Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
⌧ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2021
or
◻ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _________________________.
Commission file number: 000-16084
CITIZENS & NORTHERN CORPORATION
(Exact name of Registrant as specified in its charter)
PENNSYLVANIA
23-2451943
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
90-92 MAIN STREET, WELLSBORO, PA 16901
(Address of principal executive offices) (Zip code)
570-724-3411
(Registrant’s telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol
Name of Each Exchange on Which Registered
Common Stock Par Value $1.00
CZNC
NASDAQ Capital Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ◻ Accelerated filer ◻ Non-accelerated filer ⌧ Smaller reporting company ⌧ Emerging growth company ◻
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ⌧
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
Common Stock ($1.00 par value)
15,998,815 Shares Outstanding on May 5, 2021
CITIZENS & NORTHERN CORPORATION – FORM 10-Q
Index
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets (Unaudited) – March 31, 2021 and December 31, 2020
Page 3
Consolidated Statements of Income (Unaudited) – Three-month Periods Ended March 31, 2021 and 2020
Page 4
Consolidated Statements of Comprehensive Income (Unaudited) - Three-month Periods Ended March 31, 2021 and 2020
Page 5
Consolidated Statements of Cash Flows (Unaudited) – Three-month Periods Ended March 31, 2021 and 2020
Page 6
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) – Three-month Periods Ended March 31, 2021 and 2020
Page 7
Notes to Unaudited Consolidated Financial Statements
Pages 8 – 37
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Pages 38 – 60
Item 4. Controls and Procedures
Page 60
Part II. Other Information
Pages 60 – 63
Signatures
Page 64
2
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Data) (Unaudited)
March 31,
December 31,
2021
2020
ASSETS
Cash and due from banks:
Noninterest-bearing
$
22,449
24,780
Interest-bearing
184,696
77,077
Total cash and due from banks
207,145
101,857
Available-for-sale debt securities, at fair value
366,376
349,332
Loans receivable
1,614,587
1,644,209
Allowance for loan losses
(11,661)
(11,385)
Loans, net
1,602,926
1,632,824
Bank-owned life insurance
30,246
30,096
Accrued interest receivable
7,913
8,293
Bank premises and equipment, net
20,740
21,526
Foreclosed assets held for sale
1,472
1,338
Deferred tax asset, net
3,530
2,705
Goodwill
52,505
Core deposit intangibles, net
3,717
3,851
Other assets
37,025
34,773
TOTAL ASSETS
2,333,595
2,239,100
LIABILITIES
Deposits:
566,477
465,332
1,357,448
1,355,137
Total deposits
1,923,925
1,820,469
Short-term borrowings
9,763
20,022
Long-term borrowings
50,467
54,608
Subordinated debt
16,534
16,553
Accrued interest and other liabilities
32,850
27,692
TOTAL LIABILITIES
2,033,539
1,939,344
STOCKHOLDERS' EQUITY
Preferred stock, $1,000 par value; authorized 30,000 shares; $1,000 liquidation
preference per share; no shares issued
0
Common stock, par value $1.00 per share; authorized 20,000,000 shares;
issued 16,013,279 and outstanding 15,999,814 at March 31, 2021;
issued 15,982,815 and outstanding 15,911,984 at December 31, 2020
16,013
15,983
Paid-in capital
143,173
143,644
Retained earnings
134,176
129,703
Treasury stock, at cost; 13,465 shares at March 31, 2021 and 70,831
shares at December 31, 2020
(265)
(1,369)
Accumulated other comprehensive income
6,959
11,795
TOTAL STOCKHOLDERS' EQUITY
300,056
299,756
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these unaudited consolidated financial statements.
3
Consolidated Statements of Income
(In Thousands Except Per Share Data) (Unaudited)
Three Months Ended
INTEREST INCOME
Interest and fees on loans:
Taxable
19,491
14,461
Tax-exempt
439
459
Income from available-for-sale debt securities:
1,113
1,588
642
437
Other interest and dividend income
69
92
Total interest and dividend income
21,754
17,037
INTEREST EXPENSE
Interest on deposits
1,278
2,155
Interest on short-term borrowings
15
198
Interest on long-term borrowings
134
295
Interest on subordinated debt
244
107
Total interest expense
1,671
2,755
Net interest income
20,083
14,282
Provision for loan losses
259
1,528
Net interest income after provision for loan losses
19,824
12,754
NONINTEREST INCOME
Trust revenue
1,626
1,479
Brokerage and insurance revenue
326
355
Service charges on deposit accounts
1,015
1,250
Interchange revenue from debit card transactions
881
731
Net gains from sale of loans
1,064
315
Loan servicing fees, net
248
(14)
Increase in cash surrender value of life insurance
150
104
Other noninterest income
1,061
Total noninterest income
6,782
5,281
NONINTEREST EXPENSE
Salaries and employee benefits
8,895
7,378
Net occupancy and equipment expense
1,304
1,103
Data processing and telecommunications expense
1,380
1,224
Automated teller machine and interchange expense
337
297
Pennsylvania shares tax
491
422
Professional fees
547
379
Merger-related expenses
141
Other noninterest expense
2,109
Total noninterest expense
15,709
13,053
Income before income tax provision
10,897
4,982
Income tax provision
2,110
816
NET INCOME
8,787
4,166
EARNINGS PER COMMON SHARE - BASIC
0.55
0.30
EARNINGS PER COMMON SHARE - DILUTED
4
Consolidated Statements of Comprehensive Income
(In Thousands) (Unaudited)
Net income
Unrealized holding (losses) gains on available-for-sale debt securities
(6,114)
7,240
Unfunded pension and postretirement obligations:
Changes from plan amendments and actuarial gains and losses
(5)
88
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost
(4)
(8)
Other comprehensive (loss) income on unfunded retirement obligations
(9)
80
Other comprehensive (loss) income before income tax
(6,123)
7,320
Income tax benefit (expense) related to other comprehensive (loss) income
1,287
(1,537)
Net other comprehensive (loss) income
(4,836)
5,783
Comprehensive income
3,951
9,949
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of securities
488
367
(150)
(104)
Depreciation and amortization of bank premises and equipment
553
447
Net accretion of purchase accounting adjustments
(818)
(355)
Stock-based compensation
341
194
Deferred income taxes
462
397
(Increase) decrease in fair value of servicing rights
(75)
126
Gains on sales of loans, net
(1,064)
(315)
Origination of loans held for sale
(32,478)
(10,414)
Proceeds from sales of loans held for sale
30,727
10,842
Increase in accrued interest receivable and other assets
(2,190)
(1,886)
Increase (decrease) in accrued interest payable and other liabilities
891
(799)
Other
(20)
(67)
Net Cash Provided by Operating Activities
5,713
4,127
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of certificates of deposit
(1,250)
Proceeds from sales of available-for-sale debt securities
6,722
Proceeds from calls and maturities of available-for-sale debt securities
17,093
17,451
Purchase of available-for-sale debt securities
(34,494)
(12,993)
Redemption of Federal Home Loan Bank of Pittsburgh stock
584
3,660
Purchase of Federal Home Loan Bank of Pittsburgh stock
(473)
(2,735)
Net decrease in loans
29,936
15,179
Proceeds from bank owned life insurance
287
Proceeds from sales of premises and equipment
495
Purchase of premises and equipment
(239)
(1,300)
Proceeds from sale of foreclosed assets
1,253
70
Net Cash Provided by Investing Activities
12,009
27,307
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits
103,793
(2,789)
Net decrease in short-term borrowings
(10,211)
(48,619)
Proceeds from long-term borrowings
25,891
Repayments of long-term borrowings
(4,024)
(5,074)
Sale of treasury stock
77
124
Purchase of vested restricted stock for tax withholding
(157)
(163)
Common dividends paid
(3,912)
(3,328)
Net Cash Provided by (Used in) Financing Activities
85,566
(33,958)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
103,288
(2,524)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
96,017
31,122
CASH AND CASH EQUIVALENTS, END OF PERIOD
199,305
28,598
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Accrued purchase of certificates of deposit
750
Increase in accrued purchase of available-for-sale debt securities
6,245
Assets acquired through foreclosure of real estate loans
Interest paid
2,193
2,650
Income taxes paid
47
42
6
Consolidated Statements of Changes in Stockholders’ Equity
(In Thousands Except Share and Per Share Data) (Unaudited)
Accumulated
Common
Treasury
Paid-in
Retained
Comprehensive
Three Months Ended March 31, 2021
Shares
Stock
Capital
Earnings
Income
Total
Balance, December 31, 2020
15,982,815
70,831
Other comprehensive loss, net
Cash dividends declared on common stock, $.27 per share
(4,314)
Shares issued for dividend reinvestment plan
19,475
19
383
402
Share issued from treasury and redeemed related to exercise of stock options
(5,414)
(28)
105
Restricted stock granted
10,989
(63,402)
11
(1,240)
1,229
Forfeiture of restricted stock
3,791
73
(73)
Stock-based compensation expense
Purchase of restricted stock for tax withholding
7,659
Balance, March 31, 2021
16,013,279
13,465
Three Months Ended March 31, 2020
Balance, December 31, 2019
13,934,996
218,551
13,935
104,519
126,480
3,691
(4,173)
244,452
Other comprehensive income, net
(3,702)
(13,945)
270
374
Shares issued from treasury and redeemed related to exercise of stock options
(9,652)
(62)
186
(55,864)
(1,079)
1,079
2,884
55
(55)
5,862
Balance, March 31, 2020
147,836
103,731
126,944
9,474
(2,856)
251,228
7
1. BASIS OF INTERIM PRESENTATION AND STATUS OF RECENT ACCOUNTING PRONOUNCEMENTS
The consolidated financial statements include the accounts of Citizens & Northern Corporation and its subsidiaries, Citizens & Northern Bank (“C&N Bank”), Bucktail Life Insurance Company and Citizens & Northern Investment Corporation (collectively, “Corporation”). The consolidated financial statements also include C&N Bank’s wholly-owned subsidiaries, C&N Financial Services Corporation and Northern Tier Holding LLC. C&N Bank is the sole member of Northern Tier Holding LLC. All material intercompany balances and transactions have been eliminated in consolidation.
The consolidated financial information included herein, except the consolidated balance sheet dated December 31, 2020, is unaudited. Such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations, comprehensive income, cash flows and changes in stockholders’ equity for the interim periods; however, the information does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for a complete set of financial statements. Certain 2020 information has been reclassified for consistency with the 2021 presentation.
Operating results reported for the three-month period ended March 31, 2021 might not be indicative of the results for the year ending December 31, 2021. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) issues Accounting Standards Updates (ASUs) to the FASB Accounting Standards Codification (ASC). This section provides a summary description of recent ASUs that have significant implications (elected or required) within the consolidated financial statements, or that management expects may have a significant impact on financial statements issued in the near future.
Recently Issued But Not Yet Effective Accounting Pronouncements
ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), as modified by subsequent ASUs, changes accounting for credit losses on loans receivable and debt securities from an incurred loss methodology to an expected credit loss methodology. Among other things, ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Accordingly, ASU 2016-13 requires the use of forward-looking information to form credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, though the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, ASU 2016-13 amends the accounting for credit losses on debt securities and purchased financial assets with credit deterioration. The effect of implementing this ASU is recorded through a cumulative-effect adjustment to retained earnings. The Corporation has formed a cross functional management team and is working with an outside vendor assessing alternative loss estimation methodologies and the Corporation’s data and system needs to evaluate the impact that adoption of this standard will have on the Corporation’s financial condition and results of operations. In November 2019, the FASB approved a delay of the required implementation date of ASU 2016-13 for smaller reporting companies, including the Corporation, resulting in a required implementation date for the Corporation of January 1, 2023.
ASU 2020-04, Reference Rate Reform (Topic 848) provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. The amendments in Update 2020-04 are elective and apply to all entities that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued. The guidance includes a general principle that permits an entity to consider contract modifications due to reference rate reform to be an event that does not require contract remeasurement at the modification date or reassessment of a previous accounting determination. Some specific optional expedients are as follows:
8
The amendments in ASU 2020-04 are effective as of March 12, 2020 through December 31, 2022. The Corporation has formed a cross functional management team to evaluate and implement changes to contracts with rates indexed to LIBOR and expects to apply the amendments prospectively for applicable loan and other contracts within the effective period of ASU 2020-04.
2. BUSINESS COMBINATIONS
Acquisition of Covenant Financial, Inc.
On July 1, 2020, the Corporation completed its acquisition of Covenant Financial, Inc. (“Covenant”). Covenant was the holding company for Covenant Bank, which operated banking offices in Bucks and Chester Counties of Pennsylvania. The Covenant acquisition has contributed significantly to growth in the size of the Corporation’s balance sheet and in net interest income and noninterest expenses.
In connection with the transaction, the Corporation recorded goodwill of $24.1 million and a core deposit intangible asset of $3.1 million. Total loans acquired on July 1, 2020 were valued at $464.2 million, while total deposits assumed were valued at $481.8 million, borrowings were valued at $64.0 million and subordinated debt was valued at $10.1 million. The Corporation acquired available-for-sale debt securities valued at $10.8 million and bank-owned life insurance valued at $11.2 million. The assets purchased and liabilities assumed in the merger were recorded at their estimated fair values at the time of closing, subject to refinement for up to one year after the closing date. There were no adjustments to the fair value measurements of assets acquired or liabilities assumed in the first quarter 2021.
