10-Q 1 fdbc-20200331x10q.htm 10-Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

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For the quarterly period ended March 31, 2020

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OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

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For the transition period from ______________to______________________

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Commission file number: 001-38229

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FIDELITY D & D BANCORP, INC.

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STATE OF INCORPORATION: IRS EMPLOYER IDENTIFICATION NO:

PENNSYLVANIA 23-3017653

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Address of principal executive offices:

BLAKELY & DRINKER ST.

DUNMORE, PENNSYLVANIA 18512

TELEPHONE: 570-342-8281

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

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Title of each class | Trading Symbols(s) | Name of each exchange on which registered
Common stock, without par value | FDBC | The NASDAQ Stock Market, LLC

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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 subjected to such filing requirements for the past 90 days. [X] YES [ ] NO

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Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). [X] YES [ ] NO

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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 the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

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Large accelerated filer ☐ | Non-accelerated filer ☐ | Accelerated filer ☒ |  | Smaller reporting company ☒ | Emerging growth company ☐

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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] YES [X] NO

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The number of outstanding shares of Common Stock of Fidelity D & D Bancorp, Inc. on April 30, 2020, the latest practicable date, was 3,79 9,213 shares.

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FIDELITY D & D BANCORP, INC.

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Form 10-Q March 31, 2020

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Index

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﻿Part I. Financial Information |  | Page
Item 1. | Financial Statements (unaudited): |
﻿ | Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019 | 3
﻿ | Consolidated Statements of Income for the three months ended March 31, 2020 and 2019 | 4
﻿ | Consolidated Statements of Comprehensive Income for the three months ended March 31, 2020 and 2019 | 5
﻿ | Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2020 and 2019 | 6
﻿ | Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019 | 7
﻿ | Notes to Consolidated Financial Statements (Unaudited) | 9
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 3 2
Item 3. | Quantitative and Qualitative Disclosure about Market Risk | 5 0
Item 4. | Controls and Procedures | 55
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﻿Part II. Other Information |  |
Item 1. | Legal Proceedings | 56
Item 1A. | Risk Factors | 56
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 56
Item 3. | Defaults upon Senior Securities | 56
Item 4. | Mine Safety Disclosures | 56
Item 5. | Other Information | 56
Item 6. | Exhibits | 57
﻿Signatures |  | 59

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PART I – Financial Information

Item 1: Financial Statements

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Fidelity D & D Bancorp, Inc. and Subsidiary |  |  |  |  |  |
Consolidated Balance Sheets |  |  |  |  |  |
(Unaudited) |  |
(dollars in thousands) |  | March 31, 2020 |  | December 31, 2019
Assets: |  |  |  |  |  |
Cash and due from banks |  | $ | 4,148 |  | $ | 14,583
Interest-bearing deposits with financial institutions |  |  | 54,812 |  |  | 1,080
Total cash and cash equivalents |  |  | 58,960 |  |  | 15,663
Available-for-sale securities |  |  | 203,984 |  |  | 185,117
Federal Home Loan Bank stock |  |  | 2,732 |  |  | 4,383
Loans and leases, net (allowance for loan losses of |  |  |  |  |  |
$10,017 in 2020; $9,747 in 2019) |  |  | 735,107 |  |  | 743,663
Loans held-for-sale (fair value $1,620 in 2020, $1,660 in 2019) |  |  | 1,591 |  |  | 1,643
Foreclosed assets held-for-sale |  |  | 116 |  |  | 369
Bank premises and equipment, net |  |  | 21,412 |  |  | 21,557
Leased property under finance leases, net |  |  | 260 |  |  | 280
Right-of-use assets |  |  | 5,977 |  |  | 6,023
Cash surrender value of bank owned life insurance |  |  | 23,426 |  |  | 23,261
Accrued interest receivable |  |  | 3,239 |  |  | 3,281
Goodwill |  |  | 209 |  |  | 209
Other assets |  |  | 5,482 |  |  | 4,478
Total assets |  | $ | 1,062,495 |  | $ | 1,009,927
Liabilities: |  |  |  |  |  |
Deposits: |  |  |  |  |  |
Interest-bearing |  | $ | 675,719 |  | $ | 643,714
Non-interest-bearing |  |  | 243,942 |  |  | 192,023
Total deposits |  |  | 919,661 |  |  | 835,737
Accrued interest payable and other liabilities |  |  | 8,910 |  |  | 7,674
Finance lease obligation |  |  | 267 |  |  | 286
Operating lease liabilities |  |  | 6,517 |  |  | 6,556
Short-term borrowings |  |  | - |  |  | 37,839
FHLB advances |  |  | 15,000 |  |  | 15,000
Total liabilities |  |  | 950,355 |  |  | 903,092
Shareholders' equity: |  |  |  |  |  |
Preferred stock authorized 5,000,000 shares with no par value; none issued |  |  | - |  |  | -
Capital stock, no par value (10,000,000 shares authorized; shares issued and outstanding; 3,797,646 in 2020; and 3,781,500 in 2019) |  |  | 31,342 |  |  | 30,848
Retained earnings |  |  | 73,948 |  |  | 72,385
Accumulated other comprehensive income |  |  | 6,850 |  |  | 3,602
Total shareholders' equity |  |  | 112,140 |  |  | 106,835
Total liabilities and shareholders' equity |  | $ | 1,062,495 |  | $ | 1,009,927
﻿ |  |  |  |  |  |
See notes to unaudited consolidated financial statements |  |  |  |  |  |

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Fidelity D & D Bancorp, Inc. and Subsidiary |  |  |  |  |  |
Consolidated Statements of Income |  |  |  |  |  |
(Unaudited) |  |
(dollars in thousands except per share data) |  | March 31, 2020 |  | March 31, 2019
Interest income: |  |  |  |  |  |
Loans and leases: |  |  |  |  |  |
Taxable |  | $ | 8,063 |  | $ | 7,891
Nontaxable |  |  | 297 |  |  | 267
Interest-bearing deposits with financial institutions |  |  | 12 |  |  | 15
Restricted regulatory securities |  |  | 65 |  |  | 100
Investment securities: |  |  |  |  |  |
U.S. government agency and corporations |  |  | 846 |  |  | 960
States and political subdivisions (nontaxable) |  |  | 423 |  |  | 422
States and political subdivisions (taxable) |  |  | 5 |  |  | -
Total interest income |  |  | 9,711 |  |  | 9,655
Interest expense: |  |  |  |  |  |
Deposits |  |  | 1,516 |  |  | 1,331
Other short-term borrowings and other |  |  | 75 |  |  | 271
FHLB advances |  |  | 114 |  |  | 143
Total interest expense |  |  | 1,705 |  |  | 1,745
Net interest income |  |  | 8,006 |  |  | 7,910
Provision for loan losses |  |  | 300 |  |  | 255
Net interest income after provision for loan losses |  |  | 7,706 |  |  | 7,655
Other income: |  |  |  |  |  |
Service charges on deposit accounts |  |  | 559 |  |  | 539
Interchange fees |  |  | 557 |  |  | 494
Service charges on loans |  |  | 438 |  |  | 280
Fees from trust fiduciary activities |  |  | 419 |  |  | 294
Fees from financial services |  |  | 159 |  |  | 235
Fees and other revenue |  |  | 250 |  |  | 256
Earnings on bank-owned life insurance |  |  | 165 |  |  | 146
Gain (loss) on write-down, sale or disposal of: |  |  |  |  |  |
Loans |  |  | 215 |  |  | 218
Available-for-sale debt securities |  |  | - |  |  | (4)
Premises and equipment |  |  | (7) |  |  | (1)
Total other income |  |  | 2,755 |  |  | 2,457
Other expenses: |  |  |  |  |  |
Salaries and employee benefits |  |  | 3,923 |  |  | 3,704
Premises and equipment |  |  | 1,118 |  |  | 1,075
Data processing and communication |  |  | 460 |  |  | 411
Advertising and marketing |  |  | 434 |  |  | 399
Professional services |  |  | 411 |  |  | 366
Merger-related expenses |  |  | 273 |  |  | 19
Automated transaction processing |  |  | 227 |  |  | 186
Office supplies and postage |  |  | 106 |  |  | 105
PA shares tax |  |  | 66 |  |  | 40
Loan collection |  |  | 29 |  |  | 41
Other real estate owned |  |  | 27 |  |  | 51
FDIC assessment |  |  | - |  |  | 67
Other |  |  | 230 |  |  | 306
Total other expenses |  |  | 7,304 |  |  | 6,770
Income before income taxes |  |  | 3,157 |  |  | 3,342
Provision for income taxes |  |  | 523 |  |  | 540
Net income |  | $ | 2,634 |  | $ | 2,802
Per share data : |  |  |  |  |  |
Net income - basic |  | $ | 0.69 |  | $ | 0.74
Net income - diluted |  | $ | 0.69 |  | $ | 0.73
Dividends |  | $ | 0.28 |  | $ | 0.26
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See notes to unaudited consolidated financial statements |  |  |  |  |  |

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Fidelity D & D Bancorp, Inc. and Subsidiary |  |  |  |  |
Consolidated Statements of Comprehensive Income | Three months ended
(Unaudited) | March 31,
(dollars in thousands) | 2020 |  | 2019
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Net income | $ | 2,634 |  | $ | 2,802
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Other comprehensive income, before tax: |  |  |  |  |
Unrealized holding gain on available-for-sale debt securities |  | 4,111 |  |  | 2,516
Reclassification adjustment for net losses realized in income |  | - |  |  | 4
Net unrealized gain |  | 4,111 |  |  | 2,520
Tax effect |  | (863) |  |  | (529)
Unrealized gain, net of tax |  | 3,248 |  |  | 1,991
Other comprehensive income, net of tax |  | 3,248 |  |  | 1,991
Total comprehensive income, net of tax | $ | 5,882 |  | $ | 4,793
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See notes to unaudited consolidated financial statements |  |  |  |  |

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Fidelity D & D Bancorp, Inc. and Subsidiary |  |  |  |  |  |  |  |  |  |  |  |
Consolidated Statements of Changes in Shareholders' Equity |  |  |  |  |  |  |  |  |  |  |  |
For the three months ended March 31, 2020 and 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Unaudited) |  |  |  |  |  |  |  |  |  | Accumulated |  |  |
﻿ |  |  |  |  |  |  |  |  |  | other |  |  |
﻿ | Capital stock |  | Retained |  | comprehensive |  |  |
(dollars in thousands) | Shares |  | Amount |  | earnings |  | income (loss) |  | Total
Balance, December 31, 2018 |  | 3,759,426 |  | $ | 29,715 |  | $ | 64,937 |  | $ | (1,095) |  | $ | 93,557
Net income |  |  |  |  |  |  |  | 2,802 |  |  |  |  |  | 2,802
Other comprehensive income |  |  |  |  |  |  |  |  |  |  | 1,991 |  |  | 1,991
Effect of adopting ASU 2016-02 |  |  |  |  |  |  |  | (107) |  |  |  |  |  | (107)
Issuance of common stock through Employee Stock Purchase Plan |  | 4,535 |  |  | 175 |  |  |  |  |  |  |  |  | 175
Issuance of common stock from vested restricted share grants through stock compensation plans |  | 15,049 |  |  |  |  |  |  |  |  |  |  |  |
Issuance of common stock through exercise of SSARs |  | 1,965 |  |  | - |  |  |  |  |  |  |  |  | -
Stock-based compensation expense |  |  |  |  | 314 |  |  |  |  |  |  |  |  | 314
Cash dividends declared |  |  |  |  |  |  |  | (990) |  |  |  |  |  | (990)
Balance, March 31, 2019 |  | 3,780,975 |  | $ | 30,204 |  | $ | 66,642 |  | $ | 896 |  | $ | 97,742
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Balance, December 31, 2019 |  | 3,781,500 |  | $ | 30,848 |  | $ | 72,385 |  | $ | 3,602 |  | $ | 106,835
Net income |  |  |  |  |  |  |  | 2,634 |  |  |  |  |  | 2,634
Other comprehensive income |  |  |  |  |  |  |  |  |  |  | 3,248 |  |  | 3,248
Issuance of common stock through Employee Stock Purchase Plan |  | 3,885 |  |  | 219 |  |  |  |  |  |  |  |  | 219
Issuance of common stock from vested restricted share grants through stock compensation plans |  | 12,261 |  |  |  |  |  |  |  |  |  |  |  |
Stock-based compensation expense |  |  |  |  | 275 |  |  |  |  |  |  |  |  | 275
Cash dividends declared |  |  |  |  |  |  |  | (1,071) |  |  |  |  |  | (1,071)
Balance, March 31, 2020 |  | 3,797,646 |  | $ | 31,342 |  | $ | 73,948 |  | $ | 6,850 |  | $ | 112,140
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See notes to unaudited consolidated financial statements |  |  |  |  |  |  |  |  |  |  |

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Fidelity D & D Bancorp, Inc. and Subsidiary |  |  |  |  |  |
Consolidated Statements of Cash Flows |  |  |  |  |  |
(Unaudited) |  | Three months ended March 31,
(dollars in thousands) |  | 2020 |  | 2019
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Cash flows from operating activities: |  |  |  |  |  |
Net income |  | $ | 2,634 |  | $ | 2,802
Adjustments to reconcile net income to net cash provided by |  |  |  |  |  |
operating activities: |  |  |  |  |  |
Depreciation, amortization and accretion |  |  | 835 |  |  | 740
Provision for loan losses |  |  | 300 |  |  | 255
Deferred income tax expense |  |  | 442 |  |  | 218
Stock-based compensation expense |  |  | 243 |  |  | 279
Excess tax benefit from exercise of SSARs |  |  | - |  |  | 23
Proceeds from sale of loans held-for-sale |  |  | 13,055 |  |  | 12,702
Originations of loans held-for-sale |  |  | (11,232) |  |  | (6,231)
Earnings from bank-owned life insurance |  |  | (165) |  |  | (146)
Net gain from sales of loans |  |  | (215) |  |  | (218)
Net loss from sales of investment securities |  |  | - |  |  | 4
Net loss from sale and write-down of foreclosed assets held-for-sale |  |  | 17 |  |  | 21
Net loss from write-down and disposal of bank premises and equipment |  |  | 7 |  |  | 1
Operating lease payments |  |  | 8 |  |  | 7
Change in: |  |  |  |  |  |
Accrued interest receivable |  |  | 42 |  |  | (50)
Other assets |  |  | (903) |  |  | (633)
Accrued interest payable and other liabilities |  |  | (178) |  |  | (1,583)
Net cash provided by operating activities |  |  | 4,890 |  |  | 8,191
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Cash flows from investing activities: |  |  |  |  |  |
Available-for-sale securities: |  |  |  |  |  |
Proceeds from sales |  |  | 7,765 |  |  | 4,705
Proceeds from maturities, calls and principal pay-downs |  |  | 8,832 |  |  | 9,052
Purchases |  |  | (31,617) |  |  | (11,145)
Decrease in FHLB stock |  |  | 1,651 |  |  | 2,676
Net decrease in loans and leases |  |  | 5,837 |  |  | 12,129
Principal portion of lease payments received under direct finance leases |  |  | 759 |  |  | 717
Purchase of life insurance policies |  |  | - |  |  | (2,000)
Purchases of bank premises and equipment |  |  | (271) |  |  | (334)
Proceeds from sale of foreclosed assets held-for-sale |  |  | 236 |  |  | 26
Net cash used in investing activities |  |  | (6,808) |  |  | 15,826
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Cash flows from financing activities: |  |  |  |  |  |
Net increase in deposits |  |  | 83,924 |  |  | 55,102
Net decrease in short-term borrowings |  |  | (37,839) |  |  | (70,460)
Repayment of FHLB advances |  |  | - |  |  | (10,000)
Repayment of finance lease obligation |  |  | (18) |  |  | (19)
Proceeds from employee stock purchase plan participants |  |  | 219 |  |  | 175
Dividends paid |  |  | (1,071) |  |  | (990)
Net cash provided by financing activities |  |  | 45,215 |  |  | (26,192)
Net increase (decrease) in cash and cash equivalents |  |  | 43,297 |  |  | (2,175)
Cash and cash equivalents, beginning |  |  | 15,663 |  |  | 17,485
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Cash and cash equivalents, ending |  | $ | 58,960 |  | $ | 15,310
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See notes to unaudited consolidated financial statements |  |  |  |  |  |

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Fidelity D & D Bancorp, Inc. and Subsidiary |  |  |  |  |  |
Consolidated Statements of Cash Flows (continued) |  |  |  |  |  |
(Unaudited) |  | Three months ended March 31,
(dollars in thousands) |  | 2020 |  | 2019
Supplemental Disclosures of Cash Flow Information |  |  |  |  |  |
Cash payments for: |  |  |  |  |  |
Interest |  | $ | 1,784 |  | $ | 1,626
Income tax |  |  | - |  |  | -
Supplemental Disclosures of Non-cash Investing Activities: |  |  |  |  |  |
Net change in unrealized gains on available-for-sale securities |  |  | 4,111 |  |  | 2,520
Transfers from loans to foreclosed assets held-for-sale |  |  | - |  |  | 277
Transfers from loans to loans held-for-sale |  |  | 1,662 |  |  | 1,925
Security settlement pending |  |  | 1,445 |  |  | 1,698
Right-of-use asset |  |  | - |  |  | 4,133
Lease liability |  |  | - |  |  | 4,540
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See notes to unaudited consolidated financial statements |  |  |  |  |  |
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FIDELITY D & D BANCORP, INC.

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Notes to Consolidated Financial Statements

(Unaudited)

1. Nature of operations and critical accounting policies

Nature of operations

Fidelity D & D Bancorp, Inc. (the Company) is a bank holding company and the parent of Fidelity Deposit and Discount Bank (the Bank). The Bank is a commercial bank chartered under the law of the Commonwealth of Pennsylvania and a wholly-owned subsidiary of the Company. Having commenced operations in 1903, the Bank is committed to provide superior customer service, while offering a full range of banking products and financial and trust services to both our consumer and commercial customers from our main office located in Dunmore and other branches located throughout Lackawanna and Luzerne Counties.

Effective May 1, 2020, the Company completed its acquisition of MNB Corporation (MNB) and its wholly-owned subsidiary, Merchants Bank of Bangor. At the effective time of the acquisition, MNB merged with and into the Company with the Company surviving the merger. In addition, Merchants Bank of Bangor merged with and into the Bank with the Bank as the surviving bank. With the combination of the two organizations, the Company, on a consolidated basis, has approximately $1.6 billion in assets, $1.4 billion in deposits, and $1.1 billion in loans with 21 community banking offices located in the counties of Lackawanna, Luzerne and Northampton in Pennsylvania and a Wealth Management office in Schuylkill and Lebanon Counties in Pennsylvania. Further discussion of the acquisition of MNB can be found in Footnote 9, “Acquisition”.

Principles of consolidation

The accompanying unaudited consolidated financial statements of the Company and the Bank have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to this Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnote disclosures required by GAAP for complete financial statements. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the financial condition and results of operations for the periods have been included. All significant inter-company balances and transactions have been eliminated in consolidation.

For additional information and disclosures required under GAAP, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Management is responsible for the fairness, integrity and objectivity of the unaudited financial statements included in this report. Management prepared the unaudited financial statements in accordance with GAAP. In meeting its responsibility for the financial statements, management depends on the Company's accounting systems and related internal controls. These systems and controls are designed to provide reasonable but not absolute assurance that the financial records accurately reflect the transactions of the Company, the Company’s assets are safeguarded and that the financial statements present fairly the financial condition and results of operations of the Company.

In the opinion of management, the consolidated balance sheets as of March 31, 2020 and December 31, 2019 and the related consolidated statements of income, consolidated statements of comprehensive income and consolidated statements of changes in shareholders’ equity for the three months ended March 31, 2020 and 2019, and consolidated statements of cash flows for the three months ended March 31, 2020 and 2019 present fairly the financial condition and results of operations of the Company. All material adjustments required for a fair presentation have been made. These adjustments are of a normal recurring nature. Certain reclassifications have been made to the 2019 financial statements to conform to the 2020 presentation.

In preparing these consolidated financial statements, the Company evaluated the events and transactions that occurred after March 31, 2020 through the date these consolidated financial statements were issued.

This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2019, and the notes included therein, included within the Company’s Annual Report filed on Form 10-K.

Critical accounting policies

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates.

A material estimate that is particularly susceptible to significant change relates to the determination of the allowance for loan losses. Management believes that the allowance for loan losses at March 31, 2020 is adequate and reasonable to cover incurred losses. Given the subjective nature of identifying and estimating loan losses, it is likely that well-informed individuals could make different assumptions and could, therefore, calculate a materially different allowance amount. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in the future. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such

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agencies may require the Company to recognize adjustments to the allowance based on their judgment of information available to them at the time of their examination.

Another material estimate is the calculation of fair values of the Company’s investment securities. Fair values of investment securities are determined by pricing provided by a third-party vendor, who is a provider of financial market data, analytics and related services to financial institutions. Based on experience, management is aware that estimated fair values of investment securities tend to vary among valuation services. Accordingly, when selling investment securities, price quotes may be obtained from more than one source. All of the Company’s debt securities are classified as available-for-sale (AFS). AFS debt securities are carried at fair value on the consolidated balance sheets, with unrealized gains and losses, net of income tax, reported separately within shareholders’ equity as a component of accumulated other comprehensive income (AOCI).

The fair value of residential mortgage loans, classified as held-for-sale (HFS), is obtained from the Federal National Mortgage Association (FNMA) or the Federal Home Loan Bank (FHLB). Generally, the market to which the Company sells residential mortgages it originates for sale is restricted and price quotes from other sources are not typically obtained. On occasion, the Company may transfer loans from the loan portfolio to loans HFS. Under these circumstances, pricing may be obtained from other entities and the residential mortgage loans are transferred at the lower of cost or market value and simultaneously sold. For other loans transferred to HFS, pricing may be obtained from other entities or modeled and the other loans are transferred at the lower of cost or market value and then sold. As of March 31, 2020 and December 31, 2019, loans classified as HFS consisted of residential mortgage loans.

Financing of automobiles, provided to customers under lease arrangements of varying terms, are accounted for as direct finance leases. Interest income on automobile direct finance leasing is determined using the interest method to arrive at a level effective yield over the life of the lease. The lease residual and the lease receivable, net of unearned lease income, are recorded within loans and leases on the balance sheet.

Foreclosed assets held-for-sale includes other real estate acquired through foreclosure (ORE) and may, from time-to-time, include repossessed assets such as automobiles. ORE is carried at the lower of cost (principal balance at date of foreclosure) or fair value less estimated cost to sell. Any write-downs at the date of foreclosure are charged to the allowance for loan losses. Expenses incurred to maintain ORE properties, subsequent write downs to the asset’s fair value, any rental income received and gains or losses on disposal are included as components of other real estate owned expense in the consolidated statements of income.

Goodwill is recorded on the consolidated balance sheets as the excess of liabilities assumed over identifiable assets acquired on the acquisition date. Goodwill is recorded at its net carrying value which represents estimated fair value. The goodwill is deductible for tax purposes over a 15-year period.

The Company holds separate supplemental executive retirement (SERP) agreements for certain officers and an amount is credited to each participant’s SERP account monthly while they are actively employed by the bank until retirement. A deferred tax asset is provided for the non-deductible SERP expense. The Company also entered into separate split dollar life insurance arrangements with four executives providing post-retirement benefits and accrues monthly expense for this benefit. The split dollar life insurance expense is not deductible for tax purposes. Monthly expenses for the SERP and post-retirement split dollar life benefit are recorded as components of salaries and employee benefit expense on the consolidated statements of income.

For purposes of the consolidated statements of cash flows, cash and cash equivalents includes cash on hand, amounts due from banks and interest-bearing deposits with financial institutions.

2. New accounting pronouncements

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2016-13, Financial Instruments – Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments (CECL). The amendments in this update require financial assets measured at amortized cost basis 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. Previously, when credit losses were measured under GAAP, an entity only considered past events and current conditions when measuring the incurred loss. The amendments in this update broaden the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually. 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. An entity must use judgement in determining the relevant information and estimation methods that are appropriate under the circumstances. The amendments in this update also require that credit losses on available-for-sale debt securities be presented as an allowance for credit losses rather than a writedown.

In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, which clarifies that receivables arising from operating leases are not within the scope of Topic 326. In December 2018, regulators issued a final rule related to regulatory capital (Regulatory Capital Rule: Implementation and Transition of the Current Expected Credit Losses Methodology for Allowances and Related Adjustments to the Regulatory Capital Rule and Conforming Amendments to Other Regulations) which is intended to provide regulatory capital relief for entities transitioning to CECL. In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging and Topic 825, Financial Instruments. As it relates to CECL, this guidance amends certain provisions contained in ASU 2016-13, particularly in regards to the

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inclusion of accrued interest in the definition of amortized cost, as well as clarifying that extension and renewal options that are not unconditionally cancelable by the entity that are included in the original or modified contract should be considered in the entity’s determination of expected credit losses.

The amendments in this update are effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2019 for public companies. Early adoption is permitted beginning after December 15, 2018, including interim periods within those fiscal years. An entity will apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption (modified-retrospective approach). Upon adoption, the change in this accounting guidance could result in an increase in the Company's allowance for loan losses and require the Company to record loan losses more rapidly. The Company has engaged the services of a qualified third-party service provider to assist management in estimating credit allowances under this standard and is currently evaluating the impact of ASU 2016-13 on its consolidated financial statements. On October 16, 2019, the FASB decided to move forward with finalizing its proposal to defer the effective date for ASU 2016-13 for smaller reporting companies to fiscal years beginning after December 31, 2022, including interim periods within those fiscal periods. Since the Company currently meets the SEC definition of a smaller reporting company, the delay will be applicable to the Company.

3. Accumulated other comprehensive income

The following tables illustrate the changes in accumulated other comprehensive income by component and the details about the components of accumulated other comprehensive income as of and for the periods indicated:

﻿

﻿ |  |
﻿ |  |
As of and for the three months ended March 31, 2020
﻿ | Unrealized gains
﻿ | (losses) on
﻿ | available-for-sale
(dollars in thousands) | debt securities
Beginning balance | $ | 3,602
﻿ |  |
Other comprehensive income before reclassifications, net of tax |  | 3,248
Amounts reclassified from accumulated other comprehensive income, net of tax |  | -
Net current-period other comprehensive income |  | 3,248
Ending balance | $ | 6,850

﻿

﻿

﻿

﻿

﻿ |  |
As of and for the three months ended March 31, 2019
﻿ | Unrealized gains
﻿ | (losses) on
﻿ | available-for-sale
(dollars in thousands) | securities
Beginning balance | $ | (1,095)
﻿ |  |
Other comprehensive income before reclassifications, net of tax |  | 1,988
Amounts reclassified from accumulated other comprehensive income, net of tax |  | 3
Net current-period other comprehensive income |  | 1,991
Ending balance | $ | 896
﻿ |  |

﻿

﻿

﻿ |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |
Details about accumulated other |  |  |  |  |  |  |  |
comprehensive income components |  | Amount reclassified from accumulated |  | Affected line item in the statement
(dollars in thousands) |  | other comprehensive income |  | where net income is presented
﻿ |  | For the three months ended |  |
﻿ |  | March 31, |  |
﻿ |  | 2020 |  | 2019 |  |
﻿ |  |  |  |  |  |  |  |
Unrealized gains (losses) on AFS debt securities |  | $ | - |  | $ | (4) |  | Gain (loss) on sale of investment securities
Income tax effect |  |  | - |  |  | 1 |  | Provision for income taxes
Total reclassifications for the period |  | $ | - |  | $ | (3) |  | Net income

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﻿

﻿

﻿

﻿

4. Investment securities

Agency – Government-sponsored enterprise (GSE) and Mortgage-backed securities (MBS) - GSE residential

Agency – GSE and MBS – GSE residential securities consist of short- to long-term notes issued by Federal Home Loan Mortgage Corporation (FHLMC), FNMA, FHLB and Government National Mortgage Association (GNMA). These securities have interest rates that are fixed and adjustable, have varying short to long-term maturity dates and have contractual cash flows guaranteed by the U.S. government or agencies of the U.S. government.

