Notes to Consolidated Financial Statements
(Unaudited)
1. Nature of operations and critical accounting policies
Nature of operations
Fidelity D & D Bancorp, Inc. (the Company) is a bank holding company and the parent of The Fidelity Deposit and Discount Bank (the Bank). The Bank is a commercial bank and trust company chartered under the laws of the Commonwealth of Pennsylvania and a wholly-owned subsidiary of the Company. Having commenced operations in 1903, the Bank is committed to provide superior customer service, while offering a full range of banking products and financial and trust services to both our consumer and commercial customers from our main office located in Dunmore and other branches located throughout Lackawanna, Northampton and Luzerne Counties and Wealth Management offices in Schuylkill and Lebanon Counties.
On July 1, 2021, the Company completed its acquisition of Landmark Bancorp, Inc. (Landmark) and its wholly-owned subsidiary, Landmark Community Bank (Landmark Bank). At the time of the acquisition, Landmark merged with and into an acquisition subsidiary of the Company with the acquisition subsidiary Company surviving the merger. In addition, immediately thereafter Landmark Bank merged with and into the Bank with the Bank as the surviving bank.
Further discussion of the acquisition of Landmark can be found in Footnote 9, “Acquisition”.
Principles of consolidation
The accompanying unaudited consolidated financial statements of the Company and the Bank have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and with the instructions to this Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnote disclosures required by GAAP for complete financial statements. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the financial condition and results of operations for the periods have been included. All significant inter-company balances and transactions have been eliminated in consolidation.
For additional information and disclosures required under U.S. GAAP, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.
Management is responsible for the fairness, integrity and objectivity of the unaudited financial statements included in this report. Management prepared the unaudited financial statements in accordance with U.S. GAAP. In meeting its responsibility for the financial statements, management depends on the Company's accounting systems and related internal controls. These systems and controls are designed to provide reasonable but not absolute assurance that the financial records accurately reflect the transactions of the Company, the Company’s assets are safeguarded and that the financial statements present fairly the financial condition and results of operations of the Company.
In the opinion of management, the consolidated balance sheets as of September 30, 2022 and December 31, 2021 and the related consolidated statements of income, consolidated statements of comprehensive income and consolidated statements of changes in shareholders’ equity for the three and nine months ended September 30, 2022 and 2021 and consolidated statements of cash flows for the nine months ended September 30, 2022 and 2021 present fairly the financial condition and results of operations of the Company. All material adjustments required for a fair presentation have been made. These adjustments are of a normal recurring nature. Certain reclassifications have been made to the 2021 financial statements to conform to the 2022 presentation.
In preparing these consolidated financial statements, the Company evaluated the events and transactions that occurred after September 30, 2022 through the date these consolidated financial statements were issued.
This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2021, and the notes included therein, included within the Company’s Annual Report filed on Form 10-K.
Critical accounting policies
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates.
A material estimate that is particularly susceptible to significant change relates to the determination of the allowance for loan losses. Management believes that the allowance for loan losses at September 30, 2022 is adequate and reasonable to cover incurred losses. Given the subjective nature of identifying and estimating loan losses, it is likely that well-informed individuals could make different assumptions and could, therefore, calculate a materially different allowance amount. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in the future. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize adjustments to the allowance based on their judgment of information available to them at the time of their examination.
Another material estimate is the calculation of fair values of the Company’s investment securities. Fair values of investment securities are determined by pricing provided by a third-party vendor, who is a provider of financial market data, analytics and related services to financial institutions. Based on experience, management is aware that estimated fair values of investment securities tend to vary among valuation services. Accordingly, when selling investment securities, price quotes may be obtained from more than one source. All of the Company’s debt securities are classified as available-for-sale (AFS) or held-to-maturity (HTM). AFS debt securities are carried at fair value on the consolidated balance sheets, with unrealized gains and losses, net of income tax, reported separately within shareholders’ equity as a component of accumulated other comprehensive income (AOCI). Debt securities, for which the Company has the positive intent and ability to hold to maturity, are reported at cost. On occasion, the Company may transfer securities from AFS to HTM at fair value on the date of transfer.
The fair value of residential mortgage loans, classified as held-for-sale (HFS), is obtained from the Federal National Mortgage Association (FNMA) or the Federal Home Loan Bank (FHLB). Generally, the market to which the Company sells residential mortgages it originates for sale is restricted and price quotes from other sources are not typically obtained. On occasion, the Company may transfer loans from the loan portfolio to loans HFS. Under these circumstances, pricing may be obtained from other entities and the residential mortgage loans are transferred at the lower of cost or market value and simultaneously sold. For other loans transferred to HFS, pricing may be obtained from other entities or modeled and the other loans are transferred at the lower of cost or market value and then sold. As of September 30, 2022 and December 31, 2021, loans classified as HFS consisted of residential mortgage loans.
Financing of automobiles, provided to customers under lease arrangements of varying terms, are accounted for as direct finance leases. Interest income on automobile direct finance leasing is determined using the interest method to arrive at a level effective yield over the life of the lease. The lease residual and the lease receivable, net of unearned lease income, are recorded within loans and leases on the balance sheet.
Foreclosed assets held-for-sale includes other real estate acquired through foreclosure (ORE) and may, from time-to-time, include repossessed assets such as automobiles. ORE is carried at the lower of cost (principal balance at date of foreclosure) or fair value less estimated cost to sell. Any write-downs at the date of foreclosure are charged to the allowance for loan losses. Expenses incurred to maintain ORE properties, subsequent write downs to the asset’s fair value, any rental income received and gains or losses on disposal are included as components of other real estate owned expense in the consolidated statements of income.
The Company accounts for business combinations under the purchase method of accounting. The application of this method of accounting requires the use of significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price consideration between assets that are amortized, accreted or depreciated from those that are recorded as goodwill. Estimates of the fair values of assets acquired and liabilities assumed are based upon assumptions that management believes to be reasonable.
Goodwill is recorded on the consolidated balance sheets as the excess of liabilities assumed over identifiable assets acquired on the acquisition date. Goodwill is recorded at its net carrying value which represents estimated fair value. Goodwill is tested for impairment on at least an annual basis. There was no goodwill impairment as of September 30, 2022 and December 31, 2021. Other acquired intangible assets that have finite lives, such as core deposit intangibles, are amortized over their estimated useful lives and subject to periodic impairment testing.
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. The Company accounts for certain participation interests in commercial loans receivable (loan participation agreements) sold as a sale of financial assets pursuant to ASC 860, Transfers and Servicing. Loan participation agreements that meet the sale criteria under ASC 860 are derecognized from the Consolidated Balance Sheets at the time of transfer. If the transfer of loans does not meet the sale criteria or participating interest criteria under ASC 860, the transfer is accounted for as a secured borrowing and the loan is not de-recognized and a participating liability is recorded in the Consolidated Balance Sheets.
The Company holds separate supplemental executive retirement (SERP) agreements for certain officers and an amount is credited to each participant’s SERP account monthly while they are actively employed by the bank until retirement. A deferred tax asset is provided for the non-deductible SERP expense. The Company also entered into separate split dollar life insurance arrangements with four executives providing post-retirement benefits and accrues monthly expense for this benefit. The split dollar life insurance expense is not deductible for tax purposes. Monthly expenses for the SERP and post-retirement split dollar life benefit are recorded as components of salaries and employee benefit expense on the consolidated statements of income.
For purposes of the consolidated statements of cash flows, cash and cash equivalents includes cash on hand, amounts due from banks and interest-bearing deposits with financial institutions.
2. New accounting pronouncements
In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2016-13, Financial Instruments – Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments (CECL). The amendments in this update require financial assets measured at amortized cost basis to be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. Previously, when credit losses were measured under GAAP, an entity only considered past events and current conditions when measuring the incurred loss. The amendments in this update broaden the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgement in determining the relevant information and estimation methods that are appropriate under the circumstances. The amendments in this update also require that credit losses on available-for-sale debt securities be presented as an allowance for credit losses rather than a writedown.
In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, which clarifies that receivables arising from operating leases are not within the scope of Topic 326. In December 2018, regulators issued a final rule related to regulatory capital (Regulatory Capital Rule: Implementation and Transition of the Current Expected Credit Losses Methodology for Allowances and Related Adjustments to the Regulatory Capital Rule and Conforming Amendments to Other Regulations) which is intended to provide regulatory capital relief for entities transitioning to CECL. In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging and Topic 825, Financial Instruments. As it relates to CECL, this guidance amends certain provisions contained in ASU 2016-13, particularly in regards to the inclusion of accrued interest in the definition of amortized cost, as well as clarifying that extension and renewal options that are not unconditionally cancelable by the entity that are included in the original or modified contract should be considered in the entity’s determination of expected credit losses.
The amendments in this update are effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2019 for public companies. Early adoption is permitted beginning after December 15, 2018, including interim periods within those fiscal years. An entity will apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption (modified-retrospective approach). Upon adoption, the change in this accounting guidance could result in an increase in the Company's allowance for loan losses and require the Company to record loan losses more rapidly. On October 16, 2019, the FASB decided to move forward with finalizing its proposal to defer the effective date for ASU 2016-13 for smaller reporting companies to fiscal years beginning after December 31, 2022, including interim periods within those fiscal periods. Since the Company currently meets the SEC definition of a smaller reporting company, the delay will be applicable to the Company. The Company has engaged the services of a qualified third-party service provider to assist management in estimating credit allowances under this standard. Starting in the 3rd quarter of 2022, the Company ran its CECL model parallel to the current allowance for loan losses calculation to gain a better understanding of the effects of the change. The Company expects a change in the allowance for loan losses upon adoption of CECL at January 1, 2023 and the magnitude of the change will depend on the composition, characteristics and quality of its loan and lease portfolio, as well as economic conditions and forecasts at the time of adoption. The Company continues to work on the process of finalizing the review of the most recent model run and of finalizing certain assumptions, including qualitative adjustments and economic forecasts, which have resulted in adjustments to previous estimates. In the 3rd quarter of 2022, the Company engaged a third-party service provider to run a model validation, which will commence in the 4th quarter of 2022 and conclude in the 1st quarter of 2023. The Company has also run a CECL analysis on its held-to-maturity investment securities as of September 30, 2022 and the estimated CECL reserve is immaterial.
In March 2022, the FASB issued ASU 2022-02, Financial Instruments-Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures. The amendments in this update eliminate the accounting guidance for TDRs by creditors in Subtopic 310-40, Receivables-Troubled Debt Restructurings by Creditors, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. The amendments in this update also require that an entity disclose current-period gross writeoffs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, Financial Instruments-Credit Losses-Measured at Amortized Cost. The amendments in this update are effective for the Company upon adoption of ASU 2016-13. The amendments in this update should be applied prospectively, except as provided in the next sentence. For the transition method related to the recognition and measurement of TDRs, the Company has the option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848) – Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The amendments in this update provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The amendments in this update are elective and apply to all entities that have contracts that reference LIBOR or another reference rate expected to be discontinued. The guidance includes a general principle that permits an entity to consider contract modifications due to reference rate reform to be an event that does not require contract remeasurement at the modification date or reassessment of a previous accounting determination. An optional expedient simplifies accounting for contract modifications to loans receivable and debt, by prospectively adjusting the effective interest rate. The amendments in ASU 2020-04 are effective as of March 12, 2020 through December 31, 2022. The Company expects to apply the amendments prospectively for applicable loan and other contracts within the effective period of ASU 2020-04. As of September 30, 2022, the Company had approximately $46 million in loans with rates tied to LIBOR. The Company is working on modifying each of these existing contracts.
3. Accumulated other comprehensive income
The following tables illustrate the changes in accumulated other comprehensive income by component and the details about the components of accumulated other comprehensive income as of and for the periods indicated:
As of and for the nine months ended September 30, 2022 | |
| | Unrealized gains | | | | | | | | | |
| | (losses) on | | | Securities | | | | | |
| | available-for-sale | | | transferred to | | | | | |
(dollars in thousands) | | debt securities | | | held-to-maturity | | | Total | |
Beginning balance | | $ | 179 | | | $ | - | | | $ | 179 | |
| | | | | | | | | | | | |
Other comprehensive loss before reclassifications, net of tax | | | (64,466 | ) | | | (17,983 | ) | | | (82,449 | ) |
Amounts reclassified from accumulated other comprehensive income, net of tax | | | (3 | ) | | | - | | | | (3 | ) |
Net current-period other comprehensive loss | | | (64,469 | ) | | | (17,983 | ) | | | (82,452 | ) |
Ending balance | | $ | (64,290 | ) | | $ | (17,983 | ) | | $ | (82,273 | ) |
As of and for the three months ended September 30, 2022 | |
| | Unrealized gains | | | | | | | | | |
| | (losses) on | | | Securities | | | | | |
| | available-for-sale | | | transferred to | | | | | |
(dollars in thousands) | | debt securities | | | held-to-maturity | | | Total | |
Beginning balance | | $ | (42,491 | ) | | $ | (18,429 | ) | | $ | (60,920 | ) |
| | | | | | | | | | | | |
Other comprehensive income (loss) before reclassifications, net of tax | | | (21,796 | ) | | | 446 | | | | (21,350 | ) |
Amounts reclassified from accumulated other comprehensive income, net of tax | | | (3 | ) | | | - | | | | (3 | ) |
Net current-period other comprehensive income (loss) | | | (21,799 | ) | | | 446 | | | | (21,353 | ) |
Ending balance | | $ | (64,290 | ) | | $ | (17,983 | ) | | $ | (82,273 | ) |
As of and for the nine months ended September 30, 2021 | | | | | | | | | | | | |
| | Unrealized gains | | | | | | | | | |
| | (losses) on | | | Securities | | | | | |
| | available-for-sale | | | transferred to | | | | | |
(dollars in thousands) | | securities | | | held-to-maturity | | | Total | |
Beginning balance | | $ | 8,952 | | | $ | - | | | $ | 8,952 | |
| | | | | | | | | | | | |
Other comprehensive loss before reclassifications, net of tax | | | (8,747 | ) | | | - | | | | (8,747 | ) |
Amounts reclassified from accumulated other comprehensive income, net of tax | | | (31 | ) | | | - | | | | (31 | ) |
Net current-period other comprehensive loss | | | (8,778 | ) | | | - | | | | (8,778 | ) |
Ending balance | | $ | 174 | | | $ | - | | | $ | 174 | |
As of and for the three months ended September 30, 2021 | |
| | Unrealized gains | | | | | | | | | |
| | (losses) on | | | Securities | | | | | |
| | available-for-sale | | | transferred to | | | | | |
(dollars in thousands) | | debt securities | | | held-to-maturity | | | Total | |
Beginning balance | | $ | 5,331 | | | $ | - | | | $ | 5,331 | |
| | | | | | | | | | | | |
Other comprehensive loss before reclassifications, net of tax | | | (5,126 | ) | | | - | | | | (5,126 | ) |
Amounts reclassified from accumulated other comprehensive income, net of tax | | | (31 | ) | | | - | | | | (31 | ) |
Net current-period other comprehensive loss | | | (5,157 | ) | | | - | | | | (5,157 | ) |
Ending balance | | $ | 174 | | | $ | - | | | $ | 174 | |
Details about accumulated other | | | | | | | | | | | | | | | | | |
comprehensive income components | | Amount reclassified from accumulated | | Affected line item in the statement |
(dollars in thousands) | | other comprehensive income | | where net income is presented |
| | For the three months | | | For the nine months | | |
| | ended September 30, | | | ended September 30, | | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | | |
| | | | | | | | | | | | | | | | | |
Unrealized gains (losses) on AFS debt securities | | $ | 4 | | | $ | 40 | | | $ | 4 | | | $ | 40 | | Gain (loss) on sale of investment securities |
Income tax effect | | | (1 | ) | | | (9 | ) | | | (1 | ) | | | (9 | ) | Provision for income taxes |
Total reclassifications for the period | | $ | 3 | | | $ | 31 | | | $ | 3 | | | $ | 31 | | Net income |
4. Investment securities
Agency – Government-sponsored enterprise (GSE) and Mortgage-backed securities (MBS) - GSE residential
Agency – GSE and MBS – GSE residential securities consist of short- to long-term notes issued by Federal Home Loan Mortgage Corporation (FHLMC), FNMA, FHLB and Government National Mortgage Association (GNMA). These securities have interest rates that are fixed, have varying short to long-term maturity dates and have contractual cash flows guaranteed by the U.S. government or agencies of the U.S. government.
