from 2019. The average balance of investment securities increased$21.0 million , which had an effect of increasing interest income by$602,000 due to volume. The majority of the increase in volume was in tax-exempt securities, which experienced an increase in the average balance of$21.5 million . The average tax-effected yield on our investment portfolio decreased from 2.85% in 2019 to 2.55% in 2020. The decrease in the tax-effected yield is attributable to purchases made in a lower rate environment and calls in the third quarter of 2019 of securities purchased at a discount. As a result of the yield on investment securities decreasing 30 basis points (bps) to 2.55%, interest income on investment securities decreased$807,000 , with the decrease primarily related to taxable securities. The investment strategy for 2020 has been to utilize cashflows from the investment portfolio and deposit inflows to purchase mortgage backed securities in government sponsored entities and obligations of state and political securities, as well as US agency securities. The increase in the investment portfolio was in response to growth in deposits that exceeded organic loan opportunities. The Covid-19 pandemic did provide opportunities for the Company to purchase high quality municipal securities and mortgage backed securities with relatively high spreads in the first and second quarters of 2020. Purchases in the second half of 2020 were reflective of tighter spreads and lower yields due government stimulus and its impact on bond markets and deposit levels. We continually monitor interest rate trading ranges and try to focus purchases to times when rates are in the top of the trading range. The Bank believes its investment strategy has appropriately mitigated its interest rate risk exposure for various rate environments, while providing sufficient cashflows to meet liquidity needs. In total, loan interest income increased$8,539,000 in 2020 from 2019. The average balance of our loan portfolio increased by$189.3 million in 2020 compared to 2019, which resulted in an increase in interest income of$9,880,000 due to volume. The increase in the average balance of loans was driven by the MidCoast acquisition in the first quarter of 2020 and the PPP program authorized by the SBA in response to the COVID-19 pandemic. Organic growth in the first three quarters of 2020, excluding the PPP program was limited, but did increase in the fourth quarter of 2020, primarily in ourDelaware market. The average tax-effected yield on our loan portfolio decreased 8 basis points to 4.97% in 2020, resulting in a decrease in loan interest income of$1,341,000 . The decrease in the tax-effected yield was due to the lower rate environment promoted by theFederal Reserve in 2020 in response to the COVID-19 pandemic.
• Interest income on residential mortgage loans decreased
balance of residential mortgage loans decreased
decrease of
refinanced and sold on the secondary market. The change due to rate was a
decrease of
from 5.32% in 2019 to 5.30% in 2020 as a result of the lower rate environment
during the year as a result of COVID-19 pandemic.
• The average balance of construction loans increased
2020 as a result of the acquisition and projects in our south central
income. The average yield on construction loans decreased from 5.16% to 4.89%,
which correlated to a
• Interest income on commercial loans increased
The increase in the average balance of commercial loans of
attributable to the MidCoast acquisition and PPP loans originated in the second
and third quarters of 2020. The increase in the average balance of these loans
resulted in an increase in interest income due to volume of
lenders have been able to attract and retain loan relationships in their
markets by providing excellent customer service and having attractive
products. We believe our lenders are adept at customizing and structuring
loans to customers that meet their needs and satisfy our commitment to credit
quality. In many cases, the Bank works with the
(SBA) guaranteed loan programs to offset risk and to further promote economic
growth in our market area. The average yield on commercial loans decreased 21
basis points to 5.26% in 2020, resulting in a decrease in interest income due
to rate of$818,000 . 30
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• Interest income on agricultural loans increased
The increase in the average balance of agricultural loans of
primarily attributable to the central and south central markets as well as the
acquisition. The increase in the average balance of these loans resulted in an
increase in interest income due to volume of
agricultural loans decreased from 4.61% in 2019 to 4.49% in 2020 due to a
general decrease in rates, resulting in a decrease in interest income due to
rate of
understanding and have the expertise to structure loans for customers that meet
their needs and satisfy our commitment to credit quality. In many cases, the
Bank works with the
loan programs to offset risk and to further promote economic growth in our
market area.
• The average balance of loans to state and political subdivisions decreased
total interest income due to volume. The average tax equivalent yield on loans
to state and political subdivisions increased from 3.93% in 2019 to 4.01% in
2020, increasing interest income by
• The average balance of other loans increased
increase in outstanding student loans. This resulted in an increase of
on total interest income due to volume. The average tax equivalent yield on
other loans decreased from 7.64% in 2019 to 5.65% in 2020 as a result of the
growth in student loans, decreasing interest income by
loans Total interest expense decreased$3,935,000 in 2020 compared to 2019. The majority of the decrease was due to a decrease in the average rate paid on interest bearing liabilities of 45 basis points to 0.64%. This decrease resulted in a decrease in interest expense of$5,212,000 . The decrease in rates was driven by theFederal Reserve decreasing rates in the second half of 2019 as a result of a slowing economy and the in the first quarter of 2020 in response to the COVID-19 pandemic. The average rate on certificates of deposit decreased from 1.49% to 1.23% resulting in a decrease in interest expense of$300,000 . The average rate paid on other borrowed funds decreased from 2.59% to 1.34% resulting in a decrease in interest expense of$1,207,000 . The average rate paid on money market accounts decreased from 1.20% to 0.49% resulting in a decrease in interest expense of$1,652,000 . The average rate paid on NOW accounts decreased from 0.69% in 2019 to 0.29% in 2020 resulting in a decrease in interest expense of$1,624,000 . The average rate paid on savings accounts decreased 17 bps and resulted in a decrease in interest expense of$429,000 . Average interest bearing liabilities increased$167.1 million in 2020, with average interest bearing deposits increasing$182.9 million and average other borrowings decreasing$15.8 million . As a result of the increase in average deposits, interest expense increased$1,277,000 as result of the change in volume. Increases in average deposits, which were primarily driven by the MidCoast acquisition, included NOW accounts of$52.0 million , savings accounts of$23.2 million , money market accounts of$40.3 million and certificates of deposits of$67.5 million The combined impact to interest expense of these increases was$1,637,000 . The average balance of other borrowed funds decreased$15.8 million , which corresponds to a decrease in interest expense of$360,000 . Our tax equivalent net interest margin for 2020 was 3.92% compared to 3.72% for 2019, with the change attributable to the cost of interest-bearing liabilities decreasing more than income from interest earning assets during 2020. The interest rate environment for 2020 was flat for a majority of the year, but did experience some expansion in the fourth quarter of 2020 with long term rates rising, while short term rates remained low. Should short or long-term interest rates move in such a way that results in a further flattening or inversion, we would anticipate additional pressure on our margin. 31
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2019 vs. 2018
Tax equivalent net interest income for 2019 was$51,088,000 compared to$48,375,000 for 2018, an increase of$2,713,000 or 5.6%. Total interest income increased$5,179,000 , as loan interest income increased$4,477,000 , and total investment income increased$614,000 . Interest expense increased$2,466,000 from 2018. Total tax equivalent interest income from investment securities increased$614,000 in 2019 from 2018. The average balance of investment securities decreased$9.4 million , which was used to fund loan growth, which had an effect of decreasing interest income by$271,000 due to volume. The majority of the decrease in volume was in tax-exempt securities, which experienced a decrease in the average balance of$6.1 million . The average tax-effected yield on our investment portfolio increased from 2.51% in 2018 to 2.85% in 2019. The increase in the tax-effected yield is attributable to purchases made in a higher rate environment and calls in 2019 of securities purchased at a discount. As a result of yield on taxable securities increasing 53 basis points (bps) to 2.74%, interest income on investment securities increased$885,000 . In total, loan interest income increased$4,477,000 in 2019 from 2018. The average balance of our loan portfolio increased by$58.3 million in 2019 compared to 2018, which resulted in an increase in interest income of$2,917,000 due to volume. The increase in the average balance of loans was driven by growth in our central and south centralPennsylvania markets. The average tax-effected yield on our loan portfolio increased 15 basis points to 5.05% in 2019, resulting in an increase in loan interest income of$1,560,000 . The increase in the tax-effected yield was due to the higher rate environment promoted by theFederal Reserve in 2018 through the four rate increases made in 2018, which were partially offset by two rate decreases in 2019.
• Interest income on residential mortgage loans increased
balance of residential mortgage loans increased
increase of
2018 to 5.32% in 2019 as a result of a higher rate environment during the year
as a result of rate increases in 2018.
• The average balance of construction loans decreased
2019 as projects were completed, which resulted in a decrease of
interest income. The average yield on construction loans increased from 4.80%
to 5.16%, which correlated to a
• Interest income on commercial loans increased
The increase in the average balance of commercial loans of
attributable to organic growth in the central and south central markets as well
as completed construction projects. The increase in the average balance of
these loans resulted in an increase in interest income due to volume of
5.47% in 2019, resulting in an increase in interest income due to rate of
$630,000 .
• Interest income on agricultural loans increased
The increase in the average balance of agricultural loans of
primarily attributable to the central and south central markets as well as
completed construction projects. The increase in the average balance of these
loans resulted in an increase in interest income due to volume of
The average yield on agricultural loans increased from 4.47% in 2018 to 4.61%
in 2019 due to a general increase in rates, resulting in an increase in interest income due to rate of$427,000 .
