FNCB BANCORP, INC. Management's discussion and analysis ("MD&A") represents an overview of the financial condition and results of operations of FNCB and should be read in conjunction with our consolidated financial statements and notes thereto included in Item 8, "Financial Statements and Supplementary Data" and Item 1A, "Risk Factors" of Part I to this Annual Report on Form 10-K.
FNCB is in the business of providing customary retail and commercial banking services to individuals, businesses and local governments and municipalities through 16 full-service branch offices operated byFNCB Bank , FNCB's wholly-owned subsidiary, within its primary market area,Northeastern Pennsylvania . FORWARD-LOOKING STATEMENTS FNCB may from time to time make written or oral "forward-looking statements," including statements contained in our filings with theSEC , in our reports to shareholders, and in our other communications, which are made in good faith by us pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with respect to FNCB's beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond our control). The words "may," "could," "should," "will," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan," "project," "future" and similar expressions are intended to identify forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumption that are difficult to predict, including those under "Part I, Item 1A. Risk Factors," and elsewhere in this Annual Report on Form 10-K. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Readers are also cautioned not to place undue reliance on any forward-looking statements, which reflect management's analysis only as of the date of this report, even if subsequently made available by FNCB on its website or otherwise. FNCB does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of FNCB to reflect events or circumstances occurring after the date of this report.
CRITICAL ACCOUNTING POLICIES
In preparing the consolidated financial statements, management has made
estimates, judgments and assumptions that affect the reported amounts of assets
and liabilities as of the date of the consolidated statements of condition and
results of operations for the periods indicated. Actual results could differ
significantly from those estimates.
FNCB's accounting policies are fundamental to understanding management's
discussion and analysis of its financial condition and results of operations.
Management has identified the policies on the determination of the allowance for
loan and lease losses ("ALLL"), securities' valuation and impairment
evaluation and income taxes to be critical, as management is required to make
subjective and/or complex judgments about matters that are inherently uncertain
and could be subject to revision as new information becomes available.
The judgments used by management in applying the critical accounting policies
discussed below may be affected by changes and/or deterioration in the economic
environment, which may impact future financial results. Specifically, subsequent
evaluations of the loan portfolio, in light of the factors then prevailing, may
result in significant changes in the ALLL in future periods, and the inability
to collect on outstanding loans could result in increased loan losses. In
addition, the valuation of certain securities in FNCB's investment portfolio
could be negatively impacted by illiquidity or dislocation in marketplaces
resulting in significantly depressed market prices thus leading to impairment
losses.
Allowance for Loan and Lease Losses
Management evaluates the credit quality of FNCB's loan portfolio on an ongoing
basis and performs a formal review of the adequacy of the ALLL on a quarterly
basis. The ALLL is established through a provision for loan losses charged to
earnings and is maintained at a level management considers adequate to absorb
estimated probable losses inherent in the loan portfolio as of the evaluation
date. Loans, or portions of loans, determined by management to be uncollectible
are charged off against the ALLL, while recoveries of amounts previously charged
off are credited to the ALLL.
Determining the amount of the ALLL is considered a critical accounting estimate
because it requires significant judgment and the use of estimates related to the
amount and timing of expected future cash flows on impaired loans, estimated
losses on pools of homogeneous loans based on historical loss experience,
qualitative factors, and consideration of current economic trends and
conditions, all of which may be susceptible to significant change. Banking
regulators, as an integral part of their examination of FNCB, also review the
ALLL, and may require, based on their judgments about information available to
them at the time of their examination, that certain loan balances be charged off
or require that adjustments be made to the ALLL. Additionally, the ALLL is
determined, in part, by the composition and size of the loan portfolio.
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The ALLL consists primarily of two components, a specific component and a general component. The specific component relates to loans that are classified as impaired. For such loans, an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans and is based on historical loss experience adjusted by qualitative factors. The general reserve component of the ALLL is based on pools of unimpaired loans segregated by loan segment and risk rating categories of "Pass", "Special Mention" or "Substandard and Accruing." Historical loss factors and various qualitative factors are applied based on the risk profile in each risk rating category to determine the appropriate reserve related to those loans. Substandard loans on non-accrual status above the$100 thousand loan relationship threshold and all loans considered troubled debt restructurings ("TDRs") are classified as impaired. Based on its evaluations, management may establish an unallocated component that is used to cover any inherent losses that exist as of the evaluation date, but which may not have been identified under the methodology. See Note 2, "Summary of Significant Accounting Policies" and Note 4, "Loans" of the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" to this Annual Report on Form 10-K for additional information about the ALLL.
Securities Valuation and Evaluation for Impairment
Management utilizes various inputs to determine the fair value of its investment
portfolio. To the extent they exist, unadjusted quoted market prices in active
markets (Level 1) or quoted prices for similar assets or models using inputs
that are observable, either directly or indirectly (Level 2) are utilized to
determine the fair value of each investment in the portfolio. In the absence of
observable inputs or if markets are illiquid, valuation techniques are used to
determine fair value of any investments that require inputs that are both
unobservable and significant to the fair value measurement (Level 3). For Level
3 inputs, valuation techniques are based on various assumptions, including, but
not limited to, cash flows, discount rates, adjustments for nonperformance and
liquidity, and liquidation values. A significant degree of judgment is involved
in valuing investments using Level 3 inputs. The use of different assumptions
could have a positive or negative effect on FNCB's financial condition or
results of operations. See Note 3, "Securities" and Note 15, "Fair Value
Measurements" of the notes to consolidated financial statements included in Item
8, "Financial Statements and Supplementary Data" to this Annual Report on Form
10-K for additional information about FNCB's securities valuation techniques.
On a quarterly basis, management evaluates individual investment securities in
an unrealized loss position for other than temporary impairment ("OTTI"). The
evaluation for OTTI requires the use of various assumptions, including but not
limited to, the length of time an investment's fair value is less than book
value, the severity of the investment's decline, any credit deterioration of the
issuer, whether management intends to sell the security, and whether it is
more-likely-than-not that FNCB will be required to sell the security prior to
recovery of its amortized cost basis. Debt investment securities deemed to have
OTTI are written down by the impairment related to the estimated credit loss,
and the non-credit related impairment loss is recognized in other comprehensive
income. FNCB did not recognize any OTTI charges on investment securities for
years ended December 31, 2022 and 2021 within the consolidated statements of
income.
See Note 2, "Summary of Significant Accounting Policies" and Note 3,
"Securities" of the Notes to Consolidated Financial Statements included in Item
8, "Financial Statements and Supplementary Data" to this Annual Report on Form
10-K for additional information about valuation of securities and management's
evaluation for OTTI.
Income Taxes
The objectives of accounting for income taxes are to recognize the amount of
taxes payable or refundable for the current year and deferred tax liabilities
and assets for the future tax consequences of events that have been recognized
in an entity's financial statements or tax returns. Judgement is required in
assessing the future tax consequences of events that have been recognized in
FNCB's consolidated financial statements or tax returns. Fluctuations in the
actual outcome of these future tax consequences could impact our consolidated
financial condition or results of operations.
FNCB records an income tax provision or benefit based on the amount of
tax currently payable or receivable and the change in deferred tax assets and
liabilities. Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
and tax reporting purposes. Management conducts quarterly assessments of all
available positive and negative evidence to determine the amount of deferred tax
assets that will more likely than not be realized. FNCB establishes a valuation
allowance for deferred tax assets and records a charge to income if management
determines, based on available evidence at the time the determination is made,
that it is more likely than not that some portion or all of the deferred tax
assets will not be realized. In evaluating the need for a valuation allowance,
management considers past operating results, estimates of future taxable income
based on approved business plans, future capital requirements and ongoing tax
planning strategies. This evaluation process involves significant management
judgement about assumptions that are subject to change from period to period
depending on the related circumstances. The recognition of deferred tax assets
requires management to make significant assumptions and judgements about future
earnings, the periods in which items will impact taxable income, future
corporate tax rates, and the application of inherently complex tax laws. The use
of different estimates can result in changes in the amounts of deferred tax
items recognized, which may result in equity and earnings volatility because
such changes are reported in current period earnings. Management's evaluation as
of December 31, 2022 and 2021 concluded that no valuation allowance was
necessary for net deferred tax assets.
In connection with determining the income tax provision or benefit, management
considers maintaining liabilities for uncertain tax positions and tax strategies
that it believes contain an element of uncertainty. Periodically, management
evaluates each of FNCB's tax positions and strategies to determine whether a
liability for uncertain tax benefits is required. As of December 31, 2022 and
2021, management determined that FNCB did not have any uncertain tax positions
or tax strategies and that no liability was required to be recorded.
See Note 2, "Summary of Significant Accounting Policies" and Note 11, "Income
Taxes" of the Notes to Consolidated Financial Statements included in Item 8,
"Financial Statements and Supplementary Data" to this Annual Report on Form 10-K
for additional information about the accounting for income taxes.
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New Authoritative Accounting Guidance and Accounting Guidance to be Adopted in Future Periods
For information regarding new authoritative accounting guidance adopted by FNCB during the year endedDecember 31, 2022 and accounting guidance that FNCB will adopt in future periods, see Note 2, "Summary of Significant Accounting Policies" of the notes to consolidated financial statements included in Item 8, "Financial Statements and Supplementary Data" to this Annual Report on Form 10-K. EXECUTIVE OVERVIEW
The following overview should be read in conjunction with this MD&A in its entirety.
Results of Operations Net income in 2022 amounted to$20.4 million , or$1.03 per diluted common share, a decrease of$1.0 million , or 4.4%, compared to$21.4 million , or$1.06 per diluted common share, in 2021. The decrease in 2022 net income compared to 2021 was primarily due to increases in non-interest expense and an increase in the provision for loan and lease losses, which were partially offset by an increase in net interest income. Non-interest expense was$35.5 million in 2022, an increase of$4.4 million , or 14.2%, from$31.1 million in 2021, which reflected a$2.6 million , or 15.5%, increase in salaries and employee benefits. The provision for loan and lease losses increased$1.8 million to$2.0 million in 2022, from$166 thousand in 2021, due primarily to higher loan volume. This was partially offset by a$5.0 million , or 10.3%, increase in net interest income, to$54.0 million in 2022 from$49.0 million in 2021. Income tax expense decreased$512 thousand , or 11.0%, to$4.1 million in 2022 as compared to$4.7 million in 2021. Return on average assets and return on average shareholders' equity equaled 1.21% and 15.55%, respectively, in 2022, compared to 1.36% and 13.46%, respectively, in 2021. FNCB paid dividends to holders of common stock of$0.33 per share in 2022, an increase of$0.06 per share, or 22.2%, compared to$0.27 per share in 2021. Total dividends declared and paid in 2022 equated to a dividend yield of approximately 4.0% based on the closing stock price of$8.21 per share onDecember 31, 2022 . The dividend payout ratio was 31.9% in 2022 compared to 25.4% in 2021. Balance Sheet Profile Total assets increased$81.2 million , or 4.9%, to$1.746 billion atDecember 31, 2022 from$1.664 billion atDecember 31, 2021 . The balance sheet expansion primarily reflected substantial increases in loans and leases, net of allowance for loan and lease losses ("ALLL"), partially offset by decreases in cash and cash equivalents and available-for-sale debt securities. Loans and leases, net of ALLL, increased$143.1 million , or 14.8%, to$1.110 billion atDecember 31, 2022 from$967.0 million atDecember 31, 2021 . Meanwhile, available-for-sale debt securities decreased$46.5 million , or 8.9%, to$476.1 million atDecember 31, 2022 from$522.6 million atDecember 31, 2021 , which was caused largely by a decline in the fair value of these securities due to rising interest rates. Cash and cash equivalents decreased$57.1 million , or 57.8%, to$41.9 million atDecember 31, 2022 from$99.0 million atDecember 31, 2021 . Total deposits decreased$34.8 million , or 2.4%, to$1.421 billion atDecember 31, 2022 from$1.455 billion atDecember 31, 2021 , which reflected the return of municipal deposit seasonality and the outflow of excess COVID-19 deposits. Borrowed funds increased$152.1 million to$182.4 million atDecember 31, 2022 , compared to$30.3 million atDecember 31, 2021 , as FNCB became more reliant on wholesale funding. Total shareholders' equity decreased$43.5 million , or 26.8%, to$118.9 million atDecember 31, 2022 from$162.5 million atDecember 31, 2021 . Tangible book value decreased$2.09 per share, or 25.6%, to$6.04 per share atDecember 31, 2022 from$8.13 per share atDecember 31, 2021 . The decreases in capital and tangible book value were primarily due to an accumulated other comprehensive loss of$48.0 million atDecember 31, 2022 , compared to accumulated other comprehensive income of$6.4 million atDecember 31, 2021 . The negative change of$54.4 million was related primarily to the depreciation in the fair value of FNCB's available-for-sale debt securities, net of deferred taxes, due to the dramatic increase in market interest rates. Also impacting capital in 2022 was net income of$20.4 million partially offset by a$3.6 million utilized for the repurchase of common shares under a stock repurchase program authorized by FNCB's Board of Directors and dividends declared and paid of$6.5 million . AtDecember 31, 2022 ,FNCB Bank's total risk-based capital ratio and the Tier 1 leverage ratio were 13.10% and 8.77%, respectively, which exceeded the 10.00% and 5.00% thresholds required to be well capitalized under the prompt corrective action provisions of the Basel III capital framework forU.S. banking organizations. Management's Focus in 2022
Management continued to navigate through the lingering challenges of the pandemic and manage the rising rate environment, during 2022, while staying focused on several key strategic initiatives which included: strong organic loan growth, new product offerings and effectively managing funding costs. FNCB is always looking to improve the customer experience by further expanding and enhancing FNCB's digital and traditional product and service offerings; while continuing to create efficiency within FNCB's branch network and delivery channels; and investing in strategic business alliances and opportunities to advance financial performance over the long-term.