Merger-related expenses related to the planned acquisition of Covenant totaled $141,000 in the first quarter 2020.
9
3. PER SHARE DATA
Basic earnings per common share are calculated using the two-class method to determine income attributable to common shareholders. Unvested restricted stock awards that contain nonforfeitable rights to dividends are considered participating securities under the two-class method. Distributed dividends and an allocation of undistributed net income to participating securities reduce the amount of income attributable to common shareholders. Income attributable to common shareholders is then divided by weighted-average common shares outstanding for the period to determine basic earnings per common share.
Diluted earnings per common share are calculated under the more dilutive of either the treasury method or the two-class method. Diluted earnings per common share is computed using weighted-average common shares outstanding, plus weighted-average common shares available from the exercise of all dilutive stock options, less the number of shares that could be repurchased with the proceeds of stock option exercises based on the average share price of the Corporation’s common stock during the period.
(In Thousands, Except Share and Per Share Data)
Basic
Less: Dividends and undistributed earnings allocated to participating securities
(65)
Net income attributable to common shares
8,722
4,146
Basic weighted-average common shares outstanding
15,850,217
13,685,257
Basic earnings per common share (a)
Diluted
Dilutive effect of potential common stock arising from stock options
4,234
13,981
Diluted weighted-average common shares outstanding
15,854,451
13,699,238
Diluted earnings per common share (a)
Weighted-average nonvested restricted shares outstanding
118,442
65,533
Anti-dilutive stock options are excluded from net income per share calculations. There were no anti-dilutive instruments in the three-month periods ended March 31, 2021 and 2020.
10
4. COMPREHENSIVE INCOME
Comprehensive income is the total of (1) net income, and (2) all other changes in equity from non-stockholder sources, which are referred to as other comprehensive income (loss). The components of other comprehensive income (loss), and the related tax effects, are as follows:
(In Thousands)
Before-Tax
Income Tax
Net-of-Tax
Amount
Effect
Other comprehensive loss from available-for-sale debt securities,
Unrealized holding losses on available-for-sale debt securities
1,285
(4,829)
1
(3)
Other comprehensive loss on unfunded retirement obligations
(7)
Total other comprehensive loss
Other comprehensive income from available-for-sale debt securities,
Unrealized holding gains on available-for-sale debt securities
(1,521)
5,719
(18)
(6)
Other comprehensive income on unfunded retirement obligations
(16)
64
Total other comprehensive income
The amounts shown in the table immediately above are included in the following line items in the consolidated statements of income:
Affected Line Item in the
Description
Amortization of prior service cost and net actuarial loss included in net periodic benefit cost (before-tax)
Income tax effect
Changes in the components of accumulated other comprehensive income are as follows and are presented net of tax:
Unrealized
Gains
Unfunded
(Losses)
Retirement
on Securities
Obligations
Balance, beginning of period
11,676
119
Other comprehensive loss during three months ended March 31, 2021
Balance, end of period
6,847
112
3,511
180
Other comprehensive income during three months ended March 31, 2020
9,230
5. CASH AND DUE FROM BANKS
Cash and due from banks at March 31, 2021 and December 31, 2020 include the following:
Cash and cash equivalents
Certificates of deposit
7,840
5,840
Certificates of deposit are issues by U.S. banks with original maturities greater than three months. Each certificate of deposit is fully FDIC-insured. The Corporation maintains cash and cash equivalents with certain financial institutions in excess of the FDIC insurance limit.
Historically, C&N Bank has been required to maintain reserves against deposit liabilities in the form of cash and balances with the Federal Reserve Bank of Philadelphia. The reserves are based on deposit levels, account activity, and other services provided by the Federal Reserve Bank. In March 2020, the Federal Reserve Board reduced reserve requirements for U.S. banks to 0%. Accordingly, C&N Bank had no required reserves at March 31, 2021 and December 31, 2020.
12
6. SECURITIES
Amortized cost and fair value of available-for-sale debt securities at March 31, 2021 and December 31, 2020 are summarized as follows:
March 31, 2021
Gross
Amortized
Holding
Fair
Cost
Losses
Value
Obligations of the U.S. Treasury
15,117
(34)
15,085
Obligations of U.S. Government agencies
24,763
670
(441)
24,992
Obligations of states and political subdivisions:
120,974
4,487
(343)
125,118
51,823
1,397
(682)
52,538
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies:
Residential pass-through securities
38,790
1,099
(132)
39,757
Residential collateralized mortgage obligations
52,715
1,299
(43)
53,971
Commercial mortgage-backed securities
53,528
1,949
(562)
54,915
Total available-for-sale debt securities
357,710
10,903
(2,237)
December 31, 2020
12,184
(2)
12,182
25,349
1,003
26,344
116,427
6,000
(26)
122,401
45,230
2,246
(24)
47,452
36,853
1,323
38,176
56,048
1,428
57,467
42,461
2,849
45,310
334,552
14,849
(69)
13
The following table presents gross unrealized losses and fair value of available-for-sale debt securities with unrealized loss positions that are not deemed to be other-than-temporarily impaired, aggregated by length of time that individual securities have been in a continuous unrealized loss position at March 31, 2021 and December 31, 2020:
Less Than 12 Months
12 Months or More
9,003
12,058
26,916
19,588
(661)
524
(21)
20,112
Mortgage-backed securities issued or guaranteed by U.S. Government agencies or sponsored agencies,
9,884
5,228
10,624
Total temporarily impaired available for sale debt securities
93,301
(2,216)
93,825
9,159
4,992
3,811
5,235
2,861
Total temporarily impaired available-for-sale debt securities
26,058
Gross realized gains and losses from available-for-sale debt securities were as follows:
Gross realized gains from sales
52
Gross realized losses from sales
(52)
Net realized gains
14
The amortized cost and fair value of available-for-sale debt securities by contractual maturity are shown in the following table as of March 31, 2021. Actual maturities may differ from contractual maturities because counterparties may have the right to call or prepay obligations with or without call or prepayment penalties.
Due in one year or less
14,667
14,760
Due from one year through five years
45,128
46,421
Due from five years through ten years
51,245
52,787
Due after ten years
101,637
103,765
Sub-total
212,677
217,733
The Corporation’s mortgage-backed securities and collateralized mortgage obligations have stated maturities that may differ from actual maturities due to borrowers’ ability to prepay obligations. Cash flows from such investments are dependent upon the performance of the underlying mortgage loans and are generally influenced by the level of interest rates. In the table above, mortgage-backed securities and collateralized mortgage obligations are shown in one period.
Investment securities carried at $254,860,000 at March 31, 2021 and $247,373,000 at December 31, 2020 were pledged as collateral for public deposits, trusts and certain other deposits as provided by law. See Note 9 for information concerning securities pledged to secure borrowing arrangements and Note 12 for information related to securities pledged against interest rate swap obligations.
Management evaluates securities for other-than-temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Corporation intends to sell the security or more likely than not will be required to sell the security before its anticipated recovery.
A summary of information management considered in evaluating debt and equity securities for other-than-temporary impairment (“OTTI”) at March 31, 2021 is provided below.
Debt Securities
At March 31, 2021 and December 31, 2020, management performed an assessment for possible OTTI of the Corporation’s debt securities on an issue-by-issue basis, relying on information obtained from various sources, including publicly available financial data, ratings by external agencies, brokers and other sources. The extent of individual analysis applied to each security depended on the size of the Corporation’s investment, as well as management’s perception of the credit risk associated with each security. Based on the results of the assessment, management believes impairment of debt securities at March 31, 2021 and December 31, 2020 to be temporary.
Equity Securities
C&N Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB-Pittsburgh), which is one of 11 regional Federal Home Loan Banks. As a member, C&N Bank is required to purchase and maintain stock in FHLB-Pittsburgh. There is no active market for FHLB-Pittsburgh stock, and it must ordinarily be redeemed by FHLB-Pittsburgh in order to be liquidated. C&N Bank’s investment in FHLB-Pittsburgh stock, included in Other Assets in the consolidated balance sheets, was $9,609,000 at March 31, 2021 and $9,720,000 at December 31, 2020. The Corporation evaluated its holding of FHLB-Pittsburgh stock for impairment and deemed the stock to not be impaired at March 31, 2021 and December 31, 2020. In making this determination, management concluded that recovery of total
outstanding par value, which equals the carrying value, is expected. The decision was based on review of financial information that FHLB-Pittsburgh has made publicly available.
The Corporation has a marketable equity security included in other assets in the consolidated balance sheets with a carrying value of $982,000 at March 31, 2021 and $1,000,000 at December 31, 2020, consisting exclusively of one mutual fund. There was an unrealized loss on the mutual fund of $18,000 at March 31, 2021 and no unrealized gain or loss on the mutual fund at December 31, 2020. Changes in the unrealized gains or losses on this security are included in other noninterest income in the consolidated statements of income.
7. LOANS
The loans receivable portfolio is segmented into commercial, residential mortgage and consumer loans. Loans outstanding at March 31, 2021 and December 31, 2020 are summarized by segment, and by classes within each segment, as follows:
Summary of Loans by Type
Commercial:
Commercial loans secured by real estate
524,886
531,810
Commercial and industrial
155,828
159,577
Paycheck Protection Program - 1st Draw
71,708
132,269
Paycheck Protection Program - 2nd Draw
66,127
Political subdivisions
49,860
53,221
Commercial construction and land
45,307
42,874
Loans secured by farmland
11,736
Multi-family (5 or more) residential
54,049
55,811
Agricultural loans
2,460
3,164
Other commercial loans
16,315
17,289
Total commercial
997,437
1,007,751
Residential mortgage:
Residential mortgage loans - first liens
518,392
532,947
Residential mortgage loans - junior liens
25,402
27,311
Home equity lines of credit
39,083
39,301
1-4 Family residential construction
18,376
20,613
Total residential mortgage
601,253
620,172
Consumer
15,897
16,286
Less: allowance for loan losses
In the table above, outstanding loan balances are presented net of deferred loan origination fees, net, of $7,388,000 at March 31, 2021 and $6,286,000 at December 31, 2020.
The Corporation grants loans to individuals as well as commercial and tax-exempt entities. Commercial, residential and personal loans are made to customers geographically concentrated in northcentral Pennsylvania, the southern tier of New York State and southeastern Pennsylvania. Although the Corporation has a diversified loan portfolio, a significant portion of its debtors’ ability to honor their contracts is dependent on the local economic conditions within the region.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law. The CARES Act is a $2 trillion stimulus package designed to provide relief to U.S. businesses and consumers struggling as a result of the pandemic. A provision in the CARES Act includes creation of the Paycheck Protection Program (“PPP”) through the Small Business Administration
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(“SBA”) and Treasury Department. Under the PPP, the Corporation, as an SBA-certified lender, provides SBA-guaranteed loans to small businesses to pay their employees, rent, mortgage interest, and utilities. PPP loans will be forgiven subject to clients’ providing documentation evidencing their compliant use of funds and otherwise complying with the terms of the program. Information related to PPP loans advanced pursuant to the CARES Act are labeled “1st Draw” within the tables.
Section 4013 of the CARES Act provides that, from the period beginning March 1, 2020 until 60 days after the date on which the national emergency concerning the coronavirus (COVID-19) pandemic declared by the President of the United States under the National Emergencies Act terminates (the “applicable period”), the Corporation may elect to suspend U.S. GAAP for loan modifications related to the pandemic that would otherwise be categorized as troubled debt restructurings (TDRs) and suspend any determination of a loan modified as a result of the effects of the pandemic as being a TDR, including impairment for accounting purposes. The suspension is applicable for the term of the loan modification that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019. The suspension is not applicable to any adverse impact on the credit of a borrower that is not related to the pandemic.
In addition, the banking regulators and other financial regulators, on March 22, 2020 and revised April 7, 2020, issued a joint interagency statement titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of the COVID-19 pandemic. Pursuant to the interagency statement, loan modifications that do not meet the conditions of Section 4013 of the CARES Act may still qualify as a modification that does not need to be accounted for as a TDR. Specifically, the agencies confirmed with the FASB staff that short-term modifications made in good faith in response to the pandemic to borrowers who were current prior to any relief are not TDRs under U.S. GAAP. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. Appropriate allowances for loan and lease losses are expected to be maintained. With regard to loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to the pandemic as past due because of the deferral. The interagency statement also states that during short-term pandemic-related loan modifications, these loans generally should not be reported as nonaccrual.
On December 27, 2020, the President of the United States signed into law the Consolidated Appropriations Act, 2021 (the “CAA”), which both funds the federal government until September 30, 2021 and broadly addresses additional COVID-19 responses and relief. Among the additional relief measures included are certain extensions to elements of the CARES Act, including extension of temporary relief from troubled debt restructurings established under Section 4013 of the CARES Act to the earlier of a) January 1, 2022, or b) the date that is 60 days after the date on which the national COVID-19 emergency terminates. The CAA also includes additional funding for the PPP with additional eligibility requirements for borrowers with generally the same loan terms as provided under the CARES Act. Information related to PPP loans advanced pursuant to the CAA are labeled “2nd Draw” within the tables.
