Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis provides an overview of the financial condition and results of operations of Embassy Bancorp, Inc. (the “Company”) as of September 30, 2019 and for the three and nine months ended September 30, 2019 and 2018, respectively. This discussion should be read in conjunction with the preceding consolidated financial statements and related footnotes, as well as with the audited consolidated financial statements and the accompanying notes for the year ended December 31, 2018 included in the Company’s Form 10-K filed with the Securities and Exchange Commission. Current performance does not guarantee and may not be indicative of similar performance in the future.
Critical Accounting Policies
Disclosure of the Company’s significant accounting policies is included in Note 1 to the consolidated financial statements included in the Company’s Form 10-K for the year ended December 31, 2018. Some of these policies are particularly sensitive, requiring significant judgments, estimates and assumptions to be made by management, most particularly in connection with determining the provision for loan losses and the appropriate level of the allowance for loan losses and the valuation of deferred tax assets. Additional information is contained in this Form 10-Q under the paragraphs titled “Provision for Loan Losses,” “Credit Risk and Loan Quality,” and “Income Taxes” contained on the following pages.
Caution About Forward-looking Statements
This report contains forward-looking statements, including statements of goals, intentions, and expectations as to future trends, plans, events or results of Company operations and policies and regarding general economic conditions. These forward-looking statements are intended to be covered by the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. These statements are based upon current and anticipated economic conditions, nationally and in the Company’s market, interest rates and interest rate policy, competitive factors and other conditions that, by their nature, are not susceptible to accurate forecast, and are subject to significant uncertainty.
Such forward-looking statements can be identified by the use of forward-looking terminology such as “believes”, “expects”, “may”, “intends”, “will”, “should”, “anticipates”, or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy.
No assurance can be given that the future results covered by forward-looking statements will be achieved. Such statements are subject to risks, uncertainties, and other factors that could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could impact the Company’s operating results include, but are not limited to, (i) the effects of changing economic conditions in the Company’s market areas and nationally, (ii) credit risks of commercial, real estate, consumer and other lending activities, (iii) significant changes in interest rates, (iv) changes in federal and state banking laws and regulations which could impact the Company’s operations, (v) changes in accounting policies or procedures as may be required by FASB or regulatory agencies, and (vi) other external developments which could materially affect the Company’s business and operations, as well as the risks described in the Company’s Form 10-K for the year ended December 31, 2018 and subsequent filings with the SEC.
OVERVIEW
The Company is a Pennsylvania corporation organized in 2008 and registered as a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Company was formed for purposes of acquiring Embassy Bank For The Lehigh Valley (the “Bank”) in connection with the reorganization of the Bank into a bank holding company structure, which was consummated on November 11, 2008. Accordingly, the Company owns all of the capital stock of the Bank, giving the organization more flexibility in meeting its capital needs as the Company continues to grow. Embassy Holdings, LLC (the “LLC”) is a wholly-owned subsidiary of the Bank organized to engage in the holding of property acquired by the Bank in satisfaction of debts previously contracted. As such, the consolidated financial statements contained herein include the accounts of the Company, the Bank and the LLC.
The Bank, which is the Company’s primary operating subsidiary, was originally incorporated as a Pennsylvania bank on May 11, 2001 and opened its doors on November 6, 2001. It was formed by a group of local business persons and professionals with significant prior experience in community banking in the Lehigh Valley area of Pennsylvania, the Bank’s primary market area, for the purpose of providing a local community bank to serve Lehigh and Northampton Counties in Pennsylvania.
Since its inception, the Board’s philosophy has been that, by running the Bank with a view toward the long term, only good things will happen for the Bank’s customers, team members, shareholders and the Lehigh Valley community.
The Company’s assets increased $62.1 million from $1.10 billion at December 31, 2018 to $1.16 billion at September 30, 2019. The increase was in part due to the adoption of ASU No. 2016-02, pursuant to which the Company has recognized a right of use asset of $9.9 million as of September 30, 2019. The Company's deposits grew $103.5 million from $931.5 million at December 31, 2018 to $1.04 billion at September 30, 2019. The growth in the Company’s deposits was primarily the result of a $68.3 million increase in time deposits and a $36.5 million increase in interest bearing demand, NOW and money market accounts resulting from various promotions. In addition, the overall deposit growth is attributable to a highly effective relationship building, sales and marketing effort, which served to further increase the Company’s overall presence in the market it serves, along with deposit relationships developed as a result of cross-marketing efforts to its loan and other non-depository banking service customers. These funds were in part used to pay off FHLB short-term borrowings, fund new loan growth, purchase securities available for sale, and increase interest bearing demand deposits with banks. The Bank also continues to capitalize on opportunities created by recent merger announcements, name changes, and competitive branch closures in the Company’s market area, attracting customers looking to relocate to a local, reputable community bank.
During the same period, loans receivable, net of allowance for loan losses, increased $29.1 million from $949.9 million at December 31, 2018 to $979.0 million at September 30, 2019. The market continues to be very competitive and the Company is committed to maintaining a high-quality portfolio that returns a reasonable market rate. While the past and current economic and competitive conditions in the marketplace have created more competition for loans to credit-worthy customers, the Company anticipates that its lending activity will increase in the short-term, as the Company expands its market presence and continues to focus on developing a reputation as being a market leader in both commercial and consumer/mortgage lending. Management believes that this combination of relationship building, cross marketing and responsible underwriting will translate into continued growth of a portfolio of quality loans and core deposit relationships, although there can be no assurance of this. The Company continues to monitor interest rate exposure of its interest-bearing assets and liabilities and believes that it is well positioned for any anticipated future market rate adjustments.