Obligations of states and political subdivisions

The municipal securities are bank qualified or bank eligible, general obligation and revenue bonds rated as investment grade by various credit rating agencies and have fixed rates of interest with mid- to long-term maturities. Fair values of these securities are highly driven by interest rates. Management performs ongoing credit quality reviews on these issues.

The amortized cost and fair value of investment securities at March 31, 2020 and December 31, 2019 are summarized as follows:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  | Gross |  | Gross |  |  |
﻿ |  | Amortized |  | unrealized |  | unrealized |  | Fair
(dollars in thousands) |  | cost |  | gains |  | losses |  | value
March 31, 2020 |  |  |  |  |  |  |  |  |  |  |  |
Available-for-sale debt securities: |  |  |  |  |  |  |  |  |  |  |  |
Agency - GSE |  | $ | 5,945 |  | $ | 411 |  | $ | - |  | $ | 6,356
Obligations of states and political subdivisions |  |  | 52,813 |  |  | 3,441 |  |  | - |  |  | 56,254
MBS - GSE residential |  |  | 136,555 |  |  | 4,819 |  |  | - |  |  | 141,374
﻿ |  |  |  |  |  |  |  |  |  |  |  |
Total available-for-sale debt securities |  | $ | 195,313 |  | $ | 8,671 |  | $ | - |  | $ | 203,984
﻿ |  |  |  |  |  |  |  |  |  |  |  |

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  | Gross |  | Gross |  |  |
﻿ |  | Amortized |  | unrealized |  | unrealized |  | Fair
(dollars in thousands) |  | cost |  | gains |  | losses |  | value
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |
Available-for-sale debt securities: |  |  |  |  |  |  |  |  |  |  |  |
Agency - GSE |  | $ | 5,941 |  | $ | 218 |  | $ | - |  | $ | 6,159
Obligations of states and political subdivisions |  |  | 51,857 |  |  | 2,871 |  |  | (10) |  |  | 54,718
MBS - GSE residential |  |  | 122,759 |  |  | 1,609 |  |  | (128) |  |  | 124,240
﻿ |  |  |  |  |  |  |  |  |  |  |  |
Total available-for-sale debt securities |  | $ | 180,557 |  | $ | 4,698 |  | $ | (138) |  | $ | 185,117
﻿ |  |  |  |  |  |  |  |  |  |  |  |

﻿

The amortized cost and fair value of debt securities at March 31, 2020 by contractual maturity are summarized below:

﻿ |  |  |  |  |  |
﻿ |  |  |
﻿ |  | Amortized |  | Fair
(dollars in thousands) |  | cost |  | value
Available-for-sale securities: |  |  |  |  |  |
Debt securities: |  |  |  |  |  |
Due in one year or less |  | $ | 3,580 |  | $ | 3,594
Due after one year through five years |  |  | 6,868 |  |  | 7,336
Due after five years through ten years |  |  | 1,625 |  |  | 1,675
Due after ten years |  |  | 46,685 |  |  | 50,005
﻿ |  |  |  |  |  |
MBS - GSE residential |  |  | 136,555 |  |  | 141,374
﻿ |  |  |  |  |  |
Total available-for-sale debt securities |  | $ | 195,313 |  | $ | 203,984

﻿

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Actual maturities will differ from contractual maturities because issuers and borrowers may have the right to call or repay obligations with or without call or prepayment penalty. Agency – GSE and municipal securities are included based on their original stated maturity. MBS – GSE residential, which are based on weighted-average lives and subject to monthly principal pay-downs, are listed in total. Most of the securities have fixed rates or have predetermined scheduled rate changes and many have call features that allow the issuer to call the security at par before its stated maturity without penalty.

The following table presents the fair value and gross unrealized losses of debt securities aggregated by investment type, the length of time and the number of securities that have been in a continuous unrealized loss position as of December 31, 2019:

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  | Less than 12 months |  | More than 12 months |  | Total
﻿ |  | Fair |  | Unrealized |  | Fair |  | Unrealized |  | Fair |  | Unrealized
(dollars in thousands) |  | value |  | losses |  | value |  | losses |  | value |  | losses
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Obligations of states and political subdivisions |  | $ | 2,867 |  | $ | (10) |  | $ | - |  | $ | - |  | $ | 2,867 |  | $ | (10)
MBS - GSE residential |  |  | 5,084 |  |  | (19) |  |  | 16,518 |  |  | (109) |  |  | 21,602 |  |  | (128)
Total |  | $ | 7,951 |  | $ | (29) |  | $ | 16,518 |  | $ | (109) |  | $ | 24,469 |  | $ | (138)
Number of securities |  |  | 5 |  |  |  |  |  | 12 |  |  |  |  |  | 17 |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

﻿

The Company had no debt securities in an unrealized loss position at March 31, 2020.

Management believes the cause of the unrealized losses is related to changes in interest rates, instability in the capital markets or the limited trading activity due to illiquid conditions in the debt market and is not directly related to credit quality. Quarterly, management conducts a formal review of investment securities for the presence of other than temporary impairment (OTTI). The accounting guidance related to OTTI requires the Company to assess whether OTTI is present when the fair value of a debt security is less than its amortized cost as of the balance sheet date. Under those circumstances, OTTI is considered to have occurred if: (1) the entity has the intent to sell the security; (2) more likely than not the entity will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is not sufficient to recover the entire amortized cost. The accounting guidance requires that credit-related OTTI be recognized in earnings while non-credit-related OTTI on securities not expected to be sold be recognized in other comprehensive income (OCI). Non-credit-related OTTI is based on other factors affecting market value, including illiquidity.

The Company’s OTTI evaluation process also follows the guidance set forth in topics related to debt securities. The guidance set forth in the pronouncements require the Company to take into consideration current market conditions, fair value in relationship to cost, extent and nature of changes in fair value, issuer rating changes and trends, volatility of earnings, current analysts’ evaluations, all available information relevant to the collectability of debt securities, the ability and intent to hold investments until a recovery of fair value which may be to maturity and other factors when evaluating for the existence of OTTI. The guidance requires that credit-related OTTI be recognized as a realized loss through earnings when there has been an adverse change in the holder’s expected cash flows such that the full amount (principal and interest) will probably not be received. This requirement is consistent with the impairment model in the guidance for accounting for debt securities.

For all debt securities, as of March 31, 2020, the Company applied the criteria provided in the recognition and presentation guidance related to OTTI. That is, management has no intent to sell the securities and nor any conditions were identified by management that, more likely than not, would require the Company to sell the securities before recovery of their amortized cost basis. The results indicated there was no presence of OTTI in the Company’s security portfolio. In addition, management believes the change in fair value is attributable to changes in interest rates.

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5. Loans and leases

The classifications of loans and leases at March 31, 2020 and December 31, 2019 are summarized as follows:

﻿

﻿ |  |  |  |  |
﻿ |  |
(dollars in thousands) | March 31, 2020 |  | December 31, 2019
Commercial and industrial | $ | 118,140 |  | $ | 122,594
Commercial real estate: |  |  |  |  |
Non-owner occupied |  | 95,630 |  |  | 99,801
Owner occupied |  | 125,976 |  |  | 130,558
Construction |  | 3,196 |  |  | 4,654
Consumer: |  |  |  |  |
Home equity installment |  | 35,456 |  |  | 36,631
Home equity line of credit |  | 46,850 |  |  | 47,282
Auto loans |  | 102,213 |  |  | 105,870
Direct finance leases |  | 17,356 |  |  | 16,355
Other |  | 7,025 |  |  | 5,634
Residential: |  |  |  |  |
Real estate |  | 175,453 |  |  | 167,164
Construction |  | 18,767 |  |  | 17,770
Total |  | 746,062 |  |  | 754,313
Less: |  |  |  |  |
Allowance for loan losses |  | (10,017) |  |  | (9,747)
Unearned lease revenue |  | (938) |  |  | (903)
Loans and leases, net | $ | 735,107 |  | $ | 743,663

﻿

Net deferred loan costs of $3.0 million have been included in the carrying values of loans at both March 31, 2020 and December 31, 2019.

Direct finance leases include the lease receivable and the guaranteed lease residual. Unearned lease revenue represents the difference between the lessor’s investment in the property and the gross investment in the lease. Unearned revenue is accrued over the life of the lease using the effective interest method.

The Company services real estate loans for investors in the secondary mortgage market which are not included in the accompanying consolidated balance sheets. The approximate unpaid principal balance of mortgages serviced amounted to $299.0 million as of March 31, 2020 and $302.3 million as of December 31, 2019. Mortgage servicing rights amounted to $1.0 million and $1.0 million as of March 31, 2020 and December 31, 2019, respectively.

Management is responsible for conducting the Company’s credit risk evaluation process, which includes credit risk grading of individual commercial and industrial and commercial real estate loans. Commercial and industrial and commercial real estate loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed as the case may be. The credit risk grades may be changed at any time management feels an upgrade or downgrade may be warranted. The Company utilizes an external independent loan review firm that reviews and validates the credit risk program on at least an annual basis. Results of these reviews are presented to management and the board of directors. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

Non-accrual loans

The decision to place loans on non-accrual status is made on an individual basis after considering factors pertaining to each specific loan. C&I and CRE loans are placed on non-accrual status when management has determined that payment of all contractual principal and interest is in doubt or the loan is past due 90 days or more as to principal and interest, unless well-secured and in the process of collection. Consumer loans secured by real estate and residential mortgage loans are placed on non-accrual status at 120 days past due as to principal and interest and unsecured consumer loans are charged-off when the loan is 90 days or more past due as to principal and interest. The Company considers all non-accrual loans to be impaired loans.

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Non-accrual loans, segregated by class, at March 31, 2020 and December 31, 2019, were as follows:

﻿

﻿ |  |  |  |  |
﻿ |
(dollars in thousands) | March 31, 2020 |  | December 31, 2019
Commercial and industrial | $ | 310 |  | $ | 336
Commercial real estate: |  |  |  |  |
Non-owner occupied |  | 419 |  |  | 510
Owner occupied |  | 1,465 |  |  | 1,447
Consumer: |  |  |  |  |
Home equity installment |  | 62 |  |  | 65
Home equity line of credit |  | 340 |  |  | 294
Auto loans |  | 92 |  |  | 16
Residential: |  |  |  |  |
Real estate |  | 966 |  |  | 1,006
Total | $ | 3,654 |  | $ | 3,674

﻿

Troubled Debt Restructuring (TDR)

A modification of a loan constitutes a troubled debt restructuring (TDR) when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company considers all TDRs to be impaired loans. The Company typically considers the following concessions when modifying a loan, which may include lowering interest rates below the market rate, temporary interest-only payment periods, term extensions at interest rates lower than the current market rate for new debt with similar risk and/or converting revolving credit lines to term loans. The Company typically does not forgive principal when granting a TDR modification. Of the TDRs outstanding as of March 31, 2020 and December 31, 2019, when modified, the concessions granted consisted of temporary interest-only payments, extensions of maturity date, or a reduction in the rate of interest to a below-market rate for a contractual period of time. Other than the TDRs that were placed on non-accrual status, the TDRs were performing in accordance with their modified terms.

There were no loans modified as TDRs for the three months ended March 31, 2020 and 2019. Loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. There were no loans modified as a TDR within the previous twelve months that subsequently defaulted during the three months ended March 31, 2020 and 2019.

The allowance for loan losses (allowance) may be increased, adjustments may be made in the allocation of the allowance or partial charge-offs may be taken to further write-down the carrying value of the loan. An allowance for impaired loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s observable market price. If the loan is collateral dependent, the estimated fair value of the collateral is used to establish the allowance. As of March 31, 2020 and 2019, respectively, the allowance for impaired loans that have been modified in a TDR was $0.2 million and $0.2 million, respectively.

Past due loans

Loans are considered past due when the contractual principal and/or interest is not received by the due date. For loans reported 30-59 days past due, certain categories of loans are reported past due as and when the loan is in arrears for two payments or billing cycles. An aging analysis of past due loans, segregated by class of loans, as of the period indicated is as follows (dollars in thousands):

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﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Recorded
﻿ |  |  |  |  |  |  | Past due |  |  |  |  |  |  |  |  |  | investment past
﻿ | 30 - 59 Days |  | 60 - 89 Days |  | 90 days |  | Total |  |  |  |  | Total |  | due ≥ 90 days
March 31, 2020 | past due |  | past due |  | or more (1) |  | past due |  | Current |  | loans (3) |  | and accruing
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial | $ | 1,590 |  | $ | 1,009 |  | $ | 310 |  | $ | 2,909 |  | $ | 115,231 |  | $ | 118,140 |  | $ | -
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Non-owner occupied |  | 1,137 |  |  | 380 |  |  | 419 |  |  | 1,936 |  |  | 93,694 |  |  | 95,630 |  |  | -
Owner occupied |  | 783 |  |  | 360 |  |  | 1,465 |  |  | 2,608 |  |  | 123,368 |  |  | 125,976 |  |  | -
Construction |  | - |  |  | - |  |  | - |  |  | - |  |  | 3,196 |  |  | 3,196 |  |  | -
Consumer: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity installment |  | 63 |  |  | 28 |  |  | 62 |  |  | 153 |  |  | 35,303 |  |  | 35,456 |  |  | -
Home equity line of credit |  | 362 |  |  | 13 |  |  | 340 |  |  | 715 |  |  | 46,135 |  |  | 46,850 |  |  | -
Auto loans |  | 888 |  |  | 23 |  |  | 92 |  |  | 1,003 |  |  | 101,210 |  |  | 102,213 |  |  | -
Direct finance leases |  | 294 |  |  | - |  |  | - |  |  | 294 |  |  | 16,124 |  |  | 16,418 | (2) |  | -
Other |  | 25 |  |  | 3 |  |  | - |  |  | 28 |  |  | 6,997 |  |  | 7,025 |  |  | -
Residential: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Real estate |  | - |  |  | 1,350 |  |  | 966 |  |  | 2,316 |  |  | 173,137 |  |  | 175,453 |  |  | -
Construction |  | - |  |  | - |  |  | - |  |  | - |  |  | 18,767 |  |  | 18,767 |  |  | -
Total | $ | 5,142 |  | $ | 3,166 |  | $ | 3,654 |  | $ | 11,962 |  | $ | 733,162 |  | $ | 745,124 |  | $ | -

(1) Includes non-accrual loans. (2) Net of unearned lease revenue of $0.9 million. (3) Includes net deferred loan costs of $3.0 million.

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Recorded
﻿ |  |  |  |  |  |  | Past due |  |  |  |  |  |  |  |  |  | investment past
﻿ | 30 - 59 Days |  | 60 - 89 Days |  | 90 days |  | Total |  |  |  |  | Total |  | due ≥ 90 days
December 31, 2019 | past due |  | past due |  | or more (1) |  | past due |  | Current |  | loans (3) |  | and accruing
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial | $ | 33 |  | $ | 171 |  | $ | 336 |  | $ | 540 |  | $ | 122,054 |  | $ | 122,594 |  | $ | -
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Non-owner occupied |  | - |  |  | 70 |  |  | 510 |  |  | 580 |  |  | 99,221 |  |  | 99,801 |  |  | -
Owner occupied |  | 180 |  |  | 89 |  |  | 1,447 |  |  | 1,716 |  |  | 128,842 |  |  | 130,558 |  |  | -
Construction |  | - |  |  | - |  |  | - |  |  | - |  |  | 4,654 |  |  | 4,654 |  |  | -
Consumer: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity installment |  | - |  |  | 5 |  |  | 65 |  |  | 70 |  |  | 36,561 |  |  | 36,631 |  |  | -
Home equity line of credit |  | 49 |  |  | - |  |  | 294 |  |  | 343 |  |  | 46,939 |  |  | 47,282 |  |  | -
Auto loans |  | 316 |  |  | 46 |  |  | 16 |  |  | 378 |  |  | 105,492 |  |  | 105,870 |  |  | -
Direct finance leases |  | 59 |  |  | 79 |  |  | - |  |  | 138 |  |  | 15,314 |  |  | 15,452 | (2) |  | -
Other |  | 15 |  |  | 1 |  |  | - |  |  | 16 |  |  | 5,618 |  |  | 5,634 |  |  | -
Residential: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Real estate |  | 29 |  |  | 224 |  |  | 1,006 |  |  | 1,259 |  |  | 165,905 |  |  | 167,164 |  |  | -
Construction |  | - |  |  | - |  |  | - |  |  | - |  |  | 17,770 |  |  | 17,770 |  |  | -
Total | $ | 681 |  | $ | 685 |  | $ | 3,674 |  | $ | 5,040 |  | $ | 748,370 |  | $ | 753,410 |  | $ | -

(1) Includes non-accrual loans. (2) Net of unearned lease revenue of $0.9 million. (3) Includes net deferred loan costs of $3.0 million.

Impaired loans

A loan is considered impaired when, based on current information and events; it is probable that the Company will be unable to collect the payments in accordance with the contractual terms of the loan. Factors considered in determining impairment include payment status, collateral value and the probability of collecting payments when due. The significance of payment delays and/or shortfalls is determined on a case-by-case basis. All circumstances surrounding the loan are taken into account. Such factors include the length of the delinquency, the underlying reasons and the borrower’s prior payment record. Impairment is measured on these loans on a loan-by-loan basis. Impaired loans include non-accrual loans, TDRs and other loans deemed to be impaired based on the aforementioned factors.

At March 31, 2020, impaired loans totaled $4.6 million consisting of $1.0 million in accruing TDRs and $3.6 million in non-accrual loans. At December 31, 2019, impaired loans totaled $4.7 million consisting of $1.0 million in accruing TDRs and $3.7 million in non-accrual loans. As of March 31, 2020, the non-accrual loans included two TDRs to two unrelated borrowers totaling $0.6 million compared with two TDRs to two unrelated borrowers totaling $0.6 million as of December 31, 2019.

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Table Of Contents

Impaired loans, segregated by class, as of the period indicated are detailed below:

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  | Recorded |  | Recorded |  |  |  |  |  |
﻿ | Unpaid |  | investment |  | investment |  | Total |  |  |
﻿ | principal |  | with |  | with no |  | recorded |  | Related
(dollars in thousands) | balance |  | allowance |  | allowance |  | investment |  | allowance
March 31, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial | $ | 310 |  | $ | 310 |  | $ | - |  | $ | 310 |  | $ | 195
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Non-owner occupied |  | 1,098 |  |  | 203 |  |  | 628 |  |  | 831 |  |  | 118
Owner occupied |  | 2,352 |  |  | 1,121 |  |  | 920 |  |  | 2,041 |  |  | 194
Consumer: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity installment |  | 104 |  |  | 39 |  |  | 23 |  |  | 62 |  |  | 1
Home equity line of credit |  | 407 |  |  | 135 |  |  | 205 |  |  | 340 |  |  | 74
Auto loans |  | 108 |  |  | - |  |  | 92 |  |  | 92 |  |  | -
Residential: |  |  |  |  |  |  |  |  |  |  |  |  |  | -
Real estate |  | 1,044 |  |  | 627 |  |  | 339 |  |  | 966 |  |  | 137
Total | $ | 5,423 |  | $ | 2,435 |  | $ | 2,207 |  | $ | 4,642 |  | $ | 719

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  | Recorded |  | Recorded |  |  |  |  |  |
﻿ | Unpaid |  | investment |  | investment |  | Total |  |  |
﻿ | principal |  | with |  | with no |  | recorded |  | Related
(dollars in thousands) | balance |  | allowance |  | allowance |  | investment |  | allowance
December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial | $ | 336 |  | $ | 336 |  | $ | - |  | $ | 336 |  | $ | 221
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Non-owner occupied |  | 1,047 |  |  | 333 |  |  | 591 |  |  | 924 |  |  | 232
Owner occupied |  | 2,336 |  |  | 1,052 |  |  | 972 |  |  | 2,024 |  |  | 194
Consumer: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity installment |  | 106 |  |  | - |  |  | 65 |  |  | 65 |  |  | -
Home equity line of credit |  | 362 |  |  | 88 |  |  | 206 |  |  | 294 |  |  | 87
Auto loans |  | 32 |  |  | - |  |  | 16 |  |  | 16 |  |  | -
Residential: |  |  |  |  |  |  |  |  |  |  |  |  |  | -
Real estate |  | 1,053 |  |  | 678 |  |  | 328 |  |  | 1,006 |  |  | 174
Total | $ | 5,272 |  | $ | 2,487 |  | $ | 2,178 |  | $ | 4,665 |  | $ | 908

﻿

The following table presents the average recorded investments in impaired loans and related amount of interest income recognized during the periods indicated below. The average balances are calculated based on the quarter-end balances of impaired loans. Payments received from non-accruing impaired loans are first applied against the outstanding principal balance, then to the recovery of any charged-off amounts. Any excess is treated as a recovery of interest income. Payments received from accruing impaired loans are applied to principal and interest, as contractually agreed upon.

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |
﻿ | March 31, 2020 |  | March 31, 2019
﻿ |  |  |  |  |  |  | Cash basis |  |  |  |  |  |  |  | Cash basis
﻿ | Average |  | Interest |  | interest |  | Average |  | Interest |  | interest
﻿ | recorded |  | income |  | income |  | recorded |  | income |  | income
(dollars in thousands) | investment |  | recognized |  | recognized |  | investment |  | recognized |  | recognized
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial | $ | 252 |  | $ | - |  | $ | - |  | $ | 178 |  | $ | 1 |  | $ | -
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Non-owner occupied |  | 884 |  |  | 6 |  |  | - |  |  | 1,701 |  |  | 8 |  |  | -
Owner occupied |  | 2,327 |  |  | 6 |  |  | - |  |  | 2,589 |  |  | 10 |  |  | -
Construction |  | - |  |  | - |  |  | - |  |  | 75 |  |  | - |  |  | -
Consumer: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity installment |  | 49 |  |  | - |  |  | - |  |  | 381 |  |  | - |  |  | -
Home equity line of credit |  | 245 |  |  | - |  |  | - |  |  | 42 |  |  | - |  |  | -
Auto Loans |  | 52 |  |  | - |  |  | - |  |  | 35 |  |  | - |  |  | -
Other |  | - |  |  | - |  |  | - |  |  | 4 |  |  | - |  |  | -
Residential: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Real estate |  | 1,102 |  |  | - |  |  | - |  |  | 1,347 |  |  | 9 |  |  | -
Total | $ | 4,911 |  | $ | 12 |  | $ | - |  | $ | 6,352 |  | $ | 28 |  | $ | -
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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Table Of Contents

﻿

Credit Quality Indicators

Commercial and industrial and commercial real estate

The Company utilizes a loan grading system and assigns a credit risk grade to its loans in the C&I and CRE portfolios. The grading system provides a means to measure portfolio quality and aids in the monitoring of the credit quality of the overall loan portfolio. The credit risk grades are arrived at using a risk rating matrix to assign a grade to each of the loans in the C&I and CRE portfolios.

The following is a description of each risk rating category the Company uses to classify each of its C&I and CRE loans:

Pass

Loans in this category have an acceptable level of risk and are graded in a range of one to five. Secured loans generally have good collateral coverage. Current financial statements reflect acceptable balance sheet ratios, sales and earnings trends. Management is considered to be competent, and a reasonable succession plan is evident. Payment experience on the loans has been good with minor or no delinquency experience. Loans with a grade of one are of the highest quality in the range. Those graded five are of marginally acceptable quality.

Special Mention

Loans in this category are graded a six and may be protected but are potentially weak. They constitute a credit risk to the Company, but have not yet reached the point of adverse classification. Some of the following conditions may exist: little or no collateral coverage; lack of current financial information; delinquency problems; highly leveraged; available financial information reflects poor balance sheet ratios and profit and loss statements reflect uncertain trends; and document exceptions. Cash flow may not be sufficient to support total debt service requirements.

Substandard

Loans in this category are graded a seven and have a well-defined weakness which may jeopardize the ultimate collectability of the debt. The collateral pledged may be lacking in quality or quantity. Financial statements may indicate insufficient cash flow to service the debt; and/or do not reflect a sound net worth. The payment history indicates chronic delinquency problems. Management is considered to be weak. There is a distinct possibility that the Company may sustain a loss. All loans on non-accrual are rated substandard. Other loans that are included in the substandard category can be accruing, as well as loans that are current or past due. Loans 90 days or more past due, unless otherwise fully supported, are classified substandard. Also, borrowers that are bankrupt or have loans categorized as TDRs can be graded substandard.

Doubtful

Loans in this category are graded an eight and have a better than 50% possibility of the Company sustaining a loss, but the loss cannot be determined because of specific reasonable factors which may strengthen credit in the near-term. Many of the weaknesses present in a substandard loan exist. Liquidation of collateral, if any, is likely. Any loan graded lower than an eight is considered to be uncollectible and charged-off.

Consumer and residential

The consumer and residential loan segments are regarded as homogeneous loan pools and as such are not risk rated. For these portfolios, the Company utilizes payment activity and history in assessing performance. Non-performing loans are comprised of non-accrual loans and loans past due 90 days or more and accruing. All loans not classified as non-performing are considered performing.