The maximum term of PPP loans is five years. Most of the Corporation’s 1st Draw PPP loans have two-year terms, while 2nd Draw PPP loans have five-year terms and the Corporation will be repaid sooner to the extent the loans are forgiven. The interest rate on PPP loans is 1%, and the Corporation has received fees from the SBA ranging between 1% and 5% per loan, depending on the size of the loan. Fees on PPP loans, net of origination costs and a market rate adjustment on PPP loans acquired from Covenant, are recognized in interest income as a yield adjustment over the term of the loans.
The Corporation began accepting and processing applications for loans under the PPP on April 3, 2020. Covenant also engaged in PPP lending starting in early April 2020. As of March 31, 2021, the recorded investment in 1st Draw PPP loans was $71,708,000, including contractual principal balances of $72,987,000, increased by a market rate adjustment on PPP loans acquired from Covenant of $164,000 and reduced by net deferred origination fees of $1,443,000. The recorded investment in 2nd Draw PPP loans was $66,127,000, including contractual principal balances of $69,000,000 reduced by net deferred origination fees of $2,873,000. Accretion of fees received on 1st Draw PPP loans, net of amortization of the market rate adjustment on PPP loans acquired from Covenant, was $1,548,000 and the accretion of fees on 2nd Draw PPP loans was $97,000 in the three-month period ended March 31, 2021.
To work with clients impacted by COVID-19, the Corporation is offering short-term loan modifications on a case-by-case basis to borrowers who were current in their payments at the inception of the loan modification program. Prior to the merger, Covenant had a similar program in place, and these modified loans have been incorporated into the Corporation’s program. These efforts have been designed to assist borrowers as they deal with the current crisis and help the Corporation mitigate credit risk. For loans subject to the program, each borrower is required to resume making regularly scheduled loan payments at the end of the modification period and the
17
deferred amounts will be moved to the end of the loan term. Consistent with Section 4013 of the CARES Act, the modified loans have not been reported as past due, nonaccrual or as TDRs at March 31, 2021. Most of the initial modifications under the program became effective in March 2020 or the second quarter 2020 and provided a deferral of interest or principal and interest for 90-to-180 days. Many of the loans for which deferrals were granted returned to full payment status prior to March 31, 2021, while additional deferrals have been granted on certain loans. The quantity and balances of modifications outstanding under the program and a summary of their risk ratings at March 31, 2021 are as follows:
Deferrals Remaining
As of March 31, 2021
(Dollars in Thousands)
Number
Purchased
of
Special
Credit
Loans
Pass
Mention
Substandard
Impaired
COVID-19-related loan modifications:
Commercial
Accommodation and food services - hotels
9,186
10,349
19,535
Lessors of residential buildings and dwellings
1,557
1,612
Lessors of nonresidential buildings (except miniwarehouses)
1,411
Transportation and warehousing
1,197
Religious organizations
757
Real estate rental and leasing - other
438
11,578
2,968
24,950
Residential mortgage
619
475
1,094
25
12,197
530
26,044
For the loans in the table above, the deferral periods as of March 31, 2021 expire in the second or third quarters of 2021. The Corporation will continue to evaluate requests for additional deferrals on a case-by-case basis.
The ultimate effect of COVID-19 on the local or broader economy is not known. In June, September and December 2020, and March 2021, the Corporation’s credit administration and commercial lending staffs performed reviews of commercial credits with “Pass” ratings in an effort to reduce the risk of failing to identify loans that should be evaluated for risk rating downgrade or a specific allowance. Updated risk ratings and specific allowances based on that review have been included in the March 31, 2021 information presented below. Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its economic impact, the total impact on the Corporation’s loan portfolio is not determinable.
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As described in Note 2, effective July 1, 2020, the Corporation acquired loans pursuant to its acquisition of Covenant, and effective April 1, 2019, the Corporation acquired loans pursuant to the acquisition of Monument Bancorp, Inc. (“Monument”). The acquired loans were recorded at their initial fair value, with adjustments made to the gross amortized cost of loans based on movements in interest rates (market rate adjustment) and based on credit fair value adjustments on non-impaired loans and impaired loans. In the last three quarters of 2019 and in 2020, the Corporation recognized amortization and accretion of a portion of the market rate adjustments and credit adjustments on non-impaired (performing) loans, and a partial recovery of purchased credit impaired (PCI) loans. For the three-month periods ended March 31, 2021 and 2020, adjustments to the initial market rate and credit fair value adjustments of performing loans were recognized as follows:
Market Rate Adjustment
Adjustments to gross amortized cost of loans at beginning of period
718
(1,415)
(Amortization) accretion recognized in interest income
(366)
147
Adjustments to gross amortized cost of loans at end of period
352
(1,268)
Credit Adjustment on Non-impaired Loans
(5,979)
(1,216)
Accretion recognized in interest income
797
205
(5,182)
(1,011)
A summary of PCI loans held at March 31, 2021 and December 31, 2020 is as follows:
Outstanding balance
10,256
10,316
Carrying amount
6,781
6,841
The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. In the process of evaluating the loan portfolio, management also considers the Corporation’s exposure to losses from unfunded loan commitments. As of March 31, 2021 and December 31, 2020, management determined that no allowance for credit losses related to unfunded loan commitments was required.
Transactions within the allowance for loan losses, summarized by segment and class, for the three-month periods ended March 31, 2021 and 2020 were as follows:
Balance
Charge-offs
Recoveries
Provision (Credit)
Allowance for Loan Losses:
3,051
299
3,350
2,245
(72)
2,187
454
22
476
120
111
236
255
34
26
168
159
6,308
242
6,564
3,524
3,507
349
(15)
334
281
(1)
99
78
4,253
4,200
239
(11)
220
Unallocated
585
677
Total Allowance for Loan Losses
11,385
28
11,661
December 31, 2019
March 31, 2020
1,921
1,932
1,391
(17)
1,271
2,645
966
970
158
144
156
43
199
41
39
155
160
4,788
1,318
6,089
3,405
166
3,572
384
29
414
276
278
117
4,182
4,383
(31)
273
9,836
(48)
11,330
For the three months ended March 31, 2021, the provision for loan losses was $259,000, a decrease in expense of $1,269,000 as compared to the three months ended March 31, 2020. In the first three months of 2020, the provision included the effects of recording a specific allowance of $1,193,000 on a commercial loan for which a charge-off of $2,219,000 was subsequently recorded in the third quarter 2020.
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In determining the larger loan relationships for detailed assessment under the specific allowance component, the Corporation uses an internal risk rating system. Under the risk rating system, the Corporation classifies problem or potential problem loans as “Special Mention,” “Substandard,” or “Doubtful” on the basis of currently existing facts, conditions and values. Substandard loans include those characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that do not currently expose the Corporation to sufficient risk to warrant classification as Substandard or Doubtful, but possess weaknesses that deserve management’s close attention, are deemed to be Special Mention. Risk ratings are updated any time that conditions or the situation warrants. Loans not classified are included in the “Pass” column in the table that follows.
The following tables summarize the aggregate credit quality classification of outstanding loans by risk rating as of March 31, 2021 and December 31, 2020:
Doubtful
485,821
18,419
16,371
4,275
Commercial and Industrial
139,780
8,627
6,537
95
789
44,543
715
49
9,657
843
49,204
2,380
887
1,578
1,880
580
934,895
30,538
25,267
6,642
Residential Mortgage:
Residential Mortgage loans - first liens
501,338
5,397
11,583
74
Residential Mortgage loans - junior liens
24,601
132
604
65
38,326
59
698
582,641
5,588
12,885
139
15,784
113
Totals
1,533,320
36,126
38,265
21
494,876
17,374
15,262
4,298
143,500
8,025
7,268
784
42,110
10,473
405
858
50,563
2,405
1,614
2,569
595
946,870
28,924
25,261
6,696
516,685
6,192
9,994
76
26,480
621
38,529
713
602,307
6,392
11,328
145
16,172
114
1,565,349
35,316
36,703
The following tables present a summary of loan balances and the related allowance for loan losses summarized by portfolio segment and class for each impairment method used as of March 31, 2021 and December 31, 2020.
Loans:
Individually
Collectively
Evaluated
12,749
512,137
899
2,451
1,422
154,406
71
2,116
84
10,813
52,471
15,833
981,604
5,594
1,920
516,472
3,499
24,997
146
188
2,325
598,928
154
4,046
18,158
1,596,429
1,124
9,860
23
11,962
519,848
692
2,359
1,359
158,218
2,174
11,652
54,197
15,019
992,732
763
5,545
2,385
530,562
3,515
26,897
153
196
2,799
617,373
162
4,091
17,818
1,626,391
925
9,875
Summary information related to impaired loans at March 31, 2021 and December 31, 2020 is provided in the table immediately below.
Unpaid
Principal
Recorded
Related
Investment
Allowance
With no related allowance recorded:
6,731
4,961
7,168
5,398
1,844
1,350
1,781
1,248
100
2,734
2,770
Total with no related allowance recorded
12,279
8,804
13,211
9,736
With a related allowance recorded:
7,788
898
6,501
691
72
1,189
1,200
305
309
Total with a related allowance recorded
9,354
8,082
21,633
21,293
In the table immediately above, loans to two borrowers are presented under the Residential mortgage loans – first liens and Residential mortgage loans – junior liens classes. Each of these loans is collateralized by one property, and the allowance associated with each of these loans was determined based on an analysis of the total amounts of the Corporation’s exposure in comparison to the estimated net
24
proceeds if the Corporation were to sell the property. The total allowance related to these two borrowers was $146,000 at March 31, 2021 and $153,000 at December 31, 2020.
The average balance of impaired loans, excluding purchased credit impaired loans, and interest income recognized on these impaired loans is as follows:
Interest Income Recognized on
Average Investment in Impaired Loans
Impaired Loans on a Cash Basis
12,203
387
143
1,082
2,872
1,308
516
1,596
61
50
15,083
5,209
35
Residential mortgage loans - first lien
1,232
37
Residential mortgage loans - junior lien
382
2,906
1,679
17,989
6,888
262
44
The breakdown by portfolio segment and class of nonaccrual loans and loans past due ninety days or more and still accruing is as follows:
Past Due
90+ Days and
Accruing
Nonaccrual
12,648
395
11,550
103
1,047
142
Other commercial
446
15,406
796
14,267
550
5,964
838
6,387
45
370
378
233
791
6,629
1,123
7,064
48
81
56
85
22,116
1,975
21,416
The amounts shown in the table immediately above include loans classified as troubled debt restructurings (described in more detail below), if such loans are past due ninety days or more or nonaccrual. PCI loans with a total recorded investment of $6,781,000 at March 31, 2021 and $6,841,000 at December 31, 2020 are classified as nonaccrual.
The table below presents a summary of the contractual aging of loans as of March 31, 2021 and December 31, 2020. Loans modified under the Corporation’s program designed to work with clients impacted by COVID-19, as described above, are included in the current and past due less than 30 days category in the table that follows.
As of December 31, 2020
Current &
Less than
30-89
90+
30 Days
Days
519,474
630
4,782
529,998
66
1,746
154,745
94
989
158,523
999
45,060
42,590
284
10,593
82
222
11,419
53,860
1,951
2,364
96
3,091
990,295
1,100
6,042
1,002,260
2,453
3,038
508,818
7,176
2,398
523,191
5,703
4,053
25,201
181
27,009
191
38,455
432
38,919
101
20,457
590,850
7,628
2,775
609,576
6,071
4,525
15,752
16,063
83
140
1,596,897
8,754
8,936
1,627,899
8,607
7,703
27
Nonaccrual loans are included in the contractual aging in the immediately preceding table. A summary of the contractual aging of nonaccrual loans at March 31, 2021 and December 31, 2020 is as follows:
March 31, 2021 Nonaccrual Totals
12,654
1,861
7,601
December 31, 2020 Nonaccrual Totals
12,999
2,689
5,728
Loans whose terms are modified are classified as TDRs if the Corporation grants such borrowers concessions, and it is deemed that those borrowers are experiencing financial difficulty. Loans classified as TDRs are designated as impaired. The outstanding balance of loans subject to TDRs, as well as contractual aging information at March 31, 2021 and December 31, 2020 is as follows:
March 31, 2021 Totals
176
67
6,816
7,185
December 31, 2020 Totals
418
6,867
7,451
At March 31, 2021 and December 31, 2020, there were no commitments to loan additional funds to borrowers whose loans have been classified as TDRs.