Net income for the three months ended September 30, 2019 was $2.8 million compared to net income for the three months ended September 30, 2018 of $2.7 million, an increase of $149 thousand, or 5.6%. Basic and diluted earnings per share increased to $0.38 for the three months ended September 30, 2019, as compared to $0.36 for basic earnings per share and $0.35 for diluted earnings per share for the three months ended September 30, 2018. The difference in net income for the three months ended September 30, 2019 and September 30, 2018 resulted, in part, from an increase in net interest income due to the Company’s growing loan portfolio and increase in loan yields, increase in short-term investments and a decrease in FHLB short-term borrowing interest expense. The Company also had an increase in non-interest income from the growing customer base and no write downs of real estate owned in the quarter ending September 30, 2019, as well as a decrease in non-interest expenses primarily resulting from a decrease in advertising, FDIC insurance and other expenses, offset by increased deposit interest expense from the growth in deposit balances and rates and an increase in salaries and benefits and occupancy and equipment.
Net income for the nine months ended September 30, 2019 was $8.0 million compared to net income for the nine months ended September 30, 2018 of $7.6 million, an increase of $428 thousand, or 5.7%. Basic and diluted earnings per share increased to $1.07 and $1.06 for the nine months ended September 30, 2019, as compared to $1.01 and $1.00 for the nine months ended September 30, 2018. The difference in net income for the nine months ended September 30, 2019 and September 30, 2018 resulted, in part, from an increase in net interest income due to the Company’s growing loan portfolio and increase in yields, increase in short-term investments, decrease in FHLB short-term borrowing interest expense, decrease in the provision from loan loss, increase in non-interest income from the growing customer base, increase in bank owned life insurance income, gain on the sale of real estate owned and no write downs of real estate owned in the year ending September 30, 2019, decrease in FDIC insurance and loan and real estate non interest expenses, offset by increased deposit interest expense from the growth in deposit balances and rates, and an increase in non-interest expenses primarily caused by the increase in salaries and benefits, occupancy and equipment and data processing expense.
RESULTS OF OPERATIONS
Net Interest Income
Total interest income for the three months ended September 30, 2019 increased $903 thousand to $10.9 million, as compared to $10.0 million for the three months ended September 30, 2018. Average earning assets were $1.11 billion for the three months ended September 30, 2019, as compared to $1.04 billion for the three months ended September 30, 2018. The tax equivalent yield on average earning assets was 3.92% for the third quarter of 2019 compared to 3.85% for the third quarter of 2018.
Total interest expense for the three months ended September 30, 2019 increased $754 thousand to $2.4 million, as compared to $1.7 million for the three months ended September 30, 2018. Average interest bearing liabilities were $865.2 million for the three months ended September 30, 2019, as compared to $826.1 million for the three months ended September 30, 2018. The yield on average interest bearing liabilities was 1.12% and 0.81% for the third quarter of 2019 and 2018, respectively. The increase in yield was due primarily to changes in competitive pressure on deposit rates and resulting deposit promotions.
Total interest income for the nine months ended September 30, 2019 increased $3.6 million to $32.0 million as compared to $28.4 million for the nine months ended September 30, 2018. Average earning assets were $1.09 billion for the nine months ended September 30, 2019 as compared to $1.01 billion for the nine months ended September 30, 2018. The tax equivalent yield on average earning assets was 3.96% for the nine months ended September 30, 2019 compared to 3.80% for the nine months ended September 30, 2018.
Total interest expense for the nine months ended September 30, 2019 increased $2.8 million to $7.0 million as compared to $4.2 million for the nine months ended September 30, 2018. Average interest bearing liabilities were $859.4 million for the nine months ended September 30, 2019 as compared to $800.3 million for the nine months ended September 30, 2018. The yield on average interest bearing liabilities was 1.08% and 0.70% for the nine months ended September 30, 2019 and September 30, 2018, respectively. The increase in yield was due primarily to changes in competitive pressure on deposit rates and resulting deposit promotions.
Generally, changes in net interest income are measured by net interest rate spread and net interest margin. Interest rate spread is the mathematical difference between the average interest earned on earning assets and interest paid on interest bearing liabilities. Interest margin represents the net interest yield on earning assets. The interest margin gives a reader a better indication of asset earning results when compared to peer groups or industry standards.
Net interest income for the three months ended September 30, 2019 was $8.4 million compared to $8.3 million for the three months ended September 30, 2018. The improvement in net interest income for the three months ended September 30, 2019 is the result of an increase in the balances and rates of taxable loans and taxable investments and an increase in the balances of interest bearing deposits with banks. Also contributing to the improvement in net interest income is a decrease in the balance of savings and a decrease in balance and rates of securities sold under agreement to repurchase and short-term borrowings, offset by an increase in the balances and rates of interest bearing demand deposits, NOW and money market accounts and certificates of deposit. The Company’s net interest margin decreased sixteen (16) basis points from 3.21% for the three months ended September 30, 2018 to 3.05% for the three months ended September 30, 2019.
