This quarterly report contains certain forward-looking statements, which are
included pursuant to the "safeharbor" provisions of the Private Securities
Litigation Reform Act of 1995, and reflect management's beliefs and expectations
based on information currently available. These forward-looking statements are
inherently subject to significant risks and uncertainties, including changes in
general economic and financial market conditions, the Company's ability to
effectively carry out its business plans and changes in regulatory or
legislative requirements. Other factors that could cause or contribute to such
differences are changes in competitive conditions, and pending or threatened
litigation. Although management believes the expectations reflected in such
forward-looking statements are reasonable, actual results may differ materially.
CRITICAL ACCOUNTING ESTIMATES
The Company has chosen accounting policies that it believes are appropriate to
accurately and fairly report its operating results and financial position, and
the Company applies those accounting policies in a consistent manner. The
Significant Accounting Policies are summarized in Note 1 to the consolidated
financial statements included in the 2021 Annual Report on Form 10-K. There have
been no changes to the Critical Accounting Estimates since the Company filed its
Annual Report on Form 10-K for the year ended December 31, 2021.
RESULTS OF OPERATIONS
Quarter ended March 31, 2022 compared to quarter ended March 31, 2021
First Keystone Corporation realized earnings for the first quarter of 2022 of
$3,543,000, a decrease of $335,000, or 8.6% from the first quarter of 2021. The
decrease in net income for the three months ended March 31, 2022 was primarily
due to a decrease in non-interest income, mainly due to losses on sales of
mortgage loans and net securities losses, as compared to gains on sales of
mortgage loans and net securities gains realized during the same period in 2021.
On a per share basis, for the three months ended March 31, 2022, net income was
$0.60 versus $0.66 for the same three month period of 2021. Cash dividends
amounted to $0.28 per share for the three months ended March 31, 2022 and 2021.
NET INTEREST INCOME
The major source of operating income for the Company is net interest income,
defined as interest income less interest expense. In the three months ended
March 31, 2022, interest income amounted to $10,629,000, an increase of $354,000
or 3.4% from the three months ended March 31, 2021. The increase in interest
income was mainly the result of a $331,000 increase in interest earned on
taxable securities and a $228,000 increase in interest earned on loans, offset
by a $246,000 decrease in SBA PPP lender fees. Interest expense amounted to
$1,173,000 in the three months ended March 31, 2022, a decrease of $132,000 or
10.1% from the three months ended March 31, 2021, mainly due to a $110,000
decrease in interest paid on deposits. As a result, net interest income
increased $486,000 or 5.4% to $9,456,000 from $8,970,000 for the same period in
2021.
The Company's net interest margin for the three months ended March 31, 2022 was
3.19% compared to 3.37% for same period in 2021. The decrease in net interest
margin was primarily a result of a decrease in yields on loans.
PROVISION FOR LOAN LOSSES
The provision for loan losses for the three months ended March 31, 2022 and 2021
was $219,000 and $135,000, respectively. The increase in the provision for loan
losses resulted from the Company's analysis of the current loan portfolio,
including historic losses, past-due trends, current economic conditions, loan
portfolio growth, and other relevant factors. The provision for loan losses for
the three months ended March 31, 2022 is also reflective of
36
management's assessment of the continued credit risk associated with the
economic uncertainty surrounding the COVID-19 pandemic. Charge-off and recovery
activity in the allowance for loan losses resulted in net recoveries of $38,000
and net charge-offs of $21,000 for the the three months ended March 31, 2022 and
2021, respectively. See Allowance for Loan Losses on page 40 for further
discussion.
NON-INTEREST INCOME
Total non-interest income was $1,389,000 for the three months ended
March 31, 2022, as compared to $1,875,000 for the same period in 2021, a
decrease of $486,000, or 25.9%. The decrease was due to recognizing losses on
the sales of mortgage loans and net securities losses on held equity securities
during the first quarter of 2022 as compared to recognizing gains on both during
the same period of 2021.
Net securities (losses) gains decreased $178,000 to ($63,000) for the three
months ended March 31, 2022 as compared to the three months ended
March 31, 2021. This decrease was due to the Company recognizing $63,000 in
losses on held equity securities in the first quarter of 2022 as compared to
recognizing $115,000 in gains on held equity securities in the first quarter of
2021. Trust department income decreased $3,000 or 1.2% to $250,000 for the three
months ended March 31, 2022 as compared to the same period in 2021.
Service charges and fee income increased $134,000 or 35.7%. The increase was
mainly due to increases in overdraft fees and prepayment penalties earned on
commercial loan payoffs as compared to the same period in 2021. ATM fees and
debit card income decreased $7,000 or 1.4% to $509,000 for the three months
ended March 31, 2022.
(Losses) gains on sales of mortgage loans decreased $388,000 or 109.6% to
($34,000) due to a lower number of individual sold loans in the first quarter of
2022 as compared to the first quarter of 2021. Many of the loans sold in the
first quarter of 2022 were sold at a loss. Other non-interest income decreased
$43,000 or 38.1% to $70,000 for the three months ended March 31, 2022. The
decrease was due to lower retail investment income as income from annuities was
lower in the first quarter of 2022 as compared to the same period in 2021.
NON-INTEREST EXPENSE
Total non-interest expense was $6,516,000 for the three months ended
March 31, 2022, as compared to $6,197,000 for the three months ended
March 31, 2021.
Expenses associated with employees (salaries and employee benefits) continue to
be the largest category of non-interest expense. Salaries and benefits amounted
to $3,554,000 or 54.5% of total non-interest expense for the three months ended
March 31, 2022, as compared to $3,300,000 or 53.3% for the three months ended
March 31, 2021. The increase was mainly due to normal merit increases and new
hires along with an increase in medical insurance costs since the first quarter
of 2021.
Net occupancy, furniture and equipment, and computer expense amounted to
$1,017,000 for the three months ended March 31, 2022, an increase of $112,000 or
12.4% which was due to the implementation of several new software programs
throughout 2021. Professional services increased $39,000 or 15.1% to $298,000 as
of March 31, 2022. The increase was mainly the result of an increase in
consulting expense as the result of strategic planning and consulting services
associated with implementing new internal systems contracts. Pennsylvania shares
tax expense amounted to $324,000 for the three months ended March 31, 2022, an
increase of $11,000 or 3.5% as compared to the three months ended
March 31, 2021. The increase was the result of an increase in total equity.