TDRs that occurred during the three-month periods ended March 31, 2021 and 2020 are as follows:
Post-
Modification
(Balances in Thousands)
Residential mortgage - first liens,
Reduced monthly payments and extended maturity date
Residential mortgage - junior liens,
New loan at lower than risk-adjusted market rate to borrower from whom short sale of other collateral was accepted
30
Consumer,
36
In the three-month periods ended March 31, 2021 and 2020, defaults on loans for which modifications that were considered to be TDR and were entered into within the previous 12 months are summarized as follows:
3,392
The carrying amount of foreclosed residential real estate properties held as a result of obtaining physical possession (included in foreclosed assets held for sale in the unaudited consolidated balance sheets) is as follows:
Foreclosed residential real estate
218
The recorded investment of consumer mortgage loans secured by residential real properties for which formal foreclosure proceedings were in process is as follows:
Residential real estate in process of foreclosure
1,852
1,246
8. GOODWILL AND OTHER INTANGIBLE ASSETS
Information related to core deposit intangibles is as follows:
Gross amount
6,639
Accumulated amortization
(2,922)
(2,788)
Net
Amortization expense related to core deposit intangibles is included in other noninterest expense in the consolidated statements of income, as follows:
Amortization expense
62
Goodwill represents the excess of the cost of acquisitions over the fair value of the net assets acquired. At March 31, 2021 and December 31, 2020, the net carrying value of goodwill was $52,505,000. There were no changes in the carrying value of goodwill in the three-month periods ended March 31, 2021 and 2020.
9. BORROWED FUNDS AND SUBORDINATED DEBT
Short-term borrowings (initial maturity within one year) include the following:
FHLB-Pittsburgh borrowings
8,018
18,066
Customer repurchase agreements
1,745
1,956
Total short-term borrowings
At March 31, 2021, short-term borrowings from FHLB-Pittsburgh include two advances with par values totaling $8,000,000 which are presented in the table inclusive of the unaccreted purchase accounting adjustment, with a weighted-average effective interest rate of 0.42%. At December 31, 2020, short-term borrowings from FHLB-Pittsburgh included five advances totaling $18,000,000 par value, with a weighted average effective interest rate of 0.43%.
The Corporation had available credit with other correspondent banks totaling $45,000,000 at March 31, 2021 and December 31, 2020. These lines of credit are primarily unsecured. No amounts were outstanding at March 31, 2021 or December 31, 2020.
The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. At March 31, 2021, the Corporation had available credit in the amount of $14,522,000 on this line with no outstanding advances. At December 31, 2020, the Corporation had available credit in the amount of $14,654,000 on this line with no outstanding advances. As collateral for this line, the Corporation has pledged available-for-sale securities with a carrying value of $14,992,000 at March 31, 2021 and $15,126,000 at December 31, 2020.
The Corporation engages in repurchase agreements with certain commercial customers. These agreements provide that the Corporation sells specified investment securities to the customers on an overnight basis and repurchases them on the following business day. The weighted average rate paid by the Corporation on customer repurchase agreements was 0.10%at March 31, 2021 and December 31, 2020. The carrying value of the underlying securities was $1,780,000 at March 31, 2021 and $1,980,000 at December 31, 2020.
The FHLB-Pittsburgh loan facility is collateralized by qualifying loans secured by real estate with a book value totaling $1,033,262,000 at March 31, 2021 and $1,049,690,000 at December 31, 2020. Also, the FHLB-Pittsburgh loan facility requires the Corporation to invest in established amounts of FHLB-Pittsburgh stock. The carrying values of the Corporation’s holdings of FHLB-Pittsburgh stock (included in other assets in the consolidated balance sheets) were $9,609,000 at March 31, 2021 and $9,720,000 at December 31, 2020. In addition to the short-term and long-term borrowings shown in these tables, there was a $400,000 letter of credit from FHLB-Pittsburgh outstanding at March 31, 2021. The Corporation’s total credit facility with FHLB-Pittsburgh was $761,761,000 at March 31, 2021, including an unused (available) amount of $703,562,000. At December 31, 2020, the Corporation’s total credit facility with FHLB-Pittsburgh was $771,199,000, including an unused (available) amount of $698,977,000.
LONG-TERM BORROWINGS
Long-term borrowings from FHLB-Pittsburgh are as follows:
Loans maturing in 2021 with a weighted-average rate of 1.31%
22,072
26,098
Loans maturing in 2022 with a weighted-average rate of 0.60%
15,626
15,682
Loans maturing in 2023 with a weighted-average rate of 0.73%
7,198
7,224
Loans maturing in 2024 with a weighted-average rate of 0.75%
5,127
5,137
Loan maturing in 2025 with an average rate of 4.91%
444
467
Total long-term FHLB-Pittsburgh borrowings
_____________________________________________________
Note: Weighted-average rates are presented as of March 31, 2021.
SUBORDINATED DEBT
At March 31, 2021 and December 31, 2020, outstanding subordinated debt agreements are as follows:
Agreements with an aggregate par value of $8,000,000; bearing interest at 6.25%; maturing in June 2026 and redeemable at par in June 2021
8,012
8,027
Agreements with an aggregate par value of $6,500,000; bearing interest at 6.50%; maturing in April 2027 and redeemable at par in April 2022
6,500
Agreement with a par value of $2,000,000; bearing interest at 6.50%; maturing in July 2027 and redeemable at par in July 2022
2,022
2,026
Total carrying value
10. STOCK-BASED COMPENSATION PLANS
The Corporation has a Stock Incentive Plan for a selected group of officers and an Independent Directors Stock Incentive Plan. The 2021 restricted stock awards under the Stock Incentive Plan vest ratably over three years, and the 2021 restricted stock issued under the Independent Directors Stock Incentive Plan vests over one year. Following is a summary of restricted stock awards granted in the three-month period ended March 31, 2021:
Aggregate
Grant
Date
Number of
1st quarter 2021 awards:
Time-based awards to independent directors
Time-based awards to employees
46,178
924
Performance-based awards to employees
17,224
345
74,391
1,489
Compensation cost related to restricted stock is recognized based on the fair value of the stock at the grant date over the vesting period, adjusted for estimated and actual forfeitures. Total annual stock-based compensation for the year ending December 31, 2021 is estimated to total $1,600,000. Total stock-based compensation expense attributable to restricted stock awards amounted to $341,000 in the first quarter 2021 and $194,000 in the first quarter 2020.
11. CONTINGENCIES
Litigation Matters
In the normal course of business, the Corporation may be subject to pending and threatened lawsuits in which claims for monetary damages could be asserted. In management’s opinion, the Corporation’s financial position and results of operations would not be materially affected by the outcome of such pending legal proceedings.
Trust Department Tax Reporting Contingency
The Corporation has incurred operational losses from compliance oversight related to trust department tax preparation and administration activities that occurred prior to 2020. In 2020, the Corporation made changes in internal controls and personnel responsible for trust department tax administration activities. Management implemented the changes in internal controls and personnel in an effort to mitigate and prevent the likelihood of new instances of non-compliance from trust department tax administration activities. Estimated losses related to trust department tax compliance matters totaled $107,000 in the first quarter 2021, with no corresponding amount in the first quarter 2020. These losses are included in other noninterest expense in the consolidated statements of income. The balance of accrued interest and other liabilities in the consolidated balance sheets includes $429,000 at March 31, 2021 and $322,000 at December 31, 2020 related to specific tax compliance matters that have been identified; however, no estimate can be made of the amount of additional expenses that may be incurred related to these matters.
12. DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation is a party to derivative financial instruments. These financial instruments consist of interest rate swap agreements which contain master netting and collateral provisions designed to protect the party at risk.
Interest rate swaps with commercial banking customers were executed to facilitate their respective risk management strategies. Under the terms of these arrangements, the commercial banking customers effectively exchanged their floating interest rate exposures on loans into fixed interest rate exposures. Those interest rate swaps have been simultaneously economically hedged by offsetting interest rate swaps with a third party, such that the Corporation has effectively exchanged its fixed interest rate exposures for floating rate exposures.
31
These derivatives are not designated as hedges and are not speculative. Rather, these derivatives result from a service provided to certain customers. As the interest rate swaps associated with this program do not meet the hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings.
The aggregate notional amount of interest rate swaps was $129,416,000 at March 31, 2021 and $135,740,000 at December 31, 2020. There were no interest rate swaps originated in the first quarter 2021or first quarter 2020. There were no gross amounts of interest rate swap-related assets and liabilities not offset in the consolidated balance sheets at March 31, 2021. In the first quarter 2021, the net impact on the consolidated statements of income from interest rate swaps was a reduction in interest income on loans of $338,000. There were no interest rate swaps in place in the first quarter 2020.
The table below presents the fair value of the Corporation’s derivative financial instruments as well as their classification on the consolidated balance sheets at March 31, 2021 and December 31,2020:
At March 31, 2021
At December 31, 2020
Asset Derivatives
Liability Derivatives
Notional
Value (1)
Value (2)
Interest rate swap agreements
64,708
3,933
67,870
6,566
The Corporation’s agreement with its derivative counterparty provides that if the Corporation defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Corporation could also be declared in default on its derivative obligations. Further, if the Corporation were to fail to maintain its status as a well or adequately capitalized institution, then the counterparty could terminate the derivative positions and the Corporation would be required to settle its obligations under the agreements. Available-for-sale securities with a carrying value of $9,145,000 were pledged as collateral against the Corporation’s liability related to the interest rate swaps at March 31, 2021.
13. FAIR VALUE MEASUREMENTS AND FAIR VALUES OF FINANCIAL INSTRUMENTS
The Corporation measures certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB topic 820, “Fair Value Measurements and Disclosures” establishes a framework for measuring fair value that includes a hierarchy used to classify the inputs used in measuring fair value. The hierarchy prioritizes the inputs used in determining valuations into three levels. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. The levels of the fair value hierarchy are as follows:
Level 1 – Fair value is based on unadjusted quoted prices in active markets that are accessible to the Corporation for identical assets or liabilities. These generally provide the most reliable evidence and are used to measure fair value whenever available.
Level 2 – Fair value is based on significant inputs, other than Level 1 inputs, that are observable either directly or indirectly for substantially the full term of the asset or liability through corroboration with observable market data. Level 2 inputs include quoted market prices in active markets for similar assets or liabilities, quoted market prices in markets that are not active for identical or similar assets or liabilities and other observable inputs.
Level 3 – Fair value is based on significant unobservable inputs. Examples of valuation methodologies that would result in Level 3 classification include option pricing models, discounted cash flows and other similar techniques.
The Corporation monitors and evaluates available data relating to fair value measurements on an ongoing basis and recognizes transfers among the levels of the fair value hierarchy as of the date of an event or change in circumstances that affects the valuation method
32
chosen. Examples of such changes may include the market for a particular asset or liability becoming active or inactive, changes in the availability of quoted prices, or changes in the availability of other market data.
At March 31, 2021 and December 31, 2020, assets and liabilities measured at fair value and the valuation methods used are as follows:
Quoted
Prices
in Active
Observable
Unobservable
Markets
Inputs
(Level 1)
(Level 2)
(Level 3)
Recurring fair value measurements, assets:
AVAILABLE-FOR-SALE DEBT SECURITIES:
Marketable equity security
982
Servicing rights
Interest rate swap agreements, assets
Total recurring fair value measurements, assets
370,309
373,247
Recurring fair value measurements, liabilities,
Interest rate swap agreements, liabilities
Nonrecurring fair value measurements, assets:
Impaired loans with a valuation allowance
Valuation allowance
(1,124)
Impaired loans, net
8,230
Total nonrecurring fair value measurements, assets
9,702
33
1,000
1,689
355,898
358,587
(925)
7,157
8,495
Management’s evaluation and selection of valuation techniques and the unobservable inputs used in determining the fair values of assets valued using Level 3 methodologies include sensitive assumptions. Other market participants might use substantially different assumptions, which could result in calculations of fair values that would be substantially different than the amount calculated by management.
At March 31, 2021 and December 31, 2020, quantitative information regarding valuation techniques and the significant unobservable inputs used for assets measured on a recurring basis using unobservable inputs (Level 3 methodologies) are as follows:
Fair Value at
3/31/2021
Valuation
Method or Value As of
Asset
Technique
Input(s)
Discounted cash flow
Discount rate
13.00
%
Rate used through modeling period
Loan prepayment speeds
239.00
Weighted-average PSA
Servicing fees
0.25
of loan balances
4.00
of payments are late
5.00
late fees assessed
1.94
Miscellaneous fees per account per month
Servicing costs
6.00
Monthly servicing cost per account
24.00
Additional monthly servicing cost per loan on loans more than 30 days delinquent
1.50
of loans more than 30 days delinquent
3.00
annual increase in servicing costs
12/31/2020
277.00
The fair value of servicing rights is affected by expected future interest rates. Increases (decreases) in future expected interest rates tend to increase (decrease) the fair value of the Corporation’s servicing rights because of changes in expected prepayment behavior by the borrowers on the underlying loans. Unrealized gains (losses) in fair value of servicing rights are included in Loan servicing fees, net, in the unaudited consolidated statements of income.
Following is a reconciliation of activity for Level 3 assets measured at fair value on a recurring basis:
Servicing rights balance, beginning of period
1,277
Originations of servicing rights
192
75
Unrealized gain (loss) included in earnings
(126)
Servicing rights balance, end of period
1,226
Loans are classified as impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Foreclosed
assets held for sale consist of real estate acquired by foreclosure. For impaired commercial loans secured by real estate and foreclosed assets held for sale, estimated fair values are determined primarily using values from third-party appraisals. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property. For commercial and industrial and agricultural loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging data or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.
