FIDELITY D & D BANCORP, INC. The following is management's discussion and analysis of the significant changes in the consolidated financial condition of the Company as ofMarch 31, 2022 compared toDecember 31, 2021 and a comparison of the results of operations for the three months endedMarch 31, 2022 and 2021. Current performance may not be indicative of future results. This discussion should be read in conjunction with the Company's 2021 Annual Report filed on Form 10-K.
Forward-looking statements
Certain of the matters discussed in this Quarterly Report on Form 10-Q may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. The words "expect," "anticipate," "intend," "plan," "believe," "estimate," and similar expressions are intended to identify such forward-looking statements.
The Company's actual results may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation:
?the short-term and long-term effects of inflation, and rising costs to the Company, its customers and on the economy;
?the effects of economic conditions particularly with regard to the negative impact of severe, wide-ranging and continuing disruptions caused by the spread of Coronavirus Disease 2019 (COVID-19) and any other pandemic, epidemic or other health-related crisis and responses thereto on current customers and the operations of the Company, specifically the effect of the economy on loan customers' ability to repay loans;
?the costs and effects of litigation and of unexpected or adverse outcomes in such litigation;
?the impact of new or changes in existing laws and regulations, including laws and regulations concerning taxes, banking, securities and insurance and their application with which the Company and its subsidiaries must comply;
?impacts of the capital and liquidity requirements of the Basel III standards and other regulatory pronouncements, regulations and rules;
?governmental monetary and fiscal policies, as well as legislative and regulatory changes;
?effects of short- and long-term federal budget and tax negotiations and their effect on economic and business conditions;
?the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as theFinancial Accounting Standards Board and other accounting standard setters;
?the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities and interest rate protection agreements, as well as interest rate risks;
?the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in our market area and elsewhere, including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the internet;
?technological changes;
?the interruption or breach in security of our information systems, continually evolving cybersecurity and other technological risks and attacks resulting in failures or disruptions in customer account management, general ledger processing and loan or deposit updates and potential impacts resulting therefrom including additional costs, reputational damage, regulatory penalties, and financial losses;
?acquisitions and integration of acquired businesses;
?the failure of assumptions underlying the establishment of reserves for loan losses and estimations of values of collateral and various financial assets and liabilities;
?inflation, securities markets and monetary fluctuations and volatility;
?acts of war or terrorism;
?disruption of credit and equity markets; and
?the risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.
The Company cautions readers not to place undue reliance on forward-looking statements, which reflect analyses only as of the date of this document. The Company has no obligation to update any forward-looking statements to reflect events or circumstances after the date of this document. Readers should review the risk factors described in other documents that we file or furnish, from time to time, with theSecurities and Exchange Commission , including Annual Reports to Shareholders, Annual Reports filed on Form 10-K and other current reports filed or furnished on Form 8-K. ? 38
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Executive Summary
The Company is a
As a leadingNortheastern Pennsylvania community bank, our goals are to enhance shareholder value while continuing to build a full-service community bank. We focus on growing our core business of retail and business lending and deposit gathering while maintaining strong asset quality and controlling operating expenses. We continue to implement strategies to diversify earning assets (see "Funds Deployed" section of this management's discussion and analysis) and to increase the amount of low-cost core deposits (see "Funds Provided" section of this management's discussion and analysis). These strategies include a greater level of commercial lending and the ancillary business products and services supporting our commercial customers' needs as well as residential lending strategies and an array of consumer products. We focus on developing a full banking relationship with existing, as well as new business prospects. The Bank has a personal and corporate trust department and also provides alternative financial and insurance products with asset management services. In addition, we explore opportunities to selectively expand and optimize our franchise footprint, consisting presently of our 22-branch network. We are impacted by both national and regional economic factors, with commercial, commercial real estate and residential mortgage loans concentrated inNortheastern Pennsylvania , primarily inLackawanna andLuzerne counties, andEastern Pennsylvania , primarilyNorthampton County . TheFederal Open Market Committee (FOMC) increased interest rates by 25 basis points inMarch 2022 in the first "tightening" move sinceDecember 2018 . According to theU.S. Bureau of Labor Statistics , the national unemployment rate forMarch 2022 was 3.6%, down 0.3 percentage points fromDecember 2021 . However, the unemployment rates in theScranton -Wilkes-Barre -Hazleton (market area north) and theAllentown -Bethlehem -Easton (market area south) Metropolitan Statistical Areas (local) increased and have remained at higher levels than the national unemployment rate. The local unemployment rates atMarch 31, 2022 were 5.7% in market area north and 4.5% in market area south, respectively, an increase of 0.4 percentage points and 0.2 percentage points from the 5.3% and 4.3%, respectively, atDecember 31, 2021 . The local unemployment rates have fluctuated as a result of the effects of the pandemic. The pandemic-related business restrictions have been lifted in our local area and employees started heading back to work. Stimulus payments and enhanced unemployment benefits have supported the economy throughout 2020 and 2021 and it is uncertain if the government could continue to provide this support in the future. The median home values in theScranton -Wilkes-Barre -Hazleton metro andAllentown -Bethlehem -Easton metro increased 21.2% and 17.7%, respectively, from a year ago, according to Zillow, an online database advertising firm providing access to its real estate search engines to various media outlets. In light of these expectations, we are uncertain if real estate values could continue to increase at these levels with the pending rising rate environment, however we will continue to monitor the economic climate in our region and scrutinize growth prospects with credit quality as a principal consideration.
On
OnMay 1, 2020 , the Company completed its previously announced acquisition ofMNB Corporation ("MNB") and its wholly-owned bank subsidiary. The merger expanded the Company's full-service footprint intoNorthampton County, PA and theLehigh Valley . Non-recurring costs to facilitate the merger and integrate systems of$2.5 million were incurred during 2020. For the three months endedMarch 31, 2022 , net income was$7.5 million , or$1.32 diluted earnings per share, compared to$5.7 million , or$1.13 diluted earnings per share, for the three months endedMarch 31, 2021 . Non-recurring merger-related costs andFederal Home Loan Bank (FHLB) prepayment penalties incurred are not a part of the Company's normal operations. If these expenses had not occurred, adjusted net income (non-GAAP) for the three months endedMarch 31, 2022 and 2021 would have been$7.5 million and$6.5 million , respectively. Adjusted diluted EPS (non-GAAP) would have been$1.32 and$1.29 for the three months endedMarch 31, 2022 and 2021, respectively. As ofMarch 31, 2022 and 2021, tangible common book value per share (non-GAAP) was$27.17 and$31.00 , respectively. The decrease in tangible book value was due to the decline in tangible common equity resulting from the net unrealized losses on available-for-sale securities. These non-GAAP measures should be reviewed in connection with the reconciliation of these non-GAAP ratios. See "Non-GAAP Financial Measures" located below within this management's discussion and analysis. Branch managers, relationship bankers, mortgage originators and our business service partners are all focused on developing a mutually profitable full banking relationship. We understand our markets, offer products and services along with financial advice that is appropriate for our community, clients and prospects. The Company continues to focus on the trusted financial advisor model by utilizing the team approach of experienced bankers that are fully engaged and dedicated towards maintaining and growing profitable relationships. In addition to the challenging economic environment in which we compete, the regulation and oversight of our business has changed significantly in recent years. As described more fully in Part II, Item 1A, "Risk Factors" below, as well as Part I, Item 1A, "Risk Factors," and in the "Supervisory and Regulation" section of management's discussion and analysis of financial condition and results 39
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of operations in our 2021 Annual Report filed on Form 10-K, certain aspects of the Dodd-Frank Wall Street Reform Act (Dodd-Frank Act) continue to have a significant impact on us.
