The purpose of Management's Discussion and Analysis of First Keystone Corporation, a bank holding company (the "Corporation"), and its wholly owned subsidiary, First Keystone Community Bank (the "Bank"), is to assist the reader in reviewing the financial information presented and should be read in conjunction with the consolidated financial statements and other financial data contained herein. Refer to Forward-Looking Statements on page 1 for detailed information. 24 Table of Contents RESULTS OF OPERATIONS
End of year December 31, 2020 Compared to the year ended December 31, 2019
Net income increased to $11,837,000 for the year ended December 31, 2020, as compared to $10,227,000 for the prior year, an increase of 15.7%. Earnings per share, both basic and diluted, for 2020 was $2.03 as compared to $1.77 in 2019, an increase of 14.7%. Dividends per share for 2020 and 2019 were $1.08. The Corporation's return on average assets was 1.09% in 2020 and 1.02% in 2019. Return on average equity increased to 8.61% in 2020 from 8.17% in 2019. Total interest income in 2020 amounted to $39,567,000, an increase of $1,040,000 or 2.7% from 2019. The increase in interest income reflects $610,000 in servicing fees earned from the SBA related to the origination of PPP loans throughout 2020. Total interest expense of $6,360,000 decreased $3,883,000 or 37.9% from 2019. The majority of this decrease related to a decrease in interest paid on deposits and short-term borrowings in 2020. Net interest income, as indicated below in Table 1, increased by $4,923,000 or 17.4% to $33,207,000 for the year ended December 31, 2020. The Corporation's net interest income on a fully tax equivalent basis increased by $4,761,000, or 15.8% to $34,866,000 in 2020 as compared to $30,105,000 in 2019.
Table 1 – Reconciliation of taxable equivalent net interest income
(Dollars in thousands) 2020/2019 Increase/(Decrease) 2020 Amount % 2019 Interest Income $ 39,567$ 1,040 2.7 $ 38,527 Interest Expense 6,360 (3,883) (37.9) 10,243 Net Interest Income 33,207 4,923 17.4 28,284 Tax Equivalent Adjustment 1,659 (162)
(8.9) 1,821 Net interest income (fully tax equivalent) $ 34,866$ 4,761 15.8 $ 30,105
25 Table of Contents
Table 2 – Average Balances, Rates and Interest Income and Expenses
(Dollars in thousands) 2020 2019 Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Interest Earning Assets: Loans: Commercial, net1,2,4 $ 97,418$ 3,096 3.18 % $ 90,706$ 3,707 4.09 % Real Estate1,2 581,404 26,590 4.57 % 525,169 24,727 4.71 % Consumer, net1,4 5,310 440 8.30 % 5,723 497 8.68 % Fees on cash loans - 1,554 - % - 782 - % Total Loans5 684,132 31,680 4.63 % 621,598 29,713 4.78 % Securities: Taxable 205,236 4,792 2.33 % 192,044 5,338 2.78 % Tax-Exempt1,3 103,696 4,528 4.37 % 108,464 4,763 4.39 %
Total Investment Securities 308,932 9,320 3.02 % 300,508 10,101 3.36 % Restricted Investment in Bank Stocks 3,605 210 5.84 % 6,302 496 7.87 % Interest-Bearing Deposits in Other Banks 10,508 16 0.15 % 3,005 38 1.26 % Total Other Interest Earning Assets 14,113 226 1.61 % 9,307 534 5.74 % Total Interest Earning Assets 1,007,177 41,226 4.09 %
931 413 40 348 4.33%
Non-Interest Earning Assets: Cash and Due From Banks 8,292 8,364 Allowance for Loan Losses (7,330) (6,816) Premises and Equipment 20,309 21,215 Other Assets 52,550 53,385
Total Non-Interest Earning Assets 73,821
76,148 Total Assets $ 1,080,998$ 1,007,561 Interest Bearing Liabilities: Savings, NOW, Money Markets and Interest Checking $ 452,323$ 1,717 0.38 % $ 370,303$ 2,764 0.75 % Time Deposits 206,566 3,229 1.56 % 213,437 3,887 1.82 % Securities Sold U/A to Repurchase 18,350 105 0.58 %
15,632 161 1.03 % Short-Term Borrowings 25,396 254 1.00 % 96,377 2,494 2.59 % Long-Term Borrowings 50,587 991 1.96 % 45,370 937 2.07 % Subordinated Debentures 1,458 64 4.37 % - - - %
Total interest-bearing liabilities 754,680 6,360 0.84%
741 119 10 243 1.38%
Non-Interest Bearing Liabilities: Demand Deposits 177,691 133,835 Other Liabilities 11,172 7,463 Stockholders' Equity 137,455 125,144 Total Liabilities/Stockholders' Equity $ 1,080,998 $
Net Interest Income Tax Equivalent $ 34,866
$ 30,105 Net Interest Spread 3.25 % 2.95 % Net Interest Margin 3.46 % 3.23 %
1 Tax exempt income has been adjusted on a tax equivalence basis using a progressive rate of 21% and the rejection of statutory interest expense.
2 Includes tax equivalent adjustments on non-taxable municipal loans of $ 150,000 and
$ 269,000 for the years 2020 and 2019, respectively.
3 Includes tax equivalence adjustments on non-taxable municipal titles
$ 1,509,000 and $ 1,552,000 for the years 2020 and 2019, respectively.
4 Installment loans are shown net of unearned interest.
5Average loan balances include non-accrual loans. Interest income on non-accrual loans is not included. 26 Table of Contents NET INTEREST INCOME The major source of operating income for the Corporation is net interest income. Net interest income is the difference between interest income on earning assets, such as loans and securities, and the interest expense on liabilities used to fund those assets, including deposits and other borrowings. The amount of interest income is dependent upon both the volume of earning assets and the level of interest rates. In addition, the volume of non-performing loans affects interest income. The amount of interest expense varies with the amount of funds needed to support earning assets, interest rates paid on deposits and borrowed funds, and finally, the level of interest free deposits. Table 2 on the preceding page provides a summary of average outstanding balances of earning assets and interest bearing liabilities with the associated interest income and interest expense as well as average tax equivalent rates earned and paid as of year-end 2020 and 2019. The yield on earning assets was 4.09% in 2020 and 4.33% in 2019. The rate paid on interest bearing liabilities was 0.84% in 2020 and 1.38% in 2019. This resulted in an increase in our net interest spread to 3.25% in 2020, as compared to 2.95% in 2019. As Table 2 illustrates, net interest margin, which is interest income less interest expense divided by average earning assets was 3.46% in 2020 as compared to 3.23% in 2019. Net interest margins are presented on a tax-equivalent basis. In 2020, the yield on earning assets decreased by 0.24% and the rate paid on interest bearing liabilities decreased by 0.54%. Yields decreased across all segments of interest earning assets and interest bearing liabilities during 2020, mainly as a result of the current low interest rate environment precipitated by rate cuts that occurred in 2020 as a result of the COVID-19 pandemic. The yield on loans decreased from 4.78% in 2019 to 4.63% in 2020 mainly due to loans repaid or refinanced that were reinvested at lower interest rates, as well as the Bank's origination of SBA Paycheck Protection Program loans that have interest rates of 1.00%. The securities portfolio yield decreased to 3.02% in 2020 as compared to 3.36% in 2019. The decrease was mainly the result of reduced yield on taxable securities which declined from 2.78% in 2019 to 2.33% in 2020 due to maturities, calls, and sales of investment securities that were reinvested at lower rates. The average rate paid on short-term borrowings decreased 1.59% from 2.59% in 2019 to 1.00% in 2020. The rate paid on savings, NOW, money market, and interest checking accounts decreased 0.37% from 0.75% to 0.38% and the average rate paid on time deposits decreased 0.26% from 1.82% to 1.56%. Interest income exempt from federal tax was $3,319,000 in 2020 and $3,766,000 in 2019. Interest income exempt from federal tax decreased due to the sales and calls of tax-exempt securities and payoffs of tax-exempt loans. Tax-exempt income has been adjusted to a tax-equivalent basis using an incremental rate of 21%. The increase in net interest margin at December 31, 2020 compared to December 31, 2019 was primarily due to decreased yields on interest bearing liabilities resulting in lower interest expense in 2020, as compared to 2019. Fully tax equivalent net interest income increased by $4,761,000 or 15.8% to $34,866,000 at December 31, 2020 compared to $30,105,000 at December 31, 2019. Throughout 2020, the Federal Reserve decreased the federal-funds rate by 1.5%, resulting in a target range of 0.00% - 0.25%. The Corporation could experience a decrease in net interest income if market rates remain static or continue to decline, as the Corporation's net interest income continues to be liability sensitive. To negate the potential impact of a decreasing net interest margin, the Corporation will continue to focus on attracting lower cost core deposits such as checking, savings, and money market accounts, thereby further reducing its dependence on higher priced certificates of deposit and short-term borrowings. The Corporation is actively monitoring and restructuring its portfolios to become more asset sensitive, which will allow for better performance in a static or rates-down environment. The Corporation will continue to evaluate the potential impact of short-term rate fluctuations in 2021, as well as the slope and position of the yield curve. Table 3 sets forth changes in interest income and interest expense for the periods indicated for each category of interest earning assets and interest bearing liabilities. Information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by prior rate); (ii) changes in rate (changes in average rate multiplied by prior average volume); and, (iii) changes in rate and volume (changes in average volume multiplied by change in average rate). 27
In 2020, the increase in net interest income on a fully tax equivalent basis of $4,761,000 resulted from an increase in volume of $4,244,000 and an increase of $517,000 due to changes in rate.
