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Section 1: 10-Q (10-Q)

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

☒  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2018

 

or

 

☐ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from____________to______________

 

Commission file number: 0-15536

 

CODORUS VALLEY BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Pennsylvania 23-2428543
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

 

105 Leader Heights Road, P.O. Box 2887, York, Pennsylvania 17405
(Address of principal executive offices) (Zip code)

 

717-747-1519

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year,

if changed since the last report.)

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one): 

  Large accelerated filer ☐ Accelerated filer ☒
  Non-accelerated filer ☐ Smaller reporting company ☐
    Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. On July 27, 2018, 8,946,062 shares of common stock, par value $2.50, were outstanding.

 

 

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Codorus Valley Bancorp, Inc.

Form 10-Q Index

 

PART I – FINANCIAL INFORMATION Page #
       
Item 1. Financial statements (unaudited): 3  
  Consolidated balance sheets 3  
  Consolidated statements of income 4  
  Consolidated statements of comprehensive income 5  
  Consolidated statements of cash flows 6  
  Consolidated statements of changes in shareholders’ equity 7  
  Notes to consolidated financial statements 8  
       
Item 2. Management’s discussion and analysis of financial condition and results of operations 40  
       
Item 3. Quantitative and qualitative disclosures about market risk 65  
       
Item 4. Controls and procedures 66  
       
PART II – OTHER INFORMATION    
       
Item 1. Legal proceedings 66  
       
Item 1A. Risk factors 66  
       
Item 2. Unregistered sales of equity securities and use of proceeds 66  
       
Item 3. Defaults upon senior securities 66  
       
Item 4. Mine safety disclosures 66  
       
Item 5. Other information 67  
       
Item 6. Exhibits 68  
       
SIGNATURES   69  

 

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PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Codorus Valley Bancorp, Inc.

Consolidated Balance Sheets

         
   (Unaudited)     
   June 30,   December 31, 
(dollars in thousands, except per share data)  2018   2017 
Assets          
Interest bearing deposits with banks  $65,181   $55,566 
Cash and due from banks   20,840    23,958 
Total cash and cash equivalents   86,021    79,524 
Securities, available-for-sale   154,467    158,591 
Restricted investment in bank stocks, at cost   6,522    6,311 
Loans held for sale   2,794    1,715 
Loans (net of deferred fees of $3,907 - 2018 and $4,039 - 2017)   1,465,896    1,399,764 
Less-allowance for loan losses   (17,147)   (16,689)
Net loans   1,448,749    1,383,075 
Premises and equipment, net   24,285    24,382 
Goodwill   2,301    2,301 
Other assets   53,993    53,306 
Total assets  $1,779,132   $1,709,205 
           
Liabilities          
Deposits          
Noninterest bearing  $259,745   $246,866 
Interest bearing   1,183,079    1,137,641 
Total deposits   1,442,824    1,384,507 
Short-term borrowings   12,964    20,495 
Long-term debt   135,310    130,310 
Other liabilities   17,661    9,674 
Total liabilities   1,608,759    1,544,986 
           
Shareholders’ equity          
Preferred stock, par value $2.50 per share; 1,000,000 shares authorized;  0 shares issued and outstanding   0    0 
Common stock, par value $2.50 per share; 30,000,000 shares authorized at June 30, 2018 and 15,000,000 at December 31, 2017; shares issued and outstanding: 8,943,966 at June 30, 2018 and 8,906,052 at December 31, 2017   22,360    22,265 
Additional paid-in capital   120,938    120,052 
Retained earnings   30,233    22,860 
Accumulated other comprehensive loss   (3,158)   (958)
Total shareholders’ equity   170,373    164,219 
Total liabilities and shareholders’ equity  $1,779,132   $1,709,205 

 

See accompanying notes.

 

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Codorus Valley Bancorp, Inc.

Consolidated Statements of Income

Unaudited

                 
   Three months ended   Six months ended 
   June 30,   June 30, 
(dollars in thousands, except per share data)  2018   2017   2018   2017 
Interest income                    
Loans, including fees  $18,646   $16,102   $36,143   $31,496 
Investment securities:                    
    Taxable   568    653    1,134    1,302 
    Tax-exempt   275    316    556    649 
    Dividends   95    82    218    158 
Other   250    142    376    195 
      Total interest income   19,834    17,295    38,427    33,800 
                     
Interest expense                    
Deposits   3,070    1,948    5,702    3,755 
Federal funds purchased and other short-term borrowings   18    100    33    192 
Long-term debt   667    619    1,268    1,165 
      Total interest expense   3,755    2,667    7,003    5,112 
      Net interest income   16,079    14,628    31,424    28,688 
Provision for loan losses   300    825    500    1,475 
      Net interest income after provision for loan losses   15,779    13,803    30,924    27,213 
                     
Noninterest income                    
Trust and investment services fees   781    741    1,571    1,400 
Income from mutual fund, annuity and insurance sales   237    195    551    406 
Service charges on deposit accounts   1,195    1,051    2,298    2,021 
Income from bank owned life insurance   241    250    482    522 
Other income   531    261    857    541 
Gain on sales of loans held for sale   558    282    1,001    571 
Gain on sales of securities   0    63    0    63 
      Total noninterest income   3,543    2,843    6,760    5,524 
                     
Noninterest expense                    
Personnel   6,884    6,399    14,696    13,135 
Occupancy of premises, net   825    807    1,696    1,678 
Furniture and equipment   747    696    1,561    1,391 
Postage, stationery and supplies   192    226    364    391 
Professional and legal   143    173    323    322 
Marketing   419    361    827    697 
FDIC insurance   136    221    304    374 
Debit card processing   296    271    584    486 
Charitable donations   164    168    1,673    834 
Telecommunications   144    200    381    404 
External data processing   537    452    984    847 
Foreclosed real estate including provision for (recovery of) losses   11    1    20    (28)
Other   1,125    1,192    1,467    1,699 
      Total noninterest expense   11,623    11,167    24,880    22,230 
      Income before income taxes   7,699    5,479    12,804    10,507 
Provision for income taxes   1,645    1,794    2,667    3,403 
Net income  $6,054   $3,685   $10,137   $7,104 
      Net income per share, basic  $0.68   $0.41   $1.14   $0.80 
      Net income per share, diluted  $0.67   $0.41   $1.12   $0.79 

 

See accompanying notes.

 

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Codorus Valley Bancorp, Inc.

Consolidated Statements of Comprehensive Income

Unaudited

         
   Three months ended 
   June 30, 
(dollars in thousands)  2018   2017 
Net income  $6,054   $3,685 
Other comprehensive income (loss):          
    Securities available for sale:          
Net unrealized holding (losses) gains arising during the period (net of tax (benefit) expense of ($110) and $226, respectively)   (412)   419 
Reclassification adjustment for (gains) included in net income (net of tax expense of $0 and $22, respectively) (a) (b)   0    (41)
Net unrealized (losses) gains   (412)   378 
Comprehensive income  $5,642   $4,063 

 

   Six months ended 
   June 30, 
(dollars in thousands)  2018   2017 
Net income  $10,137   $7,104 
Other comprehensive income (loss):          
    Securities available for sale:          
Net unrealized holding (losses) gains arising during the period (net of tax (benefit) expense of ($585) and $468, respectively)   (2,200)   869 
Reclassification adjustment for (gains) included in net income (net of tax expense of $0 and $22, respectively) (a) (b)   0    (41)
Net unrealized (losses) gains   (2,200)   828 
Comprehensive income  $7,937   $7,932 
           
(a)Amounts are included in net gain on sales of securities on the Consolidated Statements of Income within noninterest income.

(b)Income tax amounts are included in the provision for income taxes on the Consolidated Statements of Income.

 

See accompanying notes.

 

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Codorus Valley Bancorp, Inc.

Consolidated Statements of Cash Flows

Unaudited

 

   Six months ended 
   June 30, 
(dollars in thousands)  2018   2017 
Cash flows from operating activities          
Net income  $10,137   $7,104 
Adjustments to reconcile net income to net cash provided by operations:          
Depreciation/amortization   1,183    1,155 
Net amortization of premiums on securities   234    376 
Amortization of deferred loan origination fees and costs   (916)   (754)
Provision for loan losses   500    1,475 
Recovery of foreclosed real estate   0    (47)
Increase in bank owned life insurance   (482)   (522)
Originations of mortgage loans held for sale   (20,064)   (19,491)
Originations of SBA loans held for sale   (8,546)   (1,677)
Proceeds from sales of mortgage loans held for sale   20,390    19,204 
Proceeds from sales of SBA loans held for sale   7,948    1,620 
Gain on sales of mortgage loans held for sale   (485)   (485)
Gain on sales of SBA loans held for sale   (516)   (86)
Gain on disposal of premises and equipment   (11)   (7)
Gain on sales of securities, available-for-sale   0    (63)
Loss (gain) on sales of foreclosed real estate   1    (11)
Stock-based compensation   332    371 
Decrease in interest receivable   96    113 
Decrease (increase) in other assets   441    (1,106)
Increase (decrease) in interest payable   125    (5)
Increase in other liabilities   3,506    907 
Net cash provided by operating activities   13,873    8,071 
Cash flows from investing activities          
Purchases of securities, available-for-sale   (6,578)   (9,532)
Maturities, repayments and calls of securities, available-for-sale   12,053    21,258 
Sales of securities, available-for-sale   0    2,051 
Net (increase) decrease in restricted investment in bank stock   (211)   60 
Net increase in loans made to customers   (65,350)   (79,637)
Purchases of premises and equipment   (1,075)   (911)
Investment in bank owned life insurance   0    (4,000)
Proceeds from sales of foreclosed real estate   114    386 
Net cash used in investing activities   (61,047)   (70,325)
Cash flows from financing activities          
Net increase in demand and savings deposits   50,277    60,369 
Net increase in time deposits   8,040    1,119 
Net decrease in short-term borrowings   (7,531)   (20,113)
Proceeds from issuance of long-term debt   30,000    10,000 
Repayment of long-term debt   (25,000)   0 
Cash dividends paid to shareholders   (2,764)   (2,276)
Issuance of stock   649    452 
Net cash provided by financing activities   53,671    49,551 
Net increase (decrease) in cash and cash equivalents   6,497    (12,703)
Cash and cash equivalents at beginning of year   79,524    74,032 
Cash and cash equivalents at end of period  $86,021   $61,329 

 

See accompanying notes.

 

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Codorus Valley Bancorp, Inc.