• The average balance of loans to state and political subdivisions decreased
million from 2018 to 2019 which had a negative impact of
interest income due to volume. The average tax equivalent yield on loans to
state and political subdivisions increased from 3.70% in 2018 to 3.93% in 2019,
increasing interest income by$210,000 . 32
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Total interest expense increased$2,466,000 in 2019 compared to 2018. The majority of the increase was due to an increase in the average rate paid on interest bearing liabilities of 20 basis points to 1.09%. This increase resulted in an increase in interest expense of$2,538,000 . The rise in rates was driven by theFederal Reserve raising short term rates in 2018, which increased pressure on the Bank to raise rates on deposit pricing and to pay higher rates for short-term and overnight borrowings. While theFederal Reserve cut rates in 2019, the cuts were less than the increases in 2018, but did have an impact in lowering rates in the second half of 2019. The average rate on certificates of deposit increased from 1.20% to 1.49% resulting in an increase in interest expense of$797,000 . The average rate paid on other borrowed funds increased from 2.26% to 2.59% resulting in an increase in interest expense of$327,000 . The average rate paid on money market accounts increased from 0.98% to 1.20% resulting in an increase in interest expense of$361,000 . Increases in rates paid on NOW accounts and savings accounts were less than 20 basis points, and resulted in a cumulative increase in interest expense of$1,053,000 . Average interest bearing liabilities increased$24.2 million in 2019, with average interest bearing deposits increasing$33.1 million and average other borrowings decreasing$8.9 million . As a result of the decrease in average borrowings, interest expense decreased$72,000 as result of the change in volume. Increases in average deposits included NOW accounts of$5.7 million , savings accounts of$25.5 million and certificates of deposits of$1.7 million . The combined impact to interest expense of these increases was$98,000 . The average balance of other borrowed funds decreased$8.9 million , which corresponds to a decrease in interest expense of$170,000 . Our tax equivalent net interest margin for 2019 was 3.72% compared to 3.66% for 2018, with the change attributable to higher tax-effected yields as a result of the higher rate environment. PROVISION FOR LOAN LOSSES For the year endedDecember 31, 2020 , we recorded a provision for loan losses of$2,400,000 . The provision for 2020 was$725,000 , or 43.3%, higher than the provision in 2019. The increase in the provision for loan losses was primarily the result of the COVID-19 pandemic and its impact on our economy as well as organic growth attributable to theDelaware market primarily in the fourth quarter of 2020 (see also "Financial Condition - Allowance for Loan Losses and Credit Quality Risk"). For the year endedDecember 31, 2019 , we recorded a provision for loan losses of$1,675,000 . The provision for 2019 was$250,000 , or 13.0% lower than the provision in 2018. The decrease in the provision for loan losses was primarily the result of organic loan growth in 2019 being less than the organic loan growth experienced in 2018 (see also "Financial Condition - Allowance for Loan Losses and Credit Quality Risk").
NON-INTEREST INCOME
The following table reflects non-interest income by major category for the years
ended
2020 2019 2018
Service charges $ 4,221 $ 4,687 $ 4,667
Trust fees 803 750 705
Brokerage and insurance commissions 1,297 1,141 790
Equity security (losses) gains, net (41 ) 120
-
Available for sale security gains (losses), net 305 24
(19 )
Gains on loans sold 2,168 473 382
Earnings on bank owned life insurance 695 623 622 Other 1,974 568 588 Total$ 11,422 $ 8,386 $ 7,735 33
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2020/2019 2019/2018
Change Change
Amount % Amount %
Service charges $ (466 ) (9.9 ) $ 20 0.4
Trust fees 53 7.1 45 6.4
Brokerage and insurance commissions 156 13.7 351 44.4
Equity security (losses) gains, net (161 ) (134.2 ) 120 NA
Available for sale security gains (losses), net 281 1,170.8
43 (226.3 )
Gains on loans sold 1,695 358.4 91 23.8
Earnings on bank owned life insurance 72 11.6 1 0.2
Other 1,406 247.5 (20 ) (3.4 )
Total $ 3,036 36.2 $ 651 8.4
2020 vs. 2019
Non-interest income increased $3,036,000 in 2020 from 2019, or 36.2%. We
experienced a $305,000 net gain on available for sale securities in 2020
compared to net gains totaling $24,000 in 2019. During 2020, we sold 19 mortgage
backed securities for a net gain of $305,000 to lock in gains that benefitted
from the Federal Reserve investment purchase program in response to the COVID-19
pandemic. During 2019, we sold 3 agency securities for a net gain of $1,000 and
4 US Treasury securities for a gain of $23,000 to fund loan growth and to
restructure the investment portfolio to improve performance in the current rate
environment. During 2020, net equity security losses amounted to $41,000 as a
result of market losses associated with the Covid-19 pandemic compared to gains
of $120,000 last year.
Gains on loans sold increased $1,695,000 compared to last year. The increase in
gains on loans sold is attributable to a $54.0 million , or 248.1% increase in
the proceeds from the sale of residential mortgages loans as a result of the low
rate environment, which has significantly increased residential refinancings.
The decrease in service charges of $466,000 for 2020 is attributable to the
Bank's response to the COVID-19 pandemic and a decrease in customer spending as
a result of mandatory stay at home orders as customers ate out less and spent
less on discretionary items. The increase in other income is due to fees on
offering derivative contracts for certain customers, that provided the customer
with fixed rate loans, which generated fee income of $1,373,000 in 2020. The
increase in brokerage and insurance commissions was primarily attributable to
growth in our south central market.
2019 vs. 2018
Non-interest income increased$651,000 in 2019 from 2018, or 8.4%. We experienced a$24,000 net gain on available for sale securities in 2019 compared to a net loss totaling$19,000 in 2018. During 2019, we sold 3 agency securities for a net gain of$1,000 and 4US Treasury securities for a gain of$23,000 to fund loan growth and to restructure the investment portfolio to improve performance in the current rate environment. During 2018, we sold 7 agency securities for a net loss of$179,000 and 14 municipal securities for a gain of$160,000 to fund loan growth. As a result of market conditions, the equity portfolio increased$120,000 during 2019, while remaining flat in 2018. Gains on loans sold increased$91,000 compared to last year. During 2019, the Bank generated$21.8 million of residential mortgage loan sale proceeds, which was$2.1 million , or 10.6% more than the proceeds received in 2018.
The increase in brokerage and insurance commissions was primarily attributable to growth in our south central market. The increase in Trust fees is due to estate settlement fees being higher in 2019 than 2018.
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Non-interest Expenses
The following tables reflect the breakdown of non-interest expense by major
category for the years ended
2020 2019 2018
Salaries and employee benefits $ 24,190 $ 20,456 $ 19,094
Occupancy 2,557 2,174 2,126
Furniture and equipment 757 674 536
Professional fees 1,517 1,423 1,925
FDIC insurance 476 75 417
Pennsylvania shares tax 868 808 835
Amortization of intangibles 216 259 296
Merger and acquisition 2,179 466 -
Other Real Estate (ORE) expenses 451 376 158
Software expenses 1,155 948 876
Other 6,481 5,682 5,294
Total $ 40,847 $ 33,341 $ 31,557
2020/2019 2019/2018
Change Change
Amount % Amount %
Salaries and employee benefits $ 3,734 18.3 $ 1,362 7.1
Occupancy 383 17.6 48 2.3
Furniture and equipment 83 12.3 138 25.7
Professional fees 94 6.6 (502 ) (26.1 )
FDIC insurance 401 534.7 (342 ) (82.0 )
Pennsylvania shares tax 60 7.4 (27 ) (3.2 )
Amortization of intangibles (43 ) (16.6 ) (37 ) (12.5 )
Merger and acquisition 1,713 367.6 466 N/A
ORE expenses 75 19.9 218 138.0
Software expenses 207 21.8 72 8.2
Other 799 14.1 388 7.3
Total $ 7,506 22.5 $ 1,784 5.7
2020 vs. 2019
Non-interest expenses for 2020 totaled $40,847,000 , which represents an increase
of $7,506,000 , compared to 2019 expenses of $33,341,000 . The primary cause of
the total increase was the MidCoast acquisition costs, as well as the additional
salaries and benefits costs of the acquired employees. Salary and benefit costs
increased $3,734,000 , or 18.3%. Base salaries and related payroll taxes
increased $3,081,000 as a result of merit increases and additional headcount
associated with the acquisition. Full time equivalent staffing was 281 and 259
for 2020 and 2019, respectively. Profit sharing expenses increased $829,000
compared to 2019, as a result of the employee mix and increased profitability,
which will result in higher bonuses to employees.
The increase in occupancy and furniture and equipment expenses was due to the
additional branches acquired as part of the MidCoast acquisition. The increase
in merger and acquisition expenses was due to costs associated with the MidCoast
acquisition that closed in April 2020 . The increase in FDIC insurance in 2020
was due to credits received from the FDIC in 2019 as the Deposit Insurance Fund
exceeded 1.38% as well as organic and acquisition growth that occurred in 2020.
The increase in software expenses is due to new systems implemented in the
second half of 2020 for our tellers and image capture and review. The largest
drivers of the increase in other expenses was the termination of a pension plan
in 2019 for a gain that was acquired as of the FNB acquisition in 2015, ATM and
data processing expenses as a result of fraud prevention, contributions in
response to the COVID-19 pandemic, supplies for the additional branches and the
Delaware franchise fee. The increase in ORE expenses is the result of net losses
on the disposal of ORE properties in 2020 compared to a net gain in 2019.
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2019 vs. 2018
Non-interest expenses for 2019 totaled$33,341,000 , which represents an increase of$1,784,000 , compared to 2018 expenses of$31,557,000 . The primary cause of the total increase was salaries and benefits. Salary and benefit costs increased$1,362,000 , or 7.1%. Base salaries and related payroll taxes increased$200,000 as a result of merit increases. Full time equivalent staffing was 259 and 261 for 2019 and 2018, respectively. As a result of actual claims utilization, health insurance related expenses increased$395,000 . Retirement and profit sharing expenses increased$539,000 compared to 2018, as a result of the employee mix and increased profitability. The increase in furniture and fixtures was due to computer upgrades made during 2019. The increase in merger and acquisition expenses is due to costs associated with the merger withMidCoast Community Bancorp, Inc. and no corresponding activity in 2018. The increase in ORE expenses is the result of having additional ORE properties in 2019 than 2018 that were acquired as part of the customer bankruptcy settlement that resulted in the decreased professional fees. The largest drivers of the increase in other expenses was operational charge-offs associated with fraudulent activity, ATM and data processing expenses as a result of fraud prevention and advertising and promotion expenses. The decrease in professional and legal fees is due to a decrease in legal fees associated with a customer's bankruptcy litigation that was settled in the first quarter of 2019. The decrease inFDIC insurance was due to credits received in 2019 from theFDIC as theDeposit Insurance Fund exceeded 1.38%.
