UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM
(Mark One)
| | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File No.
FNCB BANCORP, INC.
(Exact Name of Registrant as Specified in Its Charter)
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| (State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
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| (Address of Principal Executive Offices) | (Zip Code) |
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Registrant’s telephone number, including area code
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
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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 subject to such filing requirements for the past 90 days.
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).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or 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.
| Large accelerated filer ☐ | | |
| Non-accelerated filer ☐ | Smaller reporting company | |
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Emerging growth company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:
Part I - Financial Information
| CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION |
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| (unaudited) |
| September 30, | December 31, | |||||||
| (in thousands, except share data) | 2020 | 2019 | ||||||
| Assets | ||||||||
| Cash and cash equivalents: | ||||||||
| Cash and due from banks | $ | $ | ||||||
| Interest-bearing deposits in other banks | ||||||||
| Total cash and cash equivalents | ||||||||
| Available-for-sale debt securities, at fair value | ||||||||
| Equity securities, at fair value | ||||||||
| Restricted stock, at cost | ||||||||
| Loans held for sale | ||||||||
| Loans, net of allowance for loan and lease losses of and | ||||||||
| Bank premises and equipment, net | ||||||||
| Accrued interest receivable | ||||||||
| Bank-owned life insurance | ||||||||
| Other real estate owned | ||||||||
| Net deferred tax assets | ||||||||
| Other assets | ||||||||
| Total assets | $ | $ | ||||||
| Liabilities | ||||||||
| Deposits: | ||||||||
| Demand (non-interest-bearing) | $ | $ | ||||||
| Interest-bearing | ||||||||
| Total deposits | ||||||||
| Borrowed funds: | ||||||||
| Federal Home Loan Bank of Pittsburgh advances | ||||||||
| Junior subordinated debentures | ||||||||
| Total borrowed funds | ||||||||
| Accrued interest payable | ||||||||
| Other liabilities | ||||||||
| Total liabilities | ||||||||
| Shareholders' equity | ||||||||
| Preferred shares ( par) | ||||||||
| Authorized: shares at September 30, 2020 and December 31, 2019 | ||||||||
| Issued and outstanding: shares at September 30, 2020 and December 31, 2019 | ||||||||
| Common shares ( par) | ||||||||
| Authorized: shares at September 30, 2020 and December 31, 2019 | ||||||||
| Issued and outstanding: shares at September 30, 2020 and shares at December 31, 2019 | ||||||||
| Additional paid-in capital | ||||||||
| Retained earnings | ||||||||
| Accumulated other comprehensive income | ||||||||
| Total shareholders' equity | ||||||||
| Total liabilities and shareholders’ equity | $ | $ | ||||||
The accompanying notes to consolidated financial statements are an integral part of these statements.
| CONSOLIDATED STATEMENTS OF INCOME |
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| (unaudited) |
| Three Months Ended September 30, |
Nine Months Ended September 30, |
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| (in thousands, except share data) |
2020 |
2019 |
2020 |
2019 |
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| Interest income |
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| Interest and fees on loans |
$ | $ | $ | $ | ||||||||||||
| Interest and dividends on securities: |
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| U.S. government agencies |
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| State and political subdivisions, tax free |
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| State and political subdivisions, taxable |
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| Other securities |
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| Total interest and dividends on securities |
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| Interest on interest-bearing deposits in other banks |
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| Total interest income |
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| Interest expense |
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| Interest on deposits |
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| Interest on borrowed funds: |
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| Federal Reserve Bank Discount Window advances |
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| Federal Home Loan Bank of Pittsburgh advances |
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| Junior subordinated debentures |
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| Subordinated debentures |
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| Total interest on borrowed funds |
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| Total interest expense |
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| Net interest income before provision for loan and lease losses |
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| Provision for loan and lease losses |
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| Net interest income after provision for loan and lease losses |
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| Non-interest income |
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| Deposit service charges |
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| Net gain on the sale of available-for-sale debt securities |
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| Net gain on equity securities |
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| Net gain on the sale of mortgage loans held for sale |
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| Net gain on the sale of other real estate owned | ||||||||||||||||
| Loan-related fees |
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| Income from bank-owned life insurance |
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| Loan referral fees | ||||||||||||||||
| Merchant services revenue |
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| Other |
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| Total non-interest income |
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| Non-interest expense |
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| Salaries and employee benefits |
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| Occupancy expense |
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| Equipment expense |
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| Advertising expense |
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| Data processing expense |
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| Regulatory assessments |
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| Bank shares tax |
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| Expense of other real estate owned |
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| Professional fees |
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| Insurance expense |
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| Directors Fees | ||||||||||||||||
| Other operating expenses |
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| Total non-interest expense |
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| Income before income tax expense |
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| Income tax expense |
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| Net income |
$ | $ | $ | $ | ||||||||||||
| Earnings per share |
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| Basic |
$ | $ | $ | $ | ||||||||||||
| Diluted |
$ | $ | $ | $ | ||||||||||||
| Cash dividends declared per common share |
$ | $ | $ | $ | ||||||||||||
| WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING: |
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| Basic |
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| Diluted |
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The accompanying notes to consolidated financial statements are an integral part of these statements.
| CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME |
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| (unaudited) |
| Three Months Ended September 30, |
Nine Months Ended September 30, |
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| (in thousands) |
2020 |
2019 |
2020 |
2019 |
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| Net income |
$ | $ | $ | $ | ||||||||||||
| Other comprehensive income: |
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| Unrealized gains on available-for-sale debt securities |
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| Taxes |
( |
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| Net of tax amount |
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| Reclassification adjustment for gains included in net income |
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| Taxes |
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| Net of tax amount |
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| Derivative adjustments |
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| Taxes |
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| Net of tax amount |
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| Total other comprehensive income |
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| Comprehensive income |
$ | $ | $ | $ | ||||||||||||
The accompanying notes to consolidated financial statements are an integral part of these statements.
| CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY |
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| For the Three and Nine Months Ended September 30, 2020 and 2019 |
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| (unaudited) |
| (in thousands, except per share data) | Number of Common Shares | Common Stock | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Total Shareholders' Equity | ||||||||||||||||||
| For the three months ended: | ||||||||||||||||||||||||
| Balances, June 30, 2019 | $ | $ | $ | $ | $ | |||||||||||||||||||
| Net income for the period | - | |||||||||||||||||||||||
| Cash dividends paid, per share | - | ( | ) | ( | ) | |||||||||||||||||||
| Restricted stock awards | - | |||||||||||||||||||||||
| Common shares issued under long-term incentive compensation plan | ||||||||||||||||||||||||
| Common shares issued through dividend reinvestment/optional cash purchase plan | ( | ) | ||||||||||||||||||||||
| Other comprehensive income, net of tax of | - | |||||||||||||||||||||||
| Balances, September 30, 2019 | $ | $ | $ | $ | $ | |||||||||||||||||||
| Balances, June 30, 2020 | $ | $ | $ | $ | $ | |||||||||||||||||||
| Net income for the period | - | |||||||||||||||||||||||
| Cash dividends paid, per share | - | ( | ) | ( | ) | |||||||||||||||||||
| Restricted stock awards | - | |||||||||||||||||||||||
| Common shares issued under long-term incentive compensation plan | ||||||||||||||||||||||||
| Common shares issued through dividend reinvestment/optional cash purchase plan | ( | ) | ||||||||||||||||||||||
| Other comprehensive income, net of tax of | - | |||||||||||||||||||||||
| Balances, September 30, 2020 | $ | $ | $ | $ | $ | |||||||||||||||||||
| For the nine months ended: | ||||||||||||||||||||||||
| Balances, December 31, 2018 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||
| Net income for the period | - | |||||||||||||||||||||||
| Cash dividends paid, per share | - | ( | ) | ( | ) | |||||||||||||||||||
| Common shares issued for capital raise, net | ||||||||||||||||||||||||
| Restricted stock awards | - | |||||||||||||||||||||||
| Common shares issued under long-term incentive compensation plan | ||||||||||||||||||||||||
| Common shares issued through dividend reinvestment/optional cash purchase plan | ( | ) | ||||||||||||||||||||||
| Other comprehensive income, net of tax of | - | |||||||||||||||||||||||
| Balances, September 30, 2019 | $ | $ | $ | $ | $ | |||||||||||||||||||
| Balances, December 31, 2019 | $ | $ | $ | $ | $ | |||||||||||||||||||
| Net income for the period | - | |||||||||||||||||||||||
| Cash dividends paid, per share | - | ( | ) | ( | ) | |||||||||||||||||||
| Restricted stock awards | - | |||||||||||||||||||||||
| Common shares issued under long-term incentive compensation plan | ||||||||||||||||||||||||
| Common shares issued through dividend reinvestment/optional cash purchase plan | ( | ) | ||||||||||||||||||||||
| Other comprehensive income, net of tax of | - | |||||||||||||||||||||||
| Balances, September 30, 2020 | $ | $ | $ | $ | $ | |||||||||||||||||||
The accompanying notes to consolidated financial statements are an integral part of these statements.
| CONSOLIDATED STATEMENTS OF CASH FLOWS |
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| (unaudited) |
| Nine Months Ended September 30, |
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| (in thousands) |
2020 |
2019 |
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| Cash flows from operating activities: |
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| Net income | $ | $ | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: |
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| Investment securities amortization, net |
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| Equity in trust |
( |
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| Depreciation and amortization | ||||||||
| Valuation adjustment for loan servicing rights |
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| Stock-based compensation expense |
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| Provision for loan and lease losses | ||||||||
| Valuation adjustment for off-balance sheet commitments |
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| Net gain on the sale of available-for-sale debt securities | ( |
) | ( |
) | ||||
| Net gain on equity securities | ( |
) | ( |
) | ||||
| Net gain on the sale of mortgage loans held for sale | ( |
) | ( |
) | ||||
| Net gain on the sale of other real estate owned | ( |
) | ||||||
| Valuation adjustment of other real estate owned | ||||||||
| Loss on disposition of bank premises and equipment | ||||||||
| Gain on bank-owned life insurance settlement | ( |
) | ||||||
| Income from bank-owned life insurance | ( |
) | ( |
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| Proceeds from the sale of mortgage loans held for sale | ||||||||
| Funds used to originate mortgage loans held for sale | ( |
) | ( |
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| Decrease in net deferred tax assets |
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| (Increase) decrease in accrued interest receivable |
( |
) | ||||||
| Decrease (increase) in prepaid expenses and other assets |
( |
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| (Decrease) increase in accrued interest payable |
( |
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| Decrease in accrued expenses and other liabilities |
( |
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| Total adjustments | ||||||||
| Net cash provided by operating activities | ||||||||
| Cash flows from investing activities: |
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| Maturities, calls and principal payments of available-for-sale debt securities |
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| Proceeds from the sale of available-for-sale debt securities | ||||||||
| Proceeds from the sale/transfer of equity securities | ||||||||
| Purchases of available-for-sale debt securities | ( |
) | ( |
) | ||||
| Purchases of equity securities | ( |
) | ||||||
| Redemption (purchase) of the stock in Federal Home Loan Bank of Pittsburgh |
( |
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| Net increase in loans to customers | ( |
) | ( |
) | ||||
| Proceeds from the sale of other real estate owned |
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| Proceeds received from bank-owned life insurance | ||||||||
| Purchases of bank premises and equipment | ( |
) | ( |
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| Net cash (used in) provided by investing activities | ( |
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| Cash flows from financing activities: |
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| Net increase (decrease) in deposits |
( |
) | ||||||
| (Repayment of) proceeds from Federal Home Loan Bank of Pittsburgh advances - overnight |
( |
) | ||||||
| Proceeds from Federal Home Loan Bank of Pittsburgh advances - term |
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| Repayment of Federal Home Loan Bank of Pittsburgh advances - term |
( |
) | ( |
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| Principal reduction on subordinated debentures |
( |
) | ||||||
| Proceeds from issuance of common shares, net of discount |
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| Cash dividends paid |
( |
) | ( |
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| Net cash provided by (used in) financing activities |
( |
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| Net increase in cash and cash equivalents | ||||||||
| Cash and cash equivalents at beginning of period |
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| Cash and cash equivalents at end of period |
$ | $ | ||||||
| Supplemental cash flow information |
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| Cash paid during the period for: |
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| Interest | $ | $ | ||||||
| Other transactions: |
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| Investor loans transferred to OREO | ||||||||
| Lease liabilities arising from obtaining right-of-use assets |
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| Equity securities without a readily determinable fair value reclassified to equity securities | ||||||||
The accompanying notes to consolidated financial statements are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Basis of Presentation
The consolidated financial statements of FNCB are comprised of the accounts of FNCB Bancorp, Inc., and its wholly owned subsidiary, FNCB Bank (the “Bank”), as well as the Bank’s wholly owned subsidiaries (collectively, “FNCB”). The accounting and reporting policies of FNCB conform to accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10-01 of Regulation S-X. Accordingly, they do not include all the information and accompanying notes required by GAAP for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the financial position and the results of operations for the periods presented have been included in the consolidated financial statements. All intercompany balances and transactions have been eliminated in consolidation. Prior period amounts have been reclassified when necessary to conform to the current period’s presentation. Such reclassifications did not have an impact on the operating results or financial position of FNCB. The operating results and financial position of FNCB for the three and nine months ended September 30, 2020, may not be indicative of future results of operations and financial position.
The preparation of financial statements in accordance 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to change in the near term are the allowance for loan and lease losses (“ALLL”), securities’ valuation and impairment evaluation, the valuation of other real estate owned (“OREO”), and income taxes.
These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in FNCB’s audited financial statements, included in the Annual Report filed on Form 10-K as of and for the year ended December 31, 2019.
Risks and Uncertainties Related to COVID-19
In March 2020, the outbreak of the novel Coronavirus Disease 2019 ("COVID-19") was recognized as a pandemic by the World Health Organization. The spread of COVID-19 has created a global public health crisis that has resulted in, and continues to pose, unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity in the United States and globally, including the markets that FNCB serves. Governmental authorities responded to the pandemic by mandating the closure of locations of non-essential businesses and requiring individuals to observe social distancing and "stay-at-home" restrictions. These governmental restrictions, coupled with fear of contracting the virus, have resulted in a rapid decline in commercial and consumer activity, loss of revenues by businesses, a severe spike in unemployment, material decreases in oil and gas prices and in business valuations, disrupted global supply chains and market volatility.
The federal government has taken several actions designed to mitigate the impact of the economic disruption. Specifically, on March 27, 2020, the Coronavirus Aid, Relief, and Economic Security ("CARES") Act, a $2.0 trillion legislative package, was signed into law. The CARES Act contains substantial tax and spending provisions including direct financial aid to American families, extensive emergency funding for hospitals and medical providers, and economic stimulus to significantly impacted industry sectors. Management expects the general impact of COVID-19, as well as certain provisions of the CARES Act and other recent legislative and regulatory relief efforts, to have a material impact on FNCB's operations. Because the impact is contingent upon the duration and severity of the economic downturn, management cannot determine or estimate the magnitude of the impact at this time. However, FNCB continually monitoring the effects of COVID-19 on FNCB and the Bank.
Business Continuity, Processes and Controls
As a financial institution, FNCB is considered essential and has remained open for business and is operating under its pandemic preparedness plan. To ensure the financial needs of its customers are addressed in a safe and consistent manner, the Bank's offices are open for regular business, with administrative, lending and community branch offices adhering to federal, state, and local governmental guidelines and social distancing mandates. However, in order to limit the spread of COVID-19 customers are encouraged to utilize FNCB's drive-thru facilities, automated teller machines, Customer Care center, remote deposit capture and online and mobile banking applications. FNCB is also providing the necessary technology, when needed, to its operational staff to work remotely in a secure environment. As of September 30, 2020, FNCB did not face any material resource constraints through the implementation of its pandemic preparedness plan. Through the nine months ended September 30, 2020, FNCB incurred COVID-19-related expenses including stay-at-home pay, computer-related costs, cleaning and sanitizing facilities and safety supplies, which are included in non-interest expense in the consolidated statements of income. Additionally, FNCB has not tested for and has not identified any material operational or internal control challenges or risks, nor does it anticipate any significant challenges to its ability to maintain its systems and controls, related to operational changes resulting from implementation of the pandemic preparedness plan.
Financial Position and Results of Operations
Bank regulators have issued guidance and are encouraging banks to work prudently with, and provide short-term payment accommodations to, borrowers affected by COVID-19. Additionally, provisions under Section 4013 of the Cares Act allow banks providing borrowers with modifications related to COVID-19 to elect to not classify any such modification as a Troubled Debt Restructuring ("TDR") if such loan was not more than 30 days past due at December 31, 2019 and the modification was executed between March 1, 2020, the date the President of the United States declared the COVID-19 pandemic a national emergency, and the earlier of 60 days after the date of termination of the this national emergency or December 31, 2020. FNCB has applied the provisions of Section 4013 of the Cares Act and is prudently working with borrowers affected by COVID-19 by providing payment accommodations and other modifications, including but not limited to, payment deferrals involving either interest-only or full payment deferral for periods of up to six months. While interest and fees will still accrue to income, under normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. As a result, interest income in future periods could be negatively impacted. While FNCB is unable to determine the effect of such an impact on its financial condition or results of operations at this time, it recognizes that the sustained economic impact may affect its borrowers’ ability to repay in future periods.
At September 30, 2020, the Bank was considered well capitalized with capital ratios that were in excess of regulatory requirements. However, an extended economic recession resulting from the COVID-19 pandemic could adversely impact FNCB's and the Bank's capital position, as the Bank's regulatory capital ratios could decrease due to a potential increase in credit losses.
Lending Operations and Credit Risk
As previously mentioned, FNCB is working with its lending customers that are facing unemployment, temporary furloughs and closures, by offering a payment deferral program. Generally, FNCB has provided either a short-term interest-only period or full payment deferral depending on the specific need of the borrower. As of September 30, 2020, FNCB assisted
The CARES Act includes a Paycheck Protection Program ("PPP"), a program administered by the Small Business Administration ("SBA") designed to aid small- and medium-sized businesses through federally guaranteed loans distributed through banks. These loans were originally intended to guarantee eight weeks of payroll and other costs to help those businesses remain viable and allow their workers to pay their bills. On June 5, 2020, the payroll coverage period was extended from eight weeks to 24 weeks. As an SBA Lender, the Bank actively participated in the PPP by assisting FNCB's small business community in securing this important funding. As of September 30, 2020, FNCB has approved and/or closed with the SBA
Additionally, the Federal Reserve Bank established the Main Street Lending Program to support lending to small and mid-sized businesses and not-for-profit organizations impacted by the COVID-19 pandemic. Specifically, the Main Street Business Lending Program provides for five loan facilities with total potential funding of up to $600 billion. The Main Street New Loan Facility ("MSNLF"), the Main Street Priority Loan Facility ("MSPLF") and the Main Street Expanded Loan Facility ("MSELF") are three credit facilities that provide eligible business borrowers impacted by COVID-19 with financing in amounts ranging from $250 thousand to $300 million, depending on the facility. Terms of all three facilities include Federal Reserve Bank participation of 95.0%, lender participation of 5.0%, a maturity of 5 years, principal deferral for two years, interest deferral for one year and an adjustable interest rate based on one- or three-month LIBOR plus 300 basis points. Similarly, the Nonprofit Organization New Loan Facility ("NONLF") and the Nonprofit Organization Expanded Loan Facility ("NOELF") provide eligible not-for-profit organizations with financing in amounts ranging from $250 thousand to $10 million. The Bank has received approval from the Federal Reserve Bank as a participating lender in the Main Street Lending Program. During the three months ended September 30, 2020, FNCB originated two MSPLF loans with an aggregate principal balance of $
As the fallout of the COVID-19 pandemic ripples through the national, regional and local economies, management continues to identify and monitor potential weaknesses in the loan portfolio. Management has identified and is monitoring exposures to borrowers and industries that may be impacted more immediately and acutely than others. Additionally, management has proactively reached out to specific borrowers to provide guidance and assistance as appropriate. On a portfolio level, management continues to monitor aggregate exposures to highly sensitive segments, such as hotels and hospitality, for changes in asset quality and payment performance, and liquidity levels. Management monitors unfunded commitments such as lines of credit and overdraft protection to determine liquidity and funding issues that may arise with our customers. FNCB engaged an independent third party consultant to perform a Credit Stress Test analysis of the loan portfolio as of March 31, 2020 to assist management with evaluating the ALLL and capital planning with regard to any potential impacts of COVID-19 on the portfolio. Should economic conditions worsen, FNCB could experience further increases in its required allowance for loan and lease losses and record additional provisions for loan and lease losses. It is possible that FNCB’s asset quality metrics could be materially and adversely impacted in future periods if the effects of COVID-19 are prolonged.
Note 2. New Authoritative Accounting Guidance
Accounting Guidance to be Adopted in Future Periods
ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): “Measurement of Credit Losses on Financial Instruments,” replaces the current loss impairment methodology under GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to form credit loss estimates in an effort to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit. ASU 2016-13 is commonly referred to as Current Expected Credit Losses ("CECL") and will require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The amendments in this update affect entities holding financial assets and net investment in leases that are not accounted for at fair value through net income, including such financial assets as loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. On June 17, 2016, the four, federal financial institution regulatory agencies (the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration and the Office of the Comptroller of the Currency), issued a joint statement to provide information about ASU 2016-13 and the initial supervisory views regarding the implementation of the new standard. The joint statement applies to all banks, savings associations, credit unions and financial institution holding companies, regardless of asset size. The statement details the key elements of, and the steps necessary for, the successful transition to the new accounting standard. In addition, the statement notifies financial institutions that because the appropriate allowance levels are institution-specific amounts, the agencies will not establish benchmark targets or ranges for the change in institutions’ allowance levels upon adoption of the ASU, or for allowance levels going forward. Due to the importance of ASU 2016-13, the agencies encourage financial institutions to begin planning and preparing for the transition and state that senior management, under the oversight of the board of directors, should work closely with staff in their accounting, lending, credit risk management, internal audit, and information technology functions during the transition period leading up to, and well after, adoption. ASU 2016-13 was originally effective for public business entities that are registered with the U.S. Securities and Exchange Commission (“SEC”) under the Securities and Exchange Act of 1934, as amended, including smaller reporting companies, for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. All entities may adopt the amendments in this ASU earlier as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. On November 15, 2019, the FASB issued ASU 2019-10, "Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates," which finalized various effective dates delay for private companies, not-for-profit organizations, and certain smaller reporting companies. Specifically under ASU 2019-10, the effective date for implementation of CECL for smaller reporting companies, private companies and not-for-profits was extended to fiscal years, and interim periods within those years, beginning after December 15, 2022. FNCB is a smaller reporting company, and accordingly, will adopt this guidance on January 1, 2023. FNCB has created a CECL task group comprised of members of its finance, credit administration, lending, internal audit, loan operations and information systems units. The CECL task group understands the provisions of ASU 2016-13 and is currently in the process of implementing the new guidance, which includes, but is not limited to: (1) identifying segments and sub-segments within the loan portfolio that have similar risk characteristics; (2) determining the appropriate methodology for each segment; (3) implementing changes that are necessary to its core operating system and interfaces to be able to capture appropriate data requirements; and (4) evaluating qualitative factors and economic to develop appropriate forecasts for integration into the model. FNCB is currently evaluating the effect this guidance may have on its operating results and/or financial position, including assessing any potential impact on its capital.
Refer to Note 2 to FNCB’s consolidated financial statements included in the 2019 Annual Report on Form 10-K for a discussion of additional accounting guidance applicable to FNCB that will be adopted in future periods.
Note 3. Securities
Debt Securities
The following tables present the amortized cost, gross unrealized gains and losses, and the fair value of FNCB’s available-for-sale debt securities at September 30, 2020 and December 31, 2019:
| September 30, 2020 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Unrealized | Unrealized | |||||||||||||||
| Amortized | Holding | Holding | Fair | |||||||||||||
| (in thousands) | Cost | Gains | Losses | Value | ||||||||||||
| Available-for-sale debt securities: | ||||||||||||||||
| Obligations of state and political subdivisions | $ | $ | $ | $ | ||||||||||||
| U.S. government/government-sponsored agencies: | ||||||||||||||||
| Collateralized mortgage obligations - residential | ||||||||||||||||
| Collateralized mortgage obligations - commercial | ||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| Private collateralized mortgage obligations | ||||||||||||||||
| Corporate debt securities | ||||||||||||||||
| Asset-backed securities | ||||||||||||||||
| Negotiable certificates of deposit | ||||||||||||||||
| Total available-for-sale debt securities | $ | $ | $ | $ | ||||||||||||
| December 31, 2019 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Unrealized | Unrealized | |||||||||||||||
| Amortized | Holding | Holding | Fair | |||||||||||||
| (in thousands) | Cost | Gains | Losses | Value | ||||||||||||
| Available-for-sale debt securities: | ||||||||||||||||
| Obligations of state and political subdivisions | $ | $ | $ | $ | ||||||||||||
| U.S. government/government-sponsored agencies: | ||||||||||||||||
| Collateralized mortgage obligations - residential | ||||||||||||||||
| Collateralized mortgage obligations - commercial | ||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| Private collateralized mortgage obligations | ||||||||||||||||
| Corporate debt securities | ||||||||||||||||
| Asset-backed securities | ||||||||||||||||
| Negotiable certificates of deposit | ||||||||||||||||
| Total available-for-sale debt securities | $ | $ | $ | $ | ||||||||||||
Except for securities of U.S. government and government-sponsored agencies, there were
At September 30, 2020 and December 31, 2019 securities with a carrying amount of $
The following table presents the maturity information of FNCB’s available-for-sale debt securities at September 30, 2020. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Because collateralized mortgage obligations, mortgage-backed securities and asset-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following maturity summary.
| September 30, 2020 | ||||||||
| Amortized | Fair | |||||||
| (in thousands) | Cost | Value | ||||||
| Amounts maturing in: | ||||||||
| One year or less | $ | $ | ||||||
| After one year through five years | ||||||||
| After five years through ten years | ||||||||
| After ten years | ||||||||
| Asset-backed securities | ||||||||
| Collateralized mortgage obligations | ||||||||
| Mortgage-backed securities | ||||||||
| Total available-for-sale debt securities | $ | $ | ||||||
The following table presents the gross proceeds received and gross realized gains and losses on sales of available-for-sale debt securities for the three and nine months ended September 30, 2020 and 2019.