Non-GAAP Financial Measures
The following are non-GAAP financial measures which provide useful insight to the reader of the consolidated financial statements but should be supplemental to GAAP used to prepare the Company's financial statements and should not be read in isolation or relied upon as a substitute for GAAP measures. In addition, the Company's non-GAAP measures may not be comparable to non-GAAP measures of other companies. The Company's tax rate used to calculate the fully-taxable equivalent (FTE) adjustment was 21% atMarch 31, 2022 and 2021. The following table reconciles the non-GAAP financial measures of FTE net interest income: (dollars in thousands) March 31, 2022 March 31, 2021 Interest income (GAAP)$ 18,178 $ 14,340 Adjustment to FTE 668 416 Interest income adjusted to FTE (non-GAAP) 18,846
14,756
Interest expense (GAAP) 887
890
Net interest income adjusted to FTE (non-GAAP)
The efficiency ratio is non-interest expenses as a percentage of FTE net interest income plus non-interest income. The following table reconciles the non-GAAP financial measures of the efficiency ratio to GAAP:
(dollars in thousands) March 31, 2022 March 31, 2021 Efficiency Ratio (non-GAAP) Non-interest expenses (GAAP) $ 12,654 $ 11,456 Net interest income (GAAP) 17,291 13,450 Plus: taxable equivalent adjustment 668
416
Non-interest income (GAAP) 4,554
5,516
Net interest income (FTE) plus non-interest income (non-GAAP) $ 22,514 $
19,382
Efficiency ratio (non-GAAP) 56.21%
59.11%
The following table provides a reconciliation of the tangible common equity (non-GAAP) and the calculation of tangible book value per share:
(dollars in thousands) March 31, 2022 March 31,
2021
Tangible Book Value per Share (non-GAAP) Total assets (GAAP)$ 2,420,774 $
1,913,092
Less: Intangible assets, primarily goodwill (21,462) (8,697) Tangible assets
2,399,312 1,904,395
Total shareholders' equity (GAAP) 175,243 163,582
Less: Intangible assets, primarily goodwill (21,462) (8,697) Tangible common equity
$ 153,781 $
154,885
Common shares outstanding, end of period 5,659,068 4,995,547 Tangible Common Book Value per Share $ 27.17 $ 31.00
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The following table provides a reconciliation of the Company's earnings results
under GAAP to comparative non-GAAP results excluding merger-related expenses:
March 31, 2022 March 31, 2021
Income Income
(dollars in before Diluted before Diluted
thousands except ?income Provision for earnings ?income Provision for earnings
per share data) taxes ?income taxes Net income ?per share
taxes ?income taxes Net income ?per share
Results of
operations (GAAP)
$ 6,710 $ 1,043 $ 5,667 $ 1.13 Add: Merger-related expenses - - - - 523 8 515 0.10 Add: FHLB prepayment penalty - - - - 369 78 291 0.06 Adjusted earnings
(non-GAAP)$ 8,666 $ 1,144 $ 7,522 $ 1.32 $ 7,602 $ 1,129 $ 6,473 $ 1.29 General The Company's earnings depend primarily on net interest income. Net interest income is the difference between interest income and interest expense. Interest income is generated from yields earned on interest-earning assets, which consist principally of loans and investment securities. Interest expense is incurred from rates paid on interest-bearing liabilities, which consist of deposits and borrowings. Net interest income is determined by the Company's interest rate spread (the difference between the yields earned on its interest-earning assets and the rates paid on its interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. Interest rate spread is significantly impacted by: changes in interest rates and market yield curves and their related impact on cash flows; the composition and characteristics of interest-earning assets and interest-bearing liabilities; differences in the maturity and re-pricing characteristics of assets compared to the maturity and re-pricing characteristics of the liabilities that fund them and by the competition in the marketplace. The Company's earnings are also affected by the level of its non-interest income and expenses and by the provisions for loan losses and income taxes. Non-interest income mainly consists of: service charges on the Company's loan and deposit products; interchange fees; trust and asset management service fees; increases in the cash surrender value of the bank owned life insurance and from net gains or losses from sales of loans and securities. Non-interest expense consists of: compensation and related employee benefit costs; occupancy; equipment; data processing; advertising and marketing;FDIC insurance premiums; professional fees; loan collection; net other real estate owned (ORE) expenses; supplies and other operating overhead. Net interest income, net interest rate margin, net interest rate spread and the efficiency ratio are presented in the MD&A on a fully-taxable equivalent (FTE) basis. The Company believes this presentation to be the preferred industry measurement of net interest income as it provides a relevant comparison between taxable and non-taxable amounts. Comparison of the results of operations Three months ended March 31, 2022 and 2021 Overview For the first quarter of 2022, the Company generated net income of$7.5 million , or$1.32 per diluted share, compared to$5.7 million , or$1.13 per diluted share, for the first quarter of 2021. The$1.8 million increase in net income was primarily the result of$3.8 million higher net interest income and$0.3 million lower provision for loan losses. These increases were partially offset by$1.2 million more non-interest expenses and$1.0 million less in non-interest income. Non-interest expenses increased quarter over-quarter due to the increased bank scale following the Landmark merger. Return on average assets (ROA) was 1.26% and 1.29% for the first quarters of 2022 and 2021. During the same time periods, return on average shareholders' equity (ROE) was 15.01% and 13.75%, respectively. ROA decreased due to the pace of the increase in average assets which grew more rapidly than net income. ROE increased due to the growth in net income relative to the increase in average equity.
Net interest income and interest sensitive assets / liabilities
For the first quarter of 2022, net interest income increased$3.8 million , or 29%, to$17.3 million from$13.5 million for the first quarter of 2021 due to increased interest income. The$3.8 million growth in interest income was produced by the addition of$630.5 million in average interest-earning assets partially offset by the effect of a 27 basis point decline in FTE yield earned on those assets. The loan portfolio contributed the most by providing$2.3 million more in interest income, which absorbed$1.0 million lower fees earned under the Paycheck Protection Program (PPP), due to$305.3 million more in average loans. Interest income on loans also included$0.4 million in additional fair value purchase accounting accretion. In the investment portfolio, an increase in the average balances of each type of securities was the biggest driver of interest income growth. The average balance of total securities grew$344.0 million producing$1.8 million in additional FTE interest income. On the liability side, total interest-bearing liabilities grew$447.4 million , on average, with a nine basis point decrease in rates paid thereon. A nine basis 41
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point decrease in rates paid on deposits offset the effect of$440.3 million higher average interest-bearing deposits keeping interest expense from deposits flat for the first quarter of 2022 compared to the 2021 like period. The FTE net interest rate spread and margin decreased by 18 and 21 basis points, respectively, for the three months endedMarch 31, 2022 compared to the same 2021 period. The spread and margin decreased due to the reduction in yields earned on interest-earning assets which outpaced the lower rates paid on interest-bearing liabilities. The overall 16 basis point cost of funds, which includes the impact of non-interest bearing deposits, decreased seven basis points for the three months endedMarch 31, 2022 compared to the same 2021 period. The primary reason for the decline was the reduction in rates paid on deposits coupled with the increased average balances of non-interest bearing deposits compared to the same 2021 period. For the remainder of 2022, the Company expects to operate in a rising interest rate environment. A rate environment with rising interest rates positions the Company to improve its interest income performance from new and repricing earning assets. For the remainder of 2022, the Company anticipates net interest income to improve as growth in interest-earning assets would help mitigate an adverse impact of rate movements on the cost of funds. TheFOMC began increasing the federal funds rate during the first quarter of 2022, the first move since they cut rates during the first quarter of 2020, which did not have a significant effect on rates paid on interest-bearing liabilities. On the asset side, the prime interest rate, the benchmark rate that banks use as a base rate for adjustable rate loans was also increased 25 basis points during the first quarter of 2022. At theMay 2022 meeting, theFOMC increased the federal funds rate another 50 basis points. Consensus economic forecasts are predicting increases in short-term rates throughout the rest of 2022. The 2022 focus is to manage net interest income and control deposit costs through a rising forecasted short-term rate cycle for primarily overnight to 12 month rates. Interest income is projected to increase more than interest expense in 2022. Continued growth in the loan portfolios complemented with the achieved investment security growth is expected to boost interest income, and when coupled with a proactive relationship approach to deposit cost setting strategies should help stop spread compression and contain the interest rate margin, preventing further reductions below acceptable levels. The Company's cost of interest-bearing liabilities was 0.22% for the three months endedMarch 31, 2022 , or nine