The following table presents loans including $3.0 million and $3.0 million of deferred costs, segregated by class, categorized into the appropriate credit quality indicator category as of March 31, 2020 and December 31, 2019, respectively:

Commercial credit exposure

Credit risk profile by creditworthiness category

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﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |
﻿ | March 31, 2020
(dollars in thousands) | Pass |  | Special mention |  | Substandard |  | Doubtful |  | Total
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial | $ | 110,927 |  | $ | 1,820 |  | $ | 5,393 |  | $ | - |  | $ | 118,140
Commercial real estate - non-owner occupied |  | 88,576 |  |  | 1,090 |  |  | 5,964 |  |  | - |  |  | 95,630
Commercial real estate - owner occupied |  | 117,458 |  |  | 1,890 |  |  | 6,628 |  |  | - |  |  | 125,976
Commercial real estate - construction |  | 2,389 |  |  | 56 |  |  | 751 |  |  | - |  |  | 3,196
Total commercial | $ | 319,350 |  | $ | 4,856 |  | $ | 18,736 |  | $ | - |  | $ | 342,942

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Table Of Contents

Consumer & Mortgage lending credit exposure

Credit risk profile based on payment activity

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  | March 31, 2020
(dollars in thousands) |  |  |  |  | Performing |  | Non-performing |  | Total
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consumer |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity installment |  |  |  |  |  |  | $ | 35,394 |  | $ | 62 |  | $ | 35,456
Home equity line of credit |  |  |  |  |  |  |  | 46,510 |  |  | 340 |  |  | 46,850
Auto loans |  |  |  |  |  |  |  | 102,121 |  |  | 92 |  |  | 102,213
Direct finance leases (1) |  |  |  |  |  |  |  | 16,418 |  |  | - |  |  | 16,418
Other |  |  |  |  |  |  |  | 7,025 |  |  | - |  |  | 7,025
Total consumer |  |  |  |  |  |  |  | 207,468 |  |  | 494 |  |  | 207,962
Residential |  |  |  |  |  |  |  |  |  |  |  |  |  |
Real estate |  |  |  |  |  |  |  | 174,487 |  |  | 966 |  |  | 175,453
Construction |  |  |  |  |  |  |  | 18,767 |  |  | - |  |  | 18,767
Total residential |  |  |  |  |  |  |  | 193,254 |  |  | 966 |  |  | 194,220
Total consumer & residential |  |  |  |  |  |  | $ | 400,722 |  | $ | 1,460 |  | $ | 402,182

(1)Net of unearned lease revenue of $0.9 million.

﻿

Commercial credit exposure

Credit risk profile by creditworthiness category

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | December 31, 2019
(dollars in thousands) | Pass |  | Special mention |  | Substandard |  | Doubtful |  | Total
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial | $ | 115,585 |  | $ | 2,061 |  | $ | 4,948 |  | $ | - |  | $ | 122,594
Commercial real estate - non-owner occupied |  | 92,016 |  |  | 1,360 |  |  | 6,425 |  |  | - |  |  | 99,801
Commercial real estate - owner occupied |  | 121,887 |  |  | 2,065 |  |  | 6,606 |  |  | - |  |  | 130,558
Commercial real estate - construction |  | 3,687 |  |  | 17 |  |  | 950 |  |  | - |  |  | 4,654
Total commercial | $ | 333,175 |  | $ | 5,503 |  | $ | 18,929 |  | $ | - |  | $ | 357,607

﻿

Consumer & Mortgage lending credit exposure

Credit risk profile based on payment activity

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  | December 31, 2019
(dollars in thousands) |  |  |  |  |  |  | Performing |  | Non-performing |  | Total
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consumer |  |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity installment |  |  |  |  |  |  | $ | 36,566 |  | $ | 65 |  | $ | 36,631
Home equity line of credit |  |  |  |  |  |  |  | 46,988 |  |  | 294 |  |  | 47,282
Auto loans |  |  |  |  |  |  |  | 105,854 |  |  | 16 |  |  | 105,870
Direct finance leases (2) |  |  |  |  |  |  |  | 15,452 |  |  | - |  |  | 15,452
Other |  |  |  |  |  |  |  | 5,634 |  |  | - |  |  | 5,634
Total consumer |  |  |  |  |  |  |  | 210,494 |  |  | 375 |  |  | 210,869
Residential |  |  |  |  |  |  |  |  |  |  |  |  |  |
Real estate |  |  |  |  |  |  |  | 166,158 |  |  | 1,006 |  |  | 167,164
Construction |  |  |  |  |  |  |  | 17,770 |  |  | - |  |  | 17,770
Total residential |  |  |  |  |  |  |  | 183,928 |  |  | 1,006 |  |  | 184,934
Total consumer & residential |  |  |  |  |  |  | $ | 394,422 |  | $ | 1,381 |  | $ | 395,803

(2)Net of unearned lease revenue of $0.9 million.

Allowance for loan losses

Management continually evaluates the credit quality of the Company’s loan portfolio and performs a formal review of the adequacy of the allowance on a quarterly basis. The allowance reflects management’s best estimate of the amount of credit losses in the loan portfolio. Management’s judgment is based on the evaluation of individual loans, past experience, the assessment of current economic conditions and other relevant factors including the amounts and timing of cash flows expected to be received on impaired loans. Those estimates may be susceptible to significant change. Loan losses are charged directly against the allowance when loans are deemed to be uncollectible. Recoveries from previously charged-off loans are added to the allowance when received.

Management applies two primary components during the loan review process to determine proper allowance levels. The two components are a specific loan loss allocation for loans that are deemed impaired and a general loan loss allocation for those loans not specifically allocated. The methodology to analyze the adequacy of the allowance for loan losses is as follows:

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Table Of Contents

| § |  | identification of specific impaired loans by loan category;

| § |  | identification of specific loans that are not impaired, but have an identified potential for loss;

| § |  | calculation of specific allowances where required for the impaired loans based on collateral and other objective and quantifiable evidence;

| § |  | determination of loans with similar credit characteristics within each class of the loan portfolio segment and eliminating the impaired loans;

| § |  | application of historical loss percentages (trailing twelve-quarter average) to pools to determine the allowance allocation;

| § |  | application of qualitative factor adjustment percentages to historical losses for trends or changes in the loan portfolio.

| § |  | Qualitative factor adjustments include:

| o |  | levels of and trends in delinquencies and non-accrual loans;

| o |  | levels of and trends in charge-offs and recoveries;

| o |  | trends in volume and terms of loans;

| o |  | changes in risk selection and underwriting standards;

| o |  | changes in lending policies and legal and regulatory requirements;

| o |  | experience, ability and depth of lending management;

| o |  | national and local economic trends and conditions; and

| o |  | changes in credit concentrations.

Allocation of the allowance for different categories of loans is based on the methodology as explained above. A key element of the methodology to determine the allowance is the Company’s credit risk evaluation process, which includes credit risk grading of individual C&I and CRE loans. C&I and CRE loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed as the case may be. The credit risk grades may be changed at any time management feels an upgrade or downgrade may be warranted. The credit risk grades for the C&I and CRE loan portfolios are taken into account in the reserve methodology and loss factors are applied based upon the credit risk grades. The loss factors applied are based upon the Company’s historical experience as well as what we believe to be best practices and common industry standards. Historical experience reveals there is a direct correlation between the credit risk grades and loan charge-offs. The changes in allocations in the C&I and CRE loan portfolio from period to period are based upon the credit risk grading system and from periodic reviews of the loan portfolio. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies.

Each quarter, management performs an assessment of the allowance. The Company’s Special Assets Committee meets quarterly and the applicable lenders discuss each relationship under review and reach a consensus on the appropriate estimated loss amount, if applicable, based on current accounting guidance. The Special Assets Committee’s focus is on ensuring the pertinent facts are considered regarding not only loans considered for specific reserves, but also the collectability of loans that may be past due in payment. The assessment process also includes the review of all loans on a non-accruing basis as well as a review of certain loans to which the lenders or the Company’s Credit Administration function have assigned a criticized or classified risk rating.

The Company’s policy is to charge-off unsecured consumer loans when they become 90 days or more past due as to principal and interest. In the other portfolio segments, amounts are charged-off at the point in time when the Company deems the balance, or a portion thereof, to be uncollectible.

20

Table Of Contents

Information related to the change in the allowance and the Company’s recorded investment in loans by portfolio segment as of the period indicated is as follows:

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﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
As of and for the three months ended March 31, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | Commercial & |  | Commercial |  |  |  |  | Residential |  |  |  |  |  |
(dollars in thousands) | industrial |  | real estate |  | Consumer |  | real estate |  | Unallocated |  | Total
Allowance for Loan Losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning balance | $ | 1,484 |  | $ | 3,933 |  | $ | 2,013 |  | $ | 2,278 |  | $ | 39 |  | $ | 9,747
Charge-offs |  | (64) |  |  | (163) |  |  | (43) |  |  | (31) |  |  | - |  |  | (301)
Recoveries |  | 12 |  |  | 2 |  |  | 64 |  |  | 193 |  |  | - |  |  | 271
Provision |  | 121 |  |  | 171 |  |  | 60 |  |  | (47) |  |  | (5) |  |  | 300
Ending balance | $ | 1,553 |  | $ | 3,943 |  | $ | 2,094 |  | $ | 2,393 |  | $ | 34 |  | $ | 10,017
Ending balance: individually evaluated for impairment | $ | 195 |  | $ | 312 |  | $ | 75 |  | $ | 137 |  | $ | - |  | $ | 719
Ending balance: collectively evaluated for impairment | $ | 1,358 |  | $ | 3,631 |  | $ | 2,019 |  | $ | 2,256 |  | $ | 34 |  | $ | 9,298
Loans Receivables: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending balance (2) | $ | 118,140 |  | $ | 224,802 |  | $ | 207,962 | (1) | $ | 194,220 |  | $ | - |  | $ | 745,124
Ending balance: individually evaluated for impairment | $ | 310 |  | $ | 2,872 |  | $ | 494 |  | $ | 966 |  | $ | - |  | $ | 4,642
Ending balance: collectively evaluated for impairment | $ | 117,830 |  | $ | 221,930 |  | $ | 207,468 |  | $ | 193,254 |  | $ | - |  | $ | 740,482

(1) Net of unearned lease revenue of $0.9 million. (2) Includes $3.0 million of net deferred loan costs.

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﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
As of and for the year ended December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | Commercial & |  | Commercial |  |  |  | Residential |  |  |  |  |  |
(dollars in thousands) | industrial |  | real estate |  | Consumer |  | real estate |  | Unallocated |  | Total
Allowance for Loan Losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning balance | $ | 1,432 |  | $ | 3,901 |  | $ | 2,548 |  | $ | 1,844 |  | $ | 22 |  | $ | 9,747
Charge-offs |  | (184) |  |  | (597) |  |  | (398) |  |  | (330) |  |  | - |  |  | (1,509)
Recoveries |  | 32 |  |  | 317 |  |  | 67 |  |  | 8 |  |  | - |  |  | 424
Provision |  | 204 |  |  | 312 |  |  | (204) |  |  | 756 |  |  | 17 |  |  | 1,085
Ending balance | $ | 1,484 |  | $ | 3,933 |  | $ | 2,013 |  | $ | 2,278 |  | $ | 39 |  | $ | 9,747
Ending balance: individually evaluated for impairment | $ | 221 |  | $ | 426 |  | $ | 87 |  | $ | 174 |  | $ | - |  | $ | 908
Ending balance: collectively evaluated for impairment | $ | 1,263 |  | $ | 3,507 |  | $ | 1,926 |  | $ | 2,104 |  | $ | 39 |  | $ | 8,839
Loans Receivables: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending balance (2) | $ | 122,594 |  | $ | 235,013 |  | $ | 210,869 | (1) | $ | 184,934 |  | $ | - |  | $ | 753,410
Ending balance: individually evaluated for impairment | $ | 336 |  | $ | 2,948 |  | $ | 375 |  | $ | 1,006 |  | $ | - |  | $ | 4,665
Ending balance: collectively evaluated for impairment | $ | 122,258 |  | $ | 232,065 |  | $ | 210,494 |  | $ | 183,928 |  | $ | - |  | $ | 748,745

(1) Net of unearned lease revenue of $0.9 million. (2) Includes $3.0 million of net deferred loan costs.

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
As of and for the three months ended March 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | Commercial & |  | Commercial |  |  |  |  | Residential |  |  |  |  |  |
(dollars in thousands) | industrial |  | real estate |  | Consumer |  | real estate |  | Unallocated |  | Total
Allowance for Loan Losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning balance | $ | 1,432 |  | $ | 3,901 |  | $ | 2,548 |  | $ | 1,844 |  | $ | 22 |  | $ | 9,747
Charge-offs |  | (28) |  |  | (361) |  |  | (89) |  |  | (35) |  |  | - |  |  | (513)
Recoveries |  | 6 |  |  | 2 |  |  | 25 |  |  | - |  |  | - |  |  | 33
Provision |  | (3) |  |  | 485 |  |  | (354) |  |  | 101 |  |  | 26 |  |  | 255
Ending balance | $ | 1,407 |  | $ | 4,027 |  | $ | 2,130 |  | $ | 1,910 |  | $ | 48 |  | $ | 9,522

﻿

Direct finance leases

On January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842), and subsequent related updates to revise the accounting for leases. Lessor accounting was largely unchanged as a result of the standard. Additional disclosures required under the standard are included in this section and in Footnote 1 2, “Leases”.

The Company originates direct finance leases through two automobile dealerships. The carrying amount of the Company’s lease

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receivables, net of unearned income, was $5.0 million and $4.7 million as of March 31, 2020 and December 31, 2019, respectively. The residual value of the direct finance leases is fully guaranteed by the dealerships. Residual values amounted to $11.4 million and $10.8 million at March 31, 2020 and December 31, 2019, respectively, and are included in the carrying value of direct finance leases.

The undiscounted cash flows to be received on an annual basis for the direct finance leases are as follows:

﻿

﻿ |  |
﻿ |  |
(dollars in thousands) | Amount
﻿ |  |
2020 | $ | 5,344
2021 |  | 6,005
2022 |  | 3,720
2023 |  | 2,039
2024 |  | 248
Total future minimum lease payments receivable |  | 17,356
Less: Unearned income |  | (938)
Undiscounted cash flows to be received | $ | 16,418
﻿ |  |

﻿

﻿

6. Ear nings per share

Basic earnings per share (EPS) is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS is computed in the same manner as basic EPS but also reflects the potential dilution that could occur from the grant of stock-based compensation awards. The Company maintains two active share-based compensation plans that may generate additional potentially dilutive common shares. For granted and unexercised stock-settled stock appreciation rights (SSARs), dilution would occur if Company-issued SSARs were exercised and converted into common stock. As of the three months ended March 31, 2020 and 2019, there were 28,070 and 29,708 potentially dilutive shares related to issued and unexercised SSARs. For restricted stock, dilution would occur from the Company’s previously granted but unvested shares. There were 6,303 and 11,058 potentially dilutive shares related to unvested restricted share grants as of the three months ended March 31, 2020 and 2019, respectively.

In the computation of diluted EPS, the Company uses the treasury stock method to determine the dilutive effect of its granted but unexercised stock options and SSARs and unvested restricted stock. Under the treasury stock method, the assumed proceeds, as defined, received from shares issued in a hypothetical stock option exercise or restricted stock grant, are assumed to be used to purchase treasury stock. Proceeds include amounts received from the exercise of outstanding stock options and compensation cost for future service that the Company has not yet recognized in earnings. The Company does not consider awards from share-based grants in the computation of basic EPS.

The following table illustrates the data used in computing basic and diluted EPS for the periods indicated:

﻿ |  |  |  |  |
﻿ |  |  |  |  |
﻿ | Three months ended March 31,
﻿ | 2020 |  | 2019
(dollars in thousands except per share data) |  |  |  |  |
Basic EPS: |  |  |  |  |
Net income available to common shareholders | $ | 2,634 |  | $ | 2,802
Weighted-average common shares outstanding |  | 3,792,741 |  |  | 3,774,004
Basic EPS | $ | 0.69 |  | $ | 0.74
﻿ |  |  |  |  |
Diluted EPS: |  |  |  |  |
Net income available to common shareholders | $ | 2,634 |  | $ | 2,802
Weighted-average common shares outstanding |  | 3,792,741 |  |  | 3,774,004
Potentially dilutive common shares |  | 34,373 |  |  | 40,766
Weighted-average common and potentially dilutive shares outstanding |  | 3,827,114 |  |  | 3,814,770
Diluted EPS | $ | 0.69 |  | $ | 0.73

﻿

﻿

﻿

﻿

﻿

7. Stock plans

The Company has two stock-based compensation plans (the stock compensation plans) from which it can grant stock-based compensation awards and applies the fair value method of accounting for stock-based compensation provided under current accounting guidance. The guidelines require the cost of share-based payment transactions (including those with employees and non-employees) be recognized in the financial statements. The Company’s stock compensation plans were shareholder-approved and

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permit the grant of share-based compensation awards to its employees and directors. The Company believes that the stock-based compensation plans will advance the development, growth and financial condition of the Company by providing incentives through participation in the appreciation in the value of the Company’s common stock. In return, the Company hopes to secure, retain and motivate the employees and directors who are responsible for the operation and the management of the affairs of the Company by aligning the interest of its employees and directors with the interest of its shareholders. In the stock compensation plans, employees and directors are eligible to be awarded stock-based compensation grants which can consist of stock options (qualified and non-qualified), stock appreciation rights (SARs) and restricted stock.

At the 2012 annual shareholders’ meeting, the Company’s shareholders approved and the Company adopted the 2012 Omnibus Stock Incentive Plan and the 2012 Director Stock Incentive Plan (collectively, the 2012 stock incentive plans). Unless terminated by the Company’s board of directors, the 2012 stock incentive plans will expire on and no stock-based awards shall be granted after the year 2022.

In each of the 2012 stock incentive plans, the Company has reserved 750,000 shares of its no-par common stock for future issuance. The Company recognizes share-based compensation expense over the requisite service or vesting period. During 2015, the Company created a Long-Term Incentive Plan (LTIP) that awarded restricted stock and stock-settled stock appreciation rights (SSARs) to senior officers based on the attainment of performance goals. The service requirement wa s the participant’s continued employment throughout the LTIP with a three-year vesting period. Prior to the 2020 grants, the restricted stock had a two-year post vesting holding period requirement. The SSAR awards have a ten-year term from the date of each grant. During the first quarter of 2019, the Company approved a 1 year LTIP and awarded restricted stock and SSARs to senior officers and managers in February 2019 based on 2018 performance. During the first quarter of 2020, the Company approved a 1 year LTIP and awarded restricted stock to senior officers and managers in February and March 2020 based on 2019 performance.

The following table summarizes the weighted-average fair value and vesting of restricted stock grants awarded during the periods ended March 31, 2020 and 2019 under the 2012 stock incentive plans:

﻿

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |
﻿ | March 31, 2020 |  | March 31, 2019
﻿ |  |  | Weighted- |  |  |  | Weighted-
﻿ |  |  | average |  |  |  | average
﻿ | Shares |  | grant date |  | Shares |  | grant date
﻿ | granted |  | fair value |  | granted |  | fair value
﻿ |  |  |  |  |  |  |  |  |
Director plan | 6,000 | (3) | $ | 56.63 |  | 5,600 | (2) | $ | 54.69
Omnibus plan | 11,761 | (3) |  | 55.06 |  | 7,251 | (2) |  | 54.69
Omnibus plan | 50 | (1) |  | 57.62 |  | 50 | (1) |  | 58.08
Total | 17,811 |  | $ | 55.59 |  | 12,901 |  | $ | 54.70

(1) Vest after 1 year (2) Vest after 3 years – 33% each year (3) Vest fully after 3 years

The fair value of the shares granted in the first quarter of 2020 was calculated using the grant date stock price.

A summary of the status of the Company’s non-vested restricted stock as of and changes during the period indicated are presented in the following table:

﻿

﻿

﻿ |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |
﻿ | 2012 Stock incentive plans
﻿ | Director |  | Omnibus |  | Total |  |  | Weighted- average grant date fair value
Non-vested balance at December 31, 2019 | 11,200 |  | 15,961 |  | 27,161 |  | $ | 49.48
Granted | 6,000 |  | 11,811 |  | 17,811 |  |  | 55.59
Vested | (4,664) |  | (7,597) |  | (12,261) |  |  | 46.94
Non-vested balance at March 31, 2020 | 12,536 |  | 20,175 |  | 32,711 |  | $ | 53.76
﻿ |  |  |  |  |  |  |  |

﻿

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A summary of the status of the Company’s SSARs as of and changes during the period indicated are presented in the following table:

﻿

﻿

﻿

﻿ |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |
﻿ |  | Awards |  |  | Weighted-average grant date fair value |  | Weighted-average remaining contractual term (years)
Outstanding December 31, 2019 |  | 97,264 |  | $ | 9.47 |  | 7.5
Granted |  | - |  |  | - |  |
Exercised |  | - |  |  | - |  |
Forfeited |  | - |  |  | - |  |
Outstanding March 31, 2020 |  | 97,264 |  | $ | 9.47 |  | 7.2
﻿ |  |  |  |  |  |  |

Of the SSARs outstanding at March 31, 2020, 76,897 vested and were exercisable. SSARs vest over a three-year period – 33% per year.

During 2019, there were 3,059 SSARs exercised. The intrinsic value recorded for these SSARs was $10,631. The tax deduction realized from the exercise of these SSARs was $108,134 resulting in a tax benefit of $22,708.

Share-based compensation expense is included as a component of salaries and employee benefits in the consolidated statements of income. The following tables illustrate stock-based compensation expense recognized on non-vested equity awards during the three months ended March 31, 2020 and 2019 and the unrecognized stock-based compensation expense as of March 31, 2020:

﻿

﻿ |  |  |  |  |
﻿ |  |  |  |  |
﻿ | Three months ended March 31,
(dollars in thousands) | 2020 |  |  | 2019
Stock-based compensation expense: |  |  |  |  |
Director stock incentive plan | $ | 78 |  | $ | 59
Omnibus stock incentive plan |  | 170 |  |  | 148
Employee stock purchase plan |  | 27 |  |  | 107
Total stock-based compensation expense | $ | 275 |  | $ | 314

In addition, during the three months ended March 31, 2020, the Company reversed accruals of ($32 thousand) in stock-based compensation expense for restricted stock and SSARs awarded under the Omnibus Plan. During the three months ended March 31, 2019, the Company reversed accruals of ($35 thousand) in stock-based compensation expense.

﻿

﻿

﻿ |  |
﻿ | As of
(dollars in thousands) | March 31, 2020
Unrecognized stock-based compensation expense: |  |
Director plan | $ | 626
Omnibus plan |  | 1,262
Total unrecognized stock-based compensation expense | $ | 1,888

The unrecognized stock-based compensation expense as of March 31, 2020 will be recognized ratably over the periods ended January 2023 and January 2023 for the Director Plan and the Omnibus Plan, respectively.

In addition to the 2012 stock incentive plans, the Company established the 2002 Employee Stock Purchase Plan (the ESPP) and reserved 165,000 shares of its un-issued capital stock for issuance under the plan. The ESPP was designed to promote broad-based employee ownership of the Company’s stock and to motivate employees to improve job performance and enhance the financial results of the Company. Under the ESPP, participation is voluntary whereby employees use automatic payroll withholdings to purchase the Company’s capital stock at a discounted price based on the fair market value of the capital stock as measured on either the commencement or termination dates, as defined. As of March 31, 2020, 84,904 shares have been issued under the ESPP. The ESPP is considered a compensatory plan and is required to comply with the provisions of current accounting guidance. The Company recognizes compensation expense on its ESPP on the date the shares are purchased, and it is included as a component of salaries and employee benefits in the consolidated statements of income.

8. Fair value measurements

The accounting guidelines establish a framework for measuring and disclosing information about fair value measurements. The guidelines of fair value reporting instituted a valuation hierarchy for disclosure of the inputs used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:

Level 1 - inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities;

Level 2 - inputs are quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument;

Level 3 - inputs are unobservable and are based on the Company’s own assumptions to measure assets and liabilities at fair value.

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Level 3 pricing for securities may also include unobservable inputs based upon broker-traded transactions.

A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

The Company uses fair value to measure certain assets and, if necessary, liabilities on a recurring basis when fair value is the primary measure for accounting. Thus, the Company uses fair value for AFS securities. Fair value is used on a non-recurring basis to measure certain assets when adjusting carrying values to market values, such as impaired loans, other real estate owned (ORE) and other repossessed assets.

The following table represents the carrying amount and estimated fair value of the Company’s financial instruments as of the periods indicated:

﻿

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
March 31, 2020
﻿ |  |  |  |  |  |  | Quoted prices |  | Significant |  | Significant
﻿ |  |  |  |  |  |  | in active |  | other |  | other
﻿ | Carrying |  | Estimated |  | markets |  | observable inputs |  | unobservable inputs
(dollars in thousands) | amount |  | fair value |  | (Level 1) |  | (Level 2) |  | (Level 3)
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents | $ | 58,960 |  | $ | 58,960 |  | $ | 58,960 |  | $ | - |  | $ | -
Available-for-sale debt securities |  | 203,984 |  |  | 203,984 |  |  | - |  |  | 203,984 |  |  | -
FHLB stock |  | 2,732 |  |  | 2,732 |  |  | - |  |  | 2,732 |  |  | -
Loans and leases, net |  | 735,107 |  |  | 736,923 |  |  | - |  |  | - |  |  | 736,923
Loans held-for-sale |  | 1,591 |  |  | 1,620 |  |  | - |  |  | 1,620 |  |  | -
Accrued interest receivable |  | 3,239 |  |  | 3,239 |  |  | - |  |  | 3,239 |  |  | -
Financial liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits with no stated maturities |  | 809,714 |  |  | 809,714 |  |  | - |  |  | 809,714 |  |  | -
Time deposits |  | 109,947 |  |  | 110,692 |  |  | - |  |  | 110,692 |  |  | -
FHLB advances |  | 15,000 |  |  | 15,808 |  |  | - |  |  | 15,808 |  |  | -
Accrued interest payable |  | 564 |  |  | 564 |  |  | - |  |  | 564 |  |  | -
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
December 31, 2019
﻿ |  |  |  |  |  |  | Quoted prices |  | Significant |  | Significant
﻿ |  |  |  |  |  |  | in active |  | other |  | other
﻿ | Carrying |  | Estimated |  | markets |  | observable inputs |  | unobservable inputs
(dollars in thousands) | amount |  | fair value |  | (Level 1) |  | (Level 2) |  | (Level 3)
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Financial assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents | $ | 15,663 |  | $ | 15,663 |  | $ | 15,663 |  | $ | - |  | $ | -
Available-for-sale debt securities |  | 185,117 |  |  | 185,117 |  |  | - |  |  | 185,117 |  |  | -
FHLB stock |  | 4,383 |  |  | 4,383 |  |  | - |  |  | 4,383 |  |  | -
Loans and leases, net |  | 743,663 |  |  | 735,657 |  |  | - |  |  | - |  |  | 735,657
Loans held-for-sale |  | 1,643 |  |  | 1,660 |  |  | - |  |  | 1,660 |  |  | -
Accrued interest receivable |  | 3,281 |  |  | 3,281 |  |  | - |  |  | 3,281 |  |  | -
Financial liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits with no stated maturities |  | 719,526 |  |  | 719,526 |  |  | - |  |  | 719,526 |  |  | -
Time deposits |  | 116,211 |  |  | 115,993 |  |  | - |  |  | 115,993 |  |  | -
Short-term borrowings |  | 37,839 |  |  | 37,839 |  |  | - |  |  | 37,839 |  |  | -
FHLB advances |  | 15,000 |  |  | 15,430 |  |  | - |  |  | 15,430 |  |  | -
Accrued interest payable |  | 644 |  |  | 644 |  |  | - |  |  | 644 |  |  | -
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |

﻿

The carrying value of short-term financial instruments, as listed below, approximates their fair value. These instruments generally have limited credit exposure, no stated or short-term maturities, carry interest rates that approximate market and generally are recorded at amounts that are payable on demand:

| · |  | Cash and cash equivalents;

| · |  | Non-interest bearing deposit accounts;

| · |  | Savings, interest-bearing checking and money market accounts and

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| · |  | Short-term borrowings.