Provision for Income Taxes
The provision for income taxes was$5,263,000 ,$3,820,000 and$3,403,000 for 2020, 2019 and 2018, respectively. The effective tax rates for 2020, 2019 and 2018 were 17.3%, 16.4% and 15.9%, respectively. The increase in income tax expense of$1,443,000 in 2020 was due to the increase of$7,056,000 in income before the provision for income taxes, which accounts for an increase in tax expense of$1,482,000 at a 21% tax rate. The increase in income tax expense of$417,000 in 2019 was due to the increase of$1,873,000 in income before the provision for income taxes, which accounts for an increase in tax expense of$393,000 at a 21% tax rate. The remaining increase was due to a lower amount of tax exempt income in 2019 compared to 2018. We are involved in four limited partnership agreements that operate low-income housing projects in our market area. During 2020, 2019 and 2018, we recognized tax credits related to one of the four partnerships. Tax credits associated with one project became fully utilized inDecember 2016 . The tax credits for the other two projects were fully utilized byDecember 31, 2012 . We anticipate recognizing an aggregate of$282,000 of tax credits over the next two years.
FINANCIAL CONDITION
The following table presents ending balances (dollars in millions), the dollar amount of change and the percentage change during the past two years:
2020 % 2019 % 2018
Balance Increase Change Balance Increase Change Balance
Total assets $ 1,891.7 $ 425.4 29.0 $ 1,466.3 $ 35.6 2.5 $ 1,430.7
Total investments 295.2 54.5 22.6 240.7 (0.3 ) (0.1 ) 241.0
Total loans, net 1,389.5 287.8 26.1 1,101.7 32.7 3.1 1,069.0
Total deposits 1,588.9 377.8 31.2 1,211.1 25.9 2.2 1,185.2
Total borrowings 88.8 3.7 4.3 85.1 (6.1 ) (6.7 ) 91.2
Total stockholders' equity 194.3 39.5 25.5 154.8 15.6 11.2 139.2
Cash and Cash Equivalents
Cash and cash equivalents totaled$68.7 million atDecember 31, 2020 compared to$18.5 million atDecember 31, 2019 . Management actively measures and evaluates its liquidity through our Asset - Liability committee and believes its liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources,Federal Home Loan Bank financing, federal funds lines with correspondent banks, brokered certificates of deposit and the portion of the investment and loan portfolios that mature within one year. Management expects that these sources of funds will permit us to meet cash obligations and off-balance sheet commitments as they come due. 36
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Investments
The following table shows the year-end composition of the investment portfolio,
at fair value, for the five years ended
2020 % of 2019 % of 2018 % of 2017 % of 2016 % of
Amount Total Amount Total Amount Total Amount Total Amount Total
Available-for-sale:
U. S. Agency securities $ 81,416 27.4 $
84,863 35.1
28,043 9.4 27,661 11.5 33,358 13.8 28,604 11.2
3,000 0.9
Obligations of state & political subdivisions 102,972 34.7 61,455 25.5 52,047 21.5 79,090 31.0 96,926 30.9
Corporate obligations 6,509 2.2 3,328 1.4 3,034 1.3 3,083 1.2 3,050 1.0
Mortgage-backed securities 76,249 25.7 63,399 26.2 46,186 19.1 45,027 17.7 37,728 12.0
Equity securities (a) 1,931 0.6 701 0.3 516 0.3 91 0.1 2,899 0.9
Total $ 297,120 100.0 $ 241,407 100.0 $ 241,526 100.0 $ 254,782 100.0 $ 314,017 100.0
(a) As of
reclassification of equity securities from available for sale securities to
equity securities in the Consolidated Balance Sheet.
2020
The Company's investment portfolio increased during 2020 by$55.7 million . This growth was fueled by increases in deposits that were driven by the COVID-19 pandemic as customers received government stimulus money and held more cash, and limited loan growth opportunities during the first nine months of 2020. During 2020, we purchased$31.2 million ofU.S. agencies,$54.5 million of mortgage backed securities,$55.1 million of state and local obligations,$3.2 million of corporate obligations and$1.3 million of equity securities, which helped to offset the$21.6 million of principal repayments and$48.4 million of calls and maturities that occurred during the year. We also sold$23.4 million of bonds at a net gain of$305,000 . The fair value of our investment portfolio increased approximately$4.7 million in 2020 due to interest rate fluctuations and equity market losses. Excluding our short term investments consisting of monies held primarily at theFederal Reserve , the effective yield on our investment portfolio for 2020 was 2.55% compared to 2.85% for 2019 on a tax equivalent basis. During 2020, interest rates across the yield curve decreased significantly due to the Federal Reserves rate cuts on the short end and the markets reaction to the COVID-19 pandemic. For a majority of the year, theTreasury yield curve was relatively flat and yields were near historical lows. Late in 2020, the long end of the curve increased slightly adding some spread to theTreasury curve, but overall yields remain low from a historical perspective. The investment strategy for 2020 has been to utilize cashflows from the investment portfolio and deposit inflows to purchase mortgage backed securities in government sponsored entities and obligations of state and political securities, as well as US agency securities. The increase in the investment portfolio was in response to growth in deposits that exceeds organic loan opportunities. We continually monitor interest rate trading ranges and try to focus purchases to times when rates are in the top third of the trading range. The Company believes its investment strategy has appropriately mitigated its interest rate risk exposure if rates rise while providing sufficient cashflows for the Company's liquidity needs. AtDecember 31, 2020 , the Company did not own any securities, other than government-sponsored and government-guaranteed mortgage-backed securities, that had an aggregate book value in excess of 10% of its consolidated stockholders' equity at that date. 37
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The expected principal repayments at amortized cost and average weighted yields for the investment portfolio (excluding equity securities) as ofDecember 31, 2020 , are shown below (dollars in thousands). Expected principal repayments, which include prepayment speed assumptions for mortgage-backed securities, are significantly different than the contractual maturities detailed in Note 4 of the consolidated financial statements. Yields on tax-exempt securities are presented on a fully taxable equivalent basis, assuming a 21% tax rate, which was the rate in effect atDecember 31, 2020 . After One Year After Five Years One Year or Less to Five years to Ten Years After Ten Years Total Amortized Yield Amortized Yield Amortized Yield Amortized Yield Amortized Yield Cost % Cost % Cost % Cost % Cost % Available-for-sale securities: U.S. agency securities$ 17,799 1.8$ 61,266 2.1 $ - - $ - -$ 79,065 2.0 U.S. treasuries 11,487 2.1 15,955 2.1 - - - - 27,442 2.1 Obligations of state & political Subdivisions 12,782 3.5 50,979 2.6 36,328 2.5 - - 100,089 2.7 Corporate obligations 3,000 5.8 3,413 3.4 - - - - 6,413 4.5 Mortgage-backed securities 27,336 1.2 21,612 2.0 15,723 2.0 9,841 1.8 74,512 1.7 Total available-for-sale$ 72,404 2.1$ 153,225 2.3$ 52,051 2.3$ 9,841 1.8$ 287,521 2.2 AtDecember 31, 2020 , approximately 78.5% of the amortized cost of debt securities is expected to mature, call or pre-pay within five years or less. The Company expects that earnings from operations, the levels of cash held at theFederal Reserve and other correspondent banks, the high liquidity level of the available-for-sale securities, growth of deposits and the availability of borrowings from theFederal Home Loan Bank and other third party banks will be sufficient to meet future liquidity needs.