Obligations of states and political subdivisions (municipal)
The municipal securities are general obligation and revenue bonds rated as investment grade by various credit rating agencies and have fixed rates of interest with mid- to long-term maturities. Fair values of these securities are highly driven by interest rates. Management performs ongoing credit quality reviews on these issues.
The amortized cost and fair value of investment securities at September 30, 2022 and December 31, 2021 are summarized as follows:
| | | | | | Gross | | | Gross | | | | | |
| | Amortized | | | unrealized | | | unrealized | | | Fair | |
(dollars in thousands) | | cost | | | gains | | | losses | | | value | |
September 30, 2022 | | | | | | | | | | | | | | | | |
Held-to-maturity securities: | | | | | | | | | | | | | | | | |
Agency - GSE | | $ | 80,039 | | | $ | - | | | $ | (9,574 | ) | | $ | 70,465 | |
Obligations of states and political subdivisions | | | 142,335 | | | | - | | | | (30,560 | ) | | | 111,775 | |
| | | | | | | | | | | | | | | | |
Total held-to-maturity securities | | $ | 222,374 | | | $ | - | | | $ | (40,134 | ) | | $ | 182,240 | |
| | | | | | | | | | | | | | | | |
Available-for-sale debt securities: | | | | | | | | | | | | | | | | |
Agency - GSE | | $ | 37,050 | | | $ | - | | | $ | (4,714 | ) | | $ | 32,336 | |
Obligations of states and political subdivisions | | | 198,534 | | | | 324 | | | | (35,256 | ) | | | 163,602 | |
MBS - GSE residential | | | 259,209 | | | | - | | | | (41,734 | ) | | | 217,475 | |
| | | | | | | | | | | | | | | | |
Total available-for-sale debt securities | | $ | 494,793 | | | $ | 324 | | | $ | (81,704 | ) | | $ | 413,413 | |
| | | | | | Gross | | | Gross | | | | | |
| | Amortized | | | unrealized | | | unrealized | | | Fair | |
(dollars in thousands) | | cost | | | gains | | | losses | | | value | |
December 31, 2021 | | | | | | | | | | | | | | | | |
Available-for-sale debt securities: | | | | | | | | | | | | | | | | |
Agency - GSE | | $ | 119,399 | | | $ | 204 | | | $ | (2,600 | ) | | $ | 117,003 | |
Obligations of states and political subdivisions | | | 360,680 | | | | 6,708 | | | | (2,678 | ) | | | 364,710 | |
MBS - GSE residential | | | 258,674 | | | | 1,654 | | | | (3,061 | ) | | | 257,267 | |
| | | | | | | | | | | | | | | | |
Total available-for-sale debt securities | | $ | 738,753 | | | $ | 8,566 | | | $ | (8,339 | ) | | $ | 738,980 | |
The amortized cost and fair value of debt securities at September 30, 2022 by contractual maturity are summarized below:
| | Amortized | | | Fair | |
(dollars in thousands) | | cost | | | value | |
Held-to-maturity securities: | | | | | | | | |
Due in one year or less | | $ | - | | | $ | - | |
Due after one year through five years | | | 4,698 | | | | 4,302 | |
Due after five years through ten years | | | 66,667 | | | | 58,901 | |
Due after ten years | | | 151,009 | | | | 119,037 | |
Total held-to-maturity securities | | $ | 222,374 | | | $ | 182,240 | |
| | | | | | | | |
Available-for-sale securities: | | | | | | | | |
Debt securities: | | | | | | | | |
Due in one year or less | | $ | 2,999 | | | $ | 2,982 | |
Due after one year through five years | | | 18,773 | | | | 17,087 | |
Due after five years through ten years | | | 44,734 | | | | 37,101 | |
Due after ten years | | | 169,078 | | | | 138,768 | |
| | | | | | | | |
MBS - GSE residential | | | 259,209 | | | | 217,475 | |
Total available-for-sale debt securities | | $ | 494,793 | | | $ | 413,413 | |
Actual maturities will differ from contractual maturities because issuers and borrowers may have the right to call or repay obligations with or without call or prepayment penalty. Agency – GSE and municipal securities are included based on their original stated maturity. MBS – GSE residential, which are based on weighted-average lives and subject to monthly principal pay-downs, are listed in total. Most of the securities have fixed rates or have predetermined scheduled rate changes and many have call features that allow the issuer to call the security at par before its stated maturity without penalty.
The following table presents the fair value and gross unrealized losses of debt securities aggregated by investment type, the length of time and the number of securities that have been in a continuous unrealized loss position as of September 30, 2022 and December 31, 2021:
| | Less than 12 months | | | More than 12 months | | | Total | |
| | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | |
(dollars in thousands) | | value | | | losses | | | value | | | losses | | | value | | | losses | |
| | | | | | | | | | | | | | | | | | | | | | | | |
September 30, 2022 | | | | | | | | | | | | | | | | | | | | | | | | |
Agency - GSE | | $ | 29,095 | | | $ | (2,933 | ) | | $ | 72,706 | | | $ | (11,355 | ) | | $ | 101,801 | | | $ | (14,288 | ) |
Obligations of states and political subdivisions | | | 178,491 | | | | (40,043 | ) | | | 91,109 | | | | (25,773 | ) | | | 269,600 | | | | (65,816 | ) |
MBS - GSE residential | | | 100,151 | | | | (15,013 | ) | | | 117,324 | | | | (26,721 | ) | | | 217,475 | | | | (41,734 | ) |
Total | | $ | 307,737 | | | $ | (57,989 | ) | | $ | 281,139 | | | $ | (63,849 | ) | | $ | 588,876 | | | $ | (121,838 | ) |
Number of securities | | | 320 | | | | | | | | 163 | | | | | | | | 483 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2021 | | | | | | | | | | | | | | | | | | | | | | | | |
Agency - GSE | | $ | 84,308 | | | $ | (1,460 | ) | | $ | 26,516 | | | $ | (1,140 | ) | | $ | 110,824 | | | $ | (2,600 | ) |
Obligations of states and political subdivisions | | | 193,124 | | | | (2,662 | ) | | | 12,796 | | | | (399 | ) | | | 205,920 | | | | (3,061 | ) |
MBS - GSE residential | | | 137,495 | | | | (2,351 | ) | | | 9,469 | | | | (327 | ) | | | 146,964 | | | | (2,678 | ) |
Total | | $ | 414,927 | | | $ | (6,473 | ) | | $ | 48,781 | | | $ | (1,866 | ) | | $ | 463,708 | | | $ | (8,339 | ) |
Number of securities | | | 187 | | | | | | | | 26 | | | | | | | | 213 | | | | | |
The Company had 483 debt securities in an unrealized loss position at September 30, 2022, including 51 agency-GSE securities, 143 MBS – GSE residential securities and 289 municipal securities. The severity of these unrealized losses based on their underlying cost basis was as follows at September 30, 2022: 12.31% for agency - GSE, 16.10% for total MBS-GSE residential; and 19.62% for municipals. 163 of these securities had been in an unrealized loss position in excess of 12 months. Management has no intent to sell any securities in an unrealized loss position as of September 30, 2022.
During the second quarter of 2022, the Company transferred investment securities with a book value of $245.5 million from available-for-sale to held-to-maturity. The accounting for securities held-to-maturity on this transfer will mitigate the effect on the other comprehensive income (OCI) component of stockholders’ equity from the price risk of rising interest rates which will result in further future unrealized losses in the available-for-sale portfolio.
Management believes the cause of the unrealized losses is related to changes in interest rates and is not directly related to credit quality. Quarterly, management conducts a formal review of investment securities for the presence of other than temporary impairment (OTTI). The accounting guidance related to OTTI requires the Company to assess whether OTTI is present when the fair value of a debt security is less than its amortized cost as of the balance sheet date. Under those circumstances, OTTI is considered to have occurred if: (1) the entity has the intent to sell the security; (2) more likely than not the entity will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is not sufficient to recover the entire amortized cost. The accounting guidance requires that credit-related OTTI be recognized in earnings while non-credit-related OTTI on securities not expected to be sold be recognized in OCI. Non-credit-related OTTI is based on other factors affecting market value, including illiquidity.
The Company’s OTTI evaluation process also follows the guidance set forth in topics related to debt securities. The guidance set forth in the pronouncements require the Company to take into consideration current market conditions, fair value in relationship to cost, extent and nature of changes in fair value, issuer rating changes and trends, volatility of earnings, current analysts’ evaluations, all available information relevant to the collectability of debt securities, the ability and intent to hold investments until a recovery of fair value which may be to maturity and other factors when evaluating for the existence of OTTI. The guidance requires that credit-related OTTI be recognized as a realized loss through earnings when there has been an adverse change in the holder’s expected cash flows such that the full amount (principal and interest) will probably not be received. This requirement is consistent with the impairment model in the guidance for accounting for debt securities.
For all debt securities, as of September 30, 2022, the Company applied the criteria provided in the recognition and presentation guidance related to OTTI. That is, management has no intent to sell the securities and nor any conditions were identified by management that, more likely than not, would require the Company to sell the securities before recovery of their amortized cost basis. The results indicated there was no presence of OTTI in the Company’s security portfolio. In addition, management believes the change in fair value is attributable to changes in interest rates.
5. Loans and leases
The classifications of loans and leases at September 30, 2022 and December 31, 2021 are summarized as follows:
(dollars in thousands) | | September 30, 2022 | | | December 31, 2021 | |
Commercial and industrial | | $ | 221,911 | | | $ | 236,304 | |
Commercial real estate: | | | | | | | | |
Non-owner occupied | | | 315,323 | | | | 312,848 | |
Owner occupied | | | 256,053 | | | | 248,755 | |
Construction | | | 26,015 | | | | 21,147 | |
Consumer: | | | | | | | | |
Home equity installment | | | 56,814 | | | | 47,571 | |
Home equity line of credit | | | 53,632 | | | | 54,878 | |
Auto loans | | | 132,802 | | | | 118,029 | |
Direct finance leases | | | 32,526 | | | | 26,232 | |
Other | | | 7,733 | | | | 8,013 | |
Residential: | | | | | | | | |
Real estate | | | 384,493 | | | | 325,861 | |
Construction | | | 37,433 | | | | 34,919 | |
Total | | | 1,524,735 | | | | 1,434,557 | |
Less: | | | | | | | | |
Allowance for loan losses | | | (16,779 | ) | | | (15,624 | ) |
Unearned lease revenue | | | (1,793 | ) | | | (1,429 | ) |
Loans and leases, net | | $ | 1,506,163 | | | $ | 1,417,504 | |
As of September 30, 2022, total loans of $1.5 billion were reflected including deferred loan costs of $4.5 million, comprised of $4.6 million in deferred loan costs partially offset by $0.1 million in deferred fee income from Paycheck Protection Program (PPP) loans. As of December 31, 2021, total loans of $1.4 billion were reflected including deferred loan costs of $3.0 million, comprised of $4.2 million in deferred loan costs partially offset by $1.2 million in deferred fee income from PPP loans.
Commercial and industrial (C&I) loan balances were $221.9 million at September 30, 2022 and $236.3 million at December 31, 2021. The decrease was due to the decrease in PPP loans (net of deferred fees) which declined by $38.1 million to $1.8 million at September 30, 2022 due to standard forgiveness under the SBA program. As of September 30, 2022, the Company increased the balance of C&I loans by $23.6 million (excluding PPP loans) primarily from several large C&I loans originated during 2022.
Direct finance leases include the lease receivable and the guaranteed lease residual. Unearned lease revenue represents the difference between the lessor’s investment in the property and the gross investment in the lease. Unearned revenue is accrued over the life of the lease using the effective interest method.
The Company services real estate loans for investors in the secondary mortgage market which are not included in the accompanying consolidated balance sheets. The approximate unpaid principal balance of mortgages serviced for others amounted to $465.5 million as of September 30, 2022 and $430.9 million as of December 31, 2021. Mortgage servicing rights amounted to $1.7 million both as of September 30, 2022 and December 31, 2021, respectively.
Management is responsible for conducting the Company’s credit risk evaluation process, which includes credit risk grading of individual commercial and industrial and commercial real estate loans. Commercial and industrial and commercial real estate loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information, and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed. The credit risk grades may be changed at any time management feels an upgrade or downgrade may be warranted. The Company utilizes an external independent loan review firm that reviews and validates the credit risk program on at least an annual basis. Results of these reviews are presented to management and the board of directors. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.
Paycheck Protection Program Loans
The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, was signed into law on March 27, 2020, and provided over $2.0 trillion in emergency economic relief to individuals and businesses impacted by the COVID-19 pandemic. The CARES Act authorized the Small Business Administration (SBA) to temporarily guarantee loans under a new 7(a) loan program called the Paycheck Protection Program (PPP).
As a qualified SBA lender, the Company was automatically authorized to originate PPP loans. The SBA guaranteed 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrowers’ PPP loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount under the PPP.
On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (Economic Aid Act) was enacted, extending the authority to make PPP loans through May 31, 2021, revising certain PPP requirements, and permitting second draw PPP loans. On March 11, 2021, the American Rescue Plan Act of 2021 (American Rescue Plan Act) was enacted expanding eligibility for first and second draw PPP loans and revising the exclusions from payroll costs for purposes of loan forgiveness.