Securities: Fair values on investment securities are determined by prices provided by a third-party vendor, who is a provider of financial market data, analytics and related services to financial institutions.

Loans and leases: The fair value of accruing loans is estimated by calculating the net present value of the future expected cash flows discounted using the exit price notion. The discount rate is based upon current offering rates, with an additional discount for expected potential charge-offs. Additionally, an environmental general credit risk adjustment is subtracted from the net present value to arrive at the total estimated fair value of the accruing loan portfolio.

The carrying value that fair value is compared to is net of the allowance for loan losses and since there is significant judgment included in evaluating credit quality, loans are classified within Level 3 of the fair value hierarchy.

Non-accrual loans: Loans which the Company has measured as non-accruing are generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties. These loans are classified within Level 3 of the fair value hierarchy. The fair value consists of loan balances less the valuation allowance.

Loans held-for-sale: The fair value of loans held-for-sale is estimated using rates currently offered for similar loans and is typically obtained from the Federal National Mortgage Association (FNMA) or the Federal Home Loan Bank of Pittsburgh (FHLB).

Certificates of deposit: The fair value of certificates of deposit is based on discounted cash flows using rates which approximate market rates for deposits of similar maturities.

FHLB advances: Fair value is estimated using the rates currently offered for similar borrowings.

The following tables illustrate the financial instruments measured at fair value on a recurring basis segregated by hierarchy fair value levels as of the periods indicated:

﻿

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  | Quoted prices |  |  |  |  |  |
﻿ |  |  |  | in active |  | Significant other |  | Significant other
﻿ | Total carrying value |  | markets |  | observable inputs |  | unobservable inputs
(dollars in thousands) | March 31, 2020 |  | (Level 1) |  | (Level 2) |  | (Level 3)
Available-for-sale securities: |  |  |  |  |  |  |  |  |  |  |
Agency - GSE | $ | 6,356 |  | $ | - |  | $ | 6,356 |  | $ | -
Obligations of states and political subdivisions |  | 56,254 |  |  | - |  |  | 56,254 |  |  | -
MBS - GSE residential |  | 141,374 |  |  | - |  |  | 141,374 |  |  | -
Total available-for-sale debt securities | $ | 203,984 |  | $ | - |  | $ | 203,984 |  | $ | -
﻿ |  |  |  |  |  |  |  |  |  |  |

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  | Quoted prices |  |  |  |  |  |
﻿ |  |  |  | in active |  | Significant other |  | Significant other
﻿ | Total carrying value |  | markets |  | observable inputs |  | unobservable inputs
(dollars in thousands) | December 31, 2019 |  | (Level 1) |  | (Level 2) |  | (Level 3)
Available-for-sale securities: |  |  |  |  |  |  |  |  |  |  |
Agency - GSE | $ | 6,159 |  | $ | - |  | $ | 6,159 |  | $ | -
Obligations of states and political subdivisions |  | 54,718 |  |  | - |  |  | 54,718 |  |  | -
MBS - GSE residential |  | 124,240 |  |  | - |  |  | 124,240 |  |  | -
Total available-for-sale debt securities | $ | 185,117 |  | $ | - |  | $ | 185,117 |  | $ | -
﻿ |  |  |  |  |  |  |  |  |  |  |

﻿

Debt securities in the AFS portfolio are measured at fair value using market quotations provided by a third-party vendor, who is a provider of financial market data, analytics and related services to financial institutions. Assets classified as Level 2 use valuation techniques that are common to bond valuations. That is, in active markets whereby bonds of similar characteristics frequently trade, quotes for similar assets are obtained. For the periods ending March 31, 2020 and December 31, 2019, there were no transfers to or from Level 1 and Level 2 fair value measurements for financial assets measured on a recurring basis.

There were no changes in Level 3 financial instruments measured at fair value on a recurring basis as of and for the periods ending March 31, 2020 and December 31, 2019, respectively.

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The following table illustrates the financial instruments newly measured at fair value on a non-recurring basis segregated by hierarchy fair value levels as of the periods indicated:

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  | Quoted prices in |  | Significant other |  | Significant other
﻿ | Total carrying value |  | active markets |  | observable inputs |  | unobservable inputs
(dollars in thousands) | at March 31, 2020 |  | (Level 1) |  | (Level 2) |  | (Level 3)
﻿ |  |  |  |  |  |  |  |  |  |  |
Impaired loans | $ | 1,716 |  | $ | - |  | $ | - |  | $ | 1,716
Other real estate owned |  | 99 |  |  | - |  |  | - |  |  | 99
Other repossessed assets |  | 17 |  |  | - |  |  | - |  |  | 17
Total | $ | 1,832 |  | $ | - |  | $ | - |  | $ | 1,832
﻿ |  |  |  |  |  |  |  |  |  |  |

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  | Quoted prices in |  | Significant other |  | Significant other
﻿ | Total carrying value |  | active markets |  | observable inputs |  | unobservable inputs
(dollars in thousands) | at December 31, 2019 |  | (Level 1) |  | (Level 2) |  | (Level 3)
﻿ |  |  |  |  |  |  |  |  |  |  |
Impaired loans | $ | 1,579 |  | $ | - |  | $ | - |  | $ | 1,579
Other real estate owned |  | 350 |  |  | - |  |  | - |  |  | 350
Other repossessed assets |  | 20 |  |  | - |  |  | - |  |  | 20
Total | $ | 1,949 |  | $ | - |  | $ | - |  | $ | 1,949
﻿ |  |  |  |  |  |  |  |  |  |  |

﻿

From time-to-time, the Company may be required to record at fair value financial instruments on a non-recurring basis, such as impaired loans, ORE and other repossessed assets. These non-recurring fair value adjustments involve the application of lower-of-cost-or-market accounting on write downs of individual assets.

The following describes valuation methodologies used for financial instruments measured at fair value on a non-recurring basis. Impaired loans that are collateral dependent are written down to fair value through the establishment of specific reserves, a component of the allowance for loan losses, and as such are carried at the lower of net recorded investment or the estimated fair value. Estimates of fair value of the collateral are determined based on a variety of information, including available valuations from certified appraisers for similar assets, present value of discounted cash flows and inputs that are estimated based on commonly used and generally accepted industry liquidation advance rates and estimates and assumptions developed by management.

Valuation techniques for impaired loans are typically determined through independent appraisals of the underlying collateral or may be determined through present value of discounted cash flows. Both techniques include various Level 3 inputs which are not identifiable. The valuation technique may be adjusted by management for estimated liquidation expenses and qualitative factors such as economic conditions. If real estate is not the primary source of repayment, present value of discounted cash flows and estimates using generally accepted industry liquidation advance rates and other factors may be utilized to determine fair value.

At March 31, 2020 and December 31, 2019, the range of liquidation expenses and other valuation adjustments applied to impaired loans ranged from -20.86% and -85.08% and from -21.56% to -84.98%, respectively. The weighted average of liquidation expenses and other valuation adjustments applied to impaired loans amounted to -37.18% as of March 31, 2020 and -29.11% as of December 31, 2019, respectively. Due to the multitude of assumptions, many of which are subjective in nature, and the varying inputs and techniques used to determine fair value, the Company recognizes that valuations could differ across a wide spectrum of techniques employed. Accordingly, fair value estimates for impaired loans are classified as Level 3.

For ORE, fair value is generally determined through independent appraisals of the underlying properties which generally include various Level 3 inputs which are not identifiable. Appraisals form the basis for determining the net realizable value from these properties. Net realizable value is the result of the appraised value less certain costs or discounts associated with liquidation which occurs in the normal course of business. Management’s assumptions may include consideration of the location and occupancy of the property, along with current economic conditions. Subsequently, as these properties are actively marketed, the estimated fair values may be periodically adjusted through incremental subsequent write-downs. These write-downs usually reflect decreases in estimated values resulting from sales price observations as well as changing economic and market conditions. At March 31, 2020 and December 31, 2019, the discounts applied to the appraised values of ORE ranged from -26.94% and -89.48%, respectively. As of March 31, 2020, and December 31, 2019, the weighted average of discount to the appraisal values of ORE amounted to -56.15% and -4 8.65%, respectively.

At March 31, 2020, other repossessed assets consisted of two automobiles, totaling $1 7 thousand. At December 31, 2019, other repossessed assets consisted of two automobiles, totaling $20 thousand. The Company refers to the National Automobile Dealers Association (NADA) guide to determine a vehicle’s fair value.

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9. Acquisition

Effective May 1, 2020, the Company completed the acquisition of MNB Corporation (“MNB”) pursuant to the Agreement and Plan of Reorganization, dated December 9, 2019. MNB was the holding company of Merchants Bank of Bangor (“Merchants Bank”) which operate d 9 retail community banking offices in Eastern Pennsylvania. Subject to the terms and conditions of the agreement, MNB merge d with and into the Company and Merchants Bank merge d with and into the Bank.

Under the terms of the agreement, MNB shareholders received as consideration 1.039 shares of Fidelity common stock for each share of MNB common stock that they owned as of the closing date. As a result of the merger, the Company issued 1,17 6,993 shares of its common stock and cash in exchange for fractional shares based upon $43.767, the determined market share price of the Company’s common stock in accordance with the Agreement and Plan of Reorganization.

Effective May 1, 2020, in connection with the merger and pursuant to the terms of the Agreement and Plan of Reorganization, Richard M. Hotchkiss, formerly the Chair of the boards of directors of MNB and Merchants Bank, was appointed as a Class C director and HelenBeth Garofalo Vilcek, w as appointed as a Class A d irector of th e Board of Directors of the Company and the Bank.

With the combination of the two organizations, the Company, on a consolidated basis, will have approximate total assets of $1.6 billion, total deposi ts of $1.4 billion and total loans of $1.1 billion. For the three months ended March 31, 2020, the Corporation incurred merger-related expenses totaling $273 thousand, primarily consisting of professional fees. The remaining n on-recurring costs to facilitate the merger and integrate systems in 2020 are currently estimated to be $1.8 million.

The merger transaction will be accounted for using the acquisition method of accounting, and, accordingly, assets acquired, liabilities assumed and consideration exchanged will be recorded at estimated fair values on the acquisition date. Management is in the process of assessing the assets purchased and liabilities assumed in connection with the merger.

10. Employee Benefits

Bank-Owned Life Insurance (BOLI)

The Company has purchased single premium BOLI policies on certain officers. The policies are recorded at their cash surrender values. Increases in cash surrender values are included in non-interest income in the consolidated statements of income. In March 2019, the Company purchased an additional $2.0 million of BOLI. The policies’ cash surrender value totaled $23.4 million and $23.3 million, respectively, as of March 31, 2020 and December 31, 2019 and is reflected as an asset on the consolidated balance sheets. For the three months ended March 31, 2020 and 2019, the Company has recorded income of $165 thousand and $146 thousand, respectively.

Officer Life Insurance

In 2017, the Bank entered into separate split dollar life insurance arrangements (Split Dollar Agreements) with eleven officers. This plan provides each officer a specified death benefit should the officer die while in the Bank’s employ. The Bank paid the insurance premiums in March 2017 and the arrangements were effective in March 2017. In March 2019, the Bank entered into a new Split Dollar Agreement with one officer. The Bank owns the policies and all cash values thereunder. Upon death of the covered employee, the agreed-upon amount of death proceeds from the policies will be paid directly to the insured’s beneficiary. As of March 31, 2020, the policies had total death benefits of $23.4 million of which $4.1 million would have been paid to the officer’s beneficiaries and the remaining $19.3 million would have been paid to the Bank. In addition, four executive officers have the opportunity to retain a split dollar benefit equal to two times their highest base salary after separation from service if the vesting requirements are met. As of March 31, 2020 and December 31, 2019, the Company accrued expenses of $119 thousand and $107 thousand for the split dollar benefit.

Supplemental Executive Retirement plan (SERP)

On March 29, 2017, the Bank entered into separate supplemental executive retirement agreements (individually the “SERP Agreement”) with five officers, pursuant to which the Bank will credit an amount to a SERP account established on each participant’s behalf while they are actively employed by the Bank for each calendar month from March 1, 2017 until retirement. On March 20, 2019, the Bank entered into a SERP Agreement with one officer, pursuant to which the Bank will credit an amount to a SERP account established for the participant’s behalf while they are actively employed by the Bank for each calendar month from March 1, 2019 until normal retirement age. As of March 31, 2020 and December 31, 2019, the Company accrued expenses of $1.6 million and $1.4 million in connection with the SERP.

11. Revenue Recognition

As of January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606) and all subsequent ASUs that modified Topic 606. The Company has elected to use the modified retrospective approach with prior period financial statements unadjusted and presented with historical revenue recognition methods. The implementation of the new standard had no material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary.

The majority of the Company’s revenues are generated through interest earned on securities and loans, which is explicitly

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excluded from the scope of the guidance. In addition, certain non-interest income streams such as fees associated with mortgage servicing rights, loan service charges, life insurance earnings, rental income and gains/losses on the sale of loans and securities are not in the scope of the new guidance. The main types of contracts with customers that are in the scope of the new guidance are:

| · |  | Service charges on deposit accounts – Deposit service charges represent fees charged by the Company for the performance obligation of providing services to a customer’s deposit account. The transaction price for deposit services includes both fixed and variable amounts based on the Company’s fee schedules. Revenue is recognized and payment is received either at a point in time for transactional fees or on a monthly basis for non-transactional fees.

| · |  | Interchange fees – Interchange fees represent fees charged by the Company for customers using debit cards. The contract is between the Company and the processor and the performance obligation is the ability of customers to use debit cards to make purchases at a point in time. The transaction price is a percentage of debit card usage and the processor pays the Company and revenue is recorded throughout the month as the performance obligations are being met.

| · |  | Fees from trust fiduciary activities – Trust fees represent fees charged by the Company for the management, custody and/or administration of trusts. These are mostly monthly fees based on the market value of assets in the trust account at the prior month end. Payment is generally received a few weeks after month end through a direct charge to customers’ accounts. Estate fees are recognized and charged as the Company reaches each of six different stages of the estate administration process.

| · |  | Fees from financial services – Financial service fees represent fees charged by the Company for the performance obligation of providing various services for an investment account. Revenue is recognized twice monthly for fees on sales transactions and on a monthly basis for advisory fees and quarterly for trail fees.

| · |  | Gain/loss on ORE sales – Gain/loss on the sale of ORE is recognized at the closing date when the sales proceeds are received. In seller-financed ORE transactions, the contract is made subject to our normal underwriting standards and pricing. The Company does not have any obligation or right to repurchase any sales of ORE.

Contract balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before the payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity already received payment (or payment is due) from the customer. The Company’s non-interest income streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company typically does not enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of March 31, 2020 and December 31, 2019, the Company did no t have any significant contract balances.

Remaining performance obligations

The Company’s performance obligations have an original expected duration of less than one year and follow the relevant guidance for recognizing revenue over time. There is no variable consideration subject to constraint that is not included in information about transaction price.

Contract acquisition costs

In connection with the adoption of Topic 606, an entity is required to capitalize and subsequently amortize into expense, certain incremental costs of obtaining a contract if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, the Company did no t capitalize any contract acquisition costs.

12. Leases

ASU 2016-02 Leases (Topic 842) became effective for the Company on January 1, 2019. For all operating lease contracts where the Company is lessee, a right-of-use (ROU) asset and lease liability was recorded as of the effective date. The Company assumed all renewal terms will be exercised when calculating the ROU assets and lease liabilities. For leases existing at the transition date, any prepaid or deferred rent was added to the ROU asset to calculate the lease liability. The discount rate used to calculate the present value of future payments at the transition date was the Company’s incremental borrowing rate. The Company used the FHLB fixed rate borrowing rates on December 29, 2018 as the discount rate at transition. For all classes of underlying assets, the Company has elected not to record short-term leases (leases with a term of 12 months or less) on the balance sheet when the Company is lessee. Instead, the Company will recognize the lease payment on a straight-line basis over the lease term and variable lease payments in the period in which the obligation for those payments is incurred. For all asset classes, the Company has elected, as a lessee, not to separate nonlease components from lease components and instead to account for each separate lease component and nonlease components associated with that lease component as a single lease component.

Management determines if an arrangement is or contains a lease at contract inception. If an arrangement is determined to be or contains a lease, the Company recognizes a ROU asset and a lease liability when the asset is placed in service.

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The Company’s operating leases, where the Company is lessee, include property, land and equipment. As of March 31, 2020, six of the Company’s branch properties were leased under operating leases. In four of the branch leases, the Company leases the land from an unrelated third party, and the buildings are the Company’s own capital improvement. The Company also leases three standalone ATMs under operating leases. Additionally, the Company has two equipment leases classified as finance leases.

The following is an analysis of the leased property under finance leases:

﻿

﻿

﻿ |  |  |  |  |
﻿ |  |
﻿ |  | Asset Balance at
(dollars in thousands) | March 31, 2020 |  | December 31, 2019
﻿ |  |  |  |  |
Equipment | $ | 397 |  | $ | 397
Less accumulated depreciation and amortization |  | (137) |  |  | (117)
Leased property under finance leases, net | $ | 260 |  | $ | 280
﻿ |  |  |  |  |

﻿

The following is a schedule of future minimum lease payments under finance leases together with the present value of the net minimum lease payments as of March 31, 2020:

﻿

﻿ |  |
(dollars in thousands) | Amount
﻿ |  |
2020 | $ | 62
2021 |  | 82
2022 |  | 82
2023 |  | 55
Total minimum lease payments (a) |  | 281
Less amount representing interest (b) |  | (14)
Present value of net minimum lease payments | $ | 267
﻿ |  |

| (a) |  | The future minimum lease payments have not been reduced by estimated executory costs (such as taxes and maintenance) since this amount was deemed immaterial by management.

| (b) |  | Amount necessary to reduce net minimum lease payments to present value calculated at the Company’s incremental borrowing rate upon lease inception.

﻿

As of March 31, 2020, the Company leased its Green Ridge, Pittston, Peckville, Back Mountain, Mountain Top and Abington branches under the terms of operating leases. The Abington branch has variable lease payments which are calculated as a percentage of the national prime rate of interest which are expensed as incurred.

﻿

﻿ |  |  |  |  |
(dollars in thousands) | March 31, 2020 |  | March 31, 2019
Lease cost |  |  |  |  |
Finance lease cost: |  |  |  |  |
Amortization of right-of-use assets | $ | 20 |  | $ | 19
Interest on lease liabilities |  | 2 |  |  | 2
Operating lease cost |  | 108 |  |  | 108
Short-term lease cost |  | 5 |  |  | 5
Variable lease cost |  | (1) |  |  | -
Total lease cost | $ | 134 |  | $ | 134
﻿ |  |  |  |  |
Other information |  |  |  |  |
Cash paid for amounts included in the measurement of lease liabilities |  |  |  |  |
Operating cash flows from finance leases | $ | 2 |  | $ | 2
Operating cash flows from operating leases (Fixed payments) | $ | 99 |  | $ | 80
Operating cash flows from operating leases (Liability reduction) | $ | 39 |  | $ | 25
Financing cash flows from finance leases | $ | 18 |  | $ | 19
Right-of-use assets obtained in exchange for new finance lease liabilities | $ | - |  | $ | 17
Right-of-use assets obtained in exchange for new operating lease liabilities | $ | - |  | $ | 4,133
Weighted-average remaining lease term - finance leases |  | 3.42 yrs |  |  | 4.42 yrs
Weighted average remaining lease term - operating leases |  | 23.66 yrs |  |  | 23.45 yrs
Weighted-average discount rate - finance leases |  | 3.07% |  |  | 3.07%
Weighted-average discount rate - operating leases |  | 3.78% |  |  | 3.94%
﻿ |  |  |  |  |

﻿

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During the first quarter of 2020, $125 thousand of the total lease cost is included in premises and equipment expense and $9 thousand is included in other expenses on the consolidated statements of income. Operating lease expense is recognized on a straight-line basis over the lease term. We recognized both the interest expense and amortization expense for finance leases in premises and equipment expense since the interest expense portion was immaterial.

The future minimum lease payments for the Company’s branch network and equipment under operating leases that have lease terms in excess of one year as of March 31, 2020 are as follows:

﻿

﻿ |  |
(dollars in thousands) | Amount
﻿ |  |
2020 | $ | 289
2021 |  | 390
2022 |  | 396
2023 |  | 399
2024 |  | 401
2025 and thereafter |  | 7,936
Total future minimum lease payments |  | 9,811
Plus variable payment adjustment |  | 285
Less amount representing interest |  | (3,579)
Present value of net future minimum lease payments | $ | 6,517
﻿ |  |

﻿

The Company leases seven properties, where the Company is lessor, under operating leases to unrelated parties. Four are residential properties surrounding the Main Branch that the Company leases on a month-to-month basis and are considered short-term leases. The undiscounted cash flows to be received on an annual basis for the remaining three properties under long-term operating leases are as follows:

﻿

﻿ |  |
(dollars in thousands) | Amount
﻿ |  |
2020 | $ | 144
2021 |  | 189
2022 |  | 60
2023 |  | 48
2024 |  | 51
2025 and thereafter |  | 135
Total lease payments to be received | $ | 627
﻿ |  |

﻿

The Company also indirectly originates automobile leases classified as direct finance leases. See Footnote 5, “Loans and leases”, for more information about the Company’s direct finance leases.

Lease income recognized from direct finance leases was included in interest income from loans and leases on the consolidated statements of income. Lease income related to operating leases is included in fees and other revenue on the consolidated statements of income. The Company only receives a variable payment for taxes from one of its lessees, but the amount is immaterial and excluded from rental income. The amount of lease income recognized on the consolidated statements of income was as follows for the periods indicated:

﻿

﻿ |  |  |  |  |
﻿ | For the three months ended March 31,
(dollars in thousands) | 2020 |  | 2019
Lease income - direct finance leases |  |  |  |  |
Interest income on lease receivables | $ | 176 |  | $ | 175
﻿ |  |  |  |  |
Lease income - operating leases |  | 57 |  |  | 56
Total lease income | $ | 233 |  | $ | 231
﻿ |  |  |  |  |

﻿

﻿

﻿

﻿

﻿

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Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is management's discussion and analysis of the significant changes in the consolidated financial condition of the Company as of March 31, 2020 compared to December 31, 2019 and a comparison of the results of operations for the three months ended March 31, 2020 and 2019. Current performance may not be indicative of future results. This discussion should be read in conjunction with the Company’s 2019 Annual Report filed on Form 10-K.

Forward-looking statements

Certain of the matters discussed in this Quarterly Report on Form 10-Q may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. The words “expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate,” and similar expressions are intended to identify such forward-looking statements.

The Company’s actual results may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation:

| § |  | the effects of economic conditions particularly with regard to the negative impact of severe and wide-ranging disruptions caused by the spread of Coronavirus Disease 2019 (COVID-19) on current customers, specifically the effect of the economy on loan customers’ ability to repay loans;

| § |  | the costs and effects of litigation and of unexpected or adverse outcomes in such litigation;

| § |  | the impact of new or changes in existing laws and regulations, including the Tax Cuts and Jobs Act and Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the regulations promulgated there under;

| § |  | impacts of the capital and liquidity requirements of the Basel III standards and other regulatory pronouncements, regulations and rules;

| § |  | governmental monetary and fiscal policies, as well as legislative and regulatory changes;

| § |  | effects of short- and long-term federal budget and tax negotiations and their effect on economic and business conditions;

| § |  | the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Financial Accounting Standards Board and other accounting standard setters;

| § |  | the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities and interest rate protection agreements, as well as interest rate risks;

| § |  | the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in our market area and elsewhere, including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the internet;

| § |  | technological changes;

| § |  | the interruption or breach in security of our information systems and other technological risks and attacks resulting in failures or disruptions in customer account management, general ledger processing and loan or deposit updates and potential impacts resulting therefrom including additional costs, reputational damage, regulatory penalties, and financial losses;

| § |  | acquisitions and integration of acquired businesses;

| § |  | the failure of assumptions underlying the establishment of reserves for loan losses and estimations of values of collateral and various financial assets and liabilities;

| § |  | volatilities in the securities markets;

| § |  | acts of war or terrorism;

| § |  | disruption of credit and equity markets; and

| § |  | the risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

The Company cautions readers not to place undue reliance on forward-looking statements, which reflect analyses only as of the date of this document. The Company has no obligation to update any forward-looking statements to reflect events or circumstances after the date of this document.

Readers should review the risk factors described in other documents that we file or furnish, from time to time, with the Securities and Exchange Commission, including Annual Reports to Shareholders, Annual Reports filed on Form 10-K and other current reports filed or furnished on Form 8-K.

Executive Summary

The Company is a Pennsylvania corporation and a bank holding company, whose wholly-owned state chartered commercial bank is The Fidelity Deposit and Discount Bank. The Company is headquartered in Dunmore, Pennsylvania. We consider Lackawanna and Luzerne Counties our primary marketplace and which on May 1, 2020 expanded into Northampton County.

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As a leading Northeastern Pennsylvania community bank, our goals are to enhance shareholder value while continuing to build a full-service community bank. We focus on growing our core business of retail and business lending and deposit gathering while maintaining strong asset quality and controlling operating expenses. We continue to implement strategies to diversify earning assets (see “Funds Deployed” section of this management’s discussion and analysis) and to increase low cost core deposits (see “Funds Provided” section of this management’s discussion and analysis). These strategies include a greater level of commercial lending and the ancillary business products and services supporting our commercial customers’ needs as well as residential lending strategies and an array of consumer products. We focus on developing a full banking relationship with existing, as well as new business prospects. In addition, we explore opportunities to selectively expand our franchise footprint, consisting presently of our 21-branch network. The Company remains committed to selectively expanding branch banking and wealth management locations in Northeastern and Eastern Pennsylvania as opportunities arrive going forward.

On March 11, 2020, the World Health Organization declared a coronavirus, identified as COVID-19, a global pandemic. The Company began proactive initiatives in March 2020 to assist clients, Fidelity Bankers and communities impacted by the effects of the novel coronavirus. Management activated its established pandemic contingency plan response in March 2020 to ensure business continuity while assuring the health, safety and well-being of clients, Bankers and the community. Special measures include:

| · |  | Closing all branch lobbies for in-branch teller transactions while drive-thru locations remained open;

| · |  | Providing Fidelity Bankers personal protective equipment and disinfectant supplies when working on-site;

| · |  | Expanding use of online, mobile, telephone banking, night drop and ATMs to meet clients’ banking needs;

| · |  | Adding resources to the Customer Call Center to manage increased call and chat volume;

| · |  | Scheduling in-person meetings by appointment only, observing the guidelines of social distancing and personal safety as recommended by health and safety officials;

| · |  | Enhancing EPA approved cleaning and disinfecting protocols implemented at all locations;

| · |  | Activating telecommunications capabilities to enable Fidelity Bankers to work-from-home, as appropriate, with approximately 40% of Fidelity Bankers currently working remotely;

| · |  | Conducting all meetings virtually, including the Special Shareholder Meeting.