basis points lower than the cost for the same 2021 period. The decrease in interest paid on deposits contributed to the lower cost of interest-bearing liabilities. Management currently expects theFOMC is expected to continue to raise the federal funds rate in the immediate future, so the Company may experience pressure to increase rates paid on deposits. To help mitigate the impact of the imminent change to the economic landscape, the Company has successfully developed and will continue to strengthen its association with existing customers, develop new business relationships, generate new loan volumes, and retain and generate higher levels of average non-interest bearing deposit balances. Strategically deploying no- and low-cost deposits into interest earning-assets is an effective margin-preserving strategy that the Company expects to continue to pursue and expand to help stabilize net interest margin. The Company's Asset Liability Management (ALM) team meets regularly to discuss among other things, interest rate risk and when deemed necessary adjusts interest rates. ALM is actively addressing the Company's sensitivity to a changing rate environment to ensure interest rate risks are contained within acceptable levels. ALM also discusses revenue enhancing strategies to help combat the potential for a decline in net interest income. The Company's marketing department, together with ALM, lenders and deposit gatherers, continue to develop prudent strategies that will grow the loan portfolio and accumulate low-cost deposits to improve net interest income performance. The table that follows sets forth a comparison of average balances of assets and liabilities and their related net tax equivalent yields and rates for the periods indicated. Within the table, interest income was FTE adjusted, using the corporate federal tax rate of 21% forMarch 31, 2022 and 2021 to recognize the income from tax-exempt interest-earning assets as if the interest was taxable. See "Non-GAAP Financial Measures" within this management's discussion and analysis for the FTE adjustments. This treatment allows a uniform comparison among yields on interest-earning assets. Loans include loans held-for-sale (HFS) and non-accrual loans but exclude the allowance for loan losses. Home equity lines of credit (HELOC) are included in the residential real estate category since they are secured by real estate. Net deferred loan fee accretion of$0.4 million and$1.4 million during the first quarters of 2022 and 2021, respectively, are included in interest income from loans. MNB and Landmark loan fair value purchase accounting adjustments of$855 thousand and$455 thousand are included in interest income from loans and$8 thousand and$30 thousand reduced interest expense on deposits for the three months endedMarch 31, 2022 and 2021. Average balances are based on amortized cost and do not reflect net unrealized gains or losses. Residual values for direct finance leases are included in the average balances for consumer loans. Net interest margin is calculated by dividing net interest income-FTE by total average interest-earning assets. Cost of funds includes the effect of average non-interest bearing deposits as a funding source: ? 42
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Three months ended
(dollars in thousands) March 31, 2022 March 31, 2021
Average Yield / Average Yield /
Assets balance Interest rate balance Interest rate
Interest-earning assets
Interest-bearing deposits $ 66,832 $ 33 0.20 % $ 85,985 $ 21 0.10 %
Restricted investments in
bank stock 3,228 31 3.90 2,892 33 4.56
Investments:
Agency - GSE 120,658 420 1.41 53,068 181 1.38
MBS - GSE residential 268,479 1,088 1.64 146,487 519 1.44
State and municipal
(nontaxable) 268,239 1,943 2.94 157,508 1,186 3.05
State and municipal
(taxable) 93,121 449 1.96 49,414 224 1.84
Total investments 750,497 3,900 2.11 406,477 2,110 2.11
Loans and leases:
C&I and CRE (taxable) 761,353 8,785 4.68 645,596 7,805 4.90
C&I and CRE (nontaxable) 67,187 515 3.11 42,294 404 3.87
Consumer 198,012 1,873 3.84 162,325 1,574 3.93
Residential real estate 440,810 3,709 3.41 311,897 2,809 3.65
Total loans and leases 1,467,362 14,882 4.11 1,162,112 12,592 4.39
Total interest-earning
assets 2,287,919 18,846 3.34 % 1,657,466 14,756 3.61 %
Non-interest earning assets 131,502 121,813
Total assets $ 2,419,421 $ 1,779,279
Liabilities and
shareholders' equity
Interest-bearing
liabilities
Deposits:
Interest-bearing checking $ 727,707 $ 449 0.25 % $ 484,245 $ 376 0.31 %
Savings and clubs 243,300 27 0.04 186,473 32 0.07
MMDA 487,200 228 0.19 361,446 266 0.30
Certificates of deposit 133,966 118 0.36 119,691 190 0.64
Total interest-bearing
deposits 1,592,173 822 0.21 1,151,855 864 0.30
Secured borrowings 10,584 65 2.49 - - -
Short-term borrowings - - - 144 - 0.51
FHLB advances - - - 3,389 26 3.12
Total interest-bearing
liabilities 1,602,757 887 0.22 % 1,155,388 890 0.31 %
Non-interest bearing
deposits 586,363 437,740
Non-interest bearing
liabilities 27,008 18,944
Total liabilities 2,216,128 1,612,072
Shareholders' equity 203,293 167,207
Total liabilities and
shareholders' equity $ 2,419,421 $ 1,779,279
Net interest income - FTE $ 17,959 $ 13,866
Net interest spread 3.12 % 3.30 %
Net interest margin 3.18 % 3.39 %
Cost of funds 0.16 % 0.23 %
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Changes in net interest income are a function of both changes in interest rates
and changes in volume of interest-earning assets and interest-bearing
liabilities. The following table presents the extent to which changes in
interest rates and changes in volumes of interest-earning assets and
interest-bearing liabilities have affected the Company's interest income and
interest expense during the periods indicated. Information is provided in each
category with respect to (1) the changes attributable to changes in volume
(changes in volume multiplied by the prior period rate), (2) the changes
attributable to changes in interest rates (changes in rates multiplied by prior
period volume) and (3) the net change. The combined effect of changes in both
volume and rate has been allocated proportionately to the change due to volume
and the change due to rate. Tax-exempt income was not converted to a
tax-equivalent basis on the rate/volume analysis:
Three months ended March 31,
(dollars in thousands) 2022 compared to 2021 2021 compared to 2020
Increase (decrease) due to
Volume Rate Total Volume Rate Total
Interest income:
Interest-bearing deposits $ (6) $ 18 $ 12 $ 28 $ (19) $ 9
Restricted investments in bank stock 3 (5) (2) (9) (23) (32)
Investments:
Agency - GSE 235 4 239 169 (28) 141
MBS - GSE residential 486 83 569 116 (403) (287)
State and municipal 783 (31) 752 853 (203) 650
Other - - - - - -
Total investments 1,504 56 1,560 1,138 (634) 504
Loans and leases:
Residential real estate 1,095 (195) 900 697 (355) 342
C&I and CRE 1,584 (515) 1,069 3,877 (34) 3,843
Consumer 339 (40) 299 (16) (21) (37)
Total loans and leases 3,018 (750) 2,268 4,558 (410) 4,148
Total interest income 4,519 (681) 3,839 5,715 (1,086) 4,629
Interest expense:
Deposits:
Interest-bearing checking 161 (88) 73 237 (233) 4
Savings and clubs 8 (14) (6) 16 (10) 6
Money market 76 (114) (38) 290 (619) (329)
Certificates of deposit 21 (92) (71) 7 (340) (333)
Total deposits 266 (308) (42) 550 (1,202) (652)
Secured borrowings 65 - 65 - - -
Overnight borrowings - - - (43) (32) (75)
FHLB advances (26) - (26) (90) 2 (88)
Total interest expense 305 (308) (3) 417 (1,232) (815)
Net interest income $ 4,214 $ (373) $ 3,841 $ 5,298 $ 146 $ 5,444
Provision for loan losses
The provision for loan losses represents the necessary amount to charge against
current earnings, the purpose of which is to increase the allowance for loan
losses (the allowance) to a level that represents management's best estimate of
known and inherent losses in the Company's loan portfolio. Loans determined to
be uncollectible are charged off against the allowance. The required amount of
the provision for loan losses, based upon the adequate level of the allowance,
is subject to the ongoing analysis of the loan portfolio. The Company's Special
Assets Committee meets periodically to review problem loans. The committee is
comprised of management, including credit administration officers, loan
officers, loan workout officers and collection personnel. The committee reports
quarterly to the Credit Administration Committee of the board of directors.
Management continuously reviews the risks inherent in the loan portfolio. Specific factors used to evaluate the adequacy of the loan loss provision during the formal process include:
•specific loans that could have loss potential;
•levels of and trends in delinquencies and non-accrual loans;
•levels of and trends in charge-offs and recoveries;
•trends in volume and terms of loans;
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•changes in risk selection and underwriting standards;
•changes in lending policies and legal and regulatory requirements;
•experience, ability and depth of lending management;
•national and local economic trends and conditions; and
•changes in credit concentrations.
For the three months endedMarch 31, 2022 and 2021, the Company recorded a provision for loan losses of$0.5 million and$0.8 million , respectively, a$0.3 million decrease. The decrease in the provision compared to the quarter endedMarch 31, 2021 was due to a$0.4 million specific reserve incurred during the prior year's first quarter that was not required in the current quarter. This amount of provisioning reflected what management deemed necessary, given experienced loan growth, to maintain the allowance for loan and lease losses at an adequate level.
The provision for loan losses derives from the reserve required from the
allowance for loan losses calculation. The Company continued provisioning for
the three months ended
For a discussion on the allowance for loan losses, see "Allowance for loan losses," located in the comparison of financial condition section of management's discussion and analysis contained herein.
