UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2020

 

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: 000-21344

 

FIRST KEYSTONE CORPORATION

(Exact name of registrant as specified in its charter)

 

Pennsylvania		23-2249083
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
111 West Front Street, Berwick, PA		18603
(Address of principal executive offices)		(Zip Code)

 

Registrant’s telephone number, including area code: (570) 752-3671

 

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 x      No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x      No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “small reporting company,” and emerging growth company in Rule 12b-2 of the Exchange Act

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨		Smaller reporting company		x
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 7(a)(2)(B) of the Exchange Act. ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

 

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	FKYS	OTC: Pink

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date:

Common Stock, $2 Par Value, 5,832,107 shares as of May 7, 2020.

 

 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(Dollars in thousands, except share and per share data)

 

		March 31,				December 31,
		2020				2019
ASSETS
Cash and due from banks		$	7,785			$	10,251
Interest-bearing deposits in other banks			1,013				473
Total cash and cash equivalents			8,798				10,724
Time deposits with other banks			247				247
Debt securities available-for-sale, at fair value			283,663				277,928
Marketable equity securities, at fair value			1,394				1,933
Restricted investment in bank stocks, at cost			6,740				4,224
Loans			659,274				645,440
Loans held for sale			2,342				2,292
Allowance for loan losses			(7,179	)			(7,005	)
Net loans			654,437				640,727
Premises and equipment, net			19,244				19,387
Operating lease right-of-use assets			1,312				1,470
Accrued interest receivable			3,622				3,405
Cash surrender value of bank owned life insurance			23,737				23,583
Investments in low-income housing partnerships			1,737				1,828
Goodwill			19,133				19,133
Foreclosed assets held for resale			169				119
Other assets			2,974				2,518
TOTAL ASSETS		$	1,027,207			$	1,007,226
LIABILITIES
Deposits:
Non-interest bearing		$	153,029			$	134,648
Interest bearing			581,768				626,980
Total deposits			734,797				761,628
Short-term borrowings			106,379				54,663
Long-term borrowings			50,000				55,000
Operating lease liabilities			1,577				1,663
Accrued interest payable			550				606
Deferred income taxes			351				438
Other liabilities			3,403				4,476
TOTAL LIABILITIES			897,057				878,474
STOCKHOLDERS’ EQUITY
Preferred stock, par value $2.00 per share; authorized 1,000,000 shares as of March 31, 2020 and December 31, 2019;  issued 0 as of March 31, 2020 and December 31, 2019			―				―
Common stock, par value $2.00 per share; authorized 20,000,000 shares as of March 31, 2020 and December 31, 2019; issued 6,063,719 as of March 31, 2020 and 6,048,506 as of  December 31, 2019; outstanding 5,832,107 as of March 31, 2020 and 5,816,894 as of December 31, 2019			12,127				12,097
Surplus			38,645				38,365
Retained earnings			80,261				79,778
Accumulated other comprehensive income			4,826				4,221
Treasury stock, at cost, 231,612 shares as of March 31, 2020 and December 31, 2019			(5,709	)			(5,709	)
TOTAL STOCKHOLDERS’ EQUITY			130,150				128,752
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	1,027,207			$	1,007,226

 

See accompanying notes to consolidated financial statements.

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(Unaudited)

 

(Dollars in thousands, except per share data)
		2020				2019
Interest and fees on loans		$	7,758			$	7,074
Interest and dividend income on securities:
Taxable			1,276				1,218
Tax-exempt			630				1,018
Dividends			12				11
Dividend income on restricted investment in bank stocks			90				184
Interest on interest-bearing deposits in other banks			2				9
Total interest income			9,768				9,514
INTEREST EXPENSE
Interest on deposits			1,884				1,378
Interest on short-term borrowings			242				1,115
Interest on long-term borrowings			266				200
Total interest expense			2,392				2,693
Net interest income			7,376				6,821
Provision for loan losses			194				92
Net interest income after provision for loan losses			7,182				6,729
NON-INTEREST INCOME
Trust department			221				261
Service charges and fees			499				514
Bank owned life insurance income			154				155
ATM fees and debit card income			399				377
Gains on sales of mortgage loans			93				40
Net securities (losses) gains			(467	)			103
Other			84				57
Total non-interest income			983				1,507
NON-INTEREST EXPENSE
Salaries and employee benefits			3,219				3,132
Occupancy, net			518				464
Furniture and equipment			134				140
Computer expense			260				280
Professional services			242				270
Pennsylvania shares tax			224				192
FDIC insurance			—				65
ATM and debit card fees			209				211
Data processing fees			294				267
Foreclosed assets held for resale expense			9				38
Advertising			91				153
Other			715				643
Total non-interest expense			5,915				5,855
Income before income tax expense			2,250				2,381
Income tax expense			197				138
NET INCOME		$	2,053			$	2,243
PER SHARE DATA
Net income per share:
Basic		$	0.35			$	0.39
Diluted			0.35				0.39
Dividends per share			0.27				0.27

 

See accompanying notes to consolidated financial statements.

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(Unaudited)

 

 

(Dollars in thousands)

 

		March 31,
		2020				2019
Net Income		$	2,053			$	2,243
Other comprehensive income:
Unrealized net holding gains on debt securities available-for-sale arising during the period, net of income taxes of $176 and $986, respectively			661				3,709
Less reclassification adjustment for net realized gains included in net income, net of income taxes of $(15) and $(18), respectively (a) (b)			(56	)			(67	)
Total other comprehensive income			605				3,642
Total Comprehensive Income		$	2,658			$	5,885

 

_______________________

(a) Gross amounts are included in net securities (losses) gains on the consolidated statements of income in non-interest income.

(b) Income tax amounts are included in income tax expense on the consolidated statements of income.

 

 

See accompanying notes to consolidated financial statements.

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(Unaudited)

 

(Dollars in thousands, except per share data)

 

																		Accumulated
																		Other								Total
		Common Stock												Retained				Comprehensive				Treasury				Stockholders’
		Shares				Amount				Surplus				Earnings				Income				Stock				Equity
Balance at January 1, 2020			6,048,506			$	12,097			$	38,365			$	79,778			$	4,221			$	(5,709	)		$	128,752
Net Income															2,053												2,053
Other comprehensive income, net of taxes																			605								605
Issuance of common stock under dividend reinvestment plan			15,213				30				280																310
Dividends - $0.27 per share															(1,570	)											(1,570	)
Balance at March 31, 2020			6,063,719			$	12,127			$	38,645			$	80,261			$	4,826			$	(5,709	)		$	130,150
Balance at January 1, 2019			5,996,322			$	11,993			$	37,255			$	75,798			$	(2,581	)		$	(5,709	)		$	116,756
Net Income															2,243												2,243
Other comprehensive income, net of taxes																			3,642								3,642
Issuance of common stock under dividend reinvestment plan			12,312				24				254																278
Dividends - $0.27 per share															(1,557	)											(1,557	)
Balance at March 31, 2019			6,008,634			$	12,017			$	37,509			$	76,484			$	1,061			$	(5,709	)		$	121,362

 

See accompanying notes to consolidated financial statements.