2019
The Company's investment portfolio remained stable during 2019 as the Company maintained investment levels for pledging against public deposits and liquidity needs. During 2019, we purchased$14.1 million ofU.S. agencies,$26.2 million of mortgage backed securities,$28.4 million of state and local obligations,$250,000 of corporate obligations and$65,000 of equity securities, which helped to offset the$9.8 million of principal repayments and$52.8 million of calls and maturities that occurred during the year. We also sold$10.5 million of bonds at a net gain of$24,000 . The market value of our investment portfolio increased approximately$4.2 million in 2019 due to interest rate fluctuations and equity market gains. Excluding our short term investments consisting of monies held primarily at theFederal Reserve , the effective yield on our investment portfolio for 2019 was 2.85% compared to 2.51% for 2018 on a tax equivalent basis. During 2019, rates on the short end of theTreasury yield curve decreased as a result of the decrease in the federal funds rate and the potential for additional future decreases in the federal funds rate. The rates on the long end of the curve also decreased in 2019 primarily as a result of continued low inflation. This resulted in yield curve remaining very flat and during parts of 2019, portions of the yield curve were inverted. The investment strategy in 2019 was to maintain a consistent balance to meet public deposit pledging needs as well as to meet the Company's liquidity needs. Investment purchases during the year focused on securities with short fixed maturities for agency securities, high coupon callable municipal securities that are highly likely to be called and mortgage backed securities with consistent cashflows. AtDecember 31, 2019 , the Company did not own any securities, other than government-sponsored and government-guaranteed mortgage-backed securities, that had an aggregate book value in excess of 10% of its consolidated stockholders' equity at that date. Loans Held for Sale Loans held for sale increased$13.8 million to$14.6 million as ofDecember 31, 2020 fromDecember 31, 2019 . The increase in loans held for sale was due to the amount of refinancings occurring due to the low rate environment. 38
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Loans
The Bank's lending efforts have historically focused on north centralPennsylvania and southernNew York . With the acquisition of FNB and the opening of offices inLancaster County , this focus has grown to includeLebanon ,Schuylkill ,Berks andLancaster County markets of south central,Pennsylvania . We have a limited branch office inUnion County that is staffed by a lending team to primarily support agricultural opportunities in centralPennsylvania . InDecember 2017 , we completed a branch acquisition inState College , which provides us with opportunities inCentre County, Pennsylvania . InApril 2020 , we completed the MidCoast acquisition, which expanded our markets into theState of Delaware with activity centered around the cities ofWilmington andDover, Delaware . In November of 2020, we opened a branch inKennett Square, Pennsylvania , to further serve customers obtained as part of the MidCoast acquisition, as well as to expand operations intoChester County, Pennsylvania . We originate loans primarily through direct loans to our existing customer base, with new customers generated through the strong relationships that our lending teams have with their customers, as well as by referrals from real estate brokers, building contractors, attorneys, accountants, corporate and advisory board members, existing customers and the Bank's website. The Bank offers a variety of loans, although historically most of our lending has focused on real estate loans including residential, commercial, agricultural, and construction loans. As ofDecember 31, 2020 , approximately 81.7% of our loan portfolio consisted of real estate loans. All lending is governed by a lending policy that is developed and administered by management and approved by the Board of Directors. The Bank primarily offers fixed rate residential mortgage loans with terms of up to 25 years and adjustable rate mortgage loans (with amortization schedules up to 30 years) with interest rates and payments that adjust based on one, three, five and 15 year fixed periods. Loan to value ratios are usually 80% or less with exceptions for individuals with excellent credit and low debt to income and/or high net worth. Adjustable rate mortgages are tied to a margin above the comparableFederal Home Loan Bank of Pittsburgh borrowing rate. Home equity loans are written with terms of up to 15 years at fixed rates. Home equity lines of credit are variable rate loans tied to the Prime Rate generally with a ten year draw period followed by a ten year repayment period. Home equity loans are typically written with a maximum 80% loan to value. Commercial real estate loan terms are generally 20 years or less, with one to five year adjustable interest rates. The adjustable rates are typically tied to a margin above the comparableFederal Home Loan Bank of Pittsburgh borrowing rate with a maximum loan to value ratio of 80%. During 2020, the Bank began offering certain customers derivative contracts that allowed the customer to obtain a fixed interest rate for a period up to 10 years. Where feasible, the Bank participates in theUnited States Department of Agriculture's (USDA) andSmall Business Administration (SBA) guaranteed loan programs to offset risk and to further promote economic growth in our market area. Agriculture is an important industry throughout our market areas. Therefore, the Bank has not only developed an agriculture lending team with significant experience that has a thorough understanding of this industry, but also continually looks for additional employees with a thorough understanding of agriculture. We have an agricultural loan policy to assist in underwriting agricultural loans. Agricultural loans are made to a diversified customer base that include dairy, swine and poultry farmers and their support businesses. Agricultural loans focus on character, cash flow and collateral, while also taking into account the particular risks of the industry. Loan terms are generally 20 years or less, with one to five year adjustable interest rates. The adjustable rates are typically tied to a margin above the comparableFederal Home Loan Bank of Pittsburgh borrowing rate with a typical loan to value of less than 80%. We evaluate the financial strength of the integrators we have exposure to with our poultry and swine agricultural customers. The Bank is a preferred lender under theUSDA's Farm Service Agency (FSA) and participates in the FSA guaranteed loan program. The Bank, as part of its commitment to the communities it serves, is an active lender for projects by our local municipalities and school districts. These loans range from short term bridge financing to 20 year term loans for specific projects. These loans are typically written at rates that adjust at least every five years. Due to the size of certain municipal loans, we have developed participation lending relationships with other community banks that allow us to meet regulatory compliance issues, while meeting the needs of the customer. AtDecember 31, 2020 , the aggregate balance of our participation loans, in which a portion was sold to other lender's totaled$126.5 million , of which$76.2 million was sold. 39
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Activity associated with exploration for natural gas in 2020 was similar to 2019. Certain entities drilled new wells and created new pad sites and pipelines, while other companies only maintained their existing wells. Natural gas prices remained low in 2020. While the Bank has loaned to companies that service the exploration activities, the Bank did not originate any loans to companies performing the actual drilling and exploration activities. Loans made by the Company were to service industry customers which included trucking companies, stone quarries and other support businesses. We also originated loans to businesses and individuals for restaurants, hotels and apartment rentals that were developed and expanded to meet the housing and living needs of the gas workers. Due to our understanding of the industry and its cyclical nature, the loans made for natural gas-related activities were originated in a prudent and cautious manner and were subject to specific policies and procedures for lending to these entities, which included lower loan to value thresholds, shortened amortization periods, and expansion of our monitoring of loan concentrations associated with this activity.
The following table shows the year-end composition of the loan portfolio for the
five years ended
2020 2019 2018 2017 2016
Amount % Amount % Amount % Amount % Amount %
Real estate:
Residential $ 201,911 14.4 $ 217,088 19.4 $ 215,305 19.9 $ 214,479 21.4 $ 207,423 25.9
Commercial 596,255 42.4 342,023 30.7 319,265 29.5 308,084 30.8 252,577 31.6
Agricultural 315,158 22.4 311,464 27.9 284,520 26.3 239,957 24.0 123,624 15.5
Construction 35,404 2.5 15,519 1.4 33,913 3.1 13,502 1.3 25,441 3.2
Consumer 30,277 2.2 9,947 0.9 9,858 0.9 9,944 1.0 11,005 1.4
Other commercial loans 114,169 8.1 69,970 6.3 74,118 6.9 72,013 7.2 58,639 7.3
Other agricultural loans 48,779 3.5 55,112 4.9 42,186 3.9 37,809 3.8 23,388 2.9 State & political subdivision loans 63,328 4.5 94,446 8.5 102,718 9.5 104,737 10.5
97,514 12.2
Total loans 1,405,281 100.0 1,115,569 100.0 1,081,883 100.0 1,000,525 100.0 799,611 100.0 Less allowance for loan losses
15,815 13,845 12,884 11,190 8,886
Net loans $ 1,389,466 $ 1,101,724 $ 1,068,999 $ 989,335 $ 790,725
2020/2019 2019/2018
Change Change
Amount % Amount %
Real estate:
Residential $ (15,177 ) (7.0 ) $ 1,783 0.8
Commercial 254,232 74.3 22,758 7.1
Agricultural 3,694 1.2 26,944 9.5
Construction 19,885 128.1 (18,394 ) (54.2 )
Consumer 20,330 204.4 89 0.9
Other commercial loans 44,199 63.2 (4,148 ) (5.6 )
Other agricultural loans (6,333 ) (11.5 ) 12,926 30.6State & political subdivision loans (31,118 ) (32.9 ) (8,272 )
(8.1 )
Total loans $ 289,712 26.0 $ 33,686 3.1
2020
Total loans grew $289.7 million in 2020 and total $1.41 billion at the end of
2020. The primary driver of growth during 2020 was the MidCoast acquisition,
which increased loans $223.2 million and the PPP program administered by the
SBA, which generated loan growth of $37.2 million for 2020. We also established
a new relationship that allows us to fund student loans, which drove the
increase in consumer lending. We had numerous municipal relationships refinance
through the bond markets due to the low interest rate environment.
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Residential real estate loans decreased$15.2 million . As a result of the loan interest rate environment, there was significant refinancing of residential loans, some of which met the requirements of the secondary market and were subsequently sold. During 2020,$88.0 million of residential real estate loans were originated for sale on the secondary market, which compares to$21.2 million for 2019. For loans sold on the secondary market, the Company recognizes fee income for servicing these sold loans, which is included in non-interest income. The following table shows the maturity of commercial business and agricultural, state and political subdivision loans, commercial real estate loans, and construction loans as ofDecember 31, 2020 , classified according to the sensitivity to changes in interest rates within various time intervals (in thousands). The table does not include any estimate of prepayments which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. Commercial, municipal, Real estate agricultural construction Total Maturity of loans: One year or less$ 28,416 $ 897$ 29,313 Over one year through five years 234,160 9,490 243,650 Over five years 875,113 25,017 900,130 Total$ 1,137,689 $ 35,404 $ 1,173,093
Sensitivity of loans to changes in interest rates - loans due after
$ 300,603 $ 9,592 $ 310,195 Floating or adjustable interest rate 808,670 24,915 833,585 Total$ 1,109,273 $ 34,507 $ 1,143,780 2019 Total loans grew$33.7 million in 2019 and total$1.12 billion at the end of 2019. During 2019, the Company experienced growth in agricultural real estate loans of$26.9 million , commercial real estate loans of$22.8 million and other agricultural loans of$12.9 million . A portion of the growth in agricultural and commercial loan categories was due to transfers from construction loans as projects were completed in 2019. The remaining growth was primarily in our southcentral and centralPennsylvania markets. Residential real estate loans increased$1.8 million . Demand for non-conforming loans was slightly higher than previous years but remains highly competitive, especially in the north centralPennsylvania market. During 2019,$21.2 million of residential real estate loans were originated for sale on the secondary market, which compares to$19.5 million for 2018.