Acquired loans
Acquired loans are marked to fair value on the date of acquisition. For detailed information on calculating the fair value of acquired loans, see Footnote 9, “Acquisition.”
The carryover of allowance for loan losses related to acquired loans is prohibited as any credit losses in the loans are included in the determination of the fair value of the loans at the acquisition date. The allowance for loan losses on acquired loans reflects only those losses incurred after acquisition and represents the present value of cash flows expected at acquisition that is no longer expected to be collected.
The Company reported fair value adjustments regarding the acquired MNB and Landmark loan portfolios. Therefore, the Company did not record an allowance on the acquired non-purchased credit impaired loans. In conjunction with the quarterly evaluation of the adequacy of the allowance for loan losses, the Company performs an analysis on acquired loans to determine whether there has been subsequent deterioration in relation to those loans. If deterioration has occurred, the Company will include these loans in the calculation of the allowance for loan losses after the initial valuation and provide reserves accordingly.
Upon acquisition, in accordance with U.S. GAAP, the Company has individually determined whether each acquired loan is within the scope of ASC 310-30 deemed as purchased credit impaired (PCI). As part of this process, the Company’s senior management and other relevant individuals reviewed the seller’s loan portfolio on a loan-by-loan basis to determine if any loans met the two-part definition of an impaired loan as defined by ASC 310-30: 1) Credit deterioration on the loan from its inception until the acquisition date, and 2) It is probable that not all contractual cash flows will be collected on the loan.
With regards to ASC 310-30 loans, for external disclosure purposes, the aggregate contractual cash flows less the aggregate expected cash flows result in a credit related non-accretable yield amount. The aggregate expected cash flows less the acquisition date fair value result in an accretable yield amount. The accretable yield reflects the contractual cash flows management expects to collect above the loan's acquisition date fair value and will be recognized over the life of the loan on a level-yield basis as a component of interest income.
Over the life of the acquired ASC 310-30 loan, the Company continues to estimate cash flows expected to be collected. Decreases in expected cash flows, other than from prepayments or rate adjustments, are recognized as impairments through a charge to the provision for credit losses resulting in an increase in the allowance for credit losses. Subsequent improvements in cash flows result in first, reversal of existing valuation allowances recognized after acquisition, if any, and next, an increase in the amount of accretable yield to be subsequently recognized on a prospective basis over the loan’s remaining life.
Acquired ASC 310-30 loans that met the criteria for non-accrual of interest prior to acquisition are considered performing upon acquisition, regardless of whether the customer is contractually delinquent if the Company can reasonably estimate the timing and amount of expected cash flows on such loans. Accordingly, the Company does not consider acquired contractually delinquent loans to be non-accruing and continues to recognize accretable yield on these loans which is recognized as interest income on a level yield method over the life of the loan.
Acquired ASC 310-20 loans, which are loans that did not meet the criteria above, were pooled into groups of similar loans based on various factors including borrower type, loan purpose, and collateral type. For these pools, the Company used certain loan information, including outstanding principal balance, estimated expected losses, weighted average maturity, weighted average margin, and weighted average interest rate along with estimated prepayment rates, expected lifetime losses, and environment factors to estimate the expected cash flow for each loan pool.
Within the ASC 310-20 loans, the Company identified certain loans that have higher risk. Although performing at the time of acquisition and likely will continue making payments in accordance with contractual terms, management elected a higher credit adjustment on these loans to reflect the greater inherent risk that the borrower will default on payments. Risk factors used to identify these loans included: loans that received COVID-19 related forbearance consistent with the regulatory guidance, loans that were in industries determined to be at greater risk to economic disruption due to COVID-19, loans that had a prior history of delinquency greater than 60 days at any point in the lifetime of the loan; loans with a Special Mention or Substandard risk rating; and/or loans borrowers in the Gasoline Station industry due to the environmental risk potential of these loans.
The following table provides changes in accretable yield for all acquired loans accounted for under ASC 310-30. Loans accounted for under ASC 310-20 are not included in this table.
| | For the nine months ended September 30, | |
(dollars in thousands) | | 2022 | | | 2021 | |
Balance at beginning of period | | $ | 1,088 | | | $ | 563 | |
Accretable yield on acquired loans | | | - | | | | 589 | |
Reclassification from non-accretable difference | | | 543 | | | | 197 | |
Reclassification to loan balance due to charge-off | | | (3 | ) | | | - | |
Accretion of accretable yield | | | (335 | ) | | | (350 | ) |
Balance at end of period | | $ | 1,293 | | | $ | 999 | |
The above table excludes the $269 thousand in non-accretable yield accreted to interest income for the nine months ended September 30, 2021.
During the nine months ended September 30, 2022, management performed an analysis of all loans acquired from mergers, consistent with and applicable to ASC 310-30 (Purchased Credit Impaired loans – PCI). During this period, the accretable yield increased $205 thousand from $1,088 thousand to $1,293 thousand due to $540 thousand reclassification from non-accretable discount to accretable discount resulting from five loans that had actual payments exceed estimates and one loan that had a positive change in collateral value, which was offset by yield accretion of $335 thousand.
During the nine months ended September 30, 2021, the accretable yield increased $436 thousand from $563 thousand to $999 thousand due to $589 thousand of accretable yield from the Landmark acquisition and $197 thousand reclassification from non-accretable discount to accretable discount resulting from two loans with actual payments exceeding estimates and three loans that had a positive change in collateral value, which was offset by accretion of $350 thousand.
Expected cash flows on acquired loans are estimated quarterly by incorporating several key assumptions. These key assumptions include probability of default and the number of actual prepayments after the acquisition date. Prepayments affect the estimated life of the loans and could change the amount of interest income, and possibly principal expected to be collected. In reforecasting future estimated cash flows, credit loss expectations are adjusted as necessary. Improved cash flow expectations for loans or pools are recorded first as a reversal of previously recorded impairment, if any, and then as an increase in prospective yield when all previously recorded impairment has been recaptured.
17
Non-accrual loans
Non-accrual loans, segregated by class, at September 30, 2022 and December 31, 2021, were as follows:
(dollars in thousands) | | September 30, 2022 | | | December 31, 2021 | |
Commercial and industrial | | $ | 628 | | | $ | 154 | |
Commercial real estate: | | | | | | | | |
Non-owner occupied | | | 732 | | | | 478 | |
Owner occupied | | | 1,303 | | | | 1,570 | |
Consumer: | | | | | | | | |
Home equity installment | | | - | | | | - | |
Home equity line of credit | | | 119 | | | | 97 | |
Auto loans | | | 201 | | | | 78 | |
Residential: | | | | | | | | |
Real estate | | | 37 | | | | 572 | |
Total | | $ | 3,020 | | | $ | 2,949 | |
The table above excludes $4.7 million and $4.7 million in purchased credit impaired loans, net of unamortized fair value adjustments as of September 30, 2022 and December 31, 2021, respectively.
The decision to place loans on non-accrual status is made on an individual basis after considering factors pertaining to each specific loan. C&I and CRE loans are placed on non-accrual status when management has determined that payment of all contractual principal and interest is in doubt or the loan is past due 90 days or more as to principal and interest, unless well-secured and in the process of collection. Consumer loans secured by real estate and residential mortgage loans are placed on non-accrual status at 90 days past due as to principal and interest and unsecured consumer loans are charged-off when the loan is 90 days or more past due as to principal and interest. The Company considers all non-accrual loans to be impaired loans.
Troubled Debt Restructuring (TDR)
A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company considers all TDRs to be impaired loans. The Company typically considers the following concessions when modifying a loan, which may include lowering interest rates below the market rate, temporary interest-only payment periods, term extensions at interest rates lower than the current market rate for new debt with similar risk and/or converting revolving credit lines to term loans. The Company typically does not forgive principal when granting a TDR modification.
There were no loans modified in a TDR for the three and nine months ended September 30, 2022 and 2021. Of the TDRs outstanding as of September 30, 2022 and 2021, when modified, the concessions granted consisted of temporary interest-only payments, extensions of maturity date, or a reduction in the rate of interest to a below-market rate for a contractual period of time. Other than the TDRs that were placed on non-accrual status, the TDRs were performing in accordance with their modified terms.
Loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. There were no loans modified as a TDR within the previous twelve months that subsequently defaulted (i.e. 90 days or more past due following a modification) during the three and nine months ended September 30, 2022 and 2021.
The allowance for loan losses (allowance) may be increased, adjustments may be made in the allocation of the allowance or partial charge-offs may be taken to further write-down the carrying value of the loan. An allowance for impaired loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s observable market price. If the loan is collateral dependent, the estimated fair value of the collateral is used to establish the allowance.
As of September 30, 2022 and 2021, the balance of outstanding TDRs was $1.7 million and $3.1 million, respectively. As of September 30, 2022 and 2021, the allowance for impaired loans that have been modified in a TDR was $49 thousand and $0.7 million, respectively.
18
Past due loans
Loans are considered past due when the contractual principal and/or interest is not received by the due date. For loans reported 30-59 days past due, certain categories of loans are reported past due as and when the loan is in arrears for two payments or billing cycles. An aging analysis of past due loans, segregated by class of loans, as of the period indicated is as follows (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | Recorded | |
| | | | | | | | | | Past due | | | | | | | | | | | | | | | | investment past | |
| | 30 - 59 Days | | | 60 - 89 Days | | | 90 days | | | Total | | | | | | | Total | | | | due ≥ 90 days | |
September 30, 2022 | | past due | | | past due | | | or more (1) | | | past due | | | Current | | | loans (3) | | | | and accruing | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial and industrial | | $ | 132 | | | $ | 2 | | | $ | 628 | | | $ | 762 | | | $ | 221,149 | | | $ | 221,911 | | | | $ | - | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Non-owner occupied | | | - | | | | - | | | | 732 | | | | 732 | | | | 314,591 | | | | 315,323 | | | | | - | |
Owner occupied | | | - | | | | - | | | | 1,303 | | | | 1,303 | | | | 254,750 | | | | 256,053 | | | | | - | |
Construction | | | - | | | | - | | | | - | | | | - | | | | 26,015 | | | | 26,015 | | | | | - | |
Consumer: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Home equity installment | | | 232 | | | | - | | | | - | | | | 232 | | | | 56,582 | | | | 56,814 | | | | | - | |
Home equity line of credit | | | 51 | | | | - | | | | 119 | | | | 170 | | | | 53,462 | | | | 53,632 | | | | | - | |
Auto loans | | | 243 | | | | 24 | | | | 251 | | | | 518 | | | | 132,284 | | | | 132,802 | | | | | 50 | |
Direct finance leases | | | 92 | | | | 37 | | | | - | | | | 129 | | | | 30,604 | | | | 30,733 | | (2) | | | - | |
Other | | | 32 | | | | 7 | | | | - | | | | 39 | | | | 7,694 | | | | 7,733 | | | | | - | |
Residential: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Real estate | | | - | | | | - | | | | 37 | | | | 37 | | | | 384,456 | | | | 384,493 | | | | | - | |
Construction | | | - | | | | - | | | | - | | | | - | | | | 37,433 | | | | 37,433 | | | | | - | |
Total | | $ | 782 | | | $ | 70 | | | $ | 3,070 | | | $ | 3,922 | | | $ | 1,519,020 | | | $ | 1,522,942 | | | | $ | 50 | |
(1) Includes non-accrual loans. (2) Net of unearned lease revenue of $1.8 million. (3) Includes net deferred loan costs of $4.5 million.
| | | | | | | | | | | | | | | | | | | | | | | | | | | Recorded | |
| | | | | | | | | | Past due | | | | | | | | | | | | | | | | investment past | |
| | 30 - 59 Days | | | 60 - 89 Days | | | 90 days | | | Total | | | | | | | Total | | | | due ≥ 90 days | |
December 31, 2021 | | past due | | | past due | | | or more (1) | | | past due | | | Current | | | loans (3) | | | | and accruing | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial and industrial | | $ | - | | | $ | 4 | | | $ | 154 | | | $ | 158 | | | $ | 236,146 | | | $ | 236,304 | | | | $ | - | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Non-owner occupied | | | - | | | | 675 | | | | 478 | | | | 1,153 | | | | 311,695 | | | | 312,848 | | | | | - | |
Owner occupied | | | - | | | | - | | | | 1,570 | | | | 1,570 | | | | 247,185 | | | | 248,755 | | | | | - | |
Construction | | | - | | | | - | | | | - | | | | - | | | | 21,147 | | | | 21,147 | | | | | - | |
Consumer: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Home equity installment | | | 87 | | | | 32 | | | | - | | | | 119 | | | | 47,452 | | | | 47,571 | | | | | - | |
Home equity line of credit | | | - | | | | - | | | | 97 | | | | 97 | | | | 54,781 | | | | 54,878 | | | | | - | |
Auto loans | | | 410 | | | | 45 | | | | 78 | | | | 533 | | | | 117,496 | | | | 118,029 | | | | | - | |
Direct finance leases | | | 173 | | | | 38 | | | | 64 | | | | 275 | | | | 24,528 | | | | 24,803 | | (2) | | | 64 | |
Other | | | 49 | | | | 17 | | | | - | | | | 66 | | | | 7,947 | | | | 8,013 | | | | | - | |
Residential: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Real estate | | | - | | | | 452 | | | | 572 | | | | 1,024 | | | | 324,837 | | | | 325,861 | | | | | - | |
Construction | | | - | | | | - | | | | - | | | | - | | | | 34,919 | | | | 34,919 | | | | | - | |
Total | | $ | 719 | | | $ | 1,263 | | | $ | 3,013 | | | $ | 4,995 | | | $ | 1,428,133 | | | $ | 1,433,128 | | | | $ | 64 | |
(1) Includes non-accrual loans. (2) Net of unearned lease revenue of $1.4 million. (3) Includes net deferred loan costs of $3.0 million.