 

 

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(Unaudited)

 

(Dollars in thousands)

 

		2020				2019
OPERATING ACTIVITIES
Net income		$	2,053			$	2,243
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			194				92
Depreciation and amortization			488				254
Net premium amortization on investment securities			498				733
Deferred income tax (benefit) expense			(247	)			62
Gains on sales of mortgage loans			(93	)			(40	)
Proceeds from sales of mortgage loans originated for resale			3,137				1,250
Originations of mortgage loans originated for resale			(3,100	)			(964	)
Net securities losses (gains)			467				(103	)
Net losses on sales of foreclosed real estate held for resale, including write-downs			—				20
(Increase) decrease in accrued interest receivable			(217	)			367
Earnings on investment in bank owned life insurance			(154	)			(155	)
Net losses on disposals of premises and equipment			—				4
Increase in other assets			(537	)			(1,860	)
Amortization of investment in real estate ventures			91				88
(Decrease) increase in accrued interest payable			(56	)			58
(Decrease) increase in other liabilities			(1,159	)			1,198
NET CASH PROVIDED BY OPERATING ACTIVITIES			1,365				3,247
INVESTING ACTIVITIES
Proceeds from sales of debt securities available-for-sale			11,182				32,374
Proceeds from maturities and redemptions of debt securities available-for-sale			15,324				4,520
Purchases of debt securities available-for-sale			(31,902	)			—
Net change in restricted investment in bank stocks			(2,516	)			1,173
Net increase in loans			(13,877	)			(11,891	)
Purchases of premises and equipment			(120	)			(234	)
Proceeds from sales of foreclosed assets held for resale			—				197
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES			(21,909	)			26,139
FINANCING ACTIVITIES
Net (decrease) increase in deposits			(26,831	)			25,867
Net increase (decrease) in short-term borrowings			51,716				(42,966	)
Repayment of long-term borrowings			(5,000	)			(10,000	)
Common stock issued			303				278
Dividends paid			(1,570	)			(1,557	)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES			18,618				(28,378	)
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS			(1,926	)			1,008
CASH AND CASH EQUIVALENTS, BEGINNING			10,724				10,950
CASH AND CASH EQUIVALENTS, ENDING		$	8,798			$	11,958
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid			2,448				2,635
Income taxes paid			(249	)			62
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES
Loans transferred to foreclosed assets held for resale			50				—
Common stock subscription receivable			7				—
Right-of-use assets obtained in exchange for lease liabilities			—				1,465

 

 

See accompanying notes to consolidated financial statements.

FIRST KEYSTONE CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

NOTE 1 ― BASIS OF PRESENTATION, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND SUBSEQUENT EVENTS

 

The consolidated financial statements include the accounts of First Keystone Corporation (the “Corporation”) and its wholly owned subsidiary First Keystone Community Bank (the “Bank”) (collectively the “Company”). All significant intercompany accounts and transactions have been eliminated.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included. Operating results for the three month period ended March 31, 2020, are not necessarily indicative of the results for the year ending December 31, 2020. For further information, refer to the consolidated financial statements and notes thereto included in First Keystone Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019.

 

Subsequent Events

 

The Corporation has evaluated events and transactions occurring subsequent to the consolidated balance sheet date of March 31, 2020 for items that should potentially be recognized or disclosed in these consolidated financial statements. The evaluation was conducted through the date these consolidated financial statements were issued.

 

As a result of the spread of the COVID-19 coronavirus, economic uncertainties have arisen which are likely to negatively impact net interest income. 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 extended or modified. The extent of the impact of COVID-19 on the Corporation’s operational and financial performance will depend on certain developments including the duration and spread of the outbreak and the impact on our customers, employees and vendors.

 

The Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted on March 27, 2020 in the United States. The Corporation is approved by the U.S. Small Business Administration (“SBA”) to fund loans under the SBA’s Paycheck Protection Program (“PPP”) created as part of the CARES Act. To date, the Bank has received 456 applications for PPP loans for a combined total of $32,367,000. As of April 30, 2020, 432 PPP loan applications were approved, and 152 of the loans were funded for $16,010,000. The PPP loans have 1.00% interest rates, lender fees, and two-year terms. These forgivable loans funded by the Corporation are subject to the terms and conditions applicable to all loans made pursuant to the PPP as administered by the SBA under the CARES Act.

 

In addition, subsequent to March 31, 2020, there have been loan modification requests to defer principal and/or interest payments or modify interest rates in the wake of the COVID-19 pandemic. As of April 30, 2020, there have been 493 loan modifications approved across all loan segments, for customers with current loan balances of $181,704,000. At this time, there have been no material fluctuations in loan delinquencies because of COVID-19.

 

Other financial impact could occur, though such potential impact is unknown at this time.

 

NOTE 2 ― RECENT ACCOUNTING STANDARDS UPDATES (“ASU”)

 

Recently adopted ASUs:

 

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The ASU simplified the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Instead, under the amendments, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value with its carrying amount. Additionally, an entity should consider income tax effects from any tax-deductible goodwill on the carrying amount when measuring the goodwill impairment loss, if applicable. The update also eliminated the requirements for zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. The amendments are effective for public business entities for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. The adoption of this update on January 1, 2020 did not have a material impact on the Corporation’s consolidated financial position or results of operations.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) – Disclosure Framework – Changes to Disclosure Requirements for Fair Value Measurement. The amendments in this Update removed required disclosures regarding: 1. The amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, 2. The policy for timing of transfers between levels, 3. The valuation processes for Level 3 fair value measurements, and 4. The Update modified the disclosure requirements on fair value measurements in Topic 820: a) The changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and b) The range and weighted average significant unobservable inputs used to develop Level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information (such as the median or arithmetic average) in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. The amendments in this Update are effective for all entities for fiscal years, and interim periods within those fiscal years beginning after December 15, 2019. The adoption of this update on January 1, 2020 did not have a material impact on the Corporation’s consolidated financial statements and related disclosures.

 

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848), which provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by the discontinuation of the London Interbank Offered Rate (“LIBOR”), or by another reference rate that is expected to be discontinued. The amendments are effective for all entities as of March 12, 2020 through December 31, 2022. The Corporation has evaluated the impact of the provisions of ASU 2020-04 on our financial condition, results of operations and cash flows, and determined that there is no material impact on the consolidated financial statements and related disclosures.

 

Pending ASUs:

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU No. 2016-13 requires financial assets measured at amortized cost to be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. ASU No. 2016-13 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2019. In November 2019, the FASB issued ASU 2019-10, Financial Instruments-Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), to delay the effective date for smaller reporting companies to fiscal years, and interim periods within those fiscal years, beginning after December 15, 2022. While the Corporation (a smaller reporting company) is currently evaluating the provisions of ASU 2016-13 to determine the potential impact of the new standard will have on the Corporation’s consolidated financial statements, it has taken steps to prepare for the implementation when it becomes effective, such as: forming an internal committee, gathering pertinent data, consulting with outside professionals, subscribing to a new software system, and running existing and new methodologies concurrently through the period of implementation.

 

 

NOTE 3 — SECURITIES

 

The Corporation classifies its securities as either “Held-to-Maturity” or “Available-for-Sale” at the time of purchase. Securities are accounted for on a trade date basis. Debt securities are classified as Held-to-Maturity when the Corporation has the ability and positive intent to hold the securities to maturity. Securities classified as Held-to-Maturity are carried at cost adjusted for amortization of premium and accretion of discount to maturity.

 

Debt securities not classified as Held-to-Maturity are included in the Available-for-Sale category and are carried at fair value. The amount of any unrealized gain or loss, net of the effect of deferred income taxes, is reported as accumulated other comprehensive income (loss) (AOCI) in the consolidated balance sheets and consolidated statements of changes in stockholders’ equity. Management’s decision to sell Available-for-Sale securities is based on changes in economic conditions, controlling the sources and applications of funds, terms, availability of and yield of alternative investments, interest rate risk and the need for liquidity.