In 2022, FNCB's new commercial equipment financing and leasing product offerings, operating under 1st Equipment Finance were fully integrated and have exceeded management's expectations. This along with the purchase of several third-party originated loan pools, allowed us to diversify FNCB's loan portfolio, reduce risk and enhance net interest income run rates going forward.
In addition, during 2022, FNCB acquiredChiaro Investment Services, LLC which was combined with FNCB's Wealth Management team, and is now operating under a new brand, 1st Investment Service, out ofFNCB Bank's Exeter Community Office, inLuzerne County, Pennsylvania . With the combined experience of our team of advisors, 1st Investment Services, provides clients with a full suite of offerings, including Investment Management, Brokerage Services, Insurance Planning and Retirement Services that will build on FNCB's exceptional legacy of providing quality services to our clients. In the fourth quarter of 2022, FNCB committed to make an equity investment of$11.0 million in a senior low-income housing tax credit ("LIHTC") partnership for theScranton Square Apartments through thePennsylvania Housing Finance Agency (PHFA). The project will consist of 36 newly constructed senior housing units, located onDickson Ave , in theGreen Ridge section ofScranton ,Lackawanna County, Pennsylvania . This project is expected to provide much needed housing for low-income senior citizens, while revitalizing a large vacant lot in the city and is in line with FNCB's larger Community Caring initiative. One hundred percent (100.0%) of the rental units will qualify for Federal Low-Housing Tax credits ("LIHTCs") as provided for in Section 42 of the Internal Revenue Code of 1986, as amended. FNCB made an initial contribution of$2.2 million in the fourth quarter of 2022, upon closing the partnership agreement. The remaining obligation of$8.8 million , which is included on other liabilities in the consolidated statements of financial condition atDecember 31, 2022 , will be contributed over a series of draws over the following 18-month period according to the construction schedule. 22
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Table of Contents Focus for 2023 Looking ahead to 2023, with increased market rates, management will focus on balance sheet management, managing interest rate risk, controlling funding costs and continuing to evaluate opportunities to enhance net interest income and non-interest income run rates going forward. FNCB will continue to expand its comprehensive digital strategy to respond to evolving customer demands and create operational and delivery channel efficiencies. Specific initiatives include enhancement to the existing online banking platforms, continued utilization of our retail and commercial lending origination platforms and utilizing artificial intelligence and robotics to streamline workflows. Additional areas of focus for 2023 include: acquisition and retainage of qualified staff, building and strengthening our core customer base including increasing existing customer wallet share and organic loan growth.
Stock Repurchase Program/Subsequent Event
OnJanuary 25, 2023 , FNCB's Board of Directors authorized a stock repurchase program under which up to 750,000 shares of FNCB's outstanding common stock may be acquired in the open market commencing no earlier thanMarch 3, 2023 and expiringDecember 31, 2023 pursuant to a trading plan that was adopted in accordance with Rule 10b5-1 of the Exchange Act. In 2022 and 2021, the Board of Directors had authorized similar programs under which 384,830 and 330,759 common shares were repurchased, respectively. The 2022 plan expired onDecember 31, 2022 . The repurchase of shares under the programs are administered through an independent broker. Repurchases may occur from time to time at prevailing market prices, through open market transactions depending upon market conditions, and are subject toSEC regulations as well as certain price, market volume and timing constraints specified in the trading plan. Under the program, the purchases will be funded from working capital presently available to FNCB, and the repurchased shares will be returned to the status of authorized but unissued shares of Common Stock. There is not a guarantee as to the exact number of shares that will be repurchased by FNCB, and FNCB may discontinue purchases at any time that management determines additional repurchases are no longer warranted. As ofDecember 31, 2022 , FNCB had approximately 19.7 million shares outstanding.
SUMMARY OF FINANCIAL PERFORMANCE
Net Interest Income Net interest income is the difference between (i) interest income, interest and fees on interest-earning assets, and (ii) interest expense, interest paid on deposits and borrowed funds. Net interest income represents the largest component of FNCB's operating income and, as such, is the primary determinant of profitability. Net interest income is impacted by variations in the volume, rate and composition of earning assets and interest-bearing liabilities, changes in general market interest rates and the level of non-performing assets. Interest income is shown on a fully tax-equivalent basis using the corporate statutory tax rate of 21.0% in 2022, 2021 and 2020. In response to the economic uncertainty from the global COVID-19 pandemic, theFOMC lowered the federal funds rate 150 basis points in two emergency actions inMarch 2020 . As a result, the target range for federal funds fell from 1.50%-1.75% atDecember 31, 2019 to 0.00%-0.25% atMarch 31, 2022 and had remained at these historically low levels throughMarch 15, 2022 . Supply chain constraints, the war inUkraine and lingering effects from the COVID-19 pandemic, among other things, have resulted in rapid rise in price inflation. As a result, theFOMC , in an effort to lower inflation to its 2.0% objective, began tighteningU.S. monetary policy in 2022. Specifically, theFOMC increased the target range for the federal funds rate seven times for a total of 425 basis points during 2022, which included additional upward movements in the fourth quarter of 75 basis points onNovember 2, 2022 and 50 basis points onDecember 14, 2022 . AtDecember 31, 2022 , the federal funds target range was 4.25%-4.50% compared to 0.00%-0.25% atDecember 31, 2021 . The increase in the federal funds target rate resulted in a corresponding increase of 425 basis points in the national prime rate to 7.50% atDecember 31, 2022 compared to 3.25% atDecember 31, 2021 . In addition to these actions by theFOMC in 2022, onFebruary 1, 2023 , theFOMC raised the federal funds target rate another 25 basis points and reaffirmed its consensus statement on longer-run goals and monetary policy strategy including its goals of maximum unemployment and a 2.0% inflation rate and has indicated additional rate increases may be required in 2023 to achieve its goals. This dramatic shift to tighten monetary policy has resulted in a rapid rise in general market interest rates. Competition for deposits within FNCB's market area has intensified reflective of industrywide liquidity pressures and rate-sensitivity of depositors. Higher interest rates, coupled with the increased competition, has resulted in significant increases in deposit and wholesale funding costs that have surpassed increases in earning asset yields, which has caused interest margin and rate spread compression. Management anticipates that additional tightening actions by theFOMC in 2023, could result in further contraction of FNCB's tax-equivalent net interest margin and rate spread. Additionally, net interest income, earning assets yields and the net interest margin for the period endingDecember 31, 2022 and 2021 were impacted by the activity related to PPP loans, including the timing of forgiveness and recognition of net loan origination fees. 23
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Tax-equivalent net interest income increased$5.3 million , or 10.5%, to$55.2 million in 2022 compared to$49.9 million in 2021. The increase in tax-equivalent net interest income was due to an increase in tax-equivalent interest income reflecting higher earning asset volumes and yields, partially offset by an increase in interest expense which resulted primarily from increased utilization of wholesale funding costs and higher funding costs. Tax-equivalent net interest margin, a key measurement used in the banking industry to measure income from earning assets relative to the cost to fund those assets, is calculated by dividing tax-equivalent net interest income by average interest-earning assets. FNCB's tax-equivalent net interest margin declined 7 basis points to 3.38% in 2022 compared to 3.45% in 2021, which was largely caused by an increase in average earning assets, coupled with higher funding costs. Additionally, the magnitude and velocity of the rate increases in 2022 has led to a decrease in FNCB's rate spread, the difference between the average yield on interest-earning assets shown on a fully tax-equivalent basis and the average cost of interest-bearing liabilities, as funding costs increased to a greater extent than asset yields. FNCB's rate spread was 3.24% in 2022, a decrease of 14 basis points as compared to 3.38% in 2021. Tax-equivalent interest income increased$9.3 million , or 17.6%, to$61.9 million in 2022 from$52.6 million in 2021, which was largely caused by significant growth in average earning assets, coupled with an increase in the tax-equivalent yield on average earning assets. Average earning assets increased$183.5 million , or 12.7%, to$1.633 billion in 2022 from$1.449 billion in 2021, resulting in a corresponding increase to tax-equivalent interest income of$8.4 million . Specifically, average loans and leases increased$123.9 million , or 13.0%, to$1.074 billion in 2022 from$950.5 million in 2021, which reflected new product offerings, strong organic loan demand and the purchase of loan pools from third party originators. Investment securities averaged$550.1 million in 2022, an increase of$120.4 million , or 28.0%, compared to$429.6 million in 2021, which contributed$3.1 million to tax-equivalent interest income. The tax-equivalent yield on earning assets increased 16 basis points to 3.79% in 2022 from 3.63%, which resulted in a corresponding increase in tax-equivalent interest income of$0.8 million . Specifically, FNCB's tax-equivalent yield on loans and leases increased 7 basis points to 4.43% in 2022 compared to 4.36% in 2021, resulting in a corresponding increase in tax-equivalent interest income of$0.7 million . Meanwhile, the tax-equivalent yield on investment securities decreased 1 basis points to 2.58% in 2022 from 2.59% in 2021 and caused a corresponding decrease to tax-equivalent interest income of$44 thousand . Interest expense increased$4.0 million , or 148.9%, to$6.7 million in 2022 from$2.7 million in 2021, which primarily from an increase in averaged borrowed funds, coupled with an increase in funding costs. Similar to the banking industry in general, FNCB was more reliant on wholesale funding in 2022. As a result, average borrowed funds, which is largely comprised of FHLB ofPittsburgh advances, averaged$109.5 million for 2022, an increase of$97.3 million from just$12.2 million for 2021. Higher volumes of average borrowed funds resulted in a corresponding increase in interest expense of$2.4 million . Total interest-bearing deposits increased$51.8 million , or 4.9%, to$1.118 billion for 2022, compared to$1.066 billion for 2021, which had little impact on interest expense as increases in lower-costing interest-bearing demand and savings volumes were offset by a reduction in higher-costing time deposit volumes. Specifically, average interest-bearing demand deposits, increased$50.8 million , or 6.6%, to$815.6 million in 2022, compared to$764.8 million in 2021. Savings deposits averaged$144.3 million in 2022, an increase of$19.3 million , or 15.5%, from$125.0 million in 2021. Conversely, average time deposits decreased$18.3 million , or 10.4%, to$158.0 million in 2022 from$176.3 million in 2021. In the first half of 2022, management was successful in delaying deposit rate increases, however, in the latter half of 2022, following the rapid rise in market interest rates and change in overall market liquidity, competition for deposits intensified and depositors have become increasingly rate sensitive. Due to increased competitive pressures, FNCB responded with increases in deposit rates. As a result, FNCB experienced an increase interest expense due to an increase in funding costs. For the year-endedDecember 31, 2022 , FNCB's cost of funds increased 30 basis points to 0.55% from 0.25% for the year endedDecember 31, 2021 , which resulted in a corresponding increase in tax-equivalent interest expense of$1.6 million . With the additional 25 basis point increase onFebruary 1, 2023 , and statement by theFOMC that additional rate increases may be necessary in 2023, management anticipates that FNCB's cost of funds may continue to increase in 2023, which may result in further net interest margin and rate spread contraction and a reduction in tax-equivalent net interest income. Non-accrual loans The interest income that would have been earned on non-accrual and restructured loans, had these loans performed in accordance with their original terms approximated to$175 thousand and$215 thousand for the years endedDecember 31, 2022 and 2021, respectively. Additionally, interest income recognized on impaired loans based on payments received approximated to$336 thousand and$305 thousand for the years endedDecember 31, 2022 and 2021, respectively. 24