Federal Deposit Insurance Corporation ("FDIC") insurance expense increased
$50,000 for the three months ended March 31, 2022. FDIC insurance expense varies
with changes in net asset size, risk ratings, and FDIC derived assessment rates.
ATM and debit card fees expense amounted to $128,000 for the three months ended
March 31, 2022, a decrease of $72,000 or 36.0% as compared to the three months
ended March 31, 2021. The decrease was the result of negotiations on new
internal systems contracts resulting in relationship credits that were applied
to the expenses related to those
37
systems. Data processing expenses amounted to $258,000 for the three months
ended March 31, 2021 as compared to $294,000 for the same period of 2020, a
decrease of $36,000 or 12.2%. This decrease was also the result of the
negotiations on new internal systems contracts.
Foreclosed assets held for resale expense decreased $3,000 for the three months
ended March 31, 2022. As of March 31, 2022 the Company did not own any
foreclosed properties. Advertising expense amounted to $72,000 in the first
quarter of 2022 and 2021.
Other non-interest expense amounted to $728,000 for the three months ended
March 31, 2022, a decrease of $36,000 or 4.7% as compared to the three months
ended March 31, 2021. This decrease was mainly due to a decrease in the
provision for unfunded commitments due to a decrease in commercial real estate
commitments in the first quarter of 2022 as compared to the same period in 2021.
INCOME TAXES
Income tax expense amounted to $567,000 for the three months ended
March 31, 2022, as compared to $635,000 for the three months ended
March 31, 2021, a decrease of $68,000. The effective total income tax rate was
13.8% for the three months ended March 31, 2022 as compared to 14.1% for the
three months ended March 31, 2021. The decrease in the effective tax rate was
mainly due to lower overall operating income. The Company recognized $74,000 and
$101,000 of tax credits from low-income housing partnerships in the three months
ended March 31, 2022 and 2021, respectively.
FINANCIAL CONDITION
SUMMARY
Total assets decreased to $1,297,087,000 as of March 31, 2022, a decrease of
$23,263,000 from year-end 2021. Total assets as of December 31, 2021 amounted to
$1,320,350,000.
Total debt securities available-for-sale decreased $3,035,000 or 0.7% to
$434,881,000 as of March 31, 2022 from December 31, 2021.
Total loans increased $26,187,000 or 3.5% to $779,028,000 as of March 31, 2022
from December 31, 2021. Loan demand grew in the three months ended
March 31, 2022 as the Bank has realized an increase in loan originations,
primarily in the commercial real estate portfolio.
Total deposits decreased $32,492,000 or 3.0% to $1,045,477,000 as of
March 31, 2022 from December 31, 2021. The decrease was mainly due to a decrease
in highly rate sensitive deposits and other normal fluctuations.
The Company continues to maintain and manage its asset growth. The Company's
strong equity capital position provides an opportunity to further leverage its
asset growth. Total borrowings increased in the three months ended
March 31, 2022 by $24,954,000 to $87,331,000 from $62,377,000 as of
December 31, 2021. Borrowings increased mainly due to decreased deposit balances
and growth in the loan portfolio.
Total stockholders' equity decreased to $133,555,000 at March 31, 2022, a
decrease of $15,000,000 or 10.1% from December 31, 2021 due to a decrease in the
market value of the securities portfolio resulting in an accumulated other
comprehensive loss position.
SEGMENT REPORTING
Currently, management measures the performance and allocates the resources of
the Company as a single segment.
38
EARNING ASSETS
Earning assets are defined as those assets that produce interest income. By
maintaining a healthy asset utilization rate, i.e., the volume of earning assets
as a percentage of total assets, the Company maximizes income. The earning asset
ratio (average interest earning assets divided by average total assets) equaled
94.4% at March 31, 2022 and 93.9% at March 31, 2021. This indicates that the
management of earning assets is a priority and non-earning assets, primarily
cash and due from banks, fixed assets and other assets, are maintained at
minimal levels. The primary earning assets are loans and securities.
Our primary earning asset, total loans, increased to $779,028,000 as of
March 31, 2022, up $26,187,000, or 3.5% since year-end 2021. The loan portfolio
continues to be well diversified. Non-performing assets decreased since year-end
2021, but overall asset quality has remained consistent. Total non-performing
assets were $7,018,000 as of March 31, 2022, a decrease of $48,000, or 0.7% from
$7,066,000 reported in non-performing assets as of December 31, 2021. Total
allowance for loan losses to total non-performing assets was 127.34% as of
March 31, 2022 and 122.84% at December 31, 2021. See the Non-Performing Assets
section on page 42 for more information.
In addition to loans, another primary earning asset is our overall securities
portfolio, which decreased in size from December 31, 2021 to March 31, 2022.
Debt securities available-for-sale amounted to $434,881,000 as of
March 31, 2022, a decrease of $3,035,000 from year-end 2021. The decrease in
debt securities available-for-sale is mainly due to a $21,876,000 decrease in
the market value of the portfolio as a result of the current interest rate
environment, offset by the deployment of $34,314,000 in cash to purchase debt
securities, along with other portfolio activity.
Interest-bearing deposits in other banks decreased as of March 31, 2022, to
$1,068,000 from $51,738,000 at year-end 2021 due to decreased cash held at the
Federal Reserve Bank. Time deposits with other banks were $0 at March 31, 2022
and $247,000 at December 31, 2021 due to the maturity of the one remaining time
deposit.
LOANS
Total loans increased to $779,028,000 as of March 31, 2022 as compared to
$752,841,000 as of December 31, 2021. The table on page 19 provides data
relating to the composition of the Company's loan portfolio on the dates
indicated. Total loans increased by $26,187,000 or 3.5%.