 

Equity securities with readily determinable fair values are stated at fair value with realized and unrealized gains and losses reported in income. Equity securities without readily determinable fair values are recorded at cost less impairment, if any.

 

The cost of debt securities classified as Held-to-Maturity or Available-for-Sale is adjusted for amortization of premiums to the earliest call date and accretion of discounts to expected maturity. Such amortization and accretion, as well as interest and dividends, are included in interest and dividend income from investment securities. Realized gains and losses are included in net securities gains and losses. The cost of securities sold, redeemed or matured is based on the specific identification method.

 

The amortized cost, related estimated fair value, and unrealized gains and losses for debt securities classified as “Available-For-Sale” were as follows at March 31, 2020 and December 31, 2019:

 

		Debt Securities Available-for-Sale
(Dollars in thousands)						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
March 31, 2020:		Cost				Gains				Losses				Value
U.S. Treasury securities		$	—			$	—			$	—			$	—
Obligations of U.S. Government Corporations and Agencies:
Mortgage-backed			62,235				1,055				(785	)			62,505
Other			12,341				7				(119	)			12,229
Other mortgage backed debt securities			10,187				—				(824	)			9,363
Obligations of state and political subdivisions			131,424				9,052				(9	)			140,467
Asset backed securities			42,889				—				(2,123	)			40,766
Corporate debt securities			18,479				118				(264	)			18,333
Total		$	277,555			$	10,232			$	(4,124	)		$	283,663

 

 

		Debt Securities Available-for-Sale
(Dollars in thousands)						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
December 31, 2019:		Cost				Gains				Losses				Value
U.S. Treasury securities		$	2,852			$	3			$	―			$	2,855
Obligations of U.S. Government Corporations and Agencies:
Mortgage-backed			77,131				539				(387	)			77,283
Other			10,381				4				(88	)			10,297
Other mortgage backed securities			11,145				3				(10	)			11,138
Obligations of state and political subdivisions			114,934				5,490				(48	)			120,376
Asset backed securities			37,596				115				(175	)			37,536
Corporate debt securities			18,546				182				(285	)			18,443
Total		$	272,585			$	6,336			$	(993	)		$	277,928

 

Securities Available-for-Sale with an aggregate fair value of $183,713,000 at March 31, 2020 and $201,468,000 at December 31, 2019, were pledged to secure public funds, trust funds, securities sold under agreements to repurchase and the Federal Discount Window aggregating $128,721,000 at March 31, 2020 and $143,546,000 at December 31, 2019.

 

 

The amortized cost and estimated fair value of debt securities, by contractual maturity, are shown below at March 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.

 

(Dollars in thousands)

 

		March 31, 2020
		Debt Securities 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		$	—			$	―			$	—			$	1,001			$	—			$	2,000
Fair value			—				―				—				1,011				—				1,968
1 - 5 Years:
Amortized cost			—				772				—				21,473				2,872				16,479
Fair value			—				788				—				22,070				2,737				16,365
5 - 10 Years:
Amortized cost			—				21,610				—				23,936				4,686				—
Fair value			—				21,337				—				25,293				4,462				—
After 10 Years:
Amortized cost			—				52,194				10,187				85,014				35,331				—
Fair value			—				52,609				9,363				92,093				33,567				—
Total:
Amortized cost		$	—			$	74,576			$	10,187			$	131,424			$	42,889			$	18,479
Fair value			—				74,734				9,363				140,467				40,766				18,333

______________________

¹Mortgage-backed securities are allocated for maturity reporting at their original maturity date.

 

There were no aggregate securities with a single issuer (excluding the U.S. Government and U.S. Government Agencies and Corporations) which exceeded ten percent of consolidated stockholders’ equity at March 31, 2020. The quality rating of the obligations of state and political subdivisions are generally investment grade, as rated by Moody’s, Standard and Poor’s or Fitch. The typical exceptions are local issues which are not rated, but are secured by the full faith and credit obligations of the communities that issued these securities.

 

Proceeds from sales of investments in Debt Securities Available-For-Sale for the three months ended March 31, 2020 and 2019 were $11,182,000 and $32,374,000, respectively. Gross gains realized on these sales were $176,000 and $187,000, respectively. Gross losses realized on these sales were $105,000 and $102,000, respectively. There were no impairment losses realized on Debt Securities Available-For-Sale during the three months ended March 31, 2020 or 2019.

 

At March 31, 2020 and December 31, 2019, the Corporation had $1,394,000 and $1,933,000, respectively, in equity securities recorded at fair value. The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three months ended March 31, 2020 and 2019:

 

 

(Dollars in thousands)

 

		Three months ended				Three months ended
		March 31, 2020				March 31, 2019
Net (losses) and gains recognized during the period on equity securities		$	(538	)		$	18
Less: Net gains and (losses) recognized during the period on equity securities sold during the period			—				—
Unrealized (losses) and gains recognized during the reporting period on equity securities still held at the reporting date		$	(538	)		$	18

 

There were no proceeds from sales of investments in Held-to-Maturity debt securities during the first three months of 2020 or 2019. Therefore, there were no gains or losses realized during these periods.

 

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 an evaluation. Securities classified as Available-for-Sale or Held-to-Maturity are generally evaluated for OTTI under FASB ASC 320, Investments - Debt and Equity Securities. In determining OTTI under the FASB ASC 320 model, management considers many factors, including (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, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

 

When OTTI occurs on debt securities, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected, and the realized loss is recognized as impairment charges on securities on the consolidated statements of income. The amount of the total OTTI related to the other factors shall be recognized in other comprehensive income (loss), net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

 

The Corporation and its investment advisors monitor the entire portfolio monthly with particular attention given to securities in a continuous loss position of at least ten percent for over twelve months. Based on the factors described above, management did not consider any securities to be other-than-temporarily impaired at March 31, 2020 or December 31, 2019.

 

 

The summary below shows the gross unrealized losses and fair value of the Corporation’s debt securities. Totals are aggregated by investment category where individual securities have been in a continuous loss position for less than 12 months or 12 months or more as of March 31, 2020 and December 31, 2019:

 

March 31, 2020

 

(Dollars in thousands)		Less Than 12 Months								12 Months or More								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
Available-for-Sale:		Value				Loss				Value				Loss				Value				Loss
U.S. Treasury securities		$	—			$	—			$	—			$	—			$	—			$	—
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed			20,750				(466	)			7,747				(319	)			28,497				(785	)
Other			6,092				(64	)			4,396				(55	)			10,488				(119	)
Other mortgage backed debt securities			7,492				(824	)			—				—				7,492				(824	)
Obligations of state and political subdivisions			1,507				(9	)			—				—				1,507				(9	)
Asset backed securities			40,766				(2,123	)			—				—				40,766				(2,123	)
Corporate debt securities			4,041				(118	)			7,355				(146	)			11,396				(264	)
Total		$	80,648			$	(3,604	)		$	19,498			$	(520	)		$	100,146			$	(4,124	)

 

 

December 31, 2019

 

(Dollars in thousands)

 