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The following table presents the components of net interest income for the three
years ended
Summary of Net Interest Income
For the Year Ended December 31,
2022 2021 2020
Average Yield/ Average Yield/ Average Yield/
(dollars in
thousands) Balance Interest Cost Balance Interest Cost Balance Interest Cost
Assets:
Earning assets
(2)(3)
Loans and
leases-taxable (4) $ 1,019,254 $ 45,696 4.48 % $ 905,237 $ 39,645 4.38 % $ 863,702 $ 35,980 4.17 %
Loans and leases-tax
free (4) 55,058 1,895 3.44 45,217 1,777 3.93 47,669 2,070 4.34
Total loans and
leases (1)(2) 1,074,312 47,591 4.43 950,454 41,422 4.36 911,371 38,050 4.18
Securities-taxable 439,824 10,830 2.46 346,204 8,476 2.45 250,881 7,322 2.92
Securities-tax free 110,238 3,370 3.06 83,437 2,641 3.17 51,367 1,738 3.38
Total securities
(1)(5) 550,062 14,200 2.58 429,641 11,117 2.59 302,248 9,060 3.00
Interest-bearing
deposits in other
banks and federal
funds sold (8) 8,152 91 1.12 68,932 88 0.13 9,203 28 0.30
Total earning assets 1,632,526 61,882 3.79 % 1,449,027 52,627 3.63 % 1,222,822 47,138 3.85 %
Non-earning assets 69,602 129,386 145,227
Allowance for loan
and lease losses (13,497 ) (12,311 ) (10,867 )
Total assets $ 1,688,631 $ 1,566,102 $ 1,357,182
Liabilities and
Shareholders'
Equity:
Interest-bearing
liabilities
Interest-bearing
demand deposits $ 815,579 3,215 0.39 % $ 764,798 1,252 0.16 % $ 611,511 2,933 0.48 %
Savings deposits 144,343 174 0.12 % 125,022 87 0.07 % 101,847 97 0.10
Time deposits 157,991 581 0.37 % 176,245 1,169 0.66 % 195,140 2,374 1.22
Total
interest-bearing
deposits 1,117,913 3,970 0.36 % 1,066,065 2,508 0.24 % 908,498 5,404 0.59 Borrowed funds and other interest-bearing liabilities 109,515 2,762 2.52 12,228 197 1.61 51,287 756 1.47 Total interest-bearing liabilities 1,227,428 6,732 0.55 % 1,078,293 2,705 0.25 % 959,785 6,160 0.64 % Demand deposits 314,105 315,181 242,017 Other liabilities 15,609 13,892 11,368 Shareholders' equity 131,489 158,736 144,012 Total liabilities and shareholders' equity$ 1,688,631 $ 1,566,102 $ 1,357,182 Net interest income/interest rate spread (6) 55,150 3.24 % 49,922 3.38 % 40,978 3.21 % Tax equivalent adjustment (1,106 ) (928 ) (800 ) Net interest income as reported$ 54,044 $ 48,994 $ 40,178 Net interest margin (7) 3.38 % 3.45 % 3.35 %
(1) Interest income is presented on a tax-equivalent basis using a 21% rate.
(2) Loans and leases are stated net of unearned income.
(3) Non-accrual loans are included in loans within earning assets.
(4) Interest income on loans and leases includes net loan fees of
(5) The yields for securities that are classified as available for sale are
based on the average historical amortized cost.
(6) Interest rate spread represents the difference between the average yield on
interest-earning assets and the cost of average interest-bearing liabilities
and is presented on a tax equivalent basis.
(7) Net interest income as a percentage of total average interest earning
assets.
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The most significant impact on net income between periods is derived from the
interaction of changes in the volume and rates earned or paid on
interest-earning assets and interest-bearing liabilities. The volume of earning
assets, specifically loans and investments, compared to the volume of
interest-bearing liabilities represented by deposits and borrowings, combined
with the spread, produces the changes in net interest income between periods.
The following table summarizes the effect that changes in volumes of earning
assets and interest-bearing liabilities and the interest rates earned and paid
on these assets and liabilities have on net interest income. The net change or
mix component attributable to the combined impact of rate and volume changes has
been allocated proportionately to the change due to volume and the change due to
rate.
Rate Volume Analysis
For the Year Ended December 31,
2022 vs. 2021 2021 vs. 2020
Increase (Decrease) Due to Change in Increase (Decrease) Due to Change in
(in thousands) Volume Rate Total Volume Rate Total
Interest income:
Loans and leases-taxable
356 (238 ) 118 (110 ) (183 ) (293 )
Total loans and leases 5,449 720 6,169 1,663 1,709 3,372
Securities-taxable 2,305 49 2,354 3,097 (1,943 ) 1,154
Securities-tax free 822 (93 ) 729 1,022 (119 ) 903
Total securities 3,127 (44 ) 3,083 4,119 (2,062 ) 2,057
Interest-bearing deposits
in other banks and federal
funds sold (139 ) 142 3 279 (219 ) 60
Total interest income 8,437 818 9,255 6,061 (572 ) 5,489
Interest expense:
Interest-bearing demand
deposits 88 1,875 1,963 602 (2,283 ) (1,681 )
Savings deposits 15 72 87 19 (29 ) (10 )
Time deposits (111 ) (477 ) (588 ) (212 ) (993 ) (1,205 )
Total interest-bearing
deposits (8 ) 1,470 1,462 409 (3,305 ) (2,896 )
Borrowed funds and other
interest-bearing
liabilities 2,395 170 2,565 (623 ) 64 (559 )
Total interest expense 2,387 1,640 4,027 (214 ) (3,241 ) (3,455 )
Net interest income $ 6,050 $ (822 ) $ 5,228 $ 6,275 $ 2,669 $ 8,944 Provision for Loan and Lease Losses
The provision for loan and lease losses is an expense charged against net interest income to provide for probable losses attributable to uncollectible loans and is based on management's analysis of the adequacy of the ALLL. A credit to loan and lease losses reflects the reversal of amounts previously charged to the ALLL. Management closely monitors the loan portfolio and the adequacy of the ALLL by considering the underlying financial performance of the borrower, collateral values and associated credit risks. Future material adjustments may be necessary to the provision for loan and lease losses and the ALLL if economic conditions or loan performance differ substantially from the assumptions management considered in its evaluation of the ALLL. FNCB recorded a provision for loan and lease losses of$2.0 million for the year endedDecember 31, 2022 , an increase of$1.8 million , compared to$166 thousand for the year endedDecember 31, 2021 , which primarily reflected higher loan and lease volume, coupled with a slight increase in net loans charged off. Despite continued economic uncertainty and inflationary pressures due to remnants of the COVID-19 pandemic, supply chain constraints and other factors such as the war inUkraine , which have resulted in monetary policy tightening, FNCB's asset quality metrics have remained mostly favorable throughout 2022 and 2021. 26
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Table of Contents Non-Interest Income
The following table presents the components of non-interest income for the years
ended
Components of Non-Interest Income
Year Ended December 31,
Change
(in thousands) 2022 2021 $ %
Deposit service charges $ 4,415 $ 3,877 $ 538 13.9 %
Net (loss) gain on the sale of
available-for-sale debt securities (223 ) 213 (436 ) (204.7 )
Net (loss) gain on equity securities (34 ) 701 (735 ) (104.9 )
Net gain on the sale of mortgage loans
held for sale 205 352 (147 ) (41.8 )
Net gain on the sale of other real
estate owned - 11 (11 ) (100.0 )
Loan-related fees 243 390 (147 ) (37.7 )
Income from bank-owned life insurance 710 541 169 31.2
Bank-owned life insurance settlement 273 426 (153 ) (35.9 )
Loan referral fees 191 72 119 164.8
Merchant services revenue 712 593 119 20.1
Wealth management services revenue 563 543 20 3.7
Other 926 560 366 65.4
Total non-interest income $ 7,981 $ 8,268 $ (287 ) (3.5 )%
For the year ended December 31, 2022 , non-interest income decreased $287
thousand , or 3.5%, to $8.0 million compared to $8.3 million for the year ended
December 31, 2021 . The 3.5% decrease in non-interest income primarily from an
unfavorable change in market value of equity securities and a net loss on the
sale of available-for-sale debt securities, coupled with reductions in net gains
on the sale of mortgages held for sale, and loan-related fees. Stock market
volatility resulted in FNCB recoding a net loss on equity securities of $34
thousand in 2022, compared to a net gain of $735 thousand recorded in 2021.
Additionally, FNCB recorded a net loss on the sale of available-for sale debt
securities of $223 thousand in 2022, compared to a net gain of $213 thousand in
2021, a decrease of $436 thousand , or 204.7%. Net gains on the sale of mortgages
held for sale decreased $147 thousand , or 41.8%, to $205 thousand for the year
ended December 31, 2022 , compared to $352 thousand for the year ended December
31, 2021 , as pricing margins on loans and the volume of loan sales decreased due
to the rapid rise in market interest rates. Loan-related fees decreased $147
thousand , or 37.7%, to $243 thousand in 2022 from $390 thousand in 2021, which
was largely due to a reduction in loan servicing and letter of credit fees.
Additionally, FNCB recorded income associated with BOLI death benefit claims of
$273 thousand in 2022 and $426 thousand in 2021, a decrease of $153 thousand , or
35.9%.
Partially offsetting these decreases in non-interest income, were increases in
deposit service charges, BOLI income, loan referral fees, merchant services
revenue and other income. Loan referral fees, which include fees received from
third-party counterparties related to various commercial loan interest rate swap
transactions and fees received for the referral of FHA residential mortgage
loans to a third-party broker, increased $119 thousand . The decrease in these
fees reflected a reduction in the number and volume of such transactions in
2022 as compared to 2021. Deposit service charges increased $538 thousand , or
13.9%, to $4.4 million in 2022, compared to $3.9 million in 2021, which was
primarily due to increases in transactional-related charges, check card fees and
wire transfer fees. During 2022, FNCB purchased $3.0 million in additional BOLI
policies, which was the primary factor for the $169 thousand , or 31.2%, increase
in BOLI income. Comparing 2022 and 2021, loan referral fees and merchant
services revenue each increased by $119 thousand . Loan referral fees include
fees received from third-party counterparties to commercial loan interest rate
swap transactions and fees received for the referral of FHA residential mortgage
loans to a third-party broker. The 164.8% increase in loan referral fees largely
reflected an increase in the number and volume of such transaction due to
changing market conditions, while the 20.1% increase in revenue from merchant
services resulted primarily from an increase in card processing revenue due to
the continued shift to e-commerce. The $366 thousand , or 35.0%, increase in
other income was due primarily to an increase in commissions received from
FNCB's third-party credit card and purchasing card provider.
As previously mentioned, on September 30, 2022 FNCB announced that the Bank had
entered into an asset purchase agreement with Chiaro Investment Services, LLC ,
which was combined into the Bank's investment arm and now operates under the new
brand as 1st Investment Services. As a result of this transaction, FNCB
anticipates an increase in income from wealth management services in 2023.