We are impacted by both national and regional economic factors, with commercial, commercial real estate and residential mortgage loans concentrated in Northeastern Pennsylvania, primarily in Lackawanna and Luzerne counties. The U.S. economy may fall into a recession and our local market area remains challenging due to the impact of the pandemic. The Federal Open Market Committee (FOMC) had been adjusting the short-term federal funds rate up for over three years ending in the first half of 2019. The FOMC lowered the federal funds rate 75 basis points during the second half of 2019 followed by 150 basis point drop in the first quarter of 2020. According to the U.S. Bureau of Labor Statistics, the national unemployment rate for March 2020 was 4.4%, up 0.9 percentage points from December 2019. The unemployment rate in Scranton - Wilkes-Barre Metropolitan Statistical Area (local) increased during the first three months of 2020 and continued to lag behind the unemployment rates of the state and nation. The local unemployment rate at March 31, 2020 was 7.4%, an increase of 1.8 percentage points from 5.6% at December 31, 2019 and up from 5.4% at March 31, 2019. The local unemployment rate is bound to climb even higher as the full effects of COVID-19 did not ripple through the economy until after the first quarter ended. The surge in unemployment in April 2020 will continue to effect businesses and consumer spending in our market area and high unemployment is expected to continue for a few months. According to Zillow, an online database advertising firm providing access to its real estate search engines to various media outlets, the median home values in the region have risen 4.5% over the past year and are expected to fall -1.7% within the next year. In light of these expectations, we will continue to monitor the economic climate in our region and scrutinize growth prospects with credit quality as a principal consideration.

In addition in December 2019, the Company announced an agreement to acquire MNB Corporation (“MNB”). The Company completed this merger with MNB effective May 1, 2020. The merger expands the Company’s full-service footprint into Northampton County, PA and the Lehigh Valley. While $0.3 million in costs were incurred during the first quarter, non-recurring costs to facilitate the merger and integrate systems during the remainder of 2020 are currently estimated to be $1.8 million.

Our efforts and focus continue on building relationships concentrating on loans, deposits, wealth management, business services and retail opportunities with clients and prospects with the goal to exceed expectations by providing a valued service.

In addition to the challenging economic environment in which we compete, the regulation and oversight of our business has changed significantly in recent years. As described more fully in Part II, Item 1A, “Risk Factors” below, as well as Part I, Item 1A, “Risk Factors,” and in the “Supervisory and Regulation” section of management’s discussion and analysis of financial condition and results of operations in our 2019 Annual Report filed on Form 10-K, certain aspects of the Dodd-Frank Wall Street Reform Act (Dodd-Frank Act) continue to have a significant impact on us. In addition, final rules to implement Basel III regulatory capital reform, approved by the federal bank regulatory agencies in 2013, subject many banks including the Company, to capital requirements which became effective for the Company on January 1, 2015 and were fully phased in on January 1, 2019. The rules also revise the minimum risk-based and leverage capital ratio requirements applicable to the Company and revise the calculation of risk-weighted assets to enhance their risk sensitivity. We will continue to prepare for the impacts of the continuing implementation of the Dodd-Frank Act and the Basel III capital standards, and related rulemaking will have on our business, financial condition and results of operations.

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Non-GAAP Financial Measures

The following are non-GAAP financial measures which provide useful insight to the reader of the consolidated financial statements but should be supplemental to GAAP used to prepare the Company’s financial statements and should not be read in isolation or relied upon as a substitute for GAAP measures. In addition, the Company’s non-GAAP measures may not be comparable to non-GAAP measures of other companies. The Company’s tax rate used to calculate the fully-taxable equivalent (FTE) adjustment was 21% at March 31, 2020 and 2019.

The following table reconciles the non-GAAP financial measures of FTE net interest income:

﻿

﻿

﻿ |  |  |  |  |
﻿ |
(dollars in thousands) | March 31, 2020 |  | March 31, 2019
﻿ |  |  |  |  |
Interest income (GAAP) | $ | 9,711 |  | $ | 9,655
Adjustment to FTE |  | 191 |  |  | 187
Interest income adjusted to FTE (Non-GAAP) |  | 9,902 |  |  | 9,842
Interest expense |  | 1,705 |  |  | 1,745
Net interest income adjusted to FTE (Non-GAAP) | $ | 8,197 |  | $ | 8,097
﻿ |  |  |  |  |

﻿

The efficiency ratio is non-interest expenses as a percentage of FTE net interest income plus non-interest income. The following table reconciles the non-GAAP financial measures of the efficiency ratio to GAAP:

﻿

﻿

﻿ |  |  |  |  |
﻿ |  |  |  |  |
﻿ |
(dollars in thousands) | March 31, 2020 |  | March 31, 2019
﻿ |  |  |  |  |
Efficiency Ratio (non-GAAP) |  |  |  |  |
Non-interest expenses (GAAP) | $ | 7,304 |  | $ | 6,770
﻿ |  |  |  |  |
Net interest income (GAAP) |  | 8,006 |  |  | 7,910
Plus: taxable equivalent adjustment |  | 191 |  |  | 187
Non-interest income (GAAP) |  | 2,755 |  |  | 2,457
Net interest income (FTE) plus non-interest income (non-GAAP) | $ | 10,952 |  | $ | 10,554
Efficiency ratio (non-GAAP) |  | 66.69% |  |  | 64.15%
﻿ |  |  |  |  |

The following table provides a reconciliation of the Company’s earnings results under GAAP to comparative non-GAAP results excluding merger-related expenses:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | March 31, 2020 |  | March 31, 2019
(dollars in thousands except per share data) | Income before income taxes |  | Provision for income taxes |  | Net income |  | Diluted earnings per share |  | Income before income taxes |  | Provision for income taxes |  | Net income |  | Diluted earnings per share
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Results of operations (GAAP) | $ | 3,157 |  | $ | 523 |  | $ | 2,634 |  | $ | 0.69 |  | $ | 3,342 |  | $ | 540 |  | $ | 2,802 |  | $ | 0.73
Add: Merger-related expenses |  | 273 |  |  | 10 |  |  | 263 |  |  |  |  |  | 19 |  |  | 4 |  |  | 15 |  |  |
Adjusted earnings (non-GAAP) | $ | 3,430 |  | $ | 533 |  | $ | 2,897 |  | $ | 0.76 |  | $ | 3,361 |  | $ | 544 |  | $ | 2,817 |  | $ | 0.74
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

General

The Company’s earnings depend primarily on net interest income. Net interest income is the difference between interest income and interest expense. Interest income is generated from yields earned on interest-earning assets, which consist principally of loans and investment securities. Interest expense is incurred from rates paid on interest-bearing liabilities, which consist of deposits and borrowings. Net interest income is determined by the Company’s interest rate spread (the difference between the yields earned on its interest-earning assets and the rates paid on its interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. Interest rate spread is significantly impacted by: changes in interest rates and market yield curves and their related impact on cash flows; the composition and characteristics of interest-earning assets and interest-bearing liabilities; differences in the maturity and re-pricing characteristics of assets compared to the maturity and re-pricing characteristics of the liabilities that fund them and by the competition in the marketplace.

The Company’s earnings are also affected by the level of its non-interest income and expenses and by the provisions for loan losses and income taxes. Non-interest income mainly consists of: service charges on the Company’s loan and deposit products; interchange fees; trust and asset management service fees; increases in the cash surrender value of the bank owned life insurance

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and from net gains or losses from sales of loans and securities. Non-interest expense consists of: compensation and related employee benefit costs; occupancy; equipment; data processing; advertising and marketing; FDIC insurance premiums; professional fees; loan collection; net other real estate owned (ORE) expenses; supplies and other operating overhead.

Comparison of the results of operations

Three months ended March 31, 2020 and 2019

Overview

For the first quarter of 2020, the Company generated net income of $2.6 million, or $0.69 per diluted share, compared to $2.8 million, or $0.73 per diluted share, for the first quarter of 2019. The $0.2 million, or 6%, decrease in net income stemmed from a $0.5 million rise in non-interest expenses partially offset by $0.3 million higher non-interest income and a $0.1 million increase in net interest income.

Return on average assets (ROA) was 1.04% and 1.18% for the first quarters of 2020 and 2019, respectively. During the same time periods, return on average shareholders’ equity (ROE) was 9.74% and 11.98%, respectively. ROA and ROE both decreased due to the declines in net income while average assets and shareholders’ equity grew during the first quarter of 2020.

Net interest income and interest sensitive assets / liabilities

For the first quarter of 2020, net interest income increased $0.1 million, or 1%, to $8.0 million from $7.9 million for the first quarter of 2019. The $0.1 million growth in interest income was produced by the addition of $41.8 million in average interest-earning assets partially offset by the effect of a 21 basis point decline in FTE yield earned on those assets. The loan portfolio contributed $0.2 million to this interest income growth due to $36.0 million more average loans, primarily in the consumer and residential portfolios. In the investment portfolio, interest income decreased $0.1 million mostly due to a 36 basis point decline in yields on mortgage-backed securities. On the liability side, total interest-bearing liabilities grew $38.3 million, on average, with a nine basis point decrease in rates paid thereon. Growth of $71.3 million in average interest-bearing deposits with a one basis point increase in rates paid on these deposits resulted in $0.2 million more interest expense from deposits for the first quarter of 2020 compared to the 2019 like period. This increase in interest expense was offset by $0.2 million less in interest expense on borrowings due to lower average balances and rates paid on overnight borrowings.

The FTE net interest rate spread and margin decreased by 12 and 15 basis points for the three months ended March 31, 2020 compared to the same 2019 period. The yields earned on interest-earning assets declined faster than the rates paid on interest-bearing liabilities causing the decline in net interest rate spread. The overall cost of funds, which includes the impact of non-interest bearing deposits, decreased five basis points for the three months ended March 31, 2020 compared to the same 2019 period. The primary reason for the decline was the reduction in rates paid on a smaller average balance of overnight borrowings compared to the prior year’s first quarter.

For the remainder of 2020, the Company expects to operate in a declining interest rate environment. A rate environment with falling interest rates positions the Company to reduce its interest income performance from new and maturing earning assets. Until there is a sustained period of yield curve steepening, with rates rising more sharply at the long end, the interest rate margin may experience compression. The FOMC began easing the federal funds rate during the second half of 2019 and continued through the first quarter of 2020 which reduced rates paid on interest-bearing liabilities. On the asset side, the prime interest rate, the benchmark rate that banks use as a base rate for adjustable rate loans was cut 75 basis points in the second half of 2019 and another 150 basis points in the first quarter of 2020. The focus for 2020 is to manage net interest income through a declining rate environment by managing interest-bearing deposit costs to maintain a reasonable spread. For the remainder of 2020, interest income growth is anticipated from new loans acquired from the MNB merger and over $4 million of fees recognized, net of origination and agent fees, from Paycheck Protection Program (PPP) loans which will mitigate less interest income from lower yielding assets. Management expects to actively reduce the cost of funds to partially mitigate spread compression throughout this declining rate cycle.

The Company’s cost of interest-bearing liabilities was 0.98% for the three months ended March 31, 2020, or nine basis points lower than the cost for the same 2019 period. The decrease resulted from an 83 basis point decline in the rate paid on overnight borrowings. The FOMC is not expected to cut the federal funds rate further, but the Company has the opportunity to reduce rates paid on deposits as higher-priced promotional rates and negotiated rates reprice into products with lower rates. To help mitigate the impact of the imminent change to the economic landscape, the Company has successfully developed and will continue to strengthen its association with existing customers, develop new business relationships, generate new loan volumes, and retain and generate higher levels of average non-interest bearing deposit balances. Strategically deploying no- and low-cost deposits into interest earning-assets is an effective margin-preserving strategy that the Company expects to continue to pursue and expand to help stabilize net interest margin.

The Company’s Asset Liability Management (ALM) team meets regularly to discuss among other things, interest rate risk and when deemed necessary adjusts interest rates. ALM is actively addressing the Company's sensitivity to a declining rate environment to ensure interest rate risks are contained within acceptable levels. ALM also discusses revenue enhancing strategies to help combat the potential for a decline in net interest income. The Company’s marketing department, together with ALM, lenders and deposit gatherers, continue to develop prudent strategies that will grow the loan portfolio and accumulate low-cost deposits to improve net interest income performance.

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The table that follows sets forth a comparison of average balances of assets and liabilities and their related net tax equivalent yields and rates for the periods indicated. Within the table, interest income was FTE adjusted, using the corporate federal tax rate of 21% for March 31, 2020 and 2019 to recognize the income from tax-exempt interest-earning assets as if the interest was taxable. See “Non-GAAP Financial Measures” within this management’s discussion and analysis for the FTE adjustments. This treatment allows a uniform comparison among yields on interest-earning assets. Loans include loans held-for-sale (HFS) and non-accrual loans but exclude the allowance for loan losses. Home equity lines of credit (HELOC) are included in the residential real estate category since they are secured by real estate. Net deferred loan cost amortization of $172 thousand and $165 thousand during the first quarters of 2020 and 2019, respectively, are included in interest income from loans. Average balances are based on amortized cost and do not reflect net unrealized gains or losses. Residual values for direct finance leases are included in the average balances for consumer loans. Net interest margin is calculated by dividing net interest income-FTE by total average interest-earning assets. Cost of funds includes the effect of average non-interest bearing deposits as a funding source:

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | Three months ended
(dollars in thousands) | March 31, 2020 |  | March 31, 2019
﻿ | Average |  |  |  | Yield / |  | Average |  |  |  | Yield /
Assets | balance |  | Interest |  | rate |  | balance |  | Interest |  | rate
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-earning assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-bearing deposits | $ | 6,853 |  | $ | 12 |  | 0.72 | % |  | $ | 2,755 |  | $ | 15 |  | 2.31 | %
Restricted regulatory securities |  | 3,434 |  |  | 65 |  | 7.61 |  |  |  | 4,653 |  |  | 100 |  | 8.69 |
Investments: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Agency - GSE |  | 5,943 |  |  | 40 |  | 2.70 |  |  |  | 5,927 |  |  | 39 |  | 2.70 |
MBS - GSE residential |  | 125,504 |  |  | 806 |  | 2.58 |  |  |  | 126,843 |  |  | 921 |  | 2.94 |
State and municipal (nontaxable) |  | 51,313 |  |  | 535 |  | 4.19 |  |  |  | 47,651 |  |  | 538 |  | 4.58 |
State and municipal (taxable) |  | 641 |  |  | 5 |  | 2.97 |  |  |  | - |  |  | - |  | - |
Total investments |  | 183,401 |  |  | 1,386 |  | 3.04 |  |  |  | 180,421 |  |  | 1,498 |  | 3.37 |
Loans and leases: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
C&I and CRE (taxable) |  | 320,019 |  |  | 3,985 |  | 5.01 |  |  |  | 314,939 |  |  | 4,012 |  | 5.17 |
C&I and CRE (nontaxable) |  | 36,675 |  |  | 376 |  | 4.13 |  |  |  | 34,008 |  |  | 339 |  | 4.03 |
Consumer |  | 163,376 |  |  | 1,611 |  | 3.97 |  |  |  | 157,631 |  |  | 1,500 |  | 3.86 |
Residential real estate |  | 236,138 |  |  | 2,467 |  | 4.20 |  |  |  | 213,652 |  |  | 2,378 |  | 4.51 |
Total loans and leases |  | 756,208 |  |  | 8,439 |  | 4.49 |  |  |  | 720,230 |  |  | 8,229 |  | 4.63 |
Total interest-earning assets |  | 949,896 |  |  | 9,902 |  | 4.19 | % |  |  | 908,059 |  |  | 9,842 |  | 4.40 | %
Non-interest earning assets |  | 69,656 |  |  |  |  |  |  |  |  | 57,736 |  |  |  |  |  |
Total assets | $ | 1,019,552 |  |  |  |  |  |  |  | $ | 965,795 |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Liabilities and shareholders' equity |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-bearing liabilities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-bearing checking | $ | 248,364 |  | $ | 372 |  | 0.60 | % |  | $ | 224,476 |  | $ | 340 |  | 0.61 | %
Savings and clubs |  | 104,309 |  |  | 26 |  | 0.10 |  |  |  | 118,336 |  |  | 36 |  | 0.12 |
MMDA |  | 199,078 |  |  | 595 |  | 1.20 |  |  |  | 137,523 |  |  | 486 |  | 1.43 |
Certificates of deposit |  | 118,116 |  |  | 523 |  | 1.78 |  |  |  | 118,247 |  |  | 469 |  | 1.61 |
Total interest-bearing deposits |  | 669,867 |  |  | 1,516 |  | 0.91 |  |  |  | 598,582 |  |  | 1,331 |  | 0.90 |
Overnight borrowings |  | 16,174 |  |  | 75 |  | 1.87 |  |  |  | 40,587 |  |  | 271 |  | 2.70 |
FHLB advances |  | 15,000 |  |  | 114 |  | 3.06 |  |  |  | 23,593 |  |  | 143 |  | 2.46 |
Total interest-bearing liabilities |  | 701,041 |  |  | 1,705 |  | 0.98 | % |  |  | 662,762 |  |  | 1,745 |  | 1.07 | %
Non-interest bearing deposits |  | 194,847 |  |  |  |  |  |  |  |  | 195,349 |  |  |  |  |  |
Non-interest bearing liabilities |  | 14,891 |  |  |  |  |  |  |  |  | 12,783 |  |  |  |  |  |
Total liabilities |  | 910,779 |  |  |  |  |  |  |  |  | 870,894 |  |  |  |  |  |
Shareholders' equity |  | 108,773 |  |  |  |  |  |  |  |  | 94,901 |  |  |  |  |  |
Total liabilities and shareholders' equity | $ | 1,019,552 |  |  |  |  |  |  |  | $ | 965,795 |  |  |  |  |  |
Net interest income - FTE |  |  |  | $ | 8,197 |  |  |  |  |  |  |  | $ | 8,097 |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net interest spread |  |  |  |  |  |  | 3.21 | % |  |  |  |  |  |  |  | 3.33 | %
Net interest margin |  |  |  |  |  |  | 3.47 | % |  |  |  |  |  |  |  | 3.62 | %
Cost of funds |  |  |  |  |  |  | 0.77 | % |  |  |  |  |  |  |  | 0.82 | %
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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﻿

Changes in net interest income are a function of both changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities. The following table presents the extent to which changes in interest rates and changes in volumes of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to (1) the changes attributable to changes in volume (changes in volume multiplied by the prior period rate), (2) the changes attributable to changes in interest rates (changes in rates multiplied by prior period volume) and (3) the net change. The combined effect of changes in both volume and rate has been allocated proportionately to the change due to volume and the change due to rate. Tax-exempt income was not converted to a tax-equivalent basis on the rate/volume analysis:

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | Three months ended March 31,
(dollars in thousands) | 2020 compared to 2019 |  | 2019 compared to 2018
﻿ | Increase (decrease) due to
﻿ | Volume |  | Rate |  | Total |  | Volume |  | Rate |  | Total
Interest income: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-bearing deposits | $ | 13 |  | $ | (16) |  | $ | (3) |  | $ | (42) |  | $ | 15 |  | $ | (27)
Restricted regulatory securities |  | (24) |  |  | (11) |  |  | (35) |  |  | 44 |  |  | 16 |  |  | 60
Investments: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Agency - GSE |  | 1 |  |  | - |  |  | 1 |  |  | (8) |  |  | 13 |  |  | 5
MBS - GSE residential |  | (10) |  |  | (105) |  |  | (115) |  |  | 96 |  |  | 84 |  |  | 180
State and municipal |  | 39 |  |  | (33) |  |  | 6 |  |  | 44 |  |  | 8 |  |  | 52
Other |  | - |  |  | - |  |  | - |  |  | (5) |  |  | - |  |  | (5)
Total investments |  | 30 |  |  | (138) |  |  | (108) |  |  | 127 |  |  | 105 |  |  | 232
Loans and leases: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential real estate |  | 254 |  |  | (166) |  |  | 88 |  |  | 115 |  |  | 124 |  |  | 239
C&I and CRE |  | 110 |  |  | (106) |  |  | 4 |  |  | 331 |  |  | 325 |  |  | 656
Consumer |  | 63 |  |  | 47 |  |  | 110 |  |  | 290 |  |  | 62 |  |  | 352
Total loans and leases |  | 427 |  |  | (225) |  |  | 202 |  |  | 736 |  |  | 511 |  |  | 1,247
Total interest income |  | 446 |  |  | (390) |  |  | 56 |  |  | 865 |  |  | 647 |  |  | 1,512
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest expense: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-bearing checking |  | 38 |  |  | (6) |  |  | 32 |  |  | 14 |  |  | 79 |  |  | 93
Savings and clubs |  | (4) |  |  | (6) |  |  | (10) |  |  | (7) |  |  | (16) |  |  | (23)
Money market |  | 196 |  |  | (87) |  |  | 109 |  |  | 61 |  |  | 222 |  |  | 283
Certificates of deposit |  | - |  |  | 54 |  |  | 54 |  |  | 32 |  |  | 142 |  |  | 174
Total deposits |  | 230 |  |  | (45) |  |  | 185 |  |  | 100 |  |  | 427 |  |  | 527
Repurchase agreements |  | - |  |  | - |  |  | - |  |  | (7) |  |  | - |  |  | (7)
Overnight borrowings |  | (129) |  |  | (67) |  |  | (196) |  |  | 261 |  |  | 3 |  |  | 264
FHLB advances |  | (59) |  |  | 30 |  |  | (29) |  |  | 18 |  |  | 59 |  |  | 77
Total interest expense |  | 42 |  |  | (82) |  |  | (40) |  |  | 372 |  |  | 489 |  |  | 861
Net interest income | $ | 404 |  | $ | (308) |  | $ | 96 |  | $ | 493 |  | $ | 158 |  | $ | 651

﻿

Provision for loan losses

The provision for loan losses represents the necessary amount to charge against current earnings, the purpose of which is to increase the allowance for loan losses (the allowance) to a level that represents management’s best estimate of known and inherent losses in the Company’s loan portfolio. Loans determined to be uncollectible are charged off against the allowance. The required amount of the provision for loan losses, based upon the adequate level of the allowance, is subject to the ongoing analysis of the loan portfolio. The Company’s Special Assets Committee meets periodically to review problem loans. The committee is comprised of management, including credit administration officers, loan officers, loan workout officers and collection personnel. The committee reports quarterly to the Credit Administration Committee of the board of directors.

Management continuously reviews the risks inherent in the loan portfolio. Specific factors used to evaluate the adequacy of the loan loss provision during the formal process include:

•specific loans that could have loss potential;

•levels of and trends in delinquencies and non-accrual loans;

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•levels of and trends in charge-offs and recoveries;

•trends in volume and terms of loans;

•changes in risk selection and underwriting standards;

•changes in lending policies and legal and regulatory requirements;

•experience, ability and depth of lending management;

•national and local economic trends and conditions; and

•changes in credit concentrations.

For the three months ended March 31, 2020 and 2019, the Company recorded a provision for loan losses of $300 thousand and $255 thousand, respectively, a $45 thousand, or 18%, increase. This increase in the provision for loan losses from the year earlier period was primarily attributed to higher anticipated credit losses as a n initial result of the COVID-19 crisis coupled with growth in the loan portfolio from the year earlier period while the loan portfolio declined during the current quarter. Although uncertainty over COVID’s duration and severity complicates management’s ability to render a more precise estimate of credit losses, management believes th e level of provisioning during the first quarter was adequate based on the information that was available as of the reporting date and subsequent period up to the filing date. Further, a $193 thousand recovery in the form of a reimbursement from FNMA for previously charged-off sold mortgages offset the need for additional provisioning.

The provision for loan losses derives from the reserve required from the allowance for loan losses calculation. The Company continued provisioning for the three months ended March 31, 2020 in order to maintain an allowance level that management deemed adequate.

For a discussion on the allowance for loan losses, see “Allowance for loan losses,” located in the comparison of financial condition section of management’s discussion and analysis contained herein.

Other income

For the first quarter of 2020, non-interest income amounted to $2.8 million, an increase of $0.3 million, or 12%, compared to $2.5 million recorded for the same 2019 period. Service charges on loans, which increased the most, was $0.2 million higher than the first quarter of 2019 driven primarily by mortgage loan service charges. Fees from trust fiduciary services increased $0.1 million primarily due to higher personal trust income. Interchange fees were almost $0.1 million more than the first quarter of 2019. Partially offsetting these increases, financial service fees also declined $0.1 million quarter-over-quarter. During April 2020, deposit service charges started trending down primarily from less overdraft activities, interchange fees started to decline from less activity and mortgage servicing rights amortization increased from heightened refinance activity.

Operating expenses

For the quarter ended March 31, 2020, total non-interest operating expenses were $7.3 million, an increase of $0.5 million, or 8%, compared to $6.8 million for the same 2019 quarter. The biggest contributor to the higher expenses was merger-related expenses totaling $0.3 million, consisting mostly of professional fees. Salary and employee benefits rose $0.2 million, or 6%, to $3.9 million for the first quarter of 2020 from $3.7 million for the first quarter of 2019. The increase was primarily due to higher salaries from additional employees plus merit increases. These increases were partially offset by a $0.1 million FDIC assessment reduction due to a credit received and $0.1 million in additional loan cost reimbursement offsetting expenses. The Company expects approximately $0.2 million of costs related to COVID-19 during 2020 for supplies, cleaning, disinfecting, etc.

The ratios of non-interest expense less non-interest income to average assets, known as the expense ratio, were 1.79% and 1.81% for the three months ended March 31, 2020 and 2019. The expense ratio decreased because of higher average assets during the three months ended March 31, 2020 compared to the same 2019 period. The efficiency ratio increased from 64.15% at March 31, 2019 to 66.69% at March 31, 2020 due to the increase in non-interest expenses. For more information on the calculation of the efficiency ratio, see “Non-GAAP Financial Measures” located within this management’s discussion and analysis.

Merger related expenses of $1.8 million are anticipated for the remainder of 2020 for legal, investment banking, audit, data processing, regulatory filings, shareholder conversion and severance costs.

Provision for income taxes

The provision for income remained unchanged for the three months ended March 31, 2020 and 2019. The Company's effective tax rate was 16.6% at March 31, 2020 compared to 16.2% at March 31, 2019. Due to challenges relating to current market conditions, the Company may not have the ability to make a reliable estimate of all or part of its ordinary income. The Coronavirus Aid, Relief, and Economic Security (CARES) Act may have an effect on the Company’s effective tax rate in future periods.