19
Impaired loans
Impaired loans, segregated by class, as of the period indicated are detailed below:
| | | | | | Recorded | | | Recorded | | | | | | | | | |
| | Unpaid | | | investment | | | investment | | | Total | | | | | |
| | principal | | | with | | | with no | | | recorded | | | Related | |
(dollars in thousands) | | balance | | | allowance | | | allowance | | | investment | | | allowance | |
September 30, 2022 | | | | | | | | | | | | | | | | | | | | |
Commercial and industrial | | $ | 861 | | | $ | 18 | | | $ | 610 | | | $ | 628 | | | $ | 18 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
Non-owner occupied | | | 1,114 | | | | 322 | | | | 792 | | | | 1,114 | | | | 97 | |
Owner occupied | | | 2,887 | | | | 1,691 | | | | 577 | | | | 2,268 | | | | 362 | |
Consumer: | | | | | | | | | | | | | | | | | | | - | |
Home equity installment | | | 33 | | | | - | | | | - | | | | - | | | | - | |
Home equity line of credit | | | 162 | | | | 29 | | | | 90 | | | | 119 | | | | - | |
Auto loans | | | 239 | | | | 95 | | | | 106 | | | | 201 | | | | 25 | |
Residential: | | | | | | | | | | | | | | | | | | | | |
Real estate | | | 84 | | | | - | | | | 37 | | | | 37 | | | | - | |
Total | | $ | 5,380 | | | $ | 2,155 | | | $ | 2,212 | | | $ | 4,367 | | | $ | 502 | |
| | | | | | Recorded | | | Recorded | | | | | | | | | |
| | Unpaid | | | investment | | | investment | | | Total | | | | | |
| | principal | | | with | | | with no | | | recorded | | | Related | |
(dollars in thousands) | | balance | | | allowance | | | allowance | | | investment | | | allowance | |
December 31, 2021 | | | | | | | | | | | | | | | | | | | | |
Commercial and industrial | | $ | 218 | | | $ | 18 | | | $ | 136 | | | $ | 154 | | | $ | 18 | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | |
Non-owner occupied | | | 2,470 | | | | 1,674 | | | | 796 | | | | 2,470 | | | | 474 | |
Owner occupied | | | 3,185 | | | | 1,802 | | | | 762 | | | | 2,564 | | | | 763 | |
Consumer: | | | | | | | | | | | | | | | | | | | | |
Home equity installment | | | 33 | | | | - | | | | - | | | | - | | | | - | |
Home equity line of credit | | | 137 | | | | - | | | | 97 | | | | 97 | | | | - | |
Auto loans | | | 98 | | | | 10 | | | | 68 | | | | 78 | | | | 4 | |
Residential: | | | | | | | | | | | | | | | | | | | | |
Real estate | | | 699 | | | | - | | | | 572 | | | | 572 | | | | - | |
Total | | $ | 6,840 | | | $ | 3,504 | | | $ | 2,431 | | | $ | 5,935 | | | $ | 1,259 | |
At September 30, 2022, impaired loans totaled $4.4 million consisting of $1.4 million in accruing TDRs and $3.0 million in non-accrual loans. At December 31, 2021, impaired loans totaled $5.9 million consisting of $3.0 million in accruing TDRs and $2.9 million in non-accrual loans. As of September 30, 2022, the non-accrual loans included one TDR totaling $0.4 million compared with three TDRs to two unrelated borrowers totaling $0.6 million as of December 31, 2021.
A loan is considered impaired when, based on current information and events; it is probable that the Company will be unable to collect the payments in accordance with the contractual terms of the loan. Factors considered in determining impairment include payment status, collateral value, and the probability of collecting payments when due. The significance of payment delays and/or shortfalls is determined on a case-by-case basis. All circumstances surrounding the loan are considered. Such factors include the length of the delinquency, the underlying reasons and the borrower’s prior payment record. Impairment is measured on these loans on a loan-by-loan basis. Impaired loans include non-accrual loans, TDRs and other loans deemed to be impaired based on the aforementioned factors.
20
The following table presents the average recorded investments in impaired loans and related amount of interest income recognized during the periods indicated below. The average balances are calculated based on the quarter-end balances of impaired loans. Payments received from non-accruing impaired loans are first applied against the outstanding principal balance, then to the recovery of any charged-off amounts. Any excess is treated as a recovery of interest income. Payments received from accruing impaired loans are applied to principal and interest, as contractually agreed upon.
| | For the nine months ended | |
| | September 30, 2022 | | | September 30, 2021 | |
| | | | | | | | | | Cash basis | | | | | | | | | | | Cash basis | |
| | Average | | | Interest | | | interest | | | Average | | | Interest | | | interest | |
| | recorded | | | income | | | income | | | recorded | | | income | | | income | |
(dollars in thousands) | | investment | | | recognized | | | recognized | | | investment | | | recognized | | | recognized | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Commercial and industrial | | $ | 376 | | | $ | - | | | $ | - | | | $ | 433 | | | $ | 3 | | | $ | - | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
Non-owner occupied | | | 1,630 | | | | 57 | | | | - | | | | 2,838 | | | | 133 | | | | - | |
Owner occupied | | | 2,175 | | | | 78 | | | | - | | | | 1,711 | | | | 27 | | | | - | |
Construction | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Consumer: | | | | | | | | | | | | | | | | | | | | | | | | |
Home equity installment | | | 5 | | | | - | | | | - | | | | 35 | | | | 4 | | | | - | |
Home equity line of credit | | | 130 | | | | 7 | | | | - | | | | 268 | | | | 20 | | | | - | |
Auto loans | | | 141 | | | | 4 | | | | - | | | | 30 | | | | - | | | | - | |
Direct finance leases | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Other | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Residential: | | | | | | | | | | | | | | | | | | | | | | | | |
Real estate | | | 297 | | | | 39 | | | | - | | | | 717 | | | | - | | | | - | |
Construction | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Total | | $ | 4,754 | | | $ | 185 | | | $ | - | | | $ | 6,032 | | | $ | 187 | | | $ | - | |
Average recorded investment refers to the five quarter average of impaired loans preceding the reporting period.
| | For the three months ended | |
| | September 30, 2022 | | | September 30, 2021 | |
| | | | | | | | | | Cash basis | | | | | | | | | | | Cash basis | |
| | Average | | | Interest | | | interest | | | Average | | | Interest | | | interest | |
| | recorded | | | income | | | income | | | recorded | | | income | | | income | |
(dollars in thousands) | | investment | | | recognized | | | recognized | | | investment | | | recognized | | | recognized | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Commercial and industrial | | $ | 709 | | | $ | - | | | $ | - | | | $ | 325 | | | $ | - | | | $ | - | |
Commercial real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
Non-owner occupied | | | 1,108 | | | | 5 | | | | - | | | | 2,676 | | | | 73 | | | | - | |
Owner occupied | | | 2,262 | | | | 24 | | | | - | | | | 1,555 | | | | 7 | | | | - | |
Construction | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Consumer: | | | | | | | | | | | | | | | | | | | | | | | | |
Home equity installment | | | - | | | | - | | | | - | | | | 27 | | | | - | | | | - | |
Home equity line of credit | | | 143 | | | | 7 | | | | - | | | | 114 | | | | - | | | | - | |
Auto loans | | | 203 | | | | 2 | | | | - | | | | 44 | | | | - | | | | - | |
Direct finance leases | | | - | | | | - | | | | | | | | - | | | | - | | | | - | |
Other | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Residential: | | | | | | | | | | | | | | | | | | | | | | | | |
Real estate | | | 40 | | | | - | | | | - | | | | 699 | | | | - | | | | - | |
Construction | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | |
Total | | $ | 4,465 | | | $ | 38 | | | $ | - | | | $ | 5,440 | | | $ | 80 | | | $ | - | |
Average recorded investment refers to the two quarter average of impaired loans preceding the reporting period.
Credit Quality Indicators
Commercial and industrial and commercial real estate
The Company utilizes a loan grading system and assigns a credit risk grade to its loans in the C&I and CRE portfolios. The grading system provides a means to measure portfolio quality and aids in the monitoring of the credit quality of the overall loan portfolio. The credit risk grades are arrived at using a risk rating matrix to assign a grade to each of the loans in the C&I and CRE portfolios.
The following is a description of each risk rating category the Company uses to classify each of its C&I and CRE loans:
Pass
Loans in this category have an acceptable level of risk and are graded in a range of one to five. Secured loans generally have good collateral coverage. Current financial statements reflect acceptable balance sheet ratios, sales and earnings trends. Management is competent, and a reasonable succession plan is evident. Payment experience on the loans has been good with minor or no delinquency experience. Loans with a grade of one are of the highest quality in the range. Those graded five are of marginally acceptable quality.
Special Mention
Loans in this category are graded a six and may be protected but are potentially weak. They constitute a credit risk to the Company but have not yet reached the point of adverse classification. Some of the following conditions may exist: little or no collateral coverage; lack of current financial information; delinquency problems; highly leveraged; available financial information reflects poor balance sheet ratios and profit and loss statements reflect uncertain trends; and document exceptions. Cash flow may not be sufficient to support total debt service requirements.
Substandard
Loans in this category are graded a seven and have a well-defined weakness which may jeopardize the ultimate collectability of the debt. The collateral pledged may be lacking in quality or quantity. Financial statements may indicate insufficient cash flow to service the debt; and/or do not reflect a sound net worth. The payment history indicates chronic delinquency problems. Management is weak. There is a distinct possibility that the Company may sustain a loss. All loans on non-accrual are rated substandard. Other loans that are included in the substandard category can be accruing, as well as loans that are current or past due. Loans 90 days or more past due, unless otherwise fully supported, are classified substandard. Also, borrowers that are bankrupt or have loans categorized as TDRs can be graded substandard.
Doubtful
Loans in this category are graded an eight and have a better than 50% possibility of the Company sustaining a loss, but the loss cannot be determined because of specific reasonable factors which may strengthen credit in the near-term. Many of the weaknesses present in a substandard loan exist. Liquidation of collateral, if any, is likely. Any loan graded lower than an eight is considered to be uncollectible and charged-off.
Consumer and residential
The consumer and residential loan segments are regarded as homogeneous loan pools and as such are not risk rated. For these portfolios, the Company utilizes payment activity and history in assessing performance. Non-performing loans are comprised of non-accrual loans and loans past due 90 days or more and accruing. All loans not classified as non-performing are considered performing.
The following table presents loans including $4.5 million and $3.0 million of deferred costs, segregated by class, categorized into the appropriate credit quality indicator category as of September 30, 2022 and December 31, 2021, respectively:
Commercial credit exposure
Credit risk profile by creditworthiness category
| | September 30, 2022 | |
(dollars in thousands) | | Pass | | | Special mention | | | Substandard | | | Doubtful | | | Total | |
| | | | | | | | | | | | | | | | | | | | |
Commercial and industrial | | $ | 219,371 | | | $ | 78 | | | $ | 2,462 | | | $ | - | | | $ | 221,911 | |
Commercial real estate - non-owner occupied | | | 297,017 | | | | 9,564 | | | | 8,742 | | | | - | | | | 315,323 | |
Commercial real estate - owner occupied | | | 241,752 | | | | 1,153 | | | | 13,148 | | | | - | | | | 256,053 | |
Commercial real estate - construction | | | 26,015 | | | | - | | | | - | | | | - | | | | 26,015 | |
Total commercial | | $ | 784,155 | | | $ | 10,795 | | | $ | 24,352 | | | $ | - | | | $ | 819,302 | |
Consumer & Mortgage lending credit exposure
Credit risk profile based on payment activity
| | September 30, 2022 | |
(dollars in thousands) | | | Performing | | | | Non-performing | | | | Total | |
Consumer | | | | | | | | | | | | |
Home equity installment | | $ | 56,814 | | | $ | - | | | $ | 56,814 | |
Home equity line of credit | | | 53,513 | | | | 119 | | | | 53,632 | |
Auto loans | | | 132,551 | | | | 251 | | | | 132,802 | |
Direct finance leases (1) | | | 30,733 | | | | - | | | | 30,733 | |
Other | | | 7,733 | | | | - | | | | 7,733 | |
Total consumer | | | 281,344 | | | | 370 | | | | 281,714 | |
Residential | | | | | | | | | | | | |
Real estate | | | 384,456 | | | | 37 | | | | 384,493 | |
Construction | | | 37,433 | | | | - | | | | 37,433 | |
Total residential | | | 421,889 | | | | 37 | | | | 421,926 | |
Total consumer & residential | | $ | 703,233 | | | $ | 407 | | | $ | 703,640 | |
(1)Net of unearned lease revenue of $1.8 million.
Commercial credit exposure
Credit risk profile by creditworthiness category
| | December 31, 2021 | |
(dollars in thousands) | | | Pass | | | | Special mention | | | | Substandard | | | | Doubtful | | | | Total | |
| | | | | | | | | | | | | | | | | | | | |
Commercial and industrial | | $ | 233,565 | | | $ | 339 | | | $ | 2,400 | | | $ | - | | | $ | 236,304 | |
Commercial real estate - non-owner occupied | | | 289,679 | | | | 16,614 | | | | 6,555 | | | | - | | | | 312,848 | |
Commercial real estate - owner occupied | | | 230,146 | | | | 7,089 | | | | 11,520 | | | | - | | | | 248,755 | |
Commercial real estate - construction | | | 21,147 | | | | - | | | | - | | | | - | | | | 21,147 | |
Total commercial | | $ | 774,537 | | | $ | 24,042 | | | $ | 20,475 | | | $ | - | | | $ | 819,054 | |
22
Consumer & Mortgage lending credit exposure
Credit risk profile based on payment activity
| | December 31, 2021 | |
(dollars in thousands) | | Performing | | | Non-performing | | | Total | |
| | | | | | | | | | | | |
Consumer | | | | | | | | | | | | |
Home equity installment | | $ | 47,571 | | | $ | - | | | $ | 47,571 | |
Home equity line of credit | | | 54,781 | | | | 97 | | | | 54,878 | |
Auto loans | | | 117,951 | | | | 78 | | | | 118,029 | |
Direct finance leases (2) | | | 24,739 | | | | 64 | | | | 24,803 | |
Other | | | 8,013 | | | | - | | | | 8,013 | |
Total consumer | | | 253,055 | | | | 239 | | | | 253,294 | |
Residential | | | | | | | | | | | | |
Real estate | | | 325,289 | | | | 572 | | | | 325,861 | |
Construction | | | 34,919 | | | | - | | | | 34,919 | |
Total residential | | | 360,208 | | | | 572 | | | | 360,780 | |
Total consumer & residential | | $ | 613,263 | | | $ | 811 | | | $ | 614,074 | |
(2)Net of unearned lease revenue of $1.4 million.
Allowance for loan losses
Management continually evaluates the credit quality of the Company’s loan portfolio and performs a formal review of the adequacy of the allowance on a quarterly basis. The allowance reflects management’s best estimate of the amount of credit losses in the loan portfolio. Management’s judgment is based on the evaluation of individual loans, experience, the assessment of current economic conditions and other relevant factors including the amounts and timing of cash flows expected to be received on impaired loans. Those estimates may be susceptible to significant change. Loan losses are charged directly against the allowance when loans are deemed to be uncollectible. Recoveries from previously charged-off loans are added to the allowance when received.