Other income
For the first quarter of 2022, non-interest income amounted to$4.5 million , a decrease of$1.0 million , or 17%, compared to$5.5 million recorded for the same 2021 period. The decrease was due to$1.6 million lower gains on loan sales from less mortgage activity during the first quarter of 2022 compared to the first quarter of 2021. Partially offsetting this decrease was$0.2 million higher interchange fees from increased debit card usage, increases in deposit service charges of$0.2 million and higher wealth management fees (fees from trust fiduciary activities and financial services) of$0.2 million .
Operating expenses
For the quarter endedMarch 31, 2022 , total non-interest expenses were$12.7 million , an increase of$1.2 million , or 10%, compared to$11.5 million for the same 2021 quarter. Salary and employee benefits rose$1.5 million , or 28%, to$6.7 million for the first quarter of 2022 from$5.2 million for the first quarter of 2021. The increase was primarily due to less deferred loan origination costs reducing salaries and employee benefit expenses from a lower volume of originations from mortgages and PPP loans. Additionally, salaries and benefits were higher from 17 more full-time equivalent employees. Premises and equipment expenses increased$0.3 million , or 17%, primarily due to property and equipment acquired from the merger with Landmark. Data processing and communications expenses increased$0.1 million due to additional systems and equipment added from the merger with Landmark. TheFDIC assessment increased$0.1 million due to the larger average assets. Partially offsetting these increases, professional fees decreased$0.2 million due to lower legal expenses during the first quarter of 2022 and the write-off of$0.1 million of construction in process during the first quarter of 2021. Advertising and marketing expenses decreased$0.1 million due to a$0.1 million donation toFidelity D & D Charitable Foundation during the first quarter of 2021. Non-interest expenses would have increased$0.9 million more if the Company had not incurred$0.5 million in merger-related expenses and a$0.4 million FHLB prepayment penalty during the first quarter of 2021. The ratios of non-interest expense less non-interest income to average assets, known as the expense ratio, were 1.36% and 1.35% for the three months endedMarch 31, 2022 and 2021. The expense ratio increased because of increased non-interest expenses and decreased non-interest income. The efficiency ratio (non-GAAP) decreased from 59.11% atMarch 31, 2021 to 56.21% atMarch 31, 2022 due to revenue increasing faster than expenses. For more information on the calculation of the efficiency ratio, see "Non-GAAP Financial Measures" located within this management's discussion and analysis.
Provision for income taxes
The provision for income taxes increased$0.1 million for the three months endedMarch 31, 2022 compared to the same 2021 period due to higher pre-tax income. The Company's effective tax rate was 13.2% atMarch 31, 2022 compared to 15.5% atMarch 31, 2021 . The difference between the effective rate and the enacted statutory corporate rate of 21% is due mostly to the effect of tax-exempt income in relation to the level of pre-tax income. The decrease in the effective tax rate was primarily due to higher tax-exempt interest income. Due to challenges relating to current market conditions, the Company may not have the ability to make a reliable estimate of all or part of its ordinary income which could cause volatility in the effective tax rate. If the federal corporate tax rate is increased, the Company's net deferred tax liabilities will be re-valued upon adoption of the new tax rate. A federal tax rate increase will decrease net deferred tax assets with a corresponding decrease to provision for income taxes. Comparison of financial condition atMarch 31, 2022 andDecember 31, 2021 Overview Consolidated assets increased$1.7 million to$2.4 billion as ofMarch 31, 2022 relatively unchanged fromDecember 31, 2021 . The increase in assets occurred primarily in the loan portfolio which was offset by net unrealized losses in the investment portfolio and the 45
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related deferred tax asset. Loan portfolio increases were funded by growth in deposits. As explained in greater detail below, growth in deposits occurred because of business and seasonal tax activity, government relief due to the pandemic and increases in personal account balances.
Funds Deployed:
Investment securities
At the time of purchase, management classifies investment securities into one of three categories: trading, available-for-sale (AFS) or held-to-maturity (HTM). To date, management has not purchased any securities for trading purposes. Some of the securities the Company purchases are classified as AFS even though there is no immediate intent to sell them. The AFS designation affords management the flexibility to sell securities and position the balance sheet in response to capital levels, liquidity needs or changes in market conditions. Debt securities AFS are carried at fair value on the consolidated balance sheets with unrealized gains and losses, net of deferred income taxes, reported separately within shareholders' equity as a component of accumulated other comprehensive income (AOCI). Securities designated as HTM are carried at amortized cost and represent debt securities that the Company has the ability and intent to hold until maturity. EffectiveApril 1, 2022 , the Company transferred agency and municipal bonds with a book value of$245.5 million from AFS to HTM in order to apply the accounting for securities HTM to mitigate the effect AFS accounting has on the balance sheet. The bonds that were transferred had the highest price volatility and consisted of fixed-rate securities representing 70% of the agency portfolio, 70% of the taxable municipal portfolio each laddered out on the short to intermediate part of the curve and 35% of the tax-exempt municipal portfolio on the long end of the curve were identified as the best candidates given the Company's ability to hold those bonds to maturity. The market value of the securities on the date of the transfer was$221.7 million , after netting unrealized losses totaling$18.9 million . The$18.9 million , net of deferred taxes, will be accreted against other comprehensive income over the life of the bonds. As ofMarch 31, 2022 , the carrying value of investment securities amounted to$711.6 million , or 29% of total assets, compared to$739.0 million , or 31% of total assets, atDecember 31, 2021 . OnMarch 31, 2022 , 36% of the carrying value of the investment portfolio was comprised ofU.S. Government Sponsored Enterprise residential mortgage-backed securities (MBS - GSE residential or mortgage-backed securities) that amortize and provide monthly cash flow that the Company can use for reinvestment, loan demand, unexpected deposit outflow, facility expansion or operations. The mortgage-backed securities portfolio includes only pass-through bonds issued by Fannie Mae, Freddie Mac and theGovernment National Mortgage Association (GNMA). The Company's municipal (obligations of states and political subdivisions) portfolio is comprised of tax-free municipal bonds with a book value of$271.6 million and taxable municipal bonds with a book value of$93.1 million . The overall credit ratings of these municipal bonds was as follows: 37%AAA , 62% AA, 1% A and 1% escrowed. During the first quarter of 2022, the carrying value of total investments decreased$27.4 million , or 4%. Purchases for the quarter totaled$37.9 million , while principal reductions totaled$10.1 million and the decline in unrealized gain/loss was$54.0 million . The purchases were funded principally by cash flow generated from the portfolio and excess overnight liquidity. The Company attempts to maintain a well-diversified and proportionate investment portfolio that is structured to complement the strategic direction of the Company. Its growth typically supplements the lending activities but also considers the current and forecasted economic conditions, the Company's liquidity needs and interest rate risk profile.
A comparison of investment securities at
March 31, 2022 December 31, 2021
(dollars in
thousands) Amount % Book yield Reprice term Amount % Book yield Reprice term
MBS - GSE
residential $ 258,728 36.3 % 1.8 % 6.4 $ 257,267 34.8 % 1.6 % 5.1
Obligations of
states & political
subdivisions 338,623 47.6 2.3 14.7 364,710 49.4 2.3 7.5
Agency - GSE 114,232 16.1 1.4 7.0 117,003 15.8 1.4 5.2
Total $ 711,583 100.0 % 2.0 % 10.4 $ 738,980 100.0 % 1.9 % 6.3
The investment securities portfolio contained no private label mortgage-backed
securities, collateralized mortgage obligations, collateralized debt
obligations, or trust preferred securities, and no off-balance sheet derivatives
were in use. The portfolio had no adjustable-rate instruments as of March 31,
2022 and December 31, 2021 .