Consolidated Statements of Changes in Shareholders’ Equity

Unaudited

 

                   Accumulated         
           Additional       Other         
   Preferred   Common   Paid-in   Retained   Comprehensive   Treasury     
(dollars in thousands, except per share data)  Stock   Stock   Capital   Earnings   Loss   Stock   Total 
                             
Balance, January 1, 2018  $0   $22,265   $120,052   $22,860   $(958)  $0   $164,219 
Net income                  10,137              10,137 
Other comprehensive loss, net of tax                       (2,200)        (2,200)
Cash dividends  ($0.31 per share)                  (2,764)             (2,764)
Stock-based compensation             332                   332 
Forfeiture of restricted stock and withheld shares             5              (70)   (65)
Issuance and reissuance of stock:                                   
10,103 shares under the dividend reinvestment and stock purchase plan        20    198              57    275 
25,360 shares under the stock option plan        62    250              9    321 
1,816 shares of stock-based compensation awards        4    (4)                  0 
5,125 shares under employee stock purchase plan        9    105              4    118 
                                    
Balance, June 30, 2018  $0   $22,360   $120,938   $30,233   $(3,158)  $0   $170,373 
                                    
Balance, January 1, 2017  $0   $21,067   $106,102   $28,909   $(1,121)  $0   $154,957 
Net income                  7,104              7,104 
Other comprehensive income, net of tax                       828         828 
Cash dividends ($0.258 per share, adjusted)                  (2,276)             (2,276)
Stock-based compensation             371                   371 
Forfeiture of restricted stock             4              (4)   0 
Issuance and reissuance of stock:                                   
8,557 shares under the dividend reinvestment and stock purchase plan        21    215                   236 
5,976 shares under the stock option plan        15    86                   101 
7,037 shares of stock-based compensation awards        18    (18)                  0 
4,844 shares under employee stock purchase plan        8    103              4    115 
                                    
Balance, June 30, 2017  $0   $21,129   $106,863   $33,737   $(293)  $0   $161,436 

 

See accompanying notes.

 

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Note 1—Summary of Significant Accounting Policies

 

Nature of Operations and Basis of Presentation

The accompanying consolidated balance sheet at December 31, 2017 has been derived from audited financial statements, and the unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions to Form 10-Q, and FASB Accounting Standards Codification (ASC) 270. Accordingly, the interim financial statements do not include all of the financial information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the interim consolidated financial statements include all adjustments necessary to present fairly the financial condition and results of operations for the reported periods, and all such adjustments are of a normal and recurring nature.

 

Codorus Valley Bancorp, Inc. (“Corporation” or “Codorus Valley”) is a one-bank holding company headquartered in York, Pennsylvania that provides a full range of banking services through its subsidiary, PeoplesBank, A Codorus Valley Company (“PeoplesBank” or “Bank”). PeoplesBank operates three wholly-owned subsidiaries as of June 30, 2018. Codorus Valley Financial Advisors, Inc. d/b/a PeoplesWealth Advisors, which sells nondeposit investment products in Pennsylvania; SYC Settlement Services, Inc., which provides real estate settlement services and Codorus Valley Financial Advisors, Inc. d/b/a PeoplesWealth Advisors, which sells nondeposit investment products in Maryland. In addition, PeoplesBank may periodically create nonbank subsidiaries for the purpose of temporarily holding foreclosed properties pending the liquidation of these properties. PeoplesBank operates under a state charter and is subject to regulation by the Pennsylvania Department of Banking and Securities, and the Federal Deposit Insurance Corporation. The Corporation is subject to regulation by the Federal Reserve Board and the Pennsylvania Department of Banking and Securities.

 

The consolidated financial statements include the accounts of Codorus Valley and its wholly-owned bank subsidiary, PeoplesBank, and a wholly-owned nonbank subsidiary, SYC Realty Company, Inc. SYC Realty was inactive during the period ended June 30, 2018. The accounts of CVB Statutory Trust No. 1 and No. 2 are not included in the consolidated financial statements as discussed in Note 7—Short-Term Borrowings and Long-Term Debt. All significant intercompany account balances and transactions have been eliminated in consolidation. The accounting and reporting policies of Codorus Valley and subsidiaries conform to accounting principles generally accepted in the United States of America and have been followed on a consistent basis.

 

These consolidated statements should be read in conjunction with the notes to the audited consolidated financial statements contained in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2017.

 

The results of operations for the three and six months ended June 30, 2018 are not necessarily indicative of the results to be expected for the full year.

 

In accordance with FASB ASC 855, the Corporation evaluated the events and transactions that occurred after the balance sheet date of June 30, 2018 and through the date these consolidated financial statements were issued, for items of potential recognition or disclosure.

 

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Loans

Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances less amounts charged off, net of an allowance for loan losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Generally, loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) over the contractual life of the loan. The loans receivable portfolio is segmented into commercial and consumer loans. Commercial loans consist of the following industry classes: builder & developer, commercial real estate investor, residential real estate investor, hotel/motel, wholesale & retail, agriculture, manufacturing and all other. Consumer loans consist of the following classes: residential mortgage, home equity and all other.

 

Generally, for all classes of loans receivable, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan may be currently performing. A past due loan may remain on accrual status if it is in the process of collection and well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. Interest received on nonaccrual loans, including impaired loans, generally is either applied against principal or reported as interest income, according to the Corporation’s judgment as to the collectability of principal. Generally, nonaccrual loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, generally six months, and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments.

 

Acquired Loans

Acquired loans are initially recorded at their acquisition date fair values. The carryover of allowance for loan losses is prohibited as any credit losses in the loans are included in the determination of the fair value of the loans at the acquisition date. Fair values for acquired loans are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, prepayment risk, liquidity risk, default rates, loss severity, payment speeds, collateral values and discount rate.

 

For acquired loans that are not deemed impaired at acquisition, credit discounts representing principal losses expected over the life of the loan are a component of the initial fair value and amortized over the life of the asset. Subsequent to the acquisition date, the methods used to estimate the required allowance for loan losses on these loans is similar to originated loans. However, the Corporation records a provision for loan losses only when the required allowance for loan losses exceeds any remaining credit discount. The remaining differences between the acquisition date fair value and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loan.

 

Acquired loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that the Corporation will be unable to collect all contractually required payments are accounted for as impaired loans under FASB ASC 310-30. The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non-accretable discount. The non-accretable discount represents estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows require the Corporation to evaluate the need for an allowance for loan losses on these loans. Subsequent improvements in expected cash flows result in the reversal of a corresponding amount of the non-accretable discount which the Corporation then reclassifies as an accretable discount that is recognized into interest income over the remaining life of the loans using the interest method.

 

- 9 -

 

Allowance for Loan Losses

The allowance for loan losses represents the Corporation’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectable are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. While the Corporation attributes a portion of the allowance to individual loans and groups of loans that it evaluates and determines to be impaired, the allowance is available to cover all charge-offs that arise from the loan portfolio.

 

The allowance for loan losses is maintained at a level considered by management to be adequate to provide for losses that can be reasonably anticipated. The Corporation performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation’s past loan loss experience, 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 revision as more information becomes available.

 

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired, generally substandard and nonaccrual loans. For loans that are classified as impaired, an allowance is established when the collateral value (or discounted cash flows or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers pools of loans by loan class, including commercial loans not considered impaired, as well as smaller balance homogeneous loans such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these classes of loans, adjusted for qualitative (environmental) risk factors. Historical loss rates are based on a two year rolling average of net charge-offs. Qualitative risk factors that supplement historical losses in the evaluation of loan pools are shown below. Each factor is assigned a value to reflect improving, stable or declining conditions based on the Corporation’s best judgment using relevant information available at the time of the evaluation.

 

Changes in national and local economies and business conditions

Changes in the value of collateral for collateral dependent loans

Changes in the level of concentrations of credit

Changes in the volume and severity of classified and past due loans

Changes in the nature and volume of the portfolio

Changes in collection, charge-off, and recovery procedures

Changes in underwriting standards and loan terms

Changes in the quality of the loan review system

Changes in the experience/ability of lending management and key lending staff

Regulatory and legal regulations that could affect the level of credit losses

Other pertinent environmental factors

 

The unallocated component is maintained to cover uncertainties that could affect the Corporation’s estimate of probable losses. For example, increasing credit risks and uncertainties, not yet reflected in current leading indicators, associated with prolonged low economic growth, or recessionary business conditions for certain industries or the broad economy, or the erosion of real estate values, represent risk factors, the occurrence of any or all of which can adversely affect a borrowers’ ability to service their loans. The unallocated component of the allowance also reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the loan portfolio, including the unpredictable timing and amounts of charge-offs and related historical loss averages, and specific-credit or broader portfolio future cash flow value and collateral valuation uncertainties which could negatively impact unimpaired portfolio loss factors.

 

- 10 -

 

 

As disclosed in Note 4—Loans, the Corporation engages in commercial and consumer lending. Loans are made within the Corporation’s primary market area and surrounding areas, and include the purchase of whole loan or participation interests in loans from other financial institutions or private equity companies. Commercial loans, which pose the greatest risk of loss to the Corporation, whether originated or purchased, are generally secured by real estate. Within the broad commercial loan segment, the builder & developer and commercial real estate investor loan classes generally present a higher level of risk than other commercial loan classifications. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties, unstable real estate prices and the dependency upon successful construction and sale or operation of the real estate project. Within the consumer loan segment, junior (i.e., second) liens present a higher risk to the Corporation because economic and housing market conditions can adversely affect the underlying value of the collateral, which could render the Corporation under-secured or unsecured. In addition, economic and housing market conditions can adversely affect the ability of some borrowers to service their debt.

 

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status 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. The Corporation 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. Loans that are deemed impaired are evaluated for impairment loss based on the net realizable value of the collateral, as applicable. Loans that are not collateral dependent will rely on the present value of expected future cash flows discounted at the loan’s effective interest rate to determine impairment loss. Large groups of smaller balance homogeneous loans such as residential mortgage loans, home equity loans and other consumer loans are collectively evaluated for impairment, unless they are classified as impaired.

 

An allowance for loan losses is established for an impaired commercial loan if its carrying value exceeds its estimated fair value. For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals of the underlying collateral. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the most recent appraisal and the condition of the property. Appraisals are generally discounted to provide for selling costs and other factors to determine an estimate of the net realizable value of the property. For commercial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. In instances when specific consumer related loans become impaired, they may be partially or fully charged off, which obviates the need for a specific allowance.

 

Loans whose terms are modified are classified as troubled debt restructurings if the Corporation grants borrowers experiencing financial difficulties concessions that it would not otherwise consider. Concessions granted under a troubled debt restructuring may involve an interest rate that is below the market rate given the associated credit risk of the loan or an extension of a loan’s stated maturity date. Loans classified as troubled debt restructurings are designated as impaired. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for a reasonable period of time, generally six consecutive months after modification and future payments are reasonably assured.

 

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Banking regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses and may require the Corporation to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to the Corporation. Based on an analysis of the loan portfolio, the Corporation believes that the level of the allowance for loan losses at June 30, 2018 is adequate.