Table 3 – Flow / volume analysis
(Dollars in thousands) 2020 COMPARED TO 2019 VOLUME RATE NET Interest Income: Loans, Net $ 2,989$ (1,022)$ 1,967 Taxable Securities 367 (913) (546) Tax-Exempt Securities (209) (26) (235)
Restricted investment in Bank shares (212) (74) (286) Other
95 (117) (22) Total Interest Income $ 3,030$ (2,152)$ 878
Savings on Interest Fees, NOW and Money Markets $ 612($ 1,659)($ 1,047)
(125) (533) (658) Securities Sold U/A to Repurchase 28 (84) (56)
Short-Term Borrowings (1,837) (403) (2,240) Long-Term Borrowings 108 (54) 54 Subordinated Debentures - 64 64 Total Interest Expense (1,214) (2,669) (3,883) Net Interest Income $ 4,244$ 517$ 4,761
The change in interest due to both volume and yield/rate has been allocated to change due to volume and change due to yield/rate in proportion to the absolute value of the change in each. Balances on non-accrual loans are included for computational purposes. Interest income on non-accrual loans is not included.
PROVISION FOR LOAN LOSSES
For the year ended December 31, 2020, the provision for loan losses was $1,200,000 as compared to $450,000 for the year ended December 31, 2019. The increase in the provision for loan losses in 2020 as compared to 2019 resulted from the Corporation's analysis of the current loan portfolio, including historic losses, past-due trends, current economic conditions, loan portfolio growth, and other relevant factors. The provision for loan losses for the year ended December 31, 2020 is also reflective of management's assessment of the increased risk associated with the economic uncertainty surrounding the COVID-19 pandemic. Charge-off and recovery activity in the allowance for loan losses resulted in net charge-offs of $272,000 and $190,000 for the years ended December 31, 2020 and 2019, respectively. See Allowance for Loan Losses on page 36 for further discussion. Gross charge-offs amounted to $301,000 at December 31, 2020, as compared to $204,000 at December 31, 2019. The increased level of charge-offs for the year ended December 31, 2020 was mainly due to one charge-off totaling $86,000 completed during the fourth quarter of 2020 on a non-accrual loan to a student housing holding company. The charge-off was completed to charge the loan balance down to the net realizable value of the supporting collateral less cost to sell, as the underlying value of the collateral was deemed to be insufficient to cover the loan balance. This charge-off contributed to the increased balance of net charge-offs in 2020 vs. 2019, but was not indicative of a significant change in asset quality in the overall loan portfolio. See Table 10 - Analysis of Allowance for Loan Losses for further details.
The allowance for loan losses as a percentage of average outstanding loans was 1.16% as of December 31, 2020 and 1.13% from December 31, 2019.
On a quarterly basis, management performs, and the Corporation's Audit Committee and the Board of Directors review a detailed analysis of the adequacy of the allowance for loan losses. This analysis includes an evaluation of credit risk concentration, delinquency trends, past loss experience, current economic conditions, composition of the loan portfolio, classified loans and other relevant factors. The Corporation will continue to monitor its allowance for loan losses and make future adjustments to the allowance through the provision for loan losses as conditions warrant. Although the Corporation believes that the allowance for loan losses is adequate to provide for losses inherent in the loan portfolio, there can be no assurance that future losses will not exceed the estimated amounts or that additional provisions will not be required in the future. The Corporation is subject to periodic regulatory examination by the Pennsylvania Department of Banking and Securities and the FDIC. As part of the examination, the regulators will assess the adequacy of the Corporation's allowance for loan losses and may include factors not considered by the Corporation. In the event that a regulatory examination results in a conclusion that the Corporation's allowance for loan losses is not adequate, the Corporation may be required to increase its provision for loan losses.
INCOME WITHOUT INTEREST
Non-interest income is derived primarily from service charges and fees, ATM and debit card income, trust department revenue, income on bank owned life insurance, gains on sales of mortgage loans and other miscellaneous income. In addition, net securities gains and losses also impact total non-interest income. Table 4 provides the yearly non-interest income by category, along with the amount, dollar changes, and percentage of change. Non-interest income through December 31, 2020 was $6,012,000, a decrease of 13.2%, or $917,000, from 2019. The decrease was due primarily to a decrease in net securities gains and a decrease in service charges and fees. Table 4 provides the major categories of non-interest income and each respective change comparing the last two years. During 2020, net securities gains decreased $969,000 to a net loss of $(58,000). The decrease was due to the Corporation recognizing $287,000 in net losses on held equity securities in 2020, as compared to recognizing $373,000 in net gains on held equity securities in 2019. The Corporation also recognized $309,000 less in net gains on the sales of debt securities during 2020 as compared to 2019. Gains on sales of mortgage loans provided income of $604,000 in 2020 as compared to $277,000 in 2019. The increase in gains on sales of mortgage loans in 2020 was due to more mortgage loans being sold and higher average gains on individual mortgage loan sales in 2020 as compared to 2019. In 2020, the Corporation originated $44,485,000 in residential mortgage loans, of which $30,480,000 were originated with the intent to sell. This compared favorably to 2019 when the Corporation originated $25,592,000 in residential mortgage loans, of which $12,447,000 were originated with the intent to sell. The Corporation continues to service the majority of mortgages which are sold. This servicing income provides an additional source of non-interest income on an ongoing basis. Service charges and fees decreased by $531,000 or 23.9% in 2020 as compared to 2019. The decrease was mainly due to fewer customers in overdraft status and lower fees earned on deposit accounts, as overdraft fees and several other deposit account service charges were waived during the second quarter of 2020 due to the COVID-19 pandemic. In addition, there were fewer prepayment penalties earned on commercial loan payoffs during 2020. ATM fees and debit card income increased by $199,000 or 12.1% in 2020 as compared to 2019 due to an increase in transaction volume.
Other income, consisting mainly of the rental of safes, income from the sale of investment products without deposit and miscellaneous expenses, increased
$ 42,000, i.e. 15.2% in 2020 compared to 2019.
29 Table of Contents Table 4 - Non-Interest Income (Dollars in thousands) 2020/2019 Increase/(Decrease) 2020 Amount % 2019 Trust department $ 995$ 24 2.5 $ 971 Service charges and fees 1,693 (531) (23.9) 2,224
Life insurance income held by a bank 611 (9) (1.5) 620 ATM and debit card income
1,849 199 12.1
Gains on sales of mortgage loans 604 327 118.1 277 Other 318 42 15.2 276 Subtotal 6,070 52 0.9 6,018 Net securities (losses) gains (58) (969) (106.4) 911 Total $ 6,012$ (917) (13.2) $ 6,929 NON-INTEREST EXPENSE Total non-interest expense amounted to $24,605,000, an increase of $1,183,000, or 5.1% in 2020. Expenses associated with employees (salaries and employee benefits) continue to be the largest non-interest expenditure. Salaries and employee benefits amounted to $13,687,000 or 55.6% of total non-interest expense in 2020 and $12,457,000 or 53.2% in 2019. Salaries and employee benefits increased $1,230,000, or 9.9% in 2020. The increase in 2020 was due to an increase in commissions associated with loan growth and retail non-deposit activity, bonuses paid to all employees for working through the COVID-19 pandemic and increased healthcare costs. The Corporation experienced a 30.0% increase in healthcare costs for its employees in 2020 as compared to 2019. The number of full time equivalent employees was 195 as of December 31, 2020 and 196 as of December 31, 2019. Net occupancy expense increased $190,000, or 10.4% in 2020 as compared to 2019, mainly due to an increase in rent expense associated with the new leasing standard. Net furniture and equipment and computer expense decreased $109,000, or 6.5% in 2020 compared to 2019. The decrease in 2020 was due to several software items fully depreciating in 2019 which were still being utilized throughout 2020. Professional services increased $49,000, or 5.3% in 2020 as compared to 2019. The higher expense in 2020 was the result of higher legal fees related to the issuance of subordinated debt and additional consulting and accounting fees related to the review of the Corporation's goodwill. Pennsylvania shares tax expense increased $101,000, or 13.2% in 2020 as compared to 2019. The increase was the result of an increase in total equity. FDIC insurance expense increased $31,000, or 22.6% in 2020 as compared to 2019. This increase was due to small bank assessment credits received from the FDIC effectively reducing the expense in 2019. FDIC insurance expense varies with changes in net asset size, risk ratings, and FDIC derived assessment rates. ATM and debit card fees expense increased $14,000, or 1.6% in 2020 as compared to 2019. Data processing fees increased $55,000, or 5.0% in 2020 as compared to 2019 as the result of annual contracted pricing increases from our main third-party data processor. Foreclosed assets held for resale expense amounted to $50,000 in 2020 as compared to $295,000 in 2019, a decrease of $245,000, or 83.1%. The Corporation incurred costs associated with the maintenance and sales of four foreclosed properties in 2020 and nine foreclosed properties in 2019. The majority of the decrease was the result of a write down to the agreed upon lead bank repurchase price of a foreclosed asset in 2019. Advertising expense decreased $259,000, or 42.3% in 2020 as compared to 2019. The decrease was due to a less aggressive advertising approach in 2020 due to the COVID-19 pandemic, as 2020 saw less newspaper, billboard, digital and civic advertising. Advertising for 2020 was geared mostly towards social media and keeping customers informed and educated on the events created due to COVID-19. This advertising was significantly less expensive than 30
the Bank's traditional campaign driven messages. Civic advertising was affected by the COVID-19 pandemic as many events that the Bank would normally sponsor were canceled. Other non-interest expense increased $126,000, or 4.6% in 2020 as compared to 2019. The increase in 2020 was primarily due to higher promotional expenses for free appraisals given by the Bank. The overall level of non-interest expense remains low, relative to the Corporation's peers (community banks from $500 million to $1 billion in assets). The Corporation's total non-interest expense was 2.28% of average assets in 2020 and 2.33% in 2019, which places the Corporation among the leaders in its peer financial institution categories in controlling non-interest expense.