		Less Than 12 Months								12 Months or More								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
Available-for-Sale:		Value				Loss				Value				Loss				Value				Loss
U.S. Treasury securities		$	―			$	―			$	—			$	—			$	―			$	―
Obligations of U.S. Government
Corporations and Agencies:
Mortgage-backed			39,085				(221	)			12,650				(166	)			51,735				(387	)
Other			4,382				(24	)			4,594				(64	)			8,976				(88	)
Other mortgage backed debt securities			4,056				(10	)			―				―				4,056				(10	)
Obligations of state and political subdivisions			1,993				(15	)			1,081				(33	)			3,074				(48	)
Asset backed securities			19,236				(175	)			—				—				19,236				(175	)
Corporate debt securities			3,484				(16	)			7,231				(269	)			10,715				(285	)
Total		$	72,236			$	(461	)		$	25,556			$	(532	)		$	97,792			$	(993	)

 

The Corporation invests in various forms of agency debt including mortgage-backed securities and callable debt. The mortgage-backed securities are issued by Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”) or Government National Mortgage Association (“GNMA”). The municipal securities consist of general obligations and revenue bonds. The fair market value of the above securities is influenced by market interest rates, prepayment speeds on mortgage securities, bid-offer spreads in the market place and credit premiums for various types of agency debt. These factors change continuously and therefore the market value of these securities may be higher or lower than the Corporation’s carrying value at any measurement date. Management does not believe any of their 27 debt securities with a less than one year unrealized loss position, or any of their 13 debt securities with a one year or greater unrealized loss position as of March 31, 2020, represent an other-than-temporary impairment, as the unrealized losses relate principally to changes in interest rates subsequent to the acquisition of the specific securities. The Corporation expects to collect all principal and interest payments defined under the original terms as all contracted payments on securities in the portfolio are current as of March 31, 2020.

 

NOTE 4 — LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans

 

Net loans are stated at their outstanding recorded investment, net of deferred fees and costs, unearned income and the allowance for loan losses. Interest on loans is recognized as income over the term of each loan, generally, by the accrual method. Loan origination fees and certain direct loan origination costs have been deferred with the net amount amortized using the straight line method or the interest method over the contractual life of the related loans as an interest yield adjustment.

 

Residential mortgage loans held for sale are carried at the lower of cost or market on an aggregate basis determined by independent pricing from appropriate federal or state agency investors. These loans are sold without recourse. Loans held for sale amounted to $2,342,000 and $2,292,000 at March 31, 2020 and December 31, 2019, respectively.

 

As an addition to the commercial loans receivable portfolio, the Corporation may purchase the guaranteed portion of loans secured by the U.S. Government. The originating bank retains the unguaranteed portion of the loan. The loans are sponsored by one of the various government agencies including the U.S. Small Business Administration (SBA), United States Department of Agriculture (USDA), and the Farm Service Agency (FSA). Government Guaranteed Loans (“GGLs”) carry no credit risk due to an unconditional and irrevocable guarantee on all principal and accrued interest, which is supported by the full faith and credit of the U.S. Government. As of March 31, 2020, the Corporation’s balance of GGLs amounted to $6,059,000, compared to $6,150,000 at December 31, 2019.

 

The loans receivable portfolio is segmented into commercial, residential and consumer loans. Commercial loans consist of the following classes: Commercial and Industrial, and Commercial Real Estate.

 

Commercial and Industrial Lending

 

The Corporation originates commercial and industrial loans primarily to businesses located in its primary market area and surrounding areas. These loans are used for various business purposes, which include short-term loans and lines of credit to finance machinery and equipment, inventory and accounts receivable. Generally, the maximum term for loans extended on machinery and equipment is based on the projected useful life of such machinery and equipment. Most business lines of credit are written on demand and are reviewed annually.

 

Commercial and industrial loans are generally secured with short-term assets; however, in many cases, additional collateral such as real estate is provided as additional security for the loan. Loan-to-value maximum thresholds have been established by the Corporation and are specific to the type of collateral. Collateral values may be determined using invoices, inventory reports, accounts receivable aging reports, business financial statements, collateral appraisals, etc. Commercial and industrial loans are typically supported by personal guarantees of the borrower.

 

In underwriting commercial and industrial loans, an analysis is performed to evaluate the borrower's character and capacity to repay the loan, the adequacy of the borrower's capital and collateral, as well as the conditions affecting the borrower. Evaluation of the borrower’s past, present and future cash flows is also an important aspect of the Corporation's analysis of the borrower’s ability to repay.

 

Commercial and industrial loans generally present a higher level of risk than other types of loans due primarily to the effect of general economic conditions. Commercial and industrial loans are typically made on the basis of the borrower’s ability to make repayment from cash flows from the borrower’s primary business activities. As a result, the availability of funds for the repayment of commercial and industrial loans is dependent on the success of the business itself, which in turn, is likely to be dependent upon the general economic environment.

 

Commercial Real Estate Lending

 

The Corporation engages in commercial real estate lending in its primary market area and surrounding areas. The Corporation’s commercial real estate portfolio is secured primarily by commercial retail space, commercial office buildings, residential housing and hotels. Generally, commercial real estate loans have terms that do not exceed twenty years, have loan-to-value ratios of up to eighty percent of the value of the collateral property, and are typically supported by personal guarantees of the borrowers.

 

 

In underwriting these loans, the Corporation performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the property securing the loan. The value of the property is determined by either independent appraisers or internal evaluations by Bank officers.

 

Commercial real estate loans generally present a higher level of risk than residential real estate secured loans. Repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate project and/or the effect of the general economic conditions on income producing properties.

 

Residential Real Estate Lending (Including Home Equity)

 

The Corporation’s residential real estate portfolio is comprised of one-to-four family residential mortgage loan originations, home equity term loans and home equity lines of credit. These loans are generated by the Corporation’s marketing efforts, its present customers, walk-in customers and referrals. These loans originate primarily within or with customers from the Corporation’s market area.

 

The Corporation’s one-to-four family residential mortgage originations are secured primarily by properties located in its primary market area and surrounding areas. The Corporation offers fixed-rate mortgage loans with terms up to a maximum of thirty years for both permanent structures and those under construction. Loans with terms of thirty years are normally held for sale and sold without recourse; most of the residential mortgages held in the Corporation’s residential real estate portfolio have maximum terms of twenty years. Generally, the majority of the Corporation’s residential mortgage loans originate with a loan-to-value of eighty percent or less, or those with primary mortgage insurance at ninety-five percent or less. Home equity term loans are secured by the borrower’s primary residence and typically have a maximum loan-to-value of eighty percent and a maximum term of fifteen years. In general, home equity lines of credit are secured by the borrower’s primary residence with a maximum loan-to-value of eighty percent and a maximum term of twenty years.

 

In underwriting one-to-four family residential mortgage loans, the Corporation evaluates the borrower’s ability to make monthly payments, the borrower’s repayment history and the value of the property securing the loan. The ability and willingness to repay is assessed based upon the borrower’s employment history, current financial conditions and credit background. A majority of the properties securing residential real estate loans made by the Corporation are appraised by independent appraisers. The Corporation generally requires mortgage loan borrowers to obtain an attorney’s title opinion or title insurance and fire and property insurance, including flood insurance, if applicable.

 

Residential mortgage loans, home equity term loans and home equity lines of credit generally present a lower level of risk than consumer loans because they are secured by the borrower’s primary residence. Risk is increased when the Corporation is in a subordinate position, especially to another lender, for the loan collateral.

 

Consumer Lending

 

The Corporation offers a variety of secured and unsecured consumer loans, including vehicle loans, stock loans and loans secured by financial institution deposits. These loans originate primarily within or with customers from the Corporation’s market area.

 

Consumer loan terms vary according to the type and value of collateral and creditworthiness of the borrower. In underwriting personal loans, a thorough analysis is performed regarding the borrower’s willingness and financial ability to repay the loan as agreed. The ability and willingness to repay is assessed based upon the borrower’s employment history, current financial condition and credit background.