Net interest income for the nine months ended September 30, 2019 was $25.0 million compared to $24.2 million for the nine months ended September 30, 2018. The improvement in net interest income for the nine months ended September 30, 2019 is the result of an increase in the balances and rates of: taxable loans, taxable investments, fed funds sold and interest bearing deposits with banks. Also contributing to the improvement in net interest income is a decrease in the balances of savings, securities sold under agreement to repurchase and short-term borrowings, offset by an increase in the balances and rates of interest bearing demand deposits, NOW and money market accounts and certificates of deposit and a decrease in the balance and rate of non-taxable investment securities. The Company’s net interest margin decreased thirteen (13) basis points from 3.24% for the nine months ended September 30, 2018 to 3.11% for the nine months ended September 30, 2019.
The table below sets forth average balances and corresponding yields for the corresponding periods ended September 30, 2019 and 2018, respectively:
Distribution of Assets, Liabilities and Stockholders’ Equity:
Interest Rates and Interest Differential (quarter to date)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
2019
|
|
2018
|
|
|
|
|
|
|
|
|
Tax
|
|
|
|
|
|
|
|
Tax
|
|
|
Average
|
|
|
|
|
Equivalent
|
|
Average
|
|
|
|
|
Equivalent
|
|
|
Balance
|
|
|
Interest
|
|
Yield
|
|
Balance
|
|
|
Interest
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars In Thousands)
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans - taxable (2)
|
$
|
964,990
|
|
$
|
9,933
|
|
4.08%
|
|
$
|
920,840
|
|
$
|
9,158
|
|
3.95%
|
|
Loans - non-taxable (1)
|
|
7,863
|
|
|
62
|
|
3.96%
|
|
|
8,444
|
|
|
66
|
|
3.92%
|
|
Investment securities - taxable
|
|
68,867
|
|
|
446
|
|
2.57%
|
|
|
55,018
|
|
|
328
|
|
2.37%
|
|
Investment securities - non-taxable (1)
|
|
27,659
|
|
|
216
|
|
3.92%
|
|
|
35,732
|
|
|
312
|
|
4.38%
|
|
Federal funds sold
|
|
1,000
|
|
|
6
|
|
2.20%
|
|
|
574
|
|
|
3
|
|
1.95%
|
|
Interest bearing deposits with banks
|
|
35,494
|
|
|
203
|
|
2.27%
|
|
|
16,461
|
|
|
96
|
|
2.31%
|
|
TOTAL INTEREST EARNING ASSETS
|
|
1,105,873
|
|
|
10,866
|
|
3.92%
|
|
|
1,037,069
|
|
|
9,963
|
|
3.85%
|
|
Less allowance for loan losses
|
|
(7,669)
|
|
|
|
|
|
|
|
(7,503)
|
|
|
|
|
|
|
Other assets
|
|
50,575
|
|
|
|
|
|
|
|
38,786
|
|
|
|
|
|
|
TOTAL ASSETS
|
$
|
1,148,779
|
|
|
|
|
|
|
$
|
1,068,352
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing demand deposits,
NOW and money market
|
$
|
169,208
|
|
$
|
341
|
|
0.80%
|
|
$
|
126,719
|
|
$
|
78
|
|
0.24%
|
|
Savings
|
|
425,802
|
|
|
542
|
|
0.51%
|
|
|
465,461
|
|
|
568
|
|
0.48%
|
|
Certificates of deposit
|
|
260,554
|
|
|
1,538
|
|
2.34%
|
|
|
182,090
|
|
|
823
|
|
1.79%
|
|
Securities sold under agreements to
repurchase and short-term borrowings
|
|
9,666
|
|
|
17
|
|
0.70%
|
|
|
51,840
|
|
|
215
|
|
1.65%
|
|
TOTAL INTEREST BEARING LIABILITIES
|
|
865,230
|
|
|
2,438
|
|
1.12%
|
|
|
826,110
|
|
|
1,684
|
|
0.81%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest bearing demand deposits
|
|
166,829
|
|
|
|
|
|
|
|
150,254
|
|
|
|
|
|
|
Other liabilities
|
|
20,958
|
|
|
|
|
|
|
|
8,015
|
|
|
|
|
|
|
Stockholders' equity
|
|
95,762
|
|
|
|
|
|
|
|
83,973
|
|
|
|
|
|
|
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY
|
$
|
1,148,779
|
|
|
|
|
|
|
$
|
1,068,352
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
$
|
8,428
|
|
|
|
|
|
|
$
|
8,279
|
|
|
|
Tax equivalent adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
|
|
|
|
16
|
|
|
|
|
|
|
|
18
|
|
|
|
Investments
|
|
|
|
|
57
|
|
|
|
|
|
|
|
83
|
|
|
|
Total tax equivalent adjustments
|
|
|
|
|
73
|
|
|
|
|
|
|
|
101
|
|
|
|
Net interest income on a tax equivalent basis
|
|
|
|
$
|
8,501
|
|
|
|
|
|
|
$
|
8,380
|
|
|
|
Net interest spread
|
|
|
|
|
|
|
2.80%
|
|
|
|
|
|
|
|
3.04%
|
|
Net interest margin
|
|
|
|
|
|
|
3.05%
|
|
|
|
|
|
|
|
3.21%
|
|
|
(1)
|
|
Yields on tax exempt assets have been calculated on a fully tax equivalent basis at a tax rate of 21% as of September 30, 2019 and 2018, respectively.
|
|
(2)
|
|
The average balance of taxable loans includes loans in which interest is no longer accruing.