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| (in thousands) | 2020 | 2019 | 2020 | 2019 | ||||||||||||
| Available-for-sale debt securities: | ||||||||||||||||
| Gross proceeds received on sales | $ | $ | $ | $ | ||||||||||||
| Gross realized gains | ||||||||||||||||
| Gross realized losses | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
The following tables present the number, fair value and gross unrealized losses of available-for-sale debt securities with unrealized losses at September 30, 2020 and December 31, 2019, aggregated by investment category and length of time the securities have been in an unrealized loss position.
| September 30, 2020 | ||||||||||||||||||||||||||||||||||||
| Less than 12 Months | 12 Months or Greater | Total | ||||||||||||||||||||||||||||||||||
| Number | Gross | Number | Gross | Number | Gross | |||||||||||||||||||||||||||||||
| of | Fair | Unrealized | of | Fair | Unrealized | of | Fair | Unrealized | ||||||||||||||||||||||||||||
| (dollars in thousands) | Securities | Value | Losses | Securities | Value | Losses | Securities | Value | Losses | |||||||||||||||||||||||||||
| Obligations of state and political subdivisions | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
| U.S. government/government-sponsored agencies: | ||||||||||||||||||||||||||||||||||||
| Collateralized mortgage obligations - residential | ||||||||||||||||||||||||||||||||||||
| Collateralized mortgage obligations - commercial | ||||||||||||||||||||||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||||||||||||||||||||||
| Private collateralized mortgage obligations | ||||||||||||||||||||||||||||||||||||
| Corporate debt securities | ||||||||||||||||||||||||||||||||||||
| Asset-backed securities | ||||||||||||||||||||||||||||||||||||
| Negotiable certificates of deposit | ||||||||||||||||||||||||||||||||||||
| Total available-for-sale debt securities | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
| December 31, 2019 | ||||||||||||||||||||||||||||||||||||
| Less than 12 Months | 12 Months or Greater | Total | ||||||||||||||||||||||||||||||||||
| Number | Gross | Number | Gross | Number | Gross | |||||||||||||||||||||||||||||||
| of | Fair | Unrealized | of | Fair | Unrealized | of | Fair | Unrealized | ||||||||||||||||||||||||||||
| (dollars in thousands) | Securities | Value | Losses | Securities | Value | Losses | Securities | Value | Losses | |||||||||||||||||||||||||||
| Obligations of state and political subdivisions | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
| U.S. government/government-sponsored agencies: | ||||||||||||||||||||||||||||||||||||
| Collateralized mortgage obligations - residential | ||||||||||||||||||||||||||||||||||||
| Collateralized mortgage obligations - commercial | ||||||||||||||||||||||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||||||||||||||||||||||
| Private collateralized mortgage obligations | ||||||||||||||||||||||||||||||||||||
| Corporate debt securities | ||||||||||||||||||||||||||||||||||||
| Asset-backed securities | ||||||||||||||||||||||||||||||||||||
| Negotiable certificates of deposit | ||||||||||||||||||||||||||||||||||||
| Total available-for-sale debt securities | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
Management evaluates individual securities in an unrealized loss position quarterly for other than temporary impairment (“OTTI”). As part of its evaluation, management considers, among other things, the length of time a security’s fair value is less than its amortized cost, the severity of decline, any credit deterioration of the issuer, whether or not management intends to sell the security, and whether it is more likely than not that FNCB will be required to sell the security prior to recovery of its amortized cost.
There were
Equity Securities and Equity Securities without Readily Determinable Fair Values
At December 31, 2019, FNCB owned
On December 18, 2019, this privately held bank holding company entered into an Agreement and Plan Merger (“Merger Agreement”) with a publicly traded bank holding company. The Merger Agreement provided for the privately held bank holding company to merge with and into the publicly traded bank holding company, the company surviving the merger (“surviving company”). The surviving company’s common stock trades on Nasdaq. The acquisition was completed on July 1, 2020. FNCB received $
On September 15, 2020, FNCB purchased
FNCB’s considers its investments in common and preferred shares of the bank holding companies discussed above to be equity securities with a readily determinable fair values and therefore reports these securities at fair value on the consolidated statements of financial condition with unrealized gains and losses recognized in non-interest income in the consolidated statements of income. At September 30, 2020, the common shares had a fair value of $
Also included in equity securities at September 30, 2020 and December 31, 2019, was a $
The following table presents unrealized and realized gains and losses recognized in net income on equity securities for the three and nine months ended September 30, 2020 and 2019.
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| (in thousands) | 2020 | 2019 | 2020 | 2019 | ||||||||||||
| Net gains (losses) recognized on equity securities | $ | $ | $ | $ | ||||||||||||
| Less: net gains (losses) recognized on equity securities sold or transferred | ||||||||||||||||
| Unrealized gains (losses) on equity securities held | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||
Restricted Securities
The following table presents FNCB's investment in restricted stock at September 30, 2020 and December 31, 2019. Restricted stock has limited marketability and is carried at cost.
| September 30, | December 31, | |||||||
| (in thousands) | 2020 | 2019 | ||||||
| Stock in Federal Home Loan Bank of Pittsburgh | $ | $ | ||||||
| Stock in Atlantic Community Banker's Bank | ||||||||
| Total restricted securities, at cost | $ | $ | ||||||
Management noted indicators of impairment for the Federal Home Loan Bank of Pittsburgh or Atlantic Community Banker’s Bank stock at September 30, 2020 and December 31, 2019.
Note 4. Loans
The following table summarizes loans receivable, net, by category at September 30, 2020 and December 31, 2019:
| September 30, | December 31, | |||||||
| (in thousands) | 2020 | 2019 | ||||||
| Residential real estate | $ | $ | ||||||
| Commercial real estate | ||||||||
| Construction, land acquisition and development | ||||||||
| Commercial and industrial | ||||||||
| Consumer | ||||||||
| State and political subdivisions | ||||||||
| Total loans, gross | ||||||||
| Unearned income | ( | ) | ( | ) | ||||
| Net deferred loan (fees) costs | ( | ) | ||||||
| Allowance for loan and lease losses | ( | ) | ( | ) | ||||
| Loans, net | $ | $ | ||||||
Included in commercial and industrial loans at September 30, 2020 were $
FNCB has granted loans, letters of credit and lines of credit to certain of its executive officers and directors as well as to certain of their related parties. For more information about related party transactions, refer to Note 9, “Related Party Transactions” to these consolidated financial statements.
FNCB originates 1-4 family mortgage loans for sale in the secondary market. During the three and nine months ended September 30, 2020, the principal balance of 1-4 family mortgages sold on the secondary market were $
There were sales of Small Business Administration (“SBA”) guaranteed loans during the three and nine months ended September 30, 2020 and 2019. The unpaid principal balance of loans serviced for others, including residential mortgages and SBA-guaranteed loans, was $
FNCB does not have any lending programs commonly referred to as "subprime lending." Subprime lending generally targets borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, and bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios.
There were no material changes to the risk characteristics of FNCB’s loan segments, loan classification and credit grading systems and methodology for determining the adequacy of the ALLL during the nine months ended September 30, 2020. Refer to Note 2, “Summary of Significant Accounting Policies” to FNCB’s consolidated financial statements included in the 2019 Annual Report on Form 10-K for information about the risk characteristics related to FNCB’s loan segments, loan classification and credit grading systems and methodology for determining the adequacy of the ALLL.
Management evaluates the credit quality of the loan portfolio on an ongoing basis and performs a formal review of the adequacy of the ALLL on a quarterly basis. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions. In response to economic disruption and uncertainty caused by the COVID-19 pandemic, management increased the qualitative factor related to its assessment of national, state and local factors as part of its evaluation of the adequacy of the ALLL at September 30, 2020. However, actual loan losses may be significantly more than the established ALLL, which could have a material negative effect on FNCB’s operating results or financial condition. While management uses the best information available to make its evaluations, future adjustments to the ALLL may be necessary if conditions differ substantially from the information used in making the evaluations. Banking regulators, as an integral part of their examination of FNCB, also review the ALLL, and may require, based on their judgments about information available to them at the time of their examination, that certain loan balances be charged off or require that adjustments be made to the ALLL.
The following table summarizes activity in the ALLL by loan category for the three and nine months ended September 30, 2020 and 2019.
| Construction, | ||||||||||||||||||||||||||||||||
| Land | State and | |||||||||||||||||||||||||||||||
| Residential | Commercial | Acquisition and | Commercial | Political | ||||||||||||||||||||||||||||
| (in thousands) | Real Estate | Real Estate | Development | and Industrial | Consumer | Subdivisions | Unallocated | Total | ||||||||||||||||||||||||
| Three months ended September 30, 2020 | ||||||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||||||
| Beginning balance, July 1, 2020 | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||||||
| Provisions (credits) | ( | ) | ||||||||||||||||||||||||||||||
| Ending balance, September 30, 2020 | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Three months ended September 30, 2019 | ||||||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||||||
| Beginning balance, July 1, 2019 | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||||||
| Provisions (credits) | ||||||||||||||||||||||||||||||||
| Ending balance, September 30, 2019 | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Nine months ended September 30, 2020 | ||||||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||||||
| Beginning balance, January 1, 2020 | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||||||
| Provisions (credits) | ( | ) | ||||||||||||||||||||||||||||||
| Ending balance, September 30, 2020 | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Nine months ended September 30, 2019 | ||||||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||||||
| Beginning balance, January 1, 2019 | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||||||
| Provisions (credits) | ( | ) | ( | ) | ||||||||||||||||||||||||||||
| Ending balance, September 30, 2019 | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
The following table presents, by loan category, the allocation of the ALLL and the related loan balance disaggregated based on the impairment methodology at September 30, 2020 and December 31, 2019:
| Construction, | ||||||||||||||||||||||||||||||||
| Land | State and | |||||||||||||||||||||||||||||||
| Residential | Commercial | Acquisition and | Commercial | Political | ||||||||||||||||||||||||||||
| (in thousands) | Real Estate | Real Estate | Development | and Industrial | Consumer | Subdivisions | Unallocated | Total | ||||||||||||||||||||||||
| September 30, 2020 | ||||||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Loans receivable: | ||||||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| December 31, 2019 | ||||||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Loans receivable: | ||||||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Credit Quality Indicators – Commercial Loans
Management continuously monitors and evaluates the credit quality of FNCB’s commercial loans by regularly reviewing certain credit quality indicators. Management utilizes credit risk ratings as the key credit quality indicator for evaluating the credit quality of FNCB’s loan receivables.
FNCB’s loan rating system assigns a degree of risk to commercial loans based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. Management analyzes these non-homogeneous loans individually by grading the loans as to credit risk and probability of collection for each type of loan. Commercial and industrial loans include commercial indirect auto loans which are not individually risk rated, and construction, land acquisition and development loans include residential construction loans which are also not individually risk rated. These loans are monitored on a pool basis due to their homogeneous nature as described in “Credit Quality Indicators – Other Loans” below. FNCB risk rates certain residential real estate loans and consumer loans that are part of a larger commercial relationship using a credit grading system as described in “Credit Quality Indicators – Commercial Loans.” The grading system contains the following basic risk categories:
| 1. | Minimal Risk |
| 2. | Above Average Credit Quality |
| 3. | Average Risk |
| 4. | Acceptable Risk |
| 5. | Pass - Watch |
| 6. | Special Mention |
| 7. | Substandard - Accruing |
| 8. | Substandard - Non-Accrual |
| 9. | Doubtful |
| 10. | Loss |
This analysis is performed on a quarterly basis using the following definitions for risk ratings:
Pass – Assets rated 1 through 5 are considered pass ratings. These assets show no current or potential problems and are considered fully collectible. All such loans are evaluated collectively for ALLL calculation purposes. However, accruing loans restructured under a troubled debt restructuring (“TDRs”) that have been performing for an extended period, do not represent a higher risk of loss, and have been upgraded to a pass rating are evaluated individually for impairment.
Special Mention – Assets classified as special mention do not currently expose FNCB to a sufficient degree of risk to warrant an adverse classification but do possess credit deficiencies or potential weaknesses deserving close attention. Special mention assets have a potential weakness or pose an unwarranted financial risk which, if not corrected, could weaken the asset and increase risk in the future.
Substandard – Assets classified as substandard have well defined weaknesses based on objective evidence, and are characterized by the distinct possibility that FNCB will sustain some loss if the deficiencies are not corrected.
Doubtful – Assets classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that such weaknesses make collection or liquidation in full highly questionable and improbable based on current circumstances.
Loss – Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets is not warranted.
Credit Quality Indicators – Other Loans
Certain residential real estate loans, consumer loans, commercial and municipal indirect auto loans are monitored on a pool basis due to their homogeneous nature. Loans that are delinquent
The following tables present the recorded investment in loans receivable by loan category and credit quality indicator at September 30, 2020 and December 31, 2019:
| Credit Quality Indicators | ||||||||||||||||||||||||||||||||||||||||
| September 30, 2020 | ||||||||||||||||||||||||||||||||||||||||
| Commercial Loans | Other Loans | |||||||||||||||||||||||||||||||||||||||
| Special | Subtotal | Accruing | Non-accrual | Subtotal | Total | |||||||||||||||||||||||||||||||||||
| (in thousands) | Pass | Mention | Substandard | Doubtful | Loss | Commercial | Loans | Loans | Other | Loans | ||||||||||||||||||||||||||||||
| Residential real estate | $ | $ | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||||||||||||||||||||||
| Construction, land acquisition and development | ||||||||||||||||||||||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||||||||||||||||||
| State and political subdivisions | ||||||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
| Credit Quality Indicators | ||||||||||||||||||||||||||||||||||||||||
| December 31, 2019 | ||||||||||||||||||||||||||||||||||||||||
| Commercial Loans | Other Loans | |||||||||||||||||||||||||||||||||||||||
| Special | Subtotal | Accruing | Non-accrual | Subtotal | Total | |||||||||||||||||||||||||||||||||||
| (in thousands) | Pass | Mention | Substandard | Doubtful | Loss | Commercial | Loans | Loans | Other | Loans | ||||||||||||||||||||||||||||||
| Residential real estate | $ | $ | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||||||||||||||||||||||
| Construction, land acquisition and development | ||||||||||||||||||||||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||||||||||||||||||
| State and political subdivisions | ||||||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
Loans classified as substandard were $
Included in loans receivable are loans for which the accrual of interest income has been discontinued due to deterioration in the financial condition of the borrowers. The recorded investment in these non-accrual loans was $
The following tables present the delinquency status of past due and non-accrual loans at September 30, 2020 and December 31, 2019:
| September 30, 2020 | ||||||||||||||||||||
| Delinquency Status | ||||||||||||||||||||
| 0-29 Days | 30-59 Days | 60-89 Days | >/= 90 Days | |||||||||||||||||
| (in thousands) | Past Due | Past Due | Past Due | Past Due | Total | |||||||||||||||
| Performing (accruing) loans: | ||||||||||||||||||||
| Residential real estate | $ | $ | $ | $ | $ | |||||||||||||||
| Commercial real estate | ||||||||||||||||||||
| Construction, land acquisition and development | ||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||
| Consumer | ||||||||||||||||||||
| State and political subdivisions | ||||||||||||||||||||
| Total performing (accruing) loans | ||||||||||||||||||||
| Non-accrual loans: | ||||||||||||||||||||
| Residential real estate | ||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||
| Construction, land acquisition and development | ||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||
| Consumer | ||||||||||||||||||||
| State and political subdivisions | ||||||||||||||||||||
| Total non-accrual loans | ||||||||||||||||||||
| Total loans receivable | $ | $ | $ | $ | $ | |||||||||||||||
| December 31, 2019 | ||||||||||||||||||||
| Delinquency Status | ||||||||||||||||||||
| 0-29 Days | 30-59 Days | 60-89 Days | >/= 90 Days | |||||||||||||||||
| (in thousands) | Past Due | Past Due | Past Due | Past Due | Total | |||||||||||||||
| Performing (accruing) loans: | ||||||||||||||||||||
| Residential real estate | $ | $ | $ | $ | $ | |||||||||||||||
| Commercial real estate | ||||||||||||||||||||
| Construction, land acquisition and development | ||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||
| Consumer | ||||||||||||||||||||
| State and political subdivisions | ||||||||||||||||||||
| Total performing (accruing) loans | ||||||||||||||||||||
| Non-accrual loans: | ||||||||||||||||||||
| Residential real estate | ||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||
| Construction, land acquisition and development | ||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||
| Consumer | ||||||||||||||||||||
| State and political subdivisions | ||||||||||||||||||||
| Total non-accrual loans | ||||||||||||||||||||
| Total loans receivable | $ | $ | $ | $ | $ | |||||||||||||||
The following tables present a distribution of the recorded investment, unpaid principal balance and the related allowance for FNCB’s impaired loans, which have been analyzed for impairment under ASC 310, at September 30, 2020 and December 31, 2019. Non-accrual loans, other than TDRs, with balances less than the thousand loan relationship threshold are not evaluated individually for impairment and accordingly, are not included in the following tables. However, these loans are evaluated collectively for impairment as homogeneous pools in the general allowance under ASC Topic 450. Total non-accrual loans, other than TDRs, with balances less than the $100 thousand loan relationship threshold that were evaluated under ASC Topic 450 amounted to $
| September 30, 2020 | ||||||||||||
| Unpaid | ||||||||||||
| Recorded | Principal | Related | ||||||||||
| (in thousands) | Investment | Balance | Allowance | |||||||||
| With no allowance recorded: | ||||||||||||
| Residential real estate | $ | $ | $ | - | ||||||||
| Commercial real estate | - | |||||||||||
| Construction, land acquisition and development | - | |||||||||||
| Commercial and industrial | - | |||||||||||
| Consumer | - | |||||||||||
| State and political subdivisions | - | |||||||||||
| Total impaired loans with no related allowance recorded | - | |||||||||||
| With a related allowance recorded: | ||||||||||||
| Residential real estate | ||||||||||||
| Commercial real estate | ||||||||||||
| Construction, land acquisition and development | ||||||||||||
| Commercial and industrial | ||||||||||||
| Consumer | ||||||||||||
| State and political subdivisions | ||||||||||||
| Total impaired loans with a related allowance recorded | ||||||||||||
| Total impaired loans: | ||||||||||||
| Residential real estate | ||||||||||||
| Commercial real estate | ||||||||||||
| Construction, land acquisition and development | ||||||||||||
| Commercial and industrial | ||||||||||||
| Consumer | ||||||||||||
| State and political subdivisions | ||||||||||||
| Total impaired loans | $ | $ | $ | |||||||||
| December 31, 2019 | ||||||||||||
| Unpaid | ||||||||||||
| Recorded | Principal | Related | ||||||||||
| (in thousands) | Investment | Balance | Allowance | |||||||||
| With no allowance recorded: | ||||||||||||
| Residential real estate | $ | $ | $ | - | ||||||||
| Commercial real estate | - | |||||||||||
| Construction, land acquisition and development | - | |||||||||||
| Commercial and industrial | - | |||||||||||
| Consumer | - | |||||||||||
| State and political subdivisions | - | |||||||||||
| Total impaired loans with no related allowance recorded | - | |||||||||||
| With a related allowance recorded: | ||||||||||||
| Residential real estate | ||||||||||||
| Commercial real estate | ||||||||||||
| Construction, land acquisition and development | ||||||||||||
| Commercial and industrial | ||||||||||||
| Consumer | ||||||||||||
| State and political subdivisions | ||||||||||||
| Total impaired loans with a related allowance recorded | ||||||||||||
| Total impaired loans: | ||||||||||||
| Residential real estate | ||||||||||||
| Commercial real estate | ||||||||||||
| Construction, land acquisition and development | ||||||||||||
| Commercial and industrial | ||||||||||||
| Consumer | ||||||||||||
| State and political subdivisions | ||||||||||||
| Total impaired loans | $ | $ | $ | |||||||||
The following table presents the average balance and interest income by loan category recognized on impaired loans for the three and nine months ended September 30, 2020 and 2019:
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||||||||||||
| Average | Interest | Average | Interest | Average | Interest | Average | Interest | |||||||||||||||||||||||||
| (in thousands) | Balance | Income (1) | Balance | Income (1) | Balance | Income (1) | Balance | Income (1) | ||||||||||||||||||||||||
| Residential real estate | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||||||||||||||
| Construction, land acquisition and development | ||||||||||||||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||||||||||
| State and political subdivisions | ||||||||||||||||||||||||||||||||
| Total impaired loans | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| (1) Interest income represents income recognized on performing TDRs. |
The additional interest income that would have been earned on non-accrual and restructured loans had these loans performed in accordance with their original terms approximated $
Troubled Debt Restructured Loans
TDRs were $
The modification of the terms of loans classified as TDRs may include one or a combination of the following changes, among others: a reduction of the stated interest rate of the loan, an extension of the maturity date, capitalization of real estate taxes, a payment modification under a forbearance agreement, or a permanent reduction of the recorded investment in the loan.
There were loans modified as TDRs during the three months ended September 30, 2020. Loans modified as TDRs for the nine months ended September 30, 2020 included commercial and industrial loans and residential mortgage loan. The three commercial and industrial loans were modified under forbearance agreements with an aggregate pre- and post-modification recorded investment of $
During the three months ended September 30, 2019, there were
During the three and nine months ended September 30, 2020, there were loans modified as a TDR within the previous 12 months that subsequently defaulted, defined as 90 days or more past due. There were loans that were modified as a TDR within the previous 12 months that subsequently defaulted during the three months ended September 30, 2019. For the nine months ended September 30, 2019, subsequent defaults of TDRs modified within the previous 12 months included consumer loan with a recorded investment of thousand.
Modifications Related to COVID-19
In late March 2020, the federal banking regulators issued guidance and are encouraging banks to work prudently with, and provide short-term payment accommodations to, borrowers affected by COVID-19. Additionally, Section 4013 of the CARES Act addressed COVID-19-related modifications and specified that such modifications made on loans that were current as of December 31, 2019 do not need to be classified as TDRs. FNCB had applied this guidance and made
The following table presents information about COVID-19 related loan modifications by major loan category as of September 30, 2020.
| As of September 30, 2020 | ||||||||||||||||||||||||
| Total Loans Modified | Total Number of Loans Still Under Deferral | |||||||||||||||||||||||
| (in thousands) | Number of Loans | Recorded Investment | % of Loan Category | Number of Loans | Recorded Investment | % of Loan Category | ||||||||||||||||||
| COVID-19 related loan modifications: | ||||||||||||||||||||||||
| Residential real estate | $ | % | $ | % | ||||||||||||||||||||
| Commercial real estate | % | % | ||||||||||||||||||||||
| Construction, land acquisition and development | % | |||||||||||||||||||||||
| Commercial and industrial | % | |||||||||||||||||||||||
| Consumer | % | % | ||||||||||||||||||||||
| State and political subdivision | ||||||||||||||||||||||||
| Total | $ | % | % | |||||||||||||||||||||
Residential Real Estate Loan Foreclosures
There were residential real estate properties foreclosed upon during the three and nine months ended September 30, 2020 or included in OREO at September 30, 2020.
