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, 2017

 

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 or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

 

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, 2017, -------8,453,193 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):      
  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   41  
         
Item 3. Quantitative and qualitative disclosures about market risk   64  
         
Item 4. Controls and procedures   65  
         
PART II – OTHER INFORMATION      
       
Item 1. Legal proceedings   65  
         
Item 1A. Risk factors   65  
         
Item 2. Unregistered sales of equity securities and use of proceeds   65  
         
Item 3. Defaults upon senior securities   65  
         
Item 4. Mine safety disclosures   65  
         
Item 5. Other information   65  
         
Item 6. Exhibits   66  
         
SIGNATURES   67  

 

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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)  2017   2016 
Assets          
Interest bearing deposits with banks  $42,964   $54,966 
Cash and due from banks   18,365    19,066 
Total cash and cash equivalents   61,329    74,032 
Securities, available-for-sale   181,897    194,739 
Restricted investment in bank stocks, at cost   6,866    6,926 
Loans held for sale   2,034    1,548 
Loans (net of deferred fees of $4,053 - 2017 and $3,685 - 2016)   1,353,648    1,270,771 
Less-allowance for loan losses   (16,415)   (14,992)
Net loans   1,337,233    1,255,779 
Premises and equipment, net   24,336    24,573 
Goodwill   2,301    2,301 
Other assets   54,335    51,689 
Total assets  $1,670,331   $1,611,587 
           
Liabilities          
Deposits          
Noninterest bearing  $216,779   $202,639 
Interest bearing   1,108,886    1,061,538 
Total deposits   1,325,665    1,264,177 
Short-term borrowings   36,524    56,637 
Long-term debt   135,310    125,310 
Other liabilities   11,396    10,506 
Total liabilities   1,508,895    1,456,630 
           
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; 15,000,000 shares authorized; shares issued and outstanding: 8,451,743 at June 30, 2017 and 8,426,873 at December 31, 2016   21,129    21,067 
Additional paid-in capital   106,863    106,102 
Retained earnings   33,737    28,909 
Accumulated other comprehensive loss   (293)   (1,121)
Total shareholders’ equity   161,436    154,957 
Total liabilities and shareholders’ equity  $1,670,331   $1,611,587 

 

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)  2017   2016   2017   2016 
Interest income                    
Loans, including fees  $16,102   $14,221   $31,496   $28,032 
Investment securities:                    
Taxable   653    602    1,302    1,304 
Tax-exempt   316    420    649    845 
Dividends   82    54    158    122 
Other   142    26    195    34 
Total interest income   17,295    15,323    33,800    30,337 
                     
Interest expense                    
Deposits   1,948    1,608    3,755    3,118 
Federal funds purchased and other short-term borrowings   100    28    192    82 
Long-term debt   619    488    1,165    973 
Total interest expense   2,667    2,124    5,112    4,173 
Net interest income   14,628    13,199    28,688    26,164 
Provision for loan losses   825    800    1,475    1,600 
Net interest income after provision for loan losses   13,803    12,399    27,213    24,564 
                     
Noninterest income                    
Trust and investment services fees   741    621    1,400    1,238 
Income from mutual fund, annuity and insurance sales   195    236    406    495 
Service charges on deposit accounts   1,051    901    2,021    1,738 
Income from bank owned life insurance   250    224    522    398 
Other income   261    229    541    418 
Gain on sales of loans held for sale   282    235    571    350 
Gain on sales of securities   63    0    63    194 
Total noninterest income   2,843    2,446    5,524    4,831 
                     
Noninterest expense                    
Personnel   6,399    6,001    13,135    11,998 
Occupancy of premises, net   807    824    1,678    1,721 
Furniture and equipment   696    707    1,391    1,432 
Postage, stationery and supplies   226    204    391    377 
Professional and legal   173    167    322    330 
Marketing   361    369    697    838 
FDIC insurance   221    180    374    346 
Debit card processing   271    265    486    562 
Charitable donations   168    27    834    768 
Telecommunications   200    164    404    326 
External data processing   452    349    847    682 
Foreclosed real estate including provision for (recovery of) losses   1    95    (28)   135 
Other   1,192    1,061    1,699    1,356 
Total noninterest expense   11,167    10,413    22,230    20,871 
Income before income taxes   5,479    4,432    10,507    8,524 
Provision for income taxes   1,794    1,392    3,403    2,667 
Net income   3,685    3,040    7,104    5,857 
Preferred stock dividends   0    0    0    16 
Net income available to common shareholders  $3,685   $3,040   $7,104   $5,841 
Net income per common share, basic  $0.43   $0.36   $0.84   $0.69 
Net income per common share, diluted  $0.43   $0.36   $0.83   $0.69 

 

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)  2017   2016 
Net income  $3,685   $3,040 
Other comprehensive income (loss):          
Securities available for sale:          
Net unrealized holding gains arising during the period (net of tax expense of $226 and $321, respectively)   419    623 
Reclassification adjustment for (gains) included in net income (net of tax expense of $22 and $0, respectively) (a) (b)   (41)   0 
Net unrealized gains   378    623 
Comprehensive income  $4,063   $3,663 
           
   Six months ended 
   June 30,  
(dollars in thousands)   2017    2016 
Net income  $7,104   $5,857 
Other comprehensive income (loss):          
Securities available for sale:          
Net unrealized holding gains arising during the period (net of tax expense of $468 and $834, respectively)   869    1,619 
Reclassification adjustment for (gains) included in net income (net of tax expense of $22 and $66, respectively) (a) (b)   (41)   (128)
Net unrealized gains   828    1,491 
Comprehensive income  $7,932   $7,348 

 

(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 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)  2017   2016 
Cash flows from operating activities          
Net income  $7,104   $5,857 
Adjustments to reconcile net income to net cash provided by operations:          
Depreciation/amortization   1,155    1,163 
Net amortization of premiums on securities   376    452 
Amortization of deferred loan origination fees and costs   (754)   (488)
Provision for loan losses   1,475    1,600 
(Reversal of) losses on foreclosed real estate   (47)   (3)
Increase in bank owned life insurance   (522)   (398)
Originations of loans held for sale   (21,168)   (18,469)
Proceeds from sales of loans held for sale   20,824    18,316 
Gain on sales of loans held for sale   (571)   (350)
Gain on disposal of premises and equipment   (7)   (2)
Gain on sales of securities, available-for-sale   (63)   (194)
(Gain) loss on sales of foreclosed real estate   (11)   1 
Stock-based compensation   371    277 
Decrease in interest receivable   113    85 
(Decrease) increase in other assets   (1,106)   596 
(Decrease) Increase in interest payable   (5)   42 
Increase in other liabilities   907    1,874 
Net cash provided by operating activities   8,071    10,359 
Cash flows from investing activities          
Purchases of securities, available-for-sale   (9,532)   (12,910)
Maturities, repayments and calls of securities, available-for-sale   21,258    26,152 
Sales of securities, available-for-sale   2,051    12,903 
Net increase (decrease) in restricted investment in bank stock   60    (98)
Net increase in loans made to customers   (79,637)   (44,566)
Purchases of premises and equipment   (911)   (1,393)
Investment in bank owned life insurance   (4,000)   (6,987)
Proceeds from sales of foreclosed real estate   386    190 
Net cash used in investing activities   (70,325)   (26,709)
Cash flows from financing activities          
Net increase in demand and savings deposits   60,369    83,184 
Net increase in time deposits   1,119    21,417 
Net (decrease) in short-term borrowings   (20,113)   (52,623)
Proceeds from issuance of long-term debt   10,000    0 
Cash dividends paid to preferred shareholder   0    (46)
Cash dividends paid to common shareholders   (2,276)   (2,070)
Redemption of preferred stock   0    (12,000)
Issuance of common stock   452    337 
Net cash provided by financing activities   49,551    38,199 
Net (decrease) increase in cash and cash equivalents   (12,703)   21,849 
Cash and cash equivalents at beginning of year   74,032    57,485 
Cash and cash equivalents at end of period  $61,329   $79,334 

 

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   Income   Stock   Total 
                             
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 
Common stock cash dividends ($0.27 per share)                  (2,276)             (2,276)
Stock-based compensation             371                   371 
Forfeiture of restricted stock             4              (4)   0 
Issuance and reissuance of common 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 
                                    
Balance, January 1, 2016  $12,000   $19,893   $97,338   $28,539   $1,371   $0   $159,141 
Net income                  5,857              5,857 
Other comprehensive income, net of tax                       1,491         1,491 
Common stock cash dividends ($0.248 per share, adjusted)                  (2,070)             (2,070)
Preferred stock cash dividends                  (16)             (16)
Redemption of preferred stock   (12,000)                            (12,000)
Stock-based compensation             277                   277 
Forfeiture of restricted stock             4              (4)   0 
Issuance and reissuance of common stock:                                   
10,380 shares under the dividend reinvestment and stock purchase plan        24    189              2    215 
2,473 shares under the stock option plan        4    38              2    44 
1,005 shares of stock-based compensation awards        3    (3)                  0 
4,447 shares under employee stock purchase plan        11    67                   78 
                                    
Balance, June 30, 2016  $0   $19,935   $97,910   $32,310   $2,862   $0   $153,017 

 

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, 2016 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, 2017. 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 two wholly-owned nonbank subsidiaries, SYC Realty Company, Inc. and CVLY Subsidiary Corp. SYC Realty was inactive during the period ended June 30, 2017. CVLY Subsidiary Corp. was the surviving merged entity resulting from the acquisition of Madison Bancorp, Inc. (“Madison”) and may be used, as needed, for the financial and legal management of future acquisition transactions. 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, 2016.

 

The results of operations for the three and six months ended June 30, 2017 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, 2017 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 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 -

 

 

The following is a summary of acquired impaired loans from the merger with Madison Bancorp, Inc.:

  

(dollars in thousands)  January 16, 2015 
Contractually required principal and interest at acquisition  $1,961 
Contractual cash flows not expected to be collected   1,185 
Expected cash flows at acquisition   776 
Interest component of expected cash flows   160 
Basis in acquired loans at acquisition - estimated fair value  $616 

 

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

 

- 10 -

 

 

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.

 

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.

 

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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.

 

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, 2017 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, 2017, foreclosed real estate, net of allowance, was $68,000, compared to $2,705,000 at December 31, 2016. Included within loans receivable as of June 30, 2017 was a recorded investment of $210,000 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.

 

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Mortgage Servicing Rights

PeoplesBank retained servicing of sold mortgage loans beginning in 2016. 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. On June 30, 2017, the MSR asset was $493,000 and the balance of residential mortgage loans serviced for third parties was $53,647,000. The MSR asset was $324,000 and the balance of residential mortgage loans serviced for third parties was $36,969,000 at December 31, 2016.

 

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, 2016.

 

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, 2017, the Corporation does not have any indicators of potential impairment of either goodwill or core deposit intangibles.