Comparison of financial condition at

March 31, 2020 and December 31, 2019

Overview

Consolidated assets increased $52.6 million, or 5%, to $1,062.5 million as of March 31, 2020 from $1,009.9 million at December 31, 2019. The increase in assets occurred in cash and cash equivalents and the investment portfolio. Cash inflow from growth in deposits of $83.9 million was used to pay down borrowings which declined $37.8 million and fund asset growth.

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Funds Deployed:

Investment securities

At the time of purchase, management classifies investment securities into one of three categories: trading, available-for-sale (AFS) or held-to-maturity (HTM). To date, management has not purchased any securities for trading purposes. All of the securities the Company purchases are classified as AFS even though there is no immediate intent to sell them. The AFS designation affords management the flexibility to sell securities and position the balance sheet in response to capital levels, liquidity needs or changes in market conditions. Debt securities AFS are carried at fair value on the consolidated balance sheets with unrealized gains and losses, net of deferred income taxes, reported separately within shareholders’ equity as a component of accumulated other comprehensive income (AOCI). Securities designated as HTM are carried at amortized cost and represent debt securities that the Company has the ability and intent to hold until maturity.

As of March 31, 2020, the carrying value of investment securities amounted to $204.0 million, or 19% of total assets, compared to $185.1 million, or 18% of total assets, at December 31, 2019. As of March 31, 2020, 69% of the carrying value of the investment portfolio was comprised of U.S. Government Sponsored Enterprise residential mortgage-backed securities (MBS – GSE residential or mortgage-backed securities) that amortize and provide monthly cash flow that the Company can use for reinvestment, loan demand, unexpected deposit outflow, facility expansion or operations.

Investment securities were comprised of AFS securities as of March 31, 2020 and December 31, 2019. The AFS securities were recorded with a net unrealized gain of $8.7 million as of March 31, 2020 and a net unrealized gain of $4.6 million as of December 31, 2019. Of the net improvement in the unrealized gain position of $4.1 million, $3.3 million was net unrealized gains on mortgage-backed securities, $0.6 million was net unrealized gains on municipal securities and $0.2 million was net unrealized gains on agency securities. The direction and magnitude of the change in value of the Company’s investment portfolio is attributable to the direction and magnitude of the change in interest rates along the treasury yield curve. Generally, the values of debt securities move in the opposite direction of the changes in interest rates. As interest rates along the treasury yield curve decline, especially at the intermediate and long end, the values of debt securities tend to rise. Whether or not the value of the Company’s investment portfolio will continue to rise above its amortized cost will be largely dependent on the direction and magnitude of interest rate movements and the duration of the debt securities within the Company’s investment portfolio. When interest rates rise, the market values of the Company’s debt securities portfolio could be subject to market value declines.

As of March 31, 2020, the Company had $210.5 million in public deposits, or 23% of total deposits. Pennsylvania state law requires the Company to maintain pledged securities on these public deposits or otherwise obtain a FHLB letter of credit or FDIC insurance for these customers. As of March 31, 2020, the balance of pledged securities required for deposit accounts was $159.6 million, or 78% of total securities.

Quarterly, management performs a review of the investment portfolio to determine the causes of declines in the fair value of each security. The Company uses inputs provided by independent third parties to determine the fair value of its investment securities portfolio. Inputs provided by the third parties are reviewed and corroborated by management. Evaluations of the causes of the unrealized losses are performed to determine whether impairment exists and whether the impairment is temporary or other-than-temporary. Considerations such as the Company’s intent and ability to hold the securities until or sell prior to maturity, recoverability of the invested amounts over the intended holding period, the length of time and the severity in pricing decline below cost, the interest rate environment, the receipt of amounts contractually due and whether or not there is an active market for the securities, for example, are applied, along with an analysis of the financial condition of the issuer for management to make a realistic judgment of the probability that the Company will be unable to collect all amounts (principal and interest) due in determining whether a security is other-than-temporarily impaired. If a decline in value is deemed to be other-than-temporary, the amortized cost of the security is reduced by the credit impairment amount and a corresponding charge to current earnings is recognized. During the quarter ended March 31, 2020, the Company did not incur other-than-temporary impairment charges from its investment securities portfolio.

During the three months ended March 31, 2020, the carrying value of total investments increased $18.9 million, or 10%. The Company attempts to maintain a well-diversified and proportionate investment portfolio that is structured to complement the strategic direction of the Company. Its growth typically supplements the lending activities but also considers the current and forecasted economic conditions, the Company’s liquidity needs and interest rate risk profile. The Company expects to grow the portfolio and increase its relative size with a preference toward mortgage-backed securities. If intermediate to long-term rates rise, the strategy is expected to provide a good source of cash flow to reinvest into higher yielding interest-sensitive assets.

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A comparison of investment securities at March 31, 2020 and December 31, 2019 is as follows:

﻿

﻿ |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |
﻿ | March 31, 2020 | December 31, 2019
(dollars in thousands) | Amount |  | % | Amount |  | %
﻿ |  |  |  |  |  |  |  |  |  |
MBS - GSE residential | $ | 141,374 |  | 69.3 | % | $ | 124,240 |  | 67.1 | %
State & municipal subdivisions |  | 56,254 |  | 27.6 |  |  | 54,718 |  | 29.6 |
Agency - GSE |  | 6,356 |  | 3.1 |  |  | 6,159 |  | 3.3 |
Total | $ | 203,984 |  | 100.0 | % | $ | 185,117 |  | 100.0 | %

As of March 31, 2020, there were no investments from any one issuer with an aggregate book value that exceeded 10% of the Company’s shareholders’ equity.

The distribution of debt securities by stated maturity and tax-equivalent yield at March 31, 2020 are as follows:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  | More than |  | More than |  | More than |  |  |  |  |
﻿ | One year or less |  | one year to five years |  | five years to ten years |  | ten years |  | Total
(dollars in thousands) | $ | % |  | $ | % |  | $ | % |  | $ | % |  | $ | %
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
MBS - GSE residential | $ | - | - | % |  | $ | 322 | 4.31 | % |  | $ | 5,750 | 3.40 | % |  | $ | 135,302 | 3.22 | % |  | $ | 141,374 | 3.23 | %
State & municipal subdivisions |  | 3,594 | 14.29 |  |  |  | 980 | 6.02 |  |  |  | 1,675 | 3.10 |  |  |  | 50,005 | 4.35 |  |  |  | 56,254 | 5.01 |
Agency - GSE |  | - | - |  |  |  | 6,356 | 2.70 |  |  |  | - | - |  |  |  | - | - |  |  |  | 6,356 | 2.70 |
Total debt securities | $ | 3,594 | 14.29 | % |  | $ | 7,658 | 3.19 | % |  | $ | 7,425 | 3.33 | % |  | $ | 185,307 | 3.52 | % |  | $ | 203,984 | 3.70 | %
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

In the above table, the book yields on state & municipal subdivisions were adjusted to a tax-equivalent basis using the corporate federal tax rate of 21%. In addition, average yields on securities AFS are based on amortized cost and do not reflect unrealized gains or losses.

﻿

Federal Home Loan Bank Stock

Investment in Federal Home Loan Bank (FHLB) stock is required for membership in the organization and is carried at cost since there is no market value available. The amount the Company is required to invest is dependent upon the relative size of outstanding borrowings the Company has with the FHLB of Pittsburgh. Excess stock is repurchased from the Company at par if the amount of borrowings declined to a predetermined level. In addition, the Company earns a return or dividend based on the amount invested. The dividends received from the FHLB totaled $70 thousand and $100 thousand for the three months ended March 31, 2020 and 2019, respectively. The balance in FHLB stock was $2.7 million and $4.4 million as of March 31, 2020 and December 31, 2019, respectively.

Loans held-for-sale (HFS)

Upon origination, most residential mortgages and certain Small Business Administration (SBA) guaranteed loans may be classified as held-for-sale (HFS). In the event of market rate increases, fixed-rate loans and loans not immediately scheduled to re-price would no longer produce yields consistent with the current market. In declining interest rate environments, the Company would be exposed to prepayment risk as rates on fixed-rate loans decrease, and customers look to refinance loans. Consideration is given to the Company’s current liquidity position and projected future liquidity needs. To better manage prepayment and interest rate risk, loans that meet these conditions may be classified as HFS. Occasionally, residential mortgage and/or other nonmortgage loans may be transferred from the loan portfolio to HFS. The carrying value of loans HFS is based on the lower of cost or estimated fair value. If the fair values of these loans decline below their original cost, the difference is written down and charged to current earnings. Subsequent appreciation in the portfolio is credited to current earnings but only to the extent of previous write-downs.

As of March 31, 2020 and December 31, 2019, loans HFS consisted of residential mortgages with carrying amounts of $1.6 million and $1.6 million, respectively, which approximated their fair values. During the three months ended March 31, 2020, residential mortgage loans with principal balances of $12.9 million were sold into the secondary market and the Company recognized net gains of $0.2 million, compared to $12.6 million and $0.2 million, respectively, during the three months ended March 31, 2019.

The Company retains mortgage servicing rights (MSRs) on loans sold into the secondary market. MSRs are retained so that the Company can foster personal relationships. At March 31, 2020 and December 31, 2019, the servicing portfolio balance of sold residential mortgage loans was $299.0 million and $302.3 million, respectively, with mortgage servicing rights of $1.0 million for both periods, respectively.

Loans and leases

As of March 31, 2020, the Company had gross loans and leases totaling $746.1 million compared to $754.3 million at December 31, 2019 which represented a decrease of $8.2 million, or 1%. The decline was caused by commercial loan payoffs which was partially offset by residential loan growth.

For the remainder of 2020, management expects loan growth to continue in the residential portfolio. Other than Paycheck Protection Program (PPP) loans and the loans acquired from the merger with MNB, commercial and consumer loans are not expected to increase.

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The PPP, established by the CARES Act, provided small businesses and eligible non-profit organizations, veterans organizations, and tribal businesses described in the Small Business Act, as well as individuals who are self-employed or are independent contractors, with funds to pay up to 8 weeks of payroll costs including benefits. Funds can also be used to pay interest on mortgages, rent, and utilities. All loans are 100% guaranteed by the SBA and, under the guidelines of the program, are forgivable.

The initial funding of $349 billion lasted from April 3, 2020 – April 16, 2020. In that time, the Company provided $130 million in loans to 652 borrowers. A subsequent funding commencing on April 27, 2020 provided $2 4 million in additional PPP loans to 679 borrowers. Funding these loans will generate over $4.0 million of SBA processing fees, net of origination and agent fee costs, which are expected to be earned primarily over the second and third quarters of 2020 upon the Company receiving the payoff. The Company expects the majority of these loans will be paid off before year end.

Our service team is experienced, knowledgeable and dedicated to servicing the community and our clients. We will continue to provide products and services that benefit our clients as well as the community which is very important to our success. There is much uncertainty regarding the effects COVID-19 may have on demand for loans and leases. The Company has been proactively trying to reach out to customers to understand their needs during this crisis.

Commercial & industrial and commercial real estate

As of March 31, 2020, the commercial loan portfolio, which consisted of commercial and industrial (C&I) and commercial real estate (CRE) loans, decreased $14.7 million, or 4%, compared to December 31, 2019. This reduction resulted primarily from the payoff of two tax-free commercial loans to one customer and the payoff of a few commercial real estate loans.

Consumer

The consumer loan portfolio experienced a reduction, decreasing $2.9 million, or 1%, compared to December 31, 2019. This reduction in the consumer loan portfolio was attributed to a decline of $3.7 million in auto loans and $1.6 million in home equity products, partially offset by growth of $1.4 million in other consumer loans and $1.0 million in direct finance leases.

Residential

The residential loan portfolio grew $9.3 million, or 5%, during the first quarter of 2020. This growth was driven by an $8.3 million increase in residential real estate loans and a $1.0 million increase in residential construction loans. Homeowners’ preference for residential mortgage products supplemented the growth from mortgage modifications. The Company offered refinancing to qualified customers which predominantly caused the lift in residential real estate loans. Management expects continued growth in residential loans for the remainder of 2020.

The composition of the loan portfolio at March 31, 2020 and December 31, 2019 is summarized as follows:

﻿

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ | March 31, 2020 |  | December 31, 2019
(dollars in thousands) | Amount |  | % |  | Amount |  | %
﻿ |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial | $ | 118,140 |  | 15.8 | % |  | $ | 122,594 |  | 16.2 | %
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |
Non-owner occupied |  | 95,630 |  | 12.8 |  |  |  | 99,801 |  | 13.2 |
Owner occupied |  | 125,976 |  | 16.9 |  |  |  | 130,558 |  | 17.3 |
Construction |  | 3,196 |  | 0.4 |  |  |  | 4,654 |  | 0.6 |
Consumer: |  |  |  |  |  |  |  |  |  |  |
Home equity installment |  | 35,456 |  | 4.8 |  |  |  | 36,631 |  | 4.9 |
Home equity line of credit |  | 46,850 |  | 6.3 |  |  |  | 47,282 |  | 6.3 |
Auto |  | 102,213 |  | 13.7 |  |  |  | 105,870 |  | 14.0 |
Direct finance leases |  | 17,356 |  | 2.3 |  |  |  | 16,355 |  | 2.2 |
Other |  | 7,025 |  | 1.0 |  |  |  | 5,634 |  | 0.7 |
Residential: |  |  |  |  |  |  |  |  |  |  |
Real estate |  | 175,453 |  | 23.5 |  |  |  | 167,164 |  | 22.2 |
Construction |  | 18,767 |  | 2.5 |  |  |  | 17,770 |  | 2.4 |
Gross loans |  | 746,062 |  | 100.0 | % |  |  | 754,313 |  | 100.0 | %
Less: |  |  |  |  |  |  |  |  |  |  |
Allowance for loan losses |  | (10,017) |  |  |  |  |  | (9,747) |  |  |
Unearned lease revenue |  | (938) |  |  |  |  |  | (903) |  |  |
Net loans | $ | 735,107 |  |  |  |  | $ | 743,663 |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |
Loans held-for-sale | $ | 1,591 |  |  |  |  | $ | 1,643 |  |  |

﻿

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Allowance for loan losses

Management evaluates the credit quality of the Company’s loan portfolio and performs a formal review of the adequacy of the allowance for loan losses (the allowance) on a quarterly basis. The allowance reflects management’s best estimate of the amount of credit losses in the loan portfolio. Management’s judgment is based on the evaluation of individual loans, past experience, the assessment of current economic conditions and other relevant factors including the amounts and timing of cash flows expected to be received on impaired loans. Those estimates may be susceptible to significant change. The provision for loan losses represents the amount necessary to maintain an appropriate allowance. Loan losses are charged directly against the allowance when loans are deemed to be uncollectible. Recoveries from previously charged-off loans are added to the allowance when received.

Management applies two primary components during the loan review process to determine proper allowance levels. The two components are a specific loan loss allocation for loans that are deemed impaired and a general loan loss allocation for those loans not specifically allocated. The methodology to analyze the adequacy of the allowance for loan losses is as follows:

| · |  | identification of specific impaired loans by loan category;

| · |  | calculation of specific allowances where required for the impaired loans based on collateral and other objective and quantifiable evidence;

| · |  | determination of loans with similar credit characteristics within each class of the loan portfolio segment and eliminating the impaired loans;

| · |  | application of historical loss percentages (trailing twelve-quarter average) to pools to determine the allowance allocation;

| · |  | application of qualitative factor adjustment percentages to historical losses for trends or changes in the loan portfolio, regulations, and/or current economic conditions.

A key element of the methodology to determine the allowance is the Company’s credit risk evaluation process, which includes credit risk grading of individual commercial loans. Commercial loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed. The credit risk grades may be changed at any time management determines an upgrade or downgrade may be warranted. The credit risk grades for the commercial loan portfolio are taken into account in the reserve methodology and loss factors are applied based upon the credit risk grades. The loss factors applied are based upon the Company’s historical experience as well as what management believes to be best practices and within common industry standards. Historical experience reveals there is a direct correlation between the credit risk grades and loan charge-offs. The changes in allocations in the commercial loan portfolio from period-to-period are based upon the credit risk grading system and from periodic reviews of the loan portfolio.

Each quarter, management performs an assessment of the allowance for loan losses. The Company’s Special Assets Committee meets quarterly and the applicable lenders discuss each relationship under review and reach a consensus on the appropriate estimated loss amount, if applicable, based on current accounting guidance. The Special Assets Committee’s focus is on ensuring the pertinent facts are considered regarding not only loans considered for specific reserves, but also the collectability of loans that may be past due. The assessment process also includes the review of all loans on non-accrual status as well as a review of certain loans to which the lenders or the Credit Administration function have assigned a criticized or classified risk rating.

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The following tables set forth the activity in the allowance for loan losses and certain key ratios for the period indicated:

﻿

﻿ |  |  |  |  |  |  |  |  |
﻿ | As of and for the | As of and for the | As of and for the
﻿ | three months ended | twelve months ended | three months ended
(dollars in thousands) | March 31, 2020 | December 31, 2019 | March 31, 2019
﻿ |  |  |  |  |  |  |  |  |
Balance at beginning of period | $ | 9,747 |  | $ | 9,747 |  | $ | 9,747 |
﻿ |  |  |  |  |  |  |  |  |
Charge-offs: |  |  |  |  |  |  |  |  |
Commercial and industrial |  | (64) |  |  | (184) |  |  | (28) |
Commercial real estate |  | (163) |  |  | (597) |  |  | (361) |
Consumer |  | (43) |  |  | (398) |  |  | (89) |
Residential |  | (31) |  |  | (330) |  |  | (35) |
Total |  | (301) |  |  | (1,509) |  |  | (513) |
﻿ |  |  |  |  |  |  |  |  |
Recoveries: |  |  |  |  |  |  |  |  |
Commercial and industrial |  | 12 |  |  | 32 |  |  | 6 |
Commercial real estate |  | 2 |  |  | 317 |  |  | 2 |
Consumer |  | 64 |  |  | 67 |  |  | 25 |
Residential |  | 193 |  |  | 8 |  |  | - |
Total |  | 271 |  |  | 424 |  |  | 33 |
Net charge-offs |  | (30) |  |  | (1,085) |  |  | (480) |
Provision for loan losses |  | 300 |  |  | 1,085 |  |  | 255 |
Balance at end of period | $ | 10,017 |  | $ | 9,747 |  | $ | 9,522 |
﻿ |  |  |  |  |  |  |  |  |
Allowance for loan losses to total loans |  | 1.34 | % |  | 1.29 | % |  | 1.34 | %
Net charge-offs to average total loans outstanding |  | 0.02 | % |  | 0.15 | % |  | 0.26 | %
Average total loans | $ | 756,208 |  | $ | 732,152 |  | $ | 731,424 |
Loans 30 - 89 days past due and accruing | $ | 8,308 |  | $ | 1,366 |  | $ | 2,322 |
Loans 90 days or more past due and accruing | $ | - |  | $ | - |  | $ | 516 |
Non-accrual loans | $ | 3,654 |  | $ | 3,674 |  | $ | 3,752 |
Allowance for loan losses to non-accrual loans |  | 2.74 | x |  | 2.65 | x |  | 2.54 | x
Allowance for loan losses to non-performing loans |  | 2.74 | x |  | 2.65 | x |  | 2.23 | x
﻿ |  |  |  |  |  |  |  |  |

For the three months ended March 31, 2020, the allowance increased $0.3 million, or 3%, to $10.0 million compared to $9.7 million at December 31, 2019 due to provisioning of $0.3 million. For the three months ended March 31, 2020, total loans, which represent gross loans less unearned lease revenue, decreased by $8.3 million, or 1%, to $745.1 million at March 31, 2020 compared to $753.4 million at December 31, 2019. The allowance for loan losses increased as a percentage of total loans to 1.34% at March 31, 2020 from 1.29% at December 31, 2019 due to a reduction in the loan portfolio along with initial anticipated credit losses as a result of the COVID-19 crisis.

Management believes that the current balance in the allowance for loan losses is sufficient to meet the identified potential credit quality issues that may arise and other issues unidentified but inherent to the portfolio. Potential problem loans are those where there is known information that leads management to believe repayment of principal and/or interest is in jeopardy and the loans are currently neither on non-accrual status nor past due 90 days or more.

During the first quarter of 2020, management increased the qualitative factors associated with its commercial, consumer, and residential portfolios related to potential adverse changes in both the volume and severity of past due and non-accrual loans along with national and local economic conditions as a result of the COVID-19 pandemic. A statewide shutdown of non-essential business activity was ordered on March 16th in Pennsylvania. General economic reports and data indicate a recession with elevated unemployment and sustained low inflation. The duration and severity of the recession or the ultimate path of the recovery is not known at this point.

As of March 31, 2020, management evaluated its exposure to certain industry concentrations that pose greater potential for loss due to a protracted, COVID-related economic shutdown. Specific industries include hotel accommodations, restaurants, retail, non-owner occupied residential rental and certain parts of the transportation segment. Management concluded that none of these concentrations comprise a significant exposure and that the Company is not vulnerable to the risk of a near-term severe impact to them.

Assuming a relatively short-term impact (2-3 months) for COVID-19, management concluded that the respective increase in the aforementioned qualitative factors, and consequently, the allowance for loan and lease losses, fairly meets the expected loss exposure

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measured as of the reporting date and subsequent period up to the filing date.

Should the duration and/or severity of the pandemic’s economic impact increase, management will take measures commensurate with the then observed risk to increase the provision for loan losses and, by extension, the allowance for loan and lease losses as appropriate.

The allocation of net charge-offs among major categories of loans are as follows for the periods indicated:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ | For the three |  | % of Total |  | For the three |  | % of Total
﻿ | months ended |  | Net |  | months ended |  | Net
(dollars in thousands) | March 31, 2020 |  | Charge-offs |  | March 31, 2019 |  | Charge-offs
Net charge-offs |  |  |  |  |  |  |  |  |  |  |
Commercial and industrial | $ | (52) |  | 173 | % |  | $ | (22) |  | 5 | %
Commercial real estate |  | (161) |  | 537 |  |  |  | (359) |  | 75 |
Consumer |  | 21 |  | (70) |  |  |  | (64) |  | 13 |
Residential |  | 162 |  | (540) |  |  |  | (35) |  | 7 |
Total net charge-offs | $ | (30) |  | 100 | % |  | $ | (480) |  | 100 | %
﻿ |  |  |  |  |  |  |  |  |  |  |

For the three months ended March 31, 2020, net charge-offs against the allowance totaled $30 thousand compared with $480 thousand for the three months ended March 31, 2019, representing a $450 thousand, or 94%, decrease. The sharp decrease was attributed to a $193 thousand recovery during the first quarter of 2020 in the form of a reimbursement from the Federal National Mortgage Association (“FNMA”) for previously sold mortgages charged-off during the third quarter of 2019. Excluding this recovery, net charge-offs for the three months ended March 31, 2020 would have shown an improvement, decreasing by $257 thousand, or 54%, over the prior year.

For a discussion on the provision for loan losses, see the “Provision for loan losses,” located in the results of operations section of management’s discussion and analysis contained herein.

The allowance for loan losses can generally absorb losses throughout the loan portfolio. However, in some instances an allocation is made for specific loans or groups of loans. Allocation of the allowance for loan losses for different categories of loans is based on the methodology used by the Company, as previously explained. The changes in the allocations from period-to-period are based upon quarter-end reviews of the loan portfolio.

Allocation of the allowance among major categories of loans for the periods indicated, as well as the percentage of loans in each category to total loans, is summarized in the following table. This table should not be interpreted as an indication that charge-offs in future periods will occur in these amounts or proportions, or that the allocation indicates future charge-off trends. When present, the portion of the allowance designated as unallocated is within the Company’s guidelines:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ | March 31, 2020 |  | December 31, 2019 |  | March 31, 2019
﻿ |  |  |  | Category |  |  |  |  | Category |  |  |  |  | Category
﻿ |  |  |  | % of |  |  |  |  | % of |  |  |  |  | % of
(dollars in thousands) | Allowance |  | Loans |  | Allowance |  | Loans |  | Allowance |  | Loans
Category |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial real estate | $ | 3,943 |  | 30 | % |  | $ | 3,933 |  | 31 | % |  | $ | 4,027 |  | 31 | %
Commercial and industrial |  | 1,553 |  | 16 |  |  |  | 1,484 |  | 16 |  |  |  | 1,407 |  | 17 |
Consumer |  | 2,094 |  | 28 |  |  |  | 2,013 |  | 28 |  |  |  | 2,130 |  | 29 |
Residential real estate |  | 2,393 |  | 26 |  |  |  | 2,278 |  | 25 |  |  |  | 1,910 |  | 23 |
Unallocated |  | 34 |  | - |  |  |  | 39 |  | - |  |  |  | 48 |  | - |
Total | $ | 10,017 |  | 100 | % |  | $ | 9,747 |  | 100 | % |  | $ | 9,522 |  | 100 | %

﻿

The allocation of the allowance for the commercial loan portfolio, which is comprised of CRE and C&I loans, accounted for approximately 55% of the total allowance for loan losses at March 31, 2020, which represents a one percentage point decrease from 56% of the total allowance for loan losses at December 31, 2019 and the 57% of the total allowance for loan and lease losses at March 31, 2019. The decrease in the allowance allocated to the commercial portfolio was attributed to the reduction in the commercial portfolio relative to the total portfolio as this percentage declined to 46% at March 31, 2020 compared to 47% at December 31, 2019 and 48% at March 31, 2019.

The allocation of the allowance for the consumer loan portfolio, accounted for approximately 21% of the total allowance for loan losses at March 31, 2019, which is unchanged from 21% of the total allowance for loan losses at December 31, 2019 and down one percentage point from 22% of the total allowance for loan losses at March 31, 2019. This decrease in the allowance allocated to the consumer loan portfolio from the year earlier period was attributed to the reduction in the consumer portfolio relative the total portfolio as this percentage declined to 28% at March 31, 2020 compared to 29% at March 31, 2019.

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The allocation of the allowance for the residential real estate portfolio, accounted for approximately 24% of the total allowance for loan losses at March 31, 2020, which represents a one percentage point increase from 23% of the total allowance for loan losses at December 31, 2019 and a four percentage point increase from 20% of the total allowance for loan losses at March 31, 2019. The increase in the allowance allocated to residential real estate portfolio was attributed to the relative rise in the residential portfolio, as this percentage increased to 26% at March 31, 2020 compared to 25% at December 31, 2019 and 23% at March 31, 2019.

The unallocated amount represents the portion of the allowance not specifically identified with a loan or groups of loans. The unallocated reserve was less than 1% of the total allowance for loan losses at March 31, 2020, unchanged from less than 1% of the total allowance for loan losses at December 31, 2019 and March 31, 2019.

Non-performing assets

The Company defines non-performing assets as accruing loans past due 90 days or more, non-accrual loans, TDRs, other real estate owned (ORE) and repossessed assets.