There were consumer mortgage loans with an aggregate recorded investment of $
Note 5. Deposits
The following table presents deposits by major category at September 30, 2020 and December 31, 2019:
| September 30, | December 31, | |||||||
| (in thousands) | 2020 | 2019 | ||||||
| Demand (non-interest bearing) | $ | $ | ||||||
| Interest-bearing: | ||||||||
| Interest-bearing demand | ||||||||
| Savings | ||||||||
| Time ($250,000 and over) | ||||||||
| Other time | ||||||||
| Total interest-bearing | ||||||||
| Total deposits | $ | $ | ||||||
Total deposits were $
Note 6. Borrowings
FNCB has an agreement with the Federal Home Loan Bank (“FHLB”) of Pittsburgh which allows for borrowings, either overnight or term, up to a maximum borrowing capacity based on a percentage of qualifying loans pledged under a blanket pledge agreement. In addition to pledging loans, FNCB is required to purchase FHLB of Pittsburgh stock based upon the amount of credit extended. Loans that were pledged to collateralize borrowings under this agreement were $
Advances through the Federal Reserve Bank Discount Window generally include short-term advances which are fully collateralized by certain pledged loans in the amount of $
At September 30, 2020, there were
| September 30, | December 31, | |||||||
| (in thousands) | 2020 | 2019 | ||||||
| Federal Reserve Discount Window advances | $ | $ | ||||||
| FHLB of Pittsburgh advances: | ||||||||
| Overnight advances | ||||||||
| Term advances | ||||||||
| Subtotal FHLB of Pittsburgh advances | ||||||||
| Junior subordinated debentures | ||||||||
| Total borrowed funds | $ | $ | ||||||
Note 7. Derivative and Hedging Transactions/Subsequent Event
Risk Management Objective of Using Derivatives
FNCB is exposed to certain risks arising from both its business operations and economic conditions. It principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. FNCB manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, FNCB enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Derivative financial instruments are used to manage differences in the amount, timing, and duration of known or expected cash receipts and its known or expected cash payments principally related to FNCB's borrowings.
Cash Flow Hedges of Interest Rate Risk
FNCB’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, FNCB primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for FNCB making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. During 2020, such derivatives were used to hedge the variable cash flows associated with forecasted issuances of debt.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in accumulated other comprehensive income and subsequently reclassified into interest expense in the same period during which the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on FNCB’s variable-rate debt. During 2020, it is estimated that an additional $
Non-designated Hedges
Derivatives not designated as hedges are not speculative and result from a service FNCB provides to certain customers. FNCB executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that FNCB executes with a third party, such that FNCB minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of September 30, 2020, FNCB did have any interest rate swaps related to this program. On October 1, 2020, FNCB executed a -year forward rate swap with a notional amount of $
Fair Values of Derivative Instruments on the Balance Sheet
The table below presents the fair value of FNCB’s derivative financial instruments and the classification on the consolidated statements of financial condition at September 30, 2020 and December 31, 2019.
| Derivative Assets | Derivative Liabilities | |||||||||||||||||||||||||||
| September 30, 2020 | December 31, 2019 | September 30, 2020 | December 31, 2019 | |||||||||||||||||||||||||
| (in thousands) | Notional Amount | Balance Sheet Location | Fair Value | Balance Sheet Location | Fair Value | Notional Amount | Balance Sheet Location | Fair Value | Balance Sheet Location | Fair Value | ||||||||||||||||||
| Derivatives designated as hedging instruments | ||||||||||||||||||||||||||||
| Interest rate products | $ | - | Other assets | $ | Other assets | $ | $ | Other liabilities | $ | Other liabilities | $ | |||||||||||||||||
| Total derivatives designated as hedging instruments | ||||||||||||||||||||||||||||
| Cash and other collateral (1) | ||||||||||||||||||||||||||||
| Net derivative amounts | $ | $ | $ | $ | ||||||||||||||||||||||||
| (1) Other collateral represents the amount that cannot be used to offset FNCB's derivative assets and liabilities from a gross basis to a net basis in accordance with the applicable accounting guidance. The other collateral consists of securities and is exchanged under bilateral collateral and master netting agreements that allow FNCB to offset the net derivative position with the related collateral. The application of the other collateral cannot reduce the net derivative position below zero. Therefore, excess other collateral, if any, is not reflected above. |
Effect of Fair Value and Cash Flow Hedge Accounting on Accumulated Other Comprehensive Income
The table below presents the effect of fair value and cash flow hedge accounting on Accumulated Other Comprehensive Income as of September 30, 2020; amounts disclosed are gross and not net of taxes.
| Three Months Ended September 30, 2020 | |||||||||||||||||||||||||
| (in thousands) | Amount of Gain or (Loss) Recognized in OCI on Derivative | Amount of Gain or (Loss) Recognized in OCI Included Component | Amount of Gain or (Loss) Recognized in OCI Excluded Component | Location of Gain or (Loss) Recognized from Accumulated Other Comprehensive Income into Income | Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income | Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income Included Component | Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income Excluded Component | ||||||||||||||||||
| Derivatives in cash flow hedging relationships | |||||||||||||||||||||||||
| Interest rate products | $ | $ | $ | Interest expense | $ | ( | ) | $ | ( | ) | $ | ||||||||||||||
| Total | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | |||||||||||||||
| Nine Months Ended September 30, 2020 | |||||||||||||||||||||||||
| (in thousands) | Amount of Gain or (Loss) Recognized in OCI on Derivative | Amount of Gain or (Loss) Recognized in OCI Included Component | Amount of Gain or (Loss) Recognized in OCI Excluded Component | Location of Gain or (Loss) Recognized from Accumulated Other Comprehensive Income into Income | Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income | Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income Included Component | Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income Excluded Component | ||||||||||||||||||
| Derivatives in cash flow hedging relationships | |||||||||||||||||||||||||
| Interest rate products | $ | ( | ) | $ | ( | ) | $ | Interest expense | $ | $ | $ | ||||||||||||||
| Total | $ | ( | ) | $ | ( | ) | $ | $ | $ | $ | |||||||||||||||
Effect of Fair Value and Cash Flow Hedge Accounting on the Consolidated Statements of Income and Comprehensive Income
There were no derivative financial instruments outstanding during the nine months ended September 30, 2019. The table below presents the effect of the FNCB’s derivative financial instruments on the Income Statement for the three and nine months ended September 30, 2020.
| Location and Amount of Gain or (Loss) Recognized in Income on Fair Value and Cash Flow Hedging Relationships | ||||||||
| Three Months Ended | Nine Months Ended | |||||||
| September 30, 2020 | September 30, 2020 | |||||||
| (in thousands) | Interest Expense | Interest Expense | ||||||
| Total amounts of income and expense line items presented in the cash flow statement of financial performance in which the effects of fair value or hedges are recorded | $ | ( | ) | $ | ||||
| The effects of fair value and cash flow hedging: | ||||||||
| Gain or (loss) on cash flow hedging relationships in Subtopic 815-20 | ||||||||
| Interest contracts: | ||||||||
| Amount of gain or (loss) reclassified from accumulated other comprehensive income into income | $ | ( | ) | $ | ||||
| Amount of gain or (loss) reclassified from accumulated other comprehensive income into income as a result that a forecasted transaction is no longer probable of occurring | $ | $ | ||||||
| Amount of gain or (loss) reclassified from accumulated OCI into income - included component | $ | ( | ) | $ | ||||
| Amount of gain or (loss) reclassified from accumulated OCI into income - excluded component | $ | $ | ||||||
Credit-risk-related Contingent Features
FNCB has agreements with each of its derivative counterparties that contain a provision where if FNCB defaults or is capable of being declared in default on any of its indebtedness, then it could also be declared in default on its derivative obligations.
FNCB has agreements with certain of its derivative counterparties that contain a provision where if it fails to maintain its status as a well-capitalized institution, then it could be required to post additional collateral.
As of September 30, 2020, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $
Note 8. Income Taxes
The following table presents a reconciliation between the effective income tax expense and the income tax expense that would have been provided at the federal statutory tax rate of
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||||||||||||
| (dollars in thousands) | Amount | % | Amount | % | Amount | % | Amount | % | ||||||||||||||||||||||||
| Provision at statutory tax rates | $ | % | $ | % | $ | % | $ | % | ||||||||||||||||||||||||
| Add (deduct): | ||||||||||||||||||||||||||||||||
| Tax effects of tax free interest income | ( | ) | ( | )% | ( | ) | ( | )% | ( | ) | ( | )% | ( | ) | ( | )% | ||||||||||||||||
| Non-deductible interest expense | % | % | % | % | ||||||||||||||||||||||||||||
| Bank-owned life insurance | ( | ) | ( | )% | ( | ) | ( | )% | ( | ) | ( | )% | ( | ) | ( | )% | ||||||||||||||||
| Other items, net | ( | ) | ( | )% | % | ( | ) | ( | )% | ( | ) | ( | )% | |||||||||||||||||||
| Income tax provision | $ | % | $ | % | $ | % | $ | % | ||||||||||||||||||||||||
FNCB's deferred tax assets, net of deferred tax liabilities, were $
Management evaluates the carrying amount of its deferred tax assets on a quarterly basis, or more frequently if necessary, in accordance with guidance set forth in ASC Topic 740 “Income Taxes,” and applies the criteria in the guidance to determine whether it is more likely than not that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight of available evidence. In evaluating available evidence, management considers, among other factors, historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. In assessing the need for a valuation allowance, management carefully weighs both positive and negative evidence currently available. The weight given to the potential effect of positive and negative evidence must be commensurate with the extent to which it can be objectively verified. If management determines, based on available evidence, both positive and negative, that it is more likely than not that some portion or all of the deferred tax asset will not be realized in future periods, a valuation allowance is calculated and recorded. These determinations are inherently subjective and depend upon management’s estimates and judgments used in their evaluation of both positive and negative evidence.
Management performed an evaluation of FNCB’s deferred tax assets at September 30, 2020 taking into consideration all available positive and negative evidence at that time. Based on this evaluation, management believes that FNCB’s future taxable income will be sufficient to utilize its deferred tax assets. Accordingly, management determined that a valuation allowance for deferred tax assets was required at September 30, 2020 and December 31, 2019.
Note 9. Related Party Transactions
In conducting its business, FNCB has engaged in, and intends to continue to engage in, banking and financial transactions with directors, executive officers and their related parties.
FNCB has granted loans, letters of credit and lines of credit to directors, executive officers and their related parties. The following table summarizes the changes in the total amounts of such outstanding loans, advances under lines of credit, net of any participations sold, as well as repayments during the three and nine months ended September 30, 2020 and 2019.
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| (in thousands) | 2020 | 2019 | 2020 | 2019 | ||||||||||||
| Balance, beginning of period | $ | $ | $ | $ | ||||||||||||
| Additions, new loans and advances | ||||||||||||||||
| Repayments | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Balance, end of period | $ | $ | $ | $ | ||||||||||||
At September 30, 2020 there were
Deposits from directors, executive officers and their related parties held by the Bank at September 30, 2020 and December 31, 2019 amounted to $
In the course of its operations, FNCB acquires goods and services from, and transacts business with, various companies of related parties, which include, but are not limited to, employee health insurance, fidelity bond and errors and omissions insurance, legal services, rent and repair of repossessed automobiles for resale. FNCB recorded payments to related parties for goods and services of $
Note 10. Commitments and Contingencies
Leases
FNCB is obligated under operating leases for certain bank branches, office space, automobiles and equipment. Operating lease right of use ("ROU") assets represent FNCB's right to use an underlying asset during the lease term and operating liabilities represent our obligation to make lease payments under the lease agreement. ROU assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents FNCB's incremental borrowing rate at the commencement date. ROU assets are included in other assets and operating lease liabilities are included in other liabilities in the consolidated statements of financial condition. As of September 30, 2020, ROU assets and lease liabilities were $
The following table summarizes the components of FNCB's operating lease expense for the three and nine months ended September 30, 2020 and 2019. Operating lease expense associated with bank branches and office space is included in occupancy expense, while operating lease expense associated with automobiles and office equipment are included in equipment expense in the consolidated statements of income.
| (in thousands) | Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||
| Operating lease cost - bank branches | $ | $ | $ | $ | ||||||||||||
| Operating lease cost - automobiles and equipment | ||||||||||||||||
| Short-term lease cost - office space | ||||||||||||||||
| Short-term lease cost - automobiles and equipment | ||||||||||||||||
| Variable lease cost | ||||||||||||||||
| Total lease cost | $ | $ | $ | $ | ||||||||||||
The following table summarizes the maturity of remaining operating lease liabilities as of September 30, 2020:
| (in thousands) | September 30, 2020 | |||
| 2020 | $ | |||
| 2021 | ||||
| 2022 | ||||
| 2023 | ||||
| 2024 | ||||
| 2025 and thereafter | ||||
| Total lease payments | ||||
| Less: imputed interest | ||||
| Present value of operating lease liabilities | $ | |||
The following table presents other information related to our operating leases:
| (dollars in thousands) | September 30, 2020 | |||
| Weighted-average remaining lease term |
| |||
| Weighted-average discount rate | % | |||
| Cash paid for amounts included in the measurement of lease liabilities: | ||||
| Operating cash flows from operating leases | $ | |||
Litigation
FNCB has been subject to tax audits, and is also a party to routine litigation involving various aspects of its business, such as employment practice claims, workers compensation claims, claims to enforce liens, condemnation proceedings on properties in which FNCB holds security interests, claims involving the making and servicing of real property loans and other issues incident to its business, none of which has or is expected to have a material adverse impact on the consolidated financial condition, results of operations or liquidity of FNCB.
Note 11. Stock Compensation Plans
FNCB has a Long-Term Incentive Compensation Plan (“LTIP”) for directors, executives and key employees. The LTIP authorizes up to
On July 1, 2020,
The following table summarizes the activity related to FNCB’s unvested restricted stock awards during the three and nine months ended September 30, 2020 and 2019:
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||||||||||||
| Weighted- | Weighted- | Weighted- | Weighted- | |||||||||||||||||||||||||||||
| Average | Average | Average | Average | |||||||||||||||||||||||||||||
| Restricted | Grant Date | Restricted | Grant Date | Restricted | Grant Date | Restricted | Grant Date | |||||||||||||||||||||||||
| (dollars in thousands) | Shares | Fair Value | Shares | Fair Value | Shares | Fair Value | Shares | Fair Value | ||||||||||||||||||||||||
| Unvested restricted stock awards: | ||||||||||||||||||||||||||||||||
| Total outstanding, beginning of period | $ | $ | $ | $ | ||||||||||||||||||||||||||||
| Awards granted | ||||||||||||||||||||||||||||||||
| Forfeitures | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||
| Vestings | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||
| Total outstanding, end of period | $ | $ | $ | $ | ||||||||||||||||||||||||||||
Note 12. Regulatory Matters
On January 28, 2019, FNCB announced that it had commenced a public offering of shares of its common stock in a firm commitment underwritten offering. The offering closed on February 8, 2019 and FNCB issued
FNCB’s ability to pay dividends to its shareholders is largely dependent on the Bank’s ability to pay dividends to FNCB. Bank regulations limit the amount of dividends that may be paid without prior approval of the Bank’s regulatory agency. For the three and nine months ended September 30, 2020, cash dividends declared and paid by FNCB were $
In 2018, the Federal Reserve increased the asset limit to qualify as a small bank holding company from $1 billion to $3 billion. As a result, the Company met the eligibility criteria for a small bank holding company and was exempt from risk-based capital and leverage rules, including Basel III. FNCB 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 possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on FNCB’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, FNCB and the Bank must meet specific capital guidelines that involve quantitative measures of FNCB's and the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. FNCB's and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Management believes, as of September 30, 2020 and December 31, 2019, that FNCB and the Bank meet all applicable capital adequacy requirements. In addition, the Bank is required to maintain a "capital conservation buffer," composed entirely of common equity Tier I capital, in addition to minimum risk-based capital ratios, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers). The required capital conservation buffer is 2.500% for 2020 and 2019. Management believes the Bank was in full compliance with the additional capital conservation buffer requirement at September 30, 2020 and December 31, 2019.
Current quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the tables below) of Total capital, Tier I capital, and Tier I common equity (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). The following tables present summary information regarding the Bank’s risk-based capital and related ratios at September 30, 2020 and December 31, 2019:
| FNCB Bank | Minimum Required For Capital Adequacy Purposes | Minimum Required For Capital Adequacy Purposes with Conservation Buffer | Minimum Required To Be Well Capitalized Under Prompt Corrective Action Regulations | |||||||||||||||||
| (dollars in thousands) | Amount | Ratio | Ratio | Ratio | Ratio | |||||||||||||||
| September 30, 2020 | ||||||||||||||||||||
| Total capital (to risk-weighted assets) | $ | % | % | % | % | |||||||||||||||
| Tier I capital (to risk-weighted assets) | % | % | % | % | ||||||||||||||||
| Tier I common equity (to risk-weighted assets) | % | % | % | % | ||||||||||||||||
| Tier I capital (to average assets) | % | % | % | % | ||||||||||||||||
| Total risk-weighted assets | ||||||||||||||||||||
| Total average assets | ||||||||||||||||||||
| FNCB Bank | Minimum Required For Capital Adequacy Purposes | Minimum Required For Capital Adequacy Purposes with Conservation Buffer | Minimum Required To Be Well Capitalized Under Prompt Corrective Action Regulations | |||||||||||||||||
| (dollars in thousands) | Amount | Ratio | Ratio | Ratio | Ratio | |||||||||||||||
| December 31, 2019 | ||||||||||||||||||||
| Total capital (to risk-weighted assets) | $ | % | % | % | % | |||||||||||||||
| Tier I capital (to risk-weighted assets) | % | % | % | % | ||||||||||||||||
| Tier I common equity (to risk-weighted assets) | % | % | % | % | ||||||||||||||||
| Tier I capital (to average assets) | % | % | % | % | ||||||||||||||||
| Total risk-weighted assets | ||||||||||||||||||||
| Total average assets | ||||||||||||||||||||
Note 13. Fair Value Measurements
In determining fair value, FNCB uses various valuation approaches, including market, income and cost approaches. Accounting standards establish a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability, which are developed based on market data obtained from sources independent of FNCB. Unobservable inputs reflect FNCB’s knowledge about the assumptions the market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances.
The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). A financial asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:
| ● | Level 1 valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets; |
| ● | Level 2 valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by market data; and |
| ● | Level 3 valuation is derived from other valuation methodologies including discounted cash flow models and similar techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in determining fair value. |
A description of the valuation methodologies used for assets recorded at fair value is set forth below.
Available-for-Sale Debt Securities
The estimated fair values for FNCB’s investments in obligations of U.S. government agencies, obligations of state and political subdivisions, government-sponsored agency CMOs and mortgage-backed securities, private collateralized mortgage obligations, asset-backed securities and negotiable certificates of deposit are obtained by FNCB from a nationally-recognized pricing service. This pricing service develops estimated fair values by analyzing like securities and applying available market information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing (Level 2 inputs), to prepare valuations. Matrix pricing is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities. The fair value measurements consider observable data that may include, among other things, dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, and are based on market data obtained from sources independent from FNCB. The Level 2 investments in FNCB’s portfolio are priced using those inputs that, based on the analysis prepared by the pricing service, reflect the assumptions that market participants would use to price the assets. Management has determined that the Level 2 designation is appropriate for these securities because, as with most fixed-income securities, those in FNCB’s portfolio are not exchange-traded, and such non-exchange-traded fixed income securities are typically priced by correlation to observed market data. FNCB has reviewed the pricing service’s methodology to confirm its understanding that such methodology results in a valuation based on quoted market prices for similar instruments traded in active markets, quoted markets for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which the significant assumptions can be corroborated by market data as appropriate to a Level 2 designation.
For those securities for which the inputs used by an independent pricing service were derived from unobservable market information, FNCB evaluated the appropriateness and quality of each price. Management reviewed the volume and level of activity for all classes of securities and attempted to identify transactions which may not be orderly or reflective of a significant level of activity and volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary, to estimate fair value (fair values based on Level 3 inputs). If applicable, the adjustment to fair value was derived based on present value cash flow model projections obtained from third party providers using assumptions similar to those incorporated by market participants.
At September 30, 2020, FNCB owned twelve corporate debt securities with an aggregate amortized cost and fair value of $
Equity Securities
The estimated fair values of equity securities are determined by obtaining quoted prices on nationally recognized exchanges (Level 1 inputs).
Derivative Contracts
FNCB's derivative liabilities are reported at fair value utilizing Level 2 inputs. Values of these instruments are obtained through an independent pricing source utilizing information which may include market observed quotations for swaps, LIBOR rates, forward rates and rate volatility. Derivative contracts create exposure to interest rate movements as well as risks from the potential of non-performance of the counterparty.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following tables present the financial assets and liabilities that were measured at fair value on a recurring basis at September 30, 2020, financial assets that were measured at fair value on a recurring basis at December 31, 2019, and the fair value hierarchy of the respective valuation techniques utilized by FNCB to determine the fair value.:
| Fair Value Measurements at September 30, 2020 | ||||||||||||||||
| Significant | Significant | |||||||||||||||
| Quoted Prices | Other | Other | ||||||||||||||
| in Active Markets | Observable | Unobservable | ||||||||||||||
| for Identical Assets | Inputs | Inputs | ||||||||||||||
| (in thousands) | Fair Value | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
| Financial assets: | ||||||||||||||||
| Available-for-sale debt securities: | ||||||||||||||||
| Obligations of state and political subdivisions | $ | $ | $ | $ | ||||||||||||
| U.S. government/government-sponsored agencies: | ||||||||||||||||
| Collateralized mortgage obligations - residential | ||||||||||||||||
| Collateralized mortgage obligations - commercial | ||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| Private collateralized mortgage obligations | ||||||||||||||||
| Corporate debt securities | ||||||||||||||||
| Asset-backed securities | ||||||||||||||||
| Negotiable certificates of deposit | ||||||||||||||||
| Subtotal available-for-sale debt securities | ||||||||||||||||
| Equity securities, at fair value | ||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||
| Financial liabilities: | ||||||||||||||||
| Derivative liabilities | $ | $ | $ | $ | ||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||
| Fair Value Measurements at December 31, 2019 | ||||||||||||||||
| Significant | Significant | |||||||||||||||
| Quoted Prices | Other | Other | ||||||||||||||
| in Active Markets | Observable | Unobservable | ||||||||||||||
| for Identical Assets | Inputs | Inputs | ||||||||||||||
| (in thousands) | Fair Value | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
| Financial assets: | ||||||||||||||||
| Available-for-sale debt securities: | ||||||||||||||||
| Obligations of state and political subdivisions | $ | $ | $ | $ | ||||||||||||
| U.S. government/government-sponsored agencies: | ||||||||||||||||
| Collateralized mortgage obligations - residential | ||||||||||||||||
| Collateralized mortgage obligations - commercial | ||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| Private collateralized mortgage obligations | ||||||||||||||||
| Corporate debt securities | ||||||||||||||||
| Asset-backed securities | ||||||||||||||||
| Negotiable certificates of deposit | ||||||||||||||||
| Subtotal available-for-sale debt securities | ||||||||||||||||
| Equity securities, at fair value | ||||||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||
There were no transfers between levels within the fair value hierarchy during the nine months ended September 30, 2020 and 2019.
The following table presents a reconciliation and statement of operations classifications of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3), which consisted entirely of corporate debt securities, for the nine months ended September 30, 2020 and 2019.
| Fair Value Measurements | ||||||||
| Using Significant Unobservable Inputs (Level 3) | ||||||||
| Corporate Debt Securities | ||||||||
| For the Nine Months Ended September 30, | ||||||||
| (in thousands) | 2020 | 2019 | ||||||
| Balance at January 1, | $ | $ | ||||||
| Additions | ||||||||
| Payments Received | ||||||||
| Sales | ||||||||
| Total gains or losses (realized/unrealized): | ||||||||
| Included in earnings | ||||||||
| Included in other comprehensive income | ||||||||
| Balance at September 30, | $ | $ | ||||||
Assets Measured at Fair Value on a Non-Recurring Basis
The following tables present assets and liabilities measured at fair value on a non-recurring basis at September 30, 2020 and December 31, 2019, and additional quantitative information about the valuation techniques and inputs utilized by FNCB to determine fair value. All assets were measured using Level 3 inputs.
| September 30, 2020 | |||||||||||||||||||||
| Fair Value Measurement | Quantitative Information | ||||||||||||||||||||
| Recorded | Valuation | Fair | Valuation | Unobservable | Value/ | ||||||||||||||||
| (in thousands) | Investment | Allowance | Value | Technique | Inputs | Range | |||||||||||||||
| Impaired loans - collateral dependent | $ | $ | $ | Appraisal of collateral | Selling cost | % | |||||||||||||||
| Impaired loans - other | Discounted cash flows | Discount rate | - | ||||||||||||||||||
| Other real estate owned | Appraisal of collateral | Selling cost | % | ||||||||||||||||||
| December 31, 2019 | |||||||||||||||||||||
| Fair Value Measurement | Quantitative Information | ||||||||||||||||||||
| Recorded | Valuation | Fair | Valuation | Unobservable | Value/ | ||||||||||||||||
| (in thousands) | Investment | Allowance | Value | Technique | Inputs | Range | |||||||||||||||
| Impaired loans - collateral dependent | $ | $ | $ | Appraisal of collateral | Selling cost | % | |||||||||||||||
| Impaired loans - other | Discounted cash flows | Discount rate | |||||||||||||||||||
| Other real estate owned | Appraisal of collateral | Selling cost | % | ||||||||||||||||||
The fair value of collateral-dependent impaired loans is determined through independent appraisals or other reasonable offers, which generally include various Level 3 inputs which are not identifiable. Management reduces the appraised value by the estimated costs to sell the property and may make adjustments to the appraised values as necessary to consider any declines in real estate values since the time of the appraisal. For impaired loans that are not collateral-dependent, fair value is determined using the discounted cash flow method. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance or is charged off. The amount shown is the balance of impaired loans, net of any charge-offs and the related allowance for loan losses.