 

Consumer loans may entail greater credit risk than residential real estate loans, particularly in the case of personal loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles or recreational equipment. In such cases, repossessed collateral for a defaulted personal loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, personal loan collections are dependent on the borrower’s continuing financial stability and therefore, are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

 

Delinquent Loans

 

Generally, a loan is considered to be past-due when scheduled loan payments are in arrears 10 days or more. Delinquent notices are generated automatically when a loan is 10 or 15 days past-due, depending on loan type. Collection efforts continue on past-due loans that have not been brought current, when it is believed that some chance exists for improvement in the status of the loan. Past-due loans are continually evaluated with the determination for charge-off being made when no reasonable chance remains that the status of the loan can be improved.

 

Commercial and Industrial and Commercial Real Estate loans are charged off in whole or in part when they become sufficiently delinquent based upon the terms of the underlying loan contract and when a collateral deficiency exists. Because all or part of the contractual cash flows are not expected to be collected, the loan is considered to be impaired, and the Bank estimates the impairment based on its analysis of the cash flows or collateral estimated at fair value less cost to sell. Should a Government Guaranteed Loan default, demand is made to the originating bank for repurchase of the loan. If the originating bank does not repurchase the loan, demand for repurchase is then made to the appropriate government agency which has provided the guarantee for the loan.

 

Residential Real Estate and Consumer loans are charged off when they become sufficiently delinquent based upon the terms of the underlying loan contract and when the value of the underlying collateral is not sufficient to support the loan balance and a loss is expected. At that time, the amount of estimated collateral deficiency, if any, is charged off for loans secured by collateral, and all other loans are charged off in full. Loans with collateral are written down to the estimated fair value of the collateral less cost to sell.

 

Existing loans in which the borrower has declared bankruptcy are considered on a case by case basis to determine whether repayment is likely to occur (eg. reaffirmation by the borrower with demonstrated repayment ability). Otherwise, loans are charged off in full or written down to the estimated fair value of collateral less cost to sell.

 

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 may currently be performing. A loan may remain on accrual status if it is well secured (or supported by a strong guarantee) and in the process of collection. 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 interest income. Certain non-accrual loans may continue to perform; that is, payments are still being received. Generally, the payments are applied to principal. These loans remain under constant scrutiny, and if performance continues, interest income may be recorded on a cash basis based on management's judgment regarding the collectability of principal.

 

Allowance for Loan Losses

 

The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses and subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is maintained at a level estimated by management to be adequate to absorb potential loan losses. Management’s periodic evaluation of the adequacy of the allowance for loan losses 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 (including the timing of future payments), 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 including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.

 

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are individually classified as impaired. Select loans are not aggregated for collective impairment evaluation, as such; all loans are subject to individual impairment evaluation should the facts and circumstances pertinent to a particular loan suggest that such evaluation is necessary. Factors considered by management in determining impairment include payment status and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. If a loan is impaired, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from collateral. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loans may be reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Corporation determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

 

 

The general component covers all other loans not identified as impaired (aside from Government Guaranteed Loans, which do not require an allowance) and is based on historical losses and qualitative factors. The historical loss component of the allowance is determined by losses recognized by portfolio segment over a time period that management has determined represents the current credit cycle. Qualitative factors impacting each portfolio segment may include: delinquency trends, loan volume trends, Bank policy changes, management processes and oversight, economic trends (including change in consumer and business disposable incomes, unemployment and under-employment levels, and other conditions), concentrations by industry or product, internal and external loan review processes, collateral value and market conditions, and external factors including regulatory issues and competition.

 

Government Guaranteed Loans do not require an associated allowance for loan losses due to the underlying irrevocable and unconditional guarantee, which is supported by the full faith and credit of the U.S. Government. Should a GGL default, the loan will be repurchased by the originating bank or the appropriate government agency that has provided the guarantee for the loan.

 

The unallocated component of the allowance is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

 

A reserve for unfunded lending commitments is provided for possible credit losses on off-balance sheet credit exposures. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and, if necessary, is recorded in other liabilities on the consolidated balance sheets. As of March 31, 2020 and December 31, 2019, the amount of the reserve for unfunded lending commitments was $161,000 and $117,000, respectively.

 

The Corporation is subject to periodic examination by its federal and state examiners, and may be required by such regulators to recognize additions to the allowance for loan losses based on their assessment of credit information available to them at the time of their examinations.

 

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the original loan agreement. Under current accounting standards, the allowance for loan losses related to impaired loans is based on discounted cash flows using the loan’s effective interest rate at inception or the fair value of the collateral for certain collateral dependent loans.

 

From time to time, the Bank may agree to modify/restructure the contractual terms of a borrower’s loan. The restructuring of a loan is considered a “troubled debt restructuring” if both the following conditions are met: (i) the borrower is experiencing financial difficulties, and (ii) the Corporation has granted a concession. The most common concessions granted include one or more modifications to the terms of the debt, such as (a) a reduction in the interest rate for the remaining life of the debt, (b) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk, (c) a temporary period of interest-only payments, and (d) a reduction in the contractual payment amount for either a short period or remaining term of the loan. A less common concession is the forgiveness of a portion of the principal.

 

The determination of whether a borrower is experiencing financial difficulties takes into account not only the current financial condition of the borrower, but also the potential financial condition of the borrower were a concession not granted. Similarly, the determination of whether a concession has been granted is very subjective in nature. For example, simply extending the term of a loan at its original interest rate or even at a higher interest rate could be interpreted as a concession unless the borrower could readily obtain similar credit terms from a different lender.

 

Loans modified in a troubled debt restructuring are considered impaired and may or may not be placed on non-accrual status until the Corporation determines the future collection of principal and interest is reasonably assured, which generally requires that the borrower demonstrates a period of performance according to the restructured terms of six months. 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.

 

 

The Bank utilizes a risk grading matrix as a tool for managing credit risk in the loan portfolio and assigns an asset quality rating (risk grade) to all Commercial and Industrial, Commercial Real Estate, Residential Real Estate and Consumer borrowings. An asset quality rating is assigned using the guidance provided in the Corporation’s loan policy. Primary responsibility for assigning the asset quality rating rests with the credit department. The asset quality rating is validated periodically by both an internal and external loan review process.

 

The commercial loan grading system focuses on a borrower’s financial strength and performance, experience and depth of management, primary and secondary sources of repayment, the nature of the business and the outlook for the particular industry. Primary emphasis is placed on financial condition and trends. The grade also reflects current economic and industry conditions; as well as other variables such as liquidity, cash flow, revenue/earnings trends, management strengths or weaknesses, quality of financial information, and credit history.

 

The loan grading system for Residential Real Estate and Consumer loans focuses on the borrower’s credit score and credit history, debt-to-income ratio and income sources, collateral position and loan-to-value ratio.

 

Risk grade characteristics are as follows:

 

Risk Grade 1 – MINIMAL RISK through Risk Grade 6 – MANAGEMENT ATTENTION (Pass Grade Categories)

 

Risk is evaluated via examination of several attributes including but not limited to financial trends, strengths and weaknesses, likelihood of repayment when considering both cash flow and collateral, sources of repayment, leverage position, management expertise, and repayment history.