Management applies two primary components during the loan review process to determine proper allowance levels. The two components are a specific loan loss allocation for loans that are deemed impaired and a general loan loss allocation for those loans not specifically allocated. The methodology to analyze the adequacy of the allowance for loan losses is as follows:
| ■ | identification of specific impaired loans by loan category; |
| ■ | identification of specific loans that are not impaired, but have an identified potential for loss; |
| ■ | calculation of specific allowances where required for the impaired loans based on collateral and other objective and quantifiable evidence; |
| ■ | determination of loans with similar credit characteristics within each class of the loan portfolio segment and eliminating the impaired loans; |
| ■ | application of historical loss percentages (trailing twelve-quarter average) to pools to determine the allowance allocation; |
| ■ | application of qualitative factor adjustment percentages to historical losses for trends or changes in the loan portfolio. |
| ■ | Qualitative factor adjustments include: |
| o | levels of and trends in delinquencies and non-accrual loans; |
| o | levels of and trends in charge-offs and recoveries; |
| o | trends in volume and terms of loans; |
| o | changes in risk selection and underwriting standards; |
| o | changes in lending policies and legal and regulatory requirements; |
| o | experience, ability and depth of lending management; |
| o | national and local economic trends and conditions; and |
| o | changes in credit concentrations. |
Allocation of the allowance for different categories of loans is based on the methodology as explained above. A key element of the methodology to determine the allowance is the Company’s credit risk evaluation process, which includes credit risk grading of individual C&I and CRE loans. C&I and CRE loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed. The credit risk grades may be changed at any time management feels an upgrade or downgrade may be warranted. The credit risk grades for the C&I and CRE loan portfolios are considered in the reserve methodology and loss factors are applied based upon the credit risk grades. The loss factors applied are based upon the Company’s historical experience as well as what we believe to be best practices and common industry standards. Historical experience reveals there is a direct correlation between the credit risk grades and loan charge-offs. The changes in allocations in the C&I and CRE loan portfolio from period to period are based upon the credit risk grading system and from periodic reviews of the loan portfolio. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies.
Each quarter, management performs an assessment of the allowance. The Company’s Special Assets Committee meets quarterly, and the applicable lenders discuss each relationship under review and reach a consensus on the appropriate estimated loss amount, if applicable, based on current accounting guidance. The Special Assets Committee’s focus is on ensuring the pertinent facts are considered regarding not only loans considered for specific reserves, but also the collectability of loans that may be past due in payment. The assessment process also includes the review of all loans on a non-accruing basis as well as a review of certain loans to which the lenders or the Company’s Credit Administration function have assigned a criticized or classified risk rating.
The Company’s policy is to charge-off unsecured consumer loans when they become 90 days or more past due as to principal and interest. In the other portfolio segments, amounts are charged-off at the point in time when the Company deems the balance, or a portion thereof, to be uncollectible.
Information related to the change in the allowance and the Company’s recorded investment in loans by portfolio segment as of the period indicated is as follows:
As of and for the nine months ended September 30, 2022 | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial & | | | Commercial | | | | | | | | Residential | | | | | | | | | |
(dollars in thousands) | | industrial | | | real estate | | | Consumer | | | | real estate | | | Unallocated | | | Total | |
Allowance for Loan Losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 2,204 | | | $ | 7,422 | | | $ | 2,404 | | | | $ | 3,508 | | | $ | 86 | | | $ | 15,624 | |
Charge-offs | | | (323 | ) | | | (1 | ) | | | (226 | ) | | | | - | | | | - | | | | (550 | ) |
Recoveries | | | 8 | | | | 61 | | | | 59 | | | | | 2 | | | | - | | | | 130 | |
Provision | | | 785 | | | | (320 | ) | | | 604 | | | | | 512 | | | | (6 | ) | | | 1,575 | |
Ending balance | | $ | 2,674 | | | $ | 7,162 | | | $ | 2,841 | | | | $ | 4,022 | | | $ | 80 | | | $ | 16,779 | |
Ending balance: individually evaluated for impairment | | $ | 18 | | | $ | 459 | | | $ | 25 | | | | $ | - | | | $ | - | | | $ | 502 | |
Ending balance: collectively evaluated for impairment | | $ | 2,656 | | | $ | 6,703 | | | $ | 2,816 | | | | $ | 4,022 | | | $ | 80 | | | $ | 16,277 | |
Loans Receivables: | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance (2) | | $ | 221,911 | | | $ | 597,391 | | | $ | 281,714 | | (1) | | $ | 421,926 | | | $ | - | | | $ | 1,522,942 | |
Ending balance: individually evaluated for impairment | | $ | 628 | | | $ | 3,382 | | | $ | 320 | | | | $ | 37 | | | $ | - | | | $ | 4,367 | |
Ending balance: collectively evaluated for impairment | | $ | 221,283 | | | $ | 594,009 | | | $ | 281,394 | | | | $ | 421,889 | | | $ | - | | | $ | 1,518,575 | |
(1) Net of unearned lease revenue of $1.8 million. (2) Includes $4.5 million of net deferred loan costs.
As of and for the three months ended September 30, 2022 | | | | | | | | | | | | | | | | | | | | | |
| | Commercial & | | | Commercial | | | | | | | Residential | | | | | | | | | |
(dollars in thousands) | | industrial | | | real estate | | | Consumer | | | real estate | | | Unallocated | | | Total | |
Allowance for Loan Losses: | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 2,745 | | | $ | 6,963 | | | $ | 2,770 | | | $ | 4,037 | | | $ | 75 | | | $ | 16,590 | |
Charge-offs | | | (291 | ) | | | - | | | | (91 | ) | | | - | | | | - | | | | (382 | ) |
Recoveries | | | 5 | | | | 33 | | | | 8 | | | | - | | | | - | | | | 46 | |
Provision | | | 215 | | | | 166 | | | | 154 | | | | (15 | ) | | | 5 | | | | 525 | |
Ending balance | | $ | 2,674 | | | $ | 7,162 | | | $ | 2,841 | | | $ | 4,022 | | | $ | 80 | | | $ | 16,779 | |
As of and for the year ended December 31, 2021 | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Commercial & | | | Commercial | | | | | | | | Residential | | | | | | | | | |
(dollars in thousands) | | industrial | | | real estate | | | Consumer | | | | real estate | | | Unallocated | | | Total | |
Allowance for Loan Losses: | | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 2,407 | | | $ | 6,383 | | | $ | 2,552 | | | | $ | 2,781 | | | $ | 79 | | | $ | 14,202 | |
Charge-offs | | | (130 | ) | | | (491 | ) | | | (206 | ) | | | | (162 | ) | | | - | | | | (989 | ) |
Recoveries | | | 23 | | | | 250 | | | | 138 | | | | | - | | | | - | | | | 411 | |
Provision | | | (96 | ) | | | 1,280 | | | | (80 | ) | | | | 889 | | | | 7 | | | | 2,000 | |
Ending balance | | $ | 2,204 | | | $ | 7,422 | | | $ | 2,404 | | | | $ | 3,508 | | | $ | 86 | | | $ | 15,624 | |
Ending balance: individually evaluated for impairment | | $ | 18 | | | $ | 1,237 | | | $ | 4 | | | | $ | - | | | $ | - | | | $ | 1,259 | |
Ending balance: collectively evaluated for impairment | | $ | 2,186 | | | $ | 6,185 | | | $ | 2,400 | | | | $ | 3,508 | | | $ | 86 | | | $ | 14,365 | |
Loans Receivables: | | | | | | | | | | | | | | | | | | | | | | | | | |
Ending balance (2) | | $ | 236,304 | | | $ | 582,750 | | | $ | 253,294 | | (1) | | $ | 360,780 | | | $ | - | | | $ | 1,433,128 | |
Ending balance: individually evaluated for impairment | | $ | 154 | | | $ | 5,034 | | | $ | 175 | | | | $ | 572 | | | $ | - | | | $ | 5,935 | |
Ending balance: collectively evaluated for impairment | | $ | 236,150 | | | $ | 577,716 | | | $ | 253,119 | | | | $ | 360,208 | | | $ | - | | | $ | 1,427,193 | |
(1) Net of unearned lease revenue of $1.4 million. (2) Includes $3.0 million of net deferred loan costs.
24
As of and for the nine months ended September 30, 2021 | | | | | | | | | | | | | | | | | | | | | |
| | Commercial & | | | Commercial | | | | | | | Residential | | | | | | | | | |
(dollars in thousands) | | industrial | | | real estate | | | Consumer | | | real estate | | | Unallocated | | | Total | |
Allowance for Loan Losses: | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 2,407 | | | $ | 6,383 | | | $ | 2,552 | | | $ | 2,781 | | | $ | 79 | | | $ | 14,202 | |
Charge-offs | | | (120 | ) | | | (209 | ) | | | (110 | ) | | | (43 | ) | | | - | | | | (482 | ) |
Recoveries | | | 20 | | | | 241 | | | | 70 | | | | - | | | | - | | | | 331 | |
Provision | | | 134 | | | | 870 | | | | (66 | ) | | | 275 | | | | 337 | | | | 1,550 | |
Ending balance | | $ | 2,441 | | | $ | 7,285 | | | $ | 2,446 | | | $ | 3,013 | | | $ | 416 | | | $ | 15,601 | |
As of and for the three months ended September 30, 2021 | | | | | | | | | | | | | | | | | | | | | |
| | Commercial & | | | Commercial | | | | | | | Residential | | | | | | | | | |
(dollars in thousands) | | industrial | | | real estate | | | Consumer | | | real estate | | | Unallocated | | | Total | |
Allowance for Loan Losses: | | | | | | | | | | | | | | | | | | | | | | | | |
Beginning balance | | $ | 2,324 | | | $ | 7,228 | | | $ | 2,497 | | | $ | 3,070 | | | $ | 126 | | | $ | 15,245 | |
Charge-offs | | | (14 | ) | | | (77 | ) | | | (28 | ) | | | - | | | | - | | | | (119 | ) |
Recoveries | | | 5 | | | | 6 | | | | 14 | | | | - | | | | - | | | | 25 | |
Provision | | | 126 | | | | 128 | | | | (37 | ) | | | (57 | ) | | | 290 | | | | 450 | |
Ending balance | | $ | 2,441 | | | $ | 7,285 | | | $ | 2,446 | | | $ | 3,013 | | | $ | 416 | | | $ | 15,601 | |
Direct finance leases
The Company originates direct finance leases through two automobile dealerships. The carrying amount of the Company’s lease receivables, net of unearned income, was $8.4 million and $7.7 million as of September 30, 2022 and December 31, 2021, respectively. The residual value of the direct finance leases is fully guaranteed by the dealerships. Residual values amounted to $22.3 million and $17.1 million at September 30, 2022 and December 31, 2021, respectively, and are included in the carrying value of direct finance leases.
The undiscounted cash flows to be received on an annual basis for the direct finance leases are as follows:
(dollars in thousands) | | Amount | |
| | | | |
2022 | | $ | 1,892 | |
2023 | | | 9,256 | |
2024 | | | 9,887 | |
2025 | | | 10,401 | |
2026 | | | 1,062 | |
2027 and thereafter | | | 28 | |
Total future minimum lease payments receivable | | | 32,526 | |
Less: Unearned income | | | (1,793 | ) |
Undiscounted cash flows to be received | | $ | 30,733 | |
6. Earnings per share
Basic earnings per share (EPS) is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS is computed in the same manner as basic EPS but also reflects the potential dilution that could occur from the grant of stock-based compensation awards. The Company maintains one active share-based compensation plan that may generate additional potentially dilutive common shares. For granted and unexercised stock-settled stock appreciation rights (SSARs), dilution would occur if Company-issued SSARs were exercised and converted into common stock. As of the three and nine months ended September 30, 2022, there were 17,996 and 19,636 potentially dilutive shares related to issued and unexercised SSARs compared to 26,346 and 29,378 for the same 2021 periods, respectively. The calculation did not include 50,014 unexercised SSARs that could potentially dilute earnings per share but their effect was antidilutive as of the three and nine months ended September 30, 2022. For restricted stock, dilution would occur from the Company’s previously granted but unvested shares. There were 13,404 and 12,360 potentially dilutive shares related to unvested restricted share grants as of the three and nine months ended September 30, 2022 compared to 12,515 and 11,345 for the same 2021 periods, respectively. The calculation did not include 31,906 and 27,356 weighted average unvested restricted shares that could potentially dilute earnings per share but their effect was antidilutive as of the three and nine months ended September 30, 2022.
In the computation of diluted EPS, the Company uses the treasury stock method to determine the dilutive effect of its granted but unexercised stock options and SSARs and unvested restricted stock. Under the treasury stock method, the assumed proceeds, as defined, received from shares issued in a hypothetical stock option exercise or restricted stock grant, are assumed to be used to purchase treasury stock. Proceeds include amounts received from the exercise of outstanding stock options and compensation cost for future service that the Company has not yet recognized in earnings. The Company does not consider awards from share-based grants in the computation of basic EPS.
25
The following table illustrates the data used in computing basic and diluted EPS for the periods indicated:
| | Three months ended September 30, | | | Nine months ended September 30, | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
(dollars in thousands except per share data) | | | | | | | | | | | | | | | | |
Basic EPS: | | | | | | | | | | | | | | | | |
Net income available to common shareholders | | $ | 7,689 | | | $ | 4,859 | | | $ | 22,875 | | | $ | 16,222 | |
Weighted-average common shares outstanding | | | 5,634,182 | | | | 5,643,897 | | | | 5,649,332 | | | | 5,212,500 | |
Basic EPS | | $ | 1.36 | | | $ | 0.86 | | | $ | 4.05 | | | $ | 3.11 | |
| | | | | | | | | | | | | | | | |
Diluted EPS: | | | | | | | | | | | | | | | | |
Net income available to common shareholders | | $ | 7,689 | | | $ | 4,859 | | | $ | 22,875 | | | $ | 16,222 | |
Weighted-average common shares outstanding | | | 5,634,182 | | | | 5,643,897 | | | | 5,649,332 | | | | 5,212,500 | |
Potentially dilutive common shares | | | 31,400 | | | | 38,861 | | | | 31,996 | | | | 40,723 | |
Weighted-average common and potentially dilutive shares outstanding | | | 5,665,582 | | | | 5,682,758 | | | | 5,681,328 | | | | 5,253,223 | |
Diluted EPS | | $ | 1.36 | | | $ | 0.85 | | | $ | 4.03 | | | $ | 3.09 | |
7. Stock plans
The Company has one stock-based compensation plan (the stock compensation plan) from which it can grant stock-based compensation awards and applies the fair value method of accounting for stock-based compensation provided under current accounting guidance. The guidelines require the cost of share-based payment transactions (including those with employees and non-employees) be recognized in the financial statements. The Company’s stock compensation plan was shareholder-approved and permits the grant of share-based compensation awards to its employees and directors. The Company believes that the stock-based compensation plan will advance the development, growth and financial condition of the Company by providing incentives through participation in the appreciation in the value of the Company’s common stock. In return, the Company hopes to secure, retain and motivate the employees and directors who are responsible for the operation and the management of the affairs of the Company by aligning the interest of its employees and directors with the interest of its shareholders. In the stock compensation plan, employees and directors are eligible to be awarded stock-based compensation grants which can consist of stock options (qualified and non-qualified), stock appreciation rights (SARs) and restricted stock.