Allowance for Loan Losses and Credit Quality Risk
The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb probable future loan losses inherent in the loan portfolio. The provision for loan losses is charged against current income. Loans deemed not collectable are charged-off against the allowance while subsequent recoveries increase the allowance. The following table presents an analysis of the change in the allowance for loan losses and a summary of our non-performing assets for the years endedDecember 31, 2020 , 2019, 2018, 2017 and 2016. All non-accruing troubled debt restructurings (TDRs) are also included the non-accruing loans totals. 41
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December 31,
2020 2019 2018 2017 2016
Balance at beginning of period $ 13,845 $ 12,884 $ 11,190 $ 8,886 $ 7,106
Charge-offs:
Real estate:
Residential - 32 118 107 85
Commercial 435 578 66 41 100
Agricultural 4 - - 30 -
Consumer 50 49 40 130 100
Other commercial loans 44 38 91 - 55
Other agricultural loans - 60 50 5 -
Total loans charged-off 533 757 365 313 340
Recoveries:
Real estate:
Residential 14 - 69 - -
Commercial 37 - 3 11 479
Agricultural 19 - - - -
Consumer 21 33 31 49 88
Other commercial loans 12 10 30 16 33
Other agricultural loans - - 1 1 -
Total loans recovered 103 43 134 77 600
Net loans charged-off (recovered) 430 714 231 236 (260 )
Provision charged to expense 2,400 1,675 1,925 2,540 1,520
Balance at end of year $ 15,815 $ 13,845 $ 12,884 $ 11,190 $ 8,886
Loans outstanding at end of period $
1,405,281
$
1,291,838
$
10,732
525 487 68 555 405
Total non-performing loans $
11,257
1,836 3,404 601 1,119 1,036
Total non-performing assets $
13,093
Troubled debt restructurings (TDR) Non-accruing TDRs $
7,026
5,240 7,341 8,333 13,056 6,095
Total troubled debt restructurings $
12,266
0.03 % 0.06 % 0.02 % 0.03 % -0.04 % Allowance to total loans
1.13 % 1.24 % 1.19 % 1.12 % 1.11 % Allowance to total non-performing loans
140.49 % 115.15 % 93.42 % 104.33 % 74.93 % Non-performing loans as a percent of loans net of unearned income 0.80 % 1.08 % 1.27 % 1.07 % 1.48 % Non-performing assets as a percent of loans net of unearned income 0.93 % 1.38 % 1.33 % 1.18 % 1.61 %
The Company believes it utilizes a disciplined and thorough loan review process based upon its internal loan policy approved by the Company's Board of Directors. The purpose of the review is to assess loan quality, analyze delinquencies, identify problem loans, evaluate potential charge-offs and recoveries, and assess general overall economic conditions in the markets served. An external independent loan review is performed on our commercial portfolio at least semi-annually for the Company. The external consultant is engaged to 1) review a minimum of 50% (55% for loans in 2016) of the dollar volume of the commercial loan portfolio on an annual basis, 2) new loans originated for over$1.0 million in the last year, 3) a majority of borrowers with commitments greater than or equal to$1.0 million , 4) selected loan relationships over$750,000 which are over 30 days past due, or classified Special Mention, Substandard, Doubtful, or Loss, and 5) such other loans which management or the consultant deems appropriate. As part of this review, our underwriting process and loan grading system is evaluated. 42
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Management believes it uses the best information available to make such determinations and that the allowance for loan losses is adequate as ofDecember 31, 2020 . However, future adjustments could be required if circumstances differ substantially from assumptions and estimates used in making the initial determination. A prolonged downturn in the economy, changes in the economies of various segments of our agricultural and commercial portfolios, high unemployment rates, significant changes in the value of collateral and delays in receiving financial information from borrowers could result in increased levels of non-performing assets, charge-offs, loan loss provisions and reduction in income. Additionally, bank regulatory agencies periodically examine the Bank's allowance for loan losses. The banking agencies could require the recognition of additions to the allowance for loan losses based upon their judgment of information available to them at the time of their examination. On a monthly basis, problem loans are identified and updated primarily using internally prepared past due reports. Based on data surrounding the collection process of each identified loan, the loan may be added or deleted from the monthly watch list. The watch list includes loans graded special mention, substandard, doubtful, and loss, as well as additional loans that management may choose to include. Watch list loans are continually monitored going forward until satisfactory conditions exist that allow management to upgrade and remove the loan from the watchlist. In certain cases, loans may be placed on non-accrual status or charged-off based upon management's evaluation of the borrower's ability to pay. All commercial loans, which include commercial real estate, agricultural real estate, state and political subdivision loans, other commercial loans and other agricultural loans, on non-accrual are evaluated quarterly for impairment. The adequacy of the allowance for loan losses is subject to a formal, quarterly analysis by management of the Company. In order to better analyze the risks associated with the loan portfolio, the entire portfolio is divided into several categories. As stated above, loans on non-accrual status are specifically reviewed for impairment and given a specific reserve, if appropriate. Loans evaluated and not found to be impaired are included with other performing loans, by category, by their respective homogenous pools. Three year average historical loss factors were calculated for each pool and applied to the performing portion of the loan category for each year presented. The historical loss factors for both reviewed and homogeneous pools are adjusted based upon the following qualitative factors:
• Level of and trends in delinquencies, impaired/classified loans
? Change in volume and severity of past due loans
? Volume of non-accrual loans
? Volume and severity of classified, adversely or graded loans
• Level of and trends in charge-offs and recoveries
• Trends in volume, terms and nature of the loan portfolio
• Effects of any changes in risk selection and underwriting standards and any
other changes in lending and recovery policies, procedures and practices
• Changes in the quality of the Bank's loan review system
• Experience, ability and depth of lending management and other relevant staff
• National, state, regional and local economic trends and business conditions
? General economic conditions
? Unemployment rates ? Inflation / CPI
? Changes in values of underlying collateral for collateral-dependent loans
• Industry conditions including the effects of external factors such as
competition, legal, and regulatory requirements on the level of estimated
credit losses.
• Existence and effect of any credit concentrations, and changes in the level of
such concentrations
• Any change in the level of board oversight
See also "Note 5 - Loans and Related Allowance for Loan Losses" to the consolidated financial statements.
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Index
The allowance for loan losses was$15,815,000 or 1.13% of total loans as ofDecember 31, 2020 as compared to$13,845,000 or 1.24% of loans as ofDecember 31, 2019 . The decrease as a percent of loans is due to loans acquired as part of the MidCoast acquisition being excluded from the allowance calculation, unless the loan experiences a downgrade since acquisition. The$1,970,000 increase is a result of a$2,400,000 provision for loan losses less net charge-offs of$430,000 . During 2020, two customers accounted for the majority of the charge-offs,$425,000 in total, and if they were excluded the net charge-off amount would be lower than prior years. The following table shows the distribution of the allowance for loan losses and the percentage of loans compared to total loans by loan category (dollars in thousands) as ofDecember 31 : 2020 2019 2018 2017 2016 Amount % Amount % Amount % Amount % Amount % Real estate loans: Residential$ 1,174 14.4$ 1,114 19.4$ 1,105 19.9$ 1,049 21.4$ 1,064 25.9 Commercial 6,216 42.4 4,549 30.7 4,115 29.5 3,867 30.8 3,589 31.6 Agricultural 4,953 22.4 5,022 27.9 4,264 26.3 3,143 24.0 1,494 15.5 Construction 122 2.5 43 1.4 58 3.1 23 1.3 47 3.2 Consumer 321 2.2 112 0.9 120 0.9 124 1.0 122 1.4 Other commercial loans 1,226 8.1 1,255 6.3 1,354 6.9 1,272 7.2 1,327 7.3 Other agricultural loans 864 3.5 961 4.9 752 3.9 492 3.8 312 2.9
State & political subdivision loans 479 4.5 536
8.5 762 9.5 816 10.5 833 12.2
Unallocated 460 N/A 253 N/A 354 N/A 404 N/A 98 N/A
Total allowance for loan losses
100.0$ 12,884 100.0$ 11,190 100.0$ 8,886 100.0 As a result of previous loss experiences and other risk factors utilized in determining the allowance, the Bank's allocation of the allowance does not directly correspond to the actual balances of the loan portfolio. While commercial and agricultural real estate loans total 64.8% of the loan portfolio, 70.6% of the allowance is assigned to these portions of the loan portfolio as these loans have more inherent risks than residential real estate or loans to state and political subdivisions. Residential real estate loans comprise 14.4% of the loan portfolio as ofDecember 31, 2020 and 7.4% of the allowance is assigned to this segment as generally there are less inherent risks then commercial and agricultural loans. The following table identifies amounts of loans contractually past due 30 to 90 days and non-performing loans by loan category, as well as the change fromDecember 31, 2019 toDecember 31, 2020 in non-performing loans (in thousands). Non-performing loans include those accruing loans that are contractually past due 90 days or more and non-accrual loans. Interest does not accrue on non-accrual loans. Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of its ultimate ability to collect principal and interest. December 31, 2020 December 31, 2019 Non-Performing Loans Non-Performing Loans 30 - 89 Days 90 Days Past Non- Total Non- 30 - 89 Days 90 Days Past Non- Total Non- Past Due Due Accruing accrual Performing Past Due Due Accruing accrual Performing Real estate: Residential$ 1,351 $ 275$ 812 $ 1,087 $ 933 $ 2$ 962 $ 964 Commercial 1,247 70 4,529 4,599 1,225 - 5,080 5,080 Agricultural 366 150 3,133 3,283 118 299 2,578 2,877 Construction - - - - - - - - Consumer 155 30 - 30 123 2 6 8 Other commercial loans 930 - 1,284 1,284 283 184 1,837 2,021 Other agricultural loans 71 - 974 974 29 - 1,073 1,073
Total nonperforming loans
$ 11,257 $ 2,711 $ 487$ 11,536 $ 12,023 44
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Change in Non-Performing Loans
2020 / 2019
Amount %
Real estate:
Residential $ 123 12.8
Commercial (481 ) (9.5 )
Agricultural 406 14.1
Construction - -
Consumer 22 275.0
Other commercial loans (737 ) (36.5 )
Other agricultural loans (99 ) (9.2 )
Total nonperforming loans $ (766 ) (6.4 )
The Company is working with customers directly affected by the COVID-19
pandemic. The Company has offered assistance in accordance with regulator
guidelines. As a result of the current economic slowdown related to the COVID-19
pandemic, the Company is engaging in more frequent communication with borrowers
to better understand their situation and the challenges faced, allowing it to
respond proactively as needs and issues arise. Should economic conditions
worsen, the Company could experience increases in non-performing loans and
further increases in its required allowance for loan losses and record
additional provision expense. It is possible that the Company's asset quality
measures could worsen at future measurement periods if the effects of the
COVID-19 pandemic are prolonged.