Steady demand for borrowing by businesses accounted for the 3.5% increase in the
loan portfolio from December 31, 2021 to March 31, 2022. Overall, the Commercial
and Industrial portfolio (which includes tax-free Commercial and Industrial
loans) decreased $695,000 or 0.8% from $82,526,000 at December 31, 2021 to
$81,831,000 at March 31, 2022. The decrease in the Commercial and Industrial
portfolio during the three months ended March 31, 2022 was mainly attributable
to a reduction of $3,650,000 in the portion of the Commercial and Industrial
portfolio attributable to SBA PPP loans, the balance of which decreased from
$4,894,000 at December 31, 2021 to $1,244,000 at March 31, 2022, as a result of
loan forgiveness. The portion of the Commercial and Industrial portfolio
excluding SBA PPP loans increased $2,955,000 during the three months ended March
31, 2022, mainly resulting from $3,246,000 in new loan originations for the
three months ended March 31, 2022 and an increase in utilization of existing
Commercial and Industrial lines of credit of $2,013,000, offset by loan payoffs
of $808,000 and regular principal payments and other typical fluctuations in the
Commercial and Industrial portfolio during the three months ended March 31,
2022. The Commercial Real Estate portfolio (which includes tax-free Commercial
Real Estate loans) increased $28,267,000 or 5.4% from $521,654,000 at December
31, 2021 to $549,921,000 at March 31, 2022. The increase is mainly attributable
to new loan originations of $53,605,000 for the three months ended March 31,
2022, offset by loan payoffs of $23,289,000 and a decrease in utilization of
existing Commercial Real Estate lines of credit of $1,002,000, as well as
regular principal payments and other typical amortization in the Commercial Real
Estate portfolio during the three months ended March 31, 2022. Residential Real
Estate loans decreased $1,393,000 or 1.0% from $143,383,000 at December 31, 2021
to $141,990,000 at March 31, 2022. The decrease was mainly the result of
$7,180,000 in new loan originations and an increase in utilization of existing
Residential Real Estate (Home Equity) lines of credit of $1,018,000, offset by
net loans sold of $2,719,000, loan payoffs of $6,294,000 (of which $1,872,000
was refinanced with the Bank during the three months ended March 31,2022 with
the new refinanced loan balances included in the new
39
loan origination total), and regular principal payments and other typical
amortization in the Residential Real Estate portfolio during the three months
ended March 31, 2022. Net loans sold for the three months ended March 31, 2022
consisted of total loans sold during the three months ended March 31, 2022 of
4,463,000, offset with loans opened and sold in the same quarter during the
first quarter of 2022 which amounted to $1,744,000. The Company continues to
originate and sell certain long-term fixed rate residential mortgage loans which
conform to secondary market requirements. The Company derives ongoing income
from the servicing of mortgages sold in the secondary market. The Company
continues its efforts to lend to creditworthy borrowers.
Management believes that the loan portfolio is well diversified. The total
commercial portfolio was $631,752,000 at March 31, 2022. Of total loans,
$549,921,000 or 70.6% were secured by commercial real estate, primarily lessors
of residential buildings and dwellings and lessors of non-residential buildings.
The Company continues to monitor these portfolios.
Overall, the portfolio risk profile as measured by loan grade is considered low
risk, as $753,796,000 or 96.9% of gross loans are graded Pass; $2,319,000 or
0.3% are graded Special Mention; $21,772,000 or 2.8% are graded Substandard; and
$0 are graded Doubtful. The rating is intended to represent the best assessment
of risk available at a given point in time, based upon a review of the
borrower's financial statements, credit analysis, payment history with the Bank,
credit history and lender knowledge of the borrower. See Note 4 - Loans and
Allowance for Loan Losses for risk grading tables.
Overall, non-pass grades decreased to $24,091,000 at March 31, 2022, as compared
to $24,737,000 at December 31, 2021. Commercial and Industrial non-pass grades
decreased to $774,000 as of March 31, 2022 as compared to $796,000 as of
December 31, 2021. Commercial Real Estate non-pass grades decreased to
$21,837,000 as of March 31, 2022 as compared to $22,346,000 as of
December 31, 2021. The Residential Real Estate and Consumer loan non-pass grades
decreased to $1,480,000 as of March 31, 2022 as compared to $1,595,000 as of
December 31, 2021.
The Company continues to internally underwrite each of its loans to comply with
prescribed policies and approval levels established by its Board of Directors.
Total Loans
(Dollars in thousands) March 31, December 31,
2022 2021
Commercial and Industrial $ 81,831 $ 82,526
Commercial Real Estate 549,921 521,654
Residential Real Estate 141,990 143,383
Consumer 5,286 5,278
Total Loans $ 779,028 $ 752,841
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses constitutes the amount available to absorb losses
within the loan portfolio. As of March 31, 2022, the allowance for loan losses
was $8,937,000 as compared to $8,680,000 as of December 31, 2021. The allowance
for loan losses is established through a provision for loan losses charged to
expenses. Loans are charged against the allowance for possible loan losses when
management believes that the collectability of the principal is unlikely. The
risk characteristics of the loan portfolio are managed through various control
processes, including credit evaluations of individual borrowers, periodic
reviews, and diversification by industry. Risk is further mitigated through the
application of lending procedures such as the holding of adequate collateral and
the establishment of contractual guarantees.
Management performs a quarterly analysis to determine the adequacy of the
allowance for loan losses. The methodology in determining adequacy incorporates
specific and general allocations together with a risk/loss analysis on various
segments of the portfolio according to an internal loan review process. This
assessment results in an allocated
40
allowance. Management maintains its loan review and loan classification
standards consistent with those of its regulatory supervisory authority.
Management considers, based upon its methodology, that the allowance for loan
losses is adequate to cover foreseeable future losses. However, there can be no
assurance that the allowance for loan losses will be adequate to cover
significant losses, if any, that might be incurred in the future. On a quarterly
basis, management evaluates the qualitative factors utilized in the calculation
of the Company's allowance for loan losses and various adjustments are made to
these factors as deemed necessary at the time of evaluation. The economic impact
caused by the COVID-19 pandemic has played a large role in the qualitative
factor adjustments that have been implemented throughout 2021 and the first
quarter of 2022. Qualitative factors remained unchanged during the first quarter
of 2021, as the economy and unemployment levels showed marked improvement over
the prior quarter. During the second quarter of 2021, the qualitative factors
related to the local/regional economy were decreased by one basis point across
all loan segments, as the economy and job growth in the Company's market areas
demonstrated marked improvement over the prior quarter, and the qualitative
factor related to collateral values was increased by one basis point for both
the Commercial Real Estate and Residential Real Estate portfolio segments due to
increasing market values in the real estate sector. Qualitative factors remained
unchanged during the third quarter of 2021. During the fourth quarter of 2021,
the qualitative factors related to external factors/conditions were increased by
one basis point across all loan segments due increased inflation rates, as well
as elevated unemployment levels (although improved from 2020 and early 2021) and
the uncertainty of how broad the changes implemented by the Federal Reserve
would be, and the qualitative factors related to collateral values were
increased by one basis point across all loan segments, as collateral values
continued to artificially increase as individuals were willing to pay
above-average market prices in all sectors. During the first quarter of 2022,
the qualitative factors related to the local/regional economy were increased by
one basis point across all loan segments due to ongoing economic uncertainty
resulting from supply chain disruptions caused by the COVID-19 pandemic,
conflicts in foreign countries causing inflationary pressures due to
reductions/disruptions in the production of the commodities controlled by these
countries, increased interest rates, and the overall inflation rate continuing
to rise. Modifications granted in compliance with Section 4013 of the CARES Act
were highest in the Commercial Real Estate portfolio segment, the long-term
effects of which are still very unclear, as there is still economic uncertainty
related to the COVID-19 pandemic, especially in relation to this segment of the
Company's loan portfolio. See Allowance for Loan Losses on page 15 for further
discussion.