 

Foreclosed Real Estate

Foreclosed real estate, included in other assets, is comprised of property acquired through a foreclosure proceeding or property that is acquired through in-substance foreclosure. Foreclosed real estate is initially recorded at fair value minus estimated costs to sell at the date of foreclosure, establishing a new cost basis. Any difference between the carrying value and the new cost basis is charged against the allowance for loan losses. Appraisals, obtained from an independent third party, are generally used to determine fair value. After foreclosure, management reviews valuations at least quarterly and adjusts the asset to the lower of cost or fair value minus estimated costs to sell through a valuation allowance or a write-down. Costs related to the improvement of foreclosed real estate are generally capitalized until the real estate reaches a saleable condition subject to fair value limitations. Revenue and expense from operations and changes in the valuation allowance are included in noninterest expense. When a foreclosed real estate asset is ultimately sold, any gain or loss on the sale is included in the income statement as a component of noninterest expense. At June 30, 2018, there was $193,000 of foreclosed real estate, which included $74,000 of residential real estate, compared to $216,000, which included $96,000 of residential real estate, at December 31, 2017. Included within loans receivable as of June 30, 2018 was a recorded investment of $245,000 of consumer mortgage loans secured by residential real estate properties, for which formal foreclosure proceedings were in process according to local requirements of the applicable jurisdiction.

 

Mortgage Servicing Rights

The mortgage servicing rights (MSRs) associated with the sold loans are included in other assets on the consolidated balance sheets at an amount equal to the estimated fair value of the contractual rights to service the mortgage loans. The MSR asset is amortized as a reduction to servicing income. The MSR asset is evaluated periodically for impairment and carried at the lower of amortized cost or fair value. A third party calculates fair value by discounting the estimated cash flows from servicing income using a rate consistent with the risk associated with these assets and an expected life commensurate with the expected life of the underlying loans. In the event that the amortized cost of the MSR asset exceeds the fair value of the asset, a valuation allowance would be established through a charge against servicing income. Subsequent fair value evaluations may determine that impairment has been reduced or eliminated, in which case the valuation allowance would be reduced through a credit to earnings. At June 30, 2018, the balance of residential mortgage loans serviced for third parties was $86,854,000 compared to $70,780,000 at December 31, 2017.

 

   Three months ended   Six months ended 
   June 30,   June 30, 
(dollars in thousands)  2018   2017   2018   2017 
Amortized cost:                    
Balance at beginning of period  $715   $416   $672   $324 
Originations of mortgage servicing rights   125    94    193    201 
Amortization expense   (32)   (17)   (57)   (32)
Balance at end of period  $808   $493   $808   $493 

 

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Goodwill and Core Deposit Intangible Assets

Goodwill arising from acquisitions is not amortized, but is subject to an annual impairment test. This test consists of a qualitative analysis. If the Corporation determines events or circumstances indicate that it is more likely than not that goodwill is impaired, a quantitative analysis must be completed. Analyses may also be performed between annual tests. Significant judgment is applied when goodwill is assessed for impairment. This judgment includes developing cash flow projections, selecting appropriate discount rates, identifying relevant market comparables, incorporating general economic and market conditions, and selecting an appropriate control premium. The Corporation completes its annual goodwill impairment test on October 1st of each year. Based upon a qualitative analysis of goodwill, the Corporation concluded that the amount of recorded goodwill was not impaired as of October 1, 2017.

 

Core deposit intangibles represent the value assigned to demand, interest checking, money market, and savings accounts acquired as part of an acquisition. The core deposit intangible value represents the future economic benefit of potential cost savings from acquiring core deposits as part of an acquisition compared to the cost of alternative funding sources and the alternative cost to grow a similar core deposit base. The core deposit intangible asset resulting from the merger with Madison Bancorp, Inc. was determined to have a definite life and is being amortized using the sum of the years’ digits method over ten years. All intangible assets must be evaluated for impairment if certain events or changes in circumstances occur. Any impairment write-downs would be recognized as expense on the consolidated statements of income.

 

At June 30, 2018, the Corporation does not have any indicators of potential impairment of either goodwill or core deposit intangibles.

 

Revenue from Contracts with Customers

Revenue from contracts with customers that are required to be recognized under FASB ASC Topic 606 - Revenue from Contracts with Customers (ASC 606) is measured based on consideration specified in a contract with a customer, and excludes any sales incentives and amounts collected on behalf of third parties. The Corporation recognizes revenue when it satisfies a performance obligation by transferring control over a product or service to a customer.

 

The majority of the Corporation’s revenue-generating transactions are not within the scope of ASC 606, including revenue generated from financial instruments, such as our loans, letters of credit, derivatives and investment securities, as well as revenue related to our mortgage servicing activities, as these activities are subject to other U.S. Generally Accepted Accounting Principles (GAAP) discussed elsewhere within our disclosures. Descriptions of our revenue-generating activities that are within the scope of ASC 606, which are presented in our consolidated statements of income as components of non-interest income are as follows:

 

Trust and investment service fees - The Corporation provides trust, investment management custody and irrevocable life insurance trust services to customers. Such services are rendered in accordance with the underlying contracts for which fees are earned. Performance obligations are typically fulfilled on a monthly basis which is when revenue is recognized.

 

Income from mutual fund, annuity and insurance sales – The Corporation sells mutual funds, annuity and insurance products to its customers. The Corporation’s performance obligation is met upon the signing of the product agreement and, in certain cases, a time component may exist when the customer has the right to rescind the agreement with or without penalty. The Corporation recognizes revenues upon delivery of the product or service unless there is a time component and revenues are recognized utilizing the expected value method.

 

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Service charges on deposits accounts - These represent general service fees for monthly account maintenance and activity- or transaction based fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when the performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed.

 

Per Share Data

 

All per share computations include the effect of stock dividends distributed. The computation of net income per share is provided in the table below.

 

   Three months ended   Six months ended 
   June 30,   June 30, 
(in thousands, except per share data)  2018   2017   2018   2017 
Net income  $6,054   $3,685   $10,137   $7,104 
                     
Weighted average shares outstanding (basic)   8,932    8,862    8,923    8,857 
Effect of dilutive stock options   103    101    92    100 
Weighted average shares outstanding (diluted)   9,035    8,963    9,015    8,957 
                     
Basic earnings per share  $0.68   $0.41   $1.14   $0.80 
Diluted earnings per share  $0.67   $0.41   $1.12   $0.79 
                     
Anti-dilutive stock options excluded from the computation of earnings per share   14    0    14    0 

 

Comprehensive Income

Accounting principles generally accepted in the United States require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the shareholders’ equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

 

Cash Flow Information

For purposes of the statements of cash flows, the Corporation considers interest bearing deposits with banks, cash and due from banks, and federal funds sold to be cash and cash equivalents.

 

Supplemental cash flow information is provided in the table below.

 

   Six months ended 
   June 30, 
(dollars in thousands)  2018   2017 
Cash paid during the period for:        
Income taxes  $900   $4,450 
Interest  $6,878   $5,117 
           
Noncash investing activities:          
Transfer of loans to foreclosed real estate  $92   $0 
Transfer of loans held for sale to the held-to-maturity portfolio  $0   $228 
Sale of foreclosed real estate through loans  $0   $2,311 
Increase in other liabilities for purchase of securities settling after quarter end  $4,369   $0 

 

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Recent Accounting Pronouncements

 

Pronouncements Adopted in 2018

 

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. This standard clarifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows to reduce diversity in practice. This standard contains guidance clarifying when an entity should separate cash receipts and cash payments and classify them into more than one class of cash flows (including when reasonable judgment is required to estimate and allocate cash flows) versus when an entity should classify the aggregate amount into one class of cash flows on the basis of predominance. The new standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Corporation adopted this standard effective with its March 31, 2018 quarterly report on Form 10-Q. The adoption of the new standard did not have a material impact on its consolidated financial statements.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606).

This standards update provides a framework that replaces most existing revenue recognition guidance. The guidance requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. This ASU amends the new revenue standard to make minor technical corrections that affect narrow aspects of the guidance, including contract cost accounting, disclosures, and other matters. ASU 2014-09 and ASU 2016-20 are effective for interim and annual reporting periods beginning after December 15, 2017. The Corporation has determined that certain noninterest income financial statement line items, including trust and investment services fees, income from mutual fund, annuity and insurance sales, service charges on deposit accounts, and other noninterest income, contain revenue streams that are in scope of these updates. The Corporation adopted this standard on January 1, 2018 utilizing the modified retrospective method and the adoption of the new standard did not have a material impact on the recognition of revenue.

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 is intended to improve the recognition and measurement of financial instruments by requiring equity investments to be measured at fair value with changes in fair value recognized in net income; requiring public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; requiring separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements; eliminating the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured and amortized at cost on the balance sheet; and requiring a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. ASU 2016-01 is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2017. The amendments should be applied by means of a cumulative effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption. In February 2018, the FASB issued ASU No. 2018-03 which includes technical corrections and improvements to clarify the guidance in ASU No. 2016-01. The Corporation adopted ASU 2016-01 on January 1, 2018 and it did not have a material effect on its accounting for fair value disclosures and other disclosure requirements.

 

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Pronouncements Not Yet Effective

 

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350). This standard simplifies the test for goodwill impairment by eliminating the requirement to calculate the implied fair value of goodwill, which currently is Step 2 of the goodwill impairment test. Instead, the goodwill impairment test will consist of a single quantitative step comparing the fair value of the reporting unit with its carrying amount. An entity should recognize a goodwill impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The new standard is effective for annual and any interim goodwill impairment tests in reporting periods beginning after December 15, 2019. Early adoption is permitted. The Corporation intends to adopt this standard effective with its October 1, 2020 goodwill impairment test and the adoption of this standard is not expected to have a material impact on its consolidated financial statements based on current circumstances.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326). This standard adds a new Topic 326 which requires companies to measure and record impairment on financial instruments at the time of origination using the expected credit loss (CECL) model. The CECL model calculates impairment based on historical experience, current conditions, and reasonable and supportable forecasts, and reflects the organization’s current estimate of all expected credit losses over the contractual term of its financial assets. The new standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018. The Corporation is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements and is in the initial stages of assessing and gathering the necessary data to implement the new standard.

 

In February 2016, the FASB issued ASU 2016-02, Leases and in July 2018 issued ASU 2018-10, Codification Improvements to Topic 842, Leases. From the lessee’s perspective, the new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessees. From the lessor’s perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing lease. If the lessor doesn’t convey risks and rewards or control, an operating lease results.  The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Corporation is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements and has determined that the provisions of ASU 2016-02 will result in an increase in assets to recognize the present value of the lease obligations (right-of-use assets) with a corresponding increase in liabilities. The initial measurement of the right-of-use asset and the corresponding liability will be affected by certain key assumptions such as expectations of renewals or extensions and the interest rate to be used to discount the future lease obligations. The Corporation is currently assessing its lease portfolio to determine the key assumptions and financial statement impact; however, the total impact of the new standard will be affected by any new leases that are executed, leases that are terminated prior to the effective date, and any leases with changes to key assumptions or expectations such as renewals and extensions, and discount rates.