 

At the low-risk end of the rating scale, a risk grade of 1 – Minimal Risk is the grade reserved for loans with exceptional credit fundamentals and virtually no risk of default or loss. Loan grades then progress through escalating ratings of 2 through 6 based upon risk. Risk Grade 2 – Modest Risk are loans with sufficient cash flows; Risk Grade 3 – Average Risk are loans with key balance sheet ratios slightly above the borrower’s peers; Risk Grade 4 – Acceptable Risk are loans with key balance sheet ratios usually near the borrower’s peers, but one or more ratios may be higher; and Risk Grade 5 – Marginally Acceptable are loans with strained cash flow, increasing leverage and/or weakening markets. Risk Grade 6 – Management Attention are loans with weaknesses resulting from declining performance trends and the borrower’s cash flows may be temporarily strained. Loans in this category are performing according to terms, but present some type of potential concern.

 

Risk Grade 7 − SPECIAL MENTION (Non-Pass Category)

 

Generally, these loans are currently protected, but are “potentially weak.” They constitute an undue and unwarranted credit risk but not to the point of justifying a classification of substandard.

 

Assets in this category are protected but have potential weakness which may, if not checked or corrected, weaken the asset or inadequately protect the Corporation’s credit position at some future date. No loss of principal or interest is envisioned; however, they constitute an undue credit risk that may be minor but is unwarranted in light of the circumstances surrounding a specific asset. Risk is increasing beyond that at which the loan originally would have been granted. Historically, cash flows are inconsistent; financial trends show some deterioration. Liquidity and leverage are above industry averages. Financial information could be incomplete or inadequate. A Special Mention asset has potential weaknesses that deserve management’s close attention.

 

Risk Grade 8 − SUBSTANDARD (Non-Pass Category)

 

Generally, these assets are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have “well-defined” weaknesses that jeopardize the full liquidation of the debt.

 

These loans are characterized by the distinct possibility that the Corporation will sustain some loss if the aggregate amount of substandard assets is not fully covered by the liquidation of the collateral used as security. Substandard loans have a high probability of payment default and require more intensive supervision by Corporation management.

 

 

Risk Grade 9 − DOUBTFUL (Non-Pass Category)

 

Generally, loans graded doubtful have all the weaknesses inherent in a substandard loan with the added factor that the weaknesses are pronounced to a point whereby the basis of current information, conditions, and values, collection or liquidation in full is deemed to be highly improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to strengthen the asset, its classification is deferred until, for example, a proposed merger, acquisition, liquidation procedure, capital injection, perfection of liens on additional collateral and/or refinancing plan is completed. Loans are graded doubtful if they contain weaknesses so serious that collection or liquidation in full is questionable.

 

The following table presents the classes of the loan portfolio summarized by risk rating as of March 31, 2020 and December 31, 2019:

 

		Commercial and
(Dollars in thousands)		Industrial								Commercial Real Estate
		March 31,				December 31,				March 31,				December 31,
		2020				2019				2020				2019
Grade:
1-6    Pass		$	85,418			$	84,999			$	399,740			$	382,510
7       Special Mention			—				2				—				944
8       Substandard			963				1,068				12,229				11,590
9       Doubtful			—				—				—				―
Add (deduct): Unearned discount and			—				—				—				―
Net deferred loan fees and costs			642				643				827				757
Total loans		$	87,023			$	86,712			$	412,796			$	395,801

 

 

		Residential Real Estate
		Including Home Equity								Consumer
		March 31,				December 31,				March 31,				December 31,
		2020				2019				2020				2019
Grade:
1-6   Pass		$	155,124			$	158,301			$	5,570			$	5,662
7      Special Mention			—				117				31				83
8      Substandard			1,089				1,048				8				35
9      Doubtful			—				—				—				―
Add (deduct): Unearned discount and			—				—				—				—
Net deferred loan fees and costs			(108	)			(116	)			83				89
Total loans		$	156,105			$	159,350			$	5,692			$	5,869

 

 

		Total Loans
		March 31,				December 31,
		2020				2019
Grade:
1-6   Pass		$	645,852			$	631,472
7      Special Mention			31				1,146
8      Substandard			14,289				13,741
9      Doubtful			—				—
Add (deduct): Unearned discount and			—				—
Net deferred loan fees and costs			1,444				1,373
Total loans		$	661,616			$	647,732

 

Commercial and Industrial and Commercial Real Estate include loans categorized as tax-free in the amounts of $17,117,000 and $1,966,000 at March 31, 2020 and $17,848,000 and $2,007,000 at December 31, 2019. Commercial and Industrial loans also included $6,059,000 and $6,150,000 of Government Guaranteed Loans as of March 31, 2020 and December 31, 2019, respectively. Loans held for sale amounted to $2,342,000 at March 31, 2020 and $2,292,000 at December 31, 2019.

 

 

The activity in the allowance for loan losses, by loan class, is summarized below for the periods indicated.

 

(Dollars in thousands)		Commercial				Commercial				Residential
		and Industrial				Real Estate				Real Estate				Consumer				Unallocated				Total
As of and for the three month period ended March 31, 2020:
Allowance for Loan Losses:
Beginning balance		$	634			$	4,116			$	1,665			$	114			$	476			$	7,005
Charge-offs			(4	)			—				—				(16	)			—				(20	)
Recoveries			—				—				—				—				—				—
Provision			33				212				(22	)			15				(44	)			194
Ending Balance		$	663			$	4,328			$	1,643			$	113			$	432			$	7,179
Ending balance: individually evaluated for impairment		$	―			$	1			$	—			$	―			$	―			$	1
Ending balance: collectively evaluated for impairment		$	663			$	4,327			$	1,643			$	113			$	432			$	7,178
Loans Receivable:
Ending Balance		$	87,023			$	412,796			$	156,105			$	5,692			$	―			$	661,616
Ending balance: individually evaluated for impairment		$	1,077			$	11,510			$	1,109			$	―			$	―			$	13,696
Ending balance: collectively evaluated for impairment		$	85,946			$	401,286			$	154,996			$	5,692			$	―			$	647,920

 

 

(Dollars in thousands)		Commercial				Commercial				Residential
		and Industrial				Real Estate				Real Estate				Consumer				Unallocated				Total
As of and for the three month period ended March 31, 2019:
Allowance for Loan Losses:
Beginning balance		$	724			$	3,700			$	1,650			$	117			$	554			$	6,745
Charge-offs			—				(64	)			—				(15	)			—				(79	)
Recoveries			1				—				2				1				—				4
Provision			7				229				(11	)			7				(140	)			92
Ending Balance		$	732			$	3,865			$	1,641			$	110			$	414			$	6,762
Ending balance: individually evaluated for impairment		$	―			$	4			$	—			$	―			$	―			$	4
Ending balance: collectively evaluated for impairment		$	732			$	3,861			$	1,641			$	110			$	414			$	6,758
Loans Receivable:
Ending Balance		$	93,575			$	359,073			$	159,624			$	5,711			$	―			$	617,983
Ending balance: individually evaluated for impairment		$	1,116			$	15,557			$	491			$	―			$	―			$	17,164
Ending balance: collectively evaluated for impairment		$	92,459			$	343,516			$	159,133			$	5,711			$	―			$	600,819

 

 