 

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Per Common Share Data

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

 

   Three months ended  Six months ended
   June 30,  June 30,
(in thousands, except per share data)  2017  2016  2017  2016
Net income available to common shareholders  $3,685   $3,040   $7,104   $5,841 
                     
Weighted average shares outstanding (basic)   8,440    8,365    8,435    8,361 
Effect of dilutive stock options   96    68    95    68 
Weighted average shares outstanding (diluted)   8,536    8,433    8,530    8,429 
                     
Basic earnings per common share  $0.43   $0.36   $0.84   $0.69 
Diluted earnings per common share  $0.43   $0.36   $0.83   $0.69 
                     
Anti-dilutive stock options excluded from the computation of earnings per share   0    74    0    74 

  

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)  2017  2016
Cash paid during the period for:      
Income taxes  $4,450   $1,205 
Interest  $5,117   $4,131 
           
Noncash investing activities:          
Transfer of loans held for sale to the held-to-maturity portfolio  $228   $117 
Sale of foreclosed real estate through loans  $2,311   $0 

 

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Recent Accounting Pronouncements

 

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.

 

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. Early adoption is permitted. The Corporation intends to adopt this standard effective with its March 31, 2018 quarterly report on Form 10-Q and does not expect the adoption of the ASU to have a material impact on its consolidated financial statements.

 

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.

 

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In February 2016, the FASB issued ASU 2016-02, 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; 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.

 

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. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim periods within that year. The Corporation is evaluating the anticipated effects of these ASUs on its consolidated financial statements and related disclosures. 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. Preliminary findings indicate that there may be some changes in the presentation of certain revenues and expenses based on the principal versus agent guidance within these updates.

 

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Note 2-Securities

 

A summary of securities available-for-sale at June 30, 2017 and December 31, 2016 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, 2017, the fair value of the municipal bond portfolio was concentrated in the state of Pennsylvania at 75 percent.

 

   Amortized  Gross Unrealized  Fair
(dollars in thousands)  Cost  Gains  Losses  Value
June 30, 2017            
 Debt securities:                    
U.S. Treasury notes  $14,743   $0   $(583)  $14,160 
U.S. agency   24,028    0    (632)   23,396 
U.S. agency mortgage-backed, residential   85,945    658    (198)   86,405 
State and municipal   57,632    394    (90)   57,936 
Total debt securities  $182,348   $1,052   $(1,503)  $181,897 
December 31, 2016                    
 Debt securities:                    
U.S. Treasury notes  $14,730   $0   $(793)  $13,937 
U.S. agency   26,045    1    (960)   25,086 
U.S. agency mortgage-backed, residential   91,242    804    (285)   91,761 
State and municipal   64,421    272    (738)   63,955 
Total debt securities  $196,438   $1,077   $(2,776)  $194,739 

 

The amortized cost and estimated fair value of debt securities at June 30, 2017 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  $16,947   $16,988 
Due after one year through five years   105,633    106,230 
Due after five years through ten years   56,064    54,908 
Due after ten years   3,704    3,771 
Total debt securities  $182,348   $181,897 

 

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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)  2017    2016    2017    2016  
Realized gains  $63   $0   $63   $194 
Realized losses   0    0    0    0 
Net gains  $63   $0   $63   $194 

 

Securities, issued by agencies of the federal government, with a carrying value of $130,346,000 and $160,357,000 on June 30, 2017 and December 31, 2016, 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, 2017 and December 31, 2016.

 

   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, 2017                           
Debt securities:                                             
U.S. Treasury notes   3   $14,160   $(583)   0   $0   $0    3   $14,160   $(583)
U.S. agency   7    23,396    (632)   0    0    0    7    23,396    (632)
U.S. agency mortgage-backed, residential   11    23,521    (198)   0    0    0    11    23,521    (198)
State and municipal   31    17,069    (87)   1    501    (3)   32    17,570    (90)
Total temporarily impaired debt securities, available-for-sale   52   $78,146   $(1,500)   1   $501   $(3)   53   $78,647   $(1,503)
December 31, 2016                                             
Debt securities:                                             
U.S. Treasury notes   3   $13,937   $(793)   0   $0   $0    3   $13,937   $(793)
U.S. agency   6    22,083    (960)   0    0    0    6    22,083    (960)
U.S. agency mortgage-backed, residential   15    36,473    (285)   0    0    0    15    36,473    (285)
State and municipal   83    40,092    (734)   1    501    (4)   84    40,593    (738)
Total temporarily impaired debt securities, available-for-sale   107   $112,585   $(2,772)   1   $501   $(4)   108   $113,086   $(2,776)

 

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, 2017 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, 2017 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.

 

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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, 2017 and December 31, 2016, 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, PeoplesBank is required to maintain a minimum member stock investment, as a condition of becoming and remaining a member and as a condition of obtaining borrowings from the FHLBP. 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, 2017 and 2016. 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, 2017 and 2016.

 

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Note 4—Loans

 

Loan Portfolio Composition

 

The table below provides the composition of the loan portfolio at June 30, 2017 and December 31, 2016. 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)  2017   Loans   2016   Loans 
Builder & developer  $171,389    12.7   $148,635    11.7 
Commercial real estate investor   255,127    18.8    243,623    19.2 
Residential real estate investor   203,315    15.0    183,623    14.4 
Hotel/Motel   65,581    4.9    82,085    6.5 
Wholesale & retail   93,609    6.9    88,062    6.9 
Manufacturing   53,700    4.0    32,616    2.6 
Agriculture   57,024    4.2    51,848    4.1 
Other   257,222    19.0    242,872    19.1 
Total commercial related loans   1,156,967    85.5    1,073,364    84.5 
Residential mortgages   75,104    5.5    73,496    5.8 
Home equity   94,129    7.0    94,222    7.4 
Other   27,448    2.0    29,689    2.3 
Total consumer related loans   196,681    14.5    197,407    15.5 
Total loans  $1,353,648    100.0   $1,270,771    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.

 

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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, 2017 and December 31, 2016.

 

(dollars in thousands)  Pass   Special
Mention
   Substandard   Nonaccrual   Total 
June 30, 2017                         
Builder & developer  $162,179   $1,923   $2,999   $4,288   $171,389 
Commercial real estate investor   248,939    368    5,571    249    255,127 
Residential real estate investor   197,552    4,041    717    1,005    203,315 
Hotel/Motel   65,581    0    0    0    65,581 
Wholesale & retail   87,288    367    5,954    0    93,609 
Manufacturing   48,685    0    5,015    0    53,700 
Agriculture   55,345    1,342    0    337    57,024 
Other   254,940    871    898    513    257,222 
Total commercial related loans   1,120,509    8,912    21,154    6,392    1,156,967 
Residential mortgage   75,011    0    85    8    75,104 
Home equity   93,690    49    0    390    94,129 
Other   27,063    103    9    273    27,448 
Total consumer related loans   195,764    152    94    671    196,681 
Total loans  $1,316,273   $9,064   $21,248   $7,063   $1,353,648 
                          
December 31, 2016                         
Builder & developer  $138,653   $6,090   $3,508   $384   $148,635 
Commercial real estate investor   236,240    1,490    5,893    0    243,623 
Residential real estate investor   177,763    4,157    866    837    183,623 
Hotel/Motel   81,724    0    0    361    82,085 
Wholesale & retail   79,884    8,178    0    0    88,062 
Manufacturing   27,564    4,439    613    0    32,616 
Agriculture   50,123    796    0    929    51,848 
Other   235,515    6,213    885    259    242,872 
Total commercial related loans   1,027,466    31,363    11,765    2,770    1,073,364 
Residential mortgage   73,340    14    85    57    73,496 
Home equity   93,908    70    0    244    94,222 
Other   29,420    97    129    43    29,689 
Total consumer related loans   196,668    181    214    344    197,407 
Total loans  $1,224,134   $31,544   $11,979   $3,114   $1,270,771 

 

- 21 -

 

 

Impaired Loans

 

The table below presents a summary of impaired loans at June 30, 2017 and December 31, 2016. Generally, impaired loans are loans risk rated substandard and nonaccrual. An allowance is established for individual commercial loans where the Corporation has doubt as to full recovery of the outstanding principal balance. 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, 2017                            
Builder & developer  $2,999   $3,134   $4,288   $4,288   $1,021   $7,287   $7,422 
Commercial real estate investor   5,820    5,836    0    0    0    5,820    5,836 
Residential real estate investor   1,423    1,423    299    299    136    1,722    1,722 
Hotel/Motel   0    0    0    0    0    0    0 
Wholesale & retail   6,211    6,211    0    0    0    6,211    6,211 
Manufacturing   3,790    3,790    1,225    1,225    400    5,015    5,015 
Agriculture   0    0    337    337    263    337    337 
Other commercial   1,228    1,228    183    298    82    1,411    1,526 
Total impaired commercial related loans   21,471    21,622    6,332    6,447    1,902    27,803    28,069 
Residential mortgage   93    122    0    0    0    93    122 
Home equity   390    390    0    0    0    390    390 
Other consumer   282    282    0    0    0    282    282 
Total impaired consumer related loans   765    794    0    0    0    765    794 
Total impaired loans  $22,236   $22,416   $6,332   $6,447   $1,902   $28,568   $28,863 

                             
December 31, 2016                            
Builder & developer  $3,508   $3,644   $384   $384   $200   $3,892   $4,028 
Commercial real estate investor   5,893    5,908    0    0    0    5,893    5,908 
Residential real estate investor   1,404    1,404    299    299    136    1,703    1,703 
Hotel/Motel   361    361    0    0    0    361    361 
Wholesale & retail   260    260    0    0    0    260    260 
Manufacturing   613    613    0    0    0    613    613 
Agriculture   568    568    361    361    263    929    929 
Other commercial   961    961    183    298    82    1,144    1,259 
Total impaired commercial related loans   13,568    13,719    1,227    1,342    681    14,795    15,061 
Residential mortgage   142    222    0    0    0    142    222 
Home equity   244    244    0    0    0    244    244 
Other consumer   172    172    0    0    0    172    172 
Total impaired consumer related loans   558    638    0    0    0    558    638 
Total impaired loans  $14,126   $14,357   $1,227   $1,342   $681   $15,353   $15,699 

 

- 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, 2017 and 2016.