The following table shows the distribution of non-performing loans by loan
category (in thousands) for the past five years as of
Non-Performing Loans
2020 2019 2018 2017 2016
Real estate:
Residential $ 1,087 $ 964 $ 1,181 $ 1,604 $ 1,903
Commercial 4,599 5,080 5,993 5,354 4,445
Agricultural 3,283 2,877 3,206 205 1,340
Construction - - - 133 -
Consumer 30 8 26 49 109
Other commercial loans 1,284 2,021 2,185 2,669 4,057
Other agricultural loans 974 1,073 1,201 712 5
State & political subdivision loans - - - - -
Total nonperforming loans 11,257 12,023 13,792 10,726 11,859
For the year ended December 31, 2020 , we recorded a provision for loan losses of
$2,400,000 which compares to $1,675,000 for the same period in 2020, an increase
of $725,000 . The increase is primarily attributable to the COVID-19 pandemic and
its impact on the national and local economies, as well as an increase in
organic loans, primarily in the fourth quarter of 2020. Non-performing loans
decreased $766,000 from December 31, 2019 to December 31, 2020 with the decrease
being primarily due to one customer relationship that paid off a portion of
their balance after selling some collateral. At December 31, 2020 , approximately
53.0% of the Bank's non-performing loans are associated with the following three
customer relationships:
• A commercial loan relationship with
letters of credit of
quarries and equipment, was on non-accrual status as of
slowdown in the exploration for natural gas has significantly impacted the cash
flows of the customer, who provides excavation services and stone for pad
construction related to these activities. During 2019, the Company had the
underlying equipment collateral appraised. The 2019 appraisal indicated a
decrease in collateral values compared to the appraisal ordered for the loan
origination and an appraisal performed in 2017, however, the loan is still
considered well secured on a loan to value basis. In the fourth quarter of
2020, a forbearance agreement was signed with this customer. Management
determined that no specific reserve was required as of
45
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Index
• An agricultural loan customer with a total loan relationship of
secured by real estate, equipment and cattle, was on non-accrual status as of
of 2018 and developed a workout plan that was approved in the fourth quarter of
2019 and resulted in monthly payments resuming in late 2019. Included within
these loans to this customer are
cash flow difficulties for this customer. Absent a sizable and sustained
increase in milk prices, which is not assured, we will need to rely upon the
collateral for repayment of interest and principal. As of
there was a specific reserve of
• An agricultural loan customer with a total loan relationship of
secured by real estate was on non-accrual status as of
COVID-19 pandemic has escalated the cash flow difficulties this customer was
experiencing. We expect that we will need to rely upon the collateral for
repayment of interest and principal. Management reviewed the collateral and
determined that no specific reserve was required as of
Management believes that the allowance for loan losses at
• Three loan relationships comprise 53.0% of the non-performing loan balance,
which has approximately
• The Company has a history of low charge-offs, and were 0.03% in 2020, which was
primarily due to two relationships, which compares to 0.06% of average loans
for 2019. Bank Owned Life Insurance The Company holds bank owned life insurance policies to offset current and future employee benefit costs. These policies provide the Bank with an asset that generates earnings to partially offset the current costs of benefits, and eventually (at the death of the insureds) provide partial recovery of cash outflows associated with the benefits. As ofDecember 31, 2020 and 2019, the cash surrender value of the life insurance was$32.6 million and$28.1 million , respectively. The primary cause of the increase was related to the acquisition of MidCoast, which increased the balance by$3.8 million . The change in cash surrender value, net of purchases and amounts acquired through acquisitions, is recognized in the results of operations. The amounts recorded as non-interest income totaled$695,000 ,$623,000 and$622,000 in 2020, 2019 and 2018, respectively. The Company evaluates annually the risks associated with the life insurance policies, including limits on the amount of coverage and an evaluation of the various carriers' credit ratings. EffectiveJanuary 1, 2015 , the Company restructured its agreements so that any death benefits received from a policy while the insured person is an active employee of the Bank will be split with the beneficiary of the policy. Under the restructured agreements, the employee's beneficiary will be entitled to receive 50% of the net amount at risk from the proceeds. The policies acquired as part of the acquisition of MidCoast are only for the benefit of the Bank. The net amount at risk is the total death benefit payable less the cash surrender value of the policy as of the date of death. The policies acquired as part of the acquisition of FNB, provide a fixed dollar benefit for the beneficiarys' estate, which is dependent on several factors including whether the covered individual was a Director of FNB or an employee of FNB and their salary level. As ofDecember 31, 2020 and 2019, included in other liabilities on the Consolidated Balance sheet is a liability of$687,000 and$684,000 , respectively, for the obligation under the split-dollar benefit agreements.
Other Assets
2020
Other assets increased$3.0 million in 2020 to$19.4 million from$16.4 million in 2019. The deferred tax asset increased$2.2 million , primarily due to the MidCoast acquisition. We entered into one new lease during 2020 and acquired three leases as part of the acquisition, which resulted in the right of use asset for facilities increasing$1.1 million . As a result of derivative transactions for the Company and customers, other assets increased$1.1 million . Foreclosed properties were sold during 2020, which resulted in a decrease to other assets of$1.6 million . 46
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Index
2019
Other assets increased$2.7 million in 2019 to$16.4 million from$13.6 million in 2018. As a result of settling a lawsuit with a bankrupt customer, OREO increased$2.8 million . The deferred tax asset decreased$1.2 million as a result of an increase in unrealized gains on available for sale investments. As a result of the adoption of ASU 2016-02, the Company recorded a right of use asset for facilities leased that was$1.2 million as ofDecember 31, 2019 . As a result of an increase in FHLB borrowings and letters of credit, regulatory stock increased$739,000 . Deposits The following table shows the breakdown of deposits by deposit type (dollars in thousands) atDecember 31 : 2020 2019 2018 Amount % Amount % Amount %
Non-interest-bearing deposits
16.9$ 179,971 15.2 NOW accounts 422,083 26.6 340,273 28.1 336,756 28.4 Savings deposits 255,853 16.1 224,456 18.5 205,334 17.3 Money market deposit accounts 225,968 14.2 169,865 14.0 164,625 13.9 Certificates of deposit 381,192 24.0 272,731 22.5 298,470 25.2 Total$ 1,588,858 100.0$ 1,211,118 100.0$ 1,185,156 100.0 2020/2019 Change 2019/2018 Change Amount % Amount % Non-interest-bearing deposits$ 99,969 49.1$ 23,822 13.2 NOW accounts 81,810 24.0 3,517 1.0 Savings deposits 31,397 14.0 19,122 9.3 Money market deposit accounts 56,103 33.0 5,240 3.2 Certificates of deposit 108,461 39.8 (25,739 ) (8.6 ) Total$ 377,740 31.2$ 25,962 2.2 2020 Total deposits increased$377.7 million in 2020, or 31.2%. The primary driver of the growth was the MidCoast acquisition, in which$208.8 million of deposits were acquired. The remaining growth was driven by customers holding more cash as a result of the COVID-19 pandemic, and was experienced across all markets, which was facilitated by various government stimulus plans. As a percentage of total deposits, non-interest bearing deposits totaled 19.1% as of the end of 2020, which compares to 16.9% at the end of 2019. We continue to enhance our cash management services to improve our customer services and to grow deposits through our current deposit and loan customers. As a result of market conditions in the first half of 2020, we issued long term brokered CD's and had a balance of$23.8 million of brokered CD's outstanding as ofDecember 31, 2020 compared to$15.0 million as ofDecember 31, 2019 . The rates paid on certificates of deposit by the Company remain competitive with rates paid by our competition.
2019
Total deposits increased$26.0 million in 2019, or 2.2%. The growth in non-interest bearing deposits was driven by new customers in our south central and centralPennsylvania markets. As a percentage of total deposits, non-interest bearing deposits totaled 16.9% as of the end of 2019, which compares to 15.2% at the end of 2018. The increase in savings deposits is attributable to growth in the central and south central markets and the acquisition of new customers in these markets. As a result of market conditions, we had$15.0 million of brokered CD's outstanding as ofDecember 31, 2019 compared to$20.0 million as ofDecember 31, 2018 , which accounts for a portion of the decrease in CDs. In addition, we had a municipal customer utilizes maturing CDs to fund an infrastructure project in their community, which resulted in$9.0 million decrease in CD's. 47
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Index
Remaining maturities of certificates of deposit of
2020 2019 2018
3 months or less$ 23,974 $ 10,245 $ 29,574 Over 3 months through 6 months 31,856 14,463
10,880
Over 6 months through 12 months 55,515 35,604 26,778 Over 12 months 87,588 80,589 85,719 Total$ 198,933 $ 140,901 $ 152,951
As a percent of total certificates of deposit 52.19 % 51.66 %
51.25 %
Interest expense on certificates of deposit of
Deposits by type of depositor are as follows (dollars in thousands) atDecember 31 : 2020 2019 2018 Amount % Amount % Amount % Individuals$ 865,041 54.4$ 664,065 54.8$ 666,255 56.2 Businesses and other organizations 467,159 29.4 306,873 25.3 276,248 23.3 State & political subdivisions 256,658 16.2 240,180 19.9 242,653 20.5 Total$ 1,588,858 100.0$ 1,211,118 100.0$ 1,185,156 100.0 Borrowed Funds 2020 Borrowed funds increased$3.7 million during 2020 as a result of an increase in repurchase agreements of$3.5 million . Short term borrowings from the FHLB decreased$19.8 million fromDecember 31, 2019 and total$25.0 million atDecember 31, 2020 , while long term borrowings from the FHLB increased$20.0 million and total$41.5 million . Term loans totaled$41.5 million and$21.5 million as ofDecember 31, 2020 and 2019, respectively. The change in term loans was due to borrowing$20.0 million on a long-term basis (see Note 10 of the consolidated financial statements for additional information). As part of the MidCoast acquisition, we acquired$15.5 million of borrowed funds, which either matured or were called in 2020. Short term borrowings from the FHLB were$25.0 million as ofDecember 21, 2020 compared to$44.5 million as ofDecember 31, 2019 . Management continually monitors interest rates in order to minimize interest rate risk in future years and as part of this may extend some of the short term borrowings via term notes. The Bank entered into two interest rate swap agreements to convert floating-rate debt to fixed rate debt on notional amounts of$15.0 million and$10.0 million onApril 1, 2020 and expire onApril 1, 2025 andApril 1, 2027 . OnApril 13, 2020 , the Company entered into an interest rate swap agreement to convert floating-rate debt to fixed rate debt on a notional amount of$7.5 million . The interest rate swap agreement expires onJune 17, 2027 . OnMay 14, 2020 , the Bank entered into three two year forward interest rate swaps that will convert floating rate debt to fixed rate debt on notional amounts of$6.0 million each. The interest rate swap agreements expire onMay 14, 2027 , 2029 and 2032. The interest rate swap instruments involves an agreement to receive a floating rate and pay a fixed rate, at specified intervals, calculated on the agreed-upon notional amounts. The differentials paid or received on interest rate swap agreements are recognized as adjustments to interest expense in the period. The fair value of the interest rate swaps atDecember 31, 2020 was$11,000 and is included within other liabilities on the consolidated balance sheets.