(Dollars in thousands)		Commercial				Commercial				Residential
		and Industrial				Real Estate				Real Estate				Consumer				Unallocated				Total
As of and for the year ended
December 31, 2019
Allowance for Loan Losses:
Beginning balance		$	724			$	3,700			$	1,650			$	117			$	554			$	6,745
Charge-offs			―				(64	)			(69	)			(71	)			—				(204	)
Recoveries			6				―				2				6				—				14
Provision			(96	)			480				82				62				(78	)			450
Ending Balance		$	634			$	4,116			$	1,665			$	114			$	476			$	7,005
Ending balance: individually
evaluated for impairment		$	—			$	1			$	—			$	—			$	—			$	1
Ending balance: collectively
evaluated for impairment		$	634			$	4,115			$	1,665			$	114			$	476			$	7,004
Loans Receivable:
Ending Balance		$	86,712			$	395,801			$	159,350			$	5,869			$	—			$	647,732
Ending balance: individually
evaluated for impairment		$	1,084			$	11,158			$	712			$	—			$	—			$	12,954
Ending balance: collectively
evaluated for impairment		$	85,628			$	384,643			$	158,638			$	5,869			$	—			$	634,778

 

Of the $169,000 in foreclosed assets held for resale at March 31, 2020, $38,000 was represented by land, $50,000 was represented by residential real estate, and $81,000 was represented by commercial real estate. Of the $119,000 in foreclosed assets held for resale at December 31, 2019, $38,000 was represented by land and $81,000 was represented by commercial real estate. At March 31, 2020 and December 31, 2019, all foreclosed assets were held as the result of obtaining physical possession. Consumer mortgage loans secured by residential real estate for which the Bank has entered into formal foreclosure proceedings but for which physical possession of the property has yet to be obtained amounted to $996,000 at March 31, 2020 and $617,000 at December 31, 2019. These balances were not included in foreclosed assets held for resale at March 31, 2020 or December 31, 2019.

 

The outstanding recorded investment of TDRs as of March 31, 2020 and December 31, 2019 was $8,470,000 and $8,678,000, respectively. The decrease in TDRs at March 31, 2020 as compared to December 31, 2019 is mainly attributable to payments and payoffs on existing troubled debt restructurings that were completed during the first quarter of 2020. There were no unfunded commitments on TDRs at March 31, 2020 and December 31, 2019.

 

The following table presents the outstanding recorded investment of TDRs at the dates indicated:

 

(Dollars in thousands)		March 31,				December 31,
		2020				2019
Non-accrual TDRs		$	1,725			$	112
Accruing TDRs			6,745				8,566
Total		$	8,470			$	8,678

 

At March 31, 2020, nine Commercial Real Estate loans classified as TDRs with a combined recorded investment of $1,377,000 were not in compliance with the terms of their restructure, compared to March 31, 2019 when six Commercial Real Estate loans classified as TDRs with a combined recorded investment of $597,000 and one Commercial and Industrial loan classified as a TDR with a recorded investment of $5,000 were not in compliance with the terms of their restructure.

 

 

No loans were modified as TDRs within the twelve months preceding March 31, 2020. Of the loans that were modified as TDRs during the twelve months preceding March 31, 2019, two Commercial Real Estate Loans with a combined recorded investment of $113,000 experienced payment defaults during the three months ended Mach 31, 2019.

 

No loans were modified as TDRs during the three months ended March 31, 2020 and 2019.

 

On March 27, 2020, in response to the COVID-19 pandemic, the CARES Act was signed into law. Section 4013 of the CARES Act provides financial institutions the option to suspend requirements to categorize certain loan modifications as TDRs as long as specific criteria are met. To qualify, the loan modifications must be short-term (granted for temporary relief, ex. six months), made on a good-faith basis in response to the COVID-19 pandemic, and the contractual payments of the loan must have been paid current (less than 30 days past due prior to any relief) at the time a modification was implemented. While requests for modifications had been made, no modifications had been completed as part of this program as of March 31, 2020.

 

The recorded investment, unpaid principal balance, and the related allowance of the Corporation’s impaired loans are summarized below at March 31, 2020 and December 31, 2019.

 

(Dollars in thousands)		March 31, 2020												December 31, 2019
						Unpaid												Unpaid
		Recorded				Principal				Related				Recorded				Principal				Related
		Investment				Balance				Allowance				Investment				Balance				Allowance
With no related allowance recorded:
Commercial and Industrial		$	1,077			$	1,077			$	—			$	1,084			$	1,084			$	—
Commercial Real Estate			11,396				14,289				—				11,130				14,147				—
Residential Real Estate			1,089				1,174				—				712				822				—
With an allowance recorded:
Commercial and Industrial			—				—				—				—				—				—
Commercial Real Estate			114				114				1				28				28				1
Residential Real Estate			20				20				—				—				—				—
Total		$	13,696			$	16,674			$	1			$	12,954			$	16,081			$	1
Total consists of:
Commercial and Industrial		$	1,077			$	1,077			$	—			$	1,084			$	1,084			$	—
Commercial Real Estate		$	11,510			$	14,403			$	1			$	11,158			$	14,175			$	1
Residential Real Estate		$	1,109			$	1,194			$	—			$	712			$	822			$	—

______________________

At March 31, 2020 and December 31, 2019, $8,470,000 and $8,678,000 of loans classified as TDRs were included in impaired loans both with a total allocated allowance of $1,000, respectively. The recorded investment represents the loan balance reflected on the consolidated balance sheets net of any charge-offs. The unpaid balance is equal to the gross amount due on the loan.

 

 

The average recorded investment and interest income recognized for the Corporation’s impaired loans are summarized below for the three months ended March 31, 2020 and 2019.

 

(Dollars in thousands)		For the Three Months Ended								For the Three Months Ended
		March 31, 2020								March 31, 2019
		Average				Interest				Average				Interest
		Recorded				Income				Recorded				Income
		Investment				Recognized				Investment				Recognized
With no related allowance recorded:
Commercial and Industrial		$	1,079			$	6			$	1,122			$	14
Commercial Real Estate			11,131				76				15,574				150
Residential Real Estate			925				—				440				1
With an allowance recorded:
Commercial and Industrial			—				—				—				—
Commercial Real Estate			118				1				94				1
Residential Real Estate			21				1				—				―
Total		$	13,274			$	84			$	17,230			$	166
Total consists of:
Commercial and Industrial		$	1,079			$	6			$	1,122			$	14
Commercial Real Estate		$	11,249			$	77			$	15,668			$	151
Residential Real Estate		$	946			$	1			$	440			$	1

_____________________

Of the $84,000 and $166,000 in interest income recognized on impaired loans for the three months ended March 31, 2020 and 2019, respectively, $5,000 and $0 in interest income was recognized with respect to non-accrual loans.

 

Total non-performing assets (which includes loans receivable on non-accrual status, foreclosed assets held for resale and loans past-due 90 days or more and still accruing interest) as of March 31, 2020 and December 31, 2019 were as follows:

 

(Dollars in thousands)
		March 31,				December 31,
		2020				2019
Commercial and Industrial		$	768			$	—
Commercial Real Estate			5,094				3,697
Residential Real Estate			1,089				691
Total non-accrual loans			6,951				4,388
Foreclosed assets held for resale			169				119
Loans past-due 90 days or more and still accruing interest			579				100
Total non-performing assets		$	7,699			$	4,607

 

The following tables present the classes of the loan portfolio summarized by past-due status at March 31, 2020 and December 31, 2019:

 

(Dollars in thousands)																										90 Days
																										Or Greater
																										Past Due
										90 Days								Current–								and Still
		30-59 Days				60-89 Days				or Greater				Total				29 Days				Total				Accruing
		Past Due				Past Due				Past Due				Past Due				Past Due				Loans				Interest
March 31, 2020:
Commercial and Industrial		$	698			$	380			$	91			$	1,169			$	85,854			$	87,023			$	92
Commercial Real Estate			2,942				301				4,935				8,178				404,618				412,796				487
Residential Real Estate			1,303				177				913				2,393				153,712				156,105				—
Consumer			20				5				—				25				5,667				5,692				—
Total		$	4,963			$	863			$	5,939			$	11,765			$	649,851			$	661,616			$	579