Table 5 – Non-interest charges
(Dollars in thousands) 2020/2019 Increase/(Decrease) 2020 Amount % 2019 Salaries and employee benefits $ 13,687$ 1,230 9.9 $ 12,457 Occupancy, net 2,009 190 10.4 1,819 Furniture and equipment 590 16 2.8 574 Computer expense 990 (125) (11.2) 1,115 Professional services 981 49 5.3 932 Pennsylvania shares tax 867 101 13.2 766 FDIC Insurance 168 31 22.6 137 ATM and debit card fees 906 14 1.6 892 Data processing fees 1,166 55 5.0 1,111 Foreclosed assets held for resale 50 (245) (83.1) 295 Advertising 354 (259) (42.3) 613 Other 2,837 126 4.6 2,711 Total $ 24,605$ 1,183 5.1 $ 23,422 INCOME TAX EXPENSE
Income tax expense for the year ended December 31, 2020, has been $ 1,577,000 compared to $ 1,114,000 for the year ended December 31, 2019. The effective tax rate was 11.8% in 2020 and 9.8% in 2019. The increase in the effective tax rate for 2020 was due to a net decrease in tax-exempt investments and loans to individuals. state and local government, plus operating income.
FINANCIAL CONDITION GENERAL
Total assets increased to $ 1,179,047,000 at the end of 2020, an increase of 17.1% compared to the end of 2019.
Increase in total debt securities available for sale $ 88,783,000 or 31.9% to
$ 366,711,000 from December 31, 2020.
Net loans increased in 2020 from $640,727,000 to $712,677,000, an 11.2% increase. Loan demand grew in 2020 as the Bank has realized an increase in loan originations, primarily in the commercial real estate and commercial and industrial portfolios. The increase was partially due to the origination of PPP loans, which carried a balance of $22,976,000 at December 31, 2020. Interest receivable increased $1,139,000 or 33.5% to $4,544,000 as of December 31, 2020. This increase was mainly due to the full payment deferrals of several loans that were modified in response to the COVID-19 pandemic under Section 4013 of the CARES act, plus the impact of growth in the loan portfolio. 31
The cash surrender value of bank owned life insurance totaled $24,194,000 at December 31, 2020, an increase of $611,000 or 2.6% from 2019. This increase represents tax-free income included in non-interest income on the consolidated statements of income. Investments in low-income housing partnerships were $1,466,000 at year-end 2020, a decrease of 19.8% from year-end 2019. The Corporation became a limited partner in a new real estate venture during 2015 with an initial investment of $590,000, a second installment of $1,178,000 in 2016, third and fourth installments in 2017 of $168,000 and $84,000, respectively, and a fifth and final installment of $85,000 in 2019. Investing in low-income housing real estate ventures enables the Corporation to recognize tax credits and satisfy Community Reinvestment Act initiatives. As of December 31, 2020, total deposits amounted to $937,488,000, an increase of 23.1% from 2019. The increase in 2020 was due to many different factors including the deposit of stimulus funds via check or ACH, the deposit of PPP loan proceeds, less consumer spending, an $83,000,000 increase in highly rate sensitive deposits and other normal fluctuations. Core deposits, which include demand deposits and interest bearing demand deposits (NOWs), money market accounts, savings accounts, and time deposits of individuals, continue to be the Corporation's most significant source of funds. The Corporation continues to maintain and manage its asset growth. The Corporation's strong equity capital position provides an opportunity to further leverage its asset growth. Short and long-term borrowings decreased in 2020 by $45,169,000, mainly due to increased deposit balances.
The company issued 25,000,000 USD in subordinated debentures in the fourth quarter of 2020.
Total equity increased to $ 144,242,000 at December 31, 2020, an augmentation of $ 15,490,000, primarily due to an increase in accumulated other comprehensive income and retained earnings.
Currently, management measures performance and allocates the resources of the company as a single area.
Earning assets are defined as those assets that produce interest income. By maintaining a healthy asset utilization rate, i.e., the volume of earning assets as a percentage of total assets, the Corporation maximizes income. The earning asset ratio (average interest earning assets divided by average total assets) equaled 93.2% for 2020 compared to 92.4% for 2019. This indicates that the management of earning assets is a priority and non-earning assets, primarily cash and due from banks, fixed assets and other assets, are maintained at minimal levels. The primary earning assets are loans and investment securities.
The company uses securities not only to generate interest and dividend income, but also to help manage interest rate risk and to provide liquidity to meet operating cash requirements.
The securities portfolio consists of debt securities available-for-sale. No securities were established in a trading account. Debt securities available-for-sale increased $88,783,000 or 31.9% to $366,711,000 in 2020. At December 31, 2020, the net unrealized gain, net of the tax effect, on these securities was $12,870,000 and was included in stockholders' equity as accumulated other comprehensive income. Table 6 provides data on the fair value of the Corporation's securities portfolio on the dates indicated. The vast majority of security purchases are allocated as available-for-sale. This provides the Corporation with increased flexibility should there be a need or desire to liquidate a security. 32
The securities portfolio includes, U.S. treasuries, U.S. government corporations and agencies, corporate debt obligations, mortgage-backed securities, asset backed securities, and obligations of state and political subdivisions, both tax-exempt and taxable. Debt securities available-for-sale may be sold as part of the overall asset and liability management process. Realized gains and losses are reflected in the results of operations on the Corporation's Consolidated Statements of Income. As of December 31, 2020, the securities portfolio does not contain any off-balance sheet derivatives or trust preferred investments. Table 6 - Securities (Dollars in thousands) Available-For-Sale December 31, 2020 December 31, 2019 U.S. Treasury securities $ - $ 2,855
U. S. Government corporations and agencies 88,003 87,580 Other mortgage backed debt securities 39,844 11,138 Obligations of state and political subdivisions 165,101
120,376 Asset backed securities 44,821 37,536 Corporate debt securities 28,942 18,443 Total $ 366,711 $ 277,928 The amortized cost and fair value of securities, by contractual maturity, are shown below at December 31, 2020. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Table 7 – Maturity table of securities
(Dollars in thousands)
December 31, 2020
Titles available for sale
U.S. Government Other Obligations Corporations & Mortgage of State Asset Corporate U.S. Treasury Agencies Backed Debt & Political Backed Debt Securities Obligations1 Securities1 Subdivisions Securities Securities Within 1 Year: Amortized cost $ - $ - $ - $ 2,192 $ - $ 2,631 Fair value - - - 2,213 - 2,636 1 - 5 Years: Amortized cost - 622 2,199 23,512 1,113 15,642 Fair value - 629 2,213 24,722 1,113 16,051 5 - 10 Years: Amortized cost - 20,768 5,729 17,875 2,575 10,250 Fair value - 20,715 5,740 19,361 2,624 10,255 After 10 Years: Amortized cost - 65,414 31,492 107,343 41,063 - Fair value - 66,659 31,891 118,805 41,084 - Total: Amortized cost $ - $ 86,804 $ 39,420$ 150,922$ 44,751$ 28,523 Fair value - 88,003 39,844 165,101 44,821 28,942
1 Mortgage-backed securities are classified for maturity reporting purposes on their original maturity date.
33 Table of Contents Marketable equity securities consist of common stock investments in other commercial banks and bank holding companies. At December 31, 2020 and 2019, the Corporation had $1,646,000 and $1,933,000, respectively, in equity securities recorded at fair value, a decrease of $287,000 or 14.8%.
Total loans increased to $720,610,000 as of December 31, 2020, as compared to a balance of $647,732,000 as of December 31, 2019. Table 8 provides data relating to the composition of the Corporation's loan portfolio on the dates indicated. Total loans increased $72,878,000, or 11.3% in 2020 compared to an increase of $41,340,000, or 6.8% in 2019. Steady demand for borrowing by businesses (including loans issued through the Bank's participation in the SBA's Paycheck Protection Program) accounted for the 11.3% increase in the loan portfolio from December 31, 2019 to December 31, 2020. Overall, the Commercial and Industrial portfolio (which includes tax-free Commercial and Industrial loans) increased 6.0% or $5,163,000 to $91,875,000 at December 31, 2020 compared to $86,712,000 at December 31, 2019. The increase in the Commercial and Industrial portfolio was mainly attributable to originations of Paycheck Protection Program loans which amounted to $22,976,000 as of December 31, 2020. The portion of the Commercial and Industrial portfolio not attributable to the Paycheck Protection Program loans decreased $17,813,000 during the year ended December 31, 2020. The decrease was mainly attributable to $11,102,000 in new loan originations offset by a $5,522,000 decrease in utilization of existing Commercial and Industrial lines of credit and loan payoffs of $17,965,000, as well as regular principal payments and other typical fluctuations in the Commercial and Industrial portfolio. The Commercial Real Estate portfolio (which includes tax-free Commercial Real Estate loans) increased 17.9% or $70,927,000 to $466,728,000 at December 31, 2020 compared to $395,801,000 at December 31, 2019. The increase was mainly the result of $117,952,000 in new loan originations net against a $2,067,000 decrease in utilization of existing Commercial Real Estate lines of credit and $38,793,000 in loan payoffs, in addition to regular principal payments and other typical amortization in the Commercial Real Estate portfolio. Residential Real Estate loans decreased 1.5% or $2,367,000 to $156,983,000 at December 31, 2020 compared to $159,350,000 at December 31, 2019. The decrease was the result of $33,481,000 in new loan originations and a $206,000 increase in utilization of existing Residential Real Estate (Home Equity) lines of credit, offset by loan payoffs of $24,784,000, net loans sold of $7,019,000 and regular principal payments and other typical amortization in the Residential Real Estate portfolio. Net loans sold for the year ended December 31, 2020 consisted of total loans sold during the year ended December 31, 2020 of $14,760,000, offset with loans opened and sold in the same quarter during each quarter of 2020 which amounted to $7,741,000. The Corporation continues to originate and sell certain long-term fixed rate residential mortgage loans which conform to secondary market requirements. The Corporation derives ongoing income from the servicing of mortgages sold in the secondary market. The Corporation continues its efforts to lend to creditworthy borrowers. Management believes that the loan portfolio is well diversified. The total commercial portfolio was $558,603,000 at December 31, 2020. Of total loans, $466,728,000 or 64.8% were secured by commercial real estate, primarily lessors of residential buildings and dwellings and lessors of non-residential buildings. The Corporation continues to monitor these portfolios.