OREO properties are recorded at fair value less the estimated cost to sell at the date of FNCB’s acquisition of the property. Subsequent to acquisition of the property, the balance may be written down further. It is FNCB’s policy to obtain certified external appraisals of real estate collateral underlying impaired loans and OREO, and estimate fair value using those appraisals. Other valuation sources may be used, including broker price opinions, letters of intent and executed sale agreements.
The following table summarizes the estimated fair values of FNCB’s financial instruments using an exit price notion at September 30, 2020 and at December 31, 2019. FNCB discloses fair value information about financial instruments, whether or not recognized in the statements of financial condition, for which it is practicable to estimate that value. The fair value of financial instruments that are not measured at fair value in the financial statements were based on the exit price notion. The following estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, management judgment is required to interpret data and develop fair value estimates. Accordingly, the estimates below are not necessarily indicative of the amounts FNCB could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
| Fair Value | September 30, 2020 | December 31, 2019 | |||||||||||||||||
| (in thousands) | Measurement | Carrying Value | Fair Value | Carrying Value | Fair Value | ||||||||||||||
| Financial assets | |||||||||||||||||||
| Cash and short term investments | Level 1 | $ | $ | $ | $ | ||||||||||||||
| Available-for-sale debt securities | See previous table | ||||||||||||||||||
| Equity securities, at fair value | Level 1 | ||||||||||||||||||
| Restricted stock | Level 2 | ||||||||||||||||||
| Loans held for sale | Level 2 | ||||||||||||||||||
| Loans, net | Level 3 | ||||||||||||||||||
| Accrued interest receivable | Level 2 | ||||||||||||||||||
| Servicing rights | Level 3 | ||||||||||||||||||
| Financial liabilities | |||||||||||||||||||
| Deposits | Level 2 | ||||||||||||||||||
| Borrowed funds | Level 2 | ||||||||||||||||||
| Accrued interest payable | Level 2 | ||||||||||||||||||
| Derivative liabilities | Level 2 | ||||||||||||||||||
Note 14. Earnings per Share
For FNCB, the numerator of both the basic and diluted earnings per share of common stock is net income available to common shareholders. The weighted-average number of common shares outstanding used in the denominator for basic earnings per common share is increased to determine the denominator used for diluted earnings per common share by the effect of potentially dilutive common share equivalents utilizing the treasury stock method. For the three and nine months ended September 30, 2020 and 2019, common share equivalents consisted entirely of incremental shares of unvested restricted stock.
The following table presents the calculation of both basic and diluted earnings per share of common stock for the three and nine months ended September 30, 2020 and 2019:
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| (in thousands, except share data) | 2020 | 2019 | 2020 | 2019 | ||||||||||||
| Net income | $ | $ | $ | $ | ||||||||||||
| Basic weighted-average number of common shares outstanding | ||||||||||||||||
| Plus: Common share equivalents | ||||||||||||||||
| Diluted weighted-average number of common shares outstanding | ||||||||||||||||
| Income per common share: | ||||||||||||||||
| Basic | $ | $ | $ | $ | ||||||||||||
| Diluted | $ | $ | $ | $ | ||||||||||||
Note 15. Other Comprehensive Income
The following table summarizes the reclassifications out of accumulated other comprehensive income for the three and nine months ended September 30, 2020 and 2019, comprised entirely of unrealized gains and losses on available-for-sale debt securities:
| For the Three Months Ended September 30, 2020 | For the Nine Months Ended September 30, 2020 | |||||||||
| (in thousands) | Amount Reclassified from Accumulated Other Comprehensive Income | Affected Line Item in the Consolidated Statements of Income | Amount Reclassified from Accumulated Other Comprehensive Income | Affected Line Item in the Consolidated Statements of Income | ||||||
| Available-for-sale debt securities: | ||||||||||
| Reclassification adjustment for net gains reclassified into net income | $ | ( | ) | Net gain on the sale of available-for-sale debt securities | $ | ( | ) | Net gain on the sale of available-for-sale debt securities | ||
| Taxes | Income taxes | Income taxes | ||||||||
| Net of tax amount | $ | ( | ) | $ | ( | ) | ||||
| For the Three Months Ended September 30, 2019 | For the Nine Months Ended September 30, 2019 | |||||||||
| (in thousands) | Amount Reclassified from Accumulated Other Comprehensive Income | Affected Line Item in the Consolidated Statements of Income | Amount Reclassified from Accumulated Other Comprehensive Income | Affected Line Item in the Consolidated Statements of Income | ||||||
| Available-for-sale debt securities: | ||||||||||
| Reclassification adjustment for net gains reclassified into net income | $ | ) | Net gain on the sale of available-for-sale debt securities | $ | ) | Net gain on the sale of available-for-sale debt securities | ||||
| Taxes | Income taxes | Income taxes | ||||||||
| Net of tax amount | $ | ) | $ | ) | ||||||
The following table summarizes the changes in accumulated other comprehensive income (loss), net of tax for the three and nine months ended September 30, 2020 and 2019:
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| (in thousands) | 2020 | 2019 | 2020 | 2019 | ||||||||||||
| Balance, beginning of period | $ | $ | $ | $ | ( | ) | ||||||||||
| Other comprehensive income before reclassifications | ||||||||||||||||
| Amount reclassified from accumulated other comprehensive income | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Net other comprehensive income during the period | ||||||||||||||||
| Balance, end of period | $ | $ | $ | $ | ||||||||||||
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)
This Quarterly Report on Form 10-Q should be read in conjunction with the more detailed and comprehensive disclosures included in the Annual Report on Form 10-K for the year ended December 31, 2019 for FNCB Bancorp, Inc. In addition, please read this section in conjunction with the consolidated financial statements and notes to consolidated financial statements contained elsewhere herein.
FNCB Bancorp, Inc. and its subsidiaries ("FNCB") are in the business of providing customary retail and commercial banking services to individuals, businesses and local governments and municipalities through its wholly-owned subsidiary, FNCB Bank, at its 17 full-service branch offices within its primary market area, Northeastern Pennsylvania, and a limited purpose office based in Allentown, Lehigh County, Pennsylvania.
FORWARD-LOOKING STATEMENTS AND OTHER INFORMATION
FNCB may from time to time make written or oral “forward-looking statements,” including statements contained in our filings with the Securities and Exchange Commission (“SEC”), in our reports to shareholders, and in our other communications, which are made in good faith by us pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include statements with respect to FNCB’s beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond our control). The words “may,” “could,” “should,” “will,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “project,” “future” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause FNCB’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the effect of the novel Coronavirus Disease 2019 ("COVID-19") pandemic on FNCB and its customers, the Commonwealth of Pennsylvania and the United States, related to the economy and overall financial stability; government and regulatory responses to the COVID-19 pandemic; government intervention in the U.S. financial system including the effects of recent legislative, tax, accounting and regulatory actions and reforms, including, but not limited to, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and the Tax Cuts and Jobs Act; political instability; the ability of FNCB to manage credit risk; weakness in the economic environment, in general, and within FNCB’s market area; the deterioration of one or a few of the commercial real estate loans with relatively large balances contained in FNCB’s loan portfolio; greater risk of loan defaults and losses from concentration of loans held by FNCB, including those to insiders and related parties; if FNCB’s portfolio of loans to small and mid-sized community-based businesses increases its credit risk; if FNCB’s ALLL is not sufficient to absorb actual losses or if increases to the ALLL were required; FNCB is subject to interest-rate risk and any changes in interest rates could negatively impact net interest income or the fair value of FNCB's financial assets; if management concludes that the decline in value of any of FNCB’s investment securities is other-than-temporary could result in FNCB recording an impairment loss; if FNCB’s risk management framework is ineffective in mitigating risks or losses to FNCB; if FNCB is unable to successfully compete with others for business; a loss of depositor confidence resulting from changes in either FNCB’s financial condition or in the general banking industry; if FNCB is unable to retain or grow its core deposit base; inability or insufficient dividends from its subsidiary, FNCB Bank; if FNCB loses access to wholesale funding sources; interruptions or security breaches of FNCB’s information systems; any systems failures or interruptions in information technology and telecommunications systems of third parties on which FNCB depends; security breaches; if FNCB’s information technology is unable to keep pace with growth or industry developments or if technological developments result in higher costs or less advantageous pricing; the loss of management and other key personnel; dependence on the use of data and modeling in both its management’s decision-making generally and in meeting regulatory expectations in particular; additional risk arising from new lines of business, products, product enhancements or services offered by FNCB; inaccuracy of appraisals and other valuation techniques FNCB uses in evaluating and monitoring loans secured by real property and other real estate owned; unsoundness of other financial institutions; damage to FNCB’s reputation; defending litigation and other actions; dependence on the accuracy and completeness of information about customers and counterparties; risks arising from future expansion or acquisition activity; environmental risks and associated costs on its foreclosed real estate assets; any remediation ordered, or adverse actions taken, by federal and state regulators, including requiring FNCB to act as a source of financial and managerial strength for the FNCB Bank in times of stress; costs arising from extensive government regulation, supervision and possible regulatory enforcement actions; new or changed legislation or regulation and regulatory initiatives; noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations; failure to comply with numerous "fair and responsible banking" laws; any violation of laws regarding privacy, information security and protection of personal information or another incident involving personal, confidential or proprietary information of individuals; any rulemaking changes implemented by the Consumer Financial Protection Bureau; inability to attract and retain its highest performing employees due to potential limitations on incentive compensation contained in proposed federal agency rulemaking; any future increases in FNCB Bank’s FDIC deposit insurance premiums and assessments; and the success of FNCB at managing the risks involved in the foregoing and other risks and uncertainties, including those detailed in FNCB’s filings with the SEC.
FNCB cautions that the foregoing list of important factors is not all inclusive. Readers are also cautioned not to place undue reliance on any forward-looking statements, which reflect management’s analysis only as of the date of this report, even if subsequently made available by FNCB on its website or otherwise. FNCB does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of FNCB to reflect events or circumstances occurring after the date of this report.
Readers should carefully review the risk factors described in the documents that FNCB periodically files with the SEC, including its Annual Report on Form 10-K for the year ended December 31, 2019.
Any references to FNCB's website, www.fncb.com or any variation thereof, shall not incorporate the contents of such website into this Report.
CRITICAL ACCOUNTING POLICIES
In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of condition and results of operations for the periods indicated. Actual results could differ significantly from those estimates.
FNCB’s accounting policies are fundamental to understanding management’s discussion and analysis of its financial condition and results of operations. Management has identified the policies on the determination of the allowance for loan and lease losses (“ALLL”), securities’ valuation and impairment evaluation, the valuation of other real estate owned (“OREO”) and income taxes to be critical, as management is required to make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available.
The judgments used by management in applying the critical accounting policies discussed below may be affected by changes and/or deterioration in the economic environment, which may impact future financial results. Specifically, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the ALLL in future periods, and the inability to collect on outstanding loans could result in increased loan losses. In addition, the valuation of certain securities in FNCB’s investment portfolio could be negatively impacted by illiquidity or dislocation in marketplaces resulting in significantly depressed market prices thus leading to impairment losses.
Allowance for Loan and Lease Losses
Management evaluates the credit quality of FNCB’s loan portfolio on an ongoing basis and performs a formal review of the adequacy of the ALLL on a quarterly basis. The ALLL is established through a provision for loan losses charged to earnings and is maintained at a level management considers adequate to absorb estimated probable losses inherent in the loan portfolio as of the evaluation date. Loans, or portions of loans, determined by management to be uncollectible are charged off against the ALLL, while recoveries of amounts previously charged off are credited to the ALLL.
Determining the amount of the ALLL is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, qualitative factors, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. Banking regulators, as an integral part of their examination of FNCB, also review the ALLL, and may require, based on their judgments about information available to them at the time of their examination, that certain loan balances be charged off or require that adjustments be made to the ALLL. Additionally, the ALLL is determined, in part, by the composition and size of the loan portfolio.
The ALLL consists of two components, a specific component and a general component. The specific component relates to loans that are classified as impaired. For such loans, an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans and is based on historical loss experience adjusted by qualitative factors. The general reserve component of the ALLL is based on pools of unimpaired loans segregated by loan segment and risk rating categories of “Pass,” “Special Mention” or “Substandard and Accruing.” Historical loss factors and various qualitative factors are applied based on the risk profile in each risk rating category to determine the appropriate reserve related to those loans. Substandard loans on non-accrual status above the $100 thousand loan relationship threshold and all loans considered troubled debt restructurings (“TDRs”) are classified as impaired.
See Note 4, “Loans” of the notes to consolidated financial statements included in Item 1 hereof for additional information about the ALLL.
Securities Valuation and Evaluation for Impairment
Management utilizes various inputs to determine the fair value of its investment portfolio. To the extent they exist, unadjusted quoted market prices in active markets (Level 1) or quoted prices for similar assets or models using inputs that are observable, either directly or indirectly (Level 2) are utilized to determine the fair value of each investment in the portfolio. In the absence of observable inputs or if markets are illiquid, valuation techniques are used to determine fair value of any investments that require inputs that are both unobservable and significant to the fair value measurement (Level 3). For Level 3 inputs, valuation techniques are based on various assumptions, including, but not limited to, cash flows, discount rates, adjustments for nonperformance and liquidity, and liquidation values. A significant degree of judgment is involved in valuing investments using Level 3 inputs. The use of different assumptions could have a positive or negative effect on FNCB’s financial condition or results of operations. See Note 3, “Securities” and Note 13, “Fair Value Measurements” of the notes to consolidated financial statements included in Item 1 hereof for additional information about FNCB’s securities valuation techniques.
On a quarterly basis, management evaluates individual investment securities in an unrealized loss position for other than temporary impairment (“OTTI”). The evaluation for OTTI requires the use of various assumptions, including but not limited to, the length of time an investment’s fair value is less than book value, the severity of the investment’s decline, any credit deterioration of the issuer, whether management intends to sell the security, and whether it is more-likely-than-not that FNCB will be required to sell the security prior to recovery of its amortized cost basis. Debt investment securities deemed to have OTTI are written down by the impairment related to the estimated credit loss, and the non-credit related impairment loss is recognized in other comprehensive income. FNCB did not recognize any OTTI charges on investment securities for the three and nine months ended September 30, 2020 and 2019 within the consolidated statements of income.
Refer to Note 3, “Securities,” of the notes to consolidated financial statements included in Item 1 hereof for additional information about valuation of securities.
Other Real Estate Owned
OREO consists of property acquired by foreclosure, abandonment or conveyance of deed in-lieu of foreclosure of a loan, and bank premises that are no longer used for operation or for future expansion. OREO is held for sale and is initially recorded at fair value less estimated costs to sell at the date of acquisition or transfer, which establishes a new cost basis. Upon acquisition of the property through foreclosure or deed-in-lieu of foreclosure, any adjustment to fair value less estimated selling costs is recorded to the ALLL. The determination is made on an individual asset basis. Bank premises no longer used for operations or future expansion are transferred to OREO at fair value less estimated selling costs with any related write-down included in non-interest expense. Subsequent to acquisition, valuations are periodically performed and the assets are carried at the lower of cost or fair value less estimated cost to sell. Fair value is determined through external appraisals, current letters of intent, broker price opinions or executed agreements of sale, unless management determines that conditions exist that warrant an adjustment to the value. Costs relating to the development and improvement of the OREO properties may be capitalized; holding period costs and any subsequent changes to the valuation allowance are charged to expense as incurred.
Income Taxes
The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in FNCB’s consolidated financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could impact our consolidated financial condition or results of operations.
FNCB records an income tax provision or benefit based on the amount of tax currently payable or receivable and the change in deferred tax assets and liabilities. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial and tax reporting purposes. Management conducts quarterly assessments of all available positive and negative evidence to determine the amount of deferred tax assets that will more likely than not be realized. FNCB establishes a valuation allowance for deferred tax assets and records a charge to income if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, management considers past operating results, estimates of future taxable income based on approved business plans, future capital requirements and ongoing tax planning strategies. This evaluation process involves significant management judgment about assumptions that are subject to change from period to period depending on the related circumstances. The recognition of deferred tax assets requires management to make significant assumptions and judgments about future earnings, the periods in which items will impact taxable income, future corporate tax rates, and the application of inherently complex tax laws. The use of different estimates can result in changes in the amounts of deferred tax items recognized, which may result in equity and earnings volatility because such changes are reported in current period earnings.
In connection with determining the income tax provision or benefit, management considers maintaining liabilities for uncertain tax positions and tax strategies that it believes contain an element of uncertainty. Periodically, management evaluates each of FNCB’s tax positions and strategies to determine whether a liability for uncertain tax benefits is required. As of September 30, 2020 and December 31, 2019, management determined that FNCB did not have any uncertain tax positions or tax strategies and that no liability was required to be recorded.
Refer to Note 8, “Income Taxes,” of the notes to consolidated financial statements included in Item 1 hereof for additional information about income taxes.
New Authoritative Accounting Guidance and Accounting Guidance to be Adopted in Future Periods
Refer to Note 2, “New Authoritative Accounting Guidance,” of the notes to consolidated financial statements included in Item 1 hereof for information about new authoritative accounting guidance adopted by FNCB during the three months ended September 30, 2020, as well as new accounting guidance issued, but not previously reported, that will be adopted by FNCB in future periods.
Impact of COVID-19 and FNCB's response to the pandemic
In March 2020, the outbreak of COVID-19 was recognized as a pandemic by the World Health Organization. The spread of COVID-19 has created a global public health crisis that has resulted in unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity in the United States and globally, including the markets that FNCB serves. Governmental authorities responded to the COVID-19 pandemic by mandating the closure of locations of non-essential businesses and requiring individuals to observe social distancing and "stay-at-home" restrictions. These governmental restrictions, coupled with fear of contracting the virus, have resulted in a rapid decline in commercial and consumer activity, loss of revenues by businesses, a severe spike in unemployment, material decreases in oil and gas prices and in business valuations, disrupted global supply chains and market volatility. The federal government responded by enacting bipartisan emergency response legislation. Additionally, the Federal Open Market Committee ("FOMC") lowered the federal funds target rate a total of 150 basis points in two emergency actions, 50 basis points on March 3, 2020 and 100 basis points on March 15, 2020, with an expectation that Federal Reserve policy will maintain a low interest rate environment for the foreseeable future. Late in the second quarter of 2020, state and local economies began the re-opening process subject to a resurgence of COVID-19 locally, regionally or nationally. Businesses were allowed to operate but must adhere to capacity restrictions and safety and social distancing requirements.
As a financial institution, FNCB is considered essential and has remained open for business and is operating under its pandemic preparedness plan. To ensure the financial needs of its customers are addressed in a safe and consistent manner, the Bank's offices are open for regular business, with administrative, lending and community branch offices adhering to federal, state, and local governmental guidelines and social distancing mandates. However, in order to limit the spread of COVID-19 customers are encouraged to utilize FNCB's drive-thru facilities, automated teller machines, Customer Care center, remote deposit capture and online banking, including online chat capabilities, and mobile banking applications. FNCB is also providing the necessary technology, when needed, to its operational staff to work remotely in a secure environment. As of September 30, 2020, FNCB did not face any material resource constraints through the implementation of its pandemic preparedness plan. Through the nine months ended September 30, 2020, FNCB incurred COVID-19-related expenses including stay-at-home pay, computer-related costs, cleaning and sanitizing facilities and safety supplies which are included in non-interest expense in the consolidated statements of income. Additionally, FNCB has not tested for and has not identified any material operational or internal control challenges or risks, nor does it anticipate any significant challenges to its ability to maintain its systems and controls, related to operational changes resulting from the continued implementation of the pandemic preparedness plan.
As part of the federal emergency response, on March 27, 2020, the Coronavirus Aid, Relief, and Economic Security ("CARES") Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act includes the Paycheck Protection Program ("PPP") administered by the Small Business Administration ("SBA"), initially a nearly $350 billion program designed to aid small- and medium-sized businesses through federally guaranteed loans distributed through banks. These loans were intended to guarantee eight weeks of payroll and other costs to help those businesses remain viable and allow their workers to pay their bills. By April 16, 2020, the SBA announced funding under the initial allotment had been exhausted. Subsequently, on April 24, 2020, President Trump signed the law replenishing the PPP with approximately $320 billion in new funds. As an SBA Lender, the Bank actively participated in PPP loans assisting our small business community in securing this important funding. As of September 30, 2020, FNCB was able to serve 1,002 small business customers with PPP loans totaling $118.6 million. The PPP closed on August 8, 2020, and the SBA is no longer accepting applications for funding under this program. Subsequent to the closing of the program, the SBA began accepting applications for forgiveness. FNCB notified and began providing assistance to customers with the forgiveness application process. As of September 30, 2020, FNCB had submitted 84 forgiveness applications to the SBA for PPP loans totaling $31.1 million. As of September 30, 2020, FNCB had not received approval or funding from the SBA for the forgiveness associated with these loans. It is FNCB's understanding that loans funded through the PPP are fully guaranteed by the United States government. Should those circumstances change, FNCB could be required to increase its allowance for loan and lease losses related to these loans resulting in an increase in the provision for loan and lease losses.
Additionally, in order to provide financial stability for both personal and business customers that are facing unemployment, temporary furloughs and closures, FNCB rolled out a payment deferral program providing for either an interest-only period or full payment deferral of up to six months. As of September 30, 2020, FNCB assisted 860 customers under our payment deferral program, with the aggregate principal balance of loans modified totaling $173.6 million. FNCB also developed a special "Personal Relief Loan," an unsecured, 36-month, low interest loan up to $5,000 for individuals financially impacted by COVID-19 due to temporary loss of employment. Additionally, FNCB temporarily suspended all repossession and foreclosure activity and had suspended certain deposit service charges related to debit card usage.
The Federal Reserve Bank also established the Main Street Lending Program to support lending to small and mid-sized businesses and not-for-profit organizations impacted by the COVID-19 pandemic. Specifically, the Main Street Business Lending Program provides for five loan facilities with total potential funding of up to $600 billion. The Main Street New Loan Facility ("MSNLF"), the Main Street Priority Loan Facility ("MSPLF") and the Main Street Expanded Loan Facility ("MSELF") are three credit facilities that provide eligible business borrowers impacted by COVID-19 with financing in amounts of $250 thousand to $300 million depending on facility. Terms of all three facilities include Federal Reserve Bank participation of 95.0%, lender participation of 5.0%, a maturity of 5 years, principal deferral for two years, interest deferral for one year, an adjustable interest rate based on one- or three-month LIBOR plus 300 basis points. Similarly, the Nonprofit Organization New Loan Facility ("NONLF") and the Nonprofit Organization Expanded Loan Facility ("NOELF") provide eligible not-for-profit organizations with financing in amounts of $250 thousand to $10 million. The Bank has received approval from the Federal Reserve Bank as a participating lender in the Main Street Lending Program. As of September 30, 2020, FNCB originated two MSPLF loans with an aggregate principal balance of $53.0 million and retained 5.0% of the outstanding principal balance or $2.7 million.
FNCB is prepared to continue to offer short-term assistance in accordance with regulatory guidelines and participate in the PPP and Main Street Lending Program. As the fallout of the COVID-19 pandemic ripple through the national, regional and local economies, management continues to identify and monitor potential weaknesses in the loan portfolio. Management has identified and is monitoring exposures to borrowers and industries that may be impacted more immediately and acutely than others. Additionally, management has proactively reached out to specific borrowers to provide guidance and assistance as appropriate. On a portfolio level, management continues to monitor aggregate exposures to highly sensitive segments such as hotels and hospitality for changes in asset quality and payment performance, and liquidity levels. Management monitors unfunded commitments such as lines of credit and overdraft protection to determine liquidity and funding issues that may arise with our customers. During the first half of 2020, as part of its evaluations of the adequacy of the ALLL, management increased the unallocated portion of the ALLL, as well as adjusted the qualitative factors included in the calculation, due to economic and employment uncertainty and disruption due to the global pandemic. Should economic conditions worsen, FNCB could experience further increases in its required allowance for loan and lease losses and record additional provisions for loan and lease losses. It is possible that FNCB’s asset quality metrics could be materially and adversely impacted in future periods if the effects of COVID-19 are prolonged.
FNCB anticipates the COVID-19 pandemic will impact its business in future periods. However, because the impact is contingent upon the duration and severity of the economic downturn, management cannot determine or estimate the magnitude of the impact at this time. The FNCB team will continue to work diligently to address other issues due to the COVID-19 pandemic in a safe and sound manner as they arise. Management believes that the steps taken in 2019 to strengthen our balance sheet and capital position, as well as the additional credit provisioning will allow FNCB to withstand the challenges that may be presented.