At March 31, 2021 and December 31, 2020, quantitative information regarding valuation techniques and the significant unobservable inputs used for nonrecurring fair value measurements using Level 3 methodologies are as follows:
(Dollars In Thousands)
Weighted
Average
Balance at
Allowance at
Discount at
Impaired loans:
6,890
Sales comparison
Discount to appraised value
Liquidation of assets
Residential mortgage loans - first and junior liens
1,494
1,340
Total impaired loans
Foreclosed assets held for sale - real estate:
Commercial real estate
1,254
Residential (1-4 family)
Total foreclosed assets held for sale
5,810
1,509
1,347
1,258
Certain of the Corporation’s financial instruments are not measured at fair value in the consolidated financial statements. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements. Therefore, the aggregate fair value amounts presented may not represent the underlying fair value of the Corporation.
The estimated fair values, and related carrying amounts, of the Corporation’s financial instruments that are not recorded at fair value are as follows:
Fair Value
Hierarchy
Carrying
Level
Financial assets:
Level 1
Level 2
6,054
Restricted equity securities (included in Other Assets)
9,859
9,970
Level 3
1,617,298
1,646,207
Financial liabilities:
Deposits with no stated maturity
1,576,759
1,430,062
Time deposits
347,166
349,693
390,407
393,566
9,600
19,974
51,318
55,723
16,680
Accrued interest payable
390
The Corporation has commitments to extend credit and has issued standby letters of credit. Standby letters of credit are conditional guarantees of performance by a customer to a third party. Estimates of the fair value of these off-balance sheet items were not made because of the short-term nature of these arrangements and the credit standing of the counterparties.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements in this section and elsewhere in this quarterly report on Form 10-Q are forward-looking statements. Citizens & Northern Corporation and its wholly-owned subsidiaries (collectively, the Corporation) intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995. Forward-looking statements, which are not historical facts, are based on certain assumptions and describe future plans, business objectives and expectations, and are generally identifiable by the use of words such as, "should", “likely”, "expect", “plan”, "anticipate", “target”, “forecast”, and “goal”. These forward-looking statements are subject to risks and uncertainties that are difficult to predict, may be beyond management’s control and could cause results to differ materially from those expressed or implied by such forward-looking statements. Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following:
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
CORONAVIRUS (COVID-19) RESPONSE AND PAYCHECK PROTECTION PROGRAM
The Corporation’s Pandemic Committee has been very active since March 2020, providing frequent communication with employees and clients by telephone, video conference, email and digital tools, while substantially limiting business travel. As of March 31, 2021, branches were fully open with additional health and safety requirements to comply with federal and Pennsylvania health mandates, including, among other things, daily deep cleaning, nonsurgical face mask requirements and strict social distancing measures.
Emergency restrictions on the activities of businesses and individuals have resulted in significant adverse economic effects and a significant number of layoffs and furloughs of employees nationwide and in the regions in which the Corporation operates. The ultimate effect of COVID-19 on the local or broader economy is not known nor is the ultimate length of the restrictions described and any accompanying effects. Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its economic impact, the total impact on the Corporation’s loan portfolio is not determinable.
Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) provides that, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States under the National Emergencies Act terminates (the “applicable period”), the Corporation may elect to suspend U.S. GAAP for loan modifications related to the pandemic that would otherwise be categorized as troubled debt restructurings (TDRs) and suspend any determination of a loan modified as a result of the effects of the pandemic as being a TDR, including impairment for accounting purposes. The suspension is applicable for the term of the loan modification that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019. The suspension is not applicable to any adverse impact on the credit of a borrower that is not related to the pandemic.
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On December 27, 2020, the President of the United States signed into law the Consolidated Appropriations Act, 2021 (the “CAA”), which both funds the federal government until September 30, 2021 and broadly addresses additional COVID-19 responses and relief. Among the additional relief measures included are certain extensions to elements of the CARES Act, including extension of temporary relief from troubled debt restructurings established under Section 4013 of the CARES Act to the earlier of a) January 1, 2022, or b) the date that is 60 days after the date on which the national COVID-19 emergency terminates.
In addition, the banking regulators and other financial regulators, on March 22, 2020 and revised April 7, 2020, issued a joint interagency statement titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of the COVID-19 pandemic. Pursuant to the interagency statement, loan modifications that do not meet the conditions of Section 4013 of the CARES Act may still qualify as a modification that does not need to be accounted for as a TDR. Specifically, the agencies confirmed with the Financial Accounting Standards Board (“FASB”) staff that short-term modifications made in good faith in response to the pandemic to borrowers who were current prior to any relief are not TDRs under U.S. GAAP. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. Appropriate allowances for loan and lease losses are expected to be maintained. With regard to loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to the pandemic as past due because of the deferral. The interagency statement also states that during short-term pandemic-related loan modifications, these loans generally should not be reported as nonaccrual.
To work with clients impacted by COVID-19, the Corporation is offering short-term loan modifications on a case-by-case basis to borrowers who were current in their payments at the inception of the loan modification program. Prior to merging with the Corporation on July 1, 2020, Covenant Financial Inc. (“Covenant”) had a similar program in place, and these modified loans have been incorporated into the Corporation’s program. These efforts have been designed to assist borrowers as they deal with the current crisis and help the Corporation mitigate credit risk. For loans subject to the program, each borrower is required to resume making regularly scheduled loan payments at the end of the modification period and the deferred amounts will be moved to the end of the loan term. Consistent with Section 4013 of the CARES Act, the modified loans have not been reported as past due, nonaccrual or as TDRs at March 31, 2021. Most of the modifications under the program became effective in March or the second quarter 2020 and provided a deferral of interest or principal and interest for 90-to-180 days. Most of the loans for which deferrals were granted returned to full payment status prior to March 31, 2021, while additional deferrals have been granted on certain loans. At March 31, 2021, there were 25 loans in deferral status subject to CARES Act Section 4013 guidance with a total recorded investment of $26,044,000. A breakdown of these loans along with a summary of their risk ratings, is as follows:
The recorded investment in Paycheck Protection Program (“PPP”) loans at March 31, 2021 of $137.8 million included a first draw amount of $71.7 million and a second draw amount of $66.1 million with contractual principal balances totaling $73.0 million and $69.0 million, respectively, adjusted by net deferred loan origination fees and a market rate adjustment on PPP loans acquired from Covenant. The recorded investment of $71.7 million in first draw PPP loans at March 31, 2021 decreased $60.6 million from $132.3 million at December 31, 2020, reflecting the impact of loans forgiven and repaid by the SBA. The term of the first draw PPP loans is two years, with repayment from the SBA to occur sooner to the extent the loans are forgiven. Second draw PPP loans have terms of five years, with repayment from the SBA to occur sooner to the extent the loans are forgiven.
Capital Strength
While it is difficult to estimate the future impact of COVID-19, the Corporation, including the principal subsidiary, Citizens & Northern Bank (“C&N Bank”), entered the crisis from a position of strength. This is especially apparent in the capital ratios, which are at levels that demonstrate the capacity to absorb significant losses if they arise while continuing to meet the requirements to be considered well capitalized.
C&N Bank’s leverage ratio (Tier 1 capital to average assets) at March 31, 2021 of 10.66% is significantly higher than the well-capitalized threshold of 5%, an excess capital amount of $122.3 million. Similarly, the total capital to risk-weighted assets ratio at March 31, 2021 is 16.51%, which exceeds the well-capitalized threshold of 10%, an excess capital amount of $95.6 million.
Additional details regarding the Corporation’s and C&N Bank’s regulatory capital position are provided in the “Stockholders’ Equity and Capital Adequacy” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”).
EARNINGS OVERVIEW
Net income was $0.55 per diluted share in the first quarter 2021, up $0.12 (27.9%) from $0.43 in the fourth quarter 2020 and up $0.25 (83.3%) from $0.30 in the first quarter 2020. As described below, earnings of $0.55 per share for the first quarter 2021 were 7.8% higher than fourth quarter 2020 non-U.S. GAAP earnings per share of $0.51 as adjusted to exclude the impact of merger-related expenses, loss on prepayment of borrowings and net gains on available-for-sale debt securities. First quarter 2021 earnings per share were 77.4% higher than first quarter 2020 non-U.S. GAAP earnings per share of $0.31 as adjusted to exclude the impact of merger-related expenses.
The following table provides a reconciliation of the Corporation’s unaudited earnings results under U.S. generally accepted accounting principles (U.S. GAAP) to comparative non-U.S. GAAP results excluding merger-related expenses, loss on prepayment of borrowings and net gains on available-for-sale debt securities. Management believes disclosure of unaudited earnings results for the periods presented, adjusted to exclude the impact of these items, provides useful information to investors for comparative purposes.
RECONCILIATION OF NET INCOME AND
DILUTED EARNINGS PER SHARE TO NON-U.S.
GAAP MEASURE
(Dollars In Thousands, Except Per Share Data) (Unaudited)
1st Quarter 2021
1st Quarter 2020
Before
Per
Tax
Provision
Share
Results as Presented Under U.S. GAAP
Add: Merger-Related Expenses (1)
Adjusted Earnings (Non-U.S. GAAP)
5,123
845
4,278
0.31
40
4th Quarter 2020
8,251
1,481
6,770
0.43
182
Add: Loss on Prepayment of Borrowings (1)
1,636
344
1,292
Net Gains on Available-for-Sale Debt Securities (1)
(144)
(30)
(114)
9,925
1,833
8,092
0.51
(1) Income tax has been allocated based on a marginal income tax rate of 21%.
Additional highlights related to the Corporation’s first quarter of 2021 and 2020 unaudited earnings are presented below.
First quarter 2021 net income was $8,787,000. In comparison, first quarter 2020 net income was $4,166,000, and excluding merger-related expenses, adjusted (non-U.S. GAAP) earnings were $4,278,000. Other significant variances were as follows:
More detailed information concerning fluctuations in the Corporation’s earnings results and other financial information are provided in other sections of Management’s Discussion and Analysis.
ACQUISITION OF COVENANT FINANCIAL, INC.
The Corporation’s acquisition of Covenant was completed July 1, 2020. Covenant was the parent company of Covenant Bank, which operated banking offices in Bucks and Chester Counties of Pennsylvania. Pursuant to the transaction, Covenant merged with and into the Corporation and Covenant Bank merged with and into C&N Bank. Total purchase consideration was $63.3 million, including common stock with a fair value of $41.6 million and cash of $21.7 million. The acquisition of Covenant follows the acquisition of Monument Bancorp, Inc. (“Monument”) on April 1, 2019. Monument was the parent company of Monument Bank, with banking and lending offices in Bucks County, Pennsylvania. The total transaction value of the Monument acquisition was $42.7 million.
In connection with the Covenant acquisition, effective July 1, 2020, the Corporation recorded goodwill of $24.1 million and a core deposit intangible asset of $3.1 million. Assets acquired included loans valued at $464.2 million, cash and due from banks of $97.8 million, bank-owned life insurance valued at $11.2 million and securities valued at $10.8 million. Liabilities assumed included deposits valued at $481.8 million, borrowings valued at $64.0 million and subordinated debt valued at $10.1 million. The assets purchased and liabilities assumed in the acquisition were recorded at their preliminary estimated fair values at the time of closing and may be adjusted for up to one year subsequent to the acquisition. There were no adjustments to the fair values of assets acquired and liabilities assumed in the Covenant acquisition in the first quarter 2021.
TABLE I – QUARTERLY FINANCIAL DATA
For the Three Months Ended :
(Dollars In Thousands, Except Per Share Data)
September 30,
June 30,
(Unaudited)
Interest income
21,859
21,751
16,513
Interest expense
2,104
2,469
2,267
19,755
19,282
14,246
Provision (credit) for loan losses
620
1,941
(176)
Net interest income after provision (credit) for loan losses
19,135
17,341
14,422
Noninterest income
6,565
6,970
5,528
Net gains on securities
Loss on prepayment of borrowings
6,402
983
Other noninterest expenses
15,775
14,648
12,274
12,912
3,286
6,693
1,255
2,848
5,438
6,727
2,830
5,405
Basic earnings per common share
0.18
0.39
Diluted earnings per common share
CRITICAL ACCOUNTING POLICIES
The presentation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates.
Allowance for Loan Losses – A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. Management believes the allowance for loan losses is adequate and reasonable. Note 7 to the unaudited consolidated financial statements provides an overview of the process management uses for evaluating and determining the allowance for loan losses, and additional discussion of the allowance for loan losses is provided in a separate section later in Management’s Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.
Business Combinations – We account for business combinations under the purchase method of accounting. The application of this method of accounting requires the use of significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price consideration between assets that are amortized, accreted or depreciated from those that are recorded as goodwill. Our estimates of the fair values of assets acquired and liabilities assumed are based upon assumptions that we believe to be reasonable.