On October 26, 2022 , the Bureau of Consumer Financial Protection ("CFPB") issued
supervisory guidance which warned financial institutions that levying overdraft
fees to consumers who would not reasonably anticipate the fees may constitute an
unfair act or practice under the Consumer Financial Protection Act of 2010
("CFPA"). In addition, the CFPB issued a compliance bulletin warning that
certain depositor fees may similarly violate the CFPA. This guidance comes as a
next step in the CFPB's "junk fee" initiative, launched in January 2022 , through
which the CFPB has endeavored to identify and take certain steps to curb
potentially exploitative fees charged by banks and other financial institutions.
While management does not believe that FNCB's overdraft fees are in violation of
the CFPA, the banking industry, in general, experienced a significant reduction
in overdraft fee income in 2022, as many larger financial institutions have
eliminated overdraft charges on consumer checking accounts. Competition from
large banks and the imposition of restrictions on overdraft fees by the federal
government may result in FNCB having to change its overdraft fee structure,
which could negatively impact future non-interest income run rates.
27--------------------------------------------------------------------------------
Table of Contents Non-Interest Expense
The following table presents the major components of non-interest expense for
the years ended
Components of Non-Interest Expense
Year Ended December 31,
Change
(in thousands) 2022 2021 $ %
Salaries and employee benefits $ 19,283 $ 16,697 $ 2,586 15.5 %
Occupancy expense 2,093 2,039 54 2.6
Equipment expense 1,295 1,338 (43 ) (3.2 )
Advertising expense 801 712 89 12.5
Data processing expense 4,027 3,689 338 9.2
Regulatory assessments 811 609 202 33.2
Bank shares tax 915 975 (60 ) (6.2 )
Professional fees 1,273 674 599 88.9
Other operating expenses 4,976 4,336 640 14.8
Total non-interest expense $ 35,474 $ 31,069 $ 4,405 14.2 %
Non-interest expense totaled $35.5 million in 2022, an increase of $4.4 million ,
or 14.2%, from $31.1 million in 2021. The increase resulted primarily from
increases in salaries and employee benefits, professional fees, data processing
expenses, regulatory assessments and other operating expenses.
Salaries and employee benefits increased $2.6 million , or 15.5%, to $19.3
million in 2022 from $16.7 million in 2021. The increase in salaries and
employee benefits was primarily due to higher full-time salaries, payroll taxes
and benefits associated with staff additions. Also factoring into the increase
in salaries and employee benefits were increases in employment retirement plan
contributions and incentive pay. Recognizing the impact of inflation on
employees, at the end of 2022, FNCB awarded each employee a one-time employee
appreciation bonus to alleviate some of the pressure, the aggregate cost of this
one-time award was $393 thousand .
At the end of 2022, management engaged a third-party consultant to conduct a
comprehensive evaluation of FNCB's salary and benefit structure and industry
comparison. As a result of this study, FNCB has increased the minimum starting
salary for new employees and will be adjusting salary ranges to be competitive
as appropriate. Additionally, FNCB increased the 2023 annual cost of
living/merit increase for employees. As a result of these changes, management
anticipates FNCB's personnel-related costs will continue to increase in 2023.
Professional fees increased $599 thousand , or 88.9%, to $1.3 million in 2022,
compared to $674 thousand in 2021, while data processing expenses increased $338
thousand , or 9.2%, to $4.0 million in 2022, compared to $3.7 million in 2021.
These increases were primarily due to additional costs associated with the new
retail mortgage and commercial lending platforms, coupled with consulting and
validation services associated with implementation of CECL. Additionally,
comparing 2022 and 2021, regulatory assessments increased $202 thousand , or
33.2%, due largely to balance sheet growth, while other operating expenses
increased $640 thousand , or 14.8%, which reflected increases in insurance costs,
legal fees, correspondent bank fees and servicing costs of purchased loans.
Provision for Income Taxes
FNCB recorded income tax expense of $4.1 million in 2022, a decrease of $512
thousand , or 11.0%, compared to $4.6 million in 2021. The decrease in income tax
expense was due to lower taxable income in 2022 as compared to 2021. FNCB's
effective tax rate decreased to 16.85% at December 31, 2022 , compared to
17.89% at December 31, 2021 , which resulted primarily from an increase in
tax-exempt income.
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Management evaluates the carrying amount of its deferred tax assets on a quarterly basis, or more frequently, as necessary, in accordance with guidance set forth in ASC Topic 740 "Income Taxes," and applies the criteria in the guidance to determine whether it is more likely than not that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight of available evidence. If management determines based on available evidence, both positive and negative, that it is more likely than not that some portion or all of the deferred tax asset will not be realized in future periods, a valuation allowance is calculated and recorded. These determinations are inherently subjective and depend upon management's estimates and judgments used in their evaluation of both positive and negative evidence. In evaluating available evidence, management considers, among other factors, historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. In assessing the need for a valuation allowance, management carefully weighs both positive and negative evidence currently available. Management performed an evaluation of FNCB 's deferred tax assets atDecember 31, 2022 taking into consideration both positive and negative evidence as of that date. Based on this evaluation, management believes that FNCB's future taxable income will be sufficient to utilize deferred tax assets. Accordingly, management concluded that no valuation allowance for deferred tax assets was required atDecember 31, 2022 or 2021. FINANCIAL CONDITION Total assets increased$81.2 million , or 4.9%, to$1.746 billion atDecember 31, 2022 from$1.664 billion atDecember 31, 2021 . The balance sheet expansion primarily reflected substantial increases in loans and leases, net of ALLL, partially offset by decreases in cash and cash equivalents and available-for-sale debt securities. Loans and leases, net of ALLL, increased$143.1 million , or 14.8%, to$1.110 billion atDecember 31, 2022 from$967.0 million atDecember 31, 2021 . Available-for-sale debt securities decreased$46.5 million , or 8.9%, to$476.1 million atDecember 31, 2022 from$522.6 million atDecember 31, 2021 , which was caused largely by a decline in the fair value of these securities due to rising interest rates. Cash and cash equivalents decreased$57.1 million , or 57.8%, to$41.9 million atDecember 31, 2022 from$99.0 million atDecember 31, 2021 . Total deposits decreased$34.8 million , or 2.4%, to$1.421 billion atDecember 31, 2022 from$1.455 billion atDecember 31, 2021 , which reflected the return municipal deposit seasonality and the outflow of excess COVID-19 deposits. FNCB increased its utilization of wholesale funding, specifically advances through the FHLB ofPittsburgh , to fund loan growth. As a result, borrowed funds increased$152.1 million , or 501.6%, to$182.4 million atDecember 31, 2022 , compared to$30.3 million atDecember 31, 2021 . Total shareholders' equity decreased$43.5 million , or 26.8%, to$118.9 million atDecember 31, 2022 from$162.5 million atDecember 31, 2021 . The decrease in capital was primarily due to an accumulated other comprehensive loss of$48.0 million atDecember 31, 2022 , compared to accumulated other comprehensive income of$6.4 million atDecember 31, 2021 . The negative change of$54.4 million was related primarily to the depreciation in the fair value of FNCB's available-for-sale debt securities, net of deferred taxes, and was the main factor contributing to a$2.09 per share, or 25.6% decrease in tangible book value to$6.04 per share atDecember 31, 2022 from$8.13 per share atDecember 31, 2021 . Also impacting capital in 2022 was net income of$20.4 million partially offset by a$3.6 million utilized for the repurchase of common shares under a stock repurchase program authorized by FNCB's Board of Directors and dividends declared and paid of$6.5 million . AtDecember 31, 2022 ,FNCB Bank's total risk-based capital ratio and the Tier 1 leverage ratio were 13.11% and 8.77%, respectively, which exceeded the thresholds of 10.00% and 5.00% required to be well capitalized under the prompt corrective action provisions of the Basel III capital framework forU.S. banking organizations. Cash and Cash Equivalents Cash and cash equivalents decreased$57.1 million , or 57.8%, to$ 41.9 million atDecember 31, 2022 , from$99.0 million atDecember 31, 2021 . The decrease in cash and cash equivalents resulted primarily from cash used to fund earning asset growth. Additionally, FNCB paid cash dividends totaling$6.5 million , or$0.330 per share in 2022 compared to$5.4 million , or$0.27 per share, in 2021, while purchase of common shares under the repurchase program amounted to$3.6 million in 2022 compared to$2.4 million in 2021. Securities FNCB's investment securities portfolio provides a source of liquidity needed to meet expected loan demand and interest income to increase profitability. Additionally, the investment securities portfolio is used to meet pledging requirements to secure public deposits and for other purposes. Debt securities are classified as either available-for-sale or held-to-maturity at the time of purchase based on management's intent. Available-for-sale securities are carried at fair value, with unrealized holding gains and losses reported as a component of shareholders' equity in accumulated other comprehensive income (loss), net of tax, while held-to-maturity securities are carried at amortized cost. AtDecember 31, 2022 and 2021, all debt securities were classified as available-for-sale. Equity securities with readily determinable fair values are carried at fair value, with gains and losses due to fluctuations in market value included in the consolidated statements of income. Securities with limited marketability and/or restrictions, such as FHLB ofPittsburgh stock, are carried at cost. Decisions to purchase or sell investment securities are based upon management's current assessment of long- and short-term economic and financial conditions, including the interest rate environment and asset/liability management, liquidity and tax-planning strategies. 29
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AtDecember 31, 2022 , the investment portfolio was comprised principally of available-for-sale debt securities including, fixed-rate, taxable and tax-exempt obligations of state and political subdivisions and fixed-rate and floating-rate securities issued byU.S. government orU.S. government-sponsored agencies, which include mortgage-backed securities and residential and commercial collateralized mortgage obligations ("CMOs"). FNCB also holds investments, to a lesser extent, in private CMO's, corporate debt securities, asset-backed securities andU.S. Treasury securities. Additionally, FNCB holds equity investments in the common and preferred stock of certain publicly traded bank holding companies. Except forU.S. government and government-sponsored agencies, there were no securities of any individual issuer that exceeded 10.0% of shareholders' equity as ofDecember 31, 2022 . The majority of FNCB's debt securities are fixed-rate instruments and inherently subject to interest rate risk, as the value of fixed-rate securities fluctuate with changes in interest rates.U.S. Treasury rates increased dramatically in 2022 as theFOMC continued to tighten monetary policy. Additionally, as short-term interest rates moved up sharply, the yield curve was inverted atDecember 31, 2022 , causing spreads between the 2-year and 10-yearU.S. Treasury rates to go negative. The 10-yearTreasury rate, which was 1.52% atDecember 31, 2021 , increased 236 basis points to 3.88% atDecember 31, 2022 , while the 2-yearTreasury rate, which was 0.73% atDecember 31, 2021 , increased 368 basis point to 4.41% atDecember 31, 2022 . These movements resulted in a negative spread of 53-basis points between the 2-year and 10-yearU.S. Treasury , compared to a positive spread of 0.79% atDecember 31, 2021 . Generally, a security's value reacts inversely with changes in interest rates. Available-for-sale securities are carried at fair value, with unrealized gains or losses reported in the accumulated other comprehensive income or loss component of shareholder's equity net of deferred income taxes. AtDecember 31, 2022 , FNCB reported a net unrealized loss, included in accumulated other comprehensive loss, of$48.8 million , net of deferred income taxes of$13.0 million , a decrease of$55.0 million compared to the net unrealized holding gain of$6.1 million , net of deferred income taxes of$1.6 million , atDecember 31, 2021 . Any further increase in interest rates could result in further depreciation in the fair value of FNCB's securities portfolio and capital position. However, accumulated other comprehensive income and loss related to available-for-sale debt securities is excluded from regulatory capital and does not have an impact on FNCB's regulatory capital ratios.
The following table presents the carrying value of available-for-sale debt
securities and equity securities, at fair value at
Composition of the Investment Portfolio
December 31,
2022 2021 2020
(dollars in thousands) Fair Value % of Portfolio Fair Value % of Portfolio Fair Value % of Portfolio
Available-for-sale debt
securities
U.S. Treasuries $ 32,134 6.75 % $ 36,355 6.96 % $ - - %
Obligations of state and
political subdivisions 220,782 46.37 244,372 46.76 205,828 58.80
U.S.