|
Distribution of Assets, Liabilities and Stockholders’ Equity:
Interest Rates and Interest Differential (year to date)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
|
|
|
|
|
|
Tax
|
|
|
|
|
|
|
Tax
|
|
|
Average
|
|
|
|
|
Equivalent
|
|
Average
|
|
|
|
|
Equivalent
|
|
|
Balance
|
|
Interest
|
|
Yield
|
|
Balance
|
|
Interest
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars In Thousands)
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans - taxable (2)
|
$
|
960,776
|
|
$
|
29,278
|
|
4.07%
|
|
$
|
894,074
|
|
$
|
26,081
|
|
3.90%
|
|
Loans - non-taxable (1)
|
|
7,919
|
|
|
185
|
|
3.95%
|
|
|
8,513
|
|
|
196
|
|
3.90%
|
|
Investment securities - taxable
|
|
60,623
|
|
|
1,207
|
|
2.66%
|
|
|
54,869
|
|
|
961
|
|
2.34%
|
|
Investment securities - non-taxable (1)
|
|
30,698
|
|
|
758
|
|
4.18%
|
|
|
36,149
|
|
|
942
|
|
4.41%
|
|
Federal funds sold
|
|
745
|
|
|
13
|
|
2.30%
|
|
|
595
|
|
|
7
|
|
1.63%
|
|
Interest bearing deposits with banks
|
|
25,446
|
|
|
510
|
|
2.68%
|
|
|
15,548
|
|
|
225
|
|
1.93%
|
|
TOTAL INTEREST EARNING ASSETS
|
|
1,086,207
|
|
|
31,951
|
|
3.96%
|
|
|
1,009,748
|
|
|
28,412
|
|
3.80%
|
|
Less allowance for loan losses
|
|
(7,571)
|
|
|
|
|
|
|
|
(7,318)
|
|
|
|
|
|
|
Other assets
|
|
51,258
|
|
|
|
|
|
|
|
36,191
|
|
|
|
|
|
|
TOTAL ASSETS
|
$
|
1,129,894
|
|
|
|
|
|
|
$
|
1,038,621
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing demand deposits,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW and money market
|
$
|
152,763
|
|
$
|
722
|
|
0.63%
|
|
$
|
114,038
|
|
$
|
151
|
|
0.18%
|
|
Savings
|
|
432,522
|
|
|
1,683
|
|
0.52%
|
|
|
486,723
|
|
|
1,759
|
|
0.48%
|
|
Certificates of deposit
|
|
249,084
|
|
|
4,229
|
|
2.27%
|
|
|
162,762
|
|
|
1,947
|
|
1.60%
|
|
Securities sold under agreements to
repurchase, and short & long-term borrowings
|
|
25,007
|
|
|
335
|
|
1.79%
|
|
|
36,822
|
|
|
363
|
|
1.32%
|
|
TOTAL INTEREST BEARING LIABILITIES
|
|
859,376
|
|
|
6,969
|
|
1.08%
|
|
|
800,345
|
|
|
4,220
|
|
0.70%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest bearing demand deposits
|
|
158,188
|
|
|
|
|
|
|
|
149,015
|
|
|
|
|
|
|
Other liabilities
|
|
19,481
|
|
|
|
|
|
|
|
6,856
|
|
|
|
|
|
|
Stockholders' equity
|
|
92,849
|
|
|
|
|
|
|
|
82,405
|
|
|
|
|
|
|
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY
|
$
|
1,129,894
|
|
|
|
|
|
|
$
|
1,038,621
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
$
|
24,982
|
|
|
|
|
|
|
$
|
24,192
|
|
|
|
Tax equivalent adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
|
|
|
|
49
|
|
|
|
|
|
|
|
52
|
|
|
|
Investments
|
|
|
|
|
201
|
|
|
|
|
|
|
|
250
|
|
|
|
Total tax equivalent adjustments
|
|
|
|
|
250
|
|
|
|
|
|
|
|
302
|
|
|
|
Net interest income on a tax equivalent basis
|
|
|
|
$
|
25,232
|
|
|
|
|
|
|
$
|
24,494
|
|
|
|
Net interest spread
|
|
|
|
|
|
|
2.88%
|
|
|
|
|
|
|
|
3.10%
|
|
Net interest margin
|
|
|
|
|
|
|
3.11%
|
|
|
|
|
|
|
|
3.24%
|
|
|
(1)
|
|
Yields on tax exempt assets have been calculated on a fully tax equivalent basis at a tax rate of 21% as of September 30, 2019 and 2018, respectively.
|
|
(2)
|
|
The average balance of taxable loans includes loans in which interest is no longer accruing.