The Analysis of Allowance for Loan Losses table contains an analysis of the
allowance for loan losses indicating charge-offs and recoveries for the three
months ended March 31, 2022 and 2021. Net recoveries as a percentage of average
loans was 0.005% for the three months ended March 31, 2022 and net charge-offs
as a percentage of average loans was 0.003% for the three months ended March 31,
2021. Net recoveries amounted to $38,000 the three months ended March 31, 2022
as compared to net charge-offs of $21,000 for the three months ended
March 31, 2021.
For the three months ended March 31, 2022, the provision for loan losses was
$219,000 as compared to $135,000 for the three months ended March 31, 2021. The
provision, net of charge-offs and recoveries, resulted in the quarter end
allowance for loan losses of $8,937,000 of which 7.5% was attributed to the
Commercial and Industrial component; 64.4% attributed to the Commercial Real
Estate component; 17.2% attributed to the Residential Real Estate component;
0.9% attributed to the Consumer component; and 10.0% being the unallocated
component (refer to the activity in Note 4 - Loans and Allowance for Loan Losses
on page 15). The Company determined that the provision for loan losses made
during the current quarter was sufficient to maintain the allowance for loan
losses at a level necessary for the probable losses inherent in the loan
portfolio as of March 31, 2022.
41
Analysis of Allowance for Loan Losses
(Dollars in thousands) March 31, March 31,
2022 2021
Balance at beginning of period $ 8,680 $ 7,933
Charge-offs:
Commercial and Industrial - 13
Commercial Real Estate - -
Residential Real Estate - -
Consumer 2 10
2 23
Recoveries:
Commercial and Industrial 1 -
Commercial Real Estate 38 -
Residential Real Estate 1 -
Consumer - 2
40 2
Net (recoveries) charge-offs (38) 21
Additions charged to operations 219 135
Balance at end of period $ 8,937 $ 8,047
Ratio of net (recoveries) charge-offs during the
period to average loans outstanding during the (0.005) % 0.003 %
period
Allowance for loan losses to average loans 1.167 % 1.116 %
outstanding during the period
It is the policy of management and the Company's Board of Directors to make a
provision for both identified and unidentified losses inherent in its loan
portfolio. A provision for loan losses is charged to operations based upon an
evaluation of the potential losses in the loan portfolio. This evaluation takes
into account such factors as portfolio concentrations, delinquency trends,
trends of non-accrual and classified loans, economic conditions, and other
relevant factors.
The loan review process, which is conducted quarterly, is an integral part of
the Bank's evaluation of the loan portfolio. A detailed quarterly analysis to
determine the adequacy of the Company's allowance for loan losses is reviewed by
the Board of Directors.
With the Bank's manageable level of net charge-offs and recoveries along with
the additions to the reserve from the provision out of operations, the allowance
for loan losses as a percentage of average loans amounted to 1.167% and 1.116%
at March 31, 2022 and 2021, respectively.
NON-PERFORMING ASSETS
The table on page 45 details the Company's non-performing assets and impaired
loans as of the dates indicated. Generally, a loan is classified as non-accrual
and the accrual of interest on such a loan is discontinued when the contractual
payment of principal or interest has become 90 days past due or management has
serious doubts about further collectability of principal or interest. A loan may
remain on accrual status if it is in the process of collection and is either
guaranteed or well secured. When a loan is placed on non-accrual status, unpaid
interest credited to income in the current year is reversed and unpaid interest
accrued in prior years is charged against current period income. A modification
of a loan constitutes a TDR when a borrower is experiencing financial difficulty
and the modification constitutes a concession that the Company would not
otherwise consider. Modifications to loans classified as TDRs generally include
reductions in contractual interest rates, principal deferments and extensions of
maturity dates at a stated interest rate lower than the current market for a new
loan with similar risk characteristics. While unusual, there may be instances of
loan principal forgiveness. Any loan modifications made in response to the
COVID-19 pandemic
42
are not considered TDRs as long as the criteria set forth in Section 4013 of the
CARES Act are met. Foreclosed assets held for resale represent property acquired
through foreclosure, or considered to be an in-substance foreclosure.
Total non-performing assets amounted to $7,018,000 as of March 31, 2022, as
compared to $7,066,000 as of December 31, 2021. The economy is very unstable.
The unemployment rate has dropped significantly compared to the beginning of the
COVID-19 pandemic, but the labor force participation rate has also fallen. The
need for workers has driven wages up in most sectors. Inflation is causing
extreme concerns in all areas of the economy. The war abroad and its effects on
various commodities are pushing inflationary concerns. Values of new and used
homes and automobiles continue to climb. The Federal Reserve has indicated a
plan to raise interest rates at an accelerated level throughout the year and
there has been a resurgence of the COVID-19 pandemic in some areas of the
country and world. These forces have had a direct effect on the Company's
non-performing assets. The Company is closely monitoring its Commercial Real
Estate portfolio because of the current uncertain economic environment.
Non-accrual loans totaled $7,018,000 as of March 31, 2022, as compared to
$7,066,000 as of December 31, 2021. There were no foreclosed assets held for
resale as of March 31, 2022 and December 31, 2021. There were no loans past-due
90 days or more and still accruing interest at March 31, 2022 and December 31,
2021.