At the 2022 annual shareholders' meeting, the Company's shareholders approved and the Company adopted the 2022 Omnibus Stock Incentive Plan which replaced the 2012 Omnibus Stock Incentive Plan and the 2012 Director Stock Incentive Plan (collectively, the 2012 stock incentive plans). The 2012 stock incentive plans expired in 2022. Unless terminated by the Company’s board of directors, the 2022 Omnibus Stock Incentive Plan will expire on and no stock-based awards shall be granted after the year 2032.
In the 2022 Omnibus Stock Incentive Plan, the Company has reserved 500,000 shares of its no-par common stock for future issuance. The Company recognizes share-based compensation expense over the requisite service or vesting period. Since 2019, the Company has approved a Long-Term Incentive Plan (LTIP) each year that awarded restricted stock and/or stock-settled stock appreciation rights (SSARs) to senior officers and managers based on the attainment of performance goals. The SSAR awards have a ten-year term from the date of each grant.
During the first quarter of 2022, the Company approved a LTIP and awarded restricted stock to senior officers and managers in February 2022 based on 2021 performance.
During the first quarter of 2021, the Company approved a LTIP and awarded restricted stock to senior officers and managers in February and March 2021 based on 2020 performance.
26
The following table summarizes the weighted-average fair value and vesting of restricted stock grants awarded during the periods ended September 30, 2022 and 2021 under the 2022 and 2012 stock incentive plans:
| | September 30, 2022 | | | September 30, 2021 | |
| | | | | | | Weighted- | | | | | | | | Weighted- | |
| | Shares | | | | average grant | | | Shares | | | | average grant | |
| | granted | | | | date fair value | | | granted | | | | date fair value | |
| | | | | | | | | | | | | | | | | | |
Director plan | | | 18,000 | | (2) | | $ | 49.85 | | | | 12,500 | | (2) | | $ | 52.00 | |
Omnibus plan | | | 16,520 | | (3) | | | 49.85 | | | | 13,552 | | (3) | | | 52.00 | |
Omnibus plan | | | 50 | | (1) | | | 35.91 | | | | 50 | | (1) | | | 58.17 | |
Omnibus plan | | | - | | | | | | | | | 36 | | (3) | | | 58.17 | |
Omnibus plan | | | - | | | | | | | | | 476 | | (2) | | | 52.62 | |
Total | | | 34,570 | | | | $ | 49.83 | | | | 26,614 | | | | $ | 52.03 | |
(1) Vest after 1 year (2) Vest after 3 years – 33% each year (3) Vest fully after 3 years
The fair value of the shares granted in 2022 and 2021 was calculated using the grant date stock price.
A summary of the status of the Company’s non-vested restricted stock as of and changes during the period indicated are presented in the following table:
| | 2012 & 2022 Stock incentive plans | |
| | Director | | | Omnibus | | | Total | | | Weighted- average grant date fair value | |
Non-vested balance at December 31, 2021 | | | 14,920 | | | | 28,123 | | | | 43,043 | | | $ | 53.20 | |
Granted | | | 18,000 | | | | 16,570 | | | | 34,570 | | | | 49.83 | |
Forfeited | | | - | | | | (3,323 | ) | | | (3,323 | ) | | | 52.20 | |
Vested | | | (9,048 | ) | | | (2,651 | ) | | | (11,699 | ) | | | 52.83 | |
Non-vested balance at September 30, 2022 | | | 23,872 | | | | 38,719 | | | | 62,591 | | | $ | 51.46 | |
A summary of the status of the Company’s SSARs as of and changes during the period indicated are presented in the following table:
| | Awards | | | Weighted-average grant date fair value | | | Weighted-average remaining contractual term (years) | |
Outstanding December 31, 2021 | | | 94,332 | | | $ | 9.66 | | | | 5.5 | |
Granted | | | - | | | | | | | | | |
Exercised | | | - | | | | | | | | | |
Forfeited | | | - | | | | | | | | | |
Outstanding September 30, 2022 | | | 94,332 | | | $ | 9.66 | | | | 4.8 | |
Of the SSARs outstanding at September 30, 2022, all SSARs vested and were exercisable.
There were no SSARs exercised during the first nine months of 2022. During the first nine months of 2021, there were 2,932 SSARs exercised. The intrinsic value recorded for these SSARs was $10,190. The tax deduction realized from the exercise of these SSARs was $125,810 resulting in a tax benefit of $26,420.
Share-based compensation expense is included as a component of salaries and employee benefits in the consolidated statements of income. The following tables illustrate stock-based compensation expense recognized on non-vested equity awards during the three and nine months ended September 30, 2022 and 2021 and the unrecognized stock-based compensation expense as of September 30, 2022:
| | Three months ended September 30, | | | Nine months ended September 30, | |
(dollars in thousands) | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Stock-based compensation expense: | | | | | | | | | | | | | | | | |
2012 Director stock incentive plan | | $ | 126 | | | $ | 170 | | | $ | 497 | | | $ | 339 | |
2012 Omnibus stock incentive plan | | | 132 | | | | 163 | | | | 447 | | | | 477 | |
2022 Omnibus stock incentive plan | | | - | | | | - | | | | 1 | | | | - | |
Employee stock purchase plan | | | - | | | | - | | | | 32 | | | | 44 | |
Total stock-based compensation expense | | $ | 258 | | | $ | 333 | | | $ | 977 | | | $ | 860 | |
In addition, during the nine months ended September 30, 2021, the Company reversed accruals of ($10 thousand) in stock-based compensation expense for restricted stock and SSARs awarded under the 2012 Omnibus Stock Incentive Plan.
| | As of | |
(dollars in thousands) | | September 30, 2022 | |
Unrecognized stock-based compensation expense: | | | | |
2012 Director stock incentive plan | | $ | 898 | |
2012 Omnibus stock incentive plan | | | 985 | |
2022 Omnibus stock incentive plan | | | 1 | |
Total unrecognized stock-based compensation expense | | $ | 1,884 | |
The unrecognized stock-based compensation expense as of September 30, 2022 will be recognized ratably over the periods ended February 2025 and February 2025 for the 2012 Director Stock Incentive Plan and the 2012 Omnibus Stock Incentive Plan, respectively.
In addition to the 2022 stock incentive plan, the Company established the 2002 Employee Stock Purchase Plan (the ESPP) and reserved 165,000 shares of its un-issued capital stock for issuance under the plan. The ESPP was designed to promote broad-based employee ownership of the Company’s stock and to motivate employees to improve job performance and enhance the financial results of the Company. Under the ESPP, participation is voluntary whereby employees use automatic payroll withholdings to purchase the Company’s capital stock at a discounted price based on the fair market value of the capital stock as measured on either the commencement or termination dates, as defined. As of September 30, 2022, 94,533 shares have been issued under the ESPP. The ESPP is considered a compensatory plan and is required to comply with the provisions of current accounting guidance. The Company recognizes compensation expense on its ESPP on the date the shares are purchased, and it is included as a component of salaries and employee benefits in the consolidated statements of income.
During the second quarter of 2022, the Company announced that the Board of Directors approved a plan to purchase, in open market and privately negotiated transactions, up to 3% of its outstanding common stock. As of September 30, 2022, the Company had repurchased 31,839 shares of common stock at an average price of $38.79 under the treasury stock repurchase plan.
8. Fair value measurements
The accounting guidelines establish a framework for measuring and disclosing information about fair value measurements. The guidelines of fair value reporting instituted a valuation hierarchy for disclosure of the inputs used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:
Level 1 - inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities;
Level 2 - inputs are quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument;
Level 3 - inputs are unobservable and are based on the Company’s own assumptions to measure assets and liabilities at fair value. Level 3 pricing for securities may also include unobservable inputs based upon broker-traded transactions.
A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
The Company uses fair value to measure certain assets and, if necessary, liabilities on a recurring basis when fair value is the primary measure for accounting. Thus, the Company uses fair value for AFS securities. Fair value is used on a non-recurring basis to measure certain assets when adjusting carrying values to market values, such as impaired loans, other real estate owned (ORE) and other repossessed assets.
The following table represents the carrying amount and estimated fair value of the Company’s financial instruments as of the periods indicated:
September 30, 2022 | |
| | | | | | | | | | Quoted prices | | | Significant | | | Significant | |
| | | | | | | | | | in active | | | other | | | other | |
| | Carrying | | | Estimated | | | markets | | | observable inputs | | | unobservable inputs | |
(dollars in thousands) | | amount | | | fair value | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
Financial assets: | | | | | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 134,042 | | | $ | 134,042 | | | $ | 134,042 | | | $ | - | | | $ | - | |
Held-to-maturity securities | | | 222,374 | | | | 182,240 | | | | - | | | | 182,240 | | | | - | |
Available-for-sale debt securities | | | 413,413 | | | | 413,413 | | | | - | | | | 413,413 | | | | - | |
Restricted investments in bank stock | | | 3,639 | | | | 3,639 | | | | - | | | | 3,639 | | | | - | |
Loans and leases, net | | | 1,506,163 | | | | 1,393,596 | | | | - | | | | - | | | | 1,393,596 | |
Loans held-for-sale | | | 1,386 | | | | 1,405 | | | | - | | | | 1,405 | | | | - | |
Accrued interest receivable | | | 7,780 | | | | 7,780 | | | | - | | | | 7,780 | | | | - | |
Interest rate swaps | | | 213 | | | | 213 | | | | - | | | | 213 | | | | - | |
Financial liabilities: | | | | | | | | | | | | | | | | | | | | |
Deposits with no stated maturities | | | 2,132,227 | | | | 2,132,227 | | | | - | | | | 2,132,227 | | | | - | |
Time deposits | | | 121,006 | | | | 116,989 | | | | - | | | | 116,989 | | | | - | |
Short-term borrowings | | | 10 | | | | 10 | | | | - | | | | 10 | | | | - | |
Secured borrowings | | | 7,688 | | | | 7,078 | | | | - | | | | - | | | | 7,078 | |
Accrued interest payable | | | 163 | | | | 163 | | | | - | | | | 163 | | | | - | |
Interest rate swaps | | | 213 | | | | 213 | | | | - | | | | 213 | | | | - | |
December 31, 2021 | |
| | | | | | | | | | Quoted prices | | | Significant | | | Significant | |
| | | | | | | | | | in active | | | other | | | other | |
| | Carrying | | | Estimated | | | markets | | | observable inputs | | | unobservable inputs | |
(dollars in thousands) | | amount | | | fair value | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
Financial assets: | | | | | | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 96,877 | | | $ | 96,877 | | | $ | 96,877 | | | $ | - | | | $ | - | |
Available-for-sale debt securities | | | 738,980 | | | | 738,980 | | | | - | | | | 738,980 | | | | - | |
Restricted investments in bank stock | | | 3,206 | | | | 3,206 | | | | - | | | | 3,206 | | | | - | |
Loans and leases, net | | | 1,417,504 | | | | 1,404,103 | | | | - | | | | - | | | | 1,404,103 | |
Loans held-for-sale | | | 31,727 | | | | 32,013 | | | | - | | | | 32,013 | | | | - | |
Accrued interest receivable | | | 7,526 | | | | 7,526 | | | | - | | | | 7,526 | | | | - | |
Financial liabilities: | | | | | | | | | | | | | | | | | | | | |
Deposits with no stated maturities | | | 2,031,072 | | | | 2,031,072 | | | | - | | | | 2,031,072 | | | | - | |
Time deposits | | | 138,793 | | | | 138,291 | | | | - | | | | 138,291 | | | | - | |
Secured borrowings | | | 10,620 | | | | 10,690 | | | | - | | | | - | | | | 10,690 | |
Accrued interest payable | | | 155 | | | | 155 | | | | - | | | | 155 | | | | - | |
The carrying value of short-term financial instruments, as listed below, approximates their fair value. These instruments generally have limited credit exposure, no stated or short-term maturities, carry interest rates that approximate market and generally are recorded at amounts that are payable on demand:
| ● | Cash and cash equivalents; |
| ● | Non-interest bearing deposit accounts; |
| ● | Savings, interest-bearing checking and money market accounts and |
| ● | Short-term borrowings. |
Securities: Fair values on investment securities are determined by prices provided by a third-party vendor, who is a provider of financial market data, analytics and related services to financial institutions.
Originated loans and leases: The fair value of accruing loans is estimated by calculating the net present value of the future expected cash flows discounted using the exit price notion. The discount rate is based upon current offering rates, with an additional discount for expected potential charge-offs. Additionally, an environmental general credit risk adjustment is subtracted from the net present value to arrive at the total estimated fair value of the accruing loan portfolio.
The carrying value that fair value is compared to is net of the allowance for loan losses and since there is significant judgment included in evaluating credit quality, loans are classified within Level 3 of the fair value hierarchy.
Non-accrual loans: Loans which the Company has measured as non-accruing are generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties. These loans are classified within Level 3 of the fair value hierarchy. The fair value consists of loan balances less the valuation allowance.
Acquired loans: Acquired loans (performing and non-performing) are initially recorded at their acquisition-date fair values using Level 3 inputs. For more information on the calculation of the fair value of acquired loans, see Footnote 9, “Acquisition.”
Loans held-for-sale: The fair value of loans held-for-sale is estimated using rates currently offered for similar loans and is typically obtained from the Federal National Mortgage Association (FNMA) or the Federal Home Loan Bank of Pittsburgh (FHLB).
Interest rate swaps: Fair values on investment securities are determined by prices provided by a third-party vendor, who is a provider of financial market data, analytics and related services to financial institutions.
Certificates of deposit: The fair value of certificates of deposit is based on discounted cash flows using rates which approximate market rates for deposits of similar maturities.
Secured borrowings: The fair value for these obligations uses an income approach based on expected cash flows on a pooled basis.
29
The following tables illustrate the financial instruments measured at fair value on a recurring basis segregated by hierarchy fair value levels as of the periods indicated:
| | Total carrying value | | | Quoted prices in active markets | | | Significant other observable inputs | | | Significant other unobservable inputs | |
(dollars in thousands) | | September 30, 2022 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
Available-for-sale securities: | | | | | | | | | | | | | | | | |
Agency - GSE | | $ | 32,336 | | | $ | - | | | $ | 32,336 | | | $ | - | |
Obligations of states and political subdivisions | | | 163,602 | | | | - | | | | 163,602 | | | | - | |
MBS - GSE residential | | | 217,475 | | | | - | | | | 217,475 | | | | - | |
Total available-for-sale debt securities | | $ | 413,413 | | | $ | - | | | $ | 413,413 | | | $ | - | |
| | Total carrying value | | | Quoted prices in active markets | | | Significant other observable inputs | | | Significant other unobservable inputs | |
(dollars in thousands) | | December 31, 2021 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
Available-for-sale securities: | | | | | | | | | | | | | | | | |
Agency - GSE | | $ | 117,003 | | | $ | - | | | $ | 117,003 | | | $ | - | |
Obligations of states and political subdivisions | | | 364,710 | | | | - | | | | 364,710 | | | | - | |
MBS - GSE residential | | | 257,267 | | | | - | | | | 257,267 | | | | - | |
Total available-for-sale debt securities | | $ | 738,980 | | | $ | - | | | $ | 738,980 | | | $ | - | |
Debt securities in the AFS portfolio are measured at fair value using market quotations provided by a third-party vendor, who is a provider of financial market data, analytics and related services to financial institutions. Assets classified as Level 2 use valuation techniques that are common to bond valuations. That is, in active markets whereby bonds of similar characteristics frequently trade, quotes for similar assets are obtained.