The following are examples of items which may have a material adverse effect on FNCB's business, among others:
| ● |
Significantly lower market interest rates may have a negative impact on FNCB's loan yields as variable-rate loans and securities indexed to prime and LIBOR will reprice downward; |
| ● |
Non-interest income could decrease because of waived service charges and loan fees; |
| ● |
Point-of-sale fee income may decline due to a decrease in debit card spending due to the "Stay at Home" requirements; |
| ● |
Non-interest expense could increase as a result of additional cleaning costs, supplies, equipment and other items needed to address the effects of COVID-19; |
| ● |
Additional loan modifications may occur and borrowers may default on their loans, which may result in additional credit-related provisioning; |
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| ● | Sustained contraction in economic activity may result in reduced demand for our products and services; and | |
| ● | Continued stock market volatility could cause the price of our common stock to decline further. |
Executive Summary
The following overview should be read in conjunction with this MD&A in its entirety.
FNCB recorded consolidated net income of $4.1 million, or $0.20 per basic and diluted common share, for the three months ended September 30, 2020, an increase of $1.7 million, or 70.9%, compared to $2.4 million, or $0.12 per basic and diluted common share, for the three months ended September 30, 2019. Net income for the nine months ended September 30, 2020 totaled $10.2 million, or $0.50 per basic and diluted share, an increase of $2.6 million, or 34.3%, compared to $7.6 million, or $0.39 per basic and diluted share, for the same nine months of 2019. The increase in third quarter 2020 earnings over the same quarter of 2019 was primarily due to increases in net interest income and non-interest income, coupled with a reduction in the provision for loan and lease losses. The increase in net income comparing the nine months ended September 30, 2020 and 2019 primarily reflected increases in net interest income and non-interest income and a decrease in non-interest expense. Partially offsetting these positive factors comparing the year-to-date periods was an increase in the provision for loan and lease losses, which reflected continued uncertainty brought on by the COVID-19 global pandemic. Additionally, the results for the third quarter and year-to-date periods of 2020 include the effect on interest income of $118.6 million in PPP loans.
For the three and nine months ended September 30, 2020, the annualized return on average assets was 1.15% and 1.03%, respectively, and 0.80% and 0.84%, respectively, for the same periods of 2019. The annualized return on average equity was 11.05% and 9.63%, respectively, for the three and nine months ended September 30, 2020, compared to 7.30% and 8.32%, respectively, for the comparable periods of 2019. FNCB declared and paid dividends to holders of common stock of $0.055 per share for the third quarter and $0.165 per share for the nine months ended September 30, 2020, a 10.0% increase compared to $0.05 per share and $0.15 per share for the same periods of 2019. The dividend pay-out ratio was 32.7% for the nine months ended September 30, 2020 compared to 39.8% for the comparable period of 2019.
Total assets increased $239.7 million, or 19.9%, to $1.443 billion at September 30, 2020 from $1.204 billion at December 31, 2019. The change in total assets primarily reflected increases in net loans, available-for-sale debt securities and cash and cash equivalents. Net loans increased $128.4 million, or 15.7%, to $947.9 million at September 30, 2020 from $819.5 million at December 31, 2019. Excluding the $118.6 million in PPP loans outstanding at September 30, 2020, net loans increased $9.8 million, or 1.2%, from December 31, 2019. Cash and cash equivalents increased $70.4 million, or 203.8%, to $105.0 million at September 30, 2020 from $34.6 million at December 31, 2019. Also contributing to the balance sheet expansion was a $48.6 million, or 17.8%, increase in available-for-sale debt securities to $321.4 million at September 30, 2020 from $272.8 million at December 31, 2019. FNCB experienced unprecedented deposit demand during the first nine months of 2020 as total deposits increased $270.5 million, or 27.0%, to $1.272 billion at September 30, 2020 from $1.002 billion at December 31, 2019. Total borrowed funds decreased $46.9 million, or 82.0%, to $10.3 million at September 30, 2020 from $57.2 million at December 31, 2019. The decrease in borrowed funds reflected a decrease in advances through the FHLB of Pittsburgh as FNCB had no borrowings through the FHLB of Pittsburgh outstanding as of September 30, 2020.
Total shareholders’ equity increased $16.4 million, or 12.3%, to $150.0 million at September 30, 2020 from $133.6 million at December 31, 2019. Contributing to the increase in capital was net income for the nine months ended September 30, 2020 of $10.2 million and a $9.1 million increase in accumulated other comprehensive income related primarily to appreciation in the fair value of FNCB’s available-for-sale debt securities, net of deferred taxes. Partially offsetting these increases were dividends declared and paid of $3.3 million for the nine months ended September 30, 2020. FNCB Bank's total risk-based capital and Tier 1 leverage ratios were 16.09% and 10.17% at September 30, 2020, respectively, compared to 14.77% and 10.36% at December 31, 2019, respectively.
Summary of Performance
Net Interest Income
Net interest income, defined as the difference between (i) interest income, interest and fees on interest-earning assets, and (ii) interest expense, interest paid on deposits and borrowed funds, is the primary source of earnings for commercial banks. As such, it is the primary determinant of profitability for FNCB. Net interest income is impacted by variations in the volume, rate and composition of earnings assets and interest-bearing liabilities, changes in general market rates and the level of non-performing assets. Interest income is presented on a fully tax-equivalent basis using the corporate statutory tax rate of 21.0% in 2020 and 2019.
In response to the significant disruption and uncertainty in the economic environment brought on by COVID-19, the FOMC lowered the federal funds target rate 150 basis points in two emergency actions in March 2020. As a result, the target range for federal funds fell from 1.50%-1.75% at December 31, 2019 to 0.00%-0.25% at March 31, 2020 and has remained at that level through September 30, 2020. The emergency actions by the FOMC in 2020 followed three 25 basis-point actions to lower the federal funds target rate a total of 75 basis points in the second half of 2019. The FOMC actions, along with decreases in general market interest rates, has resulted in decreases in both the tax-equivalent yield on earnings assets and the rate paid on interest-bearing liabilities comparing the three and nine months ended September 30, 2020 and 2019. Additionally, net interest income, earning asset yields and the net interest margin were impacted by the origination and funding of $118.6 million in PPP loans at an interest rate of 1.0%.
Net interest income on a tax-equivalent basis increased $927 thousand, or 10.1%, to $10.1 million for the three months ended September 30, 2020 from $9.1 million for the comparable period of 2019. The improvement in tax-equivalent net interest income for the third quarter of 2020 primarily reflected a decrease in interest expense of $1.0 million, or 40.7%, to $1.5 million from $2.5 million for the same period of 2019. The reduction in interest expense was slightly offset by a decrease in tax-equivalent interest income of $72 thousand, or 0.6%, to $11.5 million for the three months ended September 30, 2020 from $11.6 million for the same period of 2019. For the nine months ended September 30, 2020, tax-equivalent net interest income increased $1.9 million, or 6.9%, to $29.2 million from $27.3 million for the same nine months of 2019. Similarly, the improvement in tax-equivalent net interest income comparing the year-to-date period ended September 30, 2020 and 2019 was due to a $2.6 million, or 34.0%, reduction in interest expense, partially offset by a $699 thousand, or 2.0%, decrease in tax-equivalent interest income. The tax-equivalent net interest margin, a key measurement used in the banking industry to measure income from earning assets relative to the cost to fund those assets, is calculated by dividing tax-equivalent net interest income by average interest-earning assets. Despite the increase in third quarter tax-equivalent net interest income, FNCB’s tax-equivalent net interest margin contracted 28 basis points to 3.04% for the third quarter of 2020 from 3.32% for the same quarter of 2019. The margin compression was due primarily to a $224.7 million, or 20.4%, increase in average earning asset levels, coupled with the impact of a 74-basis point reduction in the tax-equivalent yield on earning assets. Rate spread, the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities shown on a fully tax-equivalent basis, contracted 22 basis points to 2.89% for the three months ended September 30, 2020 from 3.11% for the same period of 2019. The tax-equivalent net interest margin and rate spread compressed 8 basis points and 4 basis points, respectively, comparing the nine months ended September 30, 2020 and 2019.
Comparing the three months ended September 30, 2020, the $1.0 million, or 40.7%, decrease in interest expense was entirely due to a 52-basis point reduction in the cost of funds. Specifically, the average rate paid for interest-bearing deposits decreased 41 basis points to 0.55% for the third quarter of 2020 from 0.96% for the same period of 2019, resulting in a decrease to interest expense of $806 thousand. The average rates paid for interest-bearing demand and time deposits, which reflected the reduction in market interest rates, decreased 40 basis points and 43 basis points, respectively, comparing the three months ended September 30, 2020 and 2019. The decrease in interest expense due to changes in deposit rates was coupled with a 130 basis point reduction in the cost of borrowed funds comparing the three months ended September 30, 2020 to the same period of 2019, which resulted in a $217 thousand decrease in interest expense. FNCB experienced significant demand for its deposit products, as changing customer deposit preferences and higher balances due to the reduction in economic activity and uncertainty related to the COVID-19 pandemic, were the primary factors driving a $114.5 million, or 13.0%, increase in average interest-bearing liabilities. Specifically, average interest-bearing deposits increased $148.8 million, or 18.7%, to $943.8 million for the third quarter of 2020 compared to $795.0 million for the same quarter of 2019. The strong growth in deposit volumes had little impact on interest expense, as FNCB used the excess liquidity to repay higher-costing borrowed funds. Average borrowed funds decreased by $34.3 million or 39.9% to $51.6 million for the third quarter of 2020 from $85.9 million for the same quarter of 2019. Overall, changes in volumes of average interest-bearing liabilities resulted in a slight increase in interest expense of $24 thousand comparing the third quarters of 2020 and 2019.
Partially offsetting the lower amount of interest expense was a $72 thousand, or 0.6%, decrease in tax-equivalent interest income to $11.5 million for the third quarter of 2020 from $11.6 million for the same quarter of 2019. The decrease in tax-equivalent interest income was due primarily to a reduction in the tax-equivalent yield on earning assets, almost entirely offset by an increase in average earning asset levels. The tax-equivalent yield on earning assets decreased 74 basis points to 3.48% for the third quarter of 2020 from 4.22% for the same quarter of 2019, which resulted in a corresponding decrease in tax-equivalent interest income of $1.8 million. Accounting for the majority of the decrease was an 82 basis point decrease in the tax-equivalent yield on the loan portfolio to 3.85% for the three months ended September 30, 2020 from 4.67% for the same three months of 2019, which resulted in a corresponding decrease in tax-equivalent interest income of $1.8 million. With regard to earning asset volumes, average earning assets increased $224.7 million, or 20.4%, to $1.326 billion for the three months ended September 30, 2020 from $1.101 billion for the same three months of 2019. The origination of $118.6 million in PPP loans was the predominant factor causing an increase in average loans of $133.3 million, or 16.3%, to $952.9 million for the third quarter of 2020 from $819.6 million for the same quarter of 2019, which caused a corresponding increase in interest income of $1.4 million. Additionally, comparing the third quarters of 2020 and 2019, average securities increased $30.8 million, or 11.4%, to $302.1 million from $271.3 million, respectively, which resulted in an increase to interest income of $289 thousand. Furthermore, average interest-bearing deposits in other banks and federal funds sold increased $60.6 million to $70.6 million for the three months ended September 30, 2020, from $10.0 million for the same three months of 2019, which caused tax-equivalent interest income to increase $26 thousand. Overall, the increase in average earning assets resulted in a corresponding increase to tax-equivalent interest income of $1.7 million, which was more than offset by the $1.8 million decrease in tax-equivalent interest income due to the decline in yield.
For the nine months ended September 30, 2020, tax-equivalent net interest income increased $1.9 million, or 6.9%, which was mainly attributable to a $2.6 million, or 34.0% reduction in interest expense, which was partially offset by the decline in tax-equivalent interest income of $699 thousand, or 2.0%. The decrease in interest expense for the year-to-date period was primarily caused by decreases in funding costs due to lower market rates, coupled with changes in volumes of average interest-bearing liabilities. FNCB's total cost of funds decreased 39 basis points to 0.72% for the nine months ended September 30, 2020 from 1.11% for the same period of 2019, resulting in a decrease to interest expense of $2.4 million. Specifically, comparing the nine months ended September 30, 2020 and 2019, the cost of interest-bearing deposits decreased 33 basis points, while the cost of borrowed funds declined 128 basis points, resulting in corresponding decreases to interest expense of $1.7 million and $625 thousand, respectively. For the nine months ended September 30, 2020, interest-bearing liabilities averaged $937.1 million, an increase of $21.8 million, or 2.4%, from $915.3 million for the same nine-month period of 2019. Despite the increase, changes in volumes of interest-bearing liabilities resulted in a $228 thousand decrease in interest expense, driven by changes in volumes of interest-bearing deposits. Specifically, average balances of higher-costing time deposits decreased $57.9 million, or 22.8% comparing the nine months ended September 30, 2020 and 2019 which caused a corresponding decrease to interest expense of $629 thousand. The decline in average time deposit balances largely reflected maturing retail certificates of deposit, the majority of which were transferred into a non-maturity deposit product. Volumes of average interest-bearing demand deposits and average savings deposits increased by $73.5 million and $6.7 million, respectively, comparing the nine months ended September 30, 2020 and 2019 which resulted in corresponding increases to interest expense of $406 thousand and $7 thousand, respectively, comparing the year-to-date periods of 2020 and 2019. Average borrowed funds decreased $602 thousand, or 0.9%, to $65.0 million for the nine months ended September 30, 2020, compared to $65.6 million for the same period in 2019, resulting in a small decrease in interest expense of $12 thousand.
The $699 thousand decrease in tax-equivalent interest income largely reflected a reduction in tax-equivalent yield on average earning assets, partially mitigated by an increase in average earning assets. Tax-equivalent interest income was impacted by lower market interest rates, which resulted in a 44 basis point decrease in the yield on earning assets to 3.70% for the nine months ended September 30, 2020 from 4.14% for the same nine months of 2019, which resulted in a $3.6 million decrease in tax-equivalent interest income. The reduction in market interest rates, coupled with the origination of lower-yielding PPP loans had the greatest impact on loan yields. Specifically, the tax-equivalent yield on loans declined 53 basis points to 4.08% for the nine months ended September 30, 2020 from 4.61% for the same nine months of 2019, causing a $3.5 million decline in tax-equivalent interest income. PPP loans averaged $69.5 million for the nine months ended September 30, 2020, with an average yield of 0.99%. Additionally, yields earned on average interest-bearing deposits in other banks and federal funds sold decreased 174 basis points to 0.09% for the nine months ended September 30, 2020 from 1.83% for the same period of 2019, which resulted in a corresponding decrease to tax-equivalent interest income of $244 thousand. Partially offsetting the reduction in tax-equivalent interest income due to yield decline was a $107.6 million, or 9.6%, increase in average earning assets to $1.231 billion for the nine months ended September 30, 2020, compared to $1.124 billion for the same nine months of 2019, which resulted in a $2.9 million increase in tax-equivalent interest income. Specifically, comparing the first nine months of 2020 and 2019, average loans increased $75.3 million, or 9.1%, which caused a $2.5 million increase in tax-equivalent interest income. In addition, comparing the nine months ended September 30, 2020 and 2019, the average balance of securities increased $7.8 million, or 2.8%, while the average interest-deposits in other banks and federal funds sold increased $24.4 million, or 216.1%, resulting in additional tax-equivalent interest income of $330 thousand and $114 thousand, respectively.
Net interest income depends upon the relative amount of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them. The following tables present certain information about FNCB’s consolidated statements of financial condition and consolidated statements of income for the three- and nine-month periods ended September 30, 2020 and 2019, and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are calculated by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are derived from average daily balances. The yields include amortization of fees which are considered adjustments to yields.
| Three Months Ended |
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| September 30, 2020 |
September 30, 2019 |
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| Average |
Yield/ |
Average |
Yield/ |
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| (dollars in thousands) |
Balance |
Interest |
Cost |
Balance |
Interest |
Cost |
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| Assets |
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| Earning assets (2)(3) |
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| Loans-taxable (4) |
$ | 908,095 | $ | 8,688 | 3.83 | % | $ | 781,963 | $ | 9,170 | 4.69 | % | ||||||||||||
| Loans-tax free (4) |
44,826 | 494 | 4.41 | % | 37,638 | 403 | 4.28 | % | ||||||||||||||||
| Total loans (1)(2) |
952,921 | 9,182 | 3.85 | % | 819,601 | 9,573 | 4.67 | % | ||||||||||||||||
| Securities-taxable |
232,081 | 1,760 | 3.03 | % | 266,653 | 1,951 | 2.93 | % | ||||||||||||||||
| Securities-tax free |
69,973 | 586 | 3.35 | % | 4,611 | 47 | 4.08 | % | ||||||||||||||||
| Total securities (1)(5) |
302,054 | 2,346 | 3.11 | % | 271,264 | 1,998 | 2.95 | % | ||||||||||||||||
| Interest-bearing deposits in other banks |
70,601 | 1 | 0.01 | % | 10,007 | 30 | 1.20 | % | ||||||||||||||||
| Total earning assets |
1,325,576 | 11,529 | 3.48 | % | 1,100,872 | 11,601 | 4.22 | % | ||||||||||||||||
| Non-earning assets |
108,587 | 99,888 | ||||||||||||||||||||||
| Allowance for loan and lease losses |
(11,865 | ) | (9,081 | ) | ||||||||||||||||||||
| Total assets |
$ | 1,422,298 | $ | 1,191,679 | ||||||||||||||||||||
| Liabilities and Shareholders' Equity |
||||||||||||||||||||||||
| Interest-bearing liabilities |
||||||||||||||||||||||||
| Interest-bearing demand deposits |
$ | 638,070 | 705 | 0.44 | % | $ | 480,277 | 1,011 | 0.84 | % | ||||||||||||||
| Savings deposits |
105,394 | 24 | 0.09 | % | 93,369 | 31 | 0.13 | % | ||||||||||||||||
| Time deposits |
200,290 | 562 | 1.12 | % | 221,325 | 859 | 1.55 | % | ||||||||||||||||
| Total interest-bearing deposits |
943,754 | 1,291 | 0.55 | % | 794,971 | 1,901 | 0.96 | % | ||||||||||||||||
| Borrowed funds and other interest-bearing liabilities |
51,629 | 165 | 1.28 | % | 85,927 | 554 | 2.58 | % | ||||||||||||||||
| Total interest-bearing liabilities |
995,383 | 1,456 | 0.59 | % | 880,898 | 2,455 | 1.11 | % | ||||||||||||||||
| Demand deposits |
267,636 | 169,416 | ||||||||||||||||||||||
| Other liabilities |
11,384 | 10,730 | ||||||||||||||||||||||
| Shareholders' equity |
147,895 | 130,635 | ||||||||||||||||||||||
| Total liabilities and shareholder's equity |
$ | 1,422,298 | $ | 1,191,679 | ||||||||||||||||||||
| Net interest income/interest rate spread (6) |
10,073 | 2.89 | % | 9,146 | 3.11 | % | ||||||||||||||||||
| Tax equivalent adjustment |
(227 | ) | (95 | ) | ||||||||||||||||||||
| Net interest income as reported |
$ | 9,846 | $ | 9,051 | ||||||||||||||||||||
| Net interest margin (7) |
3.04 | % | 3.32 | % | ||||||||||||||||||||
| (1) |
Interest income is presented on a tax equivalent basis using a 21% rate. |
|
| (2) |
Loans are stated net of unearned income. |
|
| (3) |
Non-accrual loans are included in loans within earning assets. |
|
| (4) |
Loan fees included in interest income are not significant. |
|
| (5) |
The yields for securities that are classified as available for sale is based on the average historical amortized cost. |
|
| (6) |
Interest rate spread represents the difference between the average yield on interest earning assets and the cost of interest-bearing liabilities and is presented on a tax equivalent basis. |
|
| (7) |
Net interest income as a percentage of total average interest earning assets. |
| Nine Months Ended |
||||||||||||||||||||||||
| September 30, 2020 |
September 30, 2019 |
|||||||||||||||||||||||
| Average |
Yield/ |
Average |
Yield/ |
|||||||||||||||||||||
| (dollars in thousands) |
Balance |
Interest |
Cost |
Balance |
Interest |
Cost |
||||||||||||||||||
| Assets |
||||||||||||||||||||||||
| Earning assets (2)(3) |
||||||||||||||||||||||||
| Loans-taxable (4) |
$ | 854,885 | $ | 26,042 | 4.06 | % | $ | 781,612 | $ | 27,194 | 4.64 | % | ||||||||||||
| Loans-tax free (4) |
48,080 | 1,564 | 4.34 | % | 46,019 | 1,417 | 4.11 | % | ||||||||||||||||
| Total loans (1)(2) |
902,965 | 27,606 | 4.08 | % | 827,631 | 28,611 | 4.61 | % | ||||||||||||||||
| Securities-taxable |
247,848 | 5,426 | 2.92 | % | 280,114 | 5,997 | 2.85 | % | ||||||||||||||||
| Securities-tax free |
44,723 | 1,149 | 3.43 | % | 4,624 | 142 | 4.09 | % | ||||||||||||||||
| Total securities (1)(5) |
292,571 | 6,575 | 3.00 | % | 284,738 | 6,139 | 2.87 | % | ||||||||||||||||
| Interest-bearing deposits in other banks |
35,746 | 25 | 0.09 | % | 11,309 | 155 | 1.83 | % | ||||||||||||||||
| Total earning assets |
1,231,282 | 34,206 | 3.70 | % | 1,123,678 | 34,905 | 4.14 | % | ||||||||||||||||
| Non-earning assets |
101,773 | 95,412 | ||||||||||||||||||||||
| Allowance for loan and lease losses |
(10,321 | ) | (9,344 | ) | ||||||||||||||||||||
| Total assets |
$ | 1,322,734 | $ | 1,209,746 | ||||||||||||||||||||
| Liabilities and Shareholders' Equity |
||||||||||||||||||||||||
| Interest-bearing liabilities |
||||||||||||||||||||||||
| Interest-bearing demand deposits |
$ | 577,012 | 2,363 | 0.55 | % | $ | 503,483 | 3,095 | 0.82 | % | ||||||||||||||
| Savings deposits |
99,627 | 75 | 0.10 | % | 92,893 | 96 | 0.14 | % | ||||||||||||||||
| Time deposits |
195,456 | 1,889 | 1.29 | % | 253,306 | 3,092 | 1.63 | % | ||||||||||||||||
| Total interest-bearing deposits |
872,095 | 4,327 | 0.66 | % | 849,682 | 6,283 | 0.99 | % | ||||||||||||||||
| Borrowed funds and other interest-bearing liabilities |
65,046 | 706 | 1.45 | % | 65,648 | 1,343 | 2.73 | % | ||||||||||||||||
| Total interest-bearing liabilities |
937,141 | 5,033 | 0.72 | % | 915,330 | 7,626 | 1.11 | % | ||||||||||||||||
| Demand deposits |
232,920 | 161,036 | ||||||||||||||||||||||
| Other liabilities |
11,361 | 11,406 | ||||||||||||||||||||||
| Shareholders' equity |
141,312 | 121,974 | ||||||||||||||||||||||
| Total liabilities and shareholder's equity |
$ | 1,322,734 | $ | 1,209,746 | ||||||||||||||||||||
| Net interest income/interest rate spread (6) |
29,173 | 2.99 | % | 27,279 | 3.03 | % | ||||||||||||||||||
| Tax equivalent adjustment |
(570 | ) | (328 | ) | ||||||||||||||||||||
| Net interest income as reported |
$ | 28,603 | $ | 26,951 | ||||||||||||||||||||
| Net interest margin (7) |
3.16 | % | 3.24 | % | ||||||||||||||||||||
| (1) |
Interest income is presented on a tax equivalent basis using a 21% rate. |
|
| (2) |
Loans are stated net of unearned income. |
|
| (3) |
Non-accrual loans are included in loans within earning assets. |
|
| (4) |
Loan fees included in interest income are not significant. |
|
| (5) |
The yields for securities that are classified as available for sale is based on the average historical amortized cost. |
|
| (6) |
Interest rate spread represents the difference between the average yield on interest earning assets and the cost of interest-bearing liabilities and is presented on a tax equivalent basis. |
|
| (7) |
Net interest income as a percentage of total average interest earning assets. |
Rate Volume Analysis
The most significant impact on net income between periods is derived from the interaction of changes in the volume and rates earned or paid on interest-earning assets and interest-bearing liabilities. The volume of earning assets, specifically loans and investments, compared to the volume of interest-bearing liabilities represented by deposits and borrowings, combined with the spread, produces the changes in net interest income between periods. Components of interest income and interest expense are presented on a tax-equivalent basis using the corporate federal income tax rate of 21%.
The following table summarizes the effect that changes in volumes of earning assets and interest-bearing liabilities and the interest rates earned and paid on these assets and liabilities have on net interest income. The net change or mix component attributable to the combined impact of rate and volume changes has been allocated proportionately to the change due to volume and the change due to rate.