Investment securities were comprised of AFS securities as of March 31, 2022 and
December 31, 2021 . The AFS securities were recorded with a net unrealized loss
of $53.8 million and a net unrealized gain of $0.2 million as of March 31, 2022
and December 31, 2021 , respectively. Of the net decline in the unrealized gain
position of $54.0 million: $30.1 million was attributable to municipal
securities; $16.4 million was attributable to mortgage-backed securities and
$7.5 million was attributable to agency securities. The
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direction and magnitude of the change in value of the Company's investment portfolio is attributable to the direction and magnitude of the change in interest rates along the treasury yield curve. Generally, the values of debt securities move in the opposite direction of the changes in interest rates. As interest rates along the treasury yield curve rise, especially at the intermediate and long end, the values of debt securities tend to decline. Whether or not the value of the Company's investment portfolio will change above or below its amortized cost will be largely dependent on the direction and magnitude of interest rate movements and the duration of the debt securities within the Company's investment portfolio. Management does not consider the reduction in value attributable to changes in credit quality. Correspondingly, when interest rates decline, the market values of the Company's debt securities portfolio could be subject to market value increases. As ofMarch 31, 2022 , the Company had$425.1 million in public deposits, or 19% of total deposits.Pennsylvania state law requires the Company to maintain pledged securities on these public deposits or otherwise obtain a FHLB letter of credit orFDIC insurance for these customers. As ofMarch 31, 2022 , the balance of pledged securities required for public and trust deposits was$402.8 million , or 57% of total securities. Quarterly, management performs a review of the investment portfolio to determine the causes of declines in the fair value of each security. The Company uses inputs provided by independent third parties to determine the fair value of its investment securities portfolio. Inputs provided by the third parties are reviewed and corroborated by management. Evaluations of the causes of the unrealized losses are performed to determine whether impairment exists and whether the impairment is temporary or other-than-temporary. Considerations such as the Company's intent and ability to hold the securities until or sell prior to maturity, recoverability of the invested amounts over the intended holding period, the length of time and the severity in pricing decline below cost, the interest rate environment, the receipt of amounts contractually due and whether or not there is an active market for the securities, for example, are applied, along with an analysis of the financial condition of the issuer for management to make a realistic judgment of the probability that the Company will be unable to collect all amounts (principal and interest) due in determining whether a security is other-than-temporarily impaired. If a decline in value is deemed to be other-than-temporary, the amortized cost of the security is reduced by the credit impairment amount and a corresponding charge to current earnings is recognized. During the quarter endedMarch 31, 2022 , the Company did not incur other-than-temporary impairment charges from its investment securities portfolio.
Restricted investments in bank stock
Investment inFederal Home Loan Bank (FHLB) stock is required for membership in the organization and is carried at cost since there is no market value available. The amount the Company is required to invest is dependent upon the relative size of outstanding borrowings the Company has with the FHLB ofPittsburgh . Excess stock is repurchased from the Company at par if the amount of borrowings decline to a predetermined level. In addition, the Company earns a return or dividend based on the amount invested. AtlanticCommunity Bankers Bank (ACBB) stock totaled$82 thousand as ofMarch 31, 2022 andDecember 31, 2021 . The dividends received from the FHLB totaled$33 thousand and$35 thousand for the three months endedMarch 31, 2022 and 2021, respectively. The balance in FHLB stock was$3.1 million both as ofMarch 31, 2022 andDecember 31, 2021 , respectively. Loans held-for-sale (HFS) Upon origination, most residential mortgages and certainSmall Business Administration (SBA) guaranteed loans may be classified as held-for-sale (HFS). In the event of market rate increases, fixed-rate loans and loans not immediately scheduled to re-price would no longer produce yields consistent with the current market. In declining interest rate environments, the Company would be exposed to prepayment risk as rates on fixed-rate loans decrease, and customers look to refinance loans. Consideration is given to the Company's current liquidity position and projected future liquidity needs. To better manage prepayment and interest rate risk, loans that meet these conditions may be classified as HFS. Occasionally, residential mortgage and/or other nonmortgage loans may be transferred from the loan portfolio to HFS. The carrying value of loans HFS is based on the lower of cost or estimated fair value. If the fair values of these loans decline below their original cost, the difference is written down and charged to current earnings. Subsequent appreciation in the portfolio is credited to current earnings but only to the extent of previous write-downs. As ofMarch 31, 2022 andDecember 31, 2021 , loans HFS consisted of residential mortgages with carrying amounts of$6.2 million and$31.7 million , respectively, which approximated their fair values. During the three months endedMarch 31, 2022 , residential mortgage loans with principal balances of$29.9 million were sold into the secondary market and the Company recognized net gains of$0.7 million , compared to$80.7 million and$2.3 million , respectively, during the three months endedMarch 31, 2021 .
Management completed a
The Company retains mortgage servicing rights (MSRs) on loans sold into the secondary market. MSRs are retained so that the Company can foster personal relationships. AtMarch 31, 2022 andDecember 31, 2021 , the servicing portfolio balance of sold residential mortgage loans was$449.9 million and$430.9 million , respectively, with mortgage servicing rights of$1.8 million and$1.7 million for the same periods, respectively. ? 47
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Loans and leases
As of
Growth in the portfolio was primarily attributed to the$16.7 million increase in the commercial and industrial portfolio, resulting from the origination of several large commercial loans during the quarter, along with the$18.8 million increase in the residential portfolio, stemming from$13 million in mortgage loans HFS originated during 2021 reclassified to the held-for-investment portfolio during the quarter to remain invested at better yields that existed early in 2022 along with management's decision to retain a greater percentage of mortgages held-for-investment that meet theFNMA underwriting guidelines.
The composition of the loan portfolio at
March 31, 2022 December 31, 2021
(dollars in thousands) Amount % Amount %
Commercial and industrial $ 252,963 17.2 % $ 236,304 16.5 %
Commercial real estate:
Non-owner occupied 310,663 21.1 312,848 21.8
Owner occupied 250,578 17.0 248,755 17.3
Construction 22,779 1.5 21,147 1.5
Consumer:
Home equity installment 47,852 3.2 47,571 3.3
Home equity line of credit 55,340 3.7 54,878 3.8
Auto 119,082 8.1 118,029 8.2
Direct finance leases 27,138 1.8 26,232 1.8
Other 8,307 0.6 8,013 0.6
Residential:
Real estate 343,360 23.3 325,861 22.8
Construction 36,247 2.5 34,919 2.4
Gross loans 1,474,309 100.0 % 1,434,557 100.0 %
Less:
Allowance for loan losses (16,081) (15,624)
Unearned lease revenue (1,431) (1,429)
Net loans $ 1,456,797 $ 1,417,504
Loans held-for-sale $ 6,236 $ 31,727 Commercial & industrial (C&I) and commercial real estate (CRE)
As ofMarch 31, 2022 , the commercial loan portfolio increased by$18.0 million , or 2%, to$837.0 million over theDecember 31, 2021 balance of$819.0 million primarily due to three large unrelated C&I loans that were originated during the quarter. Excluding the$18.0 million reduction in PPP loans (net of deferred fees) during the three months endedMarch 31, 2022 , the commercial portfolio grew$36.0 million with the growth stemming from the C&I portfolio.
CRE loans increased
Paycheck Protection Program Loans
The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, was signed into law onMarch 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 theSmall 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, and during the second and third quarter of 2020, the Company
originated 1,551 loans totaling
Under the PPP, the entire principal amount of the borrower's loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount, so long as the employer maintains or quickly rehires employees and maintains salary levels and 60% of the loan proceeds are used for payroll expenses, with the remaining 40% of the loan proceeds used for other qualifying expenses. As part of the Economic Relief Act, which became law onDecember 27, 2020 , an additional$284 billion of federal resources was allocated to a reauthorized and revised PPP. OnJanuary 19, 2021 , the Company began processing and originating PPP loans for this 48
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second round, which subsequently ended on
Beginning in the fourth quarter of 2020 and continuing during 2021, the Company submitted PPP forgiveness applications to the SBA, and throughMarch 31, 2022 , the Company received forgiveness or paydowns of$219.4 million , or 93%, of the original PPP loan balances of$236.3 million with$16.3 million occurring during the three months endedMarch 31, 2022 . As a PPP lender, the Company received fee income of approximately$9.9 million with$9.4 million recognized to date, including$0.7 million recognized during the first quarter of 2022. Unearned fees attributed to PPP loans, net of fees paid to referral sources as prescribed by the SBA under the PPP, were$0.5 million as ofMarch 31, 2022 .
The PPP loans originated by size were as follows as of
Balance SBA fee
(dollars in thousands) originated Current balance Total SBA fee recognized
$150,000 or less $ 76,594 $ 5,713 $ 4,866 $ 4,550
Greater than $150,000 but less
than $2,000,000 128,082 11,227 4,765 4,517
$2,000,000 or higher 31,656 - 316 316
Total PPP loans originated $ 236,332 $ 16,940 $ 9,947 $ 9,383
The table above does not include the $20.3 million in PPP loans acquired because
of the merger with Landmark during the third quarter of 2021. As of March 31,
2022 , the balance of outstanding acquired PPP loans was $5.5 million .
Consumer
The consumer loan portfolio consisted of home equity installment, home equity line of credit, automobile, direct finance leases and other consumer loans.