|
The table below demonstrates the relative impact on net interest income of changes in the volume of interest-earning assets and interest-bearing liabilities and changes in rates earned and paid by the Company on such assets and liabilities.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
September 30, 2019 compared
|
|
September 30, 2019 compared
|
|
to September 30, 2018
|
|
to September 30, 2018
|
|
(In Thousands)
|
|
Total
|
|
Due to change in:
|
|
Total
|
|
Due to change in:
|
|
Change
|
|
Volume
|
|
Rate
|
|
Change
|
|
Volume
|
|
Rate
|
Interest-earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans - taxable
|
$
|
775
|
|
$
|
439
|
|
$
|
336
|
|
$
|
3,197
|
|
$
|
1,946
|
|
$
|
1,251
|
Loans - non-taxable
|
|
(4)
|
|
|
(5)
|
|
|
1
|
|
|
(11)
|
|
|
(14)
|
|
|
3
|
Investment securities - taxable
|
|
118
|
|
|
83
|
|
|
35
|
|
|
246
|
|
|
101
|
|
|
145
|
Investment securities - non-taxable
|
|
(96)
|
|
|
(71)
|
|
|
(25)
|
|
|
(184)
|
|
|
(142)
|
|
|
(42)
|
Federal funds sold
|
|
3
|
|
|
2
|
|
|
1
|
|
|
6
|
|
|
2
|
|
|
4
|
Interest bearing deposits with banks
|
|
107
|
|
|
111
|
|
|
(4)
|
|
|
285
|
|
|
143
|
|
|
142
|
Total net change in income on
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
interest-earning assets
|
|
903
|
|
|
559
|
|
|
344
|
|
|
3,539
|
|
|
2,036
|
|
|
1,503
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing demand deposits,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW and money market
|
|
263
|
|
|
26
|
|
|
237
|
|
|
571
|
|
|
51
|
|
|
520
|
Savings
|
|
(26)
|
|
|
(48)
|
|
|
22
|
|
|
(76)
|
|
|
(196)
|
|
|
120
|
Certificates of deposit
|
|
715
|
|
|
355
|
|
|
360
|
|
|
2,282
|
|
|
1,033
|
|
|
1,249
|
Total deposits
|
|
952
|
|
|
333
|
|
|
619
|
|
|
2,777
|
|
|
888
|
|
|
1,889
|
Securities sold under agreements to
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
repurchase and other borrowings
|
|
(198)
|
|
|
(175)
|
|
|
(23)
|
|
|
(28)
|
|
|
(116)
|
|
|
88
|
Total net change in expense on
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
interest-bearing liabilities
|
|
754
|
|
|
158
|
|
|
596
|
|
|
2,749
|
|
|
772
|
|
|
1,977
|
Change in net interest income
|
$
|
149
|
|
$
|
401
|
|
$
|
(252)
|
|
$
|
790
|
|
$
|
1,264
|
|
$
|
(474)
|
Provision for Loan Losses
The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is maintained at a level management considers to be adequate to provide for losses that can be reasonably anticipated. Management’s periodic evaluation of the adequacy of the allowance is based on known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant change.
The allowance consists of general, specific, qualitative and unallocated components. The general component covers non-classified loans and classified loans not considered impaired, and is based on historical loss experience adjusted for qualitative factors. The specific component relates to loans that are classified as impaired and/or restructured. For loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and/or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting
scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral-dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and home equity loans for impairment disclosures, unless such loans are the subject of a restructuring agreement or there is a possible loss expected.
For the three months ended September 30, 2019, the provision for loan losses was $120 thousand, as compared to $60 thousand for the same period ended September 30, 2018. In the three months ended September 30, 2019, there were no charge-offs and $1 thousand in recoveries, as compared to no charge-offs or recoveries for the three months ended September 30, 2018. For the nine months ended September 30, 2019, the provision for loan losses was $345 thousand, as compared to $540 thousand for the same period ended September 30, 2018. In the nine months ended September 30, 2019, there were no charge-offs and $5 thousand in recoveries, as compared to $63 thousand in charge-offs and $16 thousand in recoveries for the nine months ended September 30, 2018. The allowance for loan losses is $7.8 million as of September 30, 2019, which is 0.79% of outstanding loans, compared to $7.5 million or 0.81% of outstanding loans as of September 30, 2018. At December 31, 2018, the allowance for loan losses was $7.4 million, which represented 0.77% of total outstanding loans. Based principally on economic conditions, asset quality, and loan-loss experience, including that of comparable institutions in the Bank’s market area, the allowance is believed to be adequate to absorb any losses inherent in the portfolio. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate, or that material increases will not be necessary should the quality of the loans deteriorate. The Bank has not participated in any sub-prime lending activity.
The activity in the allowance for loan losses is shown in the following table, as well as period end loans receivable and the allowance for loan losses as a percent of the total loan portfolio:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
September 30,
|
|
September 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In Thousands)
|
Loans receivable at end of period
|
$
|
985,946
|
|
$
|
931,066
|
|
$
|
985,946
|
|
$
|
931,066
|
Allowance for loan losses:
|
|
|
|
|
|
|
|
|
|
|
|
Balance, beginning
|
$
|
7,641
|
|
$
|
7,473
|
|
$
|
7,412
|
|
$
|
7,040
|
Provision for loan losses
|
|
120
|
|
|
60
|
|
|
345
|
|
|
540
|
Loans charged off:
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
Commercial construction
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
Commercial
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(40)
|
Residential real estate
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(23)
|
Consumer
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
Total loans charged off
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(63)
|
Recoveries of loans previously charged off:
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
-
|
|
|
-
|
|
|
-
|
|
|
8
|
Commercial construction
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
Commercial
|
|
-
|
|
|
-
|
|
|
4
|
|
|
-
|
Residential real estate
|
|
1
|
|
|
-
|
|
|
1
|
|
|
8
|
Consumer
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
Total recoveries
|
|
1
|
|
|
-
|
|
|
5
|
|
|
16
|
Net charge offs
|
|
1
|
|
|
-
|
|
|
5
|
|
|
(47)
|
Balance at end of period
|
$
|
7,762
|
|
$
|
7,533
|
|
$
|
7,762
|
|
$
|
7,533
|
Allowance for loan losses to loans receivable at end of period
|
|
0.79%
|
|
|
0.81%
|
|
|
0.79%
|
|
|
0.81%
|
Non-interest Income
Total non-interest income was $503 thousand for the three months ended September 30, 2019 compared to $433 thousand for the same period in 2018. The increase is attributable to an increase of $33 thousand in debit card interchange fees due primarily to the
growing customer base and due to no impairment charges on other real estate owned in the third quarter of 2019, compared to impairment charges of $56 thousand on real estate owned for the quarter ending September 30, 2018. The increase in non-interest income was offset by a decrease in bank owned life insurance of $37 thousand.