Fair Value of Debt Securities – Another material estimate is the calculation of fair values of the Corporation’s debt securities. For most of the Corporation’s debt securities, the Corporation receives estimated fair values of debt securities from an independent valuation service, or from brokers. In developing fair values, the valuation service and the brokers use estimates of cash flows, based on historical performance of similar instruments in similar interest rate environments. Based on experience, management is aware that estimated fair values of debt securities tend to vary among brokers and other valuation services.
NET INTEREST INCOME
The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense. Tables II, III and IV include information regarding the Corporation’s net interest income for the
three-month periods ended March 31, 2021 and 2020. In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis. Accordingly, the net interest income amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the related Tables.
For the three-month periods, fully taxable equivalent net interest income was $20,356,000 in 2021, which was $5,850,000 (40.3%) higher than in 2020. Interest income was $4,766,000 higher in 2021 as compared to 2020, while interest expense was lower by $1,084,000 in comparing the same periods. The increase in net interest income reflects the impact of growth mainly attributable to the Covenant acquisition. Table IV shows the net effect of changes in volume resulted in an increase in net interest income of $5,801,000, while changes in interest rates had a net positive impact of $49,000. As presented in Table III, the Net Interest Margin was 4.00% in 2021 as compared to 3.83% in 2020, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) increased to 3.86% in 2021 from 3.54% in 2020. The average yield on earning assets of 4.33% was 0.22% lower in 2021 as compared to 2020, while the average rate on interest-bearing liabilities decreased 0.54% between periods.
Income from purchase accounting-related adjustments in the first quarter 2021 had a positive effect on net interest income of $952,000, including an increase in income on loans of $430,000 and net reductions in interest expense on time deposits and borrowed funds totaling $522,000. The positive impact to the first quarter 2021 net interest margin from purchase accounting adjustments was 0.19%. In comparison, the positive impact to the first quarter 2020 net interest margin was $417,000, or 0.11%.
INTEREST INCOME AND EARNING ASSETS
Interest income totaled $22,027,000 in 2021, an increase of $4,766,000 (27.6%) from 2020. Interest and fees from loans receivable increased $5,008,000, or 33.3%, in 2021 as compared to 2020. Table IV shows the increase in interest on loans includes $5,917,000 related to an increase in average volume, offset by a decrease of $909,000 attributable to a decrease in average rate. Included in the positive volume variance is interest and fees from PPP loans totaling $1,998,000 in the first quarter 2021 with no corresponding amount in the first quarter 2020.
Average outstanding loans receivable increased $466,101,000 (39.9%) to $1,634,586,000 in 2021 from $1,168,485,000 in 2020. The increase in loans outstanding is due largely to the Covenant acquisition and the significant growth of PPP loans over the course of 2020 and the first quarter 2021. The average balance of PPP loans totaled $138,564,000 in the first quarter 2021.
The average yield on loans in the first quarter 2021 was 4.97%, down from 5.18% in the first quarter 2020, as rates on variable rate loans and rates on recent new loan originations have decreased due to decreases in market interest rates throughout most of 2020. Further, yields on loans acquired from Covenant reflect market yields at the acquisition date (July 1, 2020), which were lower than the Corporation’s average portfolio yield before the transaction. The average yield on loans in the first quarter 2021 was also affected by the comparatively low average yield on 2nd Draw PPP loans with a total average balance of $34,197,000 and a yield of 2.21%. The yield on 1st Draw PPP loans of 7.04% helped to bolster the average yield on loans in the first quarter 2021 as previously deferred fees were recognized in income upon the SBA’s repayment of loans based on forgiveness of the underlying borrowers.
Interest income from available-for-sale debt securities decreased $219,000 (10.3%) in 2021 from 2020. Total average available-for-sale debt securities (at amortized cost) in 2021 increased slightly to $335,265,000 from $335,007,000 in 2020. The average balance of tax-exempt securities increased $47,682,000, while the average balance of mortgage-backed securities and other taxable securities decreased $47,424,000. The average yield on available-for-sale debt securities was 2.32% for 2021, down from 2.56% in 2020. The reduction in yield on available-for-sale securities is a result of faster amortization on mortgage-backed securities and purchases of lower yielding securities at recent market rates.
Income from interest-bearing due from banks totaled $50,000 in 2021, a decrease of $31,000 (38.3%) from $81,000 in 2020. The average yield on interest-bearing due from banks dropped to 0.22% in 2021 from 1.68% in 2020, consistent with the decrease in market rates. The average balance increased $73,218,000 as increases in deposits and funds from loan repayments outpaced uses of funds for purchases of securities and repayments of borrowings.
INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
For the three-month periods, interest expense decreased $1,084,000 to $1,671,000 in 2021 from $2,755,000 in 2020. Interest expense on deposits decreased $877,000, as the average rate on interest-bearing deposits decreased to 0.38% in 2021 from 0.89% in 2020. The decrease in average rates on deposits includes decreases of 0.91% on time deposits, 0.22% on money market accounts, 0.18% on interest checking accounts and 0.05% on saving accounts.
Average total deposits increased $570,867,000, including the impact of deposits assumed in the Covenant acquisition, PPP-related activity and funding from other government stimulus programs.
Interest expense on total borrowed funds decreased $207,000 in 2021 as compared to 2020. The average balance of total borrowed funds decreased to $83,755,000 in the first quarter 2021 from $115,447,000 in the first quarter 2020, while the average rate on borrowed funds decreased to 1.90% in the first quarter 2021 from 2.09% in the first quarter 2020. The decrease in average balance and rate on borrowed funds includes the impact of the prepayment of higher cost borrowings of $48.0 million completed in December 2020.
Interest expense on short-term borrowings decreased $183,000 to $15,000 in 2021 from $198,000 in 2020. The average balance of short-term borrowings decreased to $14,365,000 in 2021 from $44,882,000 in 2020. The average rate on short-term borrowings decreased to 0.42% in 2021 from 1.77% in 2020, reflecting the impact of lower short-term market rates in 2021.
Interest expense on long-term borrowings (FHLB advances) decreased $161,000 to $134,000 in 2021 from $295,000 in 2020. The average balance of long-term borrowings was $52,847,000 in 2021, down from an average balance of $64,065,000 in 2020. Borrowings are classified as long-term within the Tables based on their term at origination or assumption in business combinations. The average rate on long-term borrowings was 1.03% in 2021 compared to 1.85% in 2020.
Interest expense on subordinated debt increased $137,000 to $244,000 in 2021 from $107,000 in 2020. The average balance of subordinated debt increased to $16,543,000 in 2021 from $6,500,000 in 2020 as a result of subordinated debt agreements assumed in the Covenant transaction. The average rate incurred on subordinated debt was 5.98% in 2021, down from 6.62% in 2020.
More information regarding the terms of borrowed funds and subordinated debt is provided in Note 9 to the unaudited consolidated financial statements.
TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE
Increase/
(Decrease)
Interest-bearing due from banks
Available-for-sale debt securities:
(475)
801
545
256
1,914
2,133
(219)
Loans receivable:
17,493
3,032
1,812
575
(22)
Total loans receivable
20,044
15,036
5,008
Other earning assets
Total Interest Income
22,027
17,261
4,766
Interest-bearing deposits:
Interest checking
221
243
Money market
306
263
Savings
696
1,585
(889)
Total interest-bearing deposits
(877)
Borrowed funds:
Short-term
(183)
Long-term
(161)
137
Total borrowed funds
393
600
(207)
Total Interest Expense
(1,084)
Net Interest Income
20,356
14,506
5,850
Note: Interest income from tax-exempt securities and loans has been adjusted to a fully tax-equivalent basis, using the Corporation’s marginal federal income tax rate of 21%
46
Table III - Analysis of Average Daily Balances and Rates
Three Months
Ended
Rate of
Return/
3/31/2020
Cost of
Funds %
EARNING ASSETS
92,619
0.22
19,401
1.68
Available-for-sale debt securities,
at amortized cost:
2.07
265,157
2.41
117,532
2.76
69,850
3.14
335,265
2.32
335,007
2.56
1,428,721
4.97
1,108,118
5.25
104,367
7.04
0.00
34,197
2.21
67,301
3.33
60,367
3.83
1,634,586
1,168,485
5.18
2,851
2.70
1,460
3.03
Total Earning Assets
2,065,321
4.33
1,524,353
4.55
Cash
23,796
18,042
Unrealized gain on securities
12,890
8,176
(11,739)
(10,015)
30,154
18,677
Bank premises and equipment
21,348
17,732
Intangible Assets
56,288
29,607
44,628
30,593
Total Assets
2,242,686
1,637,165
INTEREST-BEARING LIABILITIES
355,993
227,069
406,841
200,691
0.53
213,437
0.10
168,971
0.15
370,555
0.76
381,621
1.67
1,346,826
0.38
978,352
0.89
14,365
0.42
44,882
1.77
52,847
1.03
64,065
1.85
16,543
5.98
6.62
83,755
1.90
115,447
2.09
Total Interest-bearing Liabilities
1,430,581
0.47
1,093,799
1.01
Demand deposits
484,286
281,893
Other liabilities
27,930
14,071
Total Liabilities
1,942,797
1,389,763
Stockholders' equity, excluding
other comprehensive income/loss
289,591
240,718
10,298
6,684
Total Stockholders' Equity
299,889
247,402
Total Liabilities and Stockholders' Equity
Interest Rate Spread
3.86
3.54
Net Interest Income/Earning Assets
Total Deposits (Interest-bearing
and Demand)
1,831,112
1,260,245
TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES
Three Months Ended 3/31/21 vs. 3/31/20
Change in
Volume
Rate
Change
89
(120)
(267)
(208)
327
(71)
60
(279)
3,860
(828)
(81)
5,917
(909)
6,075
(1,309)
(125)
(143)
(23)
(45)
(844)
258
(1,135)
(87)
(96)
(116)
148
(223)
274
(1,358)
5,801
TABLE V – COMPARISON OF NONINTEREST INCOME
9.9
(29)
(8.2)
(235)
(18.8)
20.5
Net gains from sales of loans
749
237.8
N/M
44.2
411
38.7
1,501
28.4
N/M = Not Meaningful
Total noninterest income, in the first quarter 2021 increased $1,501,000 (28.4%) from the first quarter 2020 total. Changes of significance are discussed in the Earnings Overview section of Management’s Discussion and Analysis.
TABLE VI - COMPARISON OF NONINTEREST EXPENSE
1,517
20.6
201
18.2
12.7
13.5
16.4
44.3
646
30.6
Total noninterest expense, excluding merger-related expenses
2,797
21.7
(141)
(100.0)
2,656
20.3
Total noninterest expenses in the first quarter 2021 increased $2,656,000 (20.3%) from the first quarter 2020 total. Changes of significance are discussed in the Earnings Overview section of Management’s Discussion and Analysis.
INCOME TAXES
The income tax provision in interim periods is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The income tax provision for the first three months of 2021 was $2,110,000, which was $1,294,000 higher than the provision for the first three months of 2020 of $816,000. The effective tax rate (tax provision as a percentage of pre-tax income) was 19.4% in the first three months of 2021 compared to 16.4% in the first three months of 2020. The Corporation’s effective tax rates differ from the statutory rate of 21% in the first three months of 2021 and 2020 principally because of the effects of tax-exempt interest income, state income taxes and other permanent differences. The higher effective tax rate in the first three months of 2021 as compared to 2020 resulted mainly from an increase in state income taxes and a reduction in the proportion of tax-exempt interest income to total pre-tax income.
The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. The net deferred tax asset at March 31, 2021 and December 31, 2020 represents the following temporary difference components:
Deferred tax assets:
2,305
2,154
Purchase accounting adjustments on loans
1,854
1,930
Net operating loss carryforward
866
896
Operating leases liability
702
724
Other deferred tax assets
2,611
3,089
Total deferred tax assets
8,338
8,793
Deferred tax liabilities:
Unrealized holding gains on securities
1,819
3,104
Defined benefit plans - ASC 835
1,140
1,216
Core deposit intangibles
811
840
Right-of-use assets from operating leases
Other deferred tax liabilities
172
Total deferred tax liabilities
4,808
6,088
In connection with the Covenant merger, the Corporation received a net operating loss (“NOL”) available to be carried forward against federal taxable income of $4.6 million. Availability of the NOL does not expire; however, the amount that may be offset against taxable income is limited to approximately $563,000 per year and further limited annually to no more than 80% of taxable income without regard to the NOL. At December 31, 2020, the unused amount of the NOL was $4.3 million.
The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income.
Management believes the recorded net deferred tax asset at March 31, 2021 is fully realizable; however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings.
FINANCIAL CONDITION
This section includes information regarding the Corporation’s lending activities or other significant changes or exposures that are not otherwise addressed in Management’s Discussion and Analysis. Significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the Net Interest Income section of Management’s Discussion and Analysis. Other significant balance sheet items, including securities, the allowance for loan losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis. There are no significant concerns that have arisen related to the Corporation’s off-balance sheet loan commitments or outstanding letters of credit at March 31, 2021, and management does not expect the amount of purchases of bank premises and equipment to have a material, detrimental effect on the Corporation’s financial condition in 2021.