As of
Residential
As ofMarch 31, 2022 , the residential loan portfolio increased by$18.8 million , or 5%, to$379.6 million compared to theDecember 31, 2021 balance of$360.8 million . For the three months endedMarch 31, 2022 , growth in the portfolio was primarily attributed to the$13 million in mortgage loans held-for-sale originated during 2021 reclassified to the held-for-investment portfolio during the quarter along with management's decision to retain a greater percentage of mortgages held-for-investment that meet theFNMA underwriting guidelines. The residential loan portfolio consisted primarily of held-for-investment residential loans for primary residences. Management expects the sudden historic rise in interest rates will have an impact on demand for residential mortgages throughout the remainder of 2022.
Allowance for loan losses
Management evaluates the credit quality of the Company's loan portfolio and performs a formal review of the adequacy of the allowance for loan losses (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. The provision for loan losses represents the amount necessary to maintain an appropriate allowance. Loan losses are charged directly against the allowance when loans are deemed to be uncollectible. Recoveries from previously charged-off loans are added to the allowance when received. Management applies two primary components during the loan review process to determine proper allowance levels. The two components are a specific loan loss allocation for loans that are deemed impaired and a general loan loss allocation for those loans not specifically allocated. The methodology to analyze the adequacy of the allowance for loan losses is as follows:
?identification of specific impaired loans by loan category;
?calculation of specific allowances where required for the impaired loans based on collateral and other objective and quantifiable evidence;
?determination of loans with similar credit characteristics within each class of the loan portfolio segment and eliminating the impaired loans;
?application of historical loss percentages (trailing twelve-quarter average) to pools to determine the allowance allocation; and
?application of qualitative factor adjustment percentages to historical losses for trends or changes in the loan portfolio, regulations, and/or current economic conditions.
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A key element of the methodology to determine the allowance is the Company's credit risk evaluation process, which includes credit risk grading of individual commercial loans. Commercial loans are assigned credit risk grades based on the Company's assessment of conditions that affect the borrower's ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers' current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed. The credit risk grades may be changed at any time management determines an upgrade or downgrade may be warranted. The credit risk grades for the commercial loan portfolio are 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 management believes to be best practices and within common industry standards. Historical experience reveals there is a direct correlation between the credit risk grades and loan charge-offs. The changes in allocations in the commercial loan portfolio from period-to-period are based upon the credit risk grading system and from periodic reviews of the loan portfolio. Acquired loans are initially recorded at their acquisition date fair values with no carryover of the existing related allowance for loan losses. Fair values are based on a discounted cash flow methodology that involves assumptions and judgements as to credit risk, expected lifetime losses, environmental factors, collateral values, discount rates, expected payments and expected prepayments. Upon acquisition, in accordance with GAAP, the Company has individually determined whether each acquired loan is within the scope of ASC 310-30. These loans are deemed purchased credit impaired loans and the excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non-accretable discount. Acquired ASC 310-20 loans, which are loans that did not meet the criteria of ASC 310-30, were pooled into groups of similar loans based on various factors including borrower type, loan purpose, and collateral type. These loans are initially recorded at fair value and include credit and interest rate marks associated with purchase accounting adjustments. Purchase premiums or discounts are subsequently amortized as an adjustment to yield over the estimated contractual lives of the loans. There is no allowance for loan losses established at the acquisition date for acquired performing loans. An allowance for loan losses is recorded for any credit deterioration in these loans after acquisition. Each quarter, management performs an assessment of the allowance for loan losses. The Company's Special Assets Committee meets quarterly, and the applicable lenders discuss each relationship under review and reach a consensus on the appropriate estimated loss amount, if applicable, based on current accounting guidance. The Special Assets Committee's focus is on ensuring the pertinent facts are considered regarding not only loans considered for specific reserves, but also the collectability of loans that may be past due. The assessment process also includes the review of all loans on non-accrual status as well as a review of certain loans to which the lenders or theCredit Administration function have assigned a criticized or classified risk rating. ? 50
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The following tables set forth the activity in the allowance for loan losses and certain key ratios for the period indicated:
As of and for the As of and for the As of and for the
three months ended twelve months ended three months ended
(dollars in thousands) March 31, 2022 December 31, 2021 March 31, 2021
Balance at beginning of period $ 15,624 $ 14,202 $ 14,202
Charge-offs:
Commercial and industrial - (130) (7) Commercial real estate (1) (491) (124) Consumer (94) (206) (28) Residential - (162) (43) Total (95) (989) (202) Recoveries: Commercial and industrial 2 23 4 Commercial real estate 9 250 11 Consumer 14 138 24 Residential 2 - - Total 27 411 39 Net charge-offs (68) (578) (163) Provision for loan losses 525 2,000 800 Balance at end of period $ 16,081 $
15,624 $ 14,839
Allowance for loan losses to total loans 1.09 % 1.09 % 1.30 % Net charge-offs to average total loans outstanding 0.02 % 0.04 % 0.06 % Average total loans$ 1,467,362 $ 1,299,960 $ 1,162,112 Loans 30 - 89 days past due and accruing $ 1,512 $ 1,982 $ 912 Loans 90 days or more past due and accruing $ 174 $ 64 $ 59 Non-accrual loans $ 2,307 $ 2,949 $ 3,929 Allowance for loan losses to non-accrual loans 6.97 x 5.30 x 3.78 x Allowance for loan losses to non-performing loans 6.48 x 5.19 x 3.72 x The allowance increased$0.5 million , or 3%, to$16.1 million atMarch 31, 2022 from$15.6 million atDecember 31, 2021 due to provisioning of$0.5 million partially offset by$68 thousand in net charge-offs. The allowance for loan and lease losses remained unchanged as a percentage of total loans at 1.09% as ofMarch 31, 2022 compared toDecember 31, 2021 as the growth in the loan portfolio (3%) was the same as the growth in the allowance for loan losses (3%) during the period. Loans acquired from the Merchants and Landmark mergers (performing and non-performing) were initially recorded at their acquisition-date fair values. Since there is no initial credit valuation allowance recorded under this method, the Company establishes a post-acquisition allowance for loan losses to record losses which may subsequently arise on the acquired loans.
PPP loans made to eligible borrowers have a 100% SBA guarantee. Given this guarantee, no allowance for loan and lease losses was recorded for these loans.
Management believes that the current balance in the allowance for loan losses is
sufficient to meet the identified potential credit quality issues that may arise
and other issues unidentified but inherent to the portfolio. Potential problem
loans are those where there is known information that leads management to
believe repayment of principal and/or interest is in jeopardy and the loans are
currently neither on non-accrual status nor past due 90 days or more.
During the first quarter of 2022, management increased the qualitative factors
associated with its commercial, consumer, and residential portfolios related to
the rise in rates that occurred during the quarter, and the adverse impact that
these increased rates are anticipated to have on estimated credit losses.
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The allocation of net charge-offs among major categories of loans are as follows for the periods indicated:
For the three % of Total For the three % of Total
months ended Net months ended Net
(dollars in thousands) March 31, 2022 Charge-offs March 31, 2021 Charge-offs
Net charge-offs
Commercial and industrial $ 2 (3) % $ (3) 2 %
Commercial real estate 8 (12) (113) 69
Consumer (80) 118 (4) 3
Residential 2 (3) (43) 26
Total net charge-offs $ (68) 100 % $ (163) 100 %
For the three months ended
For a discussion on the provision for loan losses, see the "Provision for loan
losses," located in the results of operations section of management's discussion
and analysis contained herein.
The allowance for loan losses can generally absorb losses throughout the loan
portfolio. However, in some instances an allocation is made for specific loans
or groups of loans. Allocation of the allowance for loan losses for different
categories of loans is based on the methodology used by the Company, as
previously explained. The changes in the allocations from period-to-period are
based upon quarter-end reviews of the loan portfolio.
Allocation of the allowance among major categories of loans for the periods
indicated, as well as the percentage of loans in each category to total loans,
is summarized in the following table. This table should not be interpreted as an
indication that charge-offs in future periods will occur in these amounts or
proportions, or that the allocation indicates future charge-off trends. When
present, the portion of the allowance designated as unallocated is within the
Company's guidelines:
March 31, 2022 December 31, 2021 March 31, 2021
Category Category Category
% of % of % of
(dollars in thousands) Allowance Loans Allowance Loans Allowance Loans
Category
Commercial real estate $ 6,822 40 % $ 7,422 41 % $ 7,080 35 %
Commercial and industrial 2,780 17 2,204 16 2,342 26
Consumer 2,547 17 2,404 18 2,415 18
Residential real estate 3,851 26 3,508 25 2,915 21
Unallocated 81 - 86 - 87 -
Total $ 16,081 100 % $ 15,624 100 % $ 14,839 100 %
As of March 31, 2022 , the commercial loan portfolio, consisting of CRE and C&I
loans, comprised 60% of the total allowance for loan losses compared with 62% on
December 31, 2021 . The commercial loan allowance allocation declined, but
remained higher than the commercial loan allocation, due to the payoff of
commercial real estate loans to a single borrower with a large specific
impairment during the first quarter of 2022.