Total non-interest income was $1.6 million for the nine months ended September 30, 2019 compared to $1.2 million for the same period in 2019. The increase is due primarily to an increase of $126 thousand in bank owned life insurance, in part, due to the purchase of an additional $6.0 million of bank owned life insurance in the third quarter of 2018. Also contributing to the improvement in non-interest income was an increase of $60 thousand in debit card interchange fees and an increase of $33 thousand in other service fees due primarily to the growing customer base. Gain on the sale of real estate owned of $45 thousand for the nine months ended September 30, 2019 was recognized, compared to a loss on the sale of real estate owned of $16 thousand and impairment write downs on other real estate owned of $83 thousand for the nine months ending September 30, 2018.
Non-interest Expense
Non-interest expenses decreased by $68 thousand from $5.4 million for the three months ended September 30, 2018 to $5.3 million for the same period ended September 30, 2019. The decrease in non-interest expenses is attributable to a decrease of $118 thousand in FDIC insurance due to FDIC assessment credits applied in the third quarter of 2019, a decrease of $27 thousand in credit card processing due to conversion costs to a new provider being less than anticipated, a decrease of $62 thousand in advertising and promotions, a decrease of $35 thousand in loan & real estate resulting from a decrease in legal loan, collection and repossession fees and a decrease of $44 thousand in other expenses due primarily to decreases in other real estate owned expenses and operating expenses. The decrease in non-interest expenses was offset by an increase of $114 thousand in salaries and employee benefits. The Company had a 3.4% increase in full-time equivalent employees from eighty-nine (89) at September 30, 2018 to ninety-two (92) at September 30, 2019, respectively. The increase in the number of employees, together with the annual increases in salaries and benefits, resulted in an increase in overall salary and benefits. Additional increases in non-interest expenses are attributable to: an increase of $71 thousand in occupancy and equipment, in part due to an increase in rent expense, the opening of the Macungie Preview Center and expansion into the third floor of the Gateway office and an increase of $13 thousand in professional fees.
Non-interest expenses increased $777 thousand from $15.6 million for the nine months ended September 30, 2018 to $16.4 million for the same period ended September 30, 2019. The increase in non-interest expenses is primarily due to an increase of $531 thousand in salaries and employee benefits due to the increase in the number of employees and the annual increases in salaries and benefits. Additional increases in non-interest expenses are attributable to: an increase of $330 thousand in occupancy and equipment, in part due to an increase in rent expense, the opening of the Macungie Preview Center and expansion into the third floor of the Gateway office, an increase of $107 thousand in data processing due primarily to an expanding customer base, an increase of $56 thousand in charitable contributions due in part to the Educational Improvement Tax Credit program and an increase of $52 thousand in other expenses, offset by a decrease of $27 thousand in credit card processing due to conversion costs to a new provider being less than anticipated, a decrease of $127 thousand in FDIC insurance due to FDIC assessment credits applied in the third quarter of 2019 and a decrease of $138 thousand in loan and real estate expenses resulting from a decrease in legal loan, collection and repossession fees.
A breakdown of other expenses can be found in the statements of income.
Income Taxes
The provision for income taxes for the three months ended September 30, 2019 totaled $675 thousand, or 19.3% of income before taxes. The provision for income taxes for the three months ended September 30, 2018 totaled $597 thousand, or 18.2% of income before taxes. The slight increase in the tax rate is primarily the result of the change in the mix of taxable and tax free loans and investments and decrease in income on bank owned life insurance. The provision for income taxes for the nine months ended September 30, 2019 totaled $1.8 million, or 18.7% of income before taxes, compared to the income taxes for the nine months ended September 30, 2018 totaling $1.7 million, or 18.3% of income before taxes. The slight increase in the tax rate is primarily the result of the change in the mix of taxable and tax free loans and investments, offset by the increase in income on bank owned life insurance.
FINANCIAL CONDITION
Securities
The Bank’s securities portfolio continues to be classified, in its entirety, as “available for sale.” Management believes that a portfolio classification of available for sale allows complete flexibility in the investment portfolio. Using this classification, the Bank intends to hold these securities for an indefinite amount of time, but not necessarily to maturity. Such securities are carried at fair value with unrealized gains or losses reported as a separate component of stockholders’ equity. The portfolio is structured to provide maximum return on investments while providing a consistent source of liquidity and meeting strict risk standards. Investment securities consist primarily of mortgage-backed securities issued by FHLMC or FNMA and non-taxable municipal bonds. The Bank holds no high-risk securities or derivatives as of September 30, 2019. The Bank has not made any investments in non-U.S. government agency mortgage backed securities or sub-prime loans.