At March 31, 2021, gross loans outstanding totaled $1,614,587,000, an increase of $447.1 million (38.3%) from March 31, 2020. A significant portion of the Corporation’s loan growth was attributable to the Covenant acquisition and to origination of PPP loans to businesses throughout the Corporation’s market areas. At March 31, 2021, commercial loans represented approximately 62% of the portfolio while residential mortgage loans totaled 37% of the portfolio.
While the Corporation’s lending activities are primarily concentrated in its market areas, a portion of the Corporation’s commercial loan segment consists of participation loans. Participation loans represent portions of larger commercial transactions for which other institutions are the “lead banks”. Although not the lead bank, the Corporation conducts detailed underwriting and monitoring of participation loan opportunities. Participation loans are included in the “Commercial and industrial,” “Commercial loans secured by real estate”, “Political subdivisions” and “Other commercial” classes in the loan tables presented in this Form 10-Q. Total participation loans outstanding amounted to $60,457,000 at March 31, 2021, down from $65,741,000 at December 31, 2020. At March 31, 2021, the balance of participation loans outstanding includes a total of $35,889,000 to businesses located outside of the Corporation’s market areas. Also, included within participation loans are “leveraged loans,” meaning loans to businesses with minimal tangible book equity and for which the extent of collateral available is limited, though typically at the time of origination the businesses have demonstrated strong cash flow performance in their recent histories. Leveraged participation loans totaled $8,378,000 at March 31, 2021 and $8,437,000 at December 31, 2020.
Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Xtra program consist primarily of conforming, prime loans sold to the Federal National Mortgage Association (Fannie Mae), a quasi-government entity. In 2014, the Corporation began to originate and sell residential mortgage loans to the secondary market through the MPF Original program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Original program consist primarily of conforming, prime loans sold to the Federal Home Loan Bank of Pittsburgh. In late 2019, the Corporation began to originate and sell larger-balance, nonconforming mortgages under the MPF Direct Program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. The Corporation does not retain servicing rights for loans sold under the MPF Direct Program. Through March 31, 2021, the Corporation’s activity under the MPF Direct Program has been minimal.
For loan sales originated under the MPF programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met. Such repurchases or reimbursements generally result from an underwriting or documentation deficiency. At March 31, 2021, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,698,000, and the corresponding total outstanding balance of repurchased loans at December 31, 2020 was $1,714,000.
At March 31, 2021, outstanding balances of loans sold and serviced through the MPF Xtra and Original programs totaled $295,504,000, including loans sold through the MPF Xtra program of $154,553,000 and loans sold through the Original program of $140,951,000. At December 31, 2020, outstanding balances of loans sold and serviced through the two programs totaled $278,857,000, including loans sold through the MPF Xtra program of $149,463,000 and loans sold through the Original Program of $129,394,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of March 31, 2021 and December 31, 2020.
For loans sold under the Original program, the Corporation provides a credit enhancement whereby the Corporation would assume credit losses in excess of a defined First Loss Account (“FLA”) balance, up to specified amounts. The FLA is funded by the Federal Home Loan Bank of Pittsburgh based on a percentage of the outstanding balance of loans sold. At March 31, 2021, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $7,217,000, and the Corporation has recorded a related allowance for credit losses in the amount of $530,000 which is included in accrued interest and other liabilities in the accompanying consolidated balance sheets. At December 31, 2020, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $6,766,000, and the related allowance for credit losses was $500,000. Income related to providing the credit enhancement (included in other noninterest income in the consolidated statements of income) totaled $115,000 for the three months ended March 31, 2021 and $15,000 for the three months ended March 31, 2020. A provision for losses related to the credit enhancement obligation (included in other noninterest expense in the consolidated statements of income) of $30,000 was recorded in the three months ended March 31, 2021 with a credit for losses of $30,000 in the three months ended March 31, 2020. The Corporation does not provide a credit enhancement for loans sold through the Xtra program.
51
The Corporation is a participating SBA lender. Under the terms of its arrangements with the SBA, the Corporation may originate loans to commercial borrowers, with full-or-partial guarantees by the SBA, subject to the SBA’s underwriting and documentation requirements. Covenant had also been a participating SBA lender. Pursuant to the Covenant acquisition, the Corporation acquired loans with partial SBA guarantees, or in some cases, loans where the SBA-guaranteed portion of the loans had been sold back to the SBA subject to ongoing compliance with SBA underwriting and documentation requirements. As part of its due diligence, the Corporation reviewed all the loans originated through the various SBA loan programs acquired from Covenant as of July 1, 2020 and recorded an allowance for SBA claim adjustments of $800,000. Determination of the allowance was subjective in nature and was based on the Corporation’s assessment of the credit quality of the loans and the quality of the documentation supporting compliance with SBA requirements. The Corporation’s total exposure related to SBA guarantees on loans originated by Covenant was $15,210,000 at March 31, 2021 and $17,041,000 at December 31, 2020 with an allowance for SBA claim adjustments (included in accrued interest and other liabilities in the consolidated balance sheets) of $730,000 at March 31, 2021 and December 31, 2020.
TABLE VII - SUMMARY OF LOANS BY TYPE
2019
2018
2017
2016
301,227
162,611
159,266
150,468
126,374
91,856
88,276
83,854
53,570
53,263
59,287
38,068
33,555
14,527
14,287
12,251
7,146
7,255
7,294
31,070
7,180
7,713
7,896
4,319
5,659
6,178
3,998
16,535
13,950
10,986
11,475
578,901
353,627
353,488
317,340
510,641
372,339
359,987
334,102
27,503
25,450
25,325
23,706
33,638
34,319
35,758
38,057
14,798
24,698
26,216
24,908
586,580
456,806
447,286
420,773
16,741
17,130
14,939
13,722
1,182,222
827,563
815,713
751,835
(9,836)
(9,309)
(8,856)
(8,473)
1,172,386
818,254
806,857
743,362
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. Note 7 to the unaudited consolidated financial statements provides an overview of the process management uses for evaluating and determining the allowance for loan losses.
While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.
The allowance for loan losses was $11,661,000 at March 31, 2021, up from $11,385,000 at December 31, 2020. Table IX shows total specific allowances on impaired loans increased $199,000 to $1,124,000 at March 31, 2021 from $925,000 at December 31, 2020. This net increase included the impact of recording a specific allowance of $208,000 on a commercial loan with an outstanding principal balance of $1,283,000 in the first quarter of 2021.
Loans acquired from Covenant that were identified as having a deterioration in credit quality (purchased credit impaired, or PCI), were valued at $6,648,000 at July 1, 2020 and $6,479,000 at March 31, 2021. The remainder of the portfolio was deemed to be the performing component of the portfolio. Performing loans acquired from Covenant are presented net of a discount for credit losses of $4,664,000 at March 31, 2021 and $5,362,000 at December 31, 2020. This discount reflects an estimate of the present value of credit losses based on market expectations at the date of acquisition of $7,219,000, subsequently reduced as accretion has been recognized based on estimated and actual principal pay-downs.
Loans acquired from Monument that were identified as PCI were valued at $441,000 at April 1, 2019 and $304,000 at March 31, 2021. The remainder of the portfolio was deemed to be the performing component of the portfolio. Performing loans acquired from Monument are presented net of a discount for credit losses of $518,000 at March 31, 2021 and $617,000 at December 31, 2020. This discount reflects an estimate of the present value of credit losses based on market expectations at the date of acquisition of $1,914,000, subsequently reduced as accretion has been recognized based on estimated and actual principal pay-downs.
Table X shows the allowance for loan losses totaled 0.72% of gross loans outstanding at March 31, 2021, up from 0.69% at December 31, 2020 and down from levels in excess of 1.00% from 2016 to 2018. Table X also shows that the total of the allowance and the credit adjustment on purchased non-impaired loans, as a percentage of total loans plus the credit adjustment, was 1.04% at March 31, 2021, in line with ratios from the previous years.
The provision (credit) for loan losses by segment in the three-month periods ended March 31, 2021 and 2020 are as follows:
53
The (credit) provision for loan losses is further detailed as follows:
Commercial segment
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs
193
1,175
Increase (decrease) in collectively determined portion of the allowance attributable to:
Changes in loan volume
Changes in historical loss experience factors
(49)
Changes in qualitative factors
(44)
157
Total provision for loan losses - Commercial segment
Residential mortgage segment
(Decrease) increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs
(10)
(Decrease) increase in collectively determined portion of the allowance attributable to:
(38)
(40)
237
Total (credit) provision for loan losses - Residential mortgage segment
Consumer segment
Total (credit) provision for loan losses - Consumer segment
Total - All segments
1,210
125
(97)
167
Total provision for loan losses - All segments
For the periods shown in the tables immediately above, the provision related to increases or decreases in specific allowances on impaired loans was affected by changes in the results of management’s assessment of the amount of probable or actual (charged-off) losses associated with a small number of larger, individual loans. This line item also includes net charge-offs or recoveries from smaller loans that had not been individually evaluated for impairment prior to charge-off.
In the tables immediately above, the portion of the net change in the collectively determined allowance attributable to loan growth was determined by applying the historical loss experience and qualitative factors used in the allowance calculation at the end of the preceding
54
period to the net increase or reduction in loans outstanding (excluding purchased loans and loans specifically evaluated for impairment) for the period.
The effect on the provision of changes in historical loss experience and qualitative factors, as shown in the tables above, was determined by: (1) calculating the net change in each factor used in determining the allowance at the end of the period as compared to the preceding period, and (2) applying the net change in each factor to the outstanding balance of loans at the end of the preceding period (excluding loans specifically evaluated for impairment).
In the three months ended March 31, 2021, net recoveries were $17,000, including recoveries of $28,000 and charge-offs of $11,000. Table X shows the average rate of net charge-offs as a percentage of loans was 0.00% in the three months ended March 31, 2021, and annual average rates ranging from a high of 0.16% in 2020 to a low of 0.02% in 2018.
Table X presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs). Total nonperforming loans as a percentage of outstanding loans was 1.45% at March 31, 2021, up from 1.42% at December 31, 2020, and nonperforming assets as a percentage of total assets was 1.07% at March 31, 2021, down from 1.10% at December 31, 2020. Table X presents data at the end of each of the years ended December 31, 2016 through 2020. Table X shows that total nonperforming loans as a percentage of loans of 1.45% at March 31, 2021, though up from December 31, 2020 and 2019, was lower than the corresponding year-end ratio from 2016 through 2018. Similarly, the March 31, 2021 ratio of total nonperforming assets as a percentage of assets of 1.07% was lower than the corresponding ratio from 2016 through 2018.
Total impaired loans of $18,158,000 at March 31, 2021 are up $340,000 from the corresponding amount at December 31, 2020 of $17,818,000. Purchased credit impaired loans, primarily acquired from Covenant, were included in impaired loans and had carrying values totaling $6,781,000 at March 31, 2021 and $6,841,000 at December 31, 2020. Table X shows that the total balance of impaired loans at March 31, 2021 was higher than the year-end amounts over the period 2016-2020, which ranged from a low of $5,486,000 in 2019 to the high of $17,818,000 at December 31, 2020. Similarly, total nonperforming assets of $24,873,000 at March 31, 2021 and $24,729,000 at December 31, 2020 were up from the prior periods mainly due to the inclusion of purchased credit impaired loans from the Covenant acquisition.
As reflected in Table X, total loans past due 30-89 days and still accruing interest amounted to $6,777,000 at March 31, 2021, up from $5,918,000 at December 31, 2020. This variance includes the effect of fluctuations in 30-89 day past due residential mortgage loans, which totaled $5,779,000 at March 31, 2021, up from $5,084,000 at December 31, 2020. Management monitors the status of delinquent residential mortgage loans on an ongoing basis and has considered delinquency trends, which were generally favorable through the first quarter 2021, in evaluating the allowance for loan losses at March 31, 2021.
Over the period 2016-2020 and the first three months of 2021, each period includes a few large commercial relationships that have required significant monitoring and workout efforts. As a result, a limited number of relationships may significantly impact the total amount of allowance required on impaired loans, and may significantly impact the amount of total charge-offs reported in any one period.
Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of March 31, 2021. Management continues to closely monitor its commercial loan relationships for possible credit losses, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.
Tables VIII through X present historical data related to loans and the allowance for loan losses.