 

- 16 -

 

 

In July 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting. This standard expands the scope of Topic 718, Compensation – Stock Compensation to include share-based payment transactions for acquiring goods and services from nonemployees. This standard requires application of Topic 718 to nonemployee awards for specific guidance on inputs to an option pricing model and the attribution of costs (that is, the period of time over which share-based payment awards vest and the pattern of cost recognition over that period). The amendments in the Update are effective for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The adoption of this standard is not expected to have a material impact on the Corporation’s consolidated financial statements based on current circumstances.

 

Note 2-Securities

 

A summary of securities available-for-sale at June 30, 2018 and December 31, 2017 is provided below. The securities available-for-sale portfolio is generally comprised of high quality debt instruments, principally obligations of the United States government or agencies thereof and investments in the obligations of states and municipalities. The majority of municipal bonds in the portfolio are general obligation bonds, which can draw upon multiple sources of revenue, including taxes, for payment. Only a few bonds are revenue bonds, which are dependent upon a single revenue stream for payment, but they are for critical services such as water and sewer. In many cases, municipal debt issues are insured or, in the case of school districts of selected states, backed by specific loss reserves. At June 30, 2018, 83 percent of the fair value of the municipal bond portfolio was concentrated in the Commonwealth of Pennsylvania.

 

   Amortized   Gross Unrealized   Fair 
(dollars in thousands)  Cost   Gains   Losses   Value 
June 30, 2018                
  Debt securities:                    
U.S. Treasury notes  $14,772   $0   $(1,068)  $13,704 
U.S. agency   18,004    0    (1,160)   16,844 
U.S. agency mortgage-backed, residential   76,659    62    (1,378)   75,343 
State and municipal   49,029    88    (541)   48,576 
Total debt securities  $158,464   $150   $(4,147)  $154,467 
December 31, 2017                    
  Debt securities:                    
U.S. Treasury notes  $14,758   $0   $(687)  $14,071 
U.S. agency   18,015    0    (712)   17,303 
U.S. agency mortgage-backed, residential   75,204    327    (356)   75,175 
State and municipal   51,827    304    (89)   52,042 
Total debt securities  $159,804   $631   $(1,844)  $158,591 

 

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The amortized cost and estimated fair value of debt securities at June 30, 2018 by contractual maturity are shown below. Actual maturities may differ from contractual maturities if call options on select debt issues are exercised in the future. Mortgage-backed securities are included in the maturity categories based on average expected life.

 

   Available-for-sale 
   Amortized   Fair 
(dollars in thousands)  Cost   Value 
Due in one year or less  $13,073   $13,098 
Due after one year through five years   80,072    78,702 
Due after five years through ten years   57,935    55,268 
Due after ten years   7,384    7,399 
Total debt securities  $158,464   $154,467 

 

Gross realized gains and losses on sales of securities available-for-sale are shown below. Realized gains and losses are computed on the basis of specific identification of the adjusted cost of each security and are shown net as a separate line item in the income statement.

 

   Three months ended   Six months ended 
   June 30,   June 30, 
(dollars in thousands)  2018   2017   2018   2017 
Realized gains  $0   $63   $0   $63 
Realized losses   0    0    0    0 
Net gains  $0   $63   $0   $63 

 

Securities, issued by agencies of the federal government, with a carrying value of $114,175,000 and $105,603,000 on June 30, 2018 and December 31, 2017, respectively, were pledged to secure public and trust deposits, repurchase agreements and other short-term borrowings.

 

The table below shows gross unrealized losses and fair value, aggregated by investment category and length of time, for securities that have been in a continuous unrealized loss position, at June 30, 2018 and December 31, 2017.

 

   Less than 12 months   12 months or more   Total 
   Number of   Fair   Unrealized   Number of   Fair   Unrealized   Number of   Fair   Unrealized 
(dollars in thousands)  Securities   Value   Losses   Securities   Value   Losses   Securities   Value   Losses 
June 30, 2018                                    
Debt securities:                                             
U.S. Treasury notes   0   $0   $0    3   $13,704   $(1,068)   3   $13,704   $(1,068)
U.S. agency   0    0    0    5    16,844    (1,160)   5    16,844    (1,160)
 U.S. agency mortgage-backed, residential   41    57,952    (1,127)   3    6,131    (251)   44    64,083    (1,378)
State and municipal   54    27,819    (391)   6    3,634    (150)   60    31,453    (541)
Total temporarily impaired debt securities, available-for-sale   95   $85,771   $(1,518)   17   $40,313   $(2,629)   112   $126,084   $(4,147)
December 31, 2017                                             
  Debt securities:                                             
U.S. Treasury notes   0   $0   $0    3   $14,071   $(687)   3   $14,071   $(687)
U.S. agency   1    989    (12)   4    16,314    (700)   5    17,303    (712)
U.S. agency mortgage-backed, residential   25    43,329    (261)   2    5,051    (95)   27    48,380    (356)
State and municipal   27    12,171    (60)   5    3,277    (29)   32    15,448    (89)
Total temporarily impaired debt securities, available-for-sale   53   $56,489   $(333)   14   $38,713   $(1,511)   67   $95,202   $(1,844)

 

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Securities available-for-sale are analyzed quarterly for possible other-than-temporary impairment. The analysis considers, among other factors: 1) whether the Corporation has the intent to sell its securities prior to market recovery or maturity; 2) whether it is more likely than not that the Corporation will be required to sell its securities prior to market recovery or maturity; 3) default rates/history by security type; 4) third-party securities ratings; 5) third-party guarantees; 6) subordination; 7) payment delinquencies; 8) nature of the issuer; and 9) current financial news.

 

The Corporation believes that unrealized losses at June 30, 2018 were primarily the result of changes in market interest rates and that the Corporation has the ability to hold these investments for a time necessary to recover the amortized cost. Through June 30, 2018 the Corporation has collected all interest and principal on its investment securities as scheduled. The Corporation believes that collection of the contractual principal and interest is probable and, therefore, all impairment is considered to be temporary.

 

Note 3—Restricted Investment in Bank Stocks

 

Restricted stock, which represents required investments in the common stock of correspondent banks, is carried at cost and, as of June 30, 2018 and December 31, 2017, consisted primarily of the common stock of the Federal Home Loan Bank of Pittsburgh (“FHLBP”) and, to a lesser degree, Atlantic Community Bancshares, Inc. (“ACBI”), the parent company of Atlantic Community Bankers Bank (“ACBB”). Under the FHLBP’s Capital Plan member banks, including PeoplesBank, are required to maintain a minimum stock investment. The FHLBP uses a formula to determine the minimum stock investment, which is based on the volume of loans outstanding, unused borrowing capacity and other factors.

 

The FHLBP paid dividends during the periods ended June 30, 2018 and 2017. The FHLBP restricts the repurchase of the excess capital stock of member banks. The amount of excess capital stock that can be repurchased from any member is currently the lesser of five percent of the member’s total capital stock outstanding or its excess capital stock outstanding.

 

Management evaluates the restricted stock for impairment in accordance with FASB ASC Topic 942. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. Using the FHLBP as an example, the determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as: (1) the significance of the decline in net assets of the FHLBP as compared to the capital stock amount for the FHLBP and the length of time this situation has persisted; (2) commitments by the FHLBP to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLBP; and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLBP. Management believes no impairment charge was necessary related to the restricted stock during the periods ended June 30, 2018 and 2017.

 

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Note 4—Loans

 

Loan Portfolio Composition

 

The table below provides the composition of the loan portfolio at June 30, 2018 and December 31, 2017. The portfolio is comprised of two segments, commercial and consumer loans. The commercial loan segment is disaggregated by industry class which allows the Corporation to monitor risk and performance. Those industries representing the largest dollar investment and most risk are listed separately. The “Other” commercial loans category is comprised of various industries. The consumer related segment is comprised of residential mortgages, home equity and other consumer loans. The Corporation has not engaged in sub-prime residential mortgage originations.

 

   June 30,   % Total   December 31,   % Total 
(dollars in thousands)  2018   Loans   2017   Loans 
Builder & developer  $160,530    11.0   $184,402    13.2 
Commercial real estate investor   226,218    15.4    230,827    16.5 
Residential real estate investor   232,041    15.8    209,414    15.0 
Hotel/Motel   75,531    5.2    63,195    4.5 
Wholesale & retail   104,823    7.1    103,040    7.3 
Manufacturing   79,450    5.4    62,510    4.5 
Agriculture   65,476    4.5    59,931    4.3 
Other   321,276    21.9    284,511    20.3 
  Total commercial related loans   1,265,345    86.3    1,197,830    85.6 
Residential mortgages   80,393    5.5    79,325    5.6 
Home equity   96,934    6.6    97,950    7.0 
Other   23,224    1.6    24,659    1.8 
  Total consumer related loans   200,551    13.7    201,934    14.4 
    Total loans  $1,465,896    100.0   $1,399,764    100.0 

 

Loan Risk Ratings

 

The Corporation’s internal risk rating system follows regulatory guidance as to risk classifications and definitions. Every approved loan is assigned a risk rating. Generally, risk ratings for commercial related loans and residential mortgages held for investment are determined by a formal evaluation of risk factors performed by the Corporation’s underwriting staff. For consumer loans, and commercial loans up to $500,000, the Corporation uses third-party credit scoring software models for risk rating purposes. The loan portfolio is monitored on a continuous basis by loan officers, loan review personnel and senior management. Adjustments of loan risk ratings are generally performed by the Special Asset Committee, which includes senior management. The Committee, which meets at a minimum quarterly, makes changes, as appropriate, to risk ratings when it becomes aware of credit events such as payment delinquency, cessation of a business or project, bankruptcy or death of the borrower, or changes in collateral value.

 

- 20 -

 

 

The Corporation uses ten risk ratings to grade loans. The first seven ratings, representing the lowest risk, are combined and given a “pass” rating. A pass rating is a satisfactory credit rating, which applies to a loan that is expected to perform in accordance with the loan agreement and has a low probability of loss. A loan rated “special mention” has a potential weakness which may, if not corrected, weaken the loan or inadequately protect the Corporation’s position at some future date. A loan rated “substandard” is inadequately protected by the current net worth or paying capacity of the borrower or of the collateral pledged. A substandard loan has a well-defined weakness or weaknesses that could jeopardize liquidation of the loan, which exposes the Corporation to loss if the deficiencies are not corrected. A loan classified “doubtful” has all the weaknesses inherent in one classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and value highly improbable and the possibility of loss extremely high. When circumstances indicate that collection of the loan is doubtful, the loan is risk rated “nonaccrual,” the accrual of interest income is discontinued, and any unpaid interest previously credited to income is reversed. The table below does not include the regulatory classification of “doubtful,” which is subsumed within the nonaccrual risk rating category, nor does it include the regulatory classification of “loss” because the Corporation promptly charges off known loan losses.