The following table sets forth non-performing assets data as of the period indicated:

﻿

﻿

﻿ |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |
(dollars in thousands) | March 31, 2020 |  | December 31, 2019 |  | March 31, 2019
﻿ |  |  |  |  |  |  |  |
Loans past due 90 days or more and accruing | $ | - |  | $ | - |  | $ | 516
Non-accrual loans * |  | 3,654 |  |  | 3,674 |  |  | 3,752
Total non-performing loans |  | 3,654 |  |  | 3,674 |  |  | 4,268
Troubled debt restructurings |  | 988 |  |  | 991 |  |  | 1,287
Other real estate owned and repossessed assets |  | 116 |  |  | 369 |  |  | 420
Total non-performing assets | $ | 4,758 |  | $ | 5,034 |  | $ | 5,975
﻿ |  |  |  |  |  |  |  |
Total loans, including loans held-for-sale | $ | 746,715 |  | $ | 755,053 |  | $ | 713,762
Total assets | $ | 1,062,495 |  | $ | 1,009,927 |  | $ | 964,220
Non-accrual loans to total loans |  | 0.49% |  |  | 0.49% |  |  | 0.53%
Non-performing loans to total loans |  | 0.49% |  |  | 0.49% |  |  | 0.60%
Non-performing assets to total assets |  | 0.45% |  |  | 0.50% |  |  | 0.62%

* In the table above, the amount includes non-accrual TDRs of $0.6 million as of March 31, 2020, $0.6 million as of December 31, 2019 and $1.1 million as of March 31, 2019.

In the review of loans for both delinquency and collateral sufficiency, management concluded that there were several loans that lacked the ability to repay in accordance with contractual terms. The decision to place loans on non-accrual status is made on an individual basis after considering factors pertaining to each specific loan. Generally, commercial loans are placed on non-accrual status when management has determined that payment of all contractual principal and interest is in doubt or the loan is past due 90 days or more as to principal and interest, unless well-secured and in the process of collection. Consumer loans secured by residential real estate and residential mortgage loans are placed on non-accrual status at 120 days past due as to principal and interest, and unsecured consumer loans are charged-off when the loan is 90 days or more past due as to principal and interest. Uncollected interest income accrued on all loans placed on non-accrual is reversed and charged to interest income.

Non-performing assets represented 0.45% of total assets at March 31, 2020 compared with 0.50% at December 31, 2019 and 0.62% at March 31, 2019. The year-to-date improvement in the non-performing assets ratio was the result of the net reduction in non-performing assets by $0.3 million, or 6%, to $4.8 million along with a $52.6 million, or 5%, increase in total assets to $1.06 billion at March 31, 2020 and the year-over-year improvement in the non-performing assets ratio was the result of the net reduction in non-performing assets by $1.2 million, or 20%, along with a $98.3 million, or 10%, increase in total assets.

Non-performing assets improved in all categories on both a year-to-date and year-over-year basis as loans past due over 90 days and accruing, non-accrual loans, accruing troubled debt restructures and other real estate owned and repossessed assets were all lower at March 31, 2020 compared to the prior quarter and the year earlier period.

From December 31, 2019 to March 31, 2020, non-accrual loans decreased slightly. At March 31, 2020, there were a total of 46 loans to 36 unrelated borrowers with balances that ranged from less than $1 thousand to $0.5 million. At December 31, 2019, there were a total of 44 loans to 34 unrelated borrowers with balances that ranged from less than $1 thousand to $0.5 million. The decline in non-accrual loans was the result of $0.1 million in payments and $0.2 million in charge-offs, which were partially offset by $0.3 million in new non-accruals and expenses that were added to balances.

There were no accruing loans that were over 90 days past due as of March 31, 2020 and December 31, 2019. The Company seeks payments from all past due customers through an aggressive customer communication process. A past due loan will be placed on non-accrual at the 90-day point when it is deemed that a customer is non-responsive and uncooperative to collection efforts.

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The composition of non-performing loans as of March 31, 2020 is as follows:

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  | Past due |  |  |  |  |  |  |  |
﻿ | Gross |  | 90 days or |  | Non- |  | Total non- |  | % of
﻿ | loan |  | more and |  | accrual |  | performing |  | gross
(dollars in thousands) | balances |  | still accruing |  | loans |  | loans |  | loans
Commercial and industrial | $ | 118,140 |  | $ | - |  | $ | 310 |  | $ | 310 |  | 0.26%
Commercial real estate: |  |  |  |  |  |  |  |  |  |  |  |  |
Non-owner occupied |  | 95,630 |  |  | - |  |  | 419 |  |  | 419 |  | 0.44%
Owner occupied |  | 125,976 |  |  | - |  |  | 1,465 |  |  | 1,465 |  | 1.16%
Construction |  | 3,196 |  |  | - |  |  | - |  |  | - |  | -
Consumer: |  |  |  |  |  |  |  |  |  |  |  |  |
Home equity installment |  | 35,456 |  |  | - |  |  | 62 |  |  | 62 |  | 0.17%
Home equity line of credit |  | 46,850 |  |  | - |  |  | 340 |  |  | 340 |  | 0.73%
Auto loans |  | 102,213 |  |  | - |  |  | 92 |  |  | 92 |  | 0.09%
Direct finance leases * |  | 16,418 |  |  | - |  |  | - |  |  | - |  | -
Other |  | 7,025 |  |  | - |  |  | - |  |  | - |  | -
Residential: |  |  |  |  |  |  |  |  |  |  |  |  |
Real estate |  | 175,453 |  |  | - |  |  | 966 |  |  | 966 |  | 0.55%
Construction |  | 18,767 |  |  | - |  |  | - |  |  | - |  | -
Loans held-for-sale |  | 1,591 |  |  | - |  |  | - |  |  | - |  | -
Total | $ | 746,715 |  | $ | - |  | $ | 3,654 |  | $ | 3,654 |  | 0.49%
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |

*Net of unearned lease revenue of $0.9 million.

Payments received from non-accrual loans are recognized on a cost recovery method. Payments are first applied to the outstanding principal balance, then to the recovery of any charged-off loan amounts. Any excess is treated as a recovery of interest income. If the non-accrual loans that were outstanding as of March 31, 2020 had been performing in accordance with their original terms, the Company would have recognized interest income with respect to such loans of $54 thousand.

The following tables set forth the activity in TDRs for the periods indicated:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
As of and for the three months ended March 31, 2020 |  |  |  |  |  |  |  |  |  |  |  |
﻿ | Accruing |  | Non-accruing |  |  |
﻿ | Commercial |  | Commercial |  | Commercial |  | Residential |  | Consumer |  |
(dollars in thousands) | & industrial |  | real estate |  | real estate |  | real estate |  | installment |  | Total
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Troubled Debt Restructures: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning balance | $ | - |  | $ | 991 |  | $ | 561 |  | $ | - |  | $ | - |  | $ | 1,552
Pay downs / payoffs |  | - |  |  | (3) |  |  | (4) |  |  | - |  |  | - |  |  | (7)
Ending balance | $ | - |  | $ | 988 |  | $ | 557 |  | $ | - |  | $ | - |  | $ | 1,545
Number of loans |  | - |  |  | 6 |  |  | 2 |  |  | - |  |  | - |  |  | 8

﻿

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
As of and for the year ended December 31, 2019 |  |  |  |  |  |  |  |  |  |  |  |
﻿ | Accruing |  | Non-accruing |  |  |
﻿ | Commercial |  | Commercial |  | Commercial |  | Residential |  |  | Consumer |  |
(dollars in thousands) | & industrial |  | real estate |  | real estate |  | real estate |  |  | installment |  | Total
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Troubled Debt Restructures: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning balance | $ | 24 |  | $ | 1,806 |  | $ | 520 |  | $ | 764 |  | $ | 413 |  | $ | 3,527
Additions |  | - |  |  | 32 |  |  | 57 |  |  | - |  |  | - |  |  | 89
Transfers |  | - |  |  | (645) |  |  | 421 |  |  | (430) |  |  | - |  |  | (654)
Pay downs / payoffs |  | (24) |  |  | (202) |  |  | (76) |  |  | (316) |  |  | (413) |  |  | (1,031)
Charge offs |  | - |  |  | - |  |  | (361) |  |  | (18) |  |  | - |  |  | (379)
Ending balance | $ | - |  | $ | 991 |  | $ | 561 |  | $ | - |  | $ | - |  | $ | 1,552
Number of loans |  | - |  |  | 6 |  |  | 2 |  |  | - |  |  | - |  |  | 8

﻿

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The Company, on a regular basis, reviews changes to loans to determine if they meet the definition of a TDR. TDRs arise when a borrower experiences financial difficulty and the Company grants a concession that it would not otherwise grant based on current underwriting standards in order to maximize the Company’s recovery.

To address the pandemic’s impact on its clients, the Company complied with FDIC FIL-17-2020 to work with customers to make reasonable accommodations ‘in a prudent manner’, especially borrowers from particularly vulnerable industry sectors. Forbearance was offered to borrowers with preference given to those whose accounts that have consistently been handled as agreed. Each was offered a choice of full payment deferral, generally 3 months, or interest only, generally 6 months.

Through April 17, 2020, the Company received a total of 1,324 forbearance requests with a grand total net active principal balance of $165 million including $27 million in 176 loans sold to FNMA/FHLB. Of the $165 million, $93 million was commercial and $72 million was consumer.

The Company adopted guidance defined in the March 22, 2020 Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus. While the requirement to identify TDRs wasn’t waived, applicants seeking relief were not deemed to be experiencing financial difficulties at the time of modification if the borrower was current (less than 30 days past due) on their contractual obligations at the time the modification was implemented and the modification was considered ‘temporary relief’ (less than 6 months). Further, rate concessions and principal forgiveness were not granted. The Company continued to recognize interest income on all modifications consistent with their contractual obligations throughout the term of the forbearance.

From December 31, 2019 to March 31, 2020, TDRs remained relatively unchanged, decreasing $7 thousand, or less than 1%. At December 31, 2019, there were a total of 8 TDRs by 7 unrelated borrowers with balances that ranged from $80 thousand to $0.5 million. At March 31, 2020, there were a total of 8 TDRs by 7 unrelated borrowers with balances that ranged from $79 thousand to $0.5 million. The $7 thousand decrease was driven by the standard amortization of the portfolio.

Loans modified in a TDR may or may not be placed on non-accrual status. At December 31, 2019 and March 31, 2020, two TDRs totaling $0.6 million were on non-accrual status.

If applicable, a TDR loan classified as non-accrual would require a minimum of six months of payments before consideration for a return to accrual status. The concessions granted consisted of temporary interest-only payments or a reduction in the rate of interest to a below-market rate for a contractual period. The Company believes concessions have been made in the best interests of the borrower and the Company. If loans characterized as a TDR perform according to the restructured terms for a satisfactory period of time, the TDR designation may be removed in a new calendar year if the loan yields a market rate of interest.

Foreclosed assets held-for-sale

From December 31, 2019 to March 31, 2020, foreclosed assets held-for-sale (ORE) decreased from $349 thousand to $99 thousand, a $250 thousand, or 72%, decrease, due to the sale of two foreclosed asset s for $250 thousand during the first quarter. The following table sets forth the activity in the ORE component of foreclosed assets held-for-sale:

﻿

﻿ |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |
﻿ | March 31, 2020 |  | December 31, 2019
(dollars in thousands) | Amount | # |  | Amount | #
﻿ |  |  |  |  |  |  |
Balance at beginning of period | $ | 349 | 7 |  | $ | 190 | 6
﻿ |  |  |  |  |  |  |
Additions |  | - |  |  |  | 1,229 | 6
Pay downs |  | - |  |  |  | (18) |
Write downs |  | - |  |  |  | (82) |
Sold |  | (250) | (2) |  |  | (970) | (5)
Balance at end of period | $ | 99 | 5 |  | $ | 349 | 7

﻿

As of March 31, 2019, ORE consisted of five properties from five unrelated borrowers totaling $99 thousand. One of these properties ($32 thousand) was added in 2019; one of these properties ($15 thousand) was added in 2018; two of these properties ($10 thousand) were added in 2017; and one was added in 2014 ($42 thousand). Of the five properties, two properties, totaling $42 thousand, had a signed sales agreement and the other three properties are currently listed for sale.

As of March 31, 2020, the Company had two other repossessed assets held-for-sale, with a balance of $17 thousand compared to two other repossessed assets held-for-sale, with a balance of $20 thousand as of December 31, 2019.

Cash surrender value of bank owned life insurance

The Company maintains bank owned life insurance (BOLI) for a chosen group of employees at the time of purchase, namely its officers, where the Company is the owner and sole beneficiary of the policies. BOLI is classified as a non-interest earning asset. Increases in the cash surrender value are recorded as components of non-interest income. The BOLI is profitable from the

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appreciation of the cash surrender values of the pool of insurance and its tax-free advantage to the Company. This profitability is used to offset a portion of current and future employee benefit costs. In March 2019, the Company invested $2.0 million in additional BOLI as a source of funding for additional life insurance benefits that provides for payments upon death for officers and employee benefit expenses related to the Company’s non-qualified SERP implemented for certain executive officers. The BOLI can be liquidated if necessary with associated tax costs. However, the Company intends to hold this pool of insurance, because it provides income that enhances the Company’s capital position. Therefore, the Company has not provided for deferred income taxes on the earnings from the increase in cash surrender value.

Premises and equipment

Net of depreciation, premises and equipment decreased $0.1 million during the first three months of 2020. The Company recorded $0.4 million in depreciation expense which was partially offset by $0.3 million in additions to fixed assets. The Company is expected to begin the renovation of its main office first floor branch in 2020 which will increase construction in process by approximately $2.3 million with completion expected by the middle of 2021.

Other assets

During the first three months of 2020, the $1.0 million, or 22%, increase in other assets was due mostly to a $1.4 million investment settlement pending and $0.3 million higher prepaid expenses partially offset by a $0.7 million larger net deferred tax liability.

Funds Provided:

Deposits

The Company is a community based commercial depository financial institution, member FDIC, which offers a variety of deposit products with varying ranges of interest rates and terms. Generally, deposits are obtained from consumers, businesses and public entities within the communities that surround the Company’s 12 branch offices and all deposits are insured by the FDIC up to the full extent permitted by law. Deposit products consist of transaction accounts including: savings; clubs; interest-bearing checking; money market and non-interest bearing checking (DDA). The Company also offers short- and long-term time deposits or certificates of deposit (CDs). CDs are deposits with stated maturities which can range from seven days to ten years. Cash flow from deposits is influenced by economic conditions, changes in the interest rate environment, pricing and competition. To determine interest rates on its deposit products, the Company considers local competition, spreads to earning-asset yields, liquidity position and rates charged for alternative sources of funding such as short-term borrowings and FHLB advances.

The following table represents the components of deposits as of the date indicated:

﻿

﻿ |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |
﻿ | March 31, 2020 | December 31, 2019
(dollars in thousands) | Amount |  | % | Amount |  | %
﻿ |  |  |  |  |  |  |  |  |  |
Interest-bearing checking | $ | 254,379 |  | 27.6 | % | $ | 242,171 |  | 29.0 | %
Savings and clubs |  | 104,841 |  | 11.4 |  |  | 104,854 |  | 12.5 |
Money market |  | 206,552 |  | 22.5 |  |  | 180,478 |  | 21.6 |
Certificates of deposit |  | 109,947 |  | 12.0 |  |  | 116,211 |  | 13.9 |
Total interest-bearing |  | 675,719 |  | 73.5 |  |  | 643,714 |  | 77.0 |
Non-interest bearing |  | 243,942 |  | 26.5 |  |  | 192,023 |  | 23.0 |
Total deposits | $ | 919,661 |  | 100.0 | % | $ | 835,737 |  | 100.0 | %

﻿

Total deposits increased $83.9 million, or 10%, from $835.7 million at December 31, 2019 to $919.6 million at March 31, 2020. Non-interest bearing checking accounts contributed the most to the deposit growth with an increase of $51.9 million, primarily due to seasonal public tax deposits. Tax deposits are usually received mid-quarter and retained for a short period of time with disbursements occurring shortly after they are received. Money market accounts also increased $26.1 million mostly due to higher balances of existing accounts and shifts from other types of deposit accounts. Interest-bearing checking accounts increased $12.2 million due to an increase in balances from public customers. The Company focuses on obtaining a full-banking relationship with existing customers as well as forming new customer relationships. During 2020, savings accounts continued to decline due to customers’ preference for products with higher earnings potential. Savings accounts decreased $1.0 million which was partially offset by an increase of $1.0 million in club accounts. The Company will continue to execute on its relationship development strategy, explore the demographics within its marketplace and develop creative programs for its customers. For 2020, the Company will focus on deposit growth to fund asset growth and pay down short-term borrowings. We expect a temporary surge in business deposits during the second quarter of 2020 as PPP loan proceeds flow into deposit accounts. Growth in deposits from new markets is expected from a full year with the Mountain Top branch and the merger with MNB Corporation. Seasonal public deposit fluctuations are expected to remain volatile and at times may partially offset this deposit growth.

Additionally, CDs also decreased $6.3 million mostly due to migration to money market accounts. During the first quarter of 2020, deposit customers moved some money from maturing CDs to competitors offering aggressive rates. The Company will continue to

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pursue strategies to grow and retain retail and business customers with an emphasis on deepening and broadening existing and creating new relationships.

The Company uses the Certificate of Deposit Account Registry Service (CDARS) reciprocal program and Insured Cash Sweep (ICS) reciprocal program to obtain FDIC insurance protection for customers who have large deposits that at times may exceed the FDIC maximum insured amount of $250,000. In the CDARS program, deposits with varying terms and interest rates, originated in the Company’s own markets, are exchanged for deposits of other financial institutions that are members in the CDARS network. By placing the deposits in other participating institutions, the deposits of our customers are fully insured by the FDIC. In return for deposits placed with network institutions, the Company receives from network institutions deposits that are approximately equal in amount and are comprised of terms similar to those placed for our customers. Deposits the Company receives from other institutions are considered reciprocal deposits by regulatory definitions. The Company did not have any CDARs as of March 31, 2020 and December 31, 2019. As of March 31, 2020 and December 31, 2019, ICS reciprocal deposits represented $39.9 million and $19.7 million, or 4% and 2%, of total deposits which are included in interest-bearing checking accounts in the table above. The $20.2 million increase in ICS deposits is primarily due to public funds deposit transfers from other interest-bearing checking accounts to ICS accounts.

The maturity distribution of certificates of deposit at March 31, 2020 is as follows:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  | More than |  | More than |  | More |  |  |
﻿ | Three months |  | three months |  | six months to |  | than twelve |  |  |
(dollars in thousands) | or less |  | to six months |  | twelve months |  | months |  | Total
CDs of $100,000 or more | $ | 12,854 |  | $ | 20,416 |  | $ | 22,818 |  | $ | 11,659 |  | $ | 67,747
CDs of less than $100,000 |  | 8,471 |  |  | 6,270 |  |  | 12,141 |  |  | 15,318 |  |  | 42,200
Total CDs | $ | 21,325 |  | $ | 26,686 |  | $ | 34,959 |  | $ | 26,977 |  | $ | 109,947

﻿

Certificates of deposit of $250,000 or more amounted to $43.5 million and $44.5 million as of March 31, 2020 and December 31, 2019, respectively.

Approximately 57% of the CDs, with a weighted-average interest rate of 1.91%, are scheduled to mature during the remainder of 2020 and an additional 29%, with a weighted-average interest rate of 1.37%, are scheduled to mature during 2021. Renewing CDs are currently expected to re-price to lower market rates depending on the rate on the maturing CD, the pace and direction of interest rate movements, the shape of the yield curve, competition, the rate profile of the maturing accounts and depositor preference for alternative, non-term products. The Company plans to address repricing CDs in the ordinary course of business on a relationship basis and is prepared to match rates when prudent to maintain relationships. Growth in CD accounts is challenged by the current and expected rate environment and clients’ preference for short-term rates, as well as aggressive competitor rates. The Company is not currently offering any CD promotions but may resume promotions in the future. The Company will consider the needs of the customers and simultaneously be mindful of the liquidity levels, borrowing rates and the interest rate sensitivity exposure of the Company.

Borrowings

Borrowings are used as a complement to deposit generation as an alternative funding source whereby the Company will borrow under advances from the FHLB of Pittsburgh and other correspondent banks for asset growth and liquidity needs

Short-term borrowings may include overnight balances with FHLB line of credit and/or correspondent bank’s federal funds lines which the Company may require to fund daily liquidity needs such as deposit outflow, loan demand and operations. Short-term borrowings decreased $37.8 million during the first three months of 2020 as deposits grew.

During the first quarter of 2019, the Company paid off $10 million in FHLB advances with an interest rate of 1.34%. During the second quarter of 2019, the Company paid off $6.7 million in FHLB advances with an interest rate of 1.43%. As of March 31, 2020, the Company had the ability to borrow an additional $276.6 million from the FHLB.

The following table represents the components of borrowings as of the date indicated:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |
﻿ |
﻿ | March 31, 2020 |  | December 31, 2019
(dollars in thousands) | Amount |  | % |  | Amount |  | %
﻿ |  |  |  |  |  |  |  |  |  |  |
Overnight borrowings | $ | - |  | - | % |  | $ | 37,839 |  | 71.6 | %
FHLB advances |  | 15,000 |  | 100.0 |  |  |  | 15,000 |  | 28.4 |
Total | $ | 15,000 |  | 100.0 | % |  | $ | 52,839 |  | 100.0 | %

﻿

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The original maturity dates of FHLB advances as of March 31, 2020 are as follows:

﻿

﻿ |  |  |  |  |
﻿ |  |  |  |  |
(dollars in thousands) | Amount |  | Weighted average rate |
﻿ |  |  |  |  |
Maturity date 1 year or less | $ | - |  | - | %
After 1 but within 2 |  | 5,000 |  | 2.95 |
After 2 but within 3 |  | 5,000 |  | 2.99 |
After 3 but within 4 |  | 5,000 |  | 3.07 |
After 4 years |  | - |  | - |
Total | $ | 15,000 |  | 3.01 | %
﻿ |  |  |  |  |

Subsequent events

Effective May 1, 2020, the Company completed the acquisition of MNB Corporation (“MNB”) pursuant to the Agreement and Plan of Reorganization, dated December 9, 2019. MNB was the holding company of Merchants Bank of Bangor (“Merchants Bank”) which operated 9 retail community banking offices in Eastern Pennsylvania. Subject to the terms and conditions of the agreement, MNB merged with and into the Company and Merchants Bank merged with and into the Bank.

Under the terms of the agreement, MNB shareholders received as consideration 1.039 shares of Fidelity common stock for each share of MNB common stock that they owned as of the closing date. As a result of the merger, the Company issued 1,176,993 shares of its common stock and cash in exchange for fractional shares based upon $43.767, the determined market share price of the Company’s common stock in accordance with the Agreement and Plan of Reorganization.

With the combination of the two organizations, the Company, on a consolidated basis, will have approximate total assets of $1.6 billion, total deposits of $1.4 billion and total loans of $1.1 billion. For the three months ended March 31, 2020, the Corporation incurred merger-related expenses totaling $273 thousand, primarily consisting of professional fees. The remaining non-recurring costs to facilitate the merger and integrate systems in 2020 are currently estimated to be $1.8 million.

﻿

Item 3. Quantitative and Qualitative Disclosure About Market Risk

Management of interest rate risk and market risk analysis.

The adequacy and effectiveness of an institution’s interest rate risk management process and the level of its exposures are critical factors in the regulatory evaluation of an institution’s sensitivity to changes in interest rates and capital adequacy. Management believes the Company’s interest rate risk measurement framework is sound and provides an effective means to measure, monitor, analyze, identify and control interest rate risk in the balance sheet.

The Company is subject to the interest rate risks inherent in its lending, investing and financing activities. Fluctuations of interest rates will impact interest income and interest expense along with affecting market values of all interest-earning assets and interest-bearing liabilities, except for those assets or liabilities with a short term remaining to maturity. Interest rate risk management is an integral part of the asset/liability management process. The Company has instituted certain procedures and policy guidelines to manage the interest rate risk position. Those internal policies enable the Company to react to changes in market rates to protect net interest income from significant fluctuations. The primary objective in managing interest rate risk is to minimize the adverse impact of changes in interest rates on net interest income along with creating an asset/liability structure that maximizes earnings.

Asset/Liability Management. One major objective of the Company when managing the rate sensitivity of its assets and liabilities is to stabilize net interest income. The management of and authority to assume interest rate risk is the responsibility of the Company’s Asset/Liability Committee (ALCO), which is comprised of senior management and members of the board of directors. ALCO meets quarterly to monitor the relationship of interest sensitive assets to interest sensitive liabilities. The process to review interest rate risk is a regular part of managing the Company. Consistent policies and practices of measuring and reporting interest rate risk exposure, particularly regarding the treatment of non-contractual assets and liabilities, are in effect. In addition, there is an annual process to review the interest rate risk policy with the board of directors which includes limits on the impact to earnings from shifts in interest rates.

Interest Rate Risk Measurement. Interest rate risk is monitored through the use of three complementary measures: static gap analysis, earnings at risk simulation and economic value at risk simulation. While each of the interest rate risk measurements has limitations, collectively, they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company and the distribution of risk along the yield curve, the level of risk through time and the amount of exposure to changes in certain interest rate relationships.

Static Gap. The ratio between assets and liabilities re-pricing in specific time intervals is referred to as an interest rate sensitivity gap. Interest rate sensitivity gaps can be managed to take advantage of the slope of the yield curve as well as forecasted changes in the level of interest rate changes.

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To manage this interest rate sensitivity gap position, an asset/liability model commonly known as cumulative gap analysis is used to monitor the difference in the volume of the Company’s interest sensitive assets and liabilities that mature or re-price within given time intervals. A positive gap (asset sensitive) indicates that more assets will re-price during a given period compared to liabilities, while a negative gap (liability sensitive) indicates the opposite effect. The Company employs computerized net interest income simulation modeling to assist in quantifying interest rate risk exposure. This process measures and quantifies the impact on net interest income through varying interest rate changes and balance sheet compositions. The use of this model assists the ALCO to gauge the effects of the interest rate changes on interest-sensitive assets and liabilities in order to determine what impact these rate changes will have upon the net interest spread. At March 31, 2020, the Company maintained a one-year cumulative gap of positive (asset sensitive) $139.7 million, or 13%, of total assets. The effect of this positive gap position provided a mismatch of assets and liabilities which may expose the Company to interest rate risk during periods of falling interest rates. Conversely, in an increasing interest rate environment, net interest income could be positively impacted because more assets than liabilities will re-price upward during the one-year period.

Certain shortcomings are inherent in the method of analysis discussed above and presented in the next table. Although certain assets and liabilities may have similar maturities or periods of re-pricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the table amounts. The ability of many borrowers to service their adjustable-rate debt may decrease in the event of an interest rate increase.