Total securities at September 30, 2019 were $95.9 million compared to $90.7 million at December 31, 2018. The increase in the investment portfolio is the result of the purchase of six (6) mortgage-backed securities totaling $20.4 million and an increase in unrealized gains, offset by principal pay downs on mortgage-backed securities, maturities and calls. The carrying value of the securities portfolio as of September 30, 2019 includes a net unrealized gain of $1.7 million, which is recorded as accumulated other comprehensive income (loss) in stockholders’ equity net of income tax effect. This compares to a net unrealized loss of $1.6 million at December 31, 2018. The current unrealized gain position of the securities portfolio is due to changes in market interest rates since purchase. No securities are deemed to be other than temporarily impaired.
Loans
The loan portfolio comprises a major component of the Bank’s earning assets. All of the Bank’s loans are to domestic borrowers. Total net loans at September 30, 2019 increased $29.1 million to $979.0 million from $949.9 million at December 31, 2018. The gross loan-to-deposit ratio decreased from 103% at December 31, 2018 to 95% at September 30, 2019. The Bank’s loan portfolio at September 30, 2019 was comprised of residential real estate and consumer loans of $508.0 million, an increase of $29.2 million from December 31, 2018, and commercial loans of $477.9 million, an increase of $65 thousand from December 31, 2018. Commercial loans grew $3.8 million in the first two quarters of 2019, but fell $3.2 million in the third quarter of 2019 due to large pre-payments, primarily attributable to three commercial loan relationships where their businesses were sold. The Bank has not originated, nor does it intend to originate, sub-prime mortgage loans.
Credit Risk and Loan Quality
The allowance for loan losses increased $350 thousand to $7.8 million at September 30, 2019 compared to $7.4 million at December 31, 2018. At September 30, 2019 and December 31, 2018, the allowance for loan losses represented 0.79% and 0.77%, respectively, of total loans. Based upon current economic conditions, the composition of the loan portfolio, the perceived credit risk in the portfolio and loan-loss experience of the Bank and comparable institutions in the Bank’s market area, management feels the allowance is adequate to absorb reasonably anticipated losses.
At September 30, 2019, December 31, 2018, and September 30, 2018 aggregate balances on non-performing loans are included in the following table. Troubled debt restructurings, included in the following table, represent loans where the Company, for economic or legal reasons related to the debtor’s financial difficulties, has granted a concession to the debtor that it would not otherwise consider. There were no loans that were modified and classified as a TDR within the prior twelve months that experienced a payment default (loans ninety or more days past due) for the three and nine months ended September 30, 2019.
The details for non-performing loans are included in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
September 30,
|
|
|
2019
|
|
|
2018
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
(In Thousands)
|
Non-accrual - commercial
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
Non-accrual - consumer
|
|
19
|
|
|
269
|
|
|
378
|
TDR loans, accruing interest and less than 90 days past due
|
|
2,858
|
|
|
2,918
|
|
|
2,971
|
Loans past due 90 or more days, accruing interest
|
|
-
|
|
|
-
|
|
|
-
|
Total nonperforming loans
|
|
2,877
|
|
|
3,187
|
|
|
3,349
|
Foreclosed assets
|
|
-
|
|
|
135
|
|
|
480
|
Total nonperforming assets
|
$
|
2,877
|
|
$
|
3,322
|
|
$
|
3,829
|
Nonperforming loans to total loans at period-end
|
|
0.29%
|
|
|
0.33%
|
|
|
0.36%
|
Nonperforming assets to total assets
|
|
0.25%
|
|
|
0.30%
|
|
|
0.36%
|
Premises and Equipment
Company premises and equipment, net of accumulated depreciation, decreased $106 thousand from December 31, 2018 to September 30, 2019. This decrease is due primarily to depreciation on existing premises and equipment, offset by increases related to purchases.
Deposits
Total deposits at September 30, 2019 increased $103.5 million to $1.04 billion from $931.5 million at December 31, 2018. Demand, NOW and money market deposits increased $64.0 million, time deposits increased $68.3 million, and savings deposits decreased $28.8 million. The growth to the Company’s deposits was in part due to time deposit and money market promotions. The funds were primarily used to pay down FHLB short-term borrowings, to fund new loan growth, to purchase securities available for sale, and increase interest bearing demand deposits with banks. The growth was also due to a highly effective relationship building, sales and marketing effort, which served to further increase the Company’s overall presence in the market it serves, along with deposit relationships developed as a result of cross-marketing efforts to its loan and other non-depository banking service customers. The Bank also continued to capitalize on opportunities created by recent and proposed mergers in the Company’s market area, attracting customers looking to relocate to a local, reputable community bank.
Liquidity
Liquidity represents the Company’s ability to meet the demands required for the funding of loans and to meet depositors’ requirements for use of their funds. The Company’s sources of liquidity are cash balances, due from banks, and federal funds sold. Cash and cash equivalents were $48.0 million at September 30, 2019, compared to $27.6 million at December 31, 2018. The $20.4 million increase in cash and cash equivalents was primarily due to growth in deposits, offset by growth in the loan portfolio, growth in the investment portfolio, a decrease in securities sold under agreement to repurchase and the pay down of short-term borrowings.
Additional asset liquidity sources include principal and interest payments from the investment security and loan portfolios. Long-term liquidity needs may be met by selling unpledged securities available for sale, selling or participating loans, or raising additional capital. At September 30, 2019, the Company had $95.9 million of available for sale securities. Securities with carrying values of approximately $84.2 million and $85.8 million at September 30, 2019 and December 31, 2018, respectively, were pledged as collateral to secure securities sold under agreements to repurchase, public deposits, and for other purposes required or permitted by law.