 

The table below presents a summary of loan risk ratings by loan class at June 30, 2018 and December 31, 2017.

 

       Special             
(dollars in thousands)  Pass   Mention   Substandard   Nonaccrual   Total 
June 30, 2018                         
Builder & developer  $157,711   $536   $195   $2,088   $160,530 
Commercial real estate investor   218,742    362    6,059    1,055    226,218 
Residential real estate investor   225,538    4,862    521    1,120    232,041 
Hotel/Motel   75,531    0    0    0    75,531 
Wholesale & retail   95,969    2,374    6,362    118    104,823 
Manufacturing   75,426    574    3,450    0    79,450 
Agriculture   61,996    3,186    0    294    65,476 
Other   318,469    1,847    960    0    321,276 
  Total commercial related loans   1,229,382    13,741    17,547    4,675    1,265,345 
Residential mortgage   80,147    8    84    154    80,393 
Home equity   96,369    0    0    565    96,934 
Other   22,974    25    9    216    23,224 
  Total consumer related loans   199,490    33    93    935    200,551 
             Total loans  $1,428,872   $13,774   $17,640   $5,610   $1,465,896 
                          
December 31, 2017                         
Builder & developer  $179,897   $1,832   $581   $2,092   $184,402 
Commercial real estate investor   224,822    360    4,339    1,306    230,827 
Residential real estate investor   204,139    4,065    711    499    209,414 
Hotel/Motel   63,195    0    0    0    63,195 
Wholesale & retail   95,128    254    7,658    0    103,040 
Manufacturing   58,082    588    3,840    0    62,510 
Agriculture   57,140    2,476    0    315    59,931 
Other   283,086    507    918    0    284,511 
  Total commercial related loans   1,165,489    10,082    18,047    4,212    1,197,830 
Residential mortgage   79,068    10    85    162    79,325 
Home equity   97,498    0    0    452    97,950 
Other   24,394    30    9    226    24,659 
  Total consumer related loans   200,960    40    94    840    201,934 
             Total loans  $1,366,449   $10,122   $18,141   $5,052   $1,399,764 

 

- 21 -

 

 

Impaired Loans

 

The table below presents a summary of impaired loans at June 30, 2018 and December 31, 2017. Generally, impaired loans are certain loans risk rated substandard and all loans risk rated nonaccrual or classified as troubled debt restructurings. An allowance is established for individual loans that are commercial related where the Corporation has doubt as to full recovery of the outstanding principal balance. Typically, impaired consumer related loans are partially or fully charged-off eliminating the need for a specific allowance. The recorded investment represents outstanding unpaid principal loan balances adjusted for charge-offs.

 

   With No Allowance   With A Related Allowance   Total 
   Recorded   Unpaid   Recorded   Unpaid   Related   Recorded   Unpaid 
(dollars in thousands)  Investment   Principal   Investment   Principal   Allowance   Investment   Principal 
June 30, 2018                            
Builder & developer  $2,283   $2,618   $0   $0   $0   $2,283   $2,618 
Commercial real estate investor   7,114    7,129    0    0    0    7,114    7,129 
Residential real estate investor   1,641    1,911    0    0    0    1,641    1,911 
Hotel/Motel   0    0    0    0    0    0    0 
Wholesale & retail   6,730    6,730    0    0    0    6,730    6,730 
Manufacturing   3,450    3,450    0    0    0    3,450    3,450 
Agriculture   294    294    0    0    0    294    294 
Other commercial   960    960    0    0    0    960    960 
Total impaired commercial related loans   22,472    23,092    0    0    0    22,472    23,092 
Residential mortgage   238    262    0    0    0    238    262 
Home equity   565    565    0    0    0    565    565 
Other consumer   225    229    0    0    0    225    229 
Total impaired consumer related loans   1,028    1,056    0    0    0    1,028    1,056 
Total impaired loans  $23,500   $24,148   $0   $0   $0   $23,500   $24,148 
                             
December 31, 2017                                   
Builder & developer  $2,673   $3,008   $0   $0   $0   $2,673   $3,008 
Commercial real estate investor   4,585    4,601    1,060    1,060    243    5,645    5,661 
Residential real estate investor   1,210    1,510    0    0    0    1,210    1,510 
Hotel/Motel   0    0    0    0    0    0    0 
Wholesale & retail   7,912    7,912    0    0    0    7,912    7,912 
Manufacturing   3,840    3,840    0    0    0    3,840    3,840 
Agriculture   315    315    0    0    0    315    315 
Other commercial   918    918    0    0    0    918    918 
Total impaired commercial related loans   21,453    22,104    1,060    1,060    243    22,513    23,164 
Residential mortgage   247    276    0    0    0    247    276 
Home equity   452    452    0    0    0    452    452 
Other consumer   235    235    0    0    0    235    235 
Total impaired consumer related loans   934    963    0    0    0    934    963 
Total impaired loans  $22,387   $23,067   $1,060   $1,060   $243   $23,447   $24,127 

 

- 22 -

 

 

The table below presents a summary of average impaired loans and related interest income that was included in net income for the three and six months ended June 30, 2018 and 2017.

 

   With No Related Allowance   With A Related Allowance   Total 
   Average   Total   Cash Basis   Average   Total   Cash Basis   Average   Total   Cash Basis 
   Recorded   Interest   Interest   Recorded   Interest   Interest   Recorded   Interest   Interest 
(dollars in thousands)  Investment   Income   Income   Investment   Income   Income   Investment   Income   Income 
Three months ended June 30, 2018                                    
Builder & developer  $2,291   $5   $0   $0   $0   $0   $2,291   $5   $0 
Commercial real estate investor   5,817    75    3    0    0    0    5,817    75    3 
Residential real estate investor   1,582    8    2    0    0    0    1,582    8    2 
Hotel/Motel   0    0    0    0    0    0    0    0    0 
Wholesale & retail   6,501    90    0    0    0    0    6,501    90    0 
Manufacturing   3,557    92    0    0    0    0    3,557    92    0 
Agriculture   367    0    0    0    0    0    367    0    0 
Other commercial   1,045    16    0    0    0    0    1,045    16    0 
Total impaired commercial related loans   21,160    286    5    0    0    0    21,160    286    5 
Residential mortgage   257    1    0    0    0    0    257    1    0 
Home equity   511    9    9    0    0    0    511    9    9 
Other consumer   229    4    4    0    0    0    229    4    4 
Total impaired consumer related loans   997    14    13    0    0    0    997    14    13 
Total impaired loans  $22,157   $300   $18   $0   $0   $0   $22,157   $300   $18 
                                              
Three months ended June 30, 2017                                             
Builder & developer  $3,029   $48   $0   $2,336   $0   $0   $5,365   $48   $0 
Commercial real estate investor   5,292    60    4    0    0    0    5,292    60    4 
Residential real estate investor   1,411    12    2    460    0    0    1,871    12    2 
Hotel/Motel   0    0    0    18    0    0    18    0    0 
Wholesale & retail   6,743    80    0    0    0    0    6,743    80    0 
Manufacturing   2,869    76    0    1,250    18    0    4,119    94    0 
Agriculture   0    0    0    344    0    0    344    0    0 
Other commercial   1,160    14    0    183    0    0    1,343    14    0 
Total impaired commercial related loans   20,504    290    6    4,591    18    0    25,095    308    6 
Residential mortgage   93    0    0    0    0    0    93    0    0 
Home equity   393    4    4    0    0    0    393    4    4 
Other consumer   290    4    4    0    0    0    290    4    4 
Total impaired consumer related loans   776    8    8    0    0    0    776    8    8 
Total impaired loans  $21,280   $298   $14   $4,591   $18   $0   $25,871   $316   $14 

 

- 23 -

 

 

   With No Related Allowance   With A Related Allowance   Total 
   Average   Total   Cash Basis   Average   Total   Cash Basis   Average   Total   Cash Basis 
   Recorded   Interest   Interest   Recorded   Interest   Interest   Recorded   Interest   Interest 
(dollars in thousands)  Investment   Income   Income   Investment   Income   Income   Investment   Income   Income 
Six months ended June 30, 2018                                    
Builder & developer  $2,418   $11   $0   $0   $0   $0   $2,418   $11   $0 
Commercial real estate investor   5,406    135    7    0    0    0    5,406    135    7 
Residential real estate investor   1,458    20    5    0    0    0    1,458    20    5 
Hotel/Motel   0    0    0    0    0    0    0    0    0 
Wholesale & retail   6,972    190    0    0    0    0    6,972    190    0 
Manufacturing   3,652    183    0    0    0    0    3,652    183    0 
Agriculture   350    1    0    0    0    0    350    1    0 
Other commercial   1,002    31    0    0    0    0    1,002    31    0 
Total impaired commercial related loans   21,258    571    12    0    0    0    21,258    571    12 
Residential mortgage   253    1    0    0    0    0    253    1    0 
Home equity   491    11    11    0    0    0    491    11    11 
Other consumer   231    9    9    0    0    0    231    9    9 
Total impaired consumer related loans   975    21    20    0    0    0    975    21    20 
Total impaired loans  $22,233   $592   $32   $0   $0   $0   $22,233   $592   $32 
                                              
Six months ended June 30, 2017                                             
Builder & developer  $3,189   $101   $0   $1,685   $0   $0   $4,874   $101   $0 
Commercial real estate investor   5,492    123    11    0    0    0    5,492    123    11 
Residential real estate investor   1,409    27    7    406    0    0    1,815    27    7 
Hotel/Motel   120    0    0    12    0    0    132    0    0 
Wholesale & retail   4,582    83    0    0    0    0    4,582    83    0 
Manufacturing   2,117    86    0    833    18    0    2,950    104    0 
Agriculture   189    0    0    350    0    0    539    0    0 
Other commercial   1,094    27    0    183    0    0    1,277    27    0 
Total impaired commercial related loans   18,192    447    18    3,469    18    0    21,661    465    18 
Residential mortgage   109    0    0    0    0    0    109    0    0 
Home equity   343    4    4    0    0    0    343    4    4 
Other consumer   251    6    6    0    0    0    251    6    6 
Total impaired consumer related loans   703    10    10    0    0    0    703    10    10 
Total impaired loans  $18,895   $457   $28   $3,469   $18   $0   $22,364   $475   $28 

 

- 24 -

 

 

Past Due and Nonaccrual

 

The performance and credit quality of the loan portfolio is also monitored by using an aging schedule that shows the length of time a loan is past due. The table below presents a summary of past due loans, nonaccrual loans and current loans by loan segment and class at June 30, 2018 and December 31, 2017.