2019
Borrowed funds decreased$6.1 million during 2019 as a result of our deposit growth and net income exceeding the loan growth experienced in 2019. The decrease was associated with a decrease of$7.4 million of short term borrowings from the FHLB. We experienced a$6.7 million decrease in repurchase agreements. Term loans totaled$21.5 million and$13.5 million as ofDecember 31, 2019 and 2018, respectively. The change in term loans was due to borrowing$10.0 million on a long-term basis and a$2.0 million maturity in 2019 (see Note 10 of the consolidated financial statements for additional information). Short term borrowings from the FHLB were$44.5 million as ofDecember 21, 2019 compared to$52.2 million as ofDecember 31, 2018 . 48
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Index Other Liabilities 2020 Other liabilities increased$4.5 million to$18.7 million during 2020. We entered into one new lease during 2020 and acquired three leases as part of the Midcoast acquisition, which resulted in the right of use asset for facilities increasing$1.1 million . As a result of derivate transactions for the Company and customers, other liabilities increased$1.0 million . As a result of the discount rates utilized for the pension plan, a pension liability was recorded of$773,000 . Employee benefit accruals, including profit sharing increased$1.4 million . 2019 Other liabilities increased slightly to$14.2 million during 2019. The primary driver of the increase was the recording of a right of use liability for the Company's operating leases during 2019 that totaled$1.2 million as ofDecember 31, 2019 and an increase in employee benefit accruals of$863,000 . These increases were offset by a decrease associated with an available for sale security purchase of$1.5 million that did not settle byDecember 31, 2018 that subsequently settled in 2019. Stockholders' Equity
We evaluate stockholders' equity in relation to total assets and the risk associated with those assets. The greater our capital resources, the greater the likelihood of meeting our cash obligations and absorbing unforeseen losses.
For
these reasons, capital adequacy has been, and will continue to be, of paramount importance. Due to its importance, we develop a capital plan and stress test capital levels using various techniques and assumptions annually to ensure that in the event of unforeseen circumstances, we would remain in compliance with our capital plan approved by the Board of Directors and regulatory requirement levels. Our Board of Directors determines our cash dividend rate after considering our capital requirements, current and projected net income, and other factors. In 2020 and 2019, the Company paid out 29.32% and 32.40% of net income in cash dividends, respectively. As ofDecember 31, 2020 , the total number of common shares outstanding was 3,921,850. For comparative purposes, outstanding shares for prior periods were adjusted for theJune 2020 stock dividend in computing earnings and cash dividends per share as detailed in Note 1 of the consolidated financial statements. As part of the MidCoast acquisition, we issued 373,356 shares with a value of$19.2 million based on the Company's closing stock price of$51.50 per share onApril 17, 2020 . During 2020, we purchased 40,438 shares of treasury stock at a weighted average cost of$52.48 per share. The Company awarded 5,160 shares of restricted stock to employees at a weighted average cost per share of$50.89 under an equity incentive plan. The Board of Directors was awarded 1,800 shares at a cost of$51.14 per share under an incentive plan.
2020
Stockholders' equity increased 25.5% in 2020 to$194.3 million . Excluding accumulated other comprehensive income (loss), stockholders' equity increased$36.3 million , or 23.3%. As part of the MidCoast acquisition, we issued 373,356 shares with a value of$19.2 million based on the Company's closing stock price of$51.50 per share onApril 17, 2020 . In addition, net income was$25,103,000 , offset by net cash dividends of$7,360,000 and net treasury stock activity of$788,000 . All of the Company's debt investment securities are classified as available-for-sale, making this portion of the Company's balance sheet more sensitive to the changing market value of investments. Accumulated other comprehensive income increased$3,216,000 fromDecember 31, 2019 , primarily as result of the increase in the fair market value of the investment portfolio. Total stockholders' equity was approximately 10.27% of total assets as ofDecember 31, 2020 , compared to 10.56% of total assets as ofDecember 31, 2019 . 49
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Index
2019
Stockholders' equity increased 11.2% in 2019 to$154.8 million . Excluding accumulated other comprehensive income, stockholders' equity increased$12.3 million , or 8.6%. This increase is due to net income of$19,490,000 , offset by net cash dividends of$6,315,000 and net treasury stock activity of$845,000 . All of the Company's debt investment securities are classified as available-for-sale. Accumulated other comprehensive income increased$3,292,000 fromDecember 31, 2018 , primarily as result of the increase in the fair market value of the investment portfolio. Total stockholders' equity was approximately 10.56% of total assets as ofDecember 31, 2019 , compared to 9.73% of total assets as ofDecember 31, 2018 .
LIQUIDITY
Liquidity is a measure of the Company's ability to efficiently meet normal cash flow requirements of both borrowers and depositors. Liquidity is needed to meet depositors' withdrawal demands, extend credit to meet borrowers' needs, provide funds for normal operating expenses and cash dividends, and fund future capital expenditures. To maintain proper liquidity, we use funds management policies along with our investment and asset liability policies to assure we can meet our financial obligations to depositors, credit customers and stockholders. Management monitors liquidity by reviewing loan demand, investment opportunities, deposit pricing and the cost and availability of borrowing funds. Additionally, the bank has established various limits and ratios to monitor liquidity. On a quarterly basis, we stress test our liquidity position to ensure that the Bank has the capability of meeting its cash flow requirements in the event of unforeseen circumstances. The Company's historical activity in this area can be seen in the Consolidated Statement of Cash Flows from investing and financing activities. Cash generated by operating activities, investing activities and financing activities influences liquidity management. The most important source of funds is the deposits that are primarily core deposits (deposits from customers with other relationships). Short-term debt from theFederal Home Loan Bank supplements the Company's availability of funds as well as a line of credit arrangement with a corresponding bank. Other sources of short-term funds include brokered CDs and the sale of loans, if needed. The Company's use of funds is shown in the investing activity section of the Consolidated Statement of Cash Flows, where the net loan activity is detailed. Other significant uses of funds are capital expenditures, purchase of loans and acquisition premiums. Surplus funds are then invested in investment securities.
Capital expenditures, including software purchases in 2020 totaled
? Teller and imaging software totaling
? Leasehold improvements and certain equipment for an office opened in 2020
totaling
? Building and ground improvements totaling
? Computer, network and copier upgrades totaling
Capital expenditures in 2019 totaled
? Leasehold improvements and certain equipment for an office opened in 2019
totaling
? Building and ground improvements totaling
? Company vehicle purchased totaling
? Generator totaling
? Computer, network and copier upgrades totaling
We expect these expenditures will support our initiatives and will create operating efficiencies, while providing quality customer service.
50--------------------------------------------------------------------------------
Index
In addition to the Bank's cash balances, the Bank achieves additional liquidity primarily from its investment in the FHLB ofPittsburgh and the resulting borrowing capacity obtained through this investment, investments that mature in less than one year and expected principal repayments from mortgage backed securities. The Bank has a maximum borrowing capacity at the Federal Home Loan Bank of approximately$690.5 million , inclusive of any outstanding amounts, as a source of liquidity. The Bank also has two federal funds line with third party providers in the total amount of$34.0 million as ofDecember 31, 2020 , which is unsecured and a borrower in custody agreement was established with the FRB in the amount of$4.4 million , which is collateralized by$12.9 million of municipal loans. The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders. The Company also has repurchased shares of its common stock. The Company's primary source of income is dividends received from the Bank. The Bank may not declare a dividend without approval of the FRB, unless the dividend to be declared by the Bank's Board of Directors does not exceed the total of: (i) the Bank's net profits for the current year to date, plus (ii) its retained net profits for the preceding two current years, less any required transfers to surplus. In addition, the Bank can only pay dividends to the extent that its retained net profits (including the portion transferred to surplus) exceed its bad debts. The FRB, the OCC, the PDB and theFDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions. The Prompt Corrective Action Rules, described above, further limit the ability of banks to pay dividends, because banks which are not classified as well capitalized or adequately capitalized may not pay dividends and no dividend may be paid which would make the Bank undercapitalized after the dividend. AtDecember 31, 2020 , the Company (unconsolidated basis) had liquid assets of$7.2 million . CONTRACTUAL OBLIGATIONS The Company has various financial obligations, including contractual obligations which may require cash payments. The following table (in thousands) presents as ofDecember 31, 2020 , significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the obligations can be found in Notes 9, 10 and 18 to the Consolidated Financial Statements. One year One to Three to Over Five Contractual Obligations or Less Three Years Five Years Years Total Deposits without a stated maturity$ 1,207,666 $ - $ - $ -$ 1,207,666 Time deposits 220,596 130,248 25,147 5,201 381,192 FHLB Advances - - - - - Term borrowings - FHLB 46,800 4,725 15,000 - 66,525 Note Payable - - - 7,500 7,500 Repurchase agreements 14,813 - - 14,813 Operating leases 669 861 409 499 2,438 Total$ 1,490,544 $ 135,834 $ 40,556 $ 13,200 $ 1,680,134
OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers' requests for funding and take the form of loan commitments, unused lines of credit and letters of credit. For information about our loan commitments, unused lines of credit and letters of credit, see Note 16 of the notes to consolidated financial statements.