As of
As ofMarch 31, 2022 , the residential loan portfolio comprised 24% of the total allowance for loan losses compared with 22% onDecember 31, 2021 . The two percentage point increase was the result of the relative increase in this loan category, which increased from 25% as ofDecember 31, 2021 to 26% as ofMarch 31, 2022 . As ofMarch 31, 2022 , the unallocated reserve, representing the portion of the allowance not specifically identified with a loan or groups of loans, was less than 1% of the total allowance for loan losses unchanged fromDecember 31, 2021 .
Non-performing assets
The Company defines non-performing assets as accruing loans past due 90 days or
more, non-accrual loans, troubled debt restructurings (TDRs), other real estate
owned (ORE) and repossessed assets.
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The following table sets forth non-performing assets data as of the period indicated: (dollars in thousands) March 31, 2022 December 31, 2021 March 31, 2021 Loans past due 90 days or more and accruing $ 174 $ 64 $ 59 Non-accrual loans * 2,307 2,949 3,929 Total non-performing loans 2,481 3,013 3,988 Troubled debt restructurings 1,371 2,987 2,489 Other real estate owned and repossessed assets 151 434 413 Total non-performing assets $ 4,003 $ 6,434 $ 6,890 Total loans, including loans held-for-sale$ 1,479,114 $ 1,464,855$ 1,153,160 Total assets$ 2,420,774 $ 2,419,104$ 1,913,092 Non-accrual loans to total loans 0.16% 0.20% 0.34% Non-performing loans to total loans 0.17% 0.21% 0.35% Non-performing assets to total assets 0.17% 0.27% 0.36%
* In the table above, the amount includes non-accrual TDRs of
Management routinely reviews the loan portfolio to identify loans that are either delinquent or are otherwise deemed by management unable to repay in accordance with contractual terms. Generally, loans of all types are placed on non-accrual status if a loan of any type is past due 90 or more days or if collection of principal and interest is in doubt. Further, unsecured consumer loans are charged-off when the principal and/or interest is 90 days or more past due. Uncollected interest income accrued on all loans placed on non-accrual is reversed and charged to interest income. Non-performing assets represented 0.17% of total assets atMarch 31, 2022 compared with 0.27% atDecember 31, 2021 with the improvement resulting from the$2.4 million , or 38%, decrease in non-performing assets including a$0.6 million reduction in non-accrual loans, a$1.6 million reduction in accruing troubled debt restructurings, and a$0.3 million reduction in other real estate owned and repossessed assets partially offset by the$0.1 million increase in loans past due 90 days and accruing. FromDecember 31, 2021 toMarch 31, 2022 , non-accrual loans declined$0.6 million , or 22%, from$2.9 million to$2.3 million . The$0.6 million decline in non-accrual loans was primarily the result of$0.5 million in payments and$0.4 million in moves to ORE partially offset by$0.3 million in additions. AtMarch 31, 2022 , there were a total of 37 loans to 33 unrelated borrowers with balances that ranged from less than$1 thousand to$0.5 million . AtDecember 31, 2021 , there were a total of 31 loans to 28 unrelated borrowers with balances that ranged from less than$1 thousand to$0.7 million . There were one direct finance lease totaling$31 thousand and one commercial real estate loan totaling$143 thousand that was over 90 days past due as ofMarch 31, 2022 compared to two direct finance leases totaling$64 thousand that were over 90 days past due as ofDecember 31, 2021 . The delinquent direct finance lease is fully guaranteed under a formal recourse agreement with the originating auto dealer and were in process of orderly collection while the delinquent commercial real estate loan is well secured and in the process of collection. The Company seeks payments from all past due customers through an aggressive customer communication process. Unless well-secured and in the process of collection, past due loans will be placed on non-accrual at the 90-day point when it is deemed that a customer is non-responsive and uncooperative to collection efforts. ? 53
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The composition of non-performing loans as of
Past due
Gross 90 days or Non- Total non- % of
loan more and accrual performing gross
(dollars in thousands) balances still accruing loans loans loans
Commercial and industrial $ 252,963 $ - $ 49 $ 49 0.02%
Commercial real estate:
Non-owner occupied 310,663 - 478 478 0.15%
Owner occupied 250,578 143 1,300 1,443 0.58%
Construction 22,779 - - - -
Consumer:
Home equity installment 47,852 - - - -
Home equity line of credit 55,340 - 171 171 0.31%
Auto loans 119,082 - 172 172 0.14%
Direct finance leases * 25,707 31 - 31 0.12%
Other 8,307 - - - -
Residential:
Real estate 343,360 - 137 137 0.04%
Construction 36,247 - - - -
Loans held-for-sale 6,236 - - - -
Total $ 1,479,114 $ 174 $ 2,307 $ 2,481 0.17%
*Net of unearned lease revenue of
Payments received from non-accrual loans are recognized on a cost recovery method. Payments are first applied to the outstanding principal balance, then to the recovery of any charged-off loan amounts. Any excess is treated as a recovery of interest income. If the non-accrual loans that were outstanding as ofMarch 31, 2022 had been performing in accordance with their original terms, the Company would have recognized interest income with respect to such loans of$69 thousand .
The following tables set forth the activity in TDRs for the periods indicated:
As of and for the three months ended
Accruing Non-accruing
Commercial Commercial Commercial
(dollars in thousands) real estate real estate & industrial Total
Troubled Debt Restructures:
Beginning balance $ 2,987 $ 419 $ 135 $ 3,541
Additions - - - -
Pay downs / payoffs (1,616) (61) (135) (1,812)
Charge offs - - - -
Ending balance $ 1,371 $ 358 $ - $ 1,729
Number of loans 6 1 - 7
As of and for the year ended
Accruing Non-accruing
Commercial Commercial Commercial
(dollars in thousands) real estate real estate & industrial Total
Troubled Debt Restructures:
Beginning balance $ 2,571 $ 456 $ 206 $ 3,233
Additions 519 - - 519
Pay downs / payoffs (103) (37) (6) (146)
Charge offs - - (65) (65)
Ending balance $ 2,987 $ 419 $ 135 $ 3,541
Number of loans 8 1 2 11
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The Company, on a regular basis, reviews changes to loans to determine if they meet the definition of a TDR. TDRs arise when a borrower experiences financial difficulty and the Company grants a concession that it would not otherwise grant based on current underwriting standards to maximize the Company's recovery. FromDecember 31, 2021 toMarch 31, 2022 , TDRs declined$1.8 million , or 51%, primarily due to payoff of two commercial real estate TDRs to a single borrower totaling$1.6 million and the payoff of two commercial and industrial TDRs to a single borrower totaling$0.1 million . AtDecember 31, 2021 , there were a total of 11 TDRs by 8 unrelated borrowers with balances that ranged from$50 thousand to$1.3 million , and atMarch 31, 2022 , there were a total of 7 TDRs by 6 unrelated borrowers with balances that ranged from$89 thousand to$0.5 million .
Loans modified in a TDR may or may not be placed on non-accrual status. At
Foreclosed assets held-for-sale
FromDecember 31, 2021 toMarch 31, 2022 , foreclosed assets held-for-sale (ORE) declined from$434 thousand to$151 thousand , a$283 thousand decrease, which was primarily attributed to two ORE properties totaling$283 thousand that were sold during the quarter. One property totaling$437 thousand was also added to ORE and sold during the quarter. The following table sets forth the activity in the ORE component of foreclosed assets held-for-sale: March 31, 2022 December 31, 2021 (dollars in thousands) Amount # Amount #
Balance at beginning of period
Additions 437 1 969 7 Pay downs - - Write downs - (16) Sold (720) (3) (775) (8) Balance at end of period$ 151 3$ 434 5 As ofMarch 31, 2022 , ORE consisted of three properties securing loans to three unrelated borrowers totaling$151 thousand . Two properties ($150 thousand ) to two unrelated borrowers were added in 2021 and one property ($1 thousand ) was added in 2017. Of the three properties, one property is under agreement of sale and two properties are listed for sale.