Government-sponsored
agency:
Collateralized mortgage
obligations -
residential 80,407 16.89 100,710 19.27 56,972 16.28
Collateralized mortgage
obligations - commercial 3,329 0.70 3,727 0.71 3,904 1.12
Residential
mortgage-backed
securities 20,663 4.34 25,506 4.88 13,026 3.72
Private Collateralized
mortgage obligations 72,507 15.23 67,165 12.85 38,199 10.91
Corporate debt
securities 30,672 6.44 32,063 6.14 24,580 7.02
Asset backed securities 14,941 3.14 11,932 2.28 7,526 2.15
Negotiable certificates
of deposit 656 0.14 736 0.14 - -
Total available-for-sale
debt securities $ 476,091 100.00 % $ 522,566 100.00 % $ 350,035 100.00 %
Equity securities, at
fair value $ 7,717 $ 4,922 $ 3,026
FNCB purchased 73 securities with an aggregate cost of $78.1 million and a
weighted-average yield of 3.89% during the year ended December 31, 2022 .
Securities purchased were diversified across all major sectors, including $28.2
million in private CMOs, $18.4 million in tax-free obligations of state and
political subdivisions, $10.7 million in CMOs of U.S. government-sponsored
agencies, $5.7 million in asset-backed securities, $5.0 million in taxable
obligations of state and political subdivisions, $4.4 million in corporate debt
securities and $0.7 in U.S. Treasury securities. Principal repayments and a
decrease in the fair value of the available-for-sale portfolio due to an
increase in market interest rates entirely offset the increase due to the
purchases. In 2022, FNCB also sold available-for-sale securities with an
aggregate amortized cost of $14.2 million and a weighted-average yield of 3.93%.
Gross proceeds received on the sales totaled $14.0 million and a realized net
loss of $223 thousand upon the sale is included in non-interest income in 2022.
Management continually monitors the investment portfolio for credit worthiness,
value, and yield. Semiannually, management engages a third-party consultant to
review the municipal portfolio to determine if there is any undue credit risk
within the portfolio. As part of the independent review, each municipal security
is compared to their Portfolio Credit Benchmark to identify which securities may
contain more than a minimal risk of payment default. As of December 31, 2022 ,
the third-party report concluded that each municipal security held within the
portfolio met or exceeded the benchmark and that none of the securities required
further review. The next third-party review is scheduled for June 30, 2023 .
Management also monitors municipal securities monthly using a third-party surveillance report that identifies events related to the issuer that may indicate a deterioration in credit quality. Management noted no such events during 2022.
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The following table presents the weighted-average yields on available-for-sale debt securities by major category and maturity period atDecember 31, 2022 . Yields are calculated on the basis of the amortized cost and weighted for the scheduled maturity of each security. The yields on tax-exempt obligations of states and political subdivisions are presented on a tax-equivalent basis using the federal corporate income tax rate of 21.0%. Because residential, commercial and private collaterized mortgage obligations, mortgage-backed securities and asset-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following summary. December 31, 2022 Collateralized Mortgage Obligations, Mortgage-Backed and Asset-Backed Within One Year > 1 - 5 Years 6-10 Years Over 10 Years Securities Total Weighted-average yield U.S. Treasury - % 1.11 % 1.18 % - % - % 1.17 % Obligations of state and political subdivisions 2.67 2.95 2.34 2.78 - 2.77
government/government-sponsored
agencies: Collateralized mortgage obligations - residential - - - - 1.62 1.62 Collateralized mortgage obligations - commercial - - - - 1.98 - Mortgage-backed securities - - - - 2.23 2.33 Private collateralized mortgage obligations - - - - 2.32 2.32 Corporate debt securities - - 4.79 - - 4.79 Asset-backed securities - - - - 1.46 1.46 Negotiable certificates of deposit - 1.02 - - - 1.02 Weighted-average yield 2.67 % 2.80 %
2.77 % 2.78 % 1.92 % 2.43 %
OTTI Evaluation
There was no OTTI recognized during the years ended December 31, 2022 and 2021.
For additional information regarding management's evaluation of securities for
OTTI, see Note 3, "Securities" of the Notes to Consolidated Financial Statements
included in Item 8, "Financial Statements and Supplementary Data" to this Annual
Report on Form 10-K.
Management noted no indicators of impairment for the FHLB of
Loans and Leases Total loans and leases, gross increased by$141.9 million , or 14.5%, to$1.123 billion atDecember 31, 2022 from$981.4 million atDecember 31, 2021 . The growth in the loan and lease portfolio reflected increases in all major loan categories, which was primarily due to strong organic demand and the new commercial equipment financing product line. In addition, FNCB purchased individual loans and loan pools originated by third-party originators to enhance interest income revenue streams and diversify the loan portfolio. Loan purchases through 2022 included commercial equipment financing, residential mortgages loans and secured and unsecured consumer installment loans. FNCB expanded its commercial credit product offerings to include commercial equipment financing, including simple interest loans and direct finance and municipal leases, through its brand 1st Equipment Finance. The majority of equipment financing is originated through indirect, third-party dealers. As ofDecember 31, 2022 and 2021, simple interest loans outstanding under this initiative totaled$78.4 million and$7.9 million , respectively, and are included with commercial and industrial loans. Also included with commercial and industrial loans and originated under this initiative are direct finance leases, which totaled$0.9 million atDecember 31, 2022 . There were no direct leases outstanding atDecember 31, 2021 . Municipal leases originated under this initiative were$4.4 million and$2.4 million , respectively, atDecember 31, 2022 and 2021 and are included in state and municipal subdivision loans and leases. Also included in commercial and industrial loans and leases atDecember 31, 2022 and 2021, were$1.3 million and$21.9 million , respectively, in outstanding balances of PPP loans, which are 100.0% guaranteed by the SBA. Accordingly, management excluded PPP loans in its evaluations of the ALLL and there was no ALLL established for PPP loans atDecember 31,2022 and 2021. From a collateral standpoint, a majority of FNCB's loan portfolio consists of loans secured by real estate. Real estate secured loans, which include commercial real estate, construction, land acquisition and development, and residential real estate loans increased by$52.1 million , or 8.1%, to$693.8 million atDecember 31, 2022 from$641.7 million atDecember 31, 2021 . However, the percentage of real estate secured loans to total loans and leases decreased to 61.8% atDecember 31, 2022 from 65.4% atDecember 31, 2021 , which primarily reflected the originations through 1st Equipment Finance. Commercial real estate loans, which include long-term commercial mortgage financing and are primarily secured by first or second lien mortgages, increased$11.0 million , or 3.0%, to$377.0 million atDecember 31, 2022 , from$366.0 million atDecember 31, 2021 . Commercial and industrial loans consist primarily of equipment loans and leases, including purchased commercial equipment loans, working capital financing, revolving lines of credit and loans secured by cash and marketable securities and remaining PPP loans. Commercial and industrial loans increased$78.9 million , or 40.9%, during the year to$272.0 million atDecember 31, 2022 from$193.1 million atDecember 31, 2021 . The increase was primarily due to equipment loan and lease origination through 1st Equipment Finance and the purchase of loan pools through third-party originators, which was partially offset by forgiveness of PPP loans. Construction, land acquisition and development loans increased$25.0 million , or 60.1%, to$66.6 million atDecember 31, 2022 from$41.6 million atDecember 31, 2021 . 31
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Residential real estate loans include fixed-rate and variable-rate, amortizing
mortgage loans, home equity lines of credit ("HELOCs") and HELCOs with a carve
out feature. FNCB primarily underwrites fixed-rate purchase and refinance of
residential mortgage loans for sale in the secondary market to reduce interest
rate risk and provide funding for additional loans. Additionally, FNCB offers a
propriety non-saleable mortgage product branded as the WOW mortgage. The WOW
mortgage has maturity terms of 10 to 19.5 years and offers customers an
attractive fixed interest rate and low closing costs. Residential real estate
loans totaled $250.2 million at December 31, 2022 , an increase of $16.1 million ,
or 6.9%, from $234.1 million at December 31, 2021 .
Consumer loans totaled $92.6 million at December 31, 2022 , an increase of $7.1
million , or 8.3%, from $85.5 million at December 31, 2021 . The increase in
consumer loans was largely due to the purchase of individual and loans and pools
of personal installment loans from third-party originators including unsecured
loans and loans secured by chattel paper. Loans to state and municipal
governments increased $3.8 million , or 6.2%, to $64.9 million at December 31,
2022 from $61.1 million at December 31, 2021 .
The following table presents loans and leases receivable, net by major category
at
Loan and Lease Portfolio Detail
December 31,
2022 2021
% of Total % of Total
(in thousands) Amount Loans, Gross Amount Loans, Gross
Residential real estate $ 250,221 22.28 % $ 234,113 23.86 %
Commercial real estate 376,976 33.56 366,009 37.29
Construction, land acquisition and
development 66,555 5.92 41,646 4.24
Commercial and industrial 272,024 24.22 193,086 19.67
Consumer 92,612 8.24 85,522 8.72
State and political subdivisions 64,955 5.78 61,071 6.22
Total loans, gross 1,123,343 100.00 % 981,447 100.00 %
Unearned income (810 ) (1,442 )
Net deferred loan and lease fees 1,784 (566 )
Allowance for loan and lease losses (14,193 ) (12,416 )
Loans and leases, net $ 1,110,124 $ 967,023 The following tables present the maturity distribution and interest rate
information of the loan and lease portfolio by major category as of
Loans and Leases by Maturity and Interest Rate Sensitivity
December 31, 2022
Five to
Within One One to Five Fifteen Over Fifteen
(in thousands) Year Years Years Years Total
Residential real estate $ 3,897 $ 7,161 $ 114,581 $ 124,582 $ 250,221
Commercial real estate 10,446 55,553 194,572 116,405 376,976
Construction, land acquisition
and development 6,133 16,443 10,863 33,116 66,555
Commercial and industrial 90,529 135,674 45,821 - 272,024
Consumer 1,734 38,042 51,652 1,184 92,612
State and political
subdivisions 104 9,686 33,002 22,163 64,955
Total loans and leases, gross $ 112,843 $ 262,559 $ 450,491 $ 297,450 $ 1,123,343
December 31, 2022
Five to
Within One One to Five Fifteen Over Fifteen
(in thousands) Year Years Years Years Total
Loans with fixed rates
Residential real estate $ 637 $ 6,443 $ 81,396 $ 99,089 $ 187,565
Commercial real estate 2,563 41,679 33,663 - 77,905
Construction, land acquisition
and development 564 1,362 5,927 2,055 9,908
Commercial and industrial 3,316 131,454 35,096 - 169,866
Consumer 1,689 37,928 51,579 1,183 92,379
State and political
subdivisions 104 2,366 30,789 7,644 40,903
Total loans and leases with
fixed rates $ 8,873 $ 221,232 $ 238,450 $ 109,971 $ 578,526
Loans with floating rates
Residential real estate $ 3,260 $ 718 $ 33,185 $ 25,493 $ 62,656
Commercial real estate 7,883 13,874 160,909 116,405 299,071
Construction, land acquisition
and development 5,569 15,081 4,936 31,061 56,647
Commercial and industrial 87,213 4,220 10,725 - 102,158
Consumer 45 114 73 - 232
State and political
subdivisions - 7,320 2,213 14,520 24,053
Total loans and leases with
floating rates $ 103,970 $ 41,327 $ 212,041 $ 187,479 $ 544,817