 

           ≥ 90 Days                 
   30-59   60-89   Past Due       Total Past         
   Days   Days   and       Due and       Total 
(dollars in thousands)  Past Due   Past Due   Accruing   Nonaccrual   Nonaccrual   Current   Loans 
June 30, 2018                                   
Builder & developer  $257   $0   $0   $2,088   $2,345   $158,185   $160,530 
Commercial real estate investor   600    362    0    1,055    2,017    224,201    226,218 
Residential real estate investor   212    501    0    1,120    1,833    230,208    232,041 
Hotel/Motel   0    0    0    0    0    75,531    75,531 
Wholesale & retail   0    0    0    118    118    104,705    104,823 
Manufacturing   0    0    0    0    0    79,450    79,450 
Agriculture   324    70    0    294    688    64,788    65,476 
Other   3,688    0    0    0    3,688    317,588    321,276 
Total commercial related loans   5,081    933    0    4,675    10,689    1,254,656    1,265,345 
Residential mortgage   477    321    68    154    1,020    79,373    80,393 
Home equity   163    56    0    565    784    96,150    96,934 
Other   107    6    8    216    337    22,887    23,224 
Total consumer related loans   747    383    76    935    2,141    198,410    200,551 
Total loans  $5,828   $1,316   $76   $5,610   $12,830   $1,453,066   $1,465,896 
                                    
December 31, 2017                                   
Builder & developer  $615   $26   $0   $2,092   $2,733   $181,669   $184,402 
Commercial real estate investor   0    0    0    1,306    1,306    229,521    230,827 
Residential real estate investor   347    0    0    499    846    208,568    209,414 
Hotel/Motel   0    0    0    0    0    63,195    63,195 
Wholesale & retail   0    0    0    0    0    103,040    103,040 
Manufacturing   0    0    0    0    0    62,510    62,510 
Agriculture   0    137    0    315    452    59,479    59,931 
Other   203    117    0    0    320    284,191    284,511 
Total commercial related loans   1,165    280    0    4,212    5,657    1,192,173    1,197,830 
Residential mortgage   392    72    67    162    693    78,632    79,325 
Home equity   264    5    0    452    721    97,229    97,950 
Other   123    5    9    226    363    24,296    24,659 
Total consumer related loans   779    82    76    840    1,777    200,157    201,934 
Total loans  $1,944   $362   $76   $5,052   $7,434   $1,392,330   $1,399,764 

 

- 25 -

 

 

Troubled Debt Restructurings

 

Loans classified as troubled debt restructurings (TDRs) are designated impaired and arise when the Corporation grants borrowers experiencing financial difficulties concessions that it would not otherwise consider. Concessions granted with respect to these loans generally involve an extension of the maturity date or a below market interest rate relative to new debt with similar credit risk. Generally, these loans are secured by real estate. If repayment of the loan is determined to be collateral dependent, the loan is evaluated for impairment loss based on the fair value of the collateral. For loans that are not collateral dependent, the present value of expected future cash flows, discounted at the loan’s original effective interest rate, is used to determine any impairment loss. A nonaccrual TDR represents a nonaccrual loan, as previously defined, which includes an economic concession. Nonaccrual TDRs are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive payments after the modification and future principal and interest payments are reasonably assured. In contrast, an accruing TDR represents a loan that, at the time of the modification, has a demonstrated history of payments and management believes that future loan payments are reasonably assured under the modified terms.

 

The table below shows loans whose terms have been modified under TDRs during the three and six months ended June 30, 2018 and 2017. There were no impairment losses recognized on any of these TDRs, and they are all performing under their modified terms. There were no defaults during the three and six months ended June 30, 2018 for TDRs entered into during the previous 12 month period.

 

   Modifications 
       Pre-Modification   Post-Modification     
   Number   Outstanding   Outstanding   Recorded 
   of   Recorded   Recorded   Investment 
(dollars in thousands)  Contracts   Investments   Investments   at Period End 
Three months ended:                
                 
June 30, 2018                    
Commercial related loans accruing   1   $150   $150   $139 
                     
 June 30, 2017                    
None                    
                     
Six months ended:                    
                     
June 30, 2018                    
Commercial related loans accruing   1   $150   $150   $139 
                     
 June 30, 2017                    
None                    

 

- 26 -

 

 

NOTE 5 – Allowance for Loan Losses

 

The table below shows the activity in and the composition of the allowance for loan losses by loan segment and class detail as of and for the three and six months ended June 30, 2018 and 2017.

                     
    Allowance for Loan Losses 
    April 1, 2018                   June 30, 2018 
(dollars in thousands)   Balance    Charge-offs    Recoveries    Provision    Balance 
Builder & developer  $2,977   $0   $0   $(78)  $2,899 
Commercial real estate investor   2,788    0    0    (93)   2,695 
Residential real estate investor   2,539    (1)   71    (185)   2,424 
Hotel/Motel   759    0    0    5    764 
Wholesale & retail   925    0    1    12    938 
Manufacturing   542    0    0    103    645 
Agriculture   449    0    0    22    471 
Other commercial   2,715    0    0    240    2,955 
Total commercial related loans   13,694    (1)   72    26    13,791 
Residential mortgage   114    (10)   1    9    114 
Home equity   204    0    0    (1)   203 
Other consumer   152    (88)   7    121    192 
Total consumer related loans   470    (98)   8    129    509 
Unallocated   2,702    0    0    145    2,847 
Total  $16,866   $(99)  $80   $300   $17,147 

 

    Allowance for Loan Losses 
    April 1, 2017                    June 30, 2017 
(dollars in thousands)   Balance    Charge-offs    Recoveries    Provision    Balance 
Builder & developer  $2,658   $0   $2   $851   $3,511 
Commercial real estate investor   3,007    0    0    66    3,073 
Residential real estate investor   2,509    (110)   3    56    2,458 
Hotel/Motel   747    (36)   36    (85)   662 
Wholesale & retail   829    0    0    16    845 
Manufacturing   789    0    0    117    906 
Agriculture   663    0    0    10    673 
Other commercial   2,526    0    0    (92)   2,434 
Total commercial related loans   13,728    (146)   41    939    14,562 
Residential mortgage   88    0    0    6    94 
Home equity   182    0    0    0    182 
Other consumer   76    (10)   1    6    73 
Total consumer related loans   346    (10)   1    12    349 
Unallocated   1,630    0    0    (126)   1,504 
Total  $15,704   $(156)  $42   $825   $16,415 

 

- 27 -

 

 

                     
    Allowance for Loan Losses 
    January 1, 2018                   June 30, 2018 
(dollars in thousands)   Balance    Charge-offs    Recoveries    Provision    Balance 
Builder & developer  $3,388   $0   $18   $(507)  $2,899 
Commercial real estate investor   3,013    0    0    (318)   2,695 
Residential real estate investor   2,505    (1)   74    (154)   2,424 
Hotel/Motel   637    0    0    127    764 
Wholesale & retail   909    0    2    27    938 
Manufacturing   592    0    0    53    645 
Agriculture   431    0    0    40    471 
Other commercial   2,643    0    0    312    2,955 
Total commercial related loans   14,118    (1)   94    (420)   13,791 
Residential mortgage   108    (10)   1    15    114 
Home equity   217    0    0    (14)   203 
Other consumer   66    (136)   10    252    192 
Total consumer related loans   391    (146)   11    253    509 
Unallocated   2,180    0    0    667    2,847 
Total  $16,689   $(147)  $105   $500   $17,147 

 

    Allowance for Loan Losses 
    January 1, 2017                    June 30, 2017 
(dollars in thousands)   Balance    Charge-offs    Recoveries    Provision    Balance 
Builder & developer  $2,384   $0   $2   $1,125   $3,511 
Commercial real estate investor   2,870    0    0    203    3,073 
Residential real estate investor   2,517    (110)   56    (5)   2,458 
Hotel/Motel   807    (36)   36    (145)   662 
Wholesale & retail   803    0    0    42    845 
Manufacturing   307    0    0    599    906 
Agriculture   619    0    0    54    673 
Other commercial   2,467    0    0    (33)   2,434 
Total commercial related loans   12,774    (146)   94    1,840    14,562 
Residential mortgage   85    0    5    4    94 
Home equity   179    0    0    3    182 
Other consumer   193    (10)   5    (115)   73 
Total consumer related loans   457    (10)   10    (108)   349 
Unallocated   1,761    0    0    (257)   1,504 
Total  $14,992   $(156)  $104   $1,475   $16,415 

 

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The table below shows the allowance amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment at June 30, 2018, December 31, 2017, and June 30, 2017.

                         
   Allowance for Loan Losses   Loans 
   Individually   Collectively       Individually   Collectively     
   Evaluated For   Evaluated For       Evaluated For   Evaluated For      
(dollars in thousands)  Impairment   Impairment   Balance   Impairment   Impairment   Balance 
June 30, 2018                              
Builder & developer  $0   $2,899   $2,899   $2,283   $158,247   $160,530 
Commercial real estate investor   0    2,695    2,695    7,114    219,104    226,218 
Residential real estate investor   0    2,424    2,424    1,641    230,400    232,041 
Hotel/Motel   0    764    764    0    75,531    75,531 
Wholesale & retail   0    938    938    6,730    98,093    104,823 
Manufacturing   0    645    645    3,450    76,000    79,450 
Agriculture   0    471    471    294    65,182    65,476 
Other commercial   0    2,955    2,955    960    320,316    321,276 
Total commercial related   0    13,791    13,791    22,472    1,242,873    1,265,345 
Residential mortgage   0    114    114    238    80,155    80,393 
Home equity   0    203    203    565    96,369    96,934 
Other consumer   0    192    192    225    22,999    23,224 
Total consumer related   0    509    509    1,028    199,523    200,551 
Unallocated   0    2,847    2,847             
Total  $0   $17,147   $17,147   $23,500   $1,442,396   $1,465,896 
                         
December 31, 2017                              
Builder & developer  $0   $3,388   $3,388   $2,673   $181,729   $184,402 
Commercial real estate investor   243    2,770    3,013    5,645    225,182    230,827 
Residential real estate investor   0    2,505    2,505    1,210    208,204    209,414 
Hotel/Motel   0    637    637    0    63,195    63,195 
Wholesale & retail   0    909    909    7,912    95,128    103,040 
Manufacturing   0    592    592    3,840    58,670    62,510 
Agriculture   0    431    431    315    59,616    59,931 
Other commercial   0    2,643    2,643    918    283,593    284,511 
Total commercial related   243    13,875    14,118    22,513    1,175,317    1,197,830 
Residential mortgage   0    108    108    247    79,078    79,325 
Home equity   0    217    217    452    97,498    97,950 
Other consumer   0    66    66    235    24,424    24,659 
Total consumer related   0    391    391    934    201,000    201,934 
Unallocated   0    2,180    2,180             
Total  $243   $16,446   $16,689   $23,447   $1,376,317   $1,399,764 
                         
 June 30, 2017                              
Builder & developer  $1,021   $2,490   $3,511   $7,287   $164,102   $171,389 
Commercial real estate investor   0    3,073    3,073    5,820    249,307    255,127 
Residential real estate investor   136    2,322    2,458    1,722    201,593    203,315 
Hotel/Motel   0    662    662    0    65,581    65,581 
Wholesale & retail   0    845    845    6,211    87,398    93,609 
Manufacturing   400    506    906    5,015    48,685    53,700 
Agriculture   263    410    673    337    56,687    57,024 
Other commercial   82    2,352    2,434    1,411    255,811    257,222 
Total commercial related   1,902    12,660    14,562    27,803    1,129,164    1,156,967 
Residential mortgage   0    94    94    93    75,011    75,104 
Home equity   0    182    182    390    93,739    94,129 
Other consumer   0    73    73    282    27,166    27,448 
Total consumer related   0    349    349    765    195,916    196,681 
Unallocated   0    1,504    1,504             
Total  $1,902   $14,513   $16,415   $28,568   $1,325,080   $1,353,648 

 

- 29 -

 

 

Note 6—Deposits

 

The composition of deposits as of June 30, 2018 and December 31, 2017 is shown below. The aggregate amount of demand deposit overdrafts that were reclassified as loans were $117,000 at June 30, 2018, compared to $199,000 at December 31, 2017.