Non-performing assets to total loans was 0.90% at March 31, 2022 and 0.94% at
December 31, 2021. Non-performing assets to total assets was 0.54% at March 31,
2022 and December 31, 2021, respectively. The allowance for loan losses to total
non-performing assets was 127.34% as of March 31, 2022 as compared to 122.84% as
of December 31, 2021. Additional detail can be found on page 45 in the
Non-Performing Assets and Impaired Loans table and page 24 in the Non-Performing
Assets table. Asset quality is a priority and the Company retains a full-time
loan review officer to closely track and monitor overall loan quality, along
with a full-time loan workout department to manage collection and liquidation
efforts.
Performing substandard loans which are not deemed to be impaired have
characteristics that cause management to have doubts regarding the ability of
the borrower to perform under present loan repayment terms and which may result
in reporting these loans as non-performing loans in the future. Performing
substandard loans not deemed to be impaired amounted to $10,113,000 at
March 31, 2022, compared to $10,463,000 at December 31, 2021.
Impaired loans were $13,373,000 at March 31, 2022 and $13,673,000 at December
31, 2021. The largest impaired loan relationship at March 31, 2022 and December
31, 2021 consisted of a non-performing loan to a student housing holding company
which was secured by commercial real estate. At March 31, 2022, the loan carried
a balance of $3,090,000, net of $1,989,000 that had been charged off to date,
compared to December 31, 2021 when the loan carried a balance of $3,090,000, net
of $1,989,000 that had been charged off to date. The second largest impaired
loan relationship at March 31, 2022 and December 31, 2021 consisted of one
performing loan to a student housing holding company, which was classified as a
TDR. The loan was secured by commercial real estate and carried a balance of
$2,846,000 as of March 31, 2022, net of $943,000 that had been charged off to
date, compared to December 31, 2021 when the loan carried a balance of
$2,864,000, net of $943,000 that had been charged off to date. The third largest
impaired loan relationship at March 31, 2022 and December 31, 2021 consisted of
five non-performing loans to a plastic processing company focused on
non-post-consumer recycling. Three loans were classified in the Commercial and
Industrial portfolio and modified as TDRs and two loans were secured by
commercial real estate. The loans carried an aggregate balance of $1,153,000 at
March 31, 2022, compared to December 31, 2021 when the loans carried an
aggregate balance of $1,176,000.
The Company estimates impairment based on its analysis of the cash flows or
collateral estimated at fair value less cost to sell. For collateral dependent
loans, the estimated appraisal or other qualitative adjustments and cost to
sell percentages are determined based on the market area in which the real
estate securing the loan is located, among other factors, and therefore, can
differ from one loan to another. Of the $13,373,000 in impaired loans at
March 31, 2022, none were located outside of the Company's primary market area.
The outstanding recorded investment of TDRs as of March 31, 2022 and December
31, 2021 was $7,736,000 and $8,020,000, respectively. The decrease in TDRs at
March 31, 2022 as compared to December 31, 2021 is mainly attributable to
regular principal payments and paydowns on existing TDRs that were completed
during the three months ended March 31, 2022. Of the twenty-eight restructured
loans at March 31, 2022, four loans were classified in the
43
Commercial and Industrial portfolio, twenty-three loans were classified in the
Commercial Real Estate portfolio, and one loan was classified in the Residential
Real Estate portfolio. Troubled debt restructurings at March 31, 2022 consisted
of ten term modifications beyond the original stated term, three rate
modifications, and fourteen payment modifications. There was also one troubled
debt restructuring that experienced all three types of modifications-payment,
rate, and term. TDRs are separately evaluated for payment disclosures, and if
necessary, a specific allocation is established. There were no specific
allocations attributable to the TDRs at March 31, 2022 or December 31, 2021.
There were no unfunded commitments attributable to the TDRs at March 31, 2022
and December 31, 2021.
At March 31, 2022, three Commercial and Industrial loans classified as TDRs with
a combined recorded investment of $696,000, six Commercial Real Estate loans
classified as TDRs with a combined recorded investment of $431,000, and one
Residential Real Estate loan classified as a TDR with a balance of $13,000 were
not in compliance with the terms of their restructure, compared to March 31,
2021 when three Commercial and Industrial loans classified as TDRs with a
combined recorded investment of $737,000, six Commercial Real Estate loans
classified as TDRs with a combined recorded investment of $299,000, and one
Residential Real Estate loan classified as a TDR with a recorded investment of
$17,000 were not in compliance with the terms of their restructure.
One Commercial Real Estate loan that was modified as a TDR within the twelve
months preceding March 31, 2022 experienced a payment default during the three
months ended March 31, 2022, but the loan was subsequently paid off prior to the
end of the quarter. Of the loans that were modified as TDRs during the twelve
months preceding March 31, 2021, one Commercial Real Estate loan in the amount
of $92,000 experienced a payment default during the three months ended March 31,
2021.
The Company's non-accrual loan valuation procedure for any loans greater than
$250,000 requires an appraisal to be obtained and reviewed annually at year end,
unless the Board of Directors waives such requirement for a specific loan, in
favor of obtaining a Certificate of Inspection instead, defined as an internal
evaluation completed by the Company. A quarterly collateral evaluation is
performed which may include a site visit, property pictures and discussions with
realtors and other similar business professionals to ascertain current values.
For non-accrual loans less than $250,000 upon classification and typically
at year end, the Company completes a Certificate of Inspection, which includes
the results of an onsite inspection, and may consider value indicators such as
insured values, tax assessed values, recent sales comparisons and a review of
the previous evaluations.
Improving loan quality is a priority. The Company actively works with borrowers
to resolve credit problems and will continue its close monitoring efforts in
2022. Excluding the assets disclosed in the Non-Performing Assets and Impaired
Loans tables below and the Troubled Debt Restructurings section in Note 4 -
Loans and Allowance for Loan Losses, management is not aware of any information
about borrowers' possible credit problems which cause serious doubt as to their
ability to comply with present loan repayment terms.
In addition, regulatory authorities, as an integral part of their examinations,
periodically review the allowance for possible loan losses. They may require
additions to allowances based upon their judgments about information available
to them at the time of examination.
The economic climate remains uncertain at this time. The COVID-19 pandemic has
caused much upheaval and uncertainty in the national and state economy and
experts at all levels are attempting to calculate the intermediate or long term
affects. The Company may experience difficulties collecting payments on time
from its borrowers, and certain types of loans may need to be modified, which
could cause a rise in the level of impaired loans, non-performing assets,
charge-offs, and delinquencies. Should such metrics increase, additions to the
balance of the Company's allowance for loan losses could be required. The extent
of the impact of the COVID-19 pandemic on the Company's operational and
financial performance will depend on certain developments including inflationary
pressures, the labor force, supply bottlenecks, the government's ability to
respond to foreign and domestic issues, and the effectiveness in controlling the
lingering effects of the outbreak, etc. and any after-effects of these factors.