TABLE VIII - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
Years Ended December 31,
Balance, beginning of year
9,309
8,856
8,473
7,889
Charge-offs:
(2,343)
(165)
(597)
(190)
(158)
(197)
(122)
(174)
Total charge-offs
(2,465)
(379)
(497)
(479)
(757)
Recoveries:
317
Total recoveries
57
366
Net recoveries (charge-offs)
(2,364)
(322)
(131)
(418)
(637)
3,913
849
1,221
Net charge-offs as a % of average loans
0.16
0.03
0.02
0.05
0.09
TABLE IX - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES
As of December 31,
ASC 310 - Impaired loans
1,051
1,605
1,279
674
ASC 450 - Collective segments:
3,102
3,078
3,373
4,006
3,870
3,841
3,890
138
499
398
Total Allowance
TABLE X - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS
AND TROUBLED DEBT RESTRUCTURINGS (TDRs)
3,375
4,851
4,100
3,372
Impaired loans without a valuation allowance
2,023
2,895
1,670
4,923
5,411
7,488
Purchased credit impaired loans
441
5,486
9,774
9,511
10,860
Total loans past due 30-89 days and still accruing
6,777
5,918
8,889
7,142
9,449
7,735
Nonperforming assets:
Other nonaccrual loans
15,335
14,575
8,777
13,113
13,404
8,736
Total nonaccrual loans
9,218
Total loans past due 90 days or more and still accruing
1,207
3,724
6,838
Total nonperforming loans
23,401
23,391
10,425
16,019
17,128
15,574
Foreclosed assets held for sale (real estate)
2,886
1,703
1,598
2,180
Total nonperforming assets
24,873
24,729
13,311
17,722
18,726
17,754
Loans subject to troubled debt restructurings (TDRs):
Performing
302
889
655
636
5,803
Nonperforming
6,883
7,285
1,737
3,027
2,874
Total TDRs
2,626
3,539
3,663
8,677
Total nonperforming loans as a % of loans
1.45
1.42
0.88
2.10
Total nonperforming assets as a % of assets
1.07
1.10
0.80
1.37
1.47
1.43
Allowance for loan losses as a % of total loans
0.72
0.69
0.83
1.12
1.09
1.13
Credit adjustment on purchased non-impaired loans and allowance for loan lossesas a % of total loans and the credit adjustment (a)
1.04
1.05
0.93
Allowance for loan losses as a % of nonperforming loans
49.83
48.67
94.35
58.11
51.70
54.40
(a) Credit adjustment on purchased non-impaired loans at end of period
5,182
5,979
Total credit adjustment on purchased non-impaired loans at end of period and allowance for loan losses (1)
16,843
17,364
11,052
Credit adjustment on purchased non-impaired loans at end of period
Total (2)
1,619,769
1,650,188
1,183,438
Credit adjustment on purchased non-impaired loans and allowance for loan losses as a % of total loans and the credit adjustment (1)/(2)
LIQUIDITY
Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand. At March 31, 2021, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $176,856,000. The Corporation’s cash position at March 31, 2021 was elevated, as in the first quarter 2021 growth in deposits and funds received from repayment of loans have outpaced purchases of securities, repayments of borrowings and other uses of cash.
The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity. Also, the Corporation maintains borrowing facilities with the Federal Home Loan Bank of Pittsburgh, secured by various mortgage loans.
The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. Management intends to use this line of credit as a contingency funding source. As collateral for the line, the Corporation has pledged available-for-sale debt securities with a carrying value of $14,992,000 at March 31, 2021.
The Corporation’s outstanding, available, and total credit facilities at March 31, 2021 and December 31, 2020 are as follows:
Outstanding
Available
Total Credit
Federal Home Loan Bank of Pittsburgh
58,199
72,222
703,562
698,977
761,761
771,199
Federal Reserve Bank Discount Window
14,522
14,654
Other correspondent banks
45,000
Total credit facilities
763,084
758,631
821,283
830,853
At March 31, 2021, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of short-term borrowings of $8,000,000, long-term borrowings of $49,799,000 and a letter of credit of $400,000. At December 31, 2020, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of short-term borrowings of $18,000,000, long-term borrowings of $53,822,000 and a $400,000 letter of credit. Additional information regarding borrowed funds is included in Note 9 to the unaudited consolidated financial statements.
Additionally, the Corporation uses “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis. If required to raise cash in an emergency situation, the Corporation could sell available-for-sale securities to meet its obligations or use repurchase agreements placed with brokers to borrow funds secured by investment assets. At March 31, 2021, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $151,044,000.
Management believes the Corporation is well-positioned to meet its short-term and long-term funding obligations.
STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY
In August 2018, the Federal Reserve Board issued an interim final rule that expanded applicability of the Board’s small bank holding company policy statement. The interim final rule raised the policy statement’s asset threshold from $1 billion to $3 billion in total consolidated assets for a bank holding company or savings and loan holding company that: (1) is not engaged in significant nonbanking activities; (2) does not conduct significant off-balance sheet activities; and (3) does not have a material amount of debt or equity securities, other than trust-preferred securities, outstanding. The interim final rule provides that, if warranted for supervisory purposes, the Federal Reserve may exclude a company from the threshold increase. Management believes the Corporation meets the conditions of the Federal Reserve’s small bank holding company policy statement and is therefore excluded from consolidated capital requirements at March 31, 2021; however, C&N Bank remains subject to regulatory capital requirements administered by the federal banking agencies.
58
Details concerning capital ratios at March 31, 2021 and December 31, 2020 are presented below. Management believes, as of March 31, 2021, that C&N Bank meets all capital adequacy requirements to which it is subject and maintains a capital conservation buffer (described in more detail below) that allows the Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Further, as reflected in the table below, the Corporation’s and C&N Bank’s capital ratios at March 31, 2021 and December 31, 2020 exceed the Corporation’s Board policy threshold levels.
Minimum To Be
Minimum To Maintain
Well
Minimum
Capital Conservation
Capitalized Under
Minimum To Meet
Buffer at Reporting
Prompt Corrective
the Corporation's
Actual
Requirement
Action Provisions
Policy Thresholds
Ratio
March 31, 2021:
Total capital to risk-weighted assets:
Consolidated
265,515
18.03
N/A
154,644
≥10.5
C&N Bank
242,477
16.51
117,482
≥8
154,194
146,852
≥10
Tier 1 capital to risk-weighted assets:
236,790
16.08
125,188
≥8.5
230,286
15.68
88,111
≥6
124,824
Common equity tier 1 capital to risk-weighted assets:
103,096
≥7
66,083
≥4.5
102,796
≥7.0
95,454
≥6.5
Tier 1 capital to average assets:
10.88
174,138
10.66
86,406
≥4
108,008
≥5
172,813
December 31, 2020:
260,015
17.49
156,113
236,943
15.98
118,602
155,665
148,252
231,577
15.58
126,377
225,058
15.18
88,951
126,015
104,075
66,714
103,777
96,364
10.34
179,206
10.12
88,959
111,199
177,919
Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. In addition, the Corporation and C&N Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities. Further, although the Corporation is no longer subject to the specific consolidated capital requirements described herein, the Corporation’s ability to pay dividends, repurchase stock or engage in other activities may be limited by the Federal Reserve if the Corporation fails to hold capital commensurate with its overall risk profile.
To avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization subject to the rule must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets. At March 31, 2021, the minimum risk-based capital ratios, and the capital ratios including the capital conservation buffer, are as follows:
Minimum common equity tier 1 capital ratio
4.5
Minimum common equity tier 1 capital ratio plus capital conservation buffer
7.0
Minimum tier 1 capital ratio
6.0
Minimum tier 1 capital ratio plus capital conservation buffer
8.5
Minimum total capital ratio
8.0
Minimum total capital ratio plus capital conservation buffer
10.5
A banking organization with a buffer greater than 2.5% over the minimum risk-based capital ratios would not be subject to additional limits on dividend payments or discretionary bonus payments; however, a banking organization with a buffer less than 2.5% would be
subject to increasingly stringent limitations as the buffer approaches zero. Also, a banking organization is prohibited from making dividend payments or discretionary bonus payments if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% as of the beginning of that quarter. Eligible net income is defined as net income for the four calendar quarters preceding the current calendar quarter, net of any distributions and associated tax effects not already reflected in net income. A summary of payout restrictions based on the capital conservation buffer is as follows:
Capital Conservation Buffer
Maximum Payout
(as a % of risk-weighted assets)
(as a % of eligible retained income)
Greater than 2.5%
No payout limitation applies
≤2.5% and >1.875%
≤1.875% and >1.25%
≤1.25% and >0.625%
≤0.625%
At March 31, 2021, C&N Bank’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 8.51%.
The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale debt securities. The difference between amortized cost and fair value of available-for-sale debt securities, net of deferred income tax, is included in Accumulated Other Comprehensive Income within stockholders’ equity. The balance in Accumulated Other Comprehensive Income related to unrealized gains (losses) on available-for-sale debt securities, net of deferred income tax, amounted to $6,847,000 at March 31, 2021 and $11,676,000 at December 31, 2020. Changes in accumulated other comprehensive income are excluded from earnings and directly increase or decrease stockholders’ equity. If available-for-sale debt securities are deemed to be other-than-temporarily impaired, unrealized losses are recorded as a charge against earnings, and amortized cost for the affected securities is reduced. Note 6 to the unaudited consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale debt securities for other-than-temporary impairment at March 31, 2021.
ITEM 4. CONTROLS AND PROCEDURES
The Corporation’s management, under the supervision of and with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer, has carried out an evaluation of the design and effectiveness of the Corporation’s disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934 as of the end of the period covered by this report. This evaluation did not include an assessment of those disclosure controls and procedures that are involved in, and did not include an assessment of, internal control over financial reporting as it relates to Covenant Financial, Inc. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Corporation’s disclosure controls and procedures are effective to ensure that all material information required to be disclosed in reports the Corporation files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.
The Covenant Financial, Inc. acquisition was completed July 1, 2020, and during the nine months ended March 31, 2021 the Corporation began the process of integrating processes and internal control over financial reporting for the former Covenant locations into those of the Corporation. Though significant progress has been made, at March 31, 2021, the Corporation’s management had not yet completed changes to processes, information technology systems and other components of internal control over financial reporting as part of integration activities.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
The Corporation and C&N Bank are involved in various legal proceedings incidental to their business. Management believes the aggregate liability, if any, resulting from such pending and threatened legal proceedings will not have a material, adverse effect on the Corporation’s financial condition or results of operations.
Item 1A. Risk Factors
There have been no material changes from the risk factors previously disclosed in Item 1A of the Corporation’s Form 10-K filed March 5, 2021.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
Effective February 18, 2021, the Corporation amended its existing treasury stock repurchase program. Under the amended program, the Corporation is authorized to repurchase up to 1,000,000 shares of the Corporation’s common stock, or 6.25% of the Corporation’s issued and outstanding shares at February 18, 2021. To date, no shares have been repurchased under the repurchase program originally approved in 2016 and modified in 2021. As permitted by securities laws and other legal requirements and subject to market conditions and other factors, purchases under the new program may be made from time to time in the open market at prevailing prices, or through privately negotiated transactions.
Consistent with the previously approved program, the Board of Directors' February 18, 2021 approval provides that: (1) the treasury stock repurchase program, as amended to increase the repurchase authorization to 1,000,000 shares, shall be effective when publicly announced and shall continue thereafter until suspended or terminated by the Board of Directors, in its sole discretion; and (2) all shares of common stock repurchased pursuant to the program shall be held as treasury shares and be available for use and reissuance for purposes as and when determined by the Board of Directors including, without limitation, pursuant to the Company's Dividend Reinvestment and Stock Purchase Plan and its equity compensation program.
The following table sets forth a summary of the purchases by the Corporation of its common stock during the first quarter 2021.
Total Number of
Maximum
Shares that May
as Part of
Yet
Publicly
be Purchased
Total Number
Announced
Under
of Shares
Price Paid
Plans
the Plans or
Period
per Share
or Programs
Programs
January 1 - 31, 2021
600,000
February 1 - 17, 2021
February 18 - 28, 2021
1,000,000
March 1 - 31, 2021
Item 3. Defaults Upon Senior Securities
None
Item 4. Mine Safety Disclosures
Not applicable
Item 5. Other Information
Item 6. Exhibits
2.
Plan of acquisition, reorganization, arrangement, liquidation or succession:
2.1
Agreement and Plan of Merger dated September 27, 2018, between the Corporation and Monument Bancorp, Inc.
Incorporated by reference to Exhibit 2.1 of the Corporation’s Form 8-K filed September 28, 2018
2.2
Agreement and Plan of Merger dated December 18, 2019, between the Corporation and Covenant Financial, Inc.
Incorporated by reference to Exhibit 2.1 of the Corporation’s Form 8-K filed December 18, 2019
3.
(i) Articles of Incorporation
Incorporated by reference to Exhibit 3.1 of the Corporation’s Form 8-K filed September 21, 2009
(ii) By-laws
Incorporated by reference to Exhibit 3.1(ii) of The Corporation’s Form S-4/A filed April 20, 2020
4.
Instruments defining the rights of Security holders, including Indentures
10.
Material contracts
15.
Letter re: unaudited interim information
18.
Letter re: change in accounting principles
22.
Published report regarding matters submitted to vote of security holders
23.
Consents of experts and counsel
24.
Power of attorney
31.
Rule 13a-14(a)/15d-14(a) certifications:
31.1
Certification of Chief Executive Officer
Filed herewith
31.2
Certification of Chief Financial Officer
32.
Section 1350 certifications
99.
Additional exhibits
100.
XBRL-related documents
101.
Interactive data file
104.
Cover page interactive data file
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
May 7, 2021
By: /s/ J. Bradley Scovill
President and Chief Executive Officer
By: /s/ Mark A. Hughes
Treasurer and Chief Financial Officer