 

   June 30,   December 31, 
(dollars in thousands)  2018   2017 
Noninterest bearing demand  $259,745   $246,866 
Interest Bearing Demand   168,971    157,903 
Money market   471,181    447,425 
Savings   88,866    86,292 
Time deposits less than $100,000   265,216    260,482 
Time deposits $100,000 to $250,000   139,960    135,242 
Time deposits $250,000 or more   48,885    50,297 
Total deposits  $1,442,824   $1,384,507 

 

Note 7—Short-Term Borrowings and Long-Term Debt

 

Short-term borrowings consist of securities sold under agreements to repurchase, federal funds purchased and other borrowings. At June 30, 2018, the balance of securities sold under agreements to repurchase was $12,964,000 compared to $10,295,000 at December 31, 2017. At June 30, 2018, there were no other short-term borrowings compared to $10,200,000 at December 31, 2017.

 

The following table presents a summary of long-term debt as of June 30, 2018 and December 31, 2017. PeoplesBank’s long-term debt obligations to the FHLBP are fixed rate instruments. Under terms of a blanket collateral agreement with the FHLBP, the obligations are secured by FHLBP stock and PeoplesBank qualifying loan receivables, principally real estate secured loans.

 

   June 30,   December 31, 
(dollars in thousands)  2018   2017 
PeoplesBank’s obligations:          
  Federal Home Loan Bank of Pittsburgh (FHLBP)          
Due March 2018, 1.17%  $0   $10,000 
Due June 2018, 1.87%   0    5,000 
Due June 2018, 1.41%   0    10,000 
Due November 2018, 1.62%   5,000    5,000 
Due December 2018, 1.60%   15,000    15,000 
Due April 2019, 1.64%   10,000    10,000 
Due June 2019, 1.64%   5,000    5,000 
Due June 2019, 2.10%   5,000    5,000 
Due December 2019, 1.89%   15,000    15,000 
Due March 2020, 1.86%   10,000    10,000 
Due June 2020, 1.87%   15,000    15,000 
Due June 2020, 2.70%   10,000    0 
Due June 2021, 2.14%   15,000    15,000 
Due June 2021, 2.81%   10,000    0 
Due May 2022, 2.98%   10,000    0 
  Total FHLBP   125,000    120,000 
Codorus Valley Bancorp, Inc. obligations:          
  Junior subordinated debt          
Due 2034, 4.36%, floating rate based on 3 month          
   LIBOR plus 2.02%, callable quarterly   3,093    3,093 
Due 2036, 3.89% floating rate based on 3 month          
   LIBOR plus 1.54%, callable quarterly   7,217    7,217 
Total long-term debt  $135,310   $130,310 

 

- 30 -

 

 

At June 30, 2018 and December 31, 2017, municipal deposit letters of credit issued by the FHLBP on behalf of PeoplesBank naming applicable municipalities as beneficiaries were $42,000,000. The letters of credit took the place of securities pledged to the municipalities for their deposits maintained at PeoplesBank.

 

In June 2006, Codorus Valley formed CVB Statutory Trust No. 2, a wholly-owned special purpose subsidiary whose sole purpose was to facilitate a pooled trust preferred debt issuance of $7,217,000. In November 2004, Codorus Valley formed CVB Statutory Trust No. 1 to facilitate a pooled trust preferred debt issuance of $3,093,000. The Corporation owns all of the common stock of these nonbank subsidiaries, and the debentures are the sole assets of the Trusts. The accounts of both Trusts are not consolidated for financial reporting purposes in accordance with FASB ASC 810. For regulatory capital purposes, all of the Corporation’s trust preferred securities qualified as Tier 1 capital for all reported periods. Trust preferred securities are subject to capital limitations under the FDIC’s risk-based capital guidelines. The Corporation used the net proceeds from these offerings to fund its operations.

 

Note 8—Regulatory Matters

 

The Corporation and PeoplesBank are subject to various regulatory capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if imposed, could have a material adverse effect on the Corporation’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and PeoplesBank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators.

 

On July 2, 2013, the Board of Governors of the Federal Reserve System finalized its rule implementing the Basel III regulatory capital framework, which the FDIC adopted on July 9, 2013. Under the rule, minimum requirements increased both the quantity and quality of capital held by banking organizations. Consistent with the Basel III framework, the rule included a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5 percent, and a common equity Tier 1 conservation buffer of 2.5 percent of risk-weighted assets, that applies to all supervised financial institutions, which is to be phased in over a four year period beginning January 1, 2016, with the full 2.5 percent required as of January 1, 2019. The rule also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4 percent to 6 percent, and includes a minimum leverage ratio of 4 percent for all banking organizations. The new rule also increased the risk weights for past-due loans, certain commercial real estate loans, and some equity exposures, and makes selected other changes in risk weights and credit conversion factors. The rule for smaller, less complex institutions, including the Corporation, took effect January 1, 2015.

 

- 31 -

 

 

As of June 30, 2018, the Corporation and PeoplesBank met the minimum requirements of the Basel III framework, and PeoplesBank’s capital ratios exceeded the amount to be considered “well capitalized” as defined in the regulations. The table below provides a comparison of the Corporation’s and PeoplesBank’s risk-based capital ratios and leverage ratios to the minimum regulatory requirement for the periods indicated.

 

           Minimum for   Well Capitalized 
   Actual   Capital Adequacy (1)   Minimum (2) 
(dollars in thousands)  Amount   Ratio   Amount   Ratio   Amount   Ratio 
Codorus Valley Bancorp, Inc. (consolidated)                              
at June 30, 2018                              
Capital ratios:                              
Common equity Tier 1  $171,212    11.78%  $92,666    6.375%   n/a    n/a 
Tier 1 risk based   181,212    12.47    114,470    7.875    n/a    n/a 
Total risk based   198,359    13.65    143,542    9.875    n/a    n/a 
Leverage   181,212    10.37    69,920    4.00    n/a    n/a 
                               
at December 31, 2017                              
Capital ratios:                              
Common equity Tier 1  $162,860    11.58%  $80,842    5.750%   n/a    n/a 
Tier 1 risk based   172,860    12.29    101,932    7.250    n/a    n/a 
Total risk based   189,549    13.48    130,051    9.250    n/a    n/a 
Leverage   172,860    10.26    67,382    4.00    n/a    n/a 
                               
PeoplesBank, A Codorus Valley Company                              
at June 30, 2018                              
Capital ratios:                              
Common equity Tier 1  $177,166    12.22%  $92,452    6.375%  $94,264    6.50%
Tier 1 risk based   177,166    12.22    114,205    7.875    116,018    8.00 
Total risk based   194,313    13.40    143,209    9.875    145,022    10.00 
Leverage   177,166    10.16    69,779    4.00    87,224    5.00 
                               
at December 31, 2017                              
Capital ratios:                              
Common equity Tier 1  $168,879    12.04%  $80,630    5.750%  $91,147    6.50%
Tier 1 risk based   168,879    12.04    101,664    7.250    112,181    8.00 
Total risk based   185,568    13.23    129,709    9.250    140,226    10.00 
Leverage   168,879    10.05    67,234    4.00    84,043    5.00 

 

(1) Minimum amounts and ratios as of June 30, 2018 include the third year phase in of the capital conservation buffer of 1.875 percent required by the Basel III framework. At December 31, 2017, the minimum amounts and ratios included the second year phase in of the capital conservation buffer of 1.25 percent required by the Basel III framework. The conservation buffer is to be phased in over a four year period beginning January 1, 2016, with the full 2.5 percent required as of January 1, 2019.

 

(2) To be “well capitalized” under the prompt corrective action provisions in the Basel III framework. “Well capitalized” applies to PeoplesBank only.

 

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Note 9—Shareholders’ Equity

 

Authorized Shares

 

At the May 15, 2018 annual shareholder meeting, the shareholders of the Corporation approved a change in the Articles of Incorporation to increase the number of authorized shares of common stock from 15,000,000 to 30,000,000.

 

Stock Dividend

 

Periodically, the Corporation distributes stock dividends on its stock. The Corporation distributed 5 percent stock dividends on December 12, 2017 and December 13, 2016, which resulted in the issuance of 422,439 and 398,541 additional shares, respectively.

 

Note 10—Contingent Liabilities

 

There are no legal proceedings pending against Codorus Valley Bancorp, Inc. or any of its subsidiaries which are expected to have a material impact upon the consolidated financial position and/or operating results of the Corporation, other than routine litigation incidental to the business. Management is not aware of any proceedings known or contemplated by government authorities.

 

Note 11—Guarantees

 

Codorus Valley does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit.  Standby letters of credit are written conditional commitments issued by PeoplesBank to guarantee the performance of a client to a third party.  Generally, all letters of credit, when issued, have expiration dates within one year.  The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to clients.  The Corporation generally holds collateral and/or personal guarantees supporting these commitments.  The Corporation had $28,229,000 of standby letters of credit outstanding on June 30, 2018, compared to $23,603,000 on December 31, 2017. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding letters of credit. The amount of the liability as of June 30, 2018 and December 31, 2017, for guarantees under standby letters of credit issued, was not material. Many of the commitments are expected to expire without being drawn upon and, therefore, generally do not present significant liquidity risk to the Corporation or PeoplesBank.

 

- 33 -

 

Note 12—Fair Value of Assets and Liabilities

 

The Corporation uses its best judgment in estimating the fair value of the Corporation’s assets and liabilities; however, there are inherent weaknesses in any estimation technique. Therefore, the fair value estimates herein are not necessarily indicative of the amounts that could be realized in sales transactions on the dates indicated. The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values subsequent to the respective reporting dates may be different than the amounts reported at each period end.