The following table illustrates the Company’s interest sensitivity gap position at March 31, 2020:

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  | More than three |  | More than |  |  |  |  |  |
﻿ | Three months |  | months to |  | one year |  | More than |  |  |
(dollars in thousands) | or less |  | twelve months |  | to three years |  | three years |  | Total
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents | $ | 54,812 |  | $ | - |  | $ | - |  | $ | 4,148 |  | $ | 58,960
Investment securities (1)(2) |  | 13,951 |  |  | 37,184 |  |  | 52,263 |  |  | 103,318 |  |  | 206,716
Loans and leases(2) |  | 199,464 |  |  | 155,361 |  |  | 243,253 |  |  | 138,620 |  |  | 736,698
Fixed and other assets |  | - |  |  | 23,427 |  |  | - |  |  | 36,694 |  |  | 60,121
Total assets | $ | 268,227 |  | $ | 215,972 |  | $ | 295,516 |  | $ | 282,780 |  | $ | 1,062,495
Total cumulative assets | $ | 268,227 |  | $ | 484,199 |  | $ | 779,715 |  | $ | 1,062,495 |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Non-interest-bearing transaction deposits (3) | $ | - |  | $ | 24,419 |  | $ | 67,035 |  | $ | 152,488 |  | $ | 243,942
Interest-bearing transaction deposits (3) |  | 237,081 |  |  | - |  |  | 131,476 |  |  | 197,215 |  |  | 565,772
Certificates of deposit |  | 21,325 |  |  | 61,645 |  |  | 21,801 |  |  | 5,176 |  |  | 109,947
FHLB advances |  | - |  |  | - |  |  | 10,000 |  |  | 5,000 |  |  | 15,000
Other liabilities |  | - |  |  | - |  |  | - |  |  | 15,694 |  |  | 15,694
Total liabilities | $ | 258,406 |  | $ | 86,064 |  | $ | 230,312 |  | $ | 375,573 |  | $ | 950,355
Total cumulative liabilities | $ | 258,406 |  | $ | 344,470 |  | $ | 574,782 |  | $ | 950,355 |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest sensitivity gap | $ | 9,821 |  | $ | 129,908 |  | $ | 65,204 |  | $ | (92,793) |  |  |
Cumulative gap | $ | 9,821 |  | $ | 139,729 |  | $ | 204,933 |  | $ | 112,140 |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cumulative gap to total assets |  | 0.9% |  |  | 13.2% |  |  | 19.3% |  |  | 10.6% |  |  |

(1) Includes FHLB stock and the net unrealized gains/losses on available-for-sale securities.

(2) Investments and loans are included in the earlier of the period in which interest rates were next scheduled to adjust or the period in which they are due. In addition, loans were included in the periods in which they are scheduled to be repaid based on scheduled amortization. For amortizing loans and MBS – GSE residential, annual prepayment rates are assumed reflecting historical experience as well as management’s knowledge and experience of its loan products.

(3) The Company’s demand and savings accounts were generally subject to immediate withdrawal. However, management considers a certain amount of such accounts to be core accounts having significantly longer effective maturities based on the retention experiences of such deposits in changing interest rate environments. The effective maturities presented are the recommended maturity distribution limits for non-maturing deposits based on historical deposit studies.

Earnings at Risk and Economic Value at Risk Simulations. The Company recognizes that more sophisticated tools exist for measuring the interest rate risk in the balance sheet that extend beyond static re-pricing gap analysis. Although it will continue to measure its re-pricing gap position, the Company utilizes additional modeling for identifying and measuring the interest rate risk in the overall balance sheet. The ALCO is responsible for focusing on “earnings at risk” and “economic value at risk”, and how both relate to the risk-based capital position when analyzing the interest rate risk.

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Earnings at Risk. An earnings at risk simulation measures the change in net interest income and net income should interest rates rise and fall. The simulation recognizes that not all assets and liabilities re-price one-for-one with market rates (e.g., savings rate). The ALCO looks at “earnings at risk” to determine income changes from a base case scenario under an increase and decrease of 200 basis points in interest rate simulation models.

Economic Value at Risk. An earnings at risk simulation measures the short-term risk in the balance sheet. Economic value (or portfolio equity) at risk measures the long-term risk by finding the net present value of the future cash flows from the Company’s existing assets and liabilities. The ALCO examines this ratio quarterly utilizing an increase and decrease of 200 basis points in interest rate simulation models. The ALCO recognizes that, in some instances, this ratio may contradict the “earnings at risk” ratio.

The following table illustrates the simulated impact of an immediate 200 basis points upward or downward movement in interest rates on net interest income, net income and the change in the economic value (portfolio equity). This analysis assumed that the adjusted interest-earning asset and interest-bearing liability levels at March 31, 2020 remained constant. The impact of the rate movements was developed by simulating the effect of the rate change over a twelve-month period from the March 31, 2020 levels:

﻿

﻿ |  |  |  |
﻿ |  |  |  |
﻿ | % change
﻿ | Rates +200 | Rates -200
Earnings at risk: |  |  |  |
Net interest income | 2.7 | % | 1.7 | %
Net income | 6.9 |  | 3.8 |
Economic value at risk: |  |  |  |
Economic value of equity | 8.6 |  | (27.1) |
Economic value of equity as a percent of total assets | 1.1 |  | (3.4) |

﻿

Economic value has the most meaning when viewed within the context of risk-based capital. Therefore, the economic value may normally change beyond the Company’s policy guideline for a short period of time as long as the risk-based capital ratio (after adjusting for the excess equity exposure) is greater than 10%. At March 31, 2020, the Company’s risk-based capital ratio was 15.80%.

The table below summarizes estimated changes in net interest income over a twelve-month period beginning April 1, 2020, under alternate interest rate scenarios using the income simulation model described above:

﻿

﻿ |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |
﻿ | Net interest |  | $ |  | %
(dollars in thousands) | income |  | variance |  | variance
Simulated change in interest rates |  |  |  |  |  |  |  |
+200 basis points | $ | 33,522 |  | $ | 881 |  | 2.7 | %
+100 basis points |  | 33,170 |  |  | 529 |  | 1.6 |
Flat rate |  | 32,641 |  |  | - |  | - |
-100 basis points |  | 33,071 |  |  | 430 |  | 1.3 |
-200 basis points |  | 33,205 |  |  | 564 |  | 1.7 |

﻿

Simulation models require assumptions about certain categories of assets and liabilities. The models schedule existing assets and liabilities by their contractual maturity, estimated likely call date or earliest re-pricing opportunity. MBS – GSE residential securities and amortizing loans are scheduled based on their anticipated cash flow including estimated prepayments. For investment securities, the Company uses a third-party service to provide cash flow estimates in the various rate environments. Savings, money market and interest-bearing checking accounts do not have stated maturities or re-pricing terms and can be withdrawn or re-price at any time. This may impact the margin if more expensive alternative sources of deposits are required to fund loans or deposit runoff. Management projects the re-pricing characteristics of these accounts based on historical performance and assumptions that it believes reflect their rate sensitivity. The model reinvests all maturities, repayments and prepayments for each type of asset or liability into the same product for a new like term at current product interest rates. As a result, the mix of interest-earning assets and interest bearing-liabilities is held constant.

Liquidity

Liquidity management ensures that adequate funds will be available to meet customers’ needs for borrowings, deposit withdrawals and maturities, facility expansion and normal operating expenses. Sources of liquidity are cash and cash equivalents, asset maturities and pay-downs within one year, loans HFS, investments AFS, growth of core deposits, utilization of borrowing capacities from the FHLB, correspondent banks, ICS and CDARs, the Discount Window of the Federal Reserve Bank of Philadelphia (FRB), Atlantic Community Bankers Bank (ACBB) and proceeds from the issuance of capital stock. Though regularly scheduled investment and loan payments are dependable sources of daily liquidity, sales of both loans HFS and investments AFS, deposit activity and investment and loan prepayments are significantly influenced by general economic conditions including the interest rate environment. During low and declining interest rate environments, prepayments from interest-sensitive assets tend to accelerate and provide significant liquidity

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that can be used to invest in other interest-earning assets but at lower market rates. Conversely, in periods of high or rising interest rates, prepayments from interest-sensitive assets tend to decelerate causing prepayment cash flows from mortgage loans and mortgage-backed securities to decrease. Rising interest rates may also cause deposit inflow but priced at higher market interest rates or could also cause deposit outflow due to higher rates offered by the Company’s competition for similar products. The Company closely monitors activity in the capital markets and takes appropriate action to ensure that the liquidity levels are adequate for funding, investing and operating activities.

The Company’s contingency funding plan (CFP) sets a framework for handling liquidity issues in the event circumstances arise which the Company deems to be less than normal. The Company established guidelines for identifying, measuring, monitoring and managing the resolution of potentially serious liquidity crises. The CFP outlines required monitoring tools, acceptable alternative funding sources and required actions during various liquidity scenarios. Thus, the Company has implemented a proactive means for the measurement and resolution for handling potentially significant adverse liquidity conditions. At least quarterly, the CFP monitoring tools, current liquidity position and monthly projected liquidity sources and uses are presented and reviewed by the Company’s Asset/Liability Committee. As of March 31, 2020, the Company had not experienced any adverse issues that would give rise to its inability to raise liquidity in an emergency situation.

During the year ended March 31, 2020, the Company generated $43.3 million of cash. During the period, the Company’s operations provided approximately $4.9 million mostly from $8.2 million of net cash inflow from the components of net interest income and $1.8 million in proceeds of loans HFS over originations; partially offset by net non-interest expense/income related payments of $5.2 million. Cash inflow from interest-earning assets, deposits, loan payments and the sale of securities were used to purchase investment securities and replace maturing and cash runoff of securities, fund the loan portfolio, pay down overnight borrowings, invest in bank premises and equipment and make net dividend payments. The Company received a large amount of public deposits over the past four years. The seasonal nature of deposits from municipalities and other public funding sources requires the Company to be prepared for the inherent volatility and the unpredictable timing of cash outflow from this customer base, including maintaining the requirements to pledge investment securities. Starting in 2019, the Company made an effort to open new public accounts as ICS accounts and transfer some existing public accounts to ICS accounts in order to provide the customer with FDIC insurance and to free up the Company’s unencumbered securities to improve liquidity. Accordingly, the use of short-term overnight borrowings could be used to fulfill funding gap needs. The CFP is a tool to help the Company ensure that alternative funding sources are available to meet its liquidity needs.

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the financing needs of its customers and in connection with the overall interest rate management strategy. These instruments involve, to a varying degree, elements of credit, interest rate and liquidity risk. In accordance with GAAP, these instruments are either not recorded in the consolidated financial statements or are recorded in amounts that differ from the notional amounts. Such instruments primarily include lending commitments.

Lending commitments include commitments to originate loans and commitments to fund unused lines of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

During the second quarter of 2020, the Company recorded PPP loans funded by the Paycheck Protection Program Liquidity Facility (PPPLF). This will provide liquidity without having to exhaust our funding lines. We expect an approximately $150 million surge in deposits from the proceeds of PPP loans until customers pay out expenses.

As of March 31, 2020, the Company maintained $59.0 million in cash and cash equivalents and $205.6 million of investments AFS and loans HFS. Also as of March 31, 2020, the Company had approximately $276.6 million available to borrow from the FHLB, $31.0 million from correspondent banks, $90.8 million from the FRB and $152.0 million from the Promontory One-Way Buy program. The combined total of $815.0 million represented 77% of total assets at March 31, 2020. Management believes this level of liquidity to be strong and adequate to support current operations.

Capital

During the three months ended March 31, 2020, total shareholders' equity increased $5.3 million, or 5%, due principally from the $2.6 million in net income added into retained earnings and the $3.2 million after tax improvement in the net unrealized gain position in the Company’s investment portfolio. Capital was further enhanced by $0.2 million from investments in the Company’s common stock via the Employee Stock Purchase (ESPP) and $0.3 million from stock-based compensation expense from the ESPP and restricted stock and SSARs. These items were partially offset by $1.1 million of cash dividends declared on the Company’s common stock. The Company’s dividend payout ratio, defined as the rate at which current earnings are paid to shareholders, was 40.7% for the three months ended March 31, 2020. The balance of earnings is retained to further strengthen the Company’s capital position.

As of March 31, 2020, the Company reported a net unrealized gain position of $6.8 million, net of tax, from the securities AFS portfolio compared to a net unrealized gain of $3.6 million as of December 31, 2019. The improvement during 2020 was from $3.2 million in net unrealized gains on AFS securities, net of tax. Higher net unrealized gains on all types of securities contributed to the

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net unrealized gains in investment portfolio. Management believes that changes in fair value of the Company’s securities are due to changes in interest rates and not in the creditworthiness of the issuers. Generally, when U.S. Treasury rates rise, investment securities’ pricing declines and fair values of investment securities also decline. While volatility has existed in the yield curve within the past twelve months, a declining rate environment is expected and during the period of declining rates, the Company expects pricing in the bond portfolio to improve. There is no assurance that future realized and unrealized losses will not be recognized from the Company’s portfolio of investment securities. To help maintain a healthy capital position, the Company can issue stock to participants in the DRP and ESPP plans. The DRP affords the Company the option to acquire shares in open market purchases and/or issue shares directly from the Company to plan participants. During the first quarter of 2020, the Company acquired shares in the open market to fulfill the needs of the DRP. Both the DRP and the ESPP plans have been a consistent source of capital from the Company’s loyal employees and shareholders and their participation in these plans will continue to help strengthen the Company’s balance sheet.

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Under these guidelines, assets and certain off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets. The guidelines require all banks and bank holding companies to maintain a minimum ratio of total risk-based capital to total risk-weighted assets (Total Risk Adjusted Capital) of 8%, including Tier I common equity to total risk-weighted assets (Tier I Common Equity) of 4.5%, Tier I capital to total risk-weighted assets (Tier I Capital) of 6% and Tier I capital to average total assets (Leverage Ratio) of at least 4%. A capital conservation buffer, comprised of common equity Tier I capital, is also established above the regulatory minimum capital requirements of 2.50%. As of March 31, 2020 and December 31, 2019, the Company and the Bank exceeded all capital adequacy requirements to which it was subject.

During the second quarter of 2020, PPP loans funded through the PPPLF will be excluded from the Leverage Ratio.

The Company continues to closely monitor and evaluate alternatives to enhance its capital ratios as the regulatory and economic environments change. The following table depicts the capital amounts and ratios of the Company, on a consolidated basis, and the Bank as of March 31, 2020 and December 31, 2019:

﻿

﻿

﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  | For capital adequacy |  | To be well capitalized
﻿ |  |  |  |  | For capital |  | purposes with capital |  | under prompt corrective
﻿ | Actual | adequacy purposes |  | conservation buffer* |  | action provisions
(dollars in thousands) | Amount |  | Ratio | Amount | Ratio |  | Amount | Ratio |  | Amount | Ratio
As of March 31, 2020: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Total capital (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated | $ | 114,124 |  | 15.8% | ≥ | $ | 57,792 |  | 8.0% | ≥ | $ | 75,851 |  | 10.5% |  |  |  | N/A |  | N/A
Bank | $ | 113,314 |  | 15.7% | ≥ | $ | 57,786 |  | 8.0% | ≥ | $ | 75,844 |  | 10.5% |  | ≥ | $ | 72,232 |  | 10.0%
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Tier 1 common equity (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated | $ | 105,081 |  | 14.6% | ≥ | $ | 32,508 |  | 4.5% | ≥ | $ | 50,568 |  | 7.0% |  |  |  | N/A |  | N/A
Bank | $ | 104,272 |  | 14.4% | ≥ | $ | 32,504 |  | 4.5% | ≥ | $ | 50,562 |  | 7.0% |  | ≥ | $ | 46,951 |  | 6.5%
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Tier I capital (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated | $ | 105,081 |  | 14.6% | ≥ | $ | 43,344 |  | 6.0% | ≥ | $ | 61,404 |  | 8.5% |  |  |  | N/A |  | N/A
Bank | $ | 104,272 |  | 14.4% | ≥ | $ | 43,339 |  | 6.0% | ≥ | $ | 61,397 |  | 8.5% |  | ≥ | $ | 57,786 |  | 8.0%
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Tier I capital (to average assets) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated | $ | 105,081 |  | 10.4% | ≥ | $ | 40,547 |  | 4.0% | ≥ | $ | 40,547 |  | 4.0% |  |  |  | N/A |  | N/A
Bank | $ | 104,272 |  | 10.3% | ≥ | $ | 40,539 |  | 4.0% | ≥ | $ | 40,539 |  | 4.0% |  | ≥ | $ | 50,674 |  | 5.0%
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

﻿

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﻿

﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
As of December 31, 2019: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Total capital (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated | $ | 111,910 |  | 15.8% | ≥ | $ | 56,796 |  | 8.0% | ≥ | $ | 74,545 |  | 10.5% |  |  |  | N/A |  | N/A
Bank | $ | 112,188 |  | 15.8% | ≥ | $ | 56,791 |  | 8.0% | ≥ | $ | 74,538 |  | 10.5% |  | ≥ | $ | 70,989 |  | 10.0%
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Tier 1 common equity (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated | $ | 103,024 |  | 14.5% | ≥ | $ | 31,948 |  | 4.5% | ≥ | $ | 49,696 |  | 7.0% |  |  |  | N/A |  | N/A
Bank | $ | 103,303 |  | 14.6% | ≥ | $ | 31,945 |  | 4.5% | ≥ | $ | 49,692 |  | 7.0% |  | ≥ | $ | 46,143 |  | 6.5%
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Tier I capital (to risk-weighted assets) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated | $ | 103,024 |  | 14.5% | ≥ | $ | 42,597 |  | 6.0% | ≥ | $ | 60,346 |  | 8.5% |  |  |  | N/A |  | N/A
Bank | $ | 103,303 |  | 14.6% | ≥ | $ | 42,593 |  | 6.0% | ≥ | $ | 60,340 |  | 8.5% |  | ≥ | $ | 56,791 |  | 8.0%
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Tier I capital (to average assets) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consolidated | $ | 103,024 |  | 10.4% | ≥ | $ | 39,650 |  | 4.0% | ≥ | $ | 39,650 |  | 4.0% |  |  |  | N/A |  | N/A
Bank | $ | 103,303 |  | 10.3% | ≥ | $ | 40,265 |  | 4.0% | ≥ | $ | 40,265 |  | 4.0% |  | ≥ | $ | 50,331 |  | 5.0%
﻿ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

* The minimums under Basel III increased by 0.625% (the capital conservation buffer) annually until 2019.

The Company advises readers to refer to the Supervision and Regulation section of Management’s Discussion and Analysis of Financial Condition and Results of Operation, of its 2019 Form 10-K for a discussion on the regulatory environment and recent legislation and rulemaking.

Item 4. Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was carried out by the Company’s management, with the participation of its President and Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934. Based on such evaluation, the President and Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports the Company files or furnishes under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations, and are effective. The Company made no changes in its internal controls over financial reporting or in other factors that materially affected, or are reasonably likely to materially affect, these controls during the last fiscal quarter ended March 31, 2020.

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PART II - Other Information

Item 1. Legal Proceedings

The nature of the Company’s business generates a certain amount of litigation involving matters arising in the ordinary course of business. However, in the opinion of the Company after consultation with legal counsel, no legal proceedings are pending, which, if determined adversely to the Company or the Bank, would have a material adverse effect on the Company’s undivided profits or financial condition, operations or the results of such operations. No legal proceedings are pending other than ordinary routine litigation incidental to the business of the Company and the Bank. In addition, to management’s knowledge, no governmental authorities have initiated or contemplated any material legal or regulatory actions against the Company or the Bank.

Item 1A. Risk Factors

The COVID-19 Pandemic Has Adversely Impacted Our Business And Financial Results, And The Ultimate Impact Will Depend On Future Developments, Which Are Highly Uncertain And Cannot Be Predicted, Including The Scope And Duration Of The Pandemic And Actions Taken By Governmental Authorities In Response To The Pandemic.

The COVID-19 pandemic has negatively impacted the global, national and local economies, disrupted global and national supply chains, lowered equity market valuations, created significant volatility and disruption in financial markets, and increased unemployment levels. In addition, the pandemic has resulted in temporary closures of many businesses and the institution of social distancing and sheltering in place requirements in many states and communities. As a result, the demand for our products and services may be significantly impacted, which could adversely affect our revenue and results of operations. Furthermore, the pandemic could continue to result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses, particularly if businesses remain closed, the impact on the global, national and local economies worsen, or more customers draw on their lines of credit or seek additional loans to help finance their businesses. Similarly, because of changing economic and market conditions affecting issuers, we may be required to recognize further impairments on the securities we hold as well as reductions in other comprehensive income. Our business operations may also be disrupted if significant portions of our workforce are unable to work effectively, including because of illness, quarantines, government actions, or other restrictions in connection with the pandemic. The extent to which the COVID-19 pandemic impacts our business, results of operations, and financial condition, as well as our regulatory capital and liquidity ratios, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic.

We continue to closely monitor the COVID-19 pandemic and related risks as they evolve. The magnitude, duration and likelihood of the current outbreak of COVID-19, further outbreaks of COVID-19, future actions taken by governmental authorities and/or other third parties in response to the COVID-19 pandemic, and its future direct and indirect effects on the global, national and local economy and our business and results of operation are highly uncertain. The COVID-19 pandemic may cause prolonged global or national recessionary economic conditions or longer lasting effects on economic conditions than currently exist, which could have a material adverse effect on our business, results of operations and financial condition.

Management of the Company does not believe there have been any other material changes to the risk factors that were disclosed in the 2019 Form 10-K filed with the Securities and Exchange Commission on March 13, 2020.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Default Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

None

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Item 6. Exhibits

The following exhibits are filed herewith or incorporated by reference as a part of this Form 10-Q:

﻿3(i) Amended and Restated Articles of Incorporation of Registrant. Incorporated by reference to Annex B of the Proxy Statement/Prospectus included in Registrant’s Amendment 4 to its Registration Statement No. 333-90273 on Form S-4, filed with the SEC on April 6, 2000.

﻿3(ii) Amended and Restated Bylaws of Registrant. Incorporated by reference to Exhibit 3(ii) to Registrant’s Form 8-K filed with the SEC on November 21, 2007.

﻿2.1 Agreement and Plan of Reorganization by and among Fidelity D & D Bancorp, Inc., The Fidelity Deposit and Discount Bank, MNB Corporation and Merchants Bank of Bangor dated as of December 9, 2019. Incorporated by reference to Annex A of the Registrant’s Registration Statement No. 333-236453 on Form S-4, filed with the Commission on February 14, 2020. (Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Fidelity agrees to furnish supplementally to the SEC a copy of any omitted schedule upon request.)

﻿*10.1 Registrant’s 2012 Dividend Reinvestment and Stock Repurchase Plan. Incorporated by reference to Exhibit 4.1 to Registrant’s Registration Statement No. 333-183216 on Form S-3 filed with the SEC on August 10, 2012 as amended February 3, 2014.

﻿*10.2 Registrant’s 2002 Employee Stock Purchase Plan. Incorporated by reference to Appendix A to Definitive proxy Statement filed with the SEC on March 28, 2002.

﻿*10.3 Amended and Restated Executive Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity Deposit and Discount Bank and Daniel J. Santaniello, dated March 23, 2011. Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SEC on March 29, 2011.

﻿*10.4 Amended and Restated Executive Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity Deposit and Discount Bank and Timothy P. O’Brien, dated March 23, 2011. Incorporated by reference to Exhibit 99.2 to Registrant’s Current Report on Form 8-K filed with the SEC on March 29, 2011.

﻿*10.5 2012 Omnibus Stock Incentive Plan. Incorporated by reference to Appendix A to Registrant’s Definitive Proxy Statement filed with the SEC on March 30, 2012.

﻿*10.6 2012 Director Stock Incentive Plan. Incorporated by reference to Appendix B to Registrant’s Definitive Proxy Statement filed with the SEC on March 30, 2012.

﻿*10.7 Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity Deposit and Discount Bank and Salvatore R. DeFrancesco, Jr. dated as of March 17, 2016. Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SEC on March 18, 2016.

*10.8 Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity Deposit and Discount Bank and Eugene J. Walsh dated as of March 29, 2017. Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SEC on April 4, 2017.

﻿*10.9 Form of Supplemental Executive Retirement Plan – Applicable to Daniel J. Santaniello and Salvatore R. DeFrancesco, Jr. Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SEC on April 4, 2017.

*10.10 Form of Supplemental Executive Retirement Plan – Applicable to Eugene J. Walsh and Timothy P O’Brien. Incorporated by reference to Exhibit 99.2 to Registrant’s Current Report on Form 8-K filed with the SEC on April 4, 2017.

﻿*10.11 Form of Split Dollar Life Insurance Agreement – Applicable to Daniel J. Santaniello, Salvatore R. DeFrancesco, Jr. and Eugene J. Walsh. Incorporated by reference to Exhibit 99.3 to Registrant’s Current Report on Form 8-K filed with the SEC on April 4, 2017.

﻿*10.12 Form of Split Dollar Life Insurance Agreement – Applicable to Timothy P O’Brien. Incorporated by reference to Exhibit 99.4 to Registrant’s Current Report on Form 8-K filed with the SEC on April 4, 2017.

﻿*10.13 Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity Deposit and Discount Bank and Michael J. Pacyna dated as of March 20, 2019. Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SEC on March 21, 2019.

﻿*10.14 Form of Supplemental Executive Retirement Plan for Michael J. Pacyna. Incorporated by reference to Exhibit 99.2 to Registrant’s Current Report on Form 8-K filed with the SEC on March 21, 2019.

﻿*10.15 Form of Split Dollar Life Insurance Agreement for Michael J. Pacyna. Incorporated by reference to Exhibit 99.3 to Registrant’s Current Report on Form 8-K filed with the SEC on March 21, 2019.

﻿31.1 Rule 13a-14(a) Certification of Principal Executive Officer, filed herewith.

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﻿31.2 Rule 13a-14(a) Certification of Principal Financial Officer, filed herewith.

﻿32.1 Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.

﻿32.2 Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.

101 Interactive data files: The following, from Fidelity D&D Bancorp, Inc.’s. Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, is formatted in XBRL (eXtensible Business Reporting Language): Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019; Consolidated Statements of Income for the three months ended March 31, 2020 and 2019; Consolidated Statements of Comprehensive Income for the three months ended March 31, 2020 and 2019; Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2020 and 2019; Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019 and the Notes to the Consolidated Financial Statements. **

________________________________________________

* Management contract or compensatory plan or arrangement.

** Pursuant to Rule 406T of Regulation S-T, the interactive data files in Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

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Signatures

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FIDELITY D & D BANCORP, INC.

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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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﻿ |
﻿ | Fidelity D & D Bancorp, Inc.
﻿ |
Date: May 11, 2020 | /s/Daniel J. Santaniello
﻿ | Daniel J. Santaniello, President and Chief Executive Officer
﻿ |
﻿ | Fidelity D & D Bancorp, Inc.
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Date: May 11, 2020 | /s/Salvatore R. DeFrancesco, Jr.
﻿ | Salvatore R. DeFrancesco, Jr., Treasurer and Chief Financial Officer
﻿ |

﻿

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