All loan relationships exceeding 1,500,000 USD are reviewed internally and / or externally as part of a loan review process on an annual basis. This review is based on the analysis of the current financial statements of the borrower, co-borrowers / guarantors, payment history and economic conditions.
Overall, the portfolio risk profile as measured by loan grade is considered low risk, as $695,657,000 or 96.7% of gross loans are graded Pass; $1,039,000 or 0.1% are graded Special Mention; $23,098,000 or 3.2% are graded Substandard; and $0 are graded Doubtful. The rating is intended to represent the best assessment of risk available at a given point in time, based upon a review of the borrower's financial statements, credit analysis, payment history with the Bank, credit history and lender knowledge of the borrower. See Note 4 - Loans and Allowance for Loan Losses for risk grading tables.
Overall, non-pass scores increased to $ 24,137,000 at December 31, 2020, compared to $ 14,887,000 at December 31, 2019. Commercial and industrial failure scores have been reduced to $ 919,000 from December 31, 2020,
compared to $1,070,000 as of December 31, 2019. Commercial Real Estate non-pass grades increased to $21,789,000 as of December 31, 2020 as compared to $12,534,000 as of December 31, 2019. Residential Real Estate and Consumer non-pass grades increased to $1,429,000 as of December 31, 2020, as compared to $1,283,000 as of December 31, 2019. The increase in the Commercial Real Estate non-pass grade portfolio during the year ended December 31, 2020 was mainly due to the downgrade of various large loans/loan relationships to Special Mention or Substandard during the year. One Commercial Real Estate loan to a real estate developer that carried a balance of $814,000 as of December 31, 2020 was downgraded to Special Mention during the third quarter of 2020, as the borrower was unable to pay off the loan or refinance through another institution at maturity; the Bank has agreed to extend the maturity date of the loan for one year in conjunction with a principal paydown that was financed by partial release of the mortgaged premises. One Commercial Real Estate loan to the owner/operator of a hotel that carried a balance of $9,423,000 as of December 31, 2020 was downgraded to Special Mention during the third quarter of 2020 and subsequently downgraded to Substandard during the fourth quarter of 2020, as occupancy levels have been adversely impacted by the COVID-19 coronavirus pandemic, but the business remains operational. Four Commercial Real Estate loans to the owners/operators of an indoor family entertainment complex that carried a balance of $792,000 as of December 31, 2020 were downgraded to Special Mention during the third quarter of 2020 and subsequently downgraded to Substandard during the fourth quarter of 2020, as the business was adversely impacted by the COVID-19 coronavirus pandemic. Net against the large additions to Special Mention and Substandard status, there was also one Commercial Real Estate loan to the owner of a recreation facility that was classified as Substandard and carried a balance of $2,640,000 as of December 31, 2019 which was paid off during the second quarter of 2020.
The Company continues to internally guarantee each of its loans in order to comply with prescribed policies and approval levels established by its Board of Directors.
The categories of the Company’s loan portfolio, net of unearned discount and net deferred loan fees and charges, are summarized in Table 8.
Table 8 - Loans (Dollars in thousands) December 31, 2020 2019 2018 2017 2016 Commercial and Industrial $ 91,875$ 86,712$ 92,220$ 99,337$ 83,573 Commercial Real Estate 466,728 395,801 348,476 290,970 263,519 Residential Real Estate 156,983 159,350 159,741 162,925 169,035 Consumer 5,024 5,869 5,955 6,165 6,255 Total Loans $ 720,610$ 647,732$ 606,392$ 559,397$ 522,382
Information regarding the Company’s maturity and rate sensitivity relating to the loan portfolio is summarized in Table 9.
Table 9 – Loan maturity and interest sensitivity
Loans by maturity
December 31, 2020 (Dollars in thousands) One Year After One Year After and Less Through Five Years Five Years Total Commercial and Industrial $ 24,631 $ 37,513 $ 29,731$ 91,875 Commercial Real Estate 32,851 111,213 322,664 466,728 Residential Real Estate 25,749 33,768 97,466 156,983 Consumer 1,640 2,800 584 5,024 Total $ 84,871 $ 185,294 $ 450,445$ 720,610 The above data represents the amount of loans receivable at December 31, 2020 which, based on remaining scheduled repayments of principal, are due in the periods indicated. 35 Table of Contents Loans by Repricing December 31, 2020 (Dollars in thousands) One Year After One Year After and Less Through Five Years Five Years Total Commercial and Industrial $ 38,794 $ 42,455 $ 10,626$ 91,875 Commercial Real Estate 64,082 356,918 45,728 466,728 Residential Real Estate 34,769 31,055 91,159 156,983 Consumer 2,510 2,500 14 5,024 Total $ 140,155 $ 432,928 $ 147,527$ 720,610
Loans with a fixed interest rate $ 59,220 $ 82,325 $ 112,355$ 253,900 Loans with a variable interest rate 80,935 350,603
35,172 466,710 Total $ 140,155 $ 432,928 $ 147,527$ 720,610 The above data represents the amount of loans receivable at December 31, 2020 which are due or have the opportunity to reprice in the periods indicated, based on remaining scheduled repayments of principal for fixed rate loans or date of next repricing opportunity for variable rate loans. The fixed and variable portions of the amounts of loans receivable due or repricing in the periods indicated are also summarized above.
INDEMNITY FOR LOAN LOSSES
The allowance for loan losses constitutes the amount available to absorb losses within the loan portfolio. As of December 31, 2020, the allowance for loan losses was $7,933,000 as compared to $7,005,000 as of December 31, 2019. The allowance for loan losses is established through a provision for loan losses charged to expenses. Loans are charged against the allowance for possible loan losses when management believes that the collectability of the principal is unlikely. The risk characteristics of the loan portfolio are managed through various control processes, including credit evaluations of individual borrowers, periodic reviews, and diversification by industry. Risk is further mitigated through the application of lending procedures such as the holding of adequate collateral and the establishment of contractual guarantees. Management performs a quarterly analysis to determine the adequacy of the allowance for loan losses. The methodology in determining adequacy incorporates specific and general allocations together with a risk/loss analysis on various segments of the portfolio according to an internal loan review process. This assessment results in an allocated allowance. Management maintains its loan review and loan classification standards consistent with those of its regulatory supervisory authority. Management considers, based upon its methodology, that the allowance for loan losses is adequate to cover foreseeable future losses. However, there can be no assurance that the allowance for loan losses will be adequate to cover significant losses, if any, that might be incurred in the future. In response to the COVID-19 pandemic and its impact on the current economy, the qualitative factors related to the local/regional economy were increased by two basis points across all loan segments during the first quarter of 2020, and increased by an additional basis point across all loan segments during the second quarter of 2020. The qualitative factor relating to the impact of external factors/conditions for the Commercial Real Estate portfolio segment was increased by an additional basis point during the third quarter of 2020. The qualitative factors relating to the impact of external factors/conditions were increased by two additional basis points across all loan segments during the fourth quarter of 2020. Modifications granted in compliance with Section 4013 of the CARES Act are highest in the Commercial Real Estate portfolio segment, the long-term effects of which are still very unclear, as there is still economic uncertainty related to the COVID-19 pandemic, especially in relation to this segment of the Corporation's loan portfolio. Table 10 contains an analysis of the allowance for loan losses indicating charge-offs and recoveries by year. In 2020, net charge-offs as a percentage of average loans were 0.04% as compared to 0.03% in 2019. Net charge-offs amounted to $272,000 in 2020 and $190,000 in 2019. Net charge-offs were greater in 2020 than in 2019 mainly due to one charge-off totaling $86,000 in the Commercial Real Estate portfolio that was completed during the fourth quarter of 2020 on a non-accrual loan to a student housing holding company. The charge-off was completed to charge the loan 36
balance down to the net realizable value of the collateral less cost to sell, as the underlying value of the collateral was deemed insufficient to cover the loan balance. For the year ended December 31, 2020, the provision for loan losses was $1,200,000 as compared to $450,000 for the year ended December 31, 2019. The net effect of the provision, charge-offs and recoveries resulted in the year-end allowance for loan losses of $7,933,000 of which 9.9% was attributed to the Commercial and Industrial component, 60.0% attributed to the Commercial Real Estate component, 20.7% attributed to the Residential Real Estate component, 1.2% attributed to the Consumer component, and 8.2% being the unallocated component (refer to the activity in Note 4 - Loans and Allowance for Loan Losses on page 75.) The Corporation determined that the provision for loan losses made during 2020 was sufficient to maintain the allowance for loan losses at a level necessary for the probable losses inherent in the loan portfolio as of December 31, 2020.