As of
Cash surrender value of bank owned life insurance
The Company maintains bank owned life insurance (BOLI) for a chosen group of employees at the time of purchase, namely its officers, where the Company is the owner and sole beneficiary of the policies. BOLI is classified as a non-interest earning asset. Increases in the cash surrender value are recorded as components of non-interest income. The BOLI is profitable from the appreciation of the cash surrender values of the pool of insurance and its tax-free advantage to the Company. This profitability is used to offset a portion of current and future employee benefit costs. As a result of the Landmark acquisition, the Company acquired$7.2 million in BOLI during the third quarter of 2021. The BOLI cash surrender value build-up can be liquidated if necessary, with associated tax costs. However, the Company intends to hold this pool of insurance, because it provides income that enhances the Company's capital position. Therefore, the Company has not provided for deferred income taxes on the earnings from the increase in cash surrender value.
Premises and equipment
Net of depreciation, premises and equipment increased$2.0 million during the first quarter of 2022. The Company purchased$0.2 million in fixed assets and added$3.1 million in construction in process during the first quarter of 2022. The increase in construction in process was primarily due to the purchase of theScranton Electric Building for a new headquarters inScranton, PA. These increases were partially offset by$0.6 million in depreciation expense and$0.6 million in transfers to other assets held-for-sale. The Company expects to begin branch remodeling and corporate headquarters planning which may continue to increase construction in process and is evaluating its branch network looking for consolidation that makes sense for more efficient operations. OnDecember 23, 2020 , theCommonwealth of Pennsylvania authorized the release of$2.0 million in Redevelopment Assistance Capital Program (RACP) funding for the Company's headquarters project inLackawanna County . OnDecember 2, 2021 , the Company announced it would be receiving an additional$2.0 million in RACP funding in support of the project. The$4.0 million in total RACP grant funds will be allocated to the renovation and rehabilitation of the historic building located in downtownScranton which will be use for the new corporate headquarters. The Company currently expects net remaining costs for the corporate headquarters to be$15.8 million over approximately two years beginning during the fourth quarter of 2022. In addition, the Company 55
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intends to pursue a federal historic preservation tax credit which, if it qualifies, would provide a 20% tax credit on qualified improvements on the historic property.
The Company also plans to remodel the
Other assets
During the first three months of 2022, the$13.0 million increase in other assets was due mostly to a$11.5 million increase in deferred tax assets from net unrealized losses in the investment portfolio,$0.9 million of additional prepaid expenses and$0.6 million transferred to other assets held-for-sale. Funds Provided: Deposits The Company is a community based commercial depository financial institution, memberFDIC , which offers a variety of deposit products with varying ranges of interest rates and terms. Generally, deposits are obtained from consumers, businesses and public entities within the communities that surround the Company's 22 branch offices and all deposits are insured by theFDIC up to the full extent permitted by law. Deposit products consist of transaction accounts including: savings; clubs; interest-bearing checking; money market and non-interest bearing checking (DDA). The Company also offers short- and long-term time deposits or certificates of deposit (CDs). CDs are deposits with stated maturities which can range from seven days to ten years. Cash flow from deposits is influenced by economic conditions, changes in the interest rate environment, pricing and competition. To determine interest rates on its deposit products, the Company considers local competition, spreads to earning-asset yields, liquidity position and rates charged for alternative sources of funding such as short-term borrowings and FHLB advances. The following table represents the components of deposits as of the date indicated: March 31, 2022 December 31, 2021 (dollars in thousands) Amount % Amount %
Interest-bearing checking
249,757 11.3 234,747 10.8
Money market 485,469 22.0 475,447 21.9
Certificates of deposit 130,424 5.9 138,793 6.4 Total interest-bearing 1,610,508 72.9 1,579,582 72.8 Non-interest bearing 599,497 27.1 590,283 27.2 Total deposits
$ 2,210,005 100.0 %$ 2,169,865 100.0 % Total deposits increased$40.1 million , or 2%, remaining at approximately$2.2 billion atMarch 31, 2022 andDecember 31, 2021 . Savings and clubs contributed the most to the deposit growth with an increase of$15.0 million due to growth in personal account balances. Interest-bearing checking accounts also increased$14.3 million during the first quarter of 2022. The increase in interest-bearing checking accounts was primarily due to seasonal tax cycles, business activity and shifts from non-interest bearing checking accounts. Money market accounts also increased$10.0 million , mostly due to higher balances of business accounts and shifts from other types of deposit accounts. The$9.2 million growth in non-interest bearing checking accounts was primarily due to seasonal public account increases and personal account growth. The Company focuses on obtaining a full-banking relationship with existing checking account customers as well as forming new customer relationships. The Company will continue to execute on its relationship development strategy, explore the demographics within its marketplace and develop creative programs for its customers. For the remainder of 2022, the Company expects deposit growth to fund asset growth. Tax deposits are usually received during the first quarter and retained for a short period of time in checking accounts with disbursements occurring shortly after they are received. Seasonal public deposit fluctuations are expected to remain volatile and at times may partially offset future deposit growth. Partially offsetting these non-maturing deposit increases, CDs decreased$8.4 million during the first quarter of 2022. CD balances continue to decline as rates dropped and CDs with promotional rates reached maturity. The majority of maturing CDs were closed as customers could earn higher yields by investing the money elsewhere. The Company will continue to pursue strategies to grow and retain retail and business customers with an emphasis on deepening and broadening existing and creating new relationships. The Company uses the Certificate of Deposit Account Registry Service (CDARS) reciprocal program and Insured Cash Sweep (ICS) reciprocal program to obtainFDIC insurance protection for customers who have large deposits that at times may exceed theFDIC maximum insured amount of$250,000 . The Company did not have any CDARs as ofMarch 31, 2022 andDecember 31, 2021 . As ofMarch 31, 2022 andDecember 31, 2021 , ICS reciprocal deposits represented$25.6 million and$27.6 million , or 1% and 1%, of total deposits which are included in interest-bearing checking accounts in the table above. The$2.0 million decrease in ICS deposits is primarily due to public funds deposit transfers from ICS accounts to other interest-bearing checking accounts.
As of
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the same methodologies and assumptions used for regulatory reporting requirements. The Company aggregates deposit products by taxpayer identification number and classifies into ownership categories to determine amounts over theFDIC insurance limit.
The maturity distribution of certificates of deposit that meet or exceed the
(dollars in thousands) Three months or less$ 4,734 More than three months to six months 1,488 More than six months to twelve months 9,220 More than twelve months 5,439 Total$ 20,881 Approximately 59% of the CDs, with a weighted-average interest rate of 0.28%, are scheduled to mature in 2022 and an additional 28%, with a weighted-average interest rate of 0.33%, are scheduled to mature in 2023. Renewing CDs are currently expected to re-price to lower market rates depending on the rate on the maturing CD, the pace and direction of interest rate movements, the shape of the yield curve, competition, the rate profile of the maturing accounts and depositor preference for alternative, non-term products. The Company plans to address repricing CDs in the ordinary course of business on a relationship basis and is prepared to match rates when prudent to maintain relationships. Growth in CD accounts is challenged by the current and expected rate environment and clients' preference for short-term rates, as well as aggressive competitor rates. The Company is not currently offering any CD promotions but may resume promotions in the future. The Company will consider the needs of the customers and simultaneously be mindful of the liquidity levels, borrowing rates and the interest rate sensitivity exposure of the Company.
Short-term borrowings
Borrowings are used as a complement to deposit generation as an alternative
funding source whereby the Company will borrow under advances from the FHLB of
Short-term borrowings may include overnight balances with FHLB line of credit and/or correspondent bank's federal funds lines which the Company may require to fund daily liquidity needs such as deposit outflow, loan demand and operations. There were no short-term borrowings as ofMarch 31, 2022 andDecember 31, 2021 as growth in deposits funded asset growth. The Company does not expect to have short-term borrowings for the remainder of 2022. As ofMarch 31, 2022 , the Company had the ability to borrow$111.7 million from theFederal Reserve borrower-in-custody program and$31.0 million from lines of credit with correspondent banks.
Secured borrowings
As ofMarch 31, 2022 andDecember 31, 2021 , the Company had 11 secured borrowing agreements with third parties with a fair value of$10.6 million related to certain sold loan participations that did not qualify for sales treatment acquired from Landmark. Secured borrowings are expected to decrease in 2022 from scheduled amortization and, when possible, early pay-offs.
FHLB advances
The Company had no FHLB advances as ofMarch 31, 2022 andDecember 31, 2021 . During the first quarter of 2021, the Company paid off$5 million in FHLB advances with a weighted average interest rate of 3.07%. During the third quarter of 2021, the Company acquired$4.5 million in FHLB advances from the Landmark merger that was subsequently paid off. As ofMarch 31, 2022 , the Company had the ability to borrow an additional$589.3 million from the FHLB.The Company does not expect to have any FHLB advances in 2022.
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