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Under industry regulations, a concentration is considered to exist when there are loans extended to a multiple number of borrowers engaged in similar activities which would cause them to be similarly impacted by economic or other conditions. Typically, industry guidelines require disclosure of concentrations of loans exceeding 10.0% of total loans outstanding. FNCB had no such concentrations atDecember 31, 2022 and 2021. In addition to industry guidelines, FNCB's internal policy considers a concentration to exist in its loan portfolio if an aggregate loan balance outstanding to borrowers within a specific industry exceeds 25.0% of capital. However, management regularly reviews loans in all industry categories to determine if a potential concentration exists. The following table presents loans by industry, the percentage to gross loans and indicates concentrations greater than 25% of capital atDecember 31, 2022 and 2021: Loan Concentrations December 31, 2022 2021 % of Gross % of Gross (dollars in thousands) Amount Loans Amount Loans Retail space/shopping centers$ 54,461 4.85 %$ 48,590 4.95 % 1-4 family residential investment properties 113,746 10.13 % 92,745 9.45 % Asset Quality Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, net of unearned interest, deferred loan fees and costs, and reduced by the ALLL. The ALLL is established through a provision for loan and lease losses charged to earnings. FNCB has established and consistently applies loan policies and procedures designed to foster sound underwriting and credit monitoring practices. Credit risk is managed through the efforts of loan officers, the Chief Credit Officer, the loan review function, and the Credit Risk Management and the ALLL committees, as well as oversight from the Board of Directors, including the Director's Loan Committee. Management continually evaluates its credit risk management practices to ensure problems in the loan portfolio are addressed in a timely manner, although, as is the case with any financial institution, a certain degree of credit risk is dependent in part on local and general economic conditions that are beyond management's control. Under FNCB's risk rating system, loans that are rated pass, special mention, substandard, doubtful, or loss are reviewed regularly as part of the risk management practices. The Credit Risk Management Committee, which consists of key members of management from the finance, legal, retail lending and credit administration units, meets monthly, or more often as necessary, to review individual problem credits and workout strategies and provides monthly reports to the Director's Loan Committee and full Board of Directors. A loan is considered impaired when it is probable that FNCB will be unable to collect all amounts due (including principal and interest) according to the contractual terms of the note and loan agreement. For purposes of the analysis, all TDRs, loan relationships with an aggregate outstanding balance greater than$100 thousand rated substandard and non-accrual, and loans that are identified as doubtful or loss are considered impaired. Impaired loans are analyzed individually to determine the amount of impairment. For collateral-dependent loans, impairment is measured based on the fair value of the collateral supporting the loans. A loan is determined to be collateral dependent when repayment of the loan is expected to be provided through the operation or liquidation of the collateral held. For impaired loans that are secured by real estate, management obtains external appraisals annually, or more frequently as warranted, to ascertain a fair value so that the impairment analysis can be updated. Should a current appraisal not be available at the time of impairment analysis, management may use other valuations sources, including current letters of intent, broker price opinions or executed agreements of sale. Under the fair value of collateral method, the impaired amount of the loan is deemed to be the difference between the loan amount and the fair value of the collateral, less the estimated costs to sell. For real estate secured loans, management generally estimates selling costs using a factor of 10%, which is based on typical cost factors, such as a 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process. If the valuation indicates that the fair value has deteriorated below the carrying value of the loan, the difference between the fair value and the principal balance is either charged off or a specific reserve is established. For impaired loans for which the value of the collateral less estimated costs to sell exceeds the loan value, the impairment is determined to be zero. For non-collateral-dependent loans, impairment is measured based on the present value of expected future cash flows, net of any deferred fees and costs, discounted at the loan's original effective interest rate. Loans to borrowers that are experiencing financial difficulty that are modified and result in the granting of concessions to the borrowers are classified as TDRs and are considered to be impaired. Such concessions generally involve an extension of a loan's stated maturity date, a reduction of the stated interest rate, payment modifications, capitalization of property taxes with respect to mortgage loans or a combination of these modifications. Non-accrual TDRs are returned to accrual status if principal and interest payments, under the modified terms, are brought current, are performing under the modified terms for six consecutive months, and management believes that collection of the remaining interest and principal is probable. Non-performing loans are monitored on an ongoing basis as part of FNCB's loan review process. Additionally, work-out for non-performing loans and OREO are actively monitored through the Credit Risk Management Committee. A potential loss on a non-performing asset is generally determined by comparing the outstanding loan balance to the fair market value of the pledged collateral, less estimated cost to sell. 33
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Loans are placed on non-accrual when a loan is specifically determined to be impaired or when management believes that the collection of interest or principal is doubtful. This generally occurs when a default of interest or principal has existed for 90 days or more, unless the loan is well secured and in the process of collection, or when management becomes aware of facts or circumstances that the loan would default before 90 days. FNCB determines delinquency status based on the number of days since the date of the borrower's last required contractual loan payment. When the interest accrual is discontinued, all unpaid interest income is reversed and charged back against current earnings. Any subsequent cash payments received are applied, first to the outstanding loan amounts, then to the recovery of any charged-off loan amounts, with any excess treated as a recovery of lost interest. A non-accrual loan is returned to accrual status when the loan is current as to principal and interest payments, is performing according to contractual terms for six consecutive months and future payments are reasonably assured. Management actively manages impaired loans in an effort to mitigate loss to FNCB by working with customers to develop strategies to resolve borrower difficulties, through sale or liquidation of collateral, foreclosure, and other appropriate means, In addition, management monitors employment and economic conditions within FNCB's market area, as weakening of conditions could result in real estate devaluations and an increase in loan delinquencies, which could negatively impact asset quality and cause an increase in the provision for loan and lease losses.
The following table presents information about non-performing assets and
accruing TDRs as of
Non-performing Assets and Accruing TDRs
December 31,
(dollars in thousands) 2022 2021 2020 2019 2018
Non-accrual loans, including
non-accrual TDRs $ 2,763 $ 3,863 $ 5,581 $ 9,084 $ 4,696
Loans past due 90 days or more
and still accruing 79 - - - -
Total non-performing loans 2,842 3,863 5,581 9,084 4,696
Other real estate owned - 920 58 289 919
Other non-performing assets 1,773 1,773 1,900 1,900 1,900
Total non-performing assets $ 4,615 $ 6,556 $ 7,539 $ 11,273 $ 7,515
Accruing TDRs $ 5,554 $ 6,666 $ 6,975 $ 7,745 $ 8,457
Non-performing loans as a
percentage of total loans,
gross 0.25 % 0.39 % 0.62 % 1.10 % 0.56 %
FNCB's asset quality remained favorable throughout 2022. Total non-performing
assets decreased $1.9 million , or 29.6%, to $4.6 million at December 31,
2022 from $6.5 million at December 31, 2021 . The improvement reflected decreases
in non-accrual loans and OREO. Non-performing loans, which include non-accrual
loans and loans past due 90 days or more and still accruing, decreased $1.0
million , or 26.5%, to $2.8 million at December 31, 2022 from $3.8 million at
December 31, 2021 . The reduction in non-accrual loans was primarily due to the
sale to an unrelated third party of two non-accrual loans to one commercial
borrower totaling $0.9 million in the second quarter of 2022. The sale was to
another commercial bank with no gain or loss realized on the sale. The $0.9
million decrease in OREO resulted from the sale of one bank-owned property that
was held in OREO during the first quarter of 2022. In the fourth quarter of
2022, leasehold improvements of a former branch office that was held in OREO was
transferred out and returned to premises and equipment and now serves as an
off-site training facility. FNCB's ratio of non-performing loans to total gross
loans decreased to 0.25% at December 31, 2022 from 0.39% at December 31,
2021 . Similarly, FNCB's ratio of non-performing assets as a percentage of
shareholders' equity decreased to 3.9% at December 31, 2022 from 4.0% at
December 31, 2021 .
Other non-performing assets was comprised solely of a classified account
receivable, the balance of which was $1.8 million at both December 31, 2022 and
2021. The receivable is secured by an evergreen letter of credit that was
received in 2011 as part of a settlement agreement for a large construction,
land acquisition and development loan for a residential development project in
the Pocono region of Monroe County, Pennsylvania . The agreement provides for
payment to FNCB as real estate building lots are sold. The project was stalled
due to a decline in real estate values in this area following the financial
crisis of 2008. In 2019, economic development in this market area began
improving and the developer for this project had resumed construction activity,
including the completion of substantial infrastructure, and had increased
marketing and sales initiatives related to the project. To date, no single-unit
lots have been sold, however, the developer completed the construction of a
seven-unit building that houses timeshare units and owners began occupying the
units in the fourth quarter of 2020. In 2020, management negotiated a repayment
plan with the developer. FNCB received the first payment of $127 thousand in the
second quarter of 2021. Management continues to closely monitor this project and
has noted an increase in construction activity related to this project including
the construction of two additional six- or eight-unit buildings and further site
development including building pads for a new six-seven unit building and
pool/spa building during 2022. Additionally, the developer has increased
marketing and sales initiatives for the project. However, the impact of economic
uncertainty, supply-chain constraints, inflation and other factors are still
unknown and could negatively affect the timing of future sales and payments.
TDRs at
There were no loans modified as TDR during 2022. There was one loan that was modified as a TDR during the year endedDecember 31, 2021 . The modification involved a commercial and industrial loan that was granted a principal forbearance. The pre- and post-modification recorded investment for this loan was$235 thousand .
The average balance of impaired loans, including TDRs was
The additional interest income that would have been earned on non-accrual and
restructured loans had the loans been performing in accordance with their
original terms approximated
For additional information about impaired loans and TDRs, see Note 4, "Loans" of
the notes to consolidated financial statements included in Item 8, "Financial
Statements and Supplementary Data" to this Annual Report on Form 10-K.
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The following table presents the changes in non-performing loans for the years
ended
Changes in Non-performing Loans
Year ended December 31,
(in thousands) 2022 2021
Balance, January 1 $ 3,863 $ 5,581
Loans newly placed on non-accrual 2,325 1,375
Change in loans past due 90 days or more and still accruing 79 -
Loans transferred to OREO - (138 )
Loans returned to performing status - (388 )
Loans charged-off (1,237 ) (735 )
Loans sold (925 ) -
Loan payments received (1,263 ) (1,832 )
Balance, December 31 $ 2,842 $ 3,863 The following table presents accruing loan delinquencies and non-accrual loans
as a percentage of gross loans at
Loan Delinquencies and Non-accrual Loans
December 31,
2022 2021
Accruing:
30-59 days 0.15 % 0.13 %
60-89 days 0.05 0.03
90+ days 0.01 0.00
Non-accrual 0.25 0.39
Total delinquencies 0.45 % 0.55 %
Total delinquencies as a percent of gross loans decreased to 0.45% at December
31, 2022 from 0.55% at December 31, 2021 . The most predominant factor
contributing to the decrease in total delinquencies was the $1.0 million
decrease in non-accrual loans; as previously mentioned, that resulted from the
sale of the $0.9 million in a non-performing commercial relationship.
Allowance for Loan and Lease Losses
The ALLL represents management's estimate of probable loan losses inherent in the loan portfolio. The ALLL is analyzed in accordance with GAAP and is maintained at a level that is based on management's evaluation of the adequacy of the ALLL in relation to the risks inherent in the loan portfolio.
As part of its evaluation, management considers qualitative and environmental factors, including, but not limited to:
? changes in national, local, and business economic conditions and developments,
including the condition of various market segments;
? changes in the nature and volume of the loan portfolio;
? changes in lending policies and procedures, including underwriting standards,
collection, charge-off and recovery practices and results;
? changes in the experience, ability and depth of lending management and staff;
? changes in the quality of the loan review system and the degree of oversight
by the Board of Directors;
? changes in the trend of the volume and severity of past due and classified
loans, including trends in the volume of non-accrual loans, TDRs and other
loan modifications;
? the existence and effect of any concentrations of credit and changes in the
level of such concentrations;
? the effect of external factors such as competition and legal and regulatory
requirements on the level of estimated credit losses in the current loan
portfolio; and
? analysis of customers' credit quality, including knowledge of their operating
environment and financial condition.
Evaluations are intrinsically subjective, as the results are estimated based on management knowledge and experience and are subject to interpretation and modification as information becomes available or as future events occur. Management monitors the loan portfolio on an ongoing basis with emphasis on weakness in both the real estate market and the economy in general and its effect on repayment. Adjustments to the ALLL are made based on management's assessment of the factors noted above.