Table 10 – Analysis of the allowance for loan losses
(Dollars in thousands) Years Ended December 31, 2020 2019 2018 2017 2016
Balance at beginning of period $ 7,005$ 6,745$ 7,487
$ 7,357$ 6,739 Charge-offs: Commercial and Industrial 90 - 18 - 195 Commercial Real Estate 141 64 783 189 1,200 Residential Real Estate 33 69 181 62 61 Consumer 37 71 57 82 38 301 204 1,039 333 1,494 Recoveries: Commercial and Industrial 14 6 31 74 9 Commercial Real Estate - - 60 103 - Residential Real Estate 8 2 - 9 12 Consumer 7 6 6 10 8 29 14 97 196 29 Net charge-offs 272 190 942 137 1,465
Additions charged to operations 1,200 450 200 267 2,083 Balance at end of period $ 7,933$ 7,005$ 6,745
$ 7,487$ 7,357
Ratio of net charge-offs during the period to average loans outstanding during the 0.04 % 0.03 % 0.16 % 0.03 % 0.28 % period Allowance for loan losses to average loans 1.16 % 1.13 % 1.15 % 1.40 % 1.42 % outstanding during the period It is the policy of management and the Corporation's Board of Directors to make a provision for both identified and unidentified losses inherent in its loan portfolio. A provision for loan losses is charged to operations based upon an evaluation of the potential losses in the loan portfolio. This evaluation takes into account such factors as portfolio concentrations, delinquency trends, trends of non-accrual and classified loans, economic conditions, and other relevant factors. The loan review process, which is conducted quarterly, is an integral part of the Bank's evaluation of the loan portfolio. A detailed quarterly analysis to determine the adequacy of the Corporation's allowance for loan losses is reviewed by the Board of Directors. With the Bank's manageable level of net charge-offs and the additions to the reserve from the provision out of operations, the allowance for loan losses as a percentage of average loans amounted to 1.16% in 2020 and 1.13% in 2019. 37
Table 11 sets forth the allocation of the Bank's allowance for loan losses by loan category and the percentage of loans in each category to the total allowance for loan losses at the dates indicated. The portion of the allowance for loan losses allocated to each loan category does not represent the total available for future losses that may occur within the loan category, since the total loan loss allowance is a valuation reserve applicable to the entire loan portfolio.
Table 11 – Breakdown of the allowance for loan losses
(Dollars in thousands) December 31, 2020 %* 2019 %* 2018 %* 2017 %* 2016 %* Commercial and $ 787 10.8 $ 634 9.7 $ 724 11.7 $ 949 14.0 $ 836 11.7 Industrial Commercial 4,762 65.4 4,116 63.0 3,700 59.8 4,067 60.0 4,421 62.0 Real Estate Residential 1,643 22.5 1,665 25.5 1,650 26.6
1,656 24.4 1,777 24.9 Real Estate Consumer 94 1.3 114 1.8 117 1.9 111 1.6 95 1.4 Unallocated 647 N/A 476 N/A 554 N/A 704 N/A 228 N/A $ 7,933 100.0 $ 7,005 100.0 $ 6,745 100.0 $ 7,487 100.0 $ 7,357 100.0
* Percentage of allocation in each category of total allocations in the allowance for loan loss analysis, excluding unallocated allocations.
Table 12 details the Corporation's non-performing assets and impaired loans as of the dates indicated. Generally, a loan is classified as non-accrual and the accrual of interest on such a loan is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan currently is performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on non-accrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against current period income. A modification of a loan constitutes a troubled debt restructuring ("TDR") when a borrower is experiencing financial difficulty and the modification constitutes a concession that the Corporation would not otherwise consider. Modifications to loans classified as TDRs generally include reductions in contractual interest rates, principal deferments and extensions of maturity dates at a stated interest rate lower than the current market for a new loan with similar risk characteristics. While unusual, there may be instances of loan principal forgiveness. Any loan modifications made in response to the COVID-19 pandemic are not considered troubled debt restructurings as long as the criteria set forth in Section 4013 of the CARES Act are met. Foreclosed assets held for resale represent property acquired through foreclosure, or considered to be an in-substance foreclosure. Total non-performing assets amounted to $7,119,000 as of December 31, 2020, as compared to $4,607,000 as of December 31, 2019. The economy, in particular, the political unrest both domestic and abroad, the recent presidential election, the partial and full shutdowns of various government offices, the recession resulting from the COVID-19 pandemic, the large unemployment totals, and the continued slowness in the housing industries in our market areas has had a direct effect on the Corporation's non-performing assets. The Corporation is closely monitoring its Commercial Real Estate portfolio because of the current uncertain economic environment. Non-accrual loans totaled $7,078,000 as of December 31, 2020 as compared to $4,388,000 as of December 31, 2019. Foreclosed assets held for resale decreased to $28,000 as of December 31, 2020, compared to $119,000 as of December 31, 2019. Loans past-due 90 days or more and still accruing interest amounted to $13,000 at December 31, 2020, as compared to $100,000 as of December 31, 2019. At December 31, 2020, loans past-due 90 days or more and still accruing interest consisted of one Residential Real Estate loan which was well secured and in the process of collection. The increase in non-accrual loans at December 31, 2020, as compared to December 31, 2019 is mainly due to the addition of several large loans/loan relationships to non-accrual status during the year ended December 31, 2020. Five loans to a plastic processing company focused on non-post-consumer recycling totaling
$1,262,000 were moved to 38 Table of Contents non-accrual status during the first quarter of 2020 due to strained liquidity and the borrower's inability to make required payments. A loan in the amount of $762,000 to a golf course and catering venue was moved to non-accrual status during the first quarter of 2020 due to the borrower's inability to make monthly payments due to cash flow challenges exacerbated by the seasonality of the industry. A residential mortgage in the amount of $356,000 to the owner of a manufacturing company was also moved to non-accrual status during the first quarter of 2020, as poor payment performance has led to foreclosure proceedings related to the associated property. A loan in the amount of $485,000 to an agricultural producer was moved to non-accrual status during the fourth quarter of 2020 due to cash flow challenges that have led to payment delinquency, as well as issues with additional liens on the real estate collateral which are impeding efforts to sell the property and pay off the loan. Non-performing assets to total loans was 0.99% as of December 31, 2020 compared to 0.71% at December 31, 2019. Non-performing assets to total assets was 0.60% as of December 31, 2020 compared to 0.46% at December 31, 2019. The allowance for loan losses to total non-performing assets was 111.43% as of December 31, 2020 as compared to 152.05% as of December 31, 2019. Additional detail can be found in Table 12 - Non-Performing Assets and Impaired Loans and the Loans Receivable on Non-Accrual Status table in Note 4 - Loans and Allowance for Loan Losses. Asset quality is a priority and the Corporation retains a full-time loan review officer to closely track and monitor overall loan quality, along with a full-time loan workout department to manage collection and liquidation efforts. Performing substandard loans which are not deemed to be impaired have characteristics that cause management to have doubts regarding the ability of the borrower to perform under present loan repayment terms and which may result in reporting these loans as non-performing loans in the future. Performing substandard loans not deemed to be impaired amounted to $9,992,000 at December 31, 2020 and $4,074,000 at December 31, 2019. Impaired loans were $15,054,000 at December 31, 2020 and $12,954,000 at December 31, 2019. The largest impaired loan relationship at December 31, 2020 consisted of a non-performing loan to a student housing holding company which was secured by commercial real estate. At December 31, 2020, the loan carried a balance of $3,090,000, net of $1,989,000 that had been charged off to date. The second largest impaired loan relationship at December 31, 2020 consisted of one performing loan to a student housing holding company, which was classified as a TDR. The loan was secured by commercial real estate and carried a balance of $2,929,000 as of December 31, 2020, net of $943,000 that had been charged off to date. The third largest impaired loan relationship at December 31, 2020 consisted of a substandard performing loan to a developer of a residential sub-division in the amount of $1,326,000, which was secured by commercial real estate and classified as a TDR. The Corporation estimates impairment based on its analysis of the cash flows or collateral estimated at fair value less cost to sell. For collateral dependent loans, the estimated valuation adjustments and cost to sell percentages are determined based on the market area in which the real estate securing the loan is located, among other factors, and therefore, can differ from one loan to another. Of the $15,054,000 in impaired loans at December 31, 2020, none were located outside the Corporation's primary market area. The outstanding recorded investment of loans categorized as TDRs as of December 31, 2020 and December 31, 2019 was $9,563,000 and $8,678,000, respectively. The increase in TDRs at December 31, 2020 as compared to December 31, 2019 is mainly attributable to eight loans that were modified as TDRs during the year ended December 31, 2020, net against payments, payoffs, and charge-offs on existing TDRs that were completed during the year ended December 31, 2020. Of the thirty-four restructured loans at December 31, 2020, eight loans were classified in the Commercial and Industrial portfolio, twenty-five loans were classified in the Commercial Real Estate portfolio, and one loan was classified in the Residential Real Estate portfolio. Troubled debt restructurings at December 31, 2020 consisted of thirteen term modifications beyond the original stated term, three interest rate modifications, and seventeen payment modifications. At December 31, 2020, there was also one troubled debt restructuring that experienced all three types of modification-payment, rate, and term. TDRs are separately evaluated for impairment disclosures, and if necessary, a specific allocation is established. As of December 31, 2020, there were no specific allocations attributable to the TDRs, compared to December 31, 2019 when there were $1,000 in specific allocations attributable to the TDRs. There were no unfunded commitments on TDRs at December 31, 2020 and 2019. 39