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||||||||||
| 2020 vs. 2019 |
2020 vs. 2019 |
|||||||||||||||||||||||
| Increase (Decrease) |
Increase (Decrease) |
|||||||||||||||||||||||
| Due to |
Due to |
Total |
Due to |
Due to |
Total |
|||||||||||||||||||
| (in thousands) |
Volume |
Rate |
Change |
Volume |
Rate |
Change |
||||||||||||||||||
| Interest income: |
||||||||||||||||||||||||
| Loans - taxable |
$ | 1,352 | $ | (1,834 | ) | $ | (482 | ) | $ | 2,413 | $ | (3,565 | ) | $ | (1,152 | ) | ||||||||
| Loans - tax free |
79 | 12 | 91 | 65 | 82 | 147 | ||||||||||||||||||
| Total loans |
1,431 | (1,822 | ) | (391 | ) | 2,478 | (3,483 | ) | (1,005 | ) | ||||||||||||||
| Securities - taxable |
(260 | ) | 69 | (191 | ) | (704 | ) | 133 | (571 | ) | ||||||||||||||
| Securities - tax free |
549 | (10 | ) | 539 | 1,034 | (27 | ) | 1,007 | ||||||||||||||||
| Total securities |
289 | 59 | 348 | 330 | 106 | 436 | ||||||||||||||||||
| Interest-bearing deposits in other banks |
26 | (55 | ) | (29 | ) | 114 | (244 | ) | (130 | ) | ||||||||||||||
| Total interest income |
1,746 | (1,818 | ) | (72 | ) | 2,922 | (3,621 | ) | (699 | ) | ||||||||||||||
| Interest expense: |
||||||||||||||||||||||||
| Interest-bearing demand deposits |
268 | (574 | ) | (306 | ) | 406 | (1,138 | ) | (732 | ) | ||||||||||||||
| Savings deposits |
4 | (11 | ) | (7 | ) | 7 | (28 | ) | (21 | ) | ||||||||||||||
| Time deposits |
(76 | ) | (221 | ) | (297 | ) | (629 | ) | (574 | ) | (1,203 | ) | ||||||||||||
| Total interest-bearing deposits |
196 | (806 | ) | (610 | ) | (216 | ) | (1,740 | ) | (1,956 | ) | |||||||||||||
| Borrowed funds and other interest-bearing liabilities |
(172 | ) | (217 | ) | (389 | ) | (12 | ) | (625 | ) | (637 | ) | ||||||||||||
| Total interest expense |
24 | (1,023 | ) | (999 | ) | (228 | ) | (2,365 | ) | (2,593 | ) | |||||||||||||
| Net interest income |
$ | 1,722 | $ | (795 | ) | $ | 927 | $ | 3,150 | $ | (1,256 | ) | $ | 1,894 | ||||||||||
Provision for Loan and Lease Losses
The provision for loan and lease losses is an expense charged against net interest income to provide for probable losses attributable to uncollectible loans and is based on management’s analysis of the adequacy of the ALLL. A release of reserves, resulting in a credit for loan and lease losses, reflects the reversal of amounts previously charged to the ALLL. Management closely monitors the loan portfolio and the adequacy of the ALLL by considering the underlying financial performance of the borrower, collateral values and associated credit risks. Future material adjustments may be necessary to the provision for loan and lease losses and the ALLL if economic conditions or loan performance differ substantially from the assumptions management considered in its evaluation of the ALLL. During 2020, management took into consideration the potential adverse impact the COVID-19 pandemic has had on economic conditions in its application of FNCB's methodology on the allowance for loan and lease losses. Specifically, management has tried to address this adverse impact by adjusting the qualitative factor associated with changes in national, local and business economic conditions and developments, which has resulted in higher credit provisioning during the nine months ended September 30, 2020.
FNCB recorded a provision for loan and lease losses of $74 thousand for the three-month period ended September 30, 2020 compared to $637 thousand for the three months ended September 30, 2019. The $563 thousand decrease in the provision for loan and lease losses was directly attributable to substantial recoveries related to two large commercial credits received in the third quarter of 2020, partially offset by additional credit provisioning related to economic disruption and uncertainty related to the COVID-19 pandemic. The provision for loan losses amounted to $2.0 million for the nine months ended September 30, 2020, an increase of $1.2 million, from $830 thousand for the same nine months of 2019.
Non-interest Income
Non-interest income increased significantly for the third quarter and year-to-date periods, which was primarily due to increases in net gains on equity securities, net gains on the sale of mortgage loans held for sale and net gains on available-for-sale debt securities. Non-interest income increased $1.1 million, or 62.2%, to $2.9 million for the three months ended September 30, 2020 from $1.8 million for the same three months of 2019. Net gains on equity securities increased $841 thousand to $846 thousand for the third quarter of 2020 compared to $5 thousand for the same quarter of 2019. FNCB realized a gain of $1.1 million on the conversion of an equity security of a bank holding company that was part of a merger and acquisition that was completed in the third quarter of 2020. Partially offsetting this gain was a net unrealized loss on equity securities held of $287 thousand. FNCB realized net gains on the sale of mortgage loans of $186 thousand for the three months ended September 30, 2020, a $117 thousand or 169.6%, increase compared to $69 thousand in net gains realized for the same three-month period of 2019. In addition, FNCB realized net gains on the sales of available-for-sale securities of $433 thousand, an increase of $54 thousand, or 14.2%, compared to $379 thousand for the same quarter of 2019.
For the nine months ended September 30, 2020, non-interest income increased $2.3 million, or 45.5%, to $7.2 million from $4.9 million for the same period of 2019. Net gains on equity securities increased $833 thousand to $864 thousand for the nine months ended September 30, 2020 compared to $31 thousand for the same period of 2019, which was primarily related to the bank holding company stock transaction mentioned above, partially offset by unrealized losses on equity securities held of $269 thousand. For the first nine months of 2020, net gains on the sale of mortgage loans amounted to $465 thousand, an increase of $267 thousand, or 134.7%, compared to $198 thousand for the period of 2019. For the nine months ended September 30, 2020, net gains on the sale of available-for-sale securities amounted to $1.5 million, an increase of $802 thousand, or 114.2%, compared to $702 thousand for the same nine months of 2019.
Also impacting non-interest income levels for the third quarter and year-to-date periods were increases in loan referral fees and deposit service charges. Loan referral fees, which include commissions received from a correspondent bank related to an off-balance sheet commercial interest-rate hedge program and the referral of FHA residential mortgage loans to a third-party broker, increased $22 thousand, to $76 thousand for the three months ended September 30, 2020, compared to $54 thousand for the same period of 2019. Loan referral fees totaled $338 thousand for the nine months ended September 30, 2020, an increase of $264 thousand, or 357.4%, compared to $74 thousand for the nine months ended September 30, 2019. With regard to deposit service charges, in the second half of 2019 FNCB engaged an independent third party to conduct a comprehensive evaluation of FNCB's non-interest income and fee structure to identify opportunities for enhancement. Recommendations to the fee structure arising from this assessment were fully implemented prior to the beginning of 2020. As a result, deposit service charges increased $47 thousand, or 5.9%, to $844 thousand for the third quarter of 2020 from $797 thousand for the same quarter of 2019. For the nine months ended September 30, deposit service charges increased $174 thousand or 7.9%, to $2.4 million in 2020 compared to $2.2 million in 2019.
Non-interest Expense
Non-interest expense increased $514 thousand, or 7.0%, to $7.8 million for the three months ended September 30, 2020 from $7.3 million for the three months ended September 30, 2019. The increase primarily reflected increases in other operating expenses, regulatory assessments, professional fees and bank shares tax, partially offset by a reduction in salaries and benefits. Other operating expenses in the third quarter increased $288 thousand, or 35.3%, to $1.1 million in 2020 from $815 thousand in 2019. The increase was largely due to $399 thousand in FHLB penalties paid in the third quarter of 2020 related to the decision to prepay high-costing FHLB term advances. Comparing the three months ended September 30, 2020 and 2019, regulatory assessments increased $102 thousand, or 485.7%, professional fees increased $90 thousand, or 47.6%, and bank shares tax increased $58 thousand or 28.3%. The increase in regulatory assessments reflected the full utilization of the FDIC's Small Bank Assessment Credit during the prior quarter, coupled with an increase in FNCB's assessment base due to strong balance sheet growth. The increase in professional fees reflected the timing of certain services performed coupled with a contract renegotiation credit received in third quarter of 2019, while the increase in bank shares tax was due to the increase in FNCB Bank's capital. Slightly offsetting these increases was a $76 thousand, or 1.9% decrease in salaries and employee benefits, due primarily to staff reductions resulting from open positions that have not been filled.
For the nine months ended September 30, 2020, non-interest expense decreased $404 thousand, or 1.8%, to $21.5 million compared to $21.9 million for the same nine-month period of 2019, primarily due to the decline in salaries and employee benefits, data processing expenses, other operating expenses and professional fees. Salaries and employee benefits declined $372 thousand, or 3.2%, to $11.3 million at September 30, 2020, compared to $11.6 million at September 30, 2019, reflecting an increase in deferred loan origination costs associated with the origination of PPP loans and reductions to staff, partially offset by merit increases. Data processing expenses and professional fees declined $124 thousand, or 5.4%, and $64 thousand, or 8.9%, respectively comparing the year-to-date periods of 2020 and 2019. In addition, other operating expenses decreased $117 thousand, or 5.2%, comparing the nine months ended September 30, 2020 to 2019. The reduction in data processing costs and professional fees reflected more efficient utilization of third-party services. These decreases were partially offset by the $144 thousand or 14.9% increase in equipment expense, reflecting higher amounts of depreciation expense on furniture and equipment for the two new offices opened in mid-2019. Bank shares tax increased $118 thousand, or 15.5%, to $878 thousand at September 30, 2020, compared to $760 thousand at September 30, 2019. For the nine months ended September 30, 2020, FNCB incurred $199 thousand in COVID-19 related costs, including stay-at-home pay, computer-related equipment to enable employees to work remotely, cleaning and sanitizing facilities and safety supplies, which is included in non-interest expense.
Provision for Income Taxes
FNCB recorded income tax expense of $2.0 million for the nine months ended September 30, 2020, an increase of $467 thousand, or 29.5%, compared to income tax expense of $1.6 million for the same period of 2019. The increase in income tax expense primarily reflected an increase in pre-tax net income of $3.1 million, or 33.5%, when comparing the nine months ended September 30, 2020 and 2019.
Management evaluates the carrying amount of its deferred tax assets on a quarterly basis, or more frequently, if necessary, in accordance with guidance set forth in ASC Topic 740 “Income Taxes,” and applies the criteria in the guidance to determine whether it is more likely than not that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight of available evidence. If management determines based on available evidence, both positive and negative, that it is more likely than not that some portion or all of the deferred tax asset will not be realized in future periods, a valuation allowance is calculated and recorded. These determinations are inherently subjective and depend upon management’s estimates and judgments used in their evaluation of both positive and negative evidence.
In evaluating available evidence, management considers, among other factors, historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. In assessing the need for a valuation allowance, management carefully weighs both positive and negative evidence currently available.
Management performed an evaluation of FNCB’s deferred tax assets at September 30, 2020 taking into consideration both positive and negative evidence that existed as of that date. Based on this evaluation, management believes that FNCB’s future taxable income will be sufficient to utilize deferred tax assets. Accordingly, management concluded that no valuation allowance for deferred tax assets was required at September 30, 2020.
FINANCIAL CONDITION
Assets
Total assets increased $239.7 million, or 19.9%, to $1.443 billion at September 30, 2020 from $1.204 billion at December 31, 2019. The change in total assets primarily reflected increases in net loans, available-for-sale debt securities and cash and cash equivalents. Net loans increased $128.4 million, or 15.7%, to $947.9 million at September 30, 2020 from $819.5 million at December 31, 2019, primarily reflecting the origination and funding of PPP loans, of which $118.6 million were outstanding at September 30, 2020. Available-for-sale debt securities increased $48.6 million, or 17.8%, to $321.4 million at September 30, 2020 from $272.8 million at December 31, 2019 as security purchases outpaced sales and repayments. FNCB experienced unprecedented demand for its deposit products during the nine months ended September 30, 2020, which was the driving factor leading to an increase in total deposits of $270.5 million, or 27.0%, to $1.272 billion at September 30, 2020 from $1.002 billion at December 31, 2019. Meanwhile, borrowed funds decreased $46.9 million, or 82.0%, to $10.3 million at September 30, 2020 as compared to $57.2 million at December 31, 2019, as FNCB used excess liquidity to prepay certain higher-costing term advances through the FHLB of Pittsburgh.
Cash and Cash Equivalents
Cash and cash equivalents increased $70.4 million, or 203.8%, to $105.0 million at September 30, 2020 from $34.6 million at December 31, 2019. The increase was primarily due to the increase in total deposits and cash generated through bank operations, partially offset by increases in available-for-sale debt securities and gross loans. FNCB paid dividends of $0.055 per share and $0.165 per share for the three and nine months ended September 30, 2020 and 2019, respectively, an increase of 10% compared to dividends of $0.05 per share and $0.15 per share paid in the respective periods of 2019.
Securities
FNCB’s investment securities portfolio provides a source of liquidity needed to meet expected loan demand and interest income to increase profitability. Additionally, the investment securities portfolio is used to meet pledging requirements to secure public deposits and for other purposes. Debt securities are classified as either held-to-maturity or available-for-sale at the time of purchase based on management's intent. Held-to-maturity securities are carried at amortized cost, while available-for-sale securities are carried at fair value, with unrealized holding gains and losses reported as a component of shareholders’ equity in accumulated other comprehensive income (loss), net of tax. At September 30, 2020 and December 31, 2019, all debt securities were classified as available-for-sale. Equity securities with readily determinable fair values are carried at fair value, with gains and losses due to fluctuations in market value included in the consolidated statements of income. Securities with limited marketability and/or restrictions, such as FHLB of Pittsburgh stock, are carried at cost. Management monitors the investment portfolio regularly. Decisions to purchase or sell investment securities are based upon management’s current assessment of long- and short-term economic and financial conditions, including the interest rate environment and asset/liability management, liquidity and tax-planning strategies.
At September 30, 2020, the investment portfolio was comprised principally of fixed-rate taxable and tax-exempt obligations of state and political subdivisions, fixed-rate and floating-rate securities issued by U.S. government or U.S. government-sponsored agencies, which include mortgage-backed securities and residential and commercial collateralized mortgage obligations (“CMOs”), private CMOs and corporate debt securities. Except for U.S. government and government-sponsored agencies, there were no securities of any individual issuer that exceeded 10.0% of shareholders’ equity at September 30, 2020.
The following table presents the carrying value of debt securities, all of which were classified as available-for-sale and carried at fair value at September 30, 2020 and December 31, 2019:
Composition of the Investment Portfolio
| September 30, |
December 31, |
|||||||
| (in thousands) |
2020 |
2019 |
||||||
| Available-for-sale debt securities: |
||||||||
| Obligations of state and political subdivisions |
$ | 191,963 | $ | 117,763 | ||||
| U.S. government/government-sponsored agencies: |
||||||||
| Collateralized mortgage obligations - residential |
54,494 | 80,294 | ||||||
| Collateralized mortgage obligations - commercial |
2,198 | 17,723 | ||||||
| Mortgage-backed securities |
11,123 | 18,485 | ||||||
| Private collateralized mortgage obligations |
32,729 | 25,075 | ||||||
| Corporate debt securities |
19,000 | 7,182 | ||||||
| Asset-backed securities |
9,892 | 5,621 | ||||||
| Negotiable certificates of deposit |
- | 696 | ||||||
| Total available-for-sale debt securities | $ | 321,399 | $ | 272,839 | ||||
Available-for-sale debt securities increased $48.6 million, or 17.8%, to $321.4 million at September 30, 2020 from $272.8 million at December 31, 2019. Management took advantage of market opportunities during the nine months ended September 30, 2020 to sell lower-yielding investments within the available-for-sale portfolio and replace them and add to the portfolio with higher-yielding securities that were within FNCB's risk tolerance. During the nine months ended September 30, 2020, FNCB sold 28 available-for-sale debt securities which included 15 U.S. government/government sponsored agency CMOs, 12 taxable obligations of state and political subdivisions and 1 tax exempt obligation of state and political subdivisions. The securities sold had an aggregate amortized cost of $61.3 million with a weighted-average yield of 1.68%. For the nine months ended September 30, 2020, gross proceeds received totaled $62.8 million, with a net gain of $1.5 million realized upon the sales and included in non-interest income. During the nine months ended September 30, 2020, FNCB purchased 64 available-for-sale debt securities including 36 tax-exempt obligations of state and political subdivisions, 15 taxable obligations of state and political subdivisions, 6 corporate debt securities, 3 private asset-backed securities, 3 private CMOs and one agency CMO with an aggregate cost of $113.2 million and a weighted-average yield of 2.71%. Due to tax planning strategies designed to utilize NOL carryovers, management previously minimized holdings of tax-exempt obligations. However, market volatility during the first nine months of 2020 resulted in a favorable shift in yields on tax-exempt bonds, which was the driving factor leading to the purchase of the tax-exempt bonds. These actions resulted in increases in the tax-equivalent yield on the investment portfolio of 16 basis points to 3.11% from 2.95%, respectively, comparing the third quarters of 2020 and 2019 and 13 basis points to 3.00% from 2.87%, respectively, comparing the nine months ended September 30, 2020 and 2019.
Management continuously monitors FNCB's investment portfolio for credit worthiness. With regard to FNCB's holding of municipal securities, in the second quarter of 2020, management engaged an independent third party consultant to perform a semiannual credit review of FNCB's investments in obligations of state and political subdivisions as of June 30, 2020. The review included a comparison of each security to the consultant's "Portfolio Credit Benchmark" to identify any securities that may contain more than a minimal risk of payment default. Based on this review all obligations of state and political subdivision held within the portfolio at June 30, 2020 either met or exceeded the Portfolio Credit Benchmark and there were no such securities that required further review. The next third party review is scheduled for December 31, 2020. We also monitor municipal securities monthly in the Municipal Surveillance Report.
The following table presents the maturities of available-for-sale debt securities, based on carrying value at September 30, 2020 and the weighted-average yields of such securities calculated on the basis of the amortized cost and effective yields weighted for the scheduled maturity of each security. The yields on tax-exempt obligations of state and political subdivisions are presented on a tax-equivalent basis using the federal corporate income tax rate of 21.0%. Because residential, commercial and private collateralized mortgage obligations, mortgage-backed securities and asset-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following summary.
Maturity Distribution of the Investment Portfolio
| September 30, 2020 |
||||||||||||||||||||||||
| (dollars in thousands) |
< 1 Year |
>1 - 5 Years |
6 - 10 Years |
Over 10 Years |
Collateralized Mortgage Obligations, Mortgage-Backed and Asset-Backed Securities |
Total |
||||||||||||||||||
| Available-for-sale debt securities: |
||||||||||||||||||||||||
| Obligations of state and political subdivisions |
$ | 4,573 | $ | 60,632 | $ | 25,604 | $ | 101,154 | $ | - | $ | 191,963 | ||||||||||||
| Yield |
2.31 | % | 2.95 | % | 2.95 | % | 2.92 | % | 2.92 | % | ||||||||||||||
| U.S. government/government-sponsored agencies: |
||||||||||||||||||||||||
| Collateralized mortgage obligations - residential |
- | - | - | - | 54,494 | 54,494 | ||||||||||||||||||
| Yield |
2.88 | % | 2.88 | % | ||||||||||||||||||||
| Collateralized mortgage obligations - commercial |
- | - | - | - | 2,198 | 2,198 | ||||||||||||||||||
| Yield |
2.81 | % | 2.81 | % | ||||||||||||||||||||
| Mortgage-backed securities |
- | - | - | - | 11,123 | 11,123 | ||||||||||||||||||
| Yield |
3.54 | % | 3.54 | % | ||||||||||||||||||||
| Private collateralized mortgage obligations |
- | - | - | - | 32,729 | 32,729 | ||||||||||||||||||
| Yield |
2.63 | % | 2.63 | % | ||||||||||||||||||||
| Corporate debt securities |
- | - | 19,000 | - | - | 19,000 | ||||||||||||||||||
| Yield |
5.44 | % | 5.44 | % | ||||||||||||||||||||
| Asset-backed securities |
- | - | - | - | 9,892 | 9,892 | ||||||||||||||||||
| Yield |
1.47 | % | 1.47 | % | ||||||||||||||||||||
| Negotiable certificates of deposit |
- | - | - | - | - | - | ||||||||||||||||||
| Yield | ||||||||||||||||||||||||
| Total available-for-sale debt securities |
$ | 4,573 | $ | 60,632 | $ | 44,604 | $ | 101,154 | $ | 110,436 | $ | 321,399 | ||||||||||||
| Weighted average yield |
2.31 | % | 2.95 | % | 4.01 | % | 2.92 | % | 2.75 | % | 3.01 | % | ||||||||||||
OTTI Evaluation
There was no OTTI recognized during the nine months ended September 30, 2020 or 2019. For additional information regarding management’s evaluation of securities for OTTI, see Note 3, “Securities/Subsequent Event” of the notes to consolidated financial statements included in Item 1 hereof.
The following table presents the investment in FNCB’s restricted securities, which have limited marketability and are carried at cost, at September 30, 2020 and December 31, 2019:
| September 30, |
December 31, |
|||||||
| (in thousands) |
2020 |
2019 |
||||||
| Stock in Federal Home Loan Bank of Pittsburgh | $ | 1,781 | $ | 3,794 | ||||
| Stock in Atlantic Community Banker's Bank |
10 | 10 | ||||||
| Total restricted securities, at cost | $ | 1,791 | $ | 3,804 | ||||
Management noted no indicators of impairment for the Federal Home Loan Bank of Pittsburgh or Atlantic Community Banker’s Bank stock at September 30, 2020 and December 31, 2019.
Equity Securities and Equity Securities without Readily Determinable Fair Values
At December 31, 2019, FNCB owned 201,000 shares of the common stock of a privately held bank holding company. The common stock was purchased during 2017 for $8.25 per share, or $1.7 million in aggregate, as part of a private placement pursuant to an exemption from the registration requirements of the Securities Act of 1933, as amended for offerings not involving any public offering. Because the common stock of this bank holding company was not traded on any established market, FNCB accounted for this transaction as an equity security without a readily determinable fair value. Under GAAP, an equity security without a readily determinable fair value shall be carried at cost and written down to fair value if a qualitative assessment indicates that the investment is impaired and the fair value is less than its carrying value. The $1.7 million investment was included in other assets at December 31, 2019.
On December 18, 2019, this privately held bank holding company entered into an Agreement and Plan Merger (“Merger Agreement”) with a publicly traded bank holding company. The Merger Agreement provided for the privately held bank holding company to merge with and into the publicly traded bank holding company, the company surviving the merger (“surviving company”). The surviving company’s common stock trades on Nasdaq. The acquisition was completed on July 1, 2020 with FNCB receiving $1.2 million in cash for 74,113 of its shares with the remaining 122,178 shares converted into 78,822 shares of the surviving company’s common stock that had a fair value of $19.90 per share on July 1, 2020 or $1.6 million in aggregate. FNCB realized a gain of $1.1 million on the completion of this acquisition.
On September 15, 2020, FNCB purchased 20,000 shares of fixed-rate non-cumulative perpetual preferred stock of another publicly traded bank holding company pursuant to an underwritten public offering at an offering price of $25.00 per share or $500 thousand in aggregate. The preferred stock pays a quarterly dividend at a rate of 7.50%.
FNCB considers its investments in common and preferred shares of the bank holding companies discussed above to be equity securities with readily determinable fair values and therefore reports these securities at fair value on the consolidated statements of financial condition with unrealized gains and losses recognized in non-interest income in the consolidated statements of income. At September 30, 2020, the common shares had a fair value of $1.3 million, resulting in an unrealized loss of $288 thousand included in non-interest income for the three and nine months ended September 30, 2020. FNCB’s investment in the preferred stock had a fair value of $503 thousand at September 30, 2020, resulting in an unrealized gain of $3 thousand included in non-interest income for three and nine months ended September 30, 2020.
Also included in equity securities at September 30, 2020 and December 31, 2019, was a $1.0 million investment in a mutual fund comprised of 1-4 family residential mortgage-backed securities collateralized by properties within FNCB’s market area. The fair value of this mutual fund was $936 thousand at September 30, 2020 and $920 thousand at December 31, 2019.
Loans
Total loans, gross, increased $137.0 million, or 16.6%, to $963.3 million at September 30, 2020 from $826.3 million at December 31, 2019, which was predominantly due to the origination and funding of $118.6 million in PPP loans. Excluding PPP loans, FNCB saw modest growth in loans within the commercial sector, loans to state and political subdivisions and residential real estate loans. The increases in these major loan categories was partially offset by a reduction in consumer loans. Historically, commercial lending activities represented a significant portion of FNCB’s loan portfolio. Excluding PPP loans, commercial loans including commercial and industrial loans, commercial real estate loans and construction, land acquisition and development loans, as a percentage of total loans, gross, increased to 60.9% at September 30, 2020 from 57.3% at December 31, 2019.