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date. GAAP establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:

 

Level 1: Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

 

Level 2: Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the valuation methodology that utilize model-based techniques for which all significant assumptions are observable in the market.

 

Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement; inputs to the valuation methodology that utilize model-based techniques for which significant assumptions are not observable in the market; or inputs to the valuation methodology that require significant management judgment or estimation, some of which may be internally developed.

 

Since management maximizes the use of observable inputs and minimizes the use of unobservable inputs when determining fair value, an asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Management reviews and updates the fair value hierarchy classifications on a quarterly basis.

 

- 34 -

 

 

Assets Measured at Fair Value on a Recurring Basis

 

Securities available-for-sale

 

The fair values of investment securities were measured using information from a third-party pricing service. The pricing service uses quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique, used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities, but rather, by relying on the securities’ relationship to other benchmark quoted prices. At least annually, the Corporation reviews a random sample of the pricing information received from the third-party pricing service by comparing it to price quotes from third-party brokers. Historically, price deviations have been immaterial.

 

       Fair Value Measurements 
       (Level 1)   (Level 2)   (Level 3) 
         Quoted Prices in    Significant Other    Significant Other 
         Active Markets for    Observable    Unobservable 
(dollars in thousands)   Total    Identical Assets     Inputs    Inputs 
June 30, 2018                    
Securities available-for-sale:                    
  U.S. Treasury notes  $13,704   $13,704   $0   $0 
  U.S. agency   16,844    0    16,844    0 
  U.S. agency mortgage-backed, residential   75,343    0    75,343    0 
  State and municipal   48,576    0    48,576    0 
                     
December 31, 2017                    
Securities available-for-sale:                    
  U.S. Treasury notes  $14,071   $14,071   $0   $0 
  U.S. agency   17,303    0    17,303    0 
  U.S. agency mortgage-backed, residential   75,175    0    75,175    0 
  State and municipal   52,042    0    52,042    0 

 

Assets Measured at Fair Value on a Nonrecurring Basis

 

Impaired loans

Impaired loans are those that are accounted for under FASB ASC Topic 310, in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These loans are included as Level 3 fair values, based on the lowest level of input that is significant to the fair value measurements. At June 30, 2018, the fair value of impaired loans with a valuation allowance or charge-off was $478,000, net of charge-offs of $475,000. At December 31, 2017 the fair value of impaired loans with a valuation allowance or charge-off was $1,331,000, net of valuation allowances of $243,000 and charge-offs of $506,000.

 

Foreclosed Real Estate

Other real estate property acquired through foreclosure is initially recorded at fair value of the property at the transfer date less estimated selling cost. Subsequently, other real estate owned is carried at the lower of its carrying value or the fair value less estimated selling cost. Fair value is usually determined based on an independent third-party appraisal of the property or occasionally on a recent sales offer. At June 30, 2018 and December 31, 2017, there were no foreclosed real estate assets with a valuation allowance or write-down.

 

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Mortgage Servicing Rights

Mortgage servicing rights are initially recorded at fair value upon the sale of residential mortgage loans to secondary market investors. The fair value of servicing rights is based on the present value of estimated future cash flows on pools of mortgages stratified by rate and original time to maturity. Mortgage servicing rights are subsequently evaluated for impairment on a quarterly basis. Significant inputs to the valuation include expected cash flow, expected net servicing income, a cash flow discount rate and the expected life of the underlying loans. At June 30, 2018, the fair value of the mortgage servicing rights asset was $964,000. At December 31, 2017, the fair value of the mortgage servicing rights asset was $769,000.

                 
       Fair Value Measurements 
       (Level 1)       (Level 3) 
         Quoted Prices in    (Level 2)    Significant Other 
         Active Markets for    Significant Other    Unobservable 
(dollars in thousands)   Total    Identical Assets     Observable Inputs    Inputs 
June 30, 2018                    
  Impaired loans  $478   $0   $0   $478 
  Mortgage servicing rights   964    0    0    964 
                     
December 31, 2017                    
  Impaired loans  $1,331   $0   $0   $1,331 
  Mortgage servicing rights   769    0    0    769 

 

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Corporation has utilized Level 3 inputs to determine fair value:

                   
  Quantitative Information about Level 3 Fair Value Measurements
  Fair Value   Valuation Unobservable   Weighted
(dollars in thousands) Estimate   Techniques Input Range Average
June 30, 2018                  
  Impaired loans $ 478   Appraisal (1)   Appraisal adjustments (2)   15% - 60% 46%
  Mortgage servicing rights   964   Multiple of annual   Estimated prepayment speed             7.1% - 8.3% 7.4%
        service fee   based on rate and term      
December 31, 2017                  
  Impaired loans $  1,331   Appraisal (1)   Appraisal adjustments (2)   24% - 52% 38%
  Mortgage servicing rights   769   Multiple of annual   Estimated prepayment speed             6.9% - 8.5% 7.6%
        service fee   based on rate and term      

                   
(1)   Fair value is generally determined through independent appraisals, which generally include various level 3 inputs that are not identifiable.  
(2)   Appraisals may be adjusted downward by the Corporation’s management for qualitative factors such as economic conditions and estimated liquidation expenses.  The range of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.  

 

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Disclosures about Fair Value of Financial Instruments

The following methods and assumptions were used to estimate the fair value of the Corporation’s financial instruments as of June 30, 2018 and December 31, 2017:

 

Cash and cash equivalents

The carrying amount is a reasonable estimate of fair value.

 

Securities available for sale

The fair value of securities available for sale is determined in accordance with the methods described under FASB ASC Topic 820 as described above.

 

Restricted investment in bank stocks

The carrying amount of restricted investment in bank stocks is a reasonable estimate of fair value. The Corporation is required to maintain minimum investment balances in these stocks. These stocks are not actively traded and, therefore, have no readily determinable market value.

 

Loans held for sale

The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan.

 

Loans, net

The fair value of loans, for June 30, 2018, are estimated on an exit price basis incorporating discounts for such factors as credit, liquidity and marketability factors. This is not comparable with the fair values disclosed for December 31, 2017, which were based on an entrance price basis. For that date, fair values of variable rate loans that reprice frequently and with no significant change in credit risk were based on carrying values. The fair values of other loans as of that date were estimated using discounted cash flow analyses which used interest rates then being offered for loans with similar terms to borrowers of similar credit quality.

 

Interest receivable

The carrying value of interest receivable is a reasonable estimate of fair value.

 

Deposits

The fair value of demand deposits, savings accounts and money market deposits is the amount payable on demand at the reporting date. The fair values of time deposits are estimated using a discounted cash flow analyses. The discount rates used are based on rates currently offered for deposits with similar remaining maturities. The fair values of variable rate time deposits that reprice frequently are based on carrying value. The fair values of time deposit liabilities do not take into consideration the value of the Corporation’s long-term relationships with depositors, which may have significant value.

 

Short-term borrowings

For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

 

Long-term debt

Long-term debt includes FHLBP advances (Level 2) and junior subordinated debt (Level 3). The fair value of FHLBP advances is estimated using discounted cash flow analysis, based on quoted prices for new FHLBP advances with similar credit risk characteristics, terms and remaining maturity. These prices are obtained from this active market and represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party. The fair value of junior subordinated debt is estimated using discounted cash flow analysis, based on market rates and spread characteristics of similar debt with similar credit risk characteristics, terms and remaining maturity.

 

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Interest payable

The carrying value of interest payable is a reasonable estimate of fair value.

 

Off-balance sheet instruments

Off-balance sheet instruments consist of lending commitments and letters of credit and are based on fees currently charged in the market to enter into similar arrangements, taking into account the remaining terms of the agreements and counterparties’ credit standing. These amounts were not considered material.

 

The following presents the carrying amounts and estimated fair values of the Corporation’s financial instruments as of June 30, 2018 and December 31, 2017.

                     
           Fair Value Estimates 
           (Level 1)   (Level 2)   (Level 3) 
           Quoted Prices   Significant   Significant 
           in Active   Other   Other 
   Carrying   Estimated   Markets for   Observable   Unobservable 
(dollars in thousands)  Amount   Fair Value   Identical Assets   Inputs   Inputs 
June 30, 2018                    
Financial assets                         
Cash and cash equivalents  $86,021   $86,021   $86,021   $0   $0 
Securities available-for-sale   154,467    154,467    13,704    140,763    0 
Restricted investment in bank stocks   6,522    6,522    0    6,522    0 
Loans held for sale   2,794    2,918    0    2,918    0 
Loans, net   1,448,749    1,426,027    0    0    1,426,027 
Interest receivable   4,872    4,872    0    4,872    0 
Mortgage servicing rights   808    964    0    0    964 
                          
Financial liabilities                         
Deposits  $1,442,824   $1,425,645   $0   $1,425,645   $0 
Short-term borrowings   12,964    12,964    0    12,964    0 
Long-term debt   135,310    132,619    0    123,907    8,712 
Interest payable   751    751    0    751    0 
                          
Off-balance sheet instruments   0    0    0    0    0 
                          
December 31, 2017                         
Financial assets                         
Cash and cash equivalents  $79,524   $79,524   $79,524   $0   $0 
Securities available-for-sale   158,591    158,591    14,071    144,520    0 
Restricted investment in bank stocks   6,311    6,311    0    6,311    0 
Loans held for sale   1,715    1,798    0    1,798    0 
Loans, net   1,383,075    1,368,753    0    0    1,368,753 
Interest receivable   4,968    4,968    0    4,968    0 
Mortgage servicing rights   672    769    0    0    769 
                          
Financial liabilities                         
Deposits  $1,384,507   $1,369,008   $0   $1,369,008   $0 
Short-term borrowings   20,495    20,495    0    20,495    0 
Long-term debt   130,310    127,586    0    119,474    8,112 
Interest payable   626    626    0    626    0 
                          
Off-balance sheet instruments   0    0    0    0    0 

 

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Note 13—Assets and Liabilities Subject to Offsetting

 

Securities Sold Under Agreements to Repurchase

 

PeoplesBank enters into agreements with clients in which it sells securities subject to an obligation to repurchase the same securities (“repurchase agreements”). The contractual maturity of the repurchase agreement is overnight and continues until either party terminates the agreement. These repurchase agreements are accounted for as a collateralized financing arrangement (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability (short-term borrowings) in the Corporation’s consolidated financial statements of condition, while the securities underlying the repurchase agreements are appropriately segregated for safekeeping purposes and remain in the respective securities asset accounts. Thus, there is no offsetting or netting of the securities with the repurchase agreement liabilities. 

                                               
                    Gross amounts Not Offset in      
          Gross   Net Amounts     the Statements of Condition      
    Gross   Amounts   of Liabilities     Financial Instruments            
    Amounts of   Offset in the   Presented in     U.S. agency