 

 

(Dollars in thousands)																										90 Days
																										Or Greater
																										Past Due
										90 Days								Current–								and Still
		30-59 Days				60-89 Days				or Greater				Total				29 Days				Total				Accruing
		Past Due				Past Due				Past Due				Past Due				Past Due				Loans				Interest
December 31, 2019:
Commercial and Industrial		$	—			$	26			$	—			$	26			$	86,686			$	86,712			$	—
Commercial Real Estate			880				957				3,502				5,339				390,462				395,801				—
Residential Real Estate			1,118				506				613				2,237				157,113				159,350				100
Consumer			24				5				—				29				5,840				5,869				—
Total		$	2,022			$	1,494			$	4,115			$	7,631			$	640,101			$	647,732			$	100

 

At March 31, 2020 and December 31, 2019, commitments to lend additional funds with respect to impaired loans consisted of one irrevocable letter of credit totaling $1,249,000 that was associated with a loan to a developer of a residential sub-division.

 

NOTE 5 — DEPOSITS

 

Major classifications of deposits at March 31, 2020 and December 31, 2019 consisted of:

 

(Dollars in thousands)
		March 31,				December 31,
		2020				2019
Non-interest bearing demand		$	153,029			$	134,648
Interest bearing demand			211,598				218,847
Savings			173,769				173,069
Time certificates of deposits less than $250,000			176,383				210,916
Time certificates of deposits $250,000 or greater			18,639				23,006
Other time deposits			1,379				1,142
Total deposits		$	734,797			$	761,628

 

Total Deposits decreased $26,831,000 to $734,797,000 as of March 31, 2020 due to decreases in interest bearing, savings, and time deposits. The decrease in deposits was mainly due to the Corporation calling $40,000,000 worth of brokered CDs during the quarter ended March 31, 2020 due to the changing rate environment.

 

NOTE 6 — BORROWINGS

 

Short-Term Borrowings

 

Short-term borrowings include federal funds purchased, securities sold under agreements to repurchase, the Federal Discount Window, and Federal Home Loan Bank (“FHLB”) advances, which generally represent overnight or less than 30-day borrowings. Short-term borrowings and weighted–average interest rates at March 31, 2020 and December 31, 2019 are as follows:

 

(Dollars in thousands)		March 31, 2020								December 31, 2019
						Average								Average
		Amount				Rate				Amount				Rate
Federal funds purchased		$	—				—			$	—				2.01	%
Securities sold under agreements to repurchase			12,551				1.05	%			14,042				1.03	%
Federal Discount Window			—				—				—				2.92	%
Federal Home Loan Bank			93,828				1.64	%			40,621				2.59	%
Total		$	106,379				1.50	%		$	54,663				2.37	%

 

The increase in short-term borrowings is due to advances taken from the Federal Home Loan Bank, including a 21-day $50,000,000 term note, to fund decreased deposit balances resulting from the call of brokered CDs.

 

 

Securities Sold Under Agreements to Repurchase (“Repurchase Agreements”)

 

The Corporation enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities. Under these arrangements, the Corporation may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Corporation to repurchase the assets.

 

As a result, these repurchase agreements are accounted for as collateralized financing agreements (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability on the Corporation’s consolidated balance sheets, while the securities underlying the repurchase agreements remain in the respective investment securities asset accounts. In other words, there is not offsetting or netting of the investment securities assets with the repurchase agreement liabilities. In addition, as the Corporation does not enter into reverse repurchase agreements, there is no such offsetting to be done with the repurchase agreements.

 

The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral would be used to settle the fair value of the repurchase agreement should the Corporation be in default (e.g., fails to make an interest payment to the counterparty). The collateral is held by a correspondent bank in the counterparty’s custodial account. The counterparty has the right to sell or repledge the investment securities.

 

The following table presents the short-term borrowings subject to an enforceable master netting arrangement or repurchase agreements as of March 31, 2020 and December 31, 2019.

 

(Dollars in thousands)

Gross

Net Amounts

Amounts

of Liabilities

Offset

Presented

Gross

in the

in the

Amounts of

Consolidated

Consolidated

Cash

Recognized

Balance

Balance

Financial

Collateral

Net

Liabilities

Sheet

Sheet

Instruments

Pledge

Amount

March 31, 2020

Repurchase agreements (a)

$

12,551

$

―

$

12,551

$

(12,551

)

$

―

$

―

December 31, 2019

Repurchase agreements (a)

$

14,042

$

―

$

14,042

$

(14,042

)

$

―

$

―

______________________

(a) As of March 31, 2020 and December 31, 2019, the fair value of securities pledged in connection with repurchase agreements was $21,779,000 and $22,413,000, respectively.

 

The following table presents the remaining contractual maturity of the master netting arrangement or repurchase agreements as of March 31, 2020:

 

(Dollars in thousands)		Remaining Contractual Maturity of the Agreements
		Overnight								Greater
		and				Up to				30 -90				than
March 31, 2020:		Continuous				30 days				Days				90 Days				Total
Repurchase agreements and repurchase-to-maturity transactions:
U.S. Treasury and/or agency securities		$	12,551			$	―			$	―			$	―			$	12,551
Total		$	12,551			$	―			$	―			$	―			$	12,551

 

Long-Term Borrowings

 

Long-term borrowings are comprised of advances from the FHLB. Under terms of a blanket agreement, collateral for the FHLB loans is certain qualifying assets of the Corporation’s banking subsidiary. The principal assets are certain real estate mortgages and investment securities.

 

NOTE 7 — COMMITMENTS AND CONTINGENCIES

 

In the normal course of business, there are various pending legal actions and proceedings that are not reflected in the consolidated financial statements. Management does not believe the outcome of these actions and proceedings will have a material effect on the consolidated financial position or results of operations of the Corporation.

 

The Bank currently leases three branch banking facilities and one parcel of land under operating leases. At March 31, 2020, right-of-use assets and lease liabilities were recorded related to these operating leases totaling $1,312,000 and $1,577,000, respectively. At December 31, 2019, right-of-use assets and lease liabilities stood at $1,470,000 and $1,663,000, respectively. Further options to extend or terminate the lease are not applicable for any of the four leases. No significant assumptions or judgements were made in determining whether a contract contained a lease or in the consideration of lease versus non-lease components. None of the leases contained an implicit rate; therefore, our incremental borrowing rate was used for each of the leases.

 

The Bank recognized total operating lease costs for the three months ended March 31, 2020 and March 31, 2019 of $111,000 and $48,000, respectively. Cash payments totaled $38,000 for the three months ended March 31, 2020 and 2019.

 

The following table displays the weighted-average term and discount rates for operating leases outstanding as of March 31, 2020 and December 31, 2019.

 

		March 31,				December 31,
		2020				2019
		Operating				Operating
Weighted-average term (years)			25.56				25.63
Weighted-average discount rate			3.86	%			3.85	%

 

A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total operating lease liability is as follows:

 

(Dollars in thousands)		March 31,
		2020
Minimum lease payments due:
Within one year		$	139
After one but within two years			106
After two but within three years			75
After three but within four years			68
After four but within five years			68
After five years			2,309
Total undiscounted cash flows