At December 31, 2020, three Commercial and Industrial loans classified as TDRs with a combined recorded investment of $745,000, seven Commercial Real Estate loans classified as TDRs with a combined recorded investment of $984,000, and one Residential Real Estate loan classified as a TDR with a recorded investment of $18,000 were not in compliance with the terms of their restructure, compared to December 31, 2019 when six Commercial Real Estate loans classified as TDRs with a combined recorded investment of $464,000 were not in compliance with the terms of their restructure. Two Commercial Real Estate loans totaling $57,000 that were modified as TDRs within the twelve months preceding December 31, 2020 experienced payment defaults during the year ended December 31, 2020. No loans were modified as TDRs within the twelve months preceding December 31, 2019. The Corporation's non-accrual loan valuation procedure for any loans greater than $250,000 requires an appraisal to be obtained and reviewed annually at year end, unless the Board of Directors waives such requirement for a specific loan, in favor of obtaining a Certificate of Inspection instead, defined as an internal evaluation completed by the Corporation. A quarterly collateral evaluation is performed which may include a site visit, property pictures and discussions with realtors and other similar business professionals to ascertain current values. For non-accrual loans less than $250,000 upon classification and typically at year end, the Corporation completes a Certificate of Inspection, which includes the results of an onsite inspection, and may consider value indicators such as insured values, tax assessed values, recent sales comparisons and a review of the previous evaluations. Improving loan quality is a priority. The Corporation actively works with borrowers to resolve credit problems and will continue its close monitoring efforts in 2021. Excluding the assets disclosed in Table 12 - Non-Performing Assets and Impaired Loans and the Troubled Debt Restructurings section in Note 4 - Loans and Allowance for Loan Losses, management is not aware of any information about borrowers' possible credit problems which cause serious doubt as to their ability to comply with present loan repayment terms. In addition, regulatory authorities, as an integral part of their examinations, periodically review the allowance for possible loan losses. They may require additions to allowances based upon their judgments about information available to them at the time of examination. The economic climate is unclear at this time. The COVID-19 pandemic has caused much upheaval and uncertainty in the national and state economy. Experts at all levels are uncertain as to the intermediate or long term affects that may arise. The Corporation may experience difficulties collecting monthly payments on time from its borrowers, property values may decline, and certain types of loans may need to be modified, which could cause a rise in the level of impaired loans, non-performing assets, charge-offs, and delinquencies. Should such metrics increase, additions to the balance of the Corporation's allowance for loan losses could be required. The extent of the impact of the COVID-19 pandemic on the Corporation's operational and financial performance will depend on certain developments including the duration and spread of the outbreak. A concentration of credit exists when the total amount of loans to borrowers, who are engaged in similar activities that are similarly impacted by economic or other conditions, exceed 10% of total loans. As of December 31, 2020 and 2019 management is of the opinion that there were no loan concentrations exceeding 10% of total loans. 40 Table of Contents
Table 12 – Non-performing assets and impaired loans
(Dollars in thousands) December 31, December 31, 2020 2019 Non-performing assets Non-accrual loans $ 7,078 $ 4,388
Foreclosed assets held for resale 28 119 Loans past-due 90 days or more and still accruing interest 13 100 Total non-performing assets $ 7,119
$ 4,607 Impaired loans Non-accrual loans $ 7,078 $ 4,388 Accruing TDRs 7,976 8,566 Total impaired loans 15,054 12,954
Allocated allowance for loan losses (8) (1) Net investment in impaired loans $ 15,046
Impaired loans with a valuation allowance $ 486 $ 28 Impaired loans without a valuation allowance 14,568
Total impaired loans $ 15,054
Allocated valuation allowance as a percent of impaired loans 0.05 % 0.01 % Impaired loans to total loans 2.09 % 2.00 % Non-performing assets to total loans 0.99 % 0.71 % Non-performing assets to total assets 0.60 % 0.46 % Allowance for loan losses to impaired loans 52.70 % 54.08 % Allowance for loan losses to total non-performing assets 111.43 % 152.05 % Real estate mortgages comprise 86.6% of the loan portfolio as of December 31, 2020, as compared to 85.7% as of December 31, 2019. Real estate mortgages consist of both residential and commercial real estate loans. The real estate loan portfolio is well diversified in terms of borrowers, collateral, interest rates, and maturities. Also, the residential real estate loan portfolio is largely comprised of fixed rate mortgages. The real estate loans are concentrated primarily in the Corporation's market area and are subject to risks associated with the local economy. The commercial real estate loans typically reprice approximately every three to five years and are also concentrated in the Corporation's market area. The Corporation's loss exposure on its impaired loans continues to be mitigated by collateral positions on these loans. The allocated allowance for loan losses associated with impaired loans is generally computed based upon the related collateral value of the loans. The collateral values are determined by recent appraisals or Certificates of Inspection, but are generally discounted by management based on historical dispositions, changes in market conditions since the last valuation and management's expertise and knowledge of the borrower and the borrower's business.
DEPOSITS, OTHER BORROWING AND SUBORDINATED DEBT
Consumer and commercial retail deposits are attracted primarily by the Corporation's eighteen full service office locations, one loan production office, and through its internet banking presence. The Corporation offers a broad selection of deposit products and continually evaluates its interest rates and fees on deposit products. The Corporation regularly reviews competing financial institutions' interest rates, especially when establishing interest rates on certificates of deposit. Deposits increased by $175,860,000, or 23.1% for the year ending December 31, 2020 as compared to December 31, 2019. The increase in deposits in 2020 can be attributed to increases in non-interest bearing, interest bearing and savings deposits. The increase in deposits was the result of many different factors including the deposit of stimulus funds, PPP loan proceeds, an $83,000,000 increase in highly rate sensitive deposits and other normal fluctuations in
deposits during 2020. 41 Table of Contents
The following table reflects the remaining maturities of term deposits and other open term deposits of $ 100,000 or more at December 31, 2020.
(Dollars in thousands) Time Other Time Open Deposits Deposits ?$100,000 ?$100,000 Less than or equal to 3 months $ 10,053 $ - Over 3 months through 6 months 11,399 - Over 6 months through 12 months 16,894 855 Over 12 months 29,776 - $ 68,122 $ 855 Total borrowings were $64,494,000 as of December 31, 2020, compared to $109,663,000 at December 31, 2019. During 2020, long-term borrowings decreased from $55,000,000 to $45,000,000. The decrease in long-term borrowings in 2020 was the result of the maturity of two individual term notes with FHLB. Short-term debt decreased from $54,663,000 in 2019 to $19,494,000 as of December 31, 2020 as a result of increased deposit balances. Short-term borrowings are comprised of federal funds purchased, securities sold under agreements to repurchase, Federal Discount Window and short-term borrowings from FHLB. Short-term borrowings from FHLB are commonly used to offset seasonal fluctuations in deposits.
In connection with the FHLB borrowings, the federal discount window and securities sold under repurchase agreements, the Company retains certain eligible assets as collateral.
The following table presents information on the Company’s short-term borrowings as of December 31, 2020 and 2019.
Table 13 – Short-term loans
(Dollars in thousands) 2020 Maximum Month End Average Month End Average Balance Balance Balance Rate Federal funds purchased $ - $ - $ - 0.37 %
Securities sold under agreements to repurchase 19,494 18,350
23,453 0.58 % Federal Discount Window - - - 0.37 % Federal Home Loan Bank - 25,396 54,434 1.00 % $ 19,494$ 43,746$ 77,887 0.82 % (Dollars in thousands) 2019 Maximum Month End Average Month End Average Balance Balance Balance Rate Federal funds purchased $ - $ - $ - 2.01 %
Securities sold under agreements to repurchase 14,042 15,632
17,540 1.03 % Federal Discount Window - - - 2.92 % Federal Home Loan Bank 40,621 96,377 178,160 2.59 % $ 54,663$ 112,009$ 195,700 2.37 % On December 10, 2020, the Corporation issued $25,000,000 aggregate principal amount of Subordinated Notes due December 31, 2030 (the "2020 Notes"). The 2020 Notes are intended to be treated as Tier 2 capital for regulatory capital purposes. The 2020 Notes bear a fixed interest rate of 4.375% per year for the first five years and then float based on a benchmark rate (as defined). 42 Table of Contents CAPITAL STRENGTH Normal increases in capital are generated by net income, less cash dividends paid out. Also, the net unrealized gains or losses on debt securities available-for-sale, net of taxes, referred to as accumulated other comprehensive income, may increase or decrease total equity capital. The total net increase in capital was $15,490,000 in 2020 after an increase of $11,996,000 in 2019. The increase in equity capital in 2020 was due to the retention of $5,529,000 in earnings and the issuance of new shares through the Corporation's Dividend Reinvestment Program ("DRIP") amounting to $1,312,000. Accumulated other comprehensive income increased $8,649,000 in 2020 as a result of market fluctuations in the investment portfolio. The Corporation had 231,612 shares of common stock as of December 31, 2020 and December 31, 2019, at a cost of $5,709,000, as treasury stock, authorized and issued but not outstanding. Return on average equity ("ROE") is computed by dividing net income by average stockholders' equity. This ratio was 8.61% for 2020 and 8.17% for 2019. Refer to Performance Ratios on page 24 - Selected Financial Data for a more expanded listing of the ROE. Adequate capitalization of banks and bank holding companies is required and monitored by regulatory authorities. Table 14 reflects risk-based capital ratios and the leverage ratio for the Bank. The Bank's leverage ratio was 10.81% at December 31, 2020 and 9.42% at December 31, 2019. The Bank has consistently maintained regulatory capital ratios at or above the "well capitalized" standards. To be categorized as "well capitalized", the Bank must maintain minimum tier 1 risk-based capital, common equity tier 1 risk based capital, total risk-based capital and tier 1 leverage ratios of 8.0%, 6.5%, 10.0% and 5.0%, respectively. For additional information on capital ratios, see Note 14 - Regulatory Matters. The risk-based capital calculation assigns various levels of risk to different categories of bank assets, requiring higher levels of capital for assets with more risk. Also measured in the risk-based capital ratio is credit risk exposure associated with off-balance sheet contracts and commitments. Table 14 - Capital Ratios At December 31, 2020, the Bank met the definition of a "well-capitalized" institution under the regulatory framework for prompt corrective action and the minimum capital requirements under Basel III. The following table presents the Bank's capital ratios as of December 31, 2020 and December 31, 2019: To Be Well Capitalized Under Prompt December 31, December 31, Corrective Action 2020 2019 Regulations
Tier 1 leverage ratio (to average assets) 10.81 % 9.42 % 5.00 % Common Equity Tier 1 capital ratio (to risk-weighted assets) 15.99 % 13.50 % 6.50 % Tier 1 risk-based capital ratio (to risk-weighted assets) 15.99 % 13.50 % 8.00 % Total risk-based capital ratio 17.05 % 14.53 % 10.00 % The increase in the Bank's capital ratios was mainly due to $22,500,000 contributed by the Corporation from proceeds of a $25,000,000 subordinated debt issuance. The subordinated debt is treated as tier 1 capital at the Bank level and tier 2 capital at the Corporation level for regulatory capital purposes. Under the final capital rules that became effective on January 1, 2015, there was a requirement for a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets which is in addition to the other minimum risk-based capital standards in the rule. Institutions that do not maintain this required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital buffer 43
requirement was phased in over three years beginning in 2016. The capital buffer requirement effectively raises the minimum required common equity tier 1 capital ratio to 7.0%, the tier 1 capital ratio to 8.5%, and the total capital ratio to 10.5% on a fully phased-in basis on January 1, 2019. As of December 31, 2020, the Bank meets all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis.