These factors may not immediately impact the Company's operational and financial
performance, as the effects of these factors may lag into the future. The
Company is also susceptible to the impact of economic and fiscal policy factors
that may evolve in the post-pandemic environment.
44
A concentration of credit exists when the total amount of loans to borrowers,
who are engaged in similar activities that are similarly impacted by economic or
other conditions, exceed 10% of total loans. As of March 31, 2022 and
December 31, 2021, management is of the opinion that there were no loan
concentrations exceeding 10% of total loans.
Non-Performing Assets and Impaired Loans
(Dollars in thousands) March 31, December 31,
2022 2021
Non-performing assets
Non-accrual loans $ 7,018 $ 7,066
Foreclosed assets held for resale - -
Loans past-due 90 days or more and still accruing
interest - -
Total non-performing assets $ 7,018 $ 7,066
Impaired loans
Non-accrual loans $ 7,018 $ 7,066
Accruing TDRs 6,355 6,607
Total impaired loans 13,373 13,673
Allocated allowance for loan losses - -
Net investment in impaired loans $ 13,373 $ 13,673
Impaired loans with a valuation allowance $ - $ -
Impaired loans without a valuation allowance 13,373 13,673
Total impaired loans $ 13,373 $ 13,673
Allocated valuation allowance as a percent of impaired
loans
- % - %
Impaired loans to total loans 1.72 % 1.81 %
Non-performing assets to total loans 0.90 % 0.94 %
Non-performing assets to total assets 0.54 % 0.54 %
Allowance for loan losses to impaired loans 66.83 % 63.48 %
Allowance for loan losses to total non-performing
assets 127.34 % 122.84 %
Real estate mortgages comprise 88.8% of the loan portfolio as of March 31, 2022,
as compared to 88.3% as of December 31, 2021. Real estate mortgages consist of
both residential and commercial real estate loans. The real estate loan
portfolio is well diversified in terms of borrowers, collateral, interest rates,
and maturities. Also, the residential real estate loan portfolio is largely
comprised of fixed rate mortgages. The real estate loans are concentrated
primarily in the Company's market area and are subject to risks associated with
the local economy. The commercial real estate loans typically reprice
approximately every three to five years and are also concentrated in the
Company's market area. The Company's loss exposure on its impaired loans
continues to be mitigated by collateral positions on these loans. The allocated
allowance for loan losses associated with impaired loans is generally computed
based upon the related collateral value of the loans. The collateral values are
determined by recent appraisals or Certificates of Inspection, but are generally
discounted by management based on historical dispositions, changes in market
conditions since the last valuation and management's expertise and knowledge of
the borrower and the borrower's business.
DEPOSITS, OTHER BORROWED FUNDS AND SUBORDINATED DEBT
Consumer and commercial retail deposits are attracted primarily by the Bank's
eighteen full service office locations, one loan production office and through
its internet banking presence. The Bank offers a broad selection of deposit
products and continually evaluates its interest rates and fees on deposit
products. The Bank regularly reviews competing financial institutions' interest
rates, especially when establishing interest rates on certificates of deposit.
Total deposits decreased $32,492,000 to $1,045,477,000 as of March 31, 2022 as
non-interest bearing deposits decreased by $7,440,000 and interest bearing
deposits decreased by $25,052,000 from year-end 2021. The decrease in deposits
was the result of a $42,476,000 decrease in highly rate sensitive deposits and
other normal fluctuations. Total
45
short-term and long-term borrowings increased to $87,331,000 as of
March 31, 2022, from $62,377,000 at year-end 2021, an increase of $24,954,000 or
40.0%. The increase in total borrowings was mainly the result of increased
short-term borrowings as deposits decreased and cash balances were deployed into
earning assets.
On December 10, 2020, the Corporation issued $25,000,000 aggregate principal
amount of Subordinated Notes due December 31, 2030 (the "2020 Notes"). The 2020
Notes are intended to be treated as Tier 2 capital for regulatory capital
purposes. The 2020 Notes bear a fixed interest rate of 4.375% per year for the
first five years and then float based on a benchmark rate (as defined).
CAPITAL STRENGTH
Normal increases in capital are generated by net income, less dividends paid
out. During the three months ended March 31, 2022, net income less dividends
paid increased capital by $1,878,000. Accumulated other comprehensive (loss)
income derived from net unrealized gains on debt securities available-for-sale
also impacts capital. At December 31, 2021 accumulated other comprehensive
income was $7,588,000. Accumulated other comprehensive loss stood at
($9,694,000) at March 31, 2022, a decrease of $17,282,000. Fluctuations in
interest rates have regularly impacted the gain/loss position in the Bank's
securities portfolio, as well as its decision to sell securities at a gain or
loss. The fluctuations from net unrealized gains on debt securities
available-for-sale do not affect regulatory capital, as the Bank elected to
opt-out of the inclusion of this item with the filing of the March 31, 2015 Call
Report.
The Company held 231,611 shares of common stock as treasury stock at
March 31, 2022 and December 31, 2021. This had an effect of reducing our total
stockholders' equity by $5,709,000 as of March 31, 2022 and December 31, 2021.
Total stockholders' equity was $133,555,000 as of March 31, 2022, and
$148,555,000 as of December 31, 2021.
At March 31, 2022 the Bank met the definition of a "well-capitalized"
institution under the regulatory framework for prompt corrective action and the
minimum capital requirements under Basel III. The following table presents the
Bank's capital ratios as of March 31, 2022 and December 31, 2021:
To Be Well
Capitalized
Under Prompt
March 31, December 31, Corrective Action
2022 2021 Regulations
Tier 1 leverage ratio (to average assets) 10.56 % 10.14 % 5.00 %
Common Equity Tier 1 capital ratio (to
risk-weighted assets) 15.40 % 15.52 % 6.50 %
Tier 1 risk-based capital ratio (to
risk-weighted assets) 15.40 % 15.52 % 8.00 %
Total risk-based capital ratio 16.44 % 16.57 % 10.00 %
Under the final capital rules that became effective on January 1, 2015, there
was a requirement for a common equity Tier 1 capital conservation buffer of 2.5%
of risk-weighted assets which is in addition to the other minimum risk-based
capital standards in the rule. Institutions that do not maintain this required
capital buffer will become subject to progressively more stringent limitations
on the percentage of earnings that can be paid out in dividends or used for
stock repurchases and on the payment of discretionary bonuses to senior
executive management. The capital buffer requirement was phased in over
three years beginning in 2016. The capital buffer requirement effectively raises
the minimum required common equity Tier 1 capital ratio to 7.0%, the Tier 1
capital ratio to 8.5%, and the total capital ratio to 10.5% on a fully phased-in
basis as of January 1, 2019. As of March 31, 2022, the Bank meets all capital
adequacy requirements under the Basel III Capital Rules on a fully phased-in
basis.