There were no changes in Level 3 financial instruments measured at fair value on a recurring basis as of and for the periods ending September 30, 2022 and December 31, 2021, respectively.
The following table illustrates the financial instruments newly measured at fair value on a non-recurring basis segregated by hierarchy fair value levels as of the periods indicated:
| | | | | | Quoted prices in | | | Significant other | | | Significant other | |
| | Total carrying value | | | active markets | | | observable inputs | | | unobservable inputs | |
(dollars in thousands) | | at September 30, 2022 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
| | | | | | | | | | | | | | | | |
Impaired loans | | $ | 1,653 | | | $ | - | | | $ | - | | | $ | 1,653 | |
Other real estate owned | | | 103 | | | | - | | | | - | | | | 103 | |
Total | | $ | 1,756 | | | $ | - | | | $ | - | | | $ | 1,756 | |
| | | | | | Quoted prices in | | | Significant other | | | Significant other | |
| | Total carrying value | | | active markets | | | observable inputs | | | unobservable inputs | |
(dollars in thousands) | | at December 31, 2021 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
| | | | | | | | | | | | | | | | |
Impaired loans | | $ | 2,245 | | | $ | - | | | $ | - | | | $ | 2,245 | |
Other real estate owned | | | 198 | | | | - | | | | - | | | | 198 | |
Total | | $ | 2,443 | | | $ | - | | | $ | - | | | $ | 2,443 | |
From time-to-time, the Company may be required to record at fair value financial instruments on a non-recurring basis, such as impaired loans, ORE and other repossessed assets. These non-recurring fair value adjustments involve the application of lower-of-cost-or-market accounting on write downs of individual assets. The fair value of impaired loans was calculated using the value of the impaired loans with an allowance less the related allowance.
The following describes valuation methodologies used for financial instruments measured at fair value on a non-recurring basis. Impaired loans that are collateral dependent are written down to fair value through the establishment of specific reserves, a component of the allowance for loan losses, and as such are carried at the lower of net recorded investment or the estimated fair value. Estimates of fair value of the collateral are determined based on a variety of information, including available valuations from certified appraisers for similar assets, present value of discounted cash flows and inputs that are estimated based on commonly used and generally accepted industry liquidation advance rates and estimates and assumptions developed by management.
Valuation techniques for impaired loans are typically determined through independent appraisals of the underlying collateral or may be determined through present value of discounted cash flows. Both techniques include various Level 3 inputs which are not identifiable. The valuation technique may be adjusted by management for estimated liquidation expenses and qualitative factors such as economic conditions. If real estate is not the primary source of repayment, present value of discounted cash flows and estimates using generally accepted industry liquidation advance rates and other factors may be utilized to determine fair value.
At September 30, 2022 and December 31, 2021, the range of liquidation expenses and other valuation adjustments applied to impaired loans ranged from -24.06% and -37.70% and from -33.08% to -47.66%, respectively. The weighted average of liquidation expenses and other valuation adjustments applied to impaired loans amounted to -32.53% as of September 30, 2022 and -44.50% as of December 31, 2021, respectively. Due to the multitude of assumptions, many of which are subjective in nature, and the varying inputs and techniques used to determine fair value, the Company recognizes that valuations could differ across a wide spectrum of techniques employed. Accordingly, fair value estimates for impaired loans are classified as Level 3.
For ORE, fair value is generally determined through independent appraisals of the underlying properties which generally include various Level 3 inputs which are not identifiable. Appraisals form the basis for determining the net realizable value from these properties. Net realizable value is the result of the appraised value less certain costs or discounts associated with liquidation which occurs in the normal course of business. Management’s assumptions may include consideration of the location and occupancy of the property, along with current economic conditions. Subsequently, as these properties are actively marketed, the estimated fair values may be periodically adjusted through incremental subsequent write-downs. These write-downs usually reflect decreases in estimated values resulting from sales price observations as well as changing economic and market conditions. At September 30, 2022 and December 31, 2021, the discounts applied to the appraised values of ORE ranged from -24.61% to -77.60% and from -20.16% to -77.60%, respectively. As of September 30, 2022 and December 31, 2021, the weighted average of discount to the appraisal values of ORE amounted to -26.10% and -28.21%, respectively.
At September 30, 2022 and December 31, 2021, there were no other repossessed assets. The Company refers to the National Automobile Dealers Association (NADA) guide to determine a vehicle’s fair value.
9. Acquisition
On July 1, 2021, the Company completed its previously announced acquisition of Landmark. Landmark was a one-bank holding company organized under the laws of the Commonwealth of Pennsylvania and was headquartered in Pittston, PA. Its wholly owned subsidiary, Landmark Community Bank, was an independent community bank chartered under the laws of the Commonwealth of Pennsylvania. Landmark Community Bank conducted full-service commercial banking services through five bank centers located in Lackawanna and Luzerne Counties, Pennsylvania. The acquisition expanded Fidelity Deposit and Discount Bank’s full-service footprint in Luzerne County, Pennsylvania. The Company transacted the acquisition to complement the Company’s existing operations, while consistent with the Company’s strategic plan of enhancing long-term shareholder value. The fair value of total assets acquired as a result of the merger totaled $375.5 million (net of cash consideration), loans totaled $298.9 million and deposits totaled $308.5 million. Goodwill recorded in the merger was $12.6 million.
In accordance with the terms of the Reorganization Agreement, on July 1, 2021 each share of Landmark common stock was converted into the right to receive 0.272 shares of the Company’s common stock and $3.26 in cash. As a result of the acquisition, the Company issued 647,990 shares of its common stock, valued at $35.1 million, and $7.8 million in cash based upon $54.10, the determined market price of the Company’s common stock in accordance with the Reorganization Agreement. The results of the combined entity’s operations are included in the Company’s Consolidated Financial Statements from the date of acquisition. The acquisition of Landmark was accounted for as a business combination using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration paid were recorded at estimated fair values on the acquisition date.
Effective July 1, 2021, in connection with the acquisition and pursuant to the terms of the Reorganization Agreement, Paul C. Woelkers was appointed as a Class C Director of Fidelity’s Board of Directors. Mr. Woelkers was also appointed as a Director of Fidelity Bank’s Board of Directors.
30
The following table summarizes the consideration paid for Landmark and the fair value of assets acquired, and liabilities assumed as of the acquisition date:
Purchase Price Consideration in Common Stock | | | | |
Landmark shares settled for stock | | | 2,382,695 | |
Exchange ratio | | | 0.272 | |
Total FDBC shares issued | | | 647,990 | |
Value assigned to FDBC common share (9/30/2021 closing price) | | $ | 54.10 | |
| | | | |
Purchase price assigned to Landmark common shares exchanged for FDBC common shares | | $ | 35,056,259 | |
| | | | |
Purchase Price Consideration - Cash for Common Stock | | | | |
Landmark shares exchanged for cash, excluding fractional shares | | | 2,382,695 | |
Cash consideration (per Landmark share) | | $ | 3.26 | |
Cash portion of purchase price | | $ | 7,767,586 | |
| | | | |
Cash portion of purchase price (cash paid fractional shares) | | $ | 5,559 | |
| | | | |
Cash for outstanding Landmark stock options | | $ | 69,250 | |
| | | | |
Total consideration paid | | $ | 42,898,654 | |
Allocation of Purchase Price | | In thousands | | | | | |
Total Purchase Price | | | | | | $ | 42,899 | |
| | | | | | | | |
Estimated Fair Value of Assets Acquired | | | | | | | | |
Cash and cash equivalents | | | 4,090 | | | | | |
Investment securities | | | 49,430 | | | | | |
Loans | | | 298,860 | | | | | |
Restricted investments in bank stock | | | 1,186 | | | | | |
Premises and equipment | | | 3,405 | | | | | |
Lease property under finance leases | | | 1,188 | | | | | |
Core deposit intangible asset | | | 597 | | | | | |
Other real estate owned | | | 488 | | | | | |
Other assets | | | 11,629 | | | | | |
Total assets acquired | | | 370,873 | | | | | |
| | | | | | | | |
Estimated Fair Value of Liabilities Assumed | | | | | | | | |
Non-interest bearing deposits | | | 100,472 | | | | | |
Interest bearing deposits | | | 208,057 | | | | | |
Short-term borrowings | | | 2,224 | | | | | |
FHLB borrowings | | | 4,602 | | | | | |
Secured borrowings | | | 20,619 | | | | | |
Finance lease obligation | | | 1,188 | | | | | |
Other liabilities | | | 3,387 | | | | | |
Total liabilities assumed | | | 340,549 | | | | | |
| | | | | | | | |
Net Assets Acquired | | | | | | | 30,324 | |
Goodwill Recorded in Acquisition | | | | | | $ | 12,575 | |
Pursuant to the accounting requirements, the Company assigned a fair value to the assets acquired and liabilities assumed of Landmark. ASC 820 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”
The assets acquired and liabilities assumed in the acquisition of Landmark were recorded at their estimated fair values based on management’s best estimates using information available at the date of the acquisition and are subject to adjustment for up to one year after the closing date of the acquisition. While the fair values are not expected to be materially different from the estimates, any material adjustments to the estimates will be reflected, retroactively, as of the date of the acquisition. The items most susceptible to adjustment are the fair value adjustments on loans, core deposit intangible and the deferred income tax assets resulting from the acquisition. Fair values of the major categories of assets acquired and liabilities assumed were determined as follows:
Investment securities available-for-sale
The estimated fair values of the investment securities available for sale, primarily comprised of U.S. Government agency mortgage-backed securities, U.S. government agencies and municipal bonds, were determined using Level 1 and Level 2 inputs in the fair value hierarchy. The fair values were determined using executable market bids or independent pricing services. The Company’s independent pricing service utilized matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific security but rather relying on the security’s relationship to other benchmark quoted prices. Management reviewed the data and assumptions used in pricing the securities.
Loans
Acquired loans (performing and non-performing) are initially recorded at their acquisition-date fair values using Level 3 inputs. Fair values are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, expected lifetime losses, environmental factors, collateral values, discount rates, expected payments and expected prepayments. Specifically, the Company has prepared three separate loan fair value adjustments that it believed a market participant might employ in estimating the entire fair value adjustment necessary under ASC 820-10 for the acquired loan portfolio. The three-separate fair valuation methodology employed are: 1) an interest rate loan fair value adjustment, 2) a general credit fair value adjustment, and 3) a specific credit fair value adjustment for purchased credit impaired loans subject to ASC 310-30 procedures. The acquired loans were recorded at fair value at the acquisition date without carryover of Landmark’s previously established allowance for loan losses. The fair value of the financial assets acquired included loans receivable with a gross amortized cost basis of $309.8 million.
The table below illustrates the fair value adjustments made to the amortized cost basis in order to present the fair value of the loans acquired. The credit adjustment on purchased credit impaired loans is derived in accordance with ASC 310-30 and represents the portion of the loan balances that has been deemed uncollectible based on the Company’s expectations of future cash flows for each respective loan.
Dollars in thousands | |
Gross amortized cost basis at September 30, 2021 | | $ | 309,767 | |
Interest rate fair value adjustment on pools of homogeneous loans | | | (1,855 | ) |
Credit fair value adjustment on pools of homogeneous loans | | | (7,915 | ) |
Credit fair value adjustment on purchased credit impaired loans | | | (1,137 | ) |
Fair value of acquired loans at September 30, 2021 | | $ | 298,860 | |
For loans acquired without evidence of credit quality deterioration, the Company prepared the interest rate loan fair value and credit fair value adjustments. Loans were grouped into homogeneous pools by characteristics such as loan type, term, collateral, and rate. Market rates for similar loans were obtained from various internal and external data sources and reviewed by management for reasonableness. The average of these rates was used as the fair value interest rate a market participant would utilize. A present value approach was utilized to calculate the interest rate fair value discount of $1.9 million. Additionally, for loans acquired without credit deterioration, a credit fair value adjustment was calculated using a two-part credit fair value analysis: 1) expected lifetime credit migration losses; and 2) estimated fair value adjustment for certain qualitative factors. The expected lifetime losses were calculated using historical losses observed by the Company, Landmark and peer banks. The Company also estimated an environmental factor to apply to each loan type. The environmental factor represents the potential discount which may arise due to general credit and economic factors. A credit fair value discount of $7.9 million was determined. Both the interest rate and credit fair value adjustments relate to loans acquired with evidence of credit quality deterioration will be substantially recognized as interest income on a level yield amortization method over the expected life of the loans.
The following table presents the acquired purchased credit impaired loans receivable at the acquisition date:
Dollars in thousands | |
Contractual principal and interest at acquisition | | $ | 5,306 | |
Non-accretable difference | | | (1,691 | ) |
Expected cash flows at acquisition | | | 3,615 | |
Accretable yield | | | (588 | ) |
Fair value of purchased impaired loans | | $ | 3,027 | |
32
Premises and Equipment
The Company assumed leases on 2 branch facilities of Landmark. The Company compared the lease contract obligations to comparable market rental rates determined by third-party licensed appraisers. The Company believed that the leased contract rates were in a reasonable range of market rental rates and concluded that no fair market value adjustment related to leasehold interest was necessary. The fair value of Landmark’s premises, including land, buildings and improvements, was determined based upon independent third-party appraisals performed by licensed appraisers or sales agreements.
Core Deposit Intangible
The fair value of the core deposit intangible was determined based on a discounted cash flow (present value) analysis using a discount rate commensurate with market participants. To calculate cash flows, deposit account servicing costs (net of deposit fee income) and interest expense on deposits were compared to the higher cost of alternative funding sources available through national brokered CD offering rates and FHLB advance rates. The projected cash flows were developed using projected deposit attrition rates based on the average rate experienced by both institutions. The core deposit intangible will be amortized over ten years using the sum-of-years digits method.
Time Deposits
The fair value adjustment for time deposits represents a discount from the value of the contractual repayments of fixed maturity deposits using prevailing market interest rates for similar-term time deposits. The time deposit premium is being amortized into income on a level yield amortization method over the contractual life of the deposits.
Secured Borrowings
The Company identified 19 sold participations acquired from Landmark that did not meet the criteria for sales treatment under ASC 860-10-40 and should be recorded as obligations from secured borrowing arrangements. The Company has estimated the fair value of these obligations using an income approach based on the expected cash flows method on a pooled basis using Level 3 assumptions.