From a collateral standpoint, a majority of FNCB’s loan portfolio consists of loans secured by real estate. Real estate secured loans, which include commercial real estate, construction, land acquisition and development, residential real estate loans and home equity lines of credit (“HELOCs”), increased $24.8 million, or 4.8%, to $538.5 million at September 30, 2020 from $513.7 million at December 31, 2019. The increase was concentrated in commercial real estate loans. Real estate secured loans represented 55.9% and 62.2% of total loans at September 30, 2020 and December 31, 2019, respectively.
Commercial real estate loans increased $17.9 million, or 6.4%, to $296.3 million at September 30, 2020 from $278.4 million at December 31, 2019. Commercial real estate loans include long-term commercial mortgage financing and are primarily secured by first or second lien mortgages. Commercial and industrial loans, which consist primarily of equipment loans, working capital financing, revolving lines of credit and loans secured by cash and marketable securities and PPP loans,increased $138.1 million, or 93.6%, to $285.7 million at September 30, 2020 from $147.6 million at December 31, 2019. Excluding PPP loans, commercial and industrial loans increased $19.5 million, or 13.2%. Construction, land acquisition and development loans increased $3.4 million, or 7.2%, to $50.9 million at September 30, 2020 from $47.5 million at December 31, 2019.
Residential real estate loans totaled $174.0 million at September 30, 2020, an increase of $3.3 million, or 1.9%, from $170.7 million at December 31, 2019. The components of residential real estate loans include fixed-rate and variable-rate, amortizing mortgage loans. HELOCs are not included in this category but are included in consumer loans. FNCB primarily underwrites fixed-rate residential mortgage loans for sale in the secondary market to reduce interest rate risk and provide funding for additional loans. Additionally, FNCB offers its proprietary “WOW” mortgage product, which is a non-saleable mortgage with maturity terms of 7.5 to 19.5 years that provides customers with an attractive fixed interest rate, low closing costs and a guaranteed 30-day close.
Consumer loans, which are primarily comprised of indirect automobile loans and HELOCs, decreased by $27.6 million, or 20.0%, to $110.6 million at September 30, 2020 from $138.2 million at December 31, 2019. The majority of this decrease was concentrated within the indirect auto loan portfolio, as FNCB did not aggressively compete for these loans. Loans to state and political subdivisions increased $1.9 million, or 4.3%, to $45.8 million at September 30, 2020 from $43.9 million at December 31, 2019.
The following table presents loans receivable, net by major category at September 30, 2020 and December 31, 2019:
Loan Portfolio Detail
| September 30, |
December 31, |
|||||||
| (in thousands) |
2020 |
2019 |
||||||
| Residential real estate |
$ | 174,020 | $ | 170,723 | ||||
| Commercial real estate |
296,281 | 278,379 | ||||||
| Construction, land acquisition and development |
50,934 | 47,484 | ||||||
| Commercial and industrial |
285,693 | 147,623 | ||||||
| Consumer |
110,636 | 138,239 | ||||||
| State and political subdivisions |
45,738 | 43,908 | ||||||
| Total loans, gross |
963,302 | 826,356 | ||||||
| Unearned income |
(118 | ) | (69 | ) | ||||
| Net deferred loan costs |
(2,955 | ) | 2,192 | |||||
| Allowance for loan and lease losses |
(12,269 | ) | (8,950 | ) | ||||
| Loans, net |
$ | 947,960 | $ | 819,529 | ||||
Under industry regulations, a concentration is considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly impacted by economic or other conditions. Typically, industry guidelines require disclosure of concentrations of loans exceeding 10.0% of total loans outstanding. FNCB had no such concentrations at September 30, 2020 or December 31, 2019. In addition to industry guidelines, FNCB’s internal policy considers a concentration to exist in its loan portfolio if an aggregate loan balance outstanding to borrowers within a specific industry exceeds 25.0% of capital. However, management regularly reviews loans by all industry categories to determine if a potential concentration exists.
The following table presents industry concentrations within FNCB’s loan portfolio at September 30, 2020 and December 31, 2019:
Loan Concentrations
| September 30, 2020 |
December 31, 2019 |
|||||||||||||||
| (in thousands) |
Amount |
% of Gross Loans | Amount |
% of Gross Loans | ||||||||||||
| 1-4 family residential investment properties |
$ | 53,757 | 5.58 | % | $ | 38,122 | 4.61 | % | ||||||||
| Retail space/shopping centers |
45,214 | 4.69 | % | 43,865 | 5.31 | % | ||||||||||
As the fallout of the COVID-19 pandemic continues to impact the national, regional and local economies, management continues to proactively monitor the loan portfolio to identify potential weaknesses that may develop. Management has identified and is continually monitoring exposures to borrowers and industries that may be impacted more immediately and acutely than others. Of particular concern are credit exposures to businesses within the hospitality industry including hotels and motels, full and limited-service restaurants and drinking establishments, among others. In many instances, management has directly reached out to specific borrowers to provide guidance and assistance as appropriate. At September 30, 2020, FNCB had an aggregate exposure of $15.5 million in outstanding loan balances to borrowers in the hotel industry and $23.6 million in outstanding loans to borrowers of full-service, limited-service and other establishments serving alcoholic and non-alcoholic beverages and snacks. On a portfolio level, management continues to monitor aggregate exposures to these highly sensitive segments, among others, for changes in asset quality and payment performance, and even liquidity levels. During the three months ended September 30, 2020, management provided a modification under the Cares Act to a significant commercial loan relationship involving three commercial real estate loans totaling $5.1 million that is secured by a hotel in FNCB's market area. At September 30, 2020 the loans were current and performing under the terms of the modification agreement. Management applied the provisions of the Cares Act and does not consider this modification to be a TDR as the three loans were current as of December 31, 2019 and the borrower's business was directly impacted adversely by the COVID-19 pandemic. Management is closely monitoring this relationship and will appropriately address any changes in the borrower's status. Additionally, management is monitoring unfunded commitments such as lines of credit and overdraft protection to determine liquidity and funding issues that may arise with FNCB's customers.
Asset Quality
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, net of unearned interest, deferred loan fees and costs, and reduced by the ALLL. The ALLL is established through a provision for loan and lease losses charged to earnings.
FNCB has established and consistently applies loan policies and procedures designed to foster sound underwriting and credit monitoring practices. Credit risk is managed through the efforts of the Chief Lending Officer and loan officers, the Chief Credit Officer, the loan review function, and the Credit Risk Management, ALLL, Officers Loan and Directors Loan Committees, as well as through oversight of the Board of Directors. Management continually evaluates its credit risk management practices to ensure it is reacting to problems in the loan portfolio in a timely manner, although, as is the case with any financial institution, a certain degree of credit risk is dependent in part on local and general economic conditions that are beyond management’s control.
Under FNCB’s risk rating system, loans that are rated pass, special mention, substandard, doubtful, or loss are reviewed regularly as part of the risk management practices. The Credit Risk Management Committee, which consists of key members of management fromfinance, legal, lending and credit administration, meet monthly or more often as necessary to review individual problem credits and workout strategies and provides monthly reports to the Board of Directors.
A loan is considered impaired when it is probable that FNCB will be unable to collect all amounts due (including principal and interest) according to the contractual terms of the note and loan agreement. For purposes of the analysis, all TDRs, loan relationships with an aggregate outstanding balance greater than $100 thousand rated substandard and non-accrual, and loans that are identified as doubtful or loss are considered impaired. Impaired loans are analyzed individually to determine the amount of impairment. For collateral-dependent loans, impairment is measured based on the fair value of the collateral supporting the loans. A loan is determined to be collateral dependent when repayment of the loan is expected to be provided through the liquidation of the collateral held. For impaired loans that are secured by real estate, collateral evaluations and external appraisals are obtained annually, or more frequently as warranted, to ascertain a fair value so that the impairment analysis can be updated. Should a collateral evaluation or current appraisal not be available at the time of impairment analysis, other sources of valuation may be used, including current letters of intent, broker price opinions or executed agreements of sale. For non-collateral-dependent loans, impairment is measured based on the present value of expected future cash flows, net of any deferred fees and costs, discounted at the loan’s original effective interest rate.
Loans to borrowers that are experiencing financial difficulty that are modified and result in the granting of concessions to the borrowers are classified as TDRs. Such concessions generally involve an extension of a loan’s stated maturity date, a reduction of the stated interest rate, payment modifications, capitalization of property taxes with respect to mortgage loans or a combination of these modifications. Non-accrual TDRs are returned to accrual status if principal and interest payments, under the modified terms, are brought current, are performing under the modified terms for six consecutive months, and management believes that collection of the remaining interest and principal is probable. FNCB conservatively considers all TDRs to be impaired.
Non-performing loans are monitored on an ongoing basis as part of FNCB’s loan review process. Additionally, work-out for non-performing loans and OREO are actively monitored through the Credit Risk Management Committee. A potential loss on a non-performing asset is generally determined by comparing the outstanding loan balance to the fair market value of the pledged collateral, less cost to sell.
Loans are placed on non-accrual when a loan is specifically determined to be impaired or when management believes that the collection of interest or principal is doubtful. This generally occurs when a default of interest or principal has existed for 90 days or more, unless the loan is well secured and in the process of collection, or when management becomes aware of facts or circumstances that the loan would default before 90 days. FNCB determines delinquency status based on the number of days since the date of the borrower’s last required contractual loan payment. When the interest accrual is discontinued, all unpaid interest income is reversed and charged back against current earnings. Any subsequent cash payments received are applied, first to the outstanding loan amounts, then to the recovery of any charged-off loan amounts, with any excess treated as a recovery of lost interest. A non-accrual loan is returned to accrual status when the loan is current as to principal and interest payments, is performing according to contractual terms for six consecutive months and future payments are reasonably assured.
Management actively manages impaired loans in an effort to mitigate loss to FNCB by working with customers to develop strategies to resolve borrower difficulties, through sale or liquidation of collateral, foreclosure, and other appropriate means. In addition, management monitors employment and economic conditions within FNCB’s market area, as weakening of conditions could result in real estate devaluations and an increase in loan delinquencies, which could negatively impact asset quality and cause an increase in the provision for loan and lease losses.
Under the fair value of collateral method, the impaired amount of the loan is deemed to be the difference between the loan amount and the fair value of the collateral, less the estimated costs to sell. For real estate secured loans, management generally estimates selling costs using a factor of 10%, which is based on typical cost factors, such as a 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process. If the valuation indicates that the fair value has deteriorated below the carrying value of the loan, the difference between the fair value and the principal balance is charged off. For impaired loans for which the value of the collateral less costs to sell exceeds the loan value, the impairment is determined to be zero.
The following table presents information about non-performing assets and accruing TDRs at September 30, 2020 and December 31, 2019:
Non-performing Assets and Accruing TDRs
| September 30, |
December 31, |
|||||||
| (dollars in thousands) |
2020 |
2019 |
||||||
| Non-accrual loans |
$ | 6,176 | $ | 9,084 | ||||
| Loans past due 90 days or more and still accruing |
- | - | ||||||
| Total non-performing loans |
6,176 | 9,084 | ||||||
| Other real estate owned |
58 | 289 | ||||||
| Other non-performing assets |
1,900 | 1,900 | ||||||
| Total non-performing assets |
$ | 8,134 | $ | 11,273 | ||||
| Accruing TDRs |
$ | 7,216 | $ | 7,745 | ||||
| Non-performing loans as a percentage of gross loans |
0.64 | % | 1.10 | % | ||||
Total non-performing assets decreased $3.2 million, or 27.8%, to $8.1 million at September 30, 2020 from $11.3 million at December 31, 2019. The improvement was attributable to a decrease in non-accrual loans, primarily reflecting the return of two large commercial loan relationships to accrual status, coupled with a decrease in OREO. FNCB’s ratio of non-performing loans to total gross loans decreased to 0.64% at September 30, 2020 from 1.10% at December 31, 2019. FNCB’s ratio of non-performing assets as a percentage of shareholders’ equity improved to 5.4% at September 30, 2020 from 8.4% at December 31, 2019, due primarily to an increase in FNCB's capital position, coupled with the reduction in non-performing assets.
Other non-performing assets at September 30, 2020 and December 31, 2019 was comprised solely of a classified account receivable secured by an evergreen letter of credit in the amount of $1.9 million, received in 2011 as part of a settlement agreement for a large construction, land acquisition and development loan for a residential development project in the Pocono region of Monroe County, Pennsylvania. The agreement provides for payment to FNCB as real estate building lots are sold. The project was stalled due to a decline in real estate values in this area following the financial crisis of 2008. In 2019, economic development in this market area started to improve and management had confirmed that the developer for this project had resumed construction activity, including the completion of substantial infrastructure, and had increased marketing and sales initiatives related to the project. As of September 30, 2020, no single-unit lots have been sold, however, the construction of a seven-unit building is nearing completion and general business activity appears to be increasing. Management continues to monitor this project closely and is in regular contact with the Developer. However, uncertainty and economic volatility associated with the COVID-19 pandemic are unknown and could negatively impact the timing of sales and payments.
While credit quality metrics of FNCB's loan portfolio improved comparing September 30, 2020 and December 31, 2019, management believes the COVID-19 pandemic may have an adverse effect on asset quality during the remainder of 2020 and beyond. Prolonged disruption to FNCB's customers could result in increased loan delinquencies, defaults and collateral devaluations. Management actively manages problem credits through workout efforts focused on developing strategies to resolve borrower difficulties through liquidation of collateral and other appropriate means. Additionally, management continues to monitor non-accrual loans, delinquency trends and economic conditions within FNCB’s market area on an on-going basis in order to proactively address any collection-related issues and mitigate any potential losses.
There were no loans modified as TDRs during the three months ended September 30, 2020. Loans modified as TDRs for the nine months ended September 30, 2020 included three commercial and industrial loans and one residential mortgage loan. The three commercial and industrial loans were modified under forbearance agreements with an aggregate pre- and post-modification recorded investment of $196 thousand. The modification of the residential mortgage loan involved an extension of terms and the loan had a pre- and post-modification recorded investment of $88 thousand.
During the three months ended September 30, 2019, there were three residential mortgage loans modified as TDRs. The modifications involved either forbearance or capitalization of taxes and had pre- and post-modification recorded investments that totaled $250 thousand and $261 thousand respectively. For the nine months ended September 30, 2019, TDRs also included one residential mortgage loan for which the terms were extended. This TDR had a pre- and post-modification balance of $24 thousand.
During the three and nine months ended September 30, 2020, there were no loans modified as a TDR within the previous 12 months that subsequently defaulted, defined as 90 days or more past due. There were no loans that were modified as a TDR within the previous 12 months that subsequently defaulted during the three months ended September 30, 2019. For the nine months ended September 30, 2019, subsequent defaults of TDRs modified within the previous 12 months included one consumer loan with a recorded investment of $103 thousand.
Modifications Related to COVID-19
In late March 2020, the federal banking regulators issued guidance and are encouraging banks to work prudently with, and provide short-term payment accommodations to, borrowers affected by COVID-19. Additionally, Section 4013 of the CARES Act addressed COVID-19-related modifications and specified that such modifications made on loans that were current as of December 31, 2019 do not need to be classified as TDRs. FNCB had applied this guidance and made 916 such modifications, with 860 loans having an aggregate recorded investment of $173.6 million outstanding at September 30, 2020. These initial modifications provided borrowers with a short-term, typically three months, interest-only period or full payment deferral. Of the 860 loans, 71 loans with an aggregate recorded investment of $21.4 million were provided a second deferral. As of September 30, 2020, there were 16 loans with an aggregate recorded investment of $8.0 million, or 0.83% of total loans, that were still under deferral. Included in loans still under deferral was a modification provided to a significant commercial loan relationship involving three commercial real estate loans totaling $5.1 million that are secured by a hotel in FNCB's market area. At September 30, 2020 the loans were current and performing under the terms of the modification agreement. In applying the provisions of the CARES Act, management does not consider this modification to be a TDR as the three loans were current as of December 31, 2019 and the borrower's business was directly impacted adversely by the COVID-19 pandemic. Management is closely monitoring this relationship, as well as all loans for which modifications under the CARES Act have been granted, and will appropriately address any changes in the status of any of the borrowers. Additionally, management will continue to follow regulatory guidance when working with borrowers who have been impacted by COVID-19 and apply the CARES Act guidance in making any TDR determinations.
The following table presents information about COVID-19 related loan modifications by major loan category as of September 30, 2020.
| As of September 30, 2020 |
||||||||||||||||||||||||
| Total Loans Modified |
Total Number of Loans Still Under Deferral |
|||||||||||||||||||||||
| (in thousands) |
Number of Loans |
Recorded Investment |
% of Loan Category |
Number of Loans |
Recorded Investment |
% of Loan Category |
||||||||||||||||||
| COVID-19 related loan modifications: |
||||||||||||||||||||||||
| Residential real estate |
201 | $ | 18,951 | 10.89 | % | 2 | $ | 54 | 0.03 | % | ||||||||||||||
| Commercial real estate |
159 | 113,245 | 38.22 | % | 7 | 7,860 | 2.65 | % | ||||||||||||||||
| Construction, land acquisition and development |
12 | 11,340 | 22.26 | % | - | - | - | |||||||||||||||||
| Commercial and industrial |
101 | 22,748 | 7.96 | % | - | - | - | |||||||||||||||||
| Consumer |
387 | 7,283 | 6.58 | % | 7 | 107 | 0.10 | % | ||||||||||||||||
| State and political subdivision |
- | - | - | - | - | - | ||||||||||||||||||
| Total |
860 | $ | 173,567 | 18.02 | % | 16 | 8,021 | 0.83 | % | |||||||||||||||
The following table presents the changes in non-performing loans for the three and nine months ended September 30, 2020 and 2019. Loan foreclosures represent recorded investment at time of foreclosure not including the effect of any guarantees. There were no loans foreclosed upon during the three and nine months ended September 30, 2020 and 2019.
Changes in Non-Performing Loans
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
| (in thousands) |
2020 |
2019 |
2020 |
2019 |
||||||||||||
| Balance, beginning of period |
$ | 6,740 | $ | 5,302 | $ | 9,084 | $ | 4,696 | ||||||||
| Loans newly placed on non-accrual |
329 | 1,707 | 1,765 | 4,801 | ||||||||||||
| Loans returned to performing status |
(4 | ) | - | (1,573 | ) | (27 | ) | |||||||||
| Loan foreclosures |
- | - | - | - | ||||||||||||
| Loans charged-off |
(567 | ) | (411 | ) | (1,191 | ) | (1,978 | ) | ||||||||
| Loan payments received |
(322 | ) | (479 | ) | (1,909 | ) | (1,373 | ) | ||||||||
| Balance, end of period |
$ | 6,176 | $ | 6,119 | $ | 6,176 | $ | 6,119 | ||||||||
The average balance of impaired loans was $12.8 million and $14.3 million, respectively, for the three and nine months ended September 30, 2020 and 2019, compared to $12.3 million and $12.6 million, respectively, for the three and nine months ended September 30, 2019. FNCB recognized $83 thousand and $272 thousand of interest income on impaired loans for the three and nine months ended September 30, 2020, respectively and $97 thousand and $302 thousand for the respective periods of 2019.
The additional interest income that would have been earned on non-accrual and restructured loans had the loans been performing in accordance with their original terms for the three and nine months ended September 30, 2020 approximated $76 thousand and $282 thousand, respectively and $90 thousand and $267 thousand for the respective periods of 2019.
The following table presents accruing loan delinquencies and non-accrual loans as a percentage of gross loans at September 30, 2020 and December 31, 2019:
Loan Delinquencies and Non-Accrual Loans
| September 30, |
December 31, |
|||||||
| 2020 |
2019 |
|||||||
| Accruing: |
||||||||
| 30-59 days |
0.14 | % | 0.26 | % | ||||
| 60-89 days |
0.03 | % | 0.10 | % | ||||
| 90+ days |
0.00 | % | 0.00 | % | ||||
| Non-accrual |
0.64 | % | 1.10 | % | ||||
| Total delinquencies |
0.81 | % | 1.46 | % | ||||
Total delinquencies as a percent of gross loans were 0.81% at September 30, 2020 compared to 1.46% at December 31, 2019. The decrease in total delinquent loans was primarily due to a decrease in non-accrual loans of $2.9 million, coupled with a $0.6 million decrease in accruing loans past due 60-89 days.
Allowance for Loan and Lease Losses
The ALLL represents management’s estimate of probable loan losses inherent in the loan portfolio. The ALLL is analyzed in accordance with GAAP and is maintained at a level that is based on management’s evaluation of the adequacy of the ALLL in relation to the risks inherent in the loan portfolio.
As part of its evaluation, management considers qualitative and environmental factors, including, but not limited to:
| • |
changes in national, local, and business economic conditions and developments, including the condition of various market segments; |
| • |
changes in the nature and volume of the loan portfolio; |
| • |
changes in lending policies and procedures, including underwriting standards, collection, charge-off and recovery practices and results; |
| • |
changes in the experience, ability and depth of lending management and staff; |
| • |
changes in the quality of the loan review system and the degree of oversight by the Board of Directors; |
| • |
changes in the trend of the volume and severity of past due and classified loans, including trends in the volume of non-accrual loans, TDRs and other loan modifications; |
| • |
the existence and effect of any concentrations of credit and changes in the level of such concentrations; |
| • |
the effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the current loan portfolio; and |
| • |
analysis of customers’ credit quality, including knowledge of their operating environment and financial condition. |
Evaluations are intrinsically subjective, as the results are estimated based on management knowledge and experience and are subject to interpretation and modification as information becomes available or as future events occur. Management monitors the loan portfolio on an ongoing basis with emphasis on weakness in both the real estate market and the economy in general and its effect on repayment. Adjustments to the ALLL are made based on management’s assessment of the factors noted above.
For purposes of management’s analysis of the ALLL, all loan relationships with an aggregate balance greater than $100 thousand that are rated substandard and non-accrual, identified as doubtful or loss, and all TDRs are considered impaired and are analyzed individually to determine the amount of impairment. Circumstances such as construction delays, declining real estate values, and the inability of the borrowers to make scheduled payments have resulted in these loan relationships being classified as impaired. FNCB utilizes the fair value of collateral method for collateral-dependent loans and TDRs for which repayment depends on the sale of collateral. For non-collateral-dependent loans and TDRs, FNCB measures impairment based on the present value of expected future cash flows discounted at the loan’s original effective interest rate. With regard to collateral-dependent loans, appraisals are received at least annually to ensure that impairment measurements reflect current market conditions. Should a current appraisal not be available at the time of impairment analysis, other valuation sources including current letters of intent, broker price opinions or executed agreements of sale may be used. Only downward adjustments are made based on these supporting values. Included in all impairment calculations is a cost to sell adjustment of approximately 10%, which is based on typical cost factors, including a 6% broker commission, 1% transfer taxes and 3% various other miscellaneous costs associated with the sales process. Sales costs are periodically reviewed and revised based on actual experience. The ALLL analysis is adjusted for subsequent events that may arise after the end of the reporting period but before the financial reports are filed.
The ALLL equaled $12.3 million, or 1.28% of total loans at September 30, 2020, an increase of $3.3 million, or 37.1%, from $8.9 million at December 31, 2019. The increase resulted from $2.0 million in provisions for loan and lease losses for the nine months ended September 30, 2020, offset by $1.3 million in net recoveries for the same time period. The increase in the ALLL was primarily related to economic disruption and uncertainty caused by the COVID-19 pandemic. Management adjusted the qualitative factors for the potential effect of economic and employment uncertainty and disruption due to the global pandemic into its evaluation.
The ALLL consists of both specific and general components. The component of the ALLL that is related to impaired loans that are individually evaluated for impairment, the guidance for which is provided by ASC 310 “Impairment of a Loan” (“ASC 310”), was $409 thousand, or 3.3%, of the total ALLL at September 30, 2020, compared to $473 thousand, or 5.3%, of the total ALLL at December 31, 2019. A general allocation of $11.9 million was calculated for loans analyzed collectively under ASC 450 “Contingencies” (“ASC 450”), which represented 96.7% of the total ALLL of $12.3 million. Comparatively, at December 31, 2019, the general allocation for loans collectively analyzed for impairment amounted to $8.5 million, or 94.7%, of the total ALLL. Included in the general component of the ALLL at September 30, 2020 was an unallocated reserve of $1.1 million, compared to $426 thousand at December 31, 2019. The increase in the unallocated reserve was directly related to the increase in credit provisioning due to the economic disruption caused by the COVID-19 pandemic. Based on its evaluations, management may establish an unallocated component to cover any inherent losses that exist as of the evaluation date, but which may not have been identified under the methodology. The ratio of the ALLL to total loans increased to 1.28% of total loans, net of net deferred loan origination fees and unearned income, of $960.2 million at September 30, 2020 from 1.08% of total loans, net of net deferred loan costs and unearned income, of $828.5 million at December 31, 2019. Excluding PPP loans, the ALLL as a percentage of gross loans equaled 1.45% at September 30, 2020.