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For purposes of management's analysis of the ALLL, all loan relationships with an aggregate balance greater than$100 thousand that are rated substandard and non-accrual, identified as doubtful or loss, and all TDRs are considered impaired and are analyzed individually to determine the amount of impairment. Circumstances such as construction delays, declining real estate values, and the inability of the borrowers to make scheduled payments have resulted in these loan relationships being classified as impaired. FNCB utilizes the fair value of collateral method for collateral-dependent loans and TDRs for which repayment depends on the sale of collateral. For non-collateral-dependent loans and TDRs, FNCB measures impairment based on the present value of expected future cash flows discounted at the loan's original effective interest rate. With regard to collateral-dependent loans, appraisals are received at least annually to ensure that impairment measurements reflect current market conditions. Should a current appraisal not be available at the time of impairment analysis, other valuation sources including current letters of intent, broker price opinions or executed agreements of sale may be used. Only downward adjustments are made based on these supporting values. Included in all impairment calculations is a cost to sell adjustment of approximately 10%, which is based on typical cost factors, including a 6% broker commission, 1% transfer taxes and 3% various other miscellaneous costs associated with the sales process. Sales costs are periodically reviewed and revised based on actual experience. The ALLL analysis is adjusted for subsequent events that may arise after the end of the reporting period but before the financial reports are filed. The ALLL equaled$14.2 million atDecember 31, 2022 , an increase of$1.8 million , or 14.3%, from$12.4 million atDecember 31, 2021 . The increase resulted from a provision for loan and lease losses of$2.0 million offset by net charge-offs of$185 thousand for the year endedDecember 31, 2022 . The increase in credit provisioning in 2022 was largely due to the increase in loan volumes as FNCB's assets quality metrics were favorable throughout the year. The ALLL consists of both specific and general components. The component of the ALLL that is related to impaired loans that are individually evaluated for impairment, the guidance for which is provided by ASC 310 " Impairment of a Loan" ("ASC 310"), was$34 thousand , or 0.2% , of the total ALLL atDecember 31, 2022 , compared to$26 thousand , or 0.2%, of the total ALLL atDecember 31, 2021 . A general reserve of$14.2 million was established for loans analyzed collectively under ASC 450 " Contingencies" ("ASC 450"), which represented 99.8% of the total ALLL of$14.2 million atDecember 31, 2022 . Included in the general component of the ALLL were unallocated reserves of$1.1 million , for both years endedDecember 31, 2022 and 2021. Based on its evaluations, management may establish an unallocated component to cover any inherent losses that exist as of the evaluation date, but which may not have been identified under the methodology. In 2020, management established an unallocated reserve for the potential effect of economic uncertainty related to the pandemic. Management believes the level of the unallocated reserve continues to be appropriate atDecember 31, 2022 due to continued economic uncertainty related to global supply-chain issues, the war inUkraine , current inflation levels, monetary policy tightening, among other factors. AtDecember 31, 2022 , management is not aware of any asset quality deterioration and FNCB has not experienced an increase in credit losses related to these factors. The ratio of the ALLL to total loans, net of net deferred loan origination fees and unearned income atDecember 31, 2022 andDecember 31, 2021 was 1.26% and 1.27%, respectively. See Note 2, "Summary of Significant Accounting Policies" of the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" to this Annual Report on Form 10-K for additional information about FNCB's adoption of Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326): "Measurement of Credit Losses on Financial Instruments." The following table presents an allocation of the ALLL by major loan category and percent of loans in each category to total loans atDecember 31 , for each of the last five years: Allocation of the ALLL December 31, 2022 2021 2020 2019 2018 Percentage Percentage Percentage Percentage Percentage of Loans in of Loans in of Loans in of Loans in of Loans in Each Each Each Each Each (dollars in Category to Category to Category to Category to Category to
thousands) Allowance Total Loans Allowance Total Loans Allowance Total Loans Allowance Total Loans
Allowance Total Loans Residential real estate$ 2,215 22.28 %$ 2,081 23.86 %$ 1,715 21.73 %$ 1,147 22.73 %$ 1,175 22.09 % Commercial real estate 4,193 33.56 4,530 37.29 4,268 30.32 3,198 33.69 3,107 31.46 Construction, land acquisition and development 747 5.92 392 4.24 538 6.62 271 5.75 188 2.49 Commercial and industrial 4,099 24.22 2,670 19.67 2,619 26.39 1,997 17.86 2,552 18.08 Consumer 1,307 8.25 1,159 8.72 1,319 9.51 1,658 14.66 2,051 18.81 State and political subdivisions 503 5.78 455 6.22 405 5.43 253 5.31 417 7.07 Unallocated 1,129 - 1,129 - 1,086 - 426 - 29 - Total$ 14,193 100.00 %$ 12,416 100.00 %$ 11,950 100.00 %$ 8,950 100.00 %$ 9,519 100.00 % 36
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The following table presents an analysis of changes in the ALLL and the ratio of
net charge-offs (recoveries) to average loans by major loan category and certain
credit ratios for each of the last five years:
Reconciliation of the ALLL
For the Year Ended December 31,
(dollars in thousands) 2022 2021 2020 2019 2018
Balance, January 1, $ 12,416 $ 11,950 $ 8,950 $ 9,519 $ 9,034
Charge-offs:
Residential real estate 3 14 - 27 63
Commercial real estate - 11 336 - 1,845
Construction, land acquisition
and development - - - 18 -
Commercial and industrial 69 218 254 1,258 97
Consumer 1,234 543 975 1,311 1,134
State and political subdivision - - - - -
Total charge-offs 1,306 786 1,565 2,614 3,139
Recoveries of charged-off
loans:
Residential real estate 3 17 43 9 135
Commercial real estate 293 467 846 32 42
Construction, land acquisition
and development 10 13 - 82 30
Commercial and industrial 30 74 1,220 364 291
Consumer 785 515 515 761 576
State and political subdivision - - - - -
Total recoveries 1,121 1,086 2,624 1,248 1,074
Net charge-offs (recoveries) 185 (300 ) (1,059 ) 1,366 2,065
Provision for loan and lease
losses 1,962 166 1,941 797 2,550
Balance, December 31, $ 14,193 $ 12,416 $ 11,950 $ 8,950 $ 9,519
Net charge-offs (recoveries) to
average loans and leases
Residential real estate - % - % (0.03 )% 0.01 % (0.05 )%
Commercial real estate (0.02 ) (0.13 ) (0.16 ) (0.01 ) 0.62
Construction, land acquisition
and development - (0.02 ) - (0.21 ) (0.13 )
Commercial and industrial 0.36 0.06 (0.43 ) 0.59 (0.12 )
Consumer 0.04 0.03 0.42 0.37 0.35
State and political subdivision 0.04 - - - -
Net charge-offs (recoveries) to
average loans and leases 0.02 % (0.03 )% (0.12 )% 0.16 % 0.25 %
Ratios:
Allowance for loan and lease
losses to gross loans at period
end 1.26 % 1.27 % 1.33 % 1.08 % 1.13 %
Allowance for loan and lease
losses to non-accrual loans 513.68 % 321.41 % 214.12 % 98.52 % 202.70 %
Deposits
Management recognizes the importance of deposit growth as its primary funding
source for loan products and regularly evaluates new products and strategies
focused on growing commercial, consumer and municipal deposit relationships.
Deposit gathering shifted in 2022 and posed many challenges, as FNCB experienced
a return of cyclicality with respect to its municipal customers, while liquidity
pressures throughout the industry and heightened competition were the primary
factors that caused an increase in deposit rates.
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Total deposits de creased$34.4 million , or 2.4%, to$1.421 billion atDecember 31, 2022 from$1.455 billion atDecember 31, 2021 . Interest-bearing deposits decreased$20.1 million , or 1.8%, to$1.115 billion atDecember 31, 2022 from$1.135 billion atDecember 31, 2021 . In addition, non-interest-bearing deposits decreased$14.3 million , or 4.5%, to$305.8 million atDecember 31, 2022 from$320.1 million atDecember 31, 2021 . With regard to interest-bearing deposits, the decrease was primarily concentrated in interest-bearing demand accounts, specifically money market transaction accounts, interest-bearing public funds and interest-bearing business checking accounts. In total, interest-bearing demand deposits decreased$49.4 million , or 5.8%, to$808.5 million atDecember 31, 2022 from$857.9 million atDecember 31, 2021 . Savings accounts increased$14.2 million , or 10.6%, to$148.4 million atDecember 31, 2022 from$134.2 million atDecember 31, 2021 . Time deposits with balances$250 thousand and over decreased$1.6 million , or 6.1%, to$24.9 million a tDecember 31, 2022 , from$26.5 million atDecember 31, 2021 , while other time deposits increased$16.6 million , or 14.3%, to$133.0 million atDecember 31, 2022 from$116.3 million atDecember 31, 2021 . AtDecember 31, 2022 , other time deposits included$20.0 million in brokered time deposits outstanding that are part of an interest rate swap transaction, compared to$10.0 million atDecember 31, 2021 . Total deposits averaged$1.432 billion in 2022, an increase of$50.8 million , or 3.7%, compared to$1.381 billion in 2021. Non-interest-bearing demand deposits averaged$1.1 million , or 0.3%, lower at$314.1 million in 2022 as compared to$315.2 million in 2021. Interest-bearing deposits averaged$1.118 billion in 2022, an increase of$51.9 million , or 4.9%, from$1.066 billion in 2021. The increase was concentrated in average interest-bearing demand deposits which increased$50.8 million , or 6.6% comparing 2022 and 2021. Average savings deposits increased$19.3 million , or 15.5%, to$144.3 million in 2022 from$125.0 million in 2021. Partially offsetting these increases was a decrease of$18.2 million , or 10.3%, in average time deposits, to$158.0 million in 2022 from$176.2 million in 2021. FNCB's deposit funding costs increased 12 basis points, to 0.36% in 2022 from 0.24% in 2021. Rates on interest-bearing demand and savings deposits increased by 23 basis points and 5 basis points, respectively, while time deposit rates decreased by 29 basis points, comparing 2022 and 2021. Given the rising interest rate environments and increasing competition for deposits, management anticipates FNCB's deposit costs will continue to increase in 2023.