At September 30, 2019, the Bank had a maximum borrowing capacity for short-term and long-term advances of approximately $567.4 million. This borrowing capacity with the FHLB includes a line of credit of $150.0 million. There were no short-term FHLB advances outstanding as of September 30, 2019 and $54.0 million short-term FHLB advances were outstanding as of December 31, 2018. The decrease in short-term borrowings from prior year end was primarily the result of growth in the Company’s time deposit and money market portfolio due to advertised promotions. There were no long-term FHLB advances outstanding as of September 30, 2019 and December 31, 2018. All FHLB borrowings are secured by qualifying assets of the Bank.
The Bank has a federal funds line of credit with the ACBB of $10.0 million, of which none was outstanding at September 30, 2019 and December 31, 2018. Advances from this line are unsecured.
The Company has no investment in or financial relationship with any unconsolidated entities that are reasonably likely to have a material effect on liquidity or capital resources.
Off-Balance Sheet Arrangements
The Company’s consolidated financial statements do not reflect various off-balance sheet arrangements that are made in the normal course of business, which may involve some liquidity risk. These off-balance sheet arrangements consist of unfunded loans and commitments, as well as lines of credit made under the same standards as on-balance sheet instruments. These unused commitments totaled $140.5 million at September 30, 2019. At September 30, 2019 the Company had letters of credit outstanding of $3.5 million and FHLB deposit letters of credit outstanding of $7.6 million. Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Company. Management is of the opinion that the Company’s liquidity is sufficient to meet its anticipated needs.
Capital Resources and Adequacy
Total stockholders’ equity was $96.6 million as of September 30, 2019, representing a net increase of $9.4 million from December 31, 2018. The increase in capital was primarily the result of the net income of $8.0 million, an increase of $2.6 million in unrealized gains on available for sale securities, and an increase in surplus of $342 thousand due to stock grants and employee stock purchases with compensation expense, offset by dividends declared of $1.5 million.
The Company and the Bank are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain actions by regulators that could have a material effect on the consolidated financial statements.
The regulations require that banks maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined), and Tier I capital to average assets (as defined). As of September 30, 2019, the Bank met the minimum requirements. In addition, the Bank’s capital ratios exceeded the amounts required to be considered “well capitalized” as defined in the regulations.
The following table provides a comparison of the Bank’s risk-based capital ratios and leverage ratios:
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Consolidated Bank
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September 30, 2019
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December 31, 2018
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(Dollars In Thousands)
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Tier I, common stockholders' equity
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$
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95,213
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$
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88,320
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Tier II, allowable portion of allowance for loan losses
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7,762
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7,412
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Total capital
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$
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102,975
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$
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95,732
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Common equity tier 1 capital ratio
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11.7
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%
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11.3
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%
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Tier I risk based capital ratio
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11.7
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%
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11.3
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%
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Total risk based capital ratio
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12.6
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%
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12.2
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%
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Tier I leverage ratio
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8.3
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%
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8.1
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%
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Note: Unrealized gains and losses on securities available for sale are excluded from regulatory capital components of risk-based capital and leverage ratios.
In July 2013, the FDIC and the Federal Reserve approved a new rule that substantially amended the regulatory risk based capital rules applicable to the Bank and the Company. The final rule implements the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act.
The final rule includes new minimum risk-based capital and leverage ratios, which became effective for the Bank and the Company on January 1, 2015, and refines the definition of what constitutes “capital” for purposes of calculating these ratios. The revised minimum capital requirements are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. The final rule also establishes a “capital conservation buffer” of 2.5%, that resulted in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%; (ii) a Tier 1 to risk-based assets capital ratio of 8.5%; and (iii) a total capital ratio of 10.5%. The capital conservation buffer was phased in from 0.0% for 2015 to 2.50% in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that can be utilized for such actions.
In addition to the risk-based capital guidelines, the federal banking regulators established minimum leverage ratio (Tier 1 capital to total assets) guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of 3% for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a leverage ratio of at least 4%.
The capital ratios to be considered “well capitalized” under the new capital rules are: common equity of 6.5%, Tier 1 leverage of 5%, Tier 1 risk-based capital of 8%, and Total Risk-Based capital of 10%.
Effective in the third quarter of 2018, the Federal Reserve raised the consolidated asset limit to be considered a small bank holding company from $1 billion to $3 billion. A company that qualifies as a small bank holding company is not subject to the Federal Reserve’s consolidated capital rules, although a company that so qualifies may continue to file reports that include such capital amounts and ratios. The Company has elected to continue to report those amounts and ratios.
The following table provides the Company’s risk-based capital ratios and leverage ratios:
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Consolidated Corporation
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September 30, 2019
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December 31, 2018
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(Dollars In Thousands)
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Tier I, common stockholders' equity
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$
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95,327
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$
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88,472
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Tier II, allowable portion of allowance for loan losses
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7,762
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7,412
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Total capital
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$
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103,089
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$
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95,884
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Common equity tier 1 capital ratio
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11.7
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%
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11.3
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%
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Tier I risk based capital ratio
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11.7
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%
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11.3
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%
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Total risk based capital ratio
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12.6
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%
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12.2
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%
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Tier I leverage ratio
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8.3
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%
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8.1
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%
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Note: Unrealized gains and losses on securities available for sale are excluded from regulatory capital components of risk-based capital and leverage ratios.