The Corporation's capital ratios are not materially different than those of the
Bank.
46
LIQUIDITY
The Company's objective is to maintain adequate liquidity to meet funding needs
at a reasonable cost and provide contingency plans to meet unanticipated funding
needs or a loss of funding sources, while minimizing interest rate risk.
Adequate liquidity is needed to provide the funding requirements of depositors'
withdrawals, loan growth, and other operational needs.
Sources of liquidity are as follows:
? Growth in the core deposit base;
? Proceeds from sales or maturities of securities;
? Payments received on loans and mortgage-backed securities;
? Overnight correspondent bank borrowings on various credit lines, notes, etc.,
with various levels of capacity;
? Securities sold under agreements to repurchase; and
? Brokered CDs.
At March 31, 2022 the Company had $440,392,000 in maximum borrowing capacity at
FHLB (inclusive of the outstanding balances of FHLB long-term notes, FHLB
short-term borrowings, and irrevocable standby letters of credit issued by
FHLB); the maximum borrowing capacity at ACBB was $15,000,000 and the maximum
borrowing capacity of the Federal Discount Window was $2,912,000.
The Company enters into "Repurchase Agreements" in which it agrees to sell
securities subject to an obligation to repurchase the same or similar
securities. Because the agreement both entitles and obligates the Company to
repurchase the assets, the Company may transfer legal control of the securities
while still retaining effective control. As a result, the repurchase agreements
are accounted for as collateralized financing agreements (secured borrowings)
and act as an additional source of liquidity. Securities sold under agreements
to repurchase were $24,082,000 at March 31, 2022.
Asset liquidity is provided by securities maturing in one year or less, other
short-term investments, federal funds sold, and cash and due from banks. The
liquidity is augmented by repayment of loans and cash flows from mortgage-backed
and asset-backed securities. Liability liquidity is accomplished primarily by
maintaining a core deposit base, acquired by attracting new deposits and
retaining maturing deposits. Also, short-term borrowings provide funds to meet
liquidity needs.
Net cash flows provided by operating activities were $5,448,000 and $2,233,000
as of March 31, 2022 and 2021, respectively. Net income amounted to $3,543,000
for the three months ended March 31, 2022 and $3,878,000 for the three months
ended March 31, 2021. During the three months ended March 31, 2022 and 2021, net
premium amortization on securities amounted to $838,000 and $658,000,
respectively. Net losses on sales of mortgage loans amounted to $34,000 for the
three months ended March 31, 2022, compared to gains on sales of mortgage loans
of $354,000 for the three months ended March 31, 2021. Proceeds (net of
gains/losses) from sales of mortgage loans originated for resale exceeded
originations of mortgage loans originated for resale by $1,228,000 for the three
months ended March 31, 2022, and originations of mortgage loans originated for
resale exceeded proceeds (net of gains/losses) from sales of mortgage loans
originated for resale by $1,984,000 for the three months ended March 31, 2021.
Net securities losses amounted to $63,000 for the three months ended March 31,
2022, compared to net securities gains of $115,000 for the three months ended
March 31, 2021. Accrued interest receivable decreased by $40,000 and $186,000
during the three months ended March 31, 2022 and 2021, respectively. Other
assets increased by $655,000 and $889,000 during the three months ended March
31, 2022 and 2021, respectively. Other liabilities decreased by $347,000 during
the three months ended March 31, 2022 and increased by $433,000 during the three
months ended March 31, 2021.
Investing activities used cash of $48,070,000 and $26,534,000 during the three
months ended March 31, 2022 and 2021, respectively. Net activity in the
available-for-sale securities portfolio (including proceeds from maturities and
redemptions, net against purchases) used cash of $19,679,000 during the three
months ended March 31, 2022, compared to $26,687,000 for the three months ended
March 31, 2021. Changes in restricted investment in bank stocks used cash of
47
$1,130,000 during the three months ended March 31, 2022 and provided cash of
$200,000 during the three months ended March 31, 2021. Net cash used to
originate loans amounted to $27,411,000 for the three months ended March 31,
2022, compared to $62,000 for the three months ended March 31, 2021.
Financing activities used cash of $8,817,000 during the three months ended March
31, 2022 and provided cash of $37,015,000 during the three months ended March
31, 2021. Deposits decreased by $32,492,000 during the three months ended March
31, 2022, compared to an increase of $40,369,000 during the three months ended
March 31, 2021. Short-term borrowings increased by $24,954,000 and $2,929,000
during the three months ended March 31, 2022 and 2021, respectively. No
repayment of long-term borrowings transpired during the three months ended March
31, 2022, compared to the three months ended March 31, 2021 when repayment of
long-term borrowings used cash of $5,000,000. Dividends paid amounted to
$1,665,000 for the three months ended March 31, 2022, compared to $1,647,000 for
the three months ended March 31, 2021.
Managing liquidity remains an important segment of asset/liability management.
The overall liquidity position of the Company is maintained by an active
asset/liability management committee. The Company believes that its core deposit
base is stable even in periods of changing interest rates. Liquidity and funds
management are governed by policies and are measured on a monthly basis. These
measurements indicate that liquidity generally remains stable and exceeds the
Company's minimum defined levels of adequacy. Other than the trends of continued
competitive pressures and volatile interest rates, there are no known demands,
commitments, events or uncertainties that will result in, or that are reasonably
likely to result in, liquidity increasing or decreasing in any material way.
Given our financial strength, we expect to be able to maintain adequate
liquidity as we manage through the current environment, utilizing current
funding options and possibly utilizing new options.