The Company’s capital ratios are not significantly different from those of the Bank.
LIQUIDITY MANAGEMENT The Corporation's objective is to maintain adequate liquidity to meet funding needs at a reasonable cost and provide contingency plans to meet unanticipated funding needs or a loss of funding sources, while minimizing interest rate risk. Adequate liquidity is needed to provide the funding requirements of depositors' withdrawals, loan growth, and other operational needs.
The sources of liquidity are as follows:
? Growth of the base of basic deposits;
? The proceeds from sales or maturities of investment securities;
? Payments received on loans and mortgage-backed securities;
? Corresponding day-to-day bank loans on different lines of credit, banknotes, etc.,
with different levels of capacity;
? Securities sold under repurchase agreements; and
? CDs negotiated.
At December 31, 2020, the Corporation had $402,240,000 in available borrowing capacity at FHLB (which takes into account FHLB long-term notes and FHLB short-term borrowings); the maximum borrowing capacity at ACBB was $15,000,000 and the maximum borrowing capacity of the Federal Discount Window was $4,215,000. The Corporation enters into "Repurchase Agreements" in which it agrees to sell securities subject to an obligation to repurchase the same or similar securities. Because the agreement both entitles and obligates the Corporation to repurchase the assets, the Corporation may transfer legal control of the securities while still retaining effective control. As a result, the repurchase agreements are accounted for as collateralized financing agreements (secured borrowings) and act as an additional source of liquidity. Securities sold under agreements to repurchase were $19,494,000 at December 31, 2020. Asset liquidity is provided by investment securities maturing in one year or less, other short-term investments, federal funds sold, and cash and due from banks. The liquidity is augmented by repayment of loans and cash flows from mortgage-backed and asset-backed securities. Liability liquidity is accomplished primarily by maintaining a core deposit base, acquired by attracting new deposits and retaining maturing deposits. Also, short-term borrowings provide funds to meet liquidity needs. Net cash flows used in operating activities were $1,957,000 as of December 31, 2020, compared to net cash flows provided by operating activities of $12,539,000 as of December 31, 2019. Net income amounted to $11,837,000 for the year ended December 31, 2020 and $10,227,000 for the year ended December 31, 2019. During the years ended December 31, 2020 and 2019, net premium amortization on investment securities amounted to $2,003,000 and $2,624,000, respectively. Originations of mortgage loans originated for resale exceeded proceeds (including gains) from sales of mortgage loans originated for resale by $15,115,000 and $1,664,000 for the years ended December 31, 2020 and 2019, respectively. Net securities losses were $58,000 for the year ended December 31, 2020, compared to net securities gains of $911,000 for the year ended December 31, 2019. Accrued interest receivable increased by $1,139,000 during the year ended December 31, 2020 and decreased by $636,000 during the year ended December 31, 2019. Other assets decreased by $550,000 during the year ended December 31, 2020 and increased by $916,000 during the year ended December 31, 2019. Other liabilities decreased by $867,000 during the year ended December 31, 2020, compared to an increase of $1,667,000 during the year ended December 31, 2019. 44 Table of Contents Investing activities used cash of $135,264,000 during the year ended December 31, 2020 and provided cash of $11,986,000 during the year ended December 31, 2019. Net activity in the available-for-sale securities portfolio (including proceeds from sale, maturities, and redemptions net against purchases) used cash of $79,609,000 during the year ended December 31, 2020 and provided cash of $45,660,000 during the year ended December 31, 2019. Net cash used to originate loans amounted to $57,415,000 and $39,504,000 during the years ended December 31, 2020 and 2019, respectively. Financing activities provided cash of $150,677,000 during the year ended December 31, 2020 and used cash of $24,751,000 during the year ended December 31, 2019. Deposits increased by $175,860,000 and $90,075,000 during the years ended December 31, 2020 and 2019, respectively. Short-term borrowings decreased by $35,169,000 and $119,782,000 during the years ended December 31, 2020 and 2019, respectively. There were no proceeds from long-term borrowings during the year ended December 31, 2020, compared to proceeds from long-term borrowings of $30,000,000 for the year ended December 31, 2019. Repayment of long-term borrowings amounted to $10,000,000 for the year ended December 31, 2020 and $20,000,000 for the year ended December 31, 2019. Proceeds from issuance of subordinated debentures amounted to $25,000,000 for the year ended December 31, 2020, compared to the year ended December 31, 2019 when there were no issuances of subordinated debentures. Dividends paid amounted to $6,308,000 and $6,247,000 during the years ended December 31, 2020 and 2019, respectively. Managing liquidity remains an important segment of asset/liability management. The overall liquidity position of the Corporation is maintained by an active asset/liability management committee. The Corporation believes that its core deposit base is stable even in periods of changing interest rates. Liquidity and funds management are governed by policies and measured on a monthly basis. These measurements indicate that liquidity generally remains stable and exceeds the Corporation's minimum defined levels of adequacy. Other than the trends of continued competitive pressures and volatile interest rates, there are no known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way. Given our financial strength, we expect to be able to maintain adequate liquidity as we manage through the current environment, utilizing current funding options and possibly exploring new options, such as the Federal Reserve's Paycheck Protection Program Liquidity Facility ("PPPLF").
Table 15 represents the expected maturities of the Company’s contractual obligations as a function of the time remaining until maturity at December 31, 2020.
Table 15 – Contractual obligations
(Dollars in thousands) Less than 1 - 3 4 -5 Over December 31, 2020 1 Year Years Years 5 Years Total Time deposits $ 99,609$ 68,597$ 25,178$ 444$ 193,828 Securities sold under agreement to repurchase 19,494 - - - 19,494 Long-term borrowings 10,000 13,000 20,000 2,000 45,000 Subordinated debentures - - - 25,000 25,000 Operating lease obligations 140 154 136 2,258 2,688 Financing lease obligations 19 34 18 16 87 $ 129,262$ 81,785$ 45,332$ 29,718$ 286,097
Off-balance sheet arrangements
The Corporation is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and, to a lesser extent, standby letters of credit. At December 31, 2020, the Corporation had outstanding unfunded commitments to extend credit of $114,836,000 and outstanding standby letters of credit of $4,623,000. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. Please refer to Note 15 - Financial Instruments with Off-Balance 45 Table of Contents
Risk and credit risk concentrations sheet for an analysis of the nature, business purpose and importance of the Company’s off-balance sheet arrangements.