FHLB Borrowings
The Company assumed FHLB borrowings in connection with the merger. The fair value of FHLB Borrowings was determined by using FHLB prepayment penalty as a proxy for the fair value adjustment. The Company decided to pay off the borrowing post acquisition date therefore no amortization is warranted.
Merger-related expenses
The Company did not incur any merger-related expenses for the three and nine months ended September 30, 2022. For the three and nine months ended September 30, 2021, the Company incurred $2.2 million and $3.1 million in merger-related expenses related to the merger with Landmark, primarily consisting of data processing, salaries and employee benefits, and professional fee expenses.
10. Employee Benefits
Bank-Owned Life Insurance (BOLI)
The Company has purchased single premium BOLI policies on certain officers. The policies are recorded at their cash surrender values. Increases in cash surrender values are included in non-interest income in the consolidated statements of income. As a result of the acquisition of Landmark, the Company added BOLI with a value of $7.2 million during 2021. The policies’ cash surrender value totaled $53.7 million and $52.7 million, respectively, as of September 30, 2022 and December 31, 2021 and is reflected as an asset on the consolidated balance sheets. For the nine months ended September 30, 2022 and 2021, the Company has recorded income of $965 thousand and $899 thousand, respectively.
Officer Life Insurance
In 2017, the Bank entered into separate split dollar life insurance arrangements (Split Dollar Agreements) with eleven officers. This plan provides each officer a specified death benefit should the officer die while in the Bank’s employ. The Bank paid the insurance premiums in March 2017 and the arrangements were effective in March 2017. In March 2019, the Bank entered into a new Split Dollar Agreement with one officer. In January 2021, the Bank entered into Split Dollar Agreements with fifteen officers. The Bank owns the policies and all cash values thereunder. Upon death of the covered employee, the agreed-upon amount of death proceeds from the policies will be paid directly to the insured’s beneficiary. As of September 30, 2022, the policies had total death benefits of $53.7 million of which $7.8 million would have been paid to the officer’s beneficiaries and the remaining $45.9 million would have been paid to the Bank. In addition, four executive officers have the opportunity to retain a split dollar benefit equal to two times their highest base salary after separation from service if the vesting requirements are met. As of September 30, 2022 and December 31, 2021, the Company had a balance in accrued expenses of $252 thousand and $200 thousand for the split dollar benefit.
Supplemental Executive Retirement plan (SERP)
On March 29, 2017, the Bank entered into separate supplemental executive retirement agreements (individually the “SERP Agreement”) with five officers, pursuant to which the Bank will credit an amount to a SERP account established on each participant’s behalf while they are actively employed by the Bank for each calendar month from March 1, 2017 until retirement. On March 20, 2019, the Bank entered into a SERP Agreement with one officer, pursuant to which the Bank will credit an amount to a SERP account established for the participant’s behalf while they are actively employed by the Bank for each calendar month from March 1, 2019 until normal retirement age. As a result of the acquisition of Landmark, the Company added $1.0 million in accrued SERP expenses to the consolidated balance sheets. As of September 30, 2022 and December 31, 2021, the Company had a balance in accrued expenses of $3.9 million and $3.6 million in connection with the SERP.
11. Revenue Recognition
The Company adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606) and all subsequent ASUs that modified Topic 606.
The majority of the Company’s revenues are generated through interest earned on securities and loans, which is explicitly excluded from the scope of the guidance. In addition, certain non-interest income streams such as fees associated with mortgage servicing rights, loan service charges, life insurance earnings, rental income and gains/losses on the sale of loans and securities are not in the scope of the new guidance. The main types of contracts with customers that are in the scope of the new guidance are:
| ● | Service charges on deposit accounts – Deposit service charges represent fees charged by the Company for the performance obligation of providing services to a customer’s deposit account. The transaction price for deposit services includes both fixed and variable amounts based on the Company’s fee schedules. Revenue is recognized and payment is received either at a point in time for transactional fees or on a monthly basis for non-transactional fees. |
| ● | Interchange fees – Interchange fees represent fees charged by the Company for customers using debit cards. The contract is between the Company and the processor and the performance obligation is the ability of customers to use debit cards to make purchases at a point in time. The transaction price is a percentage of debit card usage and the processor pays the Company and revenue is recorded throughout the month as the performance obligations are being met. |
| ● | Fees from trust fiduciary activities – Trust fees represent fees charged by the Company for the management, custody and/or administration of trusts. These are mostly monthly fees based on the market value of assets in the trust account at the prior month end. Payment is generally received a few weeks after month end through a direct charge to customers’ accounts. Estate fees are recognized and charged as the Company reaches each of six different stages of the estate administration process. |
| ● | Fees from financial services – Financial service fees represent fees charged by the Company for the performance obligation of providing various services for an investment account. Revenue is recognized twice monthly for fees on sales transactions and on a monthly basis for advisory fees and quarterly for trail fees. |
| ● | Gain/loss on ORE sales – Gain/loss on the sale of ORE is recognized at the closing date when the sales proceeds are received. In seller-financed ORE transactions, the contract is made subject to our normal underwriting standards and pricing. The Company does not have any obligation or right to repurchase any sales of ORE. |
Contract balances
A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before the payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity already received payment (or payment is due) from the customer. The Company’s non-interest income streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company typically does not enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of September 30, 2022 and December 31, 2021, the Company did not have any significant contract balances.
Remaining performance obligations
The Company’s performance obligations have an original expected duration of less than one year and follow the relevant guidance for recognizing revenue over time. There is no variable consideration subject to constraint that is not included in information about transaction price.
Contract acquisition costs
An entity is required to capitalize and subsequently amortize into expense, certain incremental costs of obtaining a contract if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less.
34
12. Leases
ASU 2016-02 Leases (Topic 842) became effective for the Company on January 1, 2019. For all operating lease contracts where the Company is lessee, a right-of-use (ROU) asset and lease liability were recorded as of the effective date. The Company assumed all renewal terms will be exercised when calculating the ROU assets and lease liabilities. For leases existing at the transition date, any prepaid or deferred rent was added to the ROU asset to calculate the lease liability. The discount rate used to calculate the present value of future payments at the transition date was the Company’s incremental borrowing rate. The Company used the FHLB fixed rate borrowing rates as the discount rates. For all classes of underlying assets, the Company has elected not to record short-term leases (leases with a term of 12 months or less) on the balance sheet when the Company is lessee. Instead, the Company will recognize the lease payment on a straight-line basis over the lease term and variable lease payments in the period in which the obligation for those payments is incurred. For all asset classes, the Company has elected, as a lessee, not to separate nonlease components from lease components and instead to account for each separate lease component and nonlease components associated with that lease component as a single lease component.
Management determines if an arrangement is or contains a lease at contract inception. If an arrangement is determined to be or contains a lease, the Company recognizes a ROU asset and a lease liability when the asset is placed in service.
The Company’s operating leases, where the Company is lessee, include property, land and equipment. As of September 30, 2022, ten of the Company’s branch properties, one administrative office and one future branch were leased under operating leases. In four of the branch leases, the Company leases the land from an unrelated third party, and the buildings are the Company’s own capital improvement. The Company also leases three standalone ATMs under operating leases. Additionally, the Company has one property lease and four equipment leases classified as finance leases. The Company acquired a leased property classified as a finance lease with a fair value of $1.2 million from the Landmark merger during 2021.
The following is an analysis of the leased property under finance leases:
(dollars in thousands) | | September 30, 2022 | | | December 31, 2021 | |
| | | | | | | | |
Property and equipment | | $ | 1,695 | | | $ | 1,673 | |
Less accumulated depreciation and amortization | | | (546 | ) | | | (366 | ) |
Leased property under finance leases, net | | $ | 1,149 | | | $ | 1,307 | |
The following is a schedule of future minimum lease payments under finance leases together with the present value of the net minimum lease payments as of September 30, 2022:
(dollars in thousands) | | Amount | |
| | | | |
2022 | | $ | 64 | |
2023 | | | 227 | |
2024 | | | 171 | |
2025 | | | 161 | |
2026 | | | 150 | |
2027 and thereafter | | | 462 | |
Total minimum lease payments (a) | | | 1,235 | |
Less amount representing interest (b) | | | (66 | ) |
Present value of net minimum lease payments | | $ | 1,169 | |
| (a) | The future minimum lease payments have not been reduced by estimated executory costs (such as taxes and maintenance) since this amount was deemed immaterial by management. |
| (b) | Amount necessary to reduce net minimum lease payments to present value calculated at the Company’s incremental borrowing rate upon lease inception. |
As of September 30, 2022, the Company leased its Green Ridge, Pittston, Peckville, Back Mountain, Mountain Top, Abington, Nazareth, Easton, Bethlehem and Wyoming branches under the terms of operating leases. During 2021, the Company entered into a new lease for the Bethlehem branch which will be relocated in 2022. During 2022, the Company also entered into a new lease of administrative office space in Scranton. Common area maintenance is included in variable lease payments in the table below. The Abington branch has variable lease payments which are calculated as a percentage of the national prime rate of interest and are expensed as incurred. The Bethlehem and Easton branches have variable lease payments that increase annually and are expensed as incurred.
(dollars in thousands) | | September 30, 2022 | | | September 30, 2021 | |
Lease cost | | | | | | | | |
Finance lease cost: | | | | | | | | |
Amortization of right-of-use assets | | $ | 180 | | | $ | 105 | |
Interest on lease liabilities | | | 16 | | | | 10 | |
Operating lease cost | | | 555 | | | | 452 | |
Short-term lease cost | | | 112 | | | | 30 | |
Variable lease cost | | | 23 | | | | 3 | |
Total lease cost | | $ | 886 | | | $ | 600 | |
| | | | | | | | |
Other information | | | | | | | | |
Cash paid for amounts included in the measurement of lease liabilities | | | | | | | | |
Operating cash flows from finance leases | | $ | 16 | | | $ | 10 | |
Operating cash flows from operating leases (Fixed payments) | | $ | 470 | | | $ | 413 | |
Operating cash flows from operating leases (Liability reduction) | | $ | 239 | | | $ | 224 | |
Financing cash flows from finance leases | | $ | 173 | | | $ | 103 | |
Right-of-use assets obtained in exchange for new finance lease liabilities | | $ | 119 | | | $ | 1,188 | |
Right-of-use assets obtained in exchange for new operating lease liabilities | | $ | 22 | | | $ | 1,644 | |
Weighted-average remaining lease term - finance leases (in years) | | | 6.66 | | | | 7.39 | |
Weighted average remaining lease term - operating leases (in years) | | | 20.68 | | | | 19.70 | |
Weighted-average discount rate - finance leases | | | 1.74 | % | | | 1.81 | % |
Weighted-average discount rate - operating leases | | | 3.39 | % | | | 3.41 | % |
During the first nine months of 2022, $862 thousand of the total lease cost was included in premises and equipment expense and $24 thousand was included in other expenses on the consolidated statements of income. During the first nine months of 2021, $547 thousand of the total lease cost was included in premises and equipment expense and $26 thousand was included in other expenses on the consolidated statements of income. Operating lease expense is recognized on a straight-line basis over the lease term. We recognized both the interest expense and amortization expense for finance leases in premises and equipment expense since the interest expense portion was immaterial.
The future minimum lease payments for the Company’s branch network and equipment under operating leases that have lease terms in excess of one year as of September 30, 2022 are as follows:
(dollars in thousands) | | Amount | |
| | | | |
2022 | | $ | 176 | |
2023 | | | 698 | |
2024 | | | 655 | |
2025 | | | 636 | |
2026 | | | 643 | |
2027 and thereafter | | | 10,713 | |
Total future minimum lease payments | | | 13,521 | |
Plus variable payment adjustment | | | 1 | |
Less amount representing interest | | | (4,016 | ) |
Present value of net future minimum lease payments | | $ | 9,506 | |
36
The Company leases several properties, where the Company is lessor, under operating leases to unrelated parties. The undiscounted cash flows to be received on an annual basis for the remaining two properties under long-term operating leases are as follows:
(dollars in thousands) | | Amount | |
| | | | |
2022 | | $ | 12 | |
2023 | | | 48 | |
2024 | | | 51 | |
2025 | | | 54 | |
2026 | | | 54 | |
2027 and thereafter | | | 27 | |
Total lease payments to be received | | $ | 246 | |
The Company also indirectly originates automobile leases classified as direct finance leases. See Footnote 5, “Loans and leases”, for more information about the Company’s direct finance leases.
Lease income recognized from direct finance leases was included in interest income from loans and leases on the consolidated statements of income. Lease income related to operating leases is included in fees and other revenue on the consolidated statements of income. The Company only receives a variable payment for taxes from one of its lessees, but the amount is immaterial and excluded from rental income. The amount of lease income recognized on the consolidated statements of income was as follows for the periods indicated:
| | For the three months ended September 30, | | | For the nine months ended September 30, | |
(dollars in thousands) | | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Lease income - direct finance leases | | | | | | | | | | | | | | | | |
Interest income on lease receivables | | $ | 285 | | | $ | 201 | | | $ | 776 | | | $ | 596 | |
| | | | | | | | | | | | | | | | |
Lease income - operating leases | | | 55 | | | | 60 | | | | 175 | | | | 188 | |
Total lease income | | $ | 340 | | | $ | 261 | | | $ | 951 | | | $ | 784 | |
13. Derivative Instruments
The Company is a party to interest rate derivatives that are not designated as hedging instruments. The Company enters into interest rate swaps that allow certain commercial loan customers to effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. These interest rate swaps with customers are simultaneously offset by interest rate swaps that the Company executes with a third-party financial institution, such that the Company minimizes its net interest rate risk exposure resulting from such transactions. The interest rate swap agreements are free-standing derivatives and are recorded at fair value in the Company’s consolidated balance sheets (asset positions are included in other assets and liability positions are included in other liabilities). As the interest rate swaps are structured to offset each other, changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in an impact to earnings; however there may be fair value adjustments related to credit-quality variations between counterparties, which may impact earnings as required by FASB ASC 820. There was no effect on earnings in any periods presented. The Company had $1 million in investment securities pledged as collateral on its interest rate swaps with a third-party financial institution as of September 30, 2022. There were no interest rate swaps as of December 31, 2021.
| | | | | | Weighted | | | | | | | | | |
| | Notional | | | Average Maturity | | | Interest Rate | | Interest Rate | | | | |
(dollars in thousands) | | Amount | | | (Years) | | | Paid | | Received | | Fair Value | |
September 30, 2022 | | | | | | | | | | | | | | | | |
Classified in Other assets: | | | | | | | | | | | | | | | | |
Customer interest rate swaps | | $ | 2,000 | | | | 15.16 | | | 30 Day SOFR + Margin | | Fixed | | $ | 213 | |
Classified in Accrued interest payable and other liabilities: | | | | | | | | | | | | | | | | |
Third party interest rate swaps | | $ | 2,000 | | | | 15.16 | | | Fixed | | 30 Day SOFR + Margin | | $ | 213 | |