The following table presents an allocation of the ALLL by major loan category and percent of loans in each category to total loans at September 30, 2020 and December 31, 2019:
Allocation of the ALLL
| September 30, 2020 |
December 31, 2019 |
|||||||||||||||
| Percentage |
Percentage |
|||||||||||||||
| of Loans |
of Loans |
|||||||||||||||
| in Each |
in Each |
|||||||||||||||
| Category |
Category |
|||||||||||||||
| Allowance |
to Total |
Allowance |
to Total |
|||||||||||||
| (dollars in thousands) |
Amount |
Loans |
Amount |
Loans |
||||||||||||
| Residential real estate |
$ | 1,547 | 18.06 | % | $ | 1,147 | 20.66 | % | ||||||||
| Commercial real estate |
4,814 | 30.75 | % | 3,198 | 33.69 | % | ||||||||||
| Construction, land acquisition and development |
413 | 5.29 | % | 271 | 5.75 | % | ||||||||||
| Commercial and industrial |
2,354 | 29.66 | % | 1,997 | 17.86 | % | ||||||||||
| Consumer |
1,649 | 11.49 | % | 1,658 | 16.73 | % | ||||||||||
| State and political subdivision |
377 | 4.75 | % | 253 | 5.31 | % | ||||||||||
| Unallocated | 1,115 | 0.00 | % | 426 | 0.00 | % | ||||||||||
| Total |
$ | 12,269 | 100.00 | % | $ | 8,950 | 100.00 | % | ||||||||
The following table presents an analysis of the ALLL by loan category for the three and nine months ended September 30, 2020 and 2019:
Reconciliation of the ALLL
| For the Three Months Ended September 30, |
For the Nine Months Ended September 30, |
|||||||||||||||
| (dollars in thousands) |
2020 |
2019 |
2020 |
2019 |
||||||||||||
| Balance at beginning of period |
$ | 11,024 | $ | 8,945 | $ | 8,950 | $ | 9,519 | ||||||||
| Charge-offs: |
||||||||||||||||
| Residential real estate |
- | - | - | 27 | ||||||||||||
| Commercial real estate |
280 | - | 336 | - | ||||||||||||
| Construction, land acquisition and development |
- | - | - | 18 | ||||||||||||
| Commercial and industrial |
81 | 216 | 208 | 976 | ||||||||||||
| Consumer |
221 | 201 | 683 | 973 | ||||||||||||
| State and political subdivisions |
- | - | - | - | ||||||||||||
| Total charge-offs |
582 | 417 | 1,227 | 1,994 | ||||||||||||
| Recoveries of charged-off loans: |
||||||||||||||||
| Residential real estate |
3 | 1 | 42 | 7 | ||||||||||||
| Commercial real estate |
845 | - | 846 | 14 | ||||||||||||
| Construction, land acquisition and development |
- | 1 | - | 82 | ||||||||||||
| Commercial and industrial |
726 | 58 | 1,210 | 265 | ||||||||||||
| Consumer |
179 | 90 | 392 | 592 | ||||||||||||
| State and political subdivisions |
- | - | - | - | ||||||||||||
| Total recoveries |
1,753 | 150 | 2,490 | 960 | ||||||||||||
| Net (recoveries) charge-offs |
(1,171 | ) | 267 | (1,263 | ) | 1,034 | ||||||||||
| Provision for loan and lease losses |
74 | 637 | 2,056 | 830 | ||||||||||||
| Balance at end of period |
$ | 12,269 | $ | 9,315 | $ | 12,269 | $ | 9,315 | ||||||||
| Net charge-offs as a percentage of average loans |
(0.12 | )% | 0.03 | % | (0.14 | )% | 0.13 | % | ||||||||
| Allowance for loan and lease losses as a percentage of gross loans outstanding at period end |
1.28 | % | 1.11 | % | 1.28 | % | 1.11 | % | ||||||||
| Allowance for loan and lease losses as a percentage of gross loans outstanding at period end, excluding PPP Loans | 1.45 | % | - | 1.45 | % | - | ||||||||||
Other Real Estate Owned
There was one piece of commercial land with a carrying value of $58 thousand held in OREO at September 30, 2020. There were two properties with an aggregate carrying value of $289 thousand at December 31, 2019, including the piece of commercial land and a single family residential real estate property with carrying values of $85 thousand and $204 thousand, respectively. FNCB recorded a valuation adjustment to the carrying value of the piece of commercial land of $27 thousand during the nine months ended September 30, 2020. The residential real estate property, which was the collateral supporting an investor-owned residential mortgage loan, was sold during the nine months ended September 30, 2020. The agreement with the investor requires FNCB to take title to the property upon foreclosure and liquidate the property on behalf of the investor after foreclosure. FNCB did not realize any gain or loss upon the sale. There were no properties foreclosed upon during the nine months ended September 30, 2020.
At September 30, 2019, OREO consisted of four properties with an aggregate value of $412 thousand. There were two properties with an aggregate fair value less cost to sell of $256 thousand that were foreclosed upon during the nine months ended September 30, 2019. The properties foreclosed upon were the collateral supporting investor-owned residential mortgage loans. There were four OREO properties, with an aggregate carrying value of $749 thousand, sold during the nine months ended September 30, 2019. FNCB realized net gains of $20 thousand upon the sales, which was included in non-interest income for the nine months ended September 30, 2019.
The expenses related to maintaining OREO, not including adjustments to property values subsequent to foreclosure, and net of any income from operation of the properties, amounted to $65 thousand and $155 thousand for the three and nine months ended September 30, 2020, respectively, and $62 thousand and $127 thousand for the respective periods of 2019.
FNCB actively markets OREO properties for sale through a variety of channels including internal marketing and the use of outside brokers/realtors. The carrying value of OREO is generally calculated at an amount not greater than 90% of the most recent fair market appraised value unless specific conditions warrant an exception. A 10% factor is generally used to estimate costs to sell, which is based on typical cost factors, such as 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process. This fair value is updated on an annual basis or more frequently if new valuation information is available. Deterioration in the real estate market could result in additional losses on these properties. As mentioned above, FNCB recorded valuation adjustments to the carrying value of the property held in OREO of $27 thousand for the three and nine months ended September 30, 2020. There were no valuation adjustments recorded to the carrying value of OREO properties during the three and nine months ended September 30, 2019.
Liabilities
Total liabilities, which consist primarily of total deposits and borrowed funds, were $1.293 billion at September 30, 2020, an increase of $223.2 million, or 20.9%, from $1.070 billion at December 31, 2019. The increase primarily reflected strong deposit growth experienced during 2020. Changing customer deposit preferences and higher balances due to the reduction in consumer and business spending due to uncertainty related to the COVID-19 pandemic, coupled with cyclical deposit trends of public funds, were the the primary factors contributing to an increase in total deposits of $270.5 million, or 27.0%, to $1.272 billion at September 30, 2020 from $1.002 billion at December 31, 2019. FNCB experienced strong demand for both non-interest-bearing and interest-bearing deposits. Non-interest-bearing demand deposits increased $94.6 million, or 52.7%, to $274.1 million at September 30, 2020 from $179.5 million at December 31, 2019, while interest-bearing deposits increased $175.9 million, or 21.4%, to $998.1 million at September 30, 2020 from $822.2 million at December 31, 2019. Interest-bearing demand deposits increased $158.3 million, or 29.6%, to $693.0 million at September 30, 2020 from $534.7 million at December 31, 2019, while savings deposits increased $13.4 million, or 14.1%, to $107.9 million at September 30, 2020 from $94.5 million at December 31, 2019. Total time deposits increased $4.1 million, or 2.1%, to $197.2 million at September 30, 2020 from $193.0 million at December 31, 2019 primarily due to an increase in brokered certificates of deposit of $20.0 million, partially offset by maturing certificates of deposit that were primarily redirected into non-maturity interest-bearing deposits. As a result of strong increase in deposits, FNCB was able to reduce its reliance on borrowed funds as a source of liquidity. Specifically, FNCB prepaid two higher-costing term advances during the three months ended September 30, 2020. Additionally, FNCB prepaid a $36 million advance through the Federal Reserve Discount Window under the PPPLF during the three months ended September 30, 2020. There were no Discount Window advances or any FHLB of Pittsburgh overnight or term advances outstanding at September 30, 2020. Total borrowed funds decreased $46.9 million, or 82.0%, to $10.3 million at September 30, 2020 from $57.2 million at December 31, 2019. Management regularly monitors wholesale funding sources taking into consideration the cost of funds, diversification between funding sources and asset/liability management strategies. FNCB utilizes brokered deposits, including one-way purchases through the Promontory Interfinancial Network, deposits acquired through a national listing service, as well as overnight and term advances through the FHLB of Pittsburgh as wholesale sources of funds to supplement its deposit gathering initiatives.
Equity
Total shareholders’ equity increased $16.4 million, or 12.3%, to $150.0 million at September 30, 2020 from $133.6 million at December 31, 2019. The improvement in capital resulted primarily from net income for the nine months ended September 30, 2020 of $10.2 million and a $9.1 million increase in accumulated other comprehensive income related primarily to appreciation in the fair value of available-for-sale debt securities, net of deferred taxes. These improvements were partially offset by dividends declared and paid for the nine months ended September 30, 2020 of $3.3 million. FNCB's tangible book value per common share improved $0.79, or 12.0%, to $7.41 at September 30, 2020, compared to $6.62 per share at December 31, 2019.
The Bank's total regulatory capital increased $19.1 million to $152.5 million at September 30, 2020 from $133.4 million at December 31, 2019. The Bank's total risk-based capital and Tier 1 leverage ratios were 16.09% and 10.17%, respectively at September 30, 2020 compared to 14.77% and 10.36%, respectively, at December 31, 2019. The Bank's risk-based capital ratios exceeded the minimum regulatory capital ratios required for well capitalized under prompt corrective action regulations. Based on the most recent notification from its primary regulator, the Bank was considered well capitalized at September 30, 2020 and December 31, 2019. There were no conditions or events since that notification that management believes would have changed this capital designation.
Liquidity
The term liquidity refers to the ability to generate sufficient amounts of cash to meet cash flow needs. Liquidity is required to fulfill the borrowing needs of FNCB’s credit customers and the withdrawal and maturity requirements of its deposit customers, as well as to meet other financial commitments. FNCB’s liquidity position is impacted by several factors, which include, among others, loan origination volumes, loan and investment maturity structure and cash flows, deposit demand and time deposit maturity structure and retention. FNCB has liquidity and contingent funding policies in place that are designed with controls in place to provide advanced detection of potentially significant funding shortfalls, establish methods for assessing and monitoring risk levels, and institute prompt responses that may alleviate a potential liquidity crisis. Management monitors FNCB’s liquidity position and fluctuations daily, forecasts future liquidity needs, performs periodic stress tests on its liquidity levels and develops strategies to ensure adequate liquidity at all times.
The statements of cash flows present the change in cash and cash equivalents from operating, investing and financing activities. Cash and due from banks and interest-bearing deposits in other banks, which comprise cash and cash equivalents, are FNCB’s most liquid assets. At September 30, 2020, cash and cash equivalents totaled $105.0 million, an increase of $70.4 million compared to $34.6 million at December 31, 2019. For the nine months ended September 30, 2020 net cash provided by operating and financing activities were partially offset by net cash used in investing activities during that same time frame. Operating activities, net of reconciling adjustments for the nine months ended September 30, 2020 provided net cash of $15.1 million. Financing activities provided $220.3 million in net cash flow for the nine months ended September 30, 2020, which resulted primarily from the net increase in deposits of $270.5 million. Partially offsetting these net cash inflows, was $165.0 million in net cash used by FNCB's investing activities for the nine months ended September 30, 2020, which resulted primarily from the cash used of $130.8 million for new loan funding, coupled with the purchases of available-for-sale securities of $113.2 million. These investing cash outflows were partially offset by cash received from sales, maturities, calls and repayments of available-for-sale debt securities totaling $77.2 million.
Management believes the COVID-19 pandemic could pose potential stresses on liquidity management. FNCB could experience an increase in the utilization of existing lines of credit as customers manage their own liquidity needs during this time of economic uncertainty. Management believes FNCB's current liquidity position and available sources of liquidity were sufficient to meet its cash flow needs and fulfill its obligations at September 30, 2020. In addition to cash and cash equivalents of $105.0 million at September 30, 2020, FNCB had ample sources of additional liquidity including approximately $350.9 million in available borrowing capacity from the FHLB of Pittsburgh, and available borrowing capacity through the Federal Reserve Discount Window of $82.4 million under the PPPLF and $17.3 million under the borrower-in-custody program. FNCB also has available unsecured federal funds lines of credit totaling $40.0 million at September 30, 2020.
Interest Rate Risk
Interest Rate Sensitivity
Market risk is the risk to earnings and/or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. FNCB’s exposure to market risk is primarily interest rate risk associated with our lending, investing and deposit gathering activities, all of which are other than trading. Changes in interest rates affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. In addition, variations in interest rates affect the underlying economic value of our assets, liabilities and off-balance sheet items.
Asset and Liability Management
FNCB manages these objectives through its Asset and Liability Management Committee (“ALCO”) and its Rate and Liquidity and Investment Committees, which consist of certain members of management and certain members of the finance unit. Members of the committees meet regularly to develop balance sheet strategies affecting the future level of net interest income, liquidity and capital.
The major objectives of ALCO are to:
| ● |
manage exposure to changes in the interest rate environment by limiting the changes in net interest margin to an acceptable level within a reasonable range of interest rates; |
| ● |
ensure adequate liquidity and funding; |
| ● |
maintain a strong capital base; and |
| ● |
maximize net interest income opportunities. |
FNCB utilizes the pricing and structure of loans and deposits, the size and duration of the investment securities portfolio, the size and duration of the wholesale funding portfolio, and off-balance sheet interest rate contracts to manage interest rate risk. The off-balance sheet interest rate contracts may include interest rate swaps, caps and floors. These interest rate contracts involve, to varying degrees, credit risk and interest rate risk. Credit risk is the possibility that a loss may occur if a counterparty to a transaction fails to perform according to terms of the contract. The notional amount of the interest rate contracts is the amount upon which interest and other payments are based. The notional amount is not exchanged, and therefore, should not be taken as a measure of credit risk. See Note 6, "Derivative and Hedging Transactions," to the notes to consolidated financial statements for additional information about FNCB's derivative transactions.
ALCO monitors FNCB’s exposure to changes in net interest income over both a one-year planning horizon and a longer-term strategic horizon. ALCO uses net interest income simulations and economic value of equity (“EVE”) simulations as the primary tools in measuring and managing FNCB’s position and considers balance sheet forecasts, FNCB's liquidity position, the economic environment, anticipated direction of interest rates and FNCB’s earnings sensitivity to changes in these rates in its modeling. In addition, ALCO has established policy tolerance limits for acceptable negative changes in net interest income. Furthermore, as part of its ongoing monitoring, ALCO requires quarterly back testing of modeling results, which involves after-the-fact comparisons of projections with FNCB’s actual performance to measure the validity of assumptions used in the modeling techniques.
Earnings at Risk and Economic Value at Risk Simulations
Earnings at Risk
Earnings-at-risk simulation measures the change in net interest income and net income under various interest rate scenarios. Specifically, given the current market rates, ALCO looks at “earnings at risk” to determine anticipated changes in net interest income from a base case scenario with scenarios of +200, +400, and -100 basis points for simulation purposes. The simulation takes into consideration that not all assets and liabilities re-price equally and simultaneously with market rates (i.e., savings rate).
Economic Value at Risk
While 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 FNCB’s existing assets and liabilities. ALCO examines this ratio regularly, and given the current rate environment, has utilized rate shocks of +200, +400, and -100 basis points for simulation purposes. Management recognizes that, in some instances, this ratio may contradict the “earnings at risk” ratio.
While ALCO regularly performs a wide variety of simulations under various strategic balance sheet and treasury yield curve scenarios, the following results reflect FNCB’s sensitivity over the subsequent twelve months based on the following assumptions:
| ● |
asset and liability levels using September 30, 2020 as a starting point; |
| ● |
cash flows are based on contractual maturity and amortization schedules with applicable prepayments derived from internal historical data and external sources; and |
| ● |
cash flows are reinvested into similar instruments so as to keep interest-earning asset and interest-bearing liability levels constant. |
The following table illustrates the simulated impact of parallel and instantaneous interest rate shocks of +400 basis points, +200 basis points, and -100 basis points on net interest income and the change in economic value over a one-year time horizon from the September 30, 2020 levels:
| Rates +200 |
Rates +400 |
Rates -100 |
||||||||||||||||||||||
| Simulation Results |
Policy Limit |
Simulation Results |
Policy Limit |
Simulation Results |
Policy Limit |
|||||||||||||||||||
| Earnings at risk: |
||||||||||||||||||||||||
| Percent change in net interest income |
(1.8 | )% | (12.5 | )% | (1.1 | )% | (20.0 | )% | 2.1 | % | (10.0 | )% | ||||||||||||
| Economic value at risk: |
||||||||||||||||||||||||
| Percent change in economic value of equity |
10.5 | % | (20.0 | )% | 17.0 | % | (35.0 | )% | (28.3 | )% | (10.0 | )% | ||||||||||||
Model results at September 30, 2020 indicated that FNCB was liability sensitive and had minor exposure to rising rates in the near term moving to an asset sensitive position within approximately twelve months and then continuing in an asset-sensitive position for the remaining periods of the model. The liability rate sensitive position shortened as compared to model results at March 31, 2020, which indicated a shift to an asset sensitive position in months 13 through 15 of the model. Model results at September 30, 2020 indicated that FNCB’s net interest income is expected to decrease 1.8% under a +200-basis point interest rate shock. Additionally, model results indicated that FNCB's economic value of equity is expected toincrease 10.5%under a parallel shift in interest rates of +200 basis points. Under a -100-basis point interest rate shock, model results indicated that FNCB's net interest income would increase 2.1%, while the economic value of equity would decrease 28.3%, respectively. Management does not believe that the modeled decrease in the economic value of equity, which exceeds the current policy limit of 10.0%, poses any undue interest rate risk at September 30, 2020. Comparatively, model results at June 30, 2020 exhibited similar results and indicated net interest income would be expected to decrease 1.6% and economic value of equity would be expected to increase 11.0% given a +200-basis point rate shock. Conversely, given a -100 basis point rate shock at June 30, 2020, net interest income would be expected to increase 3.4% and the economic value of equity would decrease 32.2%.
This analysis does not represent a forecast for FNCB and should not be relied upon as being indicative of expected operating results. These simulations are based on numerous assumptions, including but not limited to: the nature and timing of interest rate levels, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacements of asset and liability cash flows, and other factors. While assumptions reflect current economic and local market conditions, FNCB cannot make any assurances as to the predictive nature of these assumptions, including changes in interest rates, customer preferences, competition and liquidity needs, or what actions ALCO might take in responding to these changes. In response to the economic disruption and uncertainty brought on by the COVID-19 pandemic, the FOMC lowered the federal funds target rate a total of 150 basis points in two emergency actions with an expectation that the Committee will maintain a low interest rate environment for the foreseeable future. Given FNCB's current asset/liability position, the significantly lower market interest rates may have a negative impact on FNCB's earning asset yields and variable-rate loans and securities indexed to prime and LIBOR will reprice downward.
As previously mentioned, as part of its ongoing monitoring, ALCO requires quarterly back testing of modeling results, which involves after-the-fact comparisons of projections with FNCB’s actual performance to measure the validity of assumptions used in the modeling techniques. As part of its quarterly review, management compared tax-equivalent net interest income recorded for the three months ended September 30, 2020 with tax-equivalent net interest income that was projected for the same three-month period. There was a negative variance between actual and projected tax-equivalent net interest income for the three-month period ended September 30, 2020 of approximately $1.1 million, or 12.6%. The variance primarily reflected a difference in the assumption for the volume and timing of the forgiveness of PPP loans used in the model with that actually experienced. The June 30, 2020 simulation assumed approximately 75.0% of PPP loans would be forgiven and paid off within six months, and the proceeds used to repay borrowings with the remainder re-invested into higher-yielding assets. As of September 30, 2020, there were no PPP loans that were forgiven and paid off. ALCO performs a detailed rate/volume analysis between actual and projected results in order to continue to improve the accuracy of its simulation models.
Off-Balance Sheet Arrangements
In the ordinary course of operations, FNCB engages in a variety of financial transactions that, in accordance with GAAP, are not recorded in our consolidated financial statements or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions may be used for general corporate purposes or for customer needs. Corporate purpose transactions would be used to help manage credit, interest rate and liquidity risk or to optimize capital. Customer transactions are used to manage customers’ requests for funding.
For the three and nine months ended September 30, 2020, FNCB did not engage in any off-balance sheet transactions that would have or would be reasonably likely to have a material effect on its consolidated financial condition.
Item 3 — Quantitative and Qualitative Disclosures about Market Risk
There have been no material changes in FNCB’s exposure to market risk during the nine months ended September 30, 2020. For discussion of FNCB’s exposure to market risk, refer to Item 7A, Quantitative and Qualitative Disclosures about Market Risk, contained in FNCB’s Form 10-K for the year ended December 31, 2019.
Item 4 — Controls and Procedures
FNCB’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of FNCB’s disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on that evaluation, FNCB’s Chief Executive Officer and Chief Financial Officer concluded FNCB’s disclosure controls and procedures were effective as of September 30, 2020.
There were no changes made to FNCB’s internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, FNCB’s internal control over financial reporting.
FNCB has been subject to tax audits, and is also a party to routine litigation involving various aspects of its business, such as employment practice claims, workers compensation claims, claims to enforce liens, condemnation proceedings on properties in which FNCB holds security interests, claims involving the making and servicing of real property loans and other issues incident to its business, none of which has or is expected to have a material adverse impact on the consolidated financial condition, results of operations or liquidity of FNCB.
There have been no changes in the status of the other litigation, if any, disclosed in FNCB’s Annual Report on Form 10-K for the year ended December 31, 2019.
In addition to the other information contained in this Quarterly Report on Form 10-Q, the following risk factor represents material updates and additions to the risk factors previously disclosed in FNCB's Annual Report on Form 10- K for the fiscal year ended December 31, 2019 as filed with the Securities and Exchange Commission. Additional risks not presently known to FNCB, or that FNCB currently deems immaterial, may also adversely affect its business, financial condition or results of operations. Further, to the extent that any of the information contained in this Quarterly Report on Form 10-Q constitutes forward-looking statements, the risk factor set forth below also is a cautionary statement identifying important factors that could cause our actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of FNCB.
The economic impact of the novel COVID-19 outbreak could adversely affect FNCB's financial condition and results of operations.
In December 2019, a novel coronavirus (COVID-19) was reported in China, and, in March 2020, the World Health Organization declared it a pandemic. On March 12, 2020, the President of the United States declared the COVID-19 outbreak in the United States a national emergency. The COVID-19 pandemic has caused significant economic dislocation in the United States as many state and local governments have ordered non-essential businesses to close and mandated "stay-at-home" restrictions for residents. This has resulted in an unprecedented slow-down in economic activity and a related increase in unemployment. Since the COVID-19 outbreak, more than 22 million people have filed claims for unemployment, and stock markets have declined in value and, in particular, bank stocks have significantly declined in value. In response to the COVID-19 outbreak, the Federal Reserve Board has reduced the benchmark fed funds rate to a target range of 0% to 0.25%, and the yields on 10- and 30-year treasury notes have declined to historic lows. Various state governments and federal agencies are requiring lenders to provide forbearance and other relief to borrowers (e.g., waiving late payment and other fees). The federal banking agencies have encouraged financial institutions to prudently work with affected borrowers and recently passed legislation has provided relief from reporting loan classifications due to modifications related to the COVID-19 outbreak. Certain industries have been particularly hard-hit, including the travel and hospitality industry, the restaurant industry and the retail industry. Finally, the spread of the coronavirus has caused FNCB to modify its business practices, including employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences. FNCB may take further actions as may be required by government authorities or that it determines are in the best interests of FNCB's employees, customers and business partners.
Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the full impact of the COVID-19 outbreak on FNCB's business. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated, the stabilization of economic activity and whether or not the federal government will approve additional stimulus.
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3 - Defaults upon Senior Securities.
None.
Item 4 — Mine Safety Disclosures.
Not applicable.
None.
The following exhibits are filed or furnished herewith or incorporated by reference.
| * |
Filed herewith |
| ** |
Furnished herewith |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Registrant: FNCB BANCORP, INC.
| Date: November 2, 2020 |
By: |
/s/ Gerard A. Champi |
| Gerard A. Champi |
||
| President and Chief Executive Officer |
||
| Date: November 2, 2020 |
By: |
/s/ James M. Bone, Jr. |
| James M. Bone, Jr., CPA |
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| Executive Vice President and Chief Financial Officer |
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| Principal Financial Officer |
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| Date: November 2, 2020 |
By: |
/s/ Stephanie A. Westington |
| Stephanie A. Westington, CPA |
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| Senior Vice President and Controller |
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| Principal Accounting Officer |
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