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. The Corporation's market risk is composed primarily of interest rate risk. The Corporation's interest rate risk results from timing differences in the repricing of assets, liabilities, off-balance sheet instruments, and changes in relationships between rate indices and the potential exercise of explicit or embedded options. Increases in the level of interest rates also may adversely affect the fair value of the Corporation's securities and other earning assets. Generally, the fair value of fixed-rate instruments fluctuates inversely with changes in interest rates. As a result, increases in interest rates could result in decreases in the fair value of the Corporation's interest-earning assets, which could adversely affect the Corporation's results of operations if sold, or, in the case of interest-earning assets classified as available-for-sale, the Corporation's stockholders' equity, if retained. Under FASB ASC 320-10, Investments - Debt Securities, changes in the unrealized gains and losses, net of taxes, on debt securities classified as available-for-sale are reflected in the Corporation's stockholders' equity. The Corporation does not own any trading assets. Asset/Liability Management The principal objective of asset/liability management is to manage the sensitivity of the net interest margin to potential movements in interest rates and to enhance profitability through returns from managed levels of interest rate risk. The Corporation actively manages the interest rate sensitivity of its assets and liabilities. Table 16 presents an interest sensitivity analysis of assets and liabilities as of December 31, 2020. Several techniques are used for measuring interest rate sensitivity. Interest rate risk arises from the mismatches in the repricing of assets and liabilities within a given time period, referred to as a rate sensitivity gap. If more assets than liabilities mature or reprice within the time frame, the Corporation is asset sensitive. This position would contribute positively to net interest income in a rising rate environment. Conversely, if more liabilities mature or reprice, the Corporation is liability sensitive. This position would contribute positively to net interest income in a falling rate environment. Limitations of interest rate sensitivity gap analysis as illustrated in Table 16 include: a) assets and liabilities which contractually reprice within the same period may not, in fact, reprice at the same time or to the same extent; b) changes in market interest rates do not affect all assets and liabilities to the same extent or at the same time, and c) interest rate sensitivity gaps reflect the Corporation's position on a single day (December 31, 2020 in the case of the following schedule) while the Corporation continually adjusts its interest sensitivity throughout the year. The Corporation's cumulative gap at one year indicates the Corporation is asset sensitive at December 31, 2020.
Table 16 – Interest rate sensitivity analysis
(Dollars in thousands) December 31, 2020 One 1 - 5 Beyond Not Rate Year Years 5 Years Sensitive Total Assets $ 274,042$ 489,665$ 322,069$ 93,271$ 1,179,047
Liabilities / Equity 260,020 182,963 569,102
166,962 1,179,047 Interest Rate Sensitivity Gap $ 14,022$ 306,702$ (247,033)$ (73,691) Cumulative Gap $ 14,022$ 320,724$ 73,691 - 46 Table of Contents Earnings at Risk
The Bank's Asset/Liability Committee ("ALCO") is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to interest rate risk. The guidelines established by ALCO are reviewed by the Corporation's Board of Directors. The Corporation recognizes that more sophisticated tools exist for measuring the interest rate risk in the balance sheet beyond interest rate sensitivity gap. Although the Corporation continues to measure its interest rate sensitivity gap, the Corporation utilizes additional modeling for interest rate risk in the overall balance sheet. Earnings at risk and economic values at risk are analyzed. Earnings simulation modeling addresses earnings at risk and net present value estimation addresses economic value at risk. While each of these interest rate risk measurements has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk to the Corporation.
Modeling of revenue simulation
The Corporation's net income is affected by changes in the level of interest rates. Net income is also subject to changes in the shape of the yield curve. For example, a flattening of the yield curve would result in a decline in earnings due to the compression of earning asset yields and increased liability rates, while a steepening would result in increased earnings as earning asset yields widen. Earnings simulation modeling is the primary mechanism used in assessing the impact of changes in interest rates on net interest income. The model reflects management's assumptions related to asset yields and rates paid on liabilities, deposit sensitivity, size and composition of the balance sheet. The assumptions are based on what management believes at that time to be the most likely interest rate environment. Earnings at risk is the change in net interest income from a base case scenario under various scenarios of rate shock increases and decreases in the interest rate earnings simulation model. Table 17 presents an analysis of the changes in net interest income and net present value of the balance sheet resulting from various increases or decreases in the level of interest rates, such as two percentage points (200 basis points) in the level of interest rates. The calculated estimates of change in net interest income and net present value of the balance sheet are compared to current limits approved by ALCO and the Board of Directors. The earnings simulation model projects net interest income would decrease 3.62%, 7.76% and 11.61% in the 100, 200 and 300 basis point increasing rate scenarios presented. In addition, the earnings simulation model projects net interest income would decrease 2.52% and 7.79% in the 100 and 200 basis point decreasing rate scenarios presented, respectively. All of these forecasts are within the Corporation's one year policy guidelines. The analysis and model used to quantify the sensitivity of net interest income becomes less reliable in a decreasing rate scenario given the current unprecedented low interest rate environment with federal funds trading in the 0 - 25 basis point range. Results of the decreasing basis point declining scenarios are affected by the fact that many of the Corporation's interest-bearing liabilities are at rates below 1% and therefore likely may not decline 100 or more basis points. However, the Corporation's interest-sensitive assets are able to decline by these amounts. For the years ended December 31, 2020 and 2019, the cost of interest-bearing liabilities averaged 0.84% and 1.38%, respectively, and the yield on average interest-earning assets, on a fully taxable equivalent basis, averaged 4.09% and 4.33%, respectively.
Estimated Net Present Value
The net present value measures economic value at risk and is used for helping to determine levels of risk at a point in time present in the balance sheet that might not be taken into account in the earnings simulation model. The net present value of the balance sheet is defined as the discounted present value of asset cash flows minus the discounted present value of liability cash flows. At December 31, 2020, the 100 and 200 basis point immediate decreases in rates are estimated to affect net present value with a decrease of 46.58% and 117.55%, respectively. Additionally, net present value is projected to increase 26.71%, 40.95%, and 46.03% in the 100, 200 and 300 basis point immediate increase scenarios, respectively. All scenarios presented are within the Corporation's policy limits, aside from the 100 basis point 47
immediate downside scenario to (46.58)% from a policy limit of (20)% and immediate downward scenario of 200 basis points to (117.55)% from a policy limit of (30 )%.
The computation of the effects of hypothetical interest rate changes are based on many assumptions. They should not be relied upon solely as being indicative of actual results, since the computations do not account for actions management could undertake in response to changes in interest rates.
Table 17 – Effect of changes in interest rates
Projected Change Effect on Net Interest Income 1-Year Net Income Simulation Projection +300 bp Shock vs. Stable Rate (11.61) % +200 bp Shock vs. Stable Rate (7.76) % +100 bp Shock vs. Stable Rate (3.62) % Flat rate -100 bp Shock vs. Stable Rate (2.52) % -200 bp Shock vs. Stable Rate (7.79) % Effect on Net Present Value of Balance Sheet Static Net Present Value Change +300 bp Shock vs. Stable Rate 46.03 % +200 bp Shock vs. Stable Rate 40.95 % +100 bp Shock vs. Stable Rate 26.71 % Flat rate -100 bp Shock vs. Stable Rate (46.58) % -200 bp Shock vs. Stable Rate (117.55) %
Table 18 presents the Company’s quarterly operating results for the years ended. December 31, 2020 and 2019:
Table 18 – Quarterly operating results (unaudited)
(Dollars in thousands, except per share data)
Three Months Ended 2020 March 31 June 30 September 30 December 31 Interest income $ 9,768$ 9,631$ 9,852$ 10,316 Interest expense 2,392 1,513 1,231 1,224 Net interest income 7,376 8,118 8,621 9,092
Provision for loan losses 194 194
294 518 Non-interest income 983 1,621 1,515 1,893 Non-interest expense 5,915 5,655 6,256 6,779
Income before income tax expense 2,250 3,890
3,586 3,688 Income tax expense 197 509 449 422 Net income $ 2,053$ 3,381$ 3,137$ 3,266
Basic and diluted earnings per share $ 0.35$ 0.58
$ 0.54$ 0.56 48 Table of Contents (Dollars in thousands, except per share data) Three Months Ended 2019 March 31 June 30 September 30 December 31 Interest income $ 9,514$ 9,479$ 9,728$ 9,806 Interest expense 2,693 2,597 2,589 2,364 Net interest income 6,821 6,882 7,139 7,442 Provision for loan losses 92 46 175 137 Non-interest income 1,507 1,616 2,226 1,580 Non-interest expense 5,855 5,655 5,859 6,053 Income before income tax expense 2,381 2,797 3,331 2,832 Income tax expense 138 267 408 301 Net income $ 2,243$ 2,530$ 2,923$ 2,531
Basic and diluted earnings per share $ 0.39$ 0.440.50 USD$ 0.44
Critical accounting estimates
The Corporation has chosen accounting policies that it believes are appropriate to accurately and fairly report its operating results and financial position, and the Corporation has applied those policies in a consistent manner. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America require that the Corporation make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on historical or other factors believed to be reasonable under the circumstances. The Corporation evaluates these estimates and assumptions on an ongoing basis and may retain outside consultants, lawyers and actuaries to assist in its evaluation. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, the consolidated financial statements could reflect different estimates, assumptions and judgments. The Corporation considers three accounting policies to be critical because they involve the most significant judgments and estimates used in preparation of its consolidated financial statements. The three policies are the determination of other-than-temporary impairment of securities, the determination of the allowance for loan losses, and the assessment of goodwill for possible impairment. Other-Than-Temporary Impairment of Securities. Valuations for the securities portfolio are determined using quoted market prices, where available. If quoted market prices are not available, securities valuation is based on pricing models, quotes for similar securities, and observable yield curves and spreads. In addition to valuation, management must assess whether there are any declines in value below the carrying value of the securities that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of the loss in the Corporation's Consolidated Statements of Income. Allowance for Loan Losses. The allowance for loan losses represents management's estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the Corporation's Consolidated Balance Sheets. Goodwill. Goodwill represents the excess purchase consideration over the fair value of net assets acquired in connection with acquisitions. Goodwill is not amortized but is periodically evaluated for impairment. Impairment testing is performed using either a qualitative or quantitative approach. The Corporation has selected September 30 as the date to perform the annual goodwill impairment test. Additionally, a goodwill impairment evaluation is performed on an interim basis when events or circumstances indicate impairment potentially exists. 49
ITEM 7A. QUANTITATIVE AND QUALITATIVE INFORMATION ON MARKET RISK
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