For the year ended
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INTEREST RATE AND MARKET RISK MANAGEMENT
The objective of interest rate sensitivity management is to maintain an appropriate balance between the stable growth of income and the risks associated with maximizing income through interest sensitivity imbalances and the market value risk of assets and liabilities.
Because of the nature of our operations, we are not subject to foreign currency exchange or commodity price risk and, since the Company has no trading portfolio, it is not subject to trading risk.
At
The primary factors that make assets interest-sensitive include adjustable-rate features on loans and investments, loan repayments, investment maturities and money market investments. The primary components of interest-sensitive liabilities include maturing certificates of deposit, IRA certificates of deposit, repurchase agreements and short-term borrowings. Savings deposits, NOW accounts and money market investor accounts, with the exception of top interest tier money market and NOW accounts, are considered core deposits and are not short-term interest sensitive and therefore are included in the table below in the over five year column. Top interest tier money market and NOW accounts are included in the table below in the within three month column. Borrowings subject to swap arrangements are included in the table below based on the swap arrangement maturity.
The following table shows the cumulative static gap (at amortized cost) for various time intervals (dollars in thousands):
Maturity or Re-pricing of Company
Assets and Liabilities as of
Within Four to One to Two to Three to Over
Three Twelve Two Three Five Five
Months Months Years Years Years Years Total
Interest-earning assets:
Interest-bearing deposits at banks $ 52,582 $ 2,483 $ 7,944 $ 2,832 $ 250 $ - $ 66,091
Investment securities 38,750 40,282 53,954 30,440 72,684 51,412 287,522
Residential mortgage loans 36,895 53,034 43,933 29,368 27,286 11,396 201,912
Construction loans 12,956 11,482 10,966 - - - 35,404
Commercial and farm loans 241,328 190,343 228,157 153,668 207,609 53,256 1,074,361 Loans to state & political subdivisions
8,097 6,222 4,413 11,158 5,628 27,810 63,328
Other loans 3,865 5,664 5,812 4,174 5,063 5,699 30,277
Total interest-earning assets $ 394,473 $ 309,510 $ 355,179 $ 231,640 $ 318,520 $ 149,573 $ 1,758,895
Interest-bearing liabilities:
NOW accounts $ 261,373 $ - $ - $ - $ - $ 160,710 $ 422,083
Savings accounts - - - - - 255,853 255,853
Money Market accounts 201,953 - - - - 24,015 225,968
Certificates of deposit 53,404 167,192 90,184 40,065 25,147 5,200 381,192
Long-term borrowing 16,813 19,800 4,725 - 30,000 17,500 88,838
Total interest-bearing liabilities $ 533,543 $ 186,992 $ 394,473 $ 703,983
533,543 720,535 815,444 855,509 910,656 1,373,934 Cumulative gap
$ (139,070 ) $ (16,552 )
1.30 1.51 1.77 1.28
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The previous table and the simulation models discussed below are presented assuming money market investment accounts and NOW accounts in the top interest rate tier are re-priced within the first three months. The loan amounts reflect the principal balances expected to be re-priced as a result of contractual amortization and anticipated early payoffs. Gap analysis, one of the methods used by us to analyze interest rate risk, does not necessarily show the precise impact of specific interest rate movements on the Bank's net interest income because the re-pricing of certain assets and liabilities is discretionary and is subject to competition and other pressures. In addition, assets and liabilities within the same period may, in fact, be repaid at different times and at different rate levels. We have not experienced the kind of earnings volatility that might be indicated from gap analysis. The Bank currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. We use the model as part of our risk management and asset liability management processes that we believe will effectively identify, measure, and monitor the Bank's risk exposure. In this analysis, the Bank examines the results of movements in interest rates with additional assumptions made concerning the timing of interest rate changes, prepayment speeds on mortgage loans and mortgage securities and deposit pricing movements. Shock scenarios, which assume a parallel shift in interest rates and is instantaneous, typically have the greatest impact on net interest income. The following is a rate shock analysis and the impact on net interest income as ofDecember 31, 2020 (dollars in thousands): Change In
% Change In
Prospective One-Year Prospective Prospective
Changes in Rates Net Interest Income Net Interest Income Net Interest Income -100 Shock 59,631 (968 ) (1.60 ) Base 60,599 - - +100 Shock 59,568 (1,031 ) (1.70 ) +200 Shock 59,010 (1,589 ) (2.62 ) +300 Shock 58,475 (2,124 ) (3.51 ) +400 Shock 57,744 (2,855 ) (4.71 ) The model makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage backed securities, call activity of other investment securities, and deposit selection, re-pricing and maturity structure. Because of these assumptions, actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change on net interest income. Additionally, the changes above do not necessarily represent the level of change under which management would undertake specific measures to realign its portfolio in order to reduce the projected level of change. The projections above utilize a static balance sheet and do not include any changes that may result from the growth of the Bank. Management has developed policy limits for acceptable changes in net interest income for multiple scenarios, including shock scenarios. As ofDecember 31, 2020 , changes in net interest income projected for all scenarios, including the shock scenarios noted above are in line with Bank policy limits for interest rate risk.
CRITICAL ACCOUNTING POLICIES
The Company's accounting policies are integral to understanding the results
reported. The accounting policies are described in detail in Note 1 of the
consolidated financial statements. Our most complex accounting policies require
management's judgment to ascertain the valuation of assets, liabilities,
commitments and contingencies. We have established detailed policies and
control procedures that are intended to ensure valuation methods are well
controlled and applied consistently from period to period. In addition, the
policies and procedures are intended to ensure that the process for changing
methodologies occurs in an appropriate manner. The following is a brief
description of our current accounting policies involving significant management
valuation judgments.
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Other than Temporary Impairment
All securities are evaluated periodically to determine whether a decline in their value is other than temporary and is a matter of judgment. For debt securities, management considers whether the present value of cash flows expected to be collected are less than the security's amortized cost basis (the difference defined as the credit loss), the magnitude and duration of the decline, the reasons underlying the decline and the Company's intent to sell the security or whether it is more likely than not that the Company would be required to sell the security before its anticipated recovery in market value, to determine whether the loss in value is other than temporary. Once a decline in value is determined to be other than temporary, if the Company does not intend to sell the security, and it is more-likely-than-not that it will not be required to sell the security, before recovery of the security's amortized cost basis, the charge to earnings is limited to the amount of credit loss. Any remaining difference between fair value and amortized cost (the difference defined as the non-credit portion) is recognized in other comprehensive income, net of applicable taxes. Otherwise, the entire difference between fair value and amortized cost is charged to earnings.
Allowance for Loan Losses
Arriving at an adequate level of allowance for loan losses involves a high degree of judgment. The Company's allowance for loan losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio.
Management uses historical information to assess the adequacy of the allowance for loan losses as well as the prevailing business environment; as it is affected by changing economic conditions and various external factors, which may impact the portfolio in ways currently unforeseen. This evaluation is inherently subjective as it requires significant estimates that may be susceptible to significant change, subjecting the Bank to volatility of earnings. The allowance is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off. For a full discussion of the Company's methodology of assessing the adequacy of the allowance for loan losses, refer to Note 1 of the consolidated financial statements.
As discussed in Note 1 of the consolidated financial statements, the Company performs an evaluation of goodwill for impairment on an annual basis, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company performed a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value. Based on the fair value of the reporting unit, no impairment of goodwill was recognized in 2020, 2019 or 2018.
Pension Benefits
Pension costs and liabilities are dependent on assumptions used in calculating such amounts. These assumptions include discount rates, benefits earned, interest costs, expected return on plan assets, mortality rates, and other factors. In accordance with GAAP, actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense and the recorded obligation of future periods. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect the Company's pension obligations and future expense. Our pension benefits are described further in Note 11 of the "Notes to Consolidated Financial Statements."
Deferred Tax Assets
We use an estimate of future earnings to support our position that the benefit
of our deferred tax assets will be realized. If future income should prove
non-existent or less than the amount of the deferred tax assets within the tax
years to which they may be applied, the asset may not be realized and our net
income will be reduced. Management also evaluates deferred tax assets to
determine if it is more likely than not that the deferred tax benefit will be
utilized in future periods. If not, a valuation allowance is recorded. Our
deferred tax assets are described further in Note 12 of the consolidated
financial statements.
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Business Combinations
Business combinations are accounted for by applying the acquisition method. As of acquisition date, the identifiable assets acquired and liabilities assumed are measured at fair value and recognized separately from goodwill. Results of operations of the acquired entities are included in the consolidated statement of income from the date of acquisition. The calculation of intangible assets including core deposits and the fair value of loans are based on significant judgements. Core deposits intangibles are calculated using a discounted cash flow model based on various factors including discount rate, attrition rate, interest rate, cost of alternative funds and net maintenance costs. Loans acquired in connection with acquisitions are recorded at their acquisition-date fair value with no carryover of related allowance for credit losses. Any allowance for loan loss on these pools reflect only losses incurred after the acquisition (meaning the present value of all cash flows expected at acquisition that ultimately are not to be received). Determining the fair value of the acquired loans involves estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. Management considers a number of factors in evaluating the acquisition-date fair value including the remaining life of the acquired loans, delinquency status, estimated prepayments, payment options and other loan features, internal risk grade, estimated value of the underlying collateral and interest rate environment.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
This information is included under Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Interest Rate and Market Risk
Management", appearing in this Annual Report on Form 10-K.
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