 

   With No Related Allowance   With A Related Allowance   Total 
(dollars in thousands)  Average
Recorded
Investment
   Total
Interest
Income
   Cash Basis
Interest
Income
   Average
Recorded
Investment
   Total
Interest
Income
   Cash Basis
Interest
Income
   Average
Recorded
Investment
   Total
Interest
Income
   Cash Basis
Interest
Income
 
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 
                                              
Three months ended June 30, 2016                                             
Builder & developer  $3,920   $59   $0   $0   $0   $0   $3,920   $59   $0 
Commercial real estate investor   5,789    74    0    0    0    0    5,789    74    0 
Residential real estate investor   460    4    0    661    7    0    1,121    11    0 
Hotel/Motel   396    0    0    0    0    0    396    0    0 
Wholesale & retail   285    3    0    0    0    0    285    3    0 
Manufacturing   624    10    0    0    0    0    624    10    0 
Agriculture   318    0    0    385    0    0    703    0    0 
Other commercial   1,291    30    16    91    0    0    1,382    30    16 
Total impaired commercial related loans   13,083    180    16    1,137    7    0    14,220    187    16 
Residential mortgage   300    1    1    0    0    0    300    1    1 
Home equity   332    1    1    0    0    0    332    1    1 
Other consumer   235    2    0    0    0    0    235    2    0 
Total impaired consumer related loans   867    4    2    0    0    0    867    4    2 
Total impaired loans  $13,950   $184   $18   $1,137   $7   $0   $15,087   $191   $18 
                                                       

 

- 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, 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 
                                              
Six months ended June 30, 2016                                             
Builder & developer  $4,042   $118   $0   $0   $0   $0   $4,042   $118   $0 
Commercial real estate investor   5,850    150    0    0    0    0    5,850    150    0 
Residential real estate investor   523    9    0    715    14    0    1,238    23    0 
Hotel/Motel   404    2    2    0    0    0    404    2    2 
Wholesale & retail   293    5    0    0    0    0    293    5    0 
Manufacturing   626    20    0    0    0    0    626    20    0 
Agriculture   212    0    0    397    0    0    609    0    0 
Other commercial   1,457    48    20    61    0    0    1,518    48    20 
Total impaired commercial related loans   13,407    352    22    1,173    14    0    14,580    366    22 
Residential mortgage   255    1    1    0    0    0    255    1    1 
Home equity   289    2    2    0    0    0    289    2    2 
Other consumer   239    6    2    0    0    0    239    6    2 
Total impaired consumer related loans   783    9    5    0    0    0    783    9    5 
Total impaired loans  $14,190   $361   $27   $1,173   $14   $0   $15,363   $375   $27 

 

- 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, 2017 and December 31, 2016.

 

           ≥ 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, 2017                                   
Builder & developer  $1,197   $0   $0   $4,288   $5,485   $165,904   $171,389 
Commercial real estate investor   289    0    0    249    538    254,589    255,127 
Residential real estate investor   0    0    0    1,005    1,005    202,310    203,315 
Hotel/Motel   0    0    0    0    0    65,581    65,581 
Wholesale & retail   0    0    0    0    0    93,609    93,609 
Manufacturing   0    0    0    0    0    53,700    53,700 
Agriculture   1,277    0    0    337    1,614    55,410    57,024 
Other   54    0    0    513    567    256,655    257,222 
Total commercial related loans   2,817    0    0    6,392    9,209    1,147,758    1,156,967 
Residential mortgage   0    182    67    8    257    74,847    75,104 
Home equity   261    55    0    390    706    93,423    94,129 
Other   83    56    93    273    505    26,943    27,448 
Total consumer related loans   344    293    160    671    1,468    195,213    196,681 
Total loans  $3,161   $293   $160   $7,063   $10,677   $1,342,971   $1,353,648 
                                    
December 31, 2016                                   
Builder & developer  $1,456   $0   $0   $384   $1,840   $146,795   $148,635 
Commercial real estate investor   392    209    0    0    601    243,022    243,623 
Residential real estate investor   171    0    0    837    1,008    182,615    183,623 
Hotel/Motel   0    0    0    361    361    81,724    82,085 
Wholesale & retail   0    0    0    0    0    88,062    88,062 
Manufacturing   0    0    0    0    0    32,616    32,616 
Agriculture   0    0    0    929    929    50,919    51,848 
Other   238    102    498    259    1,097    241,775    242,872 
Total commercial related loans   2,257    311    498    2,770    5,836    1,067,528    1,073,364 
Residential mortgage   55    0    68    57    180    73,316    73,496 
Home equity   203    176    0    244    623    93,599    94,222 
Other   131    127    167    43    468    29,221    29,689 
Total consumer related loans   389    303    235    344    1,271    196,136    197,407 
Total loans  $2,646   $614   $733   $3,114   $7,107   $1,263,664   $1,270,771 

 

- 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.

 

There were no loans whose terms have been modified under TDRs during the three and six months ended June 30, 2017 and June 30, 2016. There were no defaults during the three and six months ended June 30, 2017 for TDRs entered into during the previous 12 month period.

 

- 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, 2017 and 2016.  

 

   Allowance for Loan Losses
(dollars in thousands)  April 1, 2017
Balance
   Charge-offs   Recoveries   Provision   June 30, 2017
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 

 

   Allowance for Loan Losses 
(dollars in thousands)  April 1, 2016
Balance
   Charge-offs   Recoveries   Provision    June 30, 2016
Balance
 
Builder & developer  $2,063   $0   $0   $(30)  $2,033 
Commercial real estate investor   2,607    0    0    (21)   2,586 
Residential real estate investor   2,167    (301)   2    547    2,415 
Hotel/Motel   832    0    0    12    844 
Wholesale & retail   692    0    1    4    697 
Manufacturing   311    0    0    (2)   309 
Agriculture   549    0    0    19    568 
Other commercial   2,136    (17)   0    (12)   2,107 
Total commercial related loans   11,357    (318)   3    517    11,559 
Residential mortgage   73    0    0    (8)   65 
Home equity   162    0    0    5    167 
Other consumer   211    (66)   49    15    209 
Total consumer related loans   446    (66)   49    12    441 
Unallocated   1,287    0    0    271    1,558 
Total  $13,090   $(384)  $52   $800   $13,558 

 

- 27 -

 

 

 

 

                     
   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 
                     
   Allowance for Loan Losses 
   January 1, 2016                   June 30, 2016 
(dollars in thousands)  Balance   Charge-offs   Recoveries   Provision   Balance 
Builder & developer  $1,934   $0   $0   $99   $2,033 
Commercial real estate investor   2,337    0    0    249    2,586 
Residential real estate investor   2,101    (487)   2    799    2,415 
Hotel/Motel   837    0    0    7    844 
Wholesale & retail   701    0    2    (6)   697 
Manufacturing   223    (140)   0    226    309 
Agriculture   548    0    0    20    568 
Other commercial   2,054    (59)   0    112    2,107 
Total commercial related loans   10,735    (686)   4    1,506    11,559 
Residential mortgage   67    (24)   0    22    65 
Home equity   161    0    0    6    167 
Other consumer   261    (93)   53    (12)   209 
Total consumer related loans   489    (117)   53    16    441 
Unallocated   1,480    0    0    78    1,558 
Total  $12,704   $(803)  $57   $1,600   $13,558 

 

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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, 2017 and December 31, 2016.

                         
   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, 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 
                         
December 31, 2016                              
Builder & developer  $200   $2,184   $2,384   $3,892   $144,743   $148,635 
Commercial real estate investor   0    2,870    2,870    5,893    237,730    243,623 
Residential real estate investor   136    2,381    2,517    1,703    181,920    183,623 
Hotel/Motel   0    807    807    361    81,724    82,085 
Wholesale & retail   0    803    803    260    87,802    88,062 
Manufacturing   0    307    307    613    32,003    32,616 
Agriculture   263    356    619    929    50,919    51,848 
Other commercial   82    2,385    2,467    1,144    241,728    242,872 
Total commercial related   681    12,093    12,774    14,795    1,058,569    1,073,364 
Residential mortgage   0    85    85    142    73,354    73,496 
Home equity   0    179    179    244    93,978    94,222 
Other consumer   0    193    193    172    29,517    29,689 
Total consumer related   0    457    457    558    196,849    197,407 
Unallocated   0    1,761    1,761    -    -    - 
Total  $681   $14,311   $14,992   $15,353   $1,255,418   $1,270,771 
                         
June 30, 2016                              
Builder & developer  $0   $2,033   $2,033   $3,902   $136,986   $140,888 
Commercial real estate investor   0    2,586    2,586    5,756    213,638    219,394 
Residential real estate investor   29    2,386    2,415    969    168,803    169,772 
Hotel/Motel   0    844    844    380    84,360    84,740 
Wholesale & retail   0    697    697    276    77,438    77,714 
Manufacturing   0    309    309    622    32,216    32,838 
Agriculture   263    305    568    1,015    43,736    44,751 
Other commercial   31    2,076    2,107    1,136    209,580    210,716 
Total commercial related   323    11,236    11,559    14,056    966,757    980,813 
Residential mortgage   0    65    65    285    67,151    67,436 
Home equity   0    167    167    313    87,621    87,934 
Other consumer   0    209    209    194    31,142    31,336 
Total consumer related   0    441    441    792    185,914    186,706 
Unallocated   0    1,558    1,558    -    -    - 
Total  $323   $13,235   $13,558   $14,848   $1,152,671   $1,167,519 

 

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Note 6—Deposits

 

The composition of deposits as of June 30, 2017 and December 31, 2016 is shown below.

         
   June 30,   December 31, 
(dollars in thousands)  2017   2016 
Noninterest bearing demand  $216,779   $202,639 
NOW   147,002    130,394 
Money market   441,460    425,874 
Savings   92,620    78,585 
Time deposits less than $100,000   243,512    242,778 
Time deposits $100,000 to $250,000   133,255    134,811 
Time deposits $250,000 or more   51,037    49,096 
Total deposits  $1,325,665   $1,264,177 

 

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, 2017, the balance of securities sold under agreements to repurchase was $26,524,000 compared to $23,637,000 at December 31, 2016. At June 30, 2017, the balance of other short-term borrowings was $10,000,000 compared to $33,000,000 at December 31, 2016.

 

The following table presents a summary of long-term debt as of June 30, 2017 and December 31, 2016. 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)  2017   2016 
PeoplesBank’s obligations:          
Federal Home Loan Bank of Pittsburgh (FHLBP)          
Due April 2017, 0.97%  $0   $10,000 
Due November 2017, 1.19%   5,000    5,000 
Due March 2018, 1.17%   10,000    10,000 
Due June 2018, 1.87%   5,000    5,000 
Due June 2018, 1.41%   10,000    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    0 
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    0 
Due June 2020, 1.87%   15,000    15,000 
Due June 2021, 2.14%   15,000    15,000 
Total FHLBP   125,000    115,000 
Codorus Valley Bancorp, Inc. obligations:          
Junior subordinated debt          
Due 2034, 3.27%, floating rate based on 3 month          
 LIBOR plus 2.02%, callable quarterly   3,093    3,093 
Due 2036, 2.70% floating rate based on 3 month          
 LIBOR plus 1.54%, callable quarterly   7,217    7,217 
Total long-term debt  $135,310   $125,310 

 

- 30 -

 

 

At June 30, 2017, municipal deposit letter of credits issued by the FHLBP on behalf of PeoplesBank naming applicable municipalities as beneficiaries were $37,000,000 compared to none at December 31, 2016. The letter of credit took the place of securities pledged to the municipality 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.

 

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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.

 

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As of June 30, 2017, 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, 2017                              
Capital ratios:                              
Common equity Tier 1  $159,410    11.55%  $79,360    5.750%   n/a    n/a 
Tier 1 risk based   169,410    12.27    100,062    7.250    n/a    n/a 
Total risk based   185,825    13.46    127,666    9.250    n/a    n/a 
Leverage   169,410    10.17    66,602    4.00    n/a    n/a 
                               
at December 31, 2016                              
Capital ratios:                              
Common equity Tier 1  $153,762    11.88%  $66,320    5.125%   n/a    n/a 
Tier 1 risk based   163,762    12.66    85,731    6.625    n/a    n/a 
Total risk based   178,754    13.81    111,611    8.625    n/a    n/a 
Leverage   163,762    10.76    60,870    4.00    n/a    n/a 
                               
PeoplesBank, A Codorus Valley Company                              
at June 30, 2017                              
Capital ratios:                              
Common equity Tier 1  $165,677    12.03%  $79,160    5.750%  $89,485    6.50%
Tier 1 risk based   165,677    12.03    99,810    7.250    110,135    8.00 
Total risk based   182,092    13.23    127,344    9.250    137,669    10.00 
Leverage   165,677    9.97    66,463    4.00    83,079    5.00 
                               
at December 31, 2016                              
Capital ratios:                              
Common equity Tier 1  $159,832    12.38%  $66,151    5.125%  $83,899    6.50%
Tier 1 risk based   159,832    12.38    85,513    6.625    103,260    8.00 
Total risk based   174,824    13.54    111,328    8.625    129,076    10.00 
Leverage   159,832    10.53    60,723    4.00    75,903    5.00 

 

(1) Minimum amounts and ratios as of June 30, 2017 include the second year phase in of the capital conservation buffer of 1.25 percent required by the Basel III framework. At December 31, 2016, the minimum amounts and ratios included the first year phase in of the capital conservation buffer of 0.625 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

 

Preferred Stock Issued under the US Treasury’s Small Business Lending Fund Program

 

The U.S. Department of the Treasury (“Treasury”) had a capital investment in the Corporation pursuant to the Corporation’s participation in the Treasury’s Small Business Lending Funding Program (“SBLF Program”). In August 2011, the Corporation sold to the Treasury, for an aggregate purchase price of $25,000,000, 25,000 shares of non-cumulative, perpetual preferred stock, Series B, $1,000 liquidation value, $2.50 par value. On May 30, 2014, the Corporation redeemed 13,000 of the 25,000 outstanding shares of the Corporation’s preferred stock that had been issued to the Treasury, leaving 12,000 outstanding shares representing $12,000,000 of preferred stock. On February 18, 2016, the Corporation redeemed the remaining $12,000,000 of Series B preferred stock issued to the Treasury as reported on Form 8-K filed on February 19, 2016.

 

The annualized dividend rate on the preferred stock issued under the SBLF Program was 1 percent from January 1, 2016 through the redemption date of February 18, 2016.

 

Common Stock Dividend

 

Periodically, the Corporation distributes stock dividends on its common stock. The Corporation distributed 5 percent common stock dividends on December 13, 2016 and December 8, 2015, which resulted in the issuance of 398,541 and 294,161 additional common 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 $23,531,000 of standby letters of credit outstanding on June 30, 2017, compared to $19,505,000 on December 31, 2016. 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, 2017 and December 31, 2016, 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.

 

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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.

 

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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, 2017                    
Securities available-for-sale:                    
 U.S. Treasury notes  $14,160   $14,160   $0   $0 
 U.S. agency   23,396    0    23,396    0 
 U.S. agency mortgage-backed, residential   86,405    0    86,405    0 
 State and municipal   57,936    0    57,936    0 
                     
December 31, 2016                    
Securities available-for-sale:                    
 U.S. Treasury notes  $13,937   $13,937   $0   $0 
 U.S. agency   25,086    0    25,086    0 
 U.S. agency mortgage-backed, residential   91,761    0    91,761    0 
 State and municipal   63,955    0    63,955    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, 2017, the fair value of impaired loans with a valuation allowance or charge-off was $4,437,000, net of valuation allowances of $1,902,000 and charge-offs of $120,000. At December 31, 2016 the fair value of impaired loans with a valuation allowance or charge-off was $604,000, net of valuation allowances of $681,000 and charge-offs of $170,000.

 

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, 2017, there were no foreclosed real estate assets with a valuation allowance or write-down. At December 31, 2016, the fair value of foreclosed real estate with a valuation allowance or write-down was $1,594,000, net of valuation allowances of $881,000 and no write-downs.

 

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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, 2017, the fair value of the mortgage servicing rights asset was $532,000. At December 31, 2016, the fair value of the mortgage servicing rights asset was $367,000.

 

       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, 2017                    
 Impaired loans  $4,437   $0   $0   $4,437 
 Mortgage servicing rights   532    0    0    532 
                     
December 31, 2016                    
 Impaired loans  $604   $0   $0   $604 
 Foreclosed real estate   1,594    0    0    1,594 
 Mortgage servicing rights   367    0    0    367 

 

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, 2017                  
 Impaired loans $  4,437   Appraisal (1)   Appraisal adjustments (2)   15% - 50% 22%
 Mortgage servicing rights   532   Multiple of annual   Estimated prepayment speed   237% - 454% 421%
        service fee   based on rate and term      
December 31, 2016                  
 Impaired loans $  604   Appraisal (1)   Appraisal adjustments (2)   15% - 25% 19%
 Foreclosed real estate    1,594   Appraisal (1)   Appraisal adjustments (2)   9% - 9% 9%
 Mortgage servicing rights   367   Multiple of annual   Estimated prepayment speed   247% - 490% 446%
        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, 2017 and December 31, 2016:

 

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, excluding all impaired loans, is estimated using discounted cash flow analyses using the current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans were first segregated by type such as commercial, real estate, and consumer, and were further segmented into fixed and variable rate. Projected future cash flows are calculated based on contractual maturity or call dates. For variable rate loans that reprice frequently and have no significant change in credit risk, fair value is based on carrying value.

 

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, 2017 and December 31, 2016.

 

                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, 2017                            
Financial assets                            
Cash and cash equivalents $ 61,329   $ 61,329   $ 61,329   $ 0   $ 0
Securities available-for-sale   181,897     181,897     14,160     167,737     0
Restricted investment in bank stocks   6,866     6,866     0     6,866     0
Loans held for sale   2,034     2,107     0     2,107     0
Loans, net   1,337,234     1,331,238     0     0     1,331,238
Interest receivable   4,335     4,335     0     4,335     0
Mortgage servicing rights   493     532     0     0     532
                             
Financial liabilities                            
Deposits $ 1,325,665   $ 1,323,670   $ 0   $ 1,323,670   $ 0
Short-term borrowings   36,524     36,524     0     36,524     0
Long-term debt   135,310     133,155     0     125,250     7,905
Interest payable   445     445     0     445     0
                             
Off-balance sheet instruments   0     0     0     0     0
                             
December 31, 2016                            
Financial assets                            
Cash and cash equivalents $ 74,032   $ 74,032   $ 74,032   $ 0   $ 0
Securities available-for-sale   194,739     194,739     13,937     180,802     0
Restricted investment in bank stocks   6,926     6,926     0     6,926     0
Loans held for sale   1,548     1,603     0     1,603     0
Loans, net   1,255,779     1,251,031     0     0     1,251,031
Interest receivable   4,448     4,448     0     4,448     0
Mortgage servicing rights   324     367     0     0     367
                             
Financial liabilities                            
Deposits $ 1,264,177   $ 1,262,529   $ 0   $ 1,262,529   $ 0
Short-term borrowings   56,637     56,637     0     56,637     0
Long-term debt   125,310     123,353     0     115,195     8,158
Interest payable   450     450     0     450     0
                             
Off-balance sheet instruments   0     0     0     0     0

  

- 39 -

 

 

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      Cash     
   Recognized   Statements   the Statements  mortgage-backed,      Collateral   Net 
(dollars in thousands)  Liabilities   of Condition   of Condition  residential  U.S. agency   Pledged   Amount 
June 30, 2017                            
Repurchase Agreements  $26,524   $0   $ 26,524  (26,524)   0   $0   $0 
                                  
December 31, 2016                                 
Repurchase Agreements  $23,637   $0   $ 23,637  (23,529)   (108)  $0   $0 

 

As of June 30, 2017 and December 31, 2016, the fair value of securities pledged in connection with repurchase agreements was $29,998,000 and $32,535,000, respectively.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Management’s discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in the accompanying consolidated financial statements for Codorus Valley Bancorp, Inc. (“Codorus Valley” or “the Corporation”), a bank holding company, and its wholly-owned subsidiary, PeoplesBank, A Codorus Valley Company (“PeoplesBank”), are provided below. Codorus Valley’s consolidated financial condition and results of operations consist almost entirely of PeoplesBank’s financial condition and results of operations. Current performance does not guarantee, and may not be indicative of, similar performance in the future.

 

Forward-looking Statements

 

Management of the Corporation has made forward-looking statements in this Form 10-Q. These forward-looking statements may be subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of the Corporation and its subsidiaries. When words such as “believes,” “expects,” “anticipates” or similar expressions occur in the Form 10-Q, management is making forward-looking statements.

 

Note that many factors, some of which are discussed elsewhere in this report and in the documents that are incorporated by reference, could affect the future financial results of the Corporation and its subsidiaries, both individually and collectively, and could cause those results to differ materially from those expressed in the forward-looking statements contained or incorporated by reference in this Form 10-Q. These factors include, but are not limited to, the following:

 

Operating, legal and regulatory risks;

Credit risk, including an increase in nonperforming assets requiring loss provisions and the incurrence of carrying costs related to nonperforming assets;

Interest rate fluctuations which could increase our cost of funds or decrease our yield on earning assets and therefore reduce our net interest income;

Declines in the market value of investment securities considered to be other-than-temporary;

Unavailability of capital when needed, or availability at less than favorable terms;

Unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of our computer systems or otherwise, which may adversely affect the Corporation’s operations, net income or reputation;

Inability to achieve merger-related synergies, and difficulties in integrating the business and operations of acquired institutions;

A prolonged economic downturn;

Political and competitive forces affecting banking, securities, asset management and credit services businesses;

The effects of and changes in the rate of FDIC premiums, including special assessments;

Enacted financial reform legislation, e.g., Dodd-Frank Wall Street Reform and Consumer Protection Act, may have a significant impact on the Corporation’s business and results of operations; and

The risk that management’s analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

 

The Corporation undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report.

 

- 41 -

 

 

Critical Accounting Policies

 

The Corporation’s critical accounting policies, as summarized in Note 1—Summary of Significant Accounting Policies, include those related to the allowance for loan losses, valuation of foreclosed real estate, evaluation of other-than-temporary impairment of securities, and determination of acquisition-related goodwill and fair value adjustments, which require management to make significant judgments, estimates and assumptions that have a material impact on the carrying value of the respective assets and liabilities. For this Form 10-Q, there were no material changes made to the Corporation’s critical accounting policies, which are more fully disclosed in Item 7 of the Corporation’s previously filed Annual Report on Form 10-K for the year ended December 31, 2016.

 

Three Months Ended June 30, 2017 vs. Three Months Ended June 30, 2016

 

Financial Highlights

 

The Corporation’s net income available to common shareholders (earnings) was $3,685,000 for the quarter ended June 30, 2017, as compared to $3,040,000 for the quarter ended June 30, 2016, an increase of $645,000 or 21 percent.

 

Net interest income for the second quarter of 2017 increased $1,429,000 or 11 percent above the same period in 2016, primarily due to increased interest income from a higher volume of commercial loans in the second quarter of 2017 as compared to the second quarter of 2016.

 

The Corporation’s net interest margin (tax-equivalent basis) for the second quarter of 2017 was 3.76 percent, compared to 3.95 percent for the second quarter of 2016. The margin was impacted by a decline in yields on our fixed commercial loan and investment portfolios, higher balances in interest bearing deposits with banks, a loan placed on non-accrual status and an increase in overall funding costs.

 

The provision for loan losses was $825,000 for the second quarter 2017, a $25,000 increase as compared to a provision of $800,000 for the second quarter of 2016. The allowance as a percentage of total loans was 1.21 percent at June 30, 2017, as compared to 1.18 percent at December 31, 2016, and 1.16 percent at June 30, 2016.

 

Noninterest income for the second quarter of 2017 increased $397,000 or 16 percent ($334,000 or 14 percent excluding gain on sales of securities) compared to the second quarter of 2016. Several sources contributed to the rise in noninterest income, including increased trust and investment services fees, service charges on deposits and gain on sales of loans. Gain on sales of investment securities increased $63,000 when compared to the second quarter of 2016.

 

Noninterest expenses in the second quarter of 2017 were $754,000 or 7 percent higher than the second quarter of 2016. Higher personnel costs, which include compensation and benefits, charitable donations, director’s fees, external data processing and telecommunications costs accounted for the majority of the increase with a decrease in costs associated with foreclosed real estate and marketing somewhat offsetting the rise in other noninterest expenses.

 

The provision for income taxes for the second quarter of 2017 increased by $402,000 or 29 percent as compared to the second quarter of 2016. The increase is primarily a result of $1,047,000 or 24 percent rise in pre-tax income in the second quarter of 2017 compared to the same period in 2016.

 

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The schedule below presents selected performance metrics for the second quarter of both 2017 and 2016. Per share computations include the effect of stock dividends, including the 5 percent common stock dividend distributed in the fourth quarter of 2016.

 

   Three months ended
   June 30,
   2017  2016
Basic earnings per common share  $0.43   $0.36 
Diluted earnings per common share  $0.43   $0.36 
Cash dividend payout ratio   30.90%   34.05%
Return on average assets   0.88%   0.84%
Return on average equity   9.16%   8.01%
Net interest margin (tax equivalent basis)   3.76%   3.95%
Net overhead ratio   2.01%   2.19%
Efficiency ratio   62.81%   64.89%
Average equity to average assets   9.65%   10.45%

 

A more detailed analysis of the factors and trends affecting the Corporation’s earnings and financial position follows.

 

Income Statement Analysis

 

Net Interest Income

 

Unless otherwise noted, this section discusses interest income and interest expense amounts as reported in the Consolidated Statements of Income, which are not presented on a tax equivalent basis.

 

Net interest income for the quarter ended June 30, 2017 was $14,628,000, an increase of $1,429,000 or 11 percent compared to net interest income of $13,199,000 for the second quarter of 2016. The increase was primarily attributable to higher loan interest income. The Corporation’s net interest margin, computed as interest income (tax-equivalent basis) annualized as a percentage of average interest earning assets, was 3.76 percent for the second quarter of 2017 compared to the 3.95 percent for the second quarter of 2016. The margin was impacted by a decline in yields on investment securities and loans, a loan placed on non-accrual status and an increase in overall funding costs.

 

Total interest income for the second quarter of 2017 totaled $17,295,000, an increase of $1,972,000 or 13 percent above the amount of total interest income for the second quarter of 2016. The change was primarily a result of a significant increase in loan income, partially offset by a decline in investment income.

 

Interest income on investments decreased $25,000 or 2 percent in the second quarter of 2017 compared to the same period in 2016. The average balance of the investment securities portfolio decreased $875,000 or less than 1 percent when comparing the second quarter of 2017 to the same period in 2016. The tax-equivalent yield on investments for the second quarter of 2017 was 2.48 percent or 16 basis points lower than the 2.64 percent experienced in the second quarter of 2016, which also contributed to the decrease in interest income on investments.

 

Interest income on loans increased $1,878,000 or 13 percent in the second quarter of 2017 compared to the same period in 2016. The average balance of outstanding loans, primarily commercial loans, increased approximately $177,628,000 or 15 percent comparing the second quarter of 2017 to the same period in 2016 which primarily attributed to the increase in interest income on loans. The tax-equivalent yield on loans for the second quarter 2017 was 4.86 percent or 11 basis points lower than the 4.97 percent experienced in the second quarter of 2016. The decline in yields was offset by an increase in interest income from the higher volume of loans in the second quarter of 2017 compared to the same period in 2016.

 

- 43 -

 


 

 

Total interest expense for the second quarter of 2017 totaled $2,667,000, an increase of $543,000 or 26 percent as compared to total interest expense of $2,124,000 for the second quarter of 2016. The change was a result of increases in the average volume and costs of deposits, short term borrowings and long term debt.

 

Interest expense on deposits increased $340,000 or 21 percent in the second quarter of 2017 compared to the same period in 2016. The average rate paid on interest-bearing deposits was 0.71 percent in the second quarter of 2017 which was slightly higher than the average rate paid of 0.66 percent in the second quarter of 2016. The average balance of interest-bearing deposits for the second quarter of 2017 increased by $122,827,000 or 13 percent compared to the second quarter of 2016. Also, the Corporation experienced favorable growth in noninterest-bearing deposits, with the average volume for the second quarter of 2017 increasing 20 percent to $214,489,000 as compared to $179,026,000 for the second quarter of 2016.

 

Interest expense on borrowings for the second quarter of 2017 increased $203,000 or 39 percent compared to the second quarter of 2016, due primarily to a higher rate paid on the borrowings. Short-term borrowings consisting of repurchase agreements and other short-term borrowings averaged $49,556,000 for the second quarter of 2017, compared to an average balance $20,760,000 for the second quarter of 2016. The rate on average short-term borrowings for the second quarter of 2017 was 0.81 percent, an increase as compared to a rate of 0.54 percent for the second quarter of 2016. Long-term debt, primarily from the Federal Home Loan Bank of Pittsburgh (FHLBP), averaged $135,530,000 for the second quarter of 2017, compared to an average balance of approximately $120,310,000 for the second quarter of 2016. The rate on average long-term borrowings for the second quarter of 2017 was 1.83 percent, an increase as compared to a rate of 1.63 percent for the second quarter of 2016.

 

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Table 1-Average Balances and Interest Rates (tax equivalent basis)
                         
   Three months ended June 30, 
       2017           2016     
   Average       Yield/   Average       Yield/ 
(dollars in thousands)  Balance   Interest   Rate   Balance   Interest   Rate 
                         
Assets                              
Interest bearing deposits with banks  $54,399   $142    1.05%  $21,115   $26    0.50%
Investment securities:                              
Taxable   139,355    735    2.12    120,982    657    2.18 
Tax-exempt   56,697    477    3.37    74,195    625    3.39 
Total investment securities   196,052    1,212    2.48    195,177    1,282    2.64 
                               
Loans:                              
Taxable (1)   1,316,505    15,976    4.87    1,137,325    14,084    4.98 
Tax-exempt   17,801    190    4.28    19,353    204    4.24 
Total loans   1,334,306    16,166    4.86    1,156,678    14,288    4.97 
Total earning assets   1,584,757    17,520    4.43    1,372,970    15,596    4.57 
Other assets (2)   82,478              80,631           
 Total assets  $1,667,235             $1,453,601           
Liabilities and Shareholders’ Equity                               
Deposits:                              
Interest bearing demand  $582,382   $659    0.45%  $484,238   $442    0.37%
Savings   89,581    22    0.10    75,685    19    0.10 
Time   423,601    1,267    1.20    412,814    1,147    1.12 
Total interest bearing deposits   1,095,564    1,948    0.71    972,737    1,608    0.66 
Short-term borrowings   49,556    100    0.81    20,760    28    0.54 
Long-term debt   135,530    619    1.83    120,310    488    1.63 
Total interest bearing liabilities   1,280,650    2,667    0.84    1,113,807    2,124    0.77 
                               
Noninterest bearing deposits   214,489              179,026           
Other liabilities   11,211              8,909           
Shareholders’ equity   160,885              151,859           
                               
Total liabilities and shareholders’ equity  $1,667,235             $1,453,601           
Net interest income (tax equivalent basis)       $14,853             $13,472      
Net interest margin (3)             3.76%             3.95%
Tax equivalent adjustment        (225)             (273)     
Net interest income       $14,628             $13,199      

 

(1)Average balance includes average nonaccrual loans of $3,429,000 for 2017 and $2,570,000 for 2016.

Interest includes net loan fees of $708,000 for 2017 and $863,000 for 2016. 

(2)Average balance includes average bank owned life insurance, foreclosed real estate and unrealized holding gains (losses) on investment securities.

(3)Net interest income (tax equivalent basis) annualized as a percentage of average earning assets.

 

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Table 2-Rate/Volume Analysis of Changes in Net Interest Income (tax equivalent basis)
             
   Three months ended 
   June 30, 
   2017 vs. 2016 
    Increase (decrease) due to change in* 
(dollars in thousands)   Volume    Rate    Net 
                
Interest Income               
Interest bearing deposits with banks  $42   $74   $116 
Investment securities:               
 Taxable   26    52    78 
 Tax-exempt   (147)   (1)   (148)
Loans:               
 Taxable   1,924    (32)   1,892 
 Tax-exempt   (17)   3    (14)
 Total interest income   1,828    96    1,924 
Interest Expense               
Deposits:               
 Interest bearing demand   77    140    217 
 Savings   3    0    3 
 Time   30    90    120 
Short-term borrowings   38    34    72 
Long-term debt   59    72    131 
 Total interest expense   207    336    543 
 Net interest income  $1,621   $(240)  $1,381 

 

* Changes which are due to both volume and rate are allocated in proportion to their relationship to the amount of change attributed directly to volume or rate.

 

Provision for Loan Losses

 

The provision for loan losses is an expense charged to earnings to cover the estimated losses attributable to uncollected loans. The provision reflects management’s judgment of an appropriate level for the allowance for loan losses. The provision for loan losses was $825,000 for the second quarter of 2017, a $25,000 increase as compared to a provision of $800,000 for the second quarter of 2016. The provision for both periods supported adequate allowance for loan loss coverage considering several factors, including the Corporation’s continued commercial loan growth. The allowance as a percentage of total loans was 1.21 percent at June 30, 2017, as compared to 1.18 percent at December 31, 2016, and 1.16 percent at June 30, 2016.

 

More information about the allowance for loan losses can be found in this report under the caption Allowance for Loan Losses on page 61.

 

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Noninterest Income

 

The following table presents the components of total noninterest income for the second quarter of 2017, compared to the second quarter of 2016.

 

Table 3 - Noninterest income                
                 
   Three months ended   Change 
   June 30,   Increase (Decrease) 
(dollars in thousands)  2017   2016   $   % 
                 
Trust and investment services fees  $741   $621   $120    19%
Income from mutual fund, annuity and insurance sales   195    236    (41)   (17)
Service charges on deposit accounts   1,051    901    150    17 
Income from bank owned life insurance   250    224    26    12 
Other income   261    229    32    14 
Gain on sales of loans held for sale   282    235    47    20 
Gain on sales of securities   63    0    63    *nm 
 Total noninterest income  $2,843   $2,446   $397    16%

 

The discussion that follows addresses changes in selected categories of noninterest income.

 

Trust and investment services fees—The $120,000 or 19 percent increase in trust and investment services fees was due to an increase in assets under management year over year related to new accounts and market returns and a one-time executor fee.

 

Service charges on deposits accounts—The $150,000 or 17 percent increase in service charges on deposit accounts was due to the increase in the volume of demand deposit accounts subject to fees and debit card transactions.

 

Income from bank owned life insurance—The $26,000 or 12 percent increase in income from bank owned life insurance was due to additional investments of $4,000,000 during the first quarter of 2017 and $6,987,000 during the twelve months ended December 31, 2016.

 

Other income— The $32,000 or 14 percent increase in other income was due to higher miscellaneous client based fees, such as wire transfer and rental of safe deposit boxes, sales of credit cards, gift cards and checkbooks, and loan related income.

 

Gain on sales of loans held for sale—The $47,000 or 20 percent increase in gain from the sale of loans was due to a higher volume of originations and sales of residential mortgage loans held for sale during the second quarter of 2017 compared to 2016. In addition, there was $29,000 of gain on sale of the guaranteed portion of Small Business Administration (SBA) loans held for sale in the second quarter of 2017 as compared to none for the same period in 2016.

 

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Noninterest Expense

 

The following table presents the components of total noninterest expense for the first quarter of 2017, compared to the first quarter of 2016.

                 
Table 4 - Noninterest expense                
                 
   Three months ended   Change 
   June 30,   Increase (Decrease) 
(dollars in thousands)  2017   2016   $   % 
                 
Personnel  $6,399   $6,001   $398    7%
Occupancy of premises, net   807    824    (17)   (2)
Furniture and equipment   696    707    (11)   (2)
Postage, stationery and supplies   226    204    22    11 
Professional and legal   173    167    6    4 
Marketing   361    369    (8)   (2)
FDIC insurance   221    180    41    23 
Debit card processing   271    265    6    2 
Charitable donations   168    27    141    522 
Telecommunications   200    164    36    22 
External data processing   452    349    103    30 
Foreclosed real estate including provision for losses   1    95    (94)   (99)
Other   1,192    1,061    131    12 
 Total noninterest expense  $11,167   $10,413   $754    7%

 

The discussion that follows addresses changes in selected categories of noninterest expense.

 

Personnel—The $398,000 or 7 percent increase in personnel expense was due largely to the addition of new employees to support the Corporation’s business and consumer banking services in our Maryland market and expanded Pennsylvania market during the prior twelve months. Also contributing to the increase was higher cost of health insurance.

 

Charitable donationsThe $141,000 or 522 percent increase in charitable donations was primarily due to an increase in donations eligible for Pennsylvania tax credits during the second quarter of 2017 compared to 2016. The donations usually occur in the first quarter of each year but were delayed due to timing of approval of the aforementioned Pennsylvania tax credits.

 

External data processingThe $103,000 or 30 percent increase in external data processing expenses reflects increased outsourcing of transaction processing to specialized vendors on their hosted and secure websites and also an increase in transaction volume being processed due to business growth.

 

Foreclosed real estate—The $94,000 or 99 percent decrease in foreclosed real estate expenses was primarily due to the reduction in the number of properties held during the second quarter of 2017 as compared to the second quarter of 2016.

 

Other—The $131,000 or 12 percent increase in other expenses is primarily a result of stock awards granted to the Corporation’s directors during the quarter.

 

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Provision for Income Taxes

 

The provision for income taxes for the second quarter of 2017 was $1,794,000, an increase of $402,000 or 29 percent as compared to the second quarter of 2016. The increase is primarily a result of a higher level of pre-tax income for the second quarter of 2017 versus the same period in 2016. For both the second quarter of 2017 and 2016, the Corporation’s statutory federal income tax rate was 35 percent and the effective income tax rate was 33 percent and 31 percent, respectively. The effective tax rate differs from the statutory tax rate due to the impact of certain elements with specific tax benefits, including tax-exempt income, such as income from tax-exempt investments, tax-exempt loans, and bank-owned life insurance.

 

Six Months Ended June 30, 2017 vs. Six Months Ended June 30, 2016

 

Financial Highlights

 

The Corporation’s net income available to common shareholders (earnings) was $7,104,000 for the first six months of 2017 compared to $5,841,000 for the first six months of 2016, an increase of $1,263,000 or 22 percent.

 

Net interest income for the first six months of 2017 increased $2,524,000 or 10 percent above the first six months of 2016, primarily due to increased interest income from a higher volume of commercial loan growth over the previous twelve months.

 

The Corporation’s net interest margin (tax-equivalent basis) for the six months ended June 30, 2017 was 3.78 percent, compared to 3.95 percent for the first six months of 2016. The margin was impacted by a decline in yields on our fixed commercial loan and investment portfolios, higher balances in interest bearing deposits with banks, a loan placed on non-accrual status and an increase in overall funding costs.

 

The provision for loan losses for the first six months of 2017 was $1,475,000 or a $125,000 decrease as compared to a provision of $1,600,000 for the first six months of 2016. The provision for both periods supported adequate allowance for loan loss coverage including the Corporation’s substantial growth in commercial loans. The allowance as a percentage of total loans was 1.21 percent at June 30, 2017, as compared to 1.18 percent at December 31, 2016, and 1.16 percent at June 30, 2016.

 

Noninterest income for the first six months of 2017 increased $693,000 or 14 percent ($824,000 or 18 percent excluding gain on sales of securities) compared to the first six months of 2016. Contributing to the rise in noninterest income were trust and investment services fees, service charges on deposits, income from bank owned life insurance, gain on sales of loans and other income. Offsetting some of the increases were declines in income from mutual fund, annuity and insurance sales and gain on sales of securities.

 

Noninterest expenses for the first six months of 2017 were $1,359,000 or 7 percent higher than the first six months of 2016. The increase was primarily attributable to higher personnel costs, external data processing costs and other expenses. Offsetting some of the increases were declines in foreclosed real estate expenses and marketing costs.

 

The provision for income taxes for the first six months of 2017 increased $736,000 or 28 percent as compared to the first six months of 2016. The increase was primarily a result of higher pre-tax income for the first six months of 2017 compared to the same period in 2016.

 

On June 30, 2017, the Corporation’s total assets were over $1.67 billion, an increase of 4 percent since December 31, 2016. The increase was attributed to loan growth, primarily in commercial loans.

 

The Corporation’s capital level remained sound as evidenced by regulatory capital ratios that exceed current regulatory requirements for well capitalized institutions. As of June 30, 2017, the Corporation’s capital

 

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calculations and ratios reflect full compliance with the Basel III regulatory capital framework, which became effective on January 1, 2015.

 

The schedule below presents selected performance metrics for the first six months of both 2017 and 2016. Per share computations include the effect of stock dividends, including the 5 percent common stock dividend distributed in the fourth quarter of 2016.

 

                 
    Six months ended
    June 30,
    2017     2016  
Basic earnings per common share   $  0.84     $  0.69  
Diluted earnings per common share   $  0.83     $  0.69  
Cash dividend payout ratio      32.04 %      35.43 %
Return on average assets      0.87 %      0.82 %
Return on average equity      8.94 %      7.61 %
Net interest margin (tax equivalent basis)      3.78 %      3.95 %
Net overhead ratio      2.05 %      2.26 %
Efficiency ratio      63.67 %      66.09 %
Average equity to average assets      9.73 %      10.72 %

 

A more detailed analysis of the factors and trends affecting the Corporation’s earnings and financial position follows.

 

Income Statement Analysis

 

Net Interest Income

 

Net interest income for the six months ending June 30, 2017 was $28,688,000, an increase of $2,524,000 or 10 percent compared to net interest income of $26,164,000 for the first six months of 2016. The increase was primarily attributable to higher loan interest income. The Corporation’s net interest margin, computed as interest income (tax-equivalent basis) annualized as a percentage of average interest earning assets, was 3.78 percent for the first six months of 2017, representing a decrease compared to the 3.95 percent net interest margin for the first six months of 2016.

 

Total interest income for the first six months of 2017 totaled $33,800,000, an increase of $3,463,000 or 11 percent above the amount of total interest income for the first six months of 2016. The change was primarily a result of a significant increase in loan income, partially offset by a decline in investment income.

 

Interest income on loans increased $3,464,000 or 12 percent in the first six months of 2017 compared to the same period in 2016. The average balance of outstanding loans increased approximately $169,623,000 or 15 percent in the first six months of 2017 compared to the first six months of 2016, reflecting commercial loan growth over the past year.

 

Investment income for the first six months of 2017 decreased $162,000 or 7 percent compared to the first six months of 2016. The tax-equivalent yield on investments for the first six months of 2017 was 2.48 percent or 19 basis points lower than the 2.67 percent experienced during the first six months of 2016, as the yields on maturing investments were generally higher than those on investments purchased in the current lower interest rate environment.

 

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Total interest expense for the first six months of 2017 totaled $5,112,000, an increase of $939,000 or 23 percent as compared to total interest expense of $4,173,000 for the first six months of 2016. The change in interest expense was primarily a result of an increase in the average volume and cost of deposits and long-term borrowings.

 

Interest expense on deposits increased $637,000 or 20 percent in the first six months of 2017 compared to the same period in 2016. The increase was due to both an increase in the costs of and growth in deposits. The average balance of interest-bearing deposits for the first six months of 2017, primarily in lower cost core deposits, increased by $126,207,000 or 13 percent compared to the average for the first six months of 2016. The average rate paid on interest-bearing deposits in the first six months of 2017 was 0.70 percent, an increase from the average rate of 0.66 percent paid on interest-bearing deposits during the first six months of 2016. Also, the Corporation experienced favorable growth in noninterest-bearing deposits, with the average volume for the first six months of 2017 increasing to $206,544,000, as compared to $170,162,000 for the first six months of 2016.

 

Interest expense on borrowings for the first six months of 2017 increased $302,000 or 29 percent compared to the first six months of 2016, due primarily to a higher average balance and cost of both short-term borrowings and long-term debt. Outstanding long-term borrowings, consisting primarily of Federal Home Loan Bank of Pittsburgh (FHLBP) advances, averaged $130,669,000 for the first six months of 2017, compared to an average balance of approximately $120,310,000 for the same period of 2016. The rate on average long-term borrowings for the first half of 2017 was 1.80 percent, a slight increase as compared to the rate of 1.63 percent for the same period of 2016.

 

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 Table 5-Average Balances and Interest Rates (tax equivalent basis)

 

   Six months ended June 30, 
       2017           2016     
   Average       Yield/   Average       Yield/ 
(dollars in thousands)  Balance   Interest   Rate   Balance   Interest   Rate 
                         
Assets                              
Interest bearing deposits with banks  $40,109   $195    0.98%  $12,619   $34    0.54%
Investment securities:                              
Taxable   139,633    1,460    2.11    128,029    1,426    2.24 
Tax-exempt   58,772    980    3.36    73,992    1,259    3.42 
Total investment securities   198,405    2,440    2.48    202,021    2,685    2.67 
                               
Loans:                              
Taxable (1)   1,296,586    31,243    4.86    1,125,999    27,764    4.96 
Tax-exempt   18,001    383    4.29    18,965    400    4.24 
Total loans   1,314,587    31,626    4.85    1,144,964    28,164    4.95 
Total earning assets   1,553,101    34,261    4.45    1,359,604    30,883    4.57 
Other assets (2)   80,854              76,367           
Total assets  $1,633,955             $1,435,971           
Liabilities and Shareholders’ Equity                              
Deposits:                              
Interest bearing demand  $569,392   $1,234    0.44%  $473,664   $858    0.36%
Savings   85,686    42    0.10    73,313    36    0.10 
Time   423,191    2,479    1.18    405,085    2,224    1.10 
Total interest bearing deposits   1,078,269    3,755    0.70    952,062    3,118    0.66 
Short-term borrowings   47,935    192    0.81    31,242    82    0.53 
Long-term debt   130,669    1,165    1.80    120,310    973    1.63 
Total interest bearing liabilities   1,256,873    5,112    0.82    1,103,614    4,173    0.76 
                               
Noninterest bearing deposits   206,554              170,162           
Other liabilities   11,586              8,232           
Shareholders’ equity   158,942              153,963           
                               
 Total liabilities and shareholders’ equity  $1,633,955             $1,435,971           
Net interest income (tax equivalent basis)       $29,149             $26,710      
Net interest margin (3)             3.78%             3.95%
Tax equivalent adjustment        (461)             (546)     
Net interest income       $28,688             $26,164      

 

(1)Average balance includes average nonaccrual loans of $3,500,000 for 2017 and $2,826,000 for 2016.

Interest includes net loan fees of $1,378,000 for 2017 and $1,568,000 for 2016.

(2)Average balance includes average bank owned life insurance, foreclosed real estate and unrealized holding gains (losses) on investment securities.

(3)Net interest income (tax equivalent basis) annualized as a percentage of average interest earning assets.

 

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Table 6-Rate/Volume Analysis of Changes in Net Interest Income (tax equivalent basis)

 

   Six months ended 
   June 30, 
   2017 vs. 2016 
   Increase (decrease) due to change in* 
(dollars in thousands)   Volume    Rate    Net 
                
Interest Income               
Interest bearing deposits with banks  $75   $86   $161 
Investment securities:               
Taxable   (21)   55    34 
Tax-exempt   (259)   (20)   (279)
Loans:               
Taxable   3,776    (297)   3,479 
Tax-exempt   (20)   3    (17)
Total interest income   3,551    (173)   3,378 
Interest Expense               
Deposits:               
Interest bearing demand   151    225    376 
Savings   6    0    6 
Time   99    156    255 
Short-term borrowings   50    60    110 
Long-term debt   80    112    192 
Total interest expense   386    553    939 
Net interest income  $3,165   $(726)  $2,439 

 

*Changes which are due to both volume and rate are allocated in proportion to their relationship to the amount of change attributed directly to volume or rate.

 

Provision for Loan Losses

 

For the first six months of 2017, the provision for loan losses was $1,475,000, as compared to a provision of $1,600,000 for the first six months of 2016. The provision for both periods supported adequate allowance for loan loss coverage, including the Corporation’s substantial growth in commercial loans. For the first six months of 2017, net charge-offs were $52,000, as compared to $746,000 in the first six months of 2016. The allowance as a percentage of total loans was 1.21 percent at June 30, 2017, as compared to 1.18 percent at December 31, 2016, and 1.16 percent at June 30, 2016.

 

More information about the allowance for loan losses can be found in this report under the caption Allowance for Loan Losses on page 61.

 

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Noninterest Income

 

The following table presents the components of total noninterest income for the first six months of 2017, compared to the first six months of 2016.

 

Table 7 - Noninterest income                
                 
   Six months ended   Change 
   June 30,   Increase (Decrease) 
(dollars in thousands)  2017   2016   $   % 
                 
Trust and investment services fees  $1,400   $1,238   $162    13%
Income from mutual fund, annuity and insurance sales   406    495    (89)   (18)
Service charges on deposit accounts   2,021    1,738    283    16 
Income from bank owned life insurance   522    398    124    31 
Other income   541    418    123    29 
Gain on sales of loans held for sale   571    350    221    63 
Gain on sales of securities   63    194    (131)   (68)
 Total noninterest income  $5,524   $4,831   $693    14%

 

The discussion that follows addresses changes in selected categories of noninterest income.

 

Trust and investment services fees—The $162,000 or 13 percent increase in trust and investment services fee income was a result of an increase in assets under management year over year related to new accounts and market returns and a one-time executor fee.

 

Income from mutual fund, annuity and insurance sales—The $89,000 or 18 percent decrease in income from the sale of mutual fund, annuity and insurance products was partially due to a reduction in commissions received for annuity and insurance sales due to the new Department of Labor fiduciary rules.

 

Service charges on deposit accounts—The $283,000 or 16 percent increase in service charge income on deposit accounts was due to a growth in the volume of deposit accounts subject to fees.

 

Income on bank owned life insurance—The $124,000 or 31 percent increase in income from bank owned life insurance was due to additional investments during 2017 and 2016.

 

Other income—The $123,000 or 29 percent increase in other income was due to higher miscellaneous client based service charges, such as wire transfer, gift card, and credit card merchant fees and loan related income, such as mortgage loan servicing and FHA loan origination fees.

 

Gain on sales of loans held for sale—The $221,000 or 63 percent increase in gain from the sale of residential mortgage loans held for sale was due to a higher volume of mortgage originations and sales and mortgage servicing rights on residential loans sold with servicing retained during 2017 compared to 2016 and gain on sales of the guaranteed portion of SBA loans sales which did not occur in the first six months of 2016.

 

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Noninterest Expense

 

The following table presents the components of total noninterest expense for the first six months of 2017, compared to the first six months of 2016.

 

Table 8 - Noninterest expense                
                 
   Six months ended   Change 
   June 30,   Increase (Decrease) 
(dollars in thousands)  2017   2016   $   % 
                 
Personnel  $13,135   $11,998   $1,137    9%
Occupancy of premises, net   1,678    1,721    (43)   (2)
Furniture and equipment   1,391    1,432    (41)   (3)
Postage, stationery and supplies   391    377    14    4 
Professional and legal   322    330    (8)   (2)
Marketing   697    838    (141)   (17)
FDIC insurance   374    346    28    8 
Debit card processing   486    562    (76)   (14)
Charitable donations   834    768    66    9 
Telecommunications   404    326    78    24 
External data processing   847    682    165    24 
Foreclosed real estate including (recovery of) provision for losses   (28)   135    (163)   (121)
Other   1,699    1,356    343    25 
Total noninterest expense  $22,230   $20,871   $1,359    7%

 

The discussion that follows addresses changes in selected categories of noninterest expense.

 

Personnel—The $1,137,000 or 9 percent increase in personnel expense was due largely to the addition of new employees to support the Corporation’s business growth. Also contributing to the increase was higher cost of health insurance.

 

MarketingThe $141,000 or 17 percent decrease in marketing expenses was primarily due to timing of planned initiatives and campaigns during the year.

 

Debit card processingThe $76,000 or 14 percent decrease in debit card processing reflects lower card replacement costs due to 2016 including reissuance costs associated with upgrading PeoplesBank’s debit cards to the EMV chip card technology. In addition, 2017 includes a reduction to transaction processing costs as a result of an annual Visa incentive credit.

 

External data processingThe $165,000 or 24 percent increase in external data processing expenses reflects increased reliance on outsourcing transaction processing to specialized vendors, which is typically performed on such vendors’ hosted and secure websites. In addition, increased volumes in both accounts and transactions year over year due to business expansion resulted in higher costs.

 

Foreclosed real estateThe $163,000 or 121 percent decrease in foreclosed real estate expenses was primarily due to the reduction in the number of properties held during 2017 as compared to the same period in 2016 and 2017 includes a recovery of a loss provision on a property sold during the first quarter.

 

Other —The $343,000 or 25 percent increase in other expenses, which is comprised of many underlying expenses, was primarily due to stock awards granted to the Corporation’s directors during the second quarter of 2017 and increases in membership fees, Pennsylvania bank shares tax, and miscellaneous loan related expenses as compared to the same period in 2016.

 

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Provision for Income Taxes

 

The provision for income taxes for the first six months of 2017 was $3,403,000, an increase of $736,000 or 28 percent as compared to the first six months of 2016. The increase is primarily a result of a higher level of pre-tax income for the first six months of 2017 versus the same period in 2016. For both the first six months of 2017 and 2016, the Corporation’s statutory federal income tax rate was 35 percent. However, the effective income tax rate was 32 percent for the first six months of 2016, compared to 31 percent for the same period in 2016. The effective tax rate differs from the statutory tax rate due to the impact of certain elements with specific tax benefits, including tax-exempt income, such as income from tax-exempt investments, tax-exempt loans, and bank-owned life insurance.

 

Preferred Stock Dividends

 

No preferred stock dividends were paid in the first six months of 2017 as compared to $16,000 for the first six months of 2016. On February 18, 2016, the Corporation completed the redemption of all 12,000 remaining shares of the Corporation’s Series B preferred stock issued in connection with the Small Business Lending Fund Program. This transaction was reported on a Form 8-K filed on February 19, 2016.

 

Balance Sheet Review

 

Interest Bearing Deposits with Banks

 

On June 30, 2017, interest bearing deposits with banks totaled $42,964,000, a decrease of $12,002,000 or 22 percent, compared to the level at year-end 2016. The decrease was primarily the result of a decline in short-term borrowings and increase in loans.

 

Investment Securities (Available-for-Sale)

 

The Corporation’s entire investment securities portfolio is classified available-for-sale, and is comprised primarily of interest-earning debt securities. The overall composition of the Corporation’s investment securities portfolio is provided in Note 2—Securities. On June 30, 2017, the fair value of investment securities available-for-sale totaled $181,897,000, which represented a decrease of $12,842,000 as compared to the fair value of investment securities at year-end 2016. Principal reductions from investment maturities and mortgage-backed security payments exceeded new investments during the first six months of 2017 and were redeployed in higher yielding loans.

 

Loans

 

On June 30, 2017, total loans, net of deferred fees, were $1.35 billion, which was $82,877,000 or 7 percent higher than the level at year-end 2016. This change in volume was due primarily to an increase in commercial loans, particularly within the builder & developer, manufacturing and residential real estate investor sectors which reflected continued commercial loan demand in our markets. Commercial loans within the builder & developer, commercial real estate investor and residential real estate investor sectors each represented more than 10 percent of the total portfolio. The composition of the Corporation’s loan portfolio is provided in Note 4—Loans.

 

Deposits

 

Deposits are the Corporation’s principal source of funding for earning assets. On June 30, 2017, deposits totaled $1.33 billion, which reflected a $61,488,000 or 5 percent increase compared to the level at year-end 2016. Of the increase in total deposits, $14,140,000 was attributable to growth in noninterest bearing deposits, with an additional $46,229,000 related to growth in interest bearing demand, NOW, money market and savings deposits. Time deposits increased $1,119,000 compared to the level at year-end 2016. The composition of the Corporation’s total deposit portfolio is provided in Note 6—Deposits.

 

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Short-term Borrowings

 

Short-term borrowings, which consist of securities sold under agreements to repurchase (repurchase agreements), federal funds purchased, and other short-term borrowings, totaled $36,524,000 at June 30, 2017, which reflected a $20,113,000 or 36 percent decrease compared to the level at year-end 2016. The decrease was primarily attributed to a repayment of $20,000,000 in short-term borrowings.

 

Long-term Debt

 

The Corporation uses long-term borrowings as a secondary funding source for asset growth and to manage interest rate risk. On June 30, 2017 long-term debt totaled $135,310,000 compared to $125,310,000 at year-end 2016. A listing of outstanding long-term debt obligations is provided in Note 7—Short-Term Borrowings and Long-Term Debt.

 

Shareholders’ Equity and Capital Adequacy

 

Shareholders’ equity, or capital, enables Codorus Valley to maintain asset growth and absorb losses. Capital adequacy can be affected by a multitude of factors, including profitability, new stock issuances, corporate expansion and acquisitions, dividend policy and distributions, and regulatory mandates. The Corporation’s total shareholders’ equity was approximately $161,436,000 on June 30, 2017, an increase of approximately $6,479,000 or 4 percent, compared to the level at year-end 2016. The increase was primarily the result of the increase in retained earnings of $4,828,000 or 17 percent from profitable operations.

 

Cash Dividends on Common Stock

 

The Corporation has historically paid cash dividends on its common stock on a quarterly basis. The Board of Directors determines the dividend rate after considering the Corporation’s capital requirements, current and projected net income, and other relevant factors. As recently announced, the Board of Directors declared a quarterly cash dividend of $0.135 per common share on July 11, 2017, payable on August 8, 2017, to common shareholders of record at the close of business on July 25, 2017. This cash dividend follows the $0.135 common stock cash dividends distributed in February and April 2017.

 

Capital Adequacy

 

The Corporation and PeoplesBank are subject to various regulatory capital requirements administered by banking regulators that involve quantitative guidelines and qualitative judgments. The regulatory capital measures for the Corporation and PeoplesBank as of June 30, 2017 and the minimum capital ratios established by regulators are set forth in Note 8—Regulatory Matters to the financial statements. We believe that both Codorus Valley and PeoplesBank were well capitalized on June 30, 2017.

 

Our capital adequacy as of June 30, 2017, reflects updated regulatory capital guidelines from the Board of Governors of the Federal Reserve System finalized rule which implemented the Basel III regulatory capital framework, and which became effective for the Corporation and PeoplesBank on January 1, 2015. Under the revised regulatory capital framework, minimum requirements increased both the quantity and quality of capital held by banking organizations. Additionally, 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 risk-weighted assets applies to all supervised financial institutions. 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 banks. The new rule also increases 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.

 

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The new rule further provides that, in order to avoid restrictions on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold the 2.5 percent capital conservation buffer, 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 transition schedule for new ratios, including the capital conservation buffer, is as follows: 

                     
   As of January 1: 
   2015   2016   2017   2018   2019 
Minimum common equity Tier 1 capital ratio   4.5%   4.5%   4.5%   4.5%   4.5%
Common equity Tier 1 capital conservation buffer   N/A    0.625%   1.25%   1.875%   2.5%
Minimum common equity Tier 1 capital ratio plus capital conservation buffer   4.5%   5.125%   5.75%   6.375%   7.0%
Phase-in of most deductions from common equity Tier 1 capital   40%   60%   80%   100%   100%
Minimum Tier 1 capital ratio   6.0%   6.0%   6.0%   6.0%   6.0%
Minimum Tier 1 capital ratio plus capital conservation buffer   N/A    6.625%   7.25%   7.875%   8.5%
Minimum total capital ratio   8.0%   8.0%   8.0%   8.0%   8.0%
Minimum total capital ratio plus capital conservation buffer   N/A    8.625%   9.25%   9.875%   10.5%

 

As fully phased in, a banking organization with a buffer greater than 2.5% would not be subject to limits on dividend payments or discretionary bonus payments; however, a banking organization with a buffer less than 2.5% would be subject to increasingly stringent limitations as the buffer approaches zero. The new rule also prohibits a banking organization from paying dividends or discretionary bonuses if its eligible net income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% as of the beginning of that quarter. Eligible net income is defined as net income for the four calendar quarters preceding the current calendar quarter, net of any distributions and associated tax effects not already reflected in net income.

 

A summary of payout restrictions based on the capital conservation buffer is as follows: 

    
Capital Conservation Buffer  
(as a % of risk-weighted assets)
  Maximum Payout  
(as a % of eligible net income)
Greater than 2.5%  No payout limitation applies
≤2.5% and >1.875%  60%
≤1.875% and >1.25%  40%
≤1.25% and >0.625%  20%
≤0.625%  0%

 

Under the new rule as effective through the six months ending June 30, 2017, the Corporation and PeoplesBank had no regulatory dividend restrictions and remained well capitalized by all regulatory capital measures (see Note 8—Regulatory Matters to the financial statements). The Corporation plans to manage its capital adequacy to ensure continued compliance with the new capital rules.

 

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Risk Management

 

Credit Risk Management

 

Credit risk represents the possibility that a loan client, counterparty or issuer may not perform in accordance with contractual terms, posing one of the most significant risks of loss to the Corporation. Accordingly, the Corporation emphasizes the management of credit risk, and has established a lending policy which management believes is sound given the nature and scope of our operations. The Credit Risk Management section included in Item 7 of the Corporation’s previously filed Annual Report on Form 10-K for the year ended December 31, 2016, provides a more detailed overview of the Corporation’s credit risk management process.

 

Nonperforming Assets

 

Nonperforming assets, as shown in the table below, are asset categories that pose the greatest risk of loss. The level of nonperforming assets as of June 30, 2017 has increased by approximately $739,000 or 11 percent when compared to year-end 2016. The increase was primarily the result of loans placed on non-accrual status during the quarter which was offset by sales of foreclosed real estate properties.

 

The Corporation regularly monitors large and criticized assets in its commercial loan portfolio recognizing that prolonged low economic growth, or a weakening economy, could have negative effects on these commercial borrowers. Nonperforming assets are monitored and managed for collection of these accounts. Collection efforts, including modification of contractual terms for individual accounts based on prevailing market conditions and liquidation of collateral assets, are employed to maximize recovery. A special assets committee meets monthly to review nonperforming assets. We generally rely on appraisals performed by independent licensed appraisers to determine the value of real estate collateral for impaired collateral-dependent loans. Generally, an appraisal is performed when: an account reaches 90 days past due, unless a certified appraisal was completed within the past twelve months; market values have changed significantly; the condition of the property has changed significantly; or the existing appraisal is outdated based upon regulatory or policy requirements. In instances where the value of the collateral, net of costs to sell, is less than the net carrying amount for impaired commercial related loans, a specific loss allowance is established for the difference. Further provisions for loan losses may be required for nonaccrual loans as additional information becomes available or conditions change. When it is probable that some portion or an entire loan balance will not be collected, that amount is charged off as loss against the allowance.

 

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The paragraphs and table below address significant changes in the nonperforming asset categories as of June 30, 2017 compared to December 31, 2016.

 

Table 9 - Nonperforming Assets

 

   June 30,   December 31, 
(dollars in thousands)  2017   2016 
         
Nonaccrual loans  $6,943   $3,114 
Nonaccrual loans, troubled debt restructurings   120    0 
Accruing loans 90 days or more past due   160    733 
Total nonperforming loans   7,223    3,847 
Foreclosed real estate, net of allowance   68    2,705 
Total nonperforming assets  $7,291   $6,552 
Accruing troubled debt restructurings  $3,447   $3,664 
           
Total period-end loans, net of deferred fees  $1,353,648   $1,270,771 
Allowance for loan losses (ALL)  $16,415   $14,992 
ALL as a % of total period-end loans   1.21%   1.18%
Annualized net charge-offs as a % of average total loans   0.01%   0.06%
ALL as a % of nonperforming loans   227.24%   389.69%
Nonperforming loans as a % of total period-end loans   0.53%   0.30%
Nonperforming assets as a % of total period-end loans and net foreclosed real estate   0.54%   0.51%
Nonperforming assets as a % of total period-end assets   0.44%   0.41%
Nonperforming assets as a % of total period-end shareholders’ equity   4.52%   4.23%

 

Nonperforming loans consist of nonaccrual loans and accruing loans 90 days or more past due. We generally place a loan on nonaccrual status and cease accruing interest income (i.e., recognize interest income on a cash basis, as long as the loan is sufficiently collateralized) when loan payment performance is unsatisfactory and the loan is past due 90 days or more. A loan is returned to interest accruing status when we determine that circumstances have improved to the extent that all of the principal and interest amounts contractually due are current for at least six consecutive payments and future payments are reasonably assured. Loans past due 90 days or more and still accruing interest represent loans that are contractually past due, but are well collateralized and in the process of collection. As of June 30, 2017, the nonperforming loan portfolio balance totaled $7,223,000, compared to $3,847,000 at year-end 2016. The increase was a result of $3,949,000 in additions to nonaccrual loans, primarily one loan, which was offset by a decrease of $573,000 in accruing loans 90 days or more past due. For