MARKET RISK
Market risk is the risk of loss arising from adverse changes in the fair value
of financial instruments due to changes in interest rates, exchange rates and
equity prices. The Company's market risk is composed primarily of interest rate
risk. The Company's interest rate risk results from timing differences in the
repricing of assets, liabilities, off-balance sheet instruments, and changes in
relationships between rate indices and the potential exercise of explicit or
embedded options.
Increases in the level of interest rates also may adversely affect the fair
value of the Company's securities and other earning assets. Generally, the fair
value of fixed-rate instruments fluctuates inversely with changes in interest
rates. As a result, increases in interest rates could result in decreases in the
fair value of the Company's interest-earning assets, which could adversely
affect the Company's results of operations if sold, or, in the case of
interest-earning assets classified as available-for-sale, the Company's
stockholders' equity, if retained. Under FASB ASC 320-10, Investments - Debt
Securities, changes in the unrealized gains and losses, net of taxes, on debt
securities classified as available-for-sale are reflected in the Company's
stockholders' equity. The Company does not own any trading assets.
Asset/Liability Management
The principal objective of asset/liability management is to manage the
sensitivity of the net interest margin to potential movements in interest rates
and to enhance profitability through returns from managed levels of interest
rate risk. The Company actively manages the interest rate sensitivity of its
assets and liabilities. Several techniques are used for measuring interest rate
sensitivity. Interest rate risk arises from the mismatches in the repricing of
assets and liabilities within a given time period, referred to as a rate
sensitivity gap. If more assets than liabilities mature or reprice within the
time frame, the Company is asset sensitive. This position would contribute
positively to net interest income in a rising rate environment. Conversely, if
more liabilities mature or reprice, the Company is liability sensitive. This
position would contribute positively to net interest income in a falling rate
environment. The Company's cumulative gap at one year indicates the Company is
liability sensitive at March 31, 2022.
48
Earnings at Risk
The Bank's Asset/Liability Committee ("ALCO") is responsible for reviewing the
interest rate sensitivity position and establishing policies to monitor and
limit exposure to interest rate risk. The guidelines established by ALCO are
reviewed by the Company's Board of Directors. The Company recognizes that more
sophisticated tools exist for measuring the interest rate risk in the balance
sheet beyond interest rate sensitivity gap. Although the Company continues to
measure its interest rate sensitivity gap, the Company utilizes additional
modeling for interest rate risk in the overall balance sheet. Earnings at risk
and economic values at risk are analyzed.
Earnings simulation modeling addresses earnings at risk and net present value
estimation addresses economic value at risk. While each of these interest rate
risk measurements has limitations, taken together they represent a reasonably
comprehensive view of the magnitude of interest rate risk to the Company.
Earnings Simulation Modeling
The Company's net income is affected by changes in the level of interest rates.
Net income is also subject to changes in the shape of the yield curve. For
example, a flattening of the yield curve would result in a decline in earnings
due to the compression of earning asset yields and increased liability rates,
while a steepening would result in increased earnings as earning asset and
interest-bearing liability yields widen.
Earnings simulation modeling is the primary mechanism used in assessing the
impact of changes in interest rates on net interest income. The model reflects
management's assumptions related to asset yields and rates paid on liabilities,
deposit sensitivity, size and composition of the balance sheet. The assumptions
are based on what management believes at that time to be the most likely
interest rate environment. Earnings at risk is the change in net interest income
from a base case scenario under various scenarios of rate shock increases and
decreases in the interest rate earnings simulation model.
The table on the next page presents an analysis of the changes in net interest
income and net present value of the balance sheet resulting from various
increases or decreases in the level of interest rates, such as two percentage
points (200 basis points) in the level of interest rates. The calculated
estimates of change in net interest income and net present value of the balance
sheet are compared to current limits approved by ALCO and the Board of
Directors. The earnings simulation model projects net interest income would
decrease 7.63%, 14.22% and 20.45% in the 100, 200 and 300 basis point increasing
rate scenarios presented. In addition, the earnings simulation model projects
net interest income would decrease 0.05% and 4.99% in the 100 and 200 basis
point decreasing rate scenarios presented. All of these forecasts are within the
Company's one year policy guidelines.
The analysis and model used to quantify the sensitivity of net interest income
becomes less reliable in a decreasing rate scenario given the current
unprecedented low interest rate environment with federal funds trading in the 25
- 50 basis point range. Results of the decreasing basis point declining
scenarios are affected by the fact that many of the Company's interest-bearing
liabilities are at rates below 1% and therefore likely may not decline 100 or
more basis points. However, the Company's interest-sensitive assets are able to
decline by these amounts. For the three months ended March 31, 2022, the cost of
interest-bearing liabilities averaged 0.51%, and the yield on interest-earning
assets, on a fully taxable equivalent basis, averaged 3.57%.
Net Present Value Estimation
The net present value measures economic value at risk and is used for helping to
determine levels of risk at a point in time present in the balance sheet that
might not be taken into account in the earnings simulation model. The net
present value of the balance sheet is defined as the discounted present value of
asset cash flows minus the discounted present value of liability cash flows. At
March 31, 2022, net present value is projected to increase 4.52%, 1.23%, and
5.67% in the 100, 200, and 300 basis point immediate increase scenarios,
respectively. Additionally, the 100 and 200 basis point immediate decrease
scenarios are estimated to affect net present value with a decrease of 16.75%
and 51.31%, respectively. These scenarios presented are within the Company's
policy limits, aside from the 200 basis point immediate decrease scenario at
(51.31)% vs. a policy limit of (30.0)%.
49
The computation of the effects of hypothetical interest rate changes are based
on many assumptions. They should not be relied upon solely as being indicative
of actual results, since the computations do not account for actions management
could undertake in response to changes in interest rates.
Effect of Change in Interest Rates
Projected Change
Effect on Net Interest Income
1-Year Net Income Simulation Projection
+300 bp Shock vs. Stable Rate (20.45) %
+200 bp Shock vs. Stable Rate (14.22) %
+100 bp Shock vs. Stable Rate (7.63) %
Flat rate
-100 bp Shock vs. Stable Rate (0.05) %
-200 bp Shock vs. Stable Rate (4.99) %
Effect on Net Present Value of Balance Sheet
Static Net Present Value Change
+300 bp Shock vs. Stable Rate 5.67 %
+200 bp Shock vs. Stable Rate 1.23 %
+100 bp Shock vs. Stable Rate 4.52 %
Flat rate
-100 bp Shock vs. Stable Rate (16.75) %
-200 bp Shock vs. Stable Rate (51.31) %
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