The average balance of, and the rate paid on, the major classifications of deposits for the past three years are summarized in the following table:
Deposit Distribution
For the Year Ended December 31,
2022 2021 2020
Average Average Average
(dollars in
thousands) Balance Rate Balance Rate Balance Rate
Interest-bearing
deposits:
Demand $ 815,579 0.39 % $ 764,798 0.16 % $ 611,511 0.48 %
Savings 144,343 0.12 125,022 0.07 101,847 0.10
Time 157,991 0.37 176,245 0.66 195,140 1.22
Total
interest-bearing
deposits 1,117,913 0.36 % 1,066,065 0.24 % 908,498 0.59 %
Non-interest-bearing
deposits 314,105 315,181 242,017
Total deposits $ 1,432,018 $ 1,381,246 $ 1,150,515 The following table presents the maturity distribution of time deposits in
excess of insurance limit at
Maturity Distribution of Time Deposits
December 31,
(in thousands) 2022 2021
3 months or less $ 10,009 $ 10,740
Over 3 through 6 months 4,524 5,354
Over 6 through 12 months 7,362 8,431
Over 12 months 3,007 2,006
Total $ 24,902 $ 26,531
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Table of Contents Borrowings FNCB has an agreement with the FHLB ofPittsburgh which allows for borrowings, either overnight or term, up to a maximum borrowing capacity based on a percentage of qualifying loans pledged under a blanket pledge agreement. In addition to pledging loans, FNCB is required to purchase FHLB ofPittsburgh stock based upon the amount of credit extended. Loans that were pledged to collateralize borrowings under this agreement were$482.1 million atDecember 31, 2022 and$478.3 million atDecember 31, 2021 . FNCB's maximum borrowing capacity was$394.7 million atDecember 31, 2022 . There was$47.5 million in letters of credit to secure municipal deposits outstanding atDecember 31, 2022 under this agreement. There were$139.4 million in overnight advances and$32.7 million in term advances, that were hedged under interest-rate swaps through the FHLB ofPittsburgh outstanding atDecember 31, 2022 . Advances through the Federal Reserve Bank Discount Window generally include short-term advances which are fully collateralized by certain pledged loans of$25.8 million under theFederal Reserve Bank's Borrower-in-Custody ("BIC") program. There were no advances under the BIC program outstanding atDecember 31, 2022 andDecember 31, 2021 . FNCB had available borrowing capacity of$19.0 million under this program atDecember 31, 2022 . FNCB also had$10.3 million of junior subordinated debentures outstanding atDecember 31, 2022 and 2021. The interest rate on these debentures resets quarterly at a spread of 1.67% above the current 3-month LIBOR rate. Upon the expected phase-out of LIBOR onJune 30, 2023 , the interest rate on the debentures will reset quarterly at a spread of 1.67% above 3-month CME Term SOFR plus 0.26161%. CME Term SOFR are administered byCME Group Benchmark Administration Limited (CBA) which is registered under Benchmarks (Amendment and Transitional Provision) (EU Exit) Regulations 2019 (SI 2019/657) is authorized and supervised by theUK Financial Conduct Authority (FCA) and is aligned to the IOSCO Principles for Financial Benchmarks. The average interest rate paid on the junior subordinated debentures in 2022 was 3.47%, compared to 1.85% in 2021. Average borrowed funds increased$97.3 million to$109.5 million in 2022 from$12.2 million in 2021. The average rate paid on borrowed funds increased 91 basis points to 2.52% in 2022 from 1.61% in 2021. The increase in rate on borrowed funds reflected higher average volumes of overnight and short-term borrowings through the FHLB ofPittsburgh in 2022 as compared to 2021, as short-term borrowing rates were at historical lows. Average borrowed funds in 2022 was comprised mainly of overnight advances through the FHLB ofPittsburgh . See Note 8, "Borrowed Funds" of the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" to this Annual Report on Form 10-K for additional information about FNCB's borrowed funds. Liquidity The term liquidity refers to the ability to generate sufficient amounts of cash to meet cash flow needs. Liquidity is required to fulfill the borrowing needs of FNCB's credit customers and the withdrawal and maturity requirements of its deposit customers, as well as to meet other financial commitments. FNCB's liquidity position is impacted by several factors, which include, among others, loan and lease origination volumes, loan, lease and investment maturity structure and cash flows, deposit demand and time deposit maturity structure and retention. FNCB has liquidity and contingent funding policies in place that are designed with controls in place to provide advanced detection of potentially significant funding shortfalls, establish methods for assessing and monitoring risk levels, and institute prompt responses that may alleviate a potential liquidity crisis. Management monitors fluctuations in FNCB's liquidity position daily and forecasts future liquidity needs. Additionally, management performs periodic stress tests on FNCB's liquidity position that attempt to model in varying degrees of stress in order to proactively develop strategies to ensure adequate liquidity at all times. Additionally, management regularly monitors FNCB's wholesale funding sources taking into consideration the cost of funds, diversification between funding sources and asset/liability management strategies. FNCB utilizes brokered deposits, including one-way purchases through the IntraFiSM Network, deposits acquired through a national listing service, as well as overnight and term advances through the FHLB ofPittsburgh as wholesale sources of funds to supplement its deposit gathering initiatives. The statements of cash flows present the change in cash and cash equivalents from operating, investing and financing activities. Cash and due from banks and interest-bearing deposits in other banks, which comprise cash and cash equivalents, are FNCB's most liquid assets. Cash and cash equivalents totaled$41.9 million atDecember 31, 2022 , a decrease of$57.1 million , or 57.7%, from$99.0 million atDecember 31, 2021 , as net cash outflows for investing activities more than offset net cash inflows from operating and financing activities. Net cash outflows from investing activities used$184.6 million of cash and cash equivalents during the year endedDecember 31, 2022 . Accounting for the majority of the net cash outflow was a net increase in loans and leases of$144.5 million , which reflected increased demand, ALCO initiatives to hold in portfolio saleable 1-4 family residential mortgages, and the purchase of individual loans and loan pools from third-party originators. Additionally, cash outflows for purchases of available-for-sale debt securities, net of inflows for sales, maturities, calls and repayments, were$26.2 million in 2022. Also contributing to the net cash outflow for investing activities were purchases of$6.6 million in restricted stock,$3.2 million in equity securities,$3.0 million in new BOLI policies and$2.2 million for the initial investment in a LIHTC program. Financing activities provided$107.5 million in net cash, which resulted primarily from the proceeds from overnight and net term advances through the FHLB ofPittsburgh , of$139.4 million and$12.7 million , respectively. These inflows were slightly offset by the$34.4 million decrease in deposits, net cash used to pay dividends to shareholder dividends of$6.5 million and to repurchase shares of common stock totaling$3.6 million . Operating activities include net income, adjusted for the effects of non-cash transactions including, among others, depreciation and amortization and the provision for loan and lease losses, and is the primary source of cash flows from operations. In 2022, operating activities provided FNCB with$20.0 million in net cash, which reflected net income of$20.4 million , net of a reduction for non-cash negative adjustments of$475 thousand . 39
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Management is actively monitoring FNCB's liquidity position and capital adequacy in light of the changing circumstances related to economic uncertainty, liquidity constraints, current inflation levels, rising interest rates and increased competition. Management believes that FNCB's current liquidity position is sufficient to meet its cash flow needs as ofDecember 31, 2022 . In addition to cash and cash equivalents of$41.9 million atDecember 31, 2022 , FNCB had ample sources of additional liquidity including approximately$394.5 million in available borrowing capacity with the FHLB ofPittsburgh , and available borrowing capacity through The Federal Reserve Discount Window of$19.0 million under the BIC program. In addition, FNCB had$75.0 million in federal fund lines of credit available through correspondent banks atDecember 31, 2022 , as well as access to wholesale deposit markets. While management believes FNCB has adequate liquidity to meet its cash flow needs, they are keenly aware that changes in general economic conditions, including inflation, further increases in interest rates and competition, among other factors, could pose potential stress on liquidity should deposits begin exiting the Bank and/or FNCB's asset quality deteriorates. Additionally, FNCB could experience an increase in the utilization of existing lines of credit as customers manage their own liquidity needs during this time of economic uncertainty. Management continually monitors FNCB's liquidity positions and sources of available liquidity in relation to funding and cash flow need and evaluates potential sources of additional liquidity. Management is currently evaluating FNCB's ability to pledge equipment loans originated under 1st Equipment Finance and increase borrowing capacity through the Federal Reserve Discount Window under the BIC program. Capital A strong capital base is essential to the continued growth and profitability of FNCB and is therefore a management priority. Management's principal capital planning goals include providing an adequate return to shareholders, retaining a sufficient base from which to provide for future growth, and complying with applicable regulatory standards. As more fully described in Note 15, "Regulatory Matters" to the notes to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K, regulatory authorities have prescribed specified minimum capital ratios as guidelines for determining capital adequacy to help assure the safety and soundness of financial institutions.
The following schedules present information regarding the Bank's risk-based
capital at
Minimum
Minimum Required To
Minimum Required For Be Well
Required Capital Capitalized
For Adequacy Under Prompt
Capital Purposes with Corrective
Adequacy Conservation Action
FNCB Bank Purposes Buffer Regulations
(dollars in thousands) Amount Ratio Ratio Ratio Ratio
Total capital (to risk-weighted assets)$ 169,984 13.11 % 8.00 % 10.50 % 10.00 % Tier I capital (to risk-weighted assets) 154,842 11.94 % 6.00 % 8.50 % 8.00 % Tier I common equity (to risk-weighted assets) 154,842 11.94 % 4.50 % 7.00 % 6.50 % Tier I capital (to average assets) 154,842 8.77 % 4.00 % 4.00 % 5.00 % Total risk-weighted assets 1,296,618 Total average assets 1,765,251 Minimum Minimum Required To Minimum Required For Be Well Required Capital Capitalized For Adequacy Under Prompt Capital Purposes with Corrective Adequacy Conservation Action FNCB Bank Purposes Buffer Regulations (dollars in thousands) Amount Ratio Ratio Ratio Ratio
Total capital (to risk-weighted assets)$ 161,957 14.64 % 8.00 % 10.50 % 10.00 % Tier I capital (to risk-weighted assets) 148,958 13.46 % 6.00 % 8.5 % 8.00 % Tier I common equity (to risk-weighted assets) 148,958 13.46 % 4.50 % 7.00 % 6.50 % Tier I capital (to average assets) 148,958 8.92 % 4.00 % 4.00 % 5.00 % Total risk-weighted assets 1,106,636 Total average assets 1,669,932 40
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FNCB's total regulatory capital increased
As ofDecember 31, 2022 , FNCB had 30,132,391 shares of common stock available for future sale or share dividends. Quarterly market highs and lows, dividends paid and known market makers are highlighted in Part I, Item 5, "Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases ofEquity Securities " of this Annual Report on Form 10-K. For further discussion of FNCB's capital requirements and dividend limitations, refer to Note 15, "Regulatory Matters," of the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.
Additionally, FNCB has available 20,000,000 authorized shares of preferred
stock. There were no preferred shares issued and outstanding at
OnJanuary 25, 2023 , FNCB's Board of Directors authorized the repurchase of up to 750,000 shares of FNCB's outstanding common stock may be acquired in the open market commencing no earlier thanMarch 3, 2023 and expiring onDecember 31, 2023 pursuant to a trading plan that was adopted in accordance with rule 10b5-1 of the Exchange Act. Repurchases under this program are administered through an independent broker and are subjected toSEC regulations as well as certain price, market volume and timing constraints specified in the trading plan. In 2022 and 2021, the Board of Directors had authorized a similar program under which 384,830 and 330,759 common shares were repurchased, respectively. FNCB's ability to pay dividends to its shareholders is largely dependent on the Bank's ability to pay dividends toFNCB. Bank regulations limit the amount of dividends that may be paid without prior approval of the Bank's regulatory agency. Cash dividends declared and paid by FNCB during 2022 and 2021 were$0.33 per share and$0 .27per share, respectively. FNCB offers a Dividend Reinvestment and Stock Purchase plan ("DRP") to its shareholders. For the years endedDecember 31, 2022 and 2021 dividend reinvestment shares were purchased in open market transactions, while shares under the optional cash purchase feature of the DRP were issued from authorized but unissued common shares. Shares of common stock issued under the DRP totaled 5,089 and 12,189 for the years endedDecember 31, 2022 and 2021, respectively. Subsequent toDecember 31, 2022 , onJanuary 25, 2023 , FNCB declared a$0.090 per share dividend payable onMarch 15, 2023 to shareholders of record onMarch 1, 2023 .
Off-Balance Sheet Arrangements
In the ordinary course of operations, FNCB engages in a variety of financial transactions that, in accordance with GAAP, are not recorded in our consolidated financial statements or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions may be used for general corporate purposes or for customer needs. Corporate purpose transactions would be used to help manage credit, interest rate and liquidity risk or to optimize capital. Customer transactions are used to manage customers' requests for funding. For the year endedDecember 31, 2022 , FNCB did not engage in any off-balance sheet transactions that would have or would be reasonably likely to have a material effect on its consolidated financial condition. For a further discussion of FNCB's off-balance sheet arrangements, refer to Note 13, "Commitments, Contingencies, and Concentrations" to the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K. The following table presents off-balance financial instruments whose contractual amounts represent credit risk atDecember 31, 2022 and 2021. With the exception of credit availability for certain commercial construction, land acquisition and development loans having a 24-month draw period, all of the off-balance sheet financial instruments outstanding atDecember 31, 2022 expire within one year of their respective contract dates. Off-Balance Sheet Commitments December 31, (in thousands) 2022 2021 Commitments to extend credit$ 301,300 $ 273,883 Standby letters of credit 17,923 17,179
In order to provide for probable losses inherent in these instruments, FNCB
recorded reserves for unfunded commitments of
Impact of Inflation and Changing Prices
The preparation of financial statements in conformity with GAAP requires
management to measure the FNCB's financial position and operating results
primarily in terms of historic dollars. Changes in the relative value of money
due to inflation or recession are generally not considered. The primary effect
of inflation on FNCB's operations is primarily related to increases in operating
expenses. Management considers changes in interest rates to impact our financial
condition and results of operations to a far greater degree than changes in
prices due to inflation. Although interest rates are greatly influenced by
changes in the inflation rate, they do not necessarily change at the same rate
or in the same magnitude as the inflation rate. FNCB manages interest rate risk
in several ways. Refer to "Interest Rate Risk" in Item 7A for further
discussion. There can be no assurance that FNCB will not be materially adversely
affected by future changes in interest rates, as interest rates are highly
sensitive to many factors that are beyond its control. Additionally, inflation
may adversely impact the financial condition of FNCB's borrowers and could
impact their ability to repay their loans, which could negatively affect FNCB's
asset quality through higher delinquency rates and increased charge-offs.
Management will carefully consider the impact of inflation and rising interest
rates on FNCB borrowers in managing credit risk related to the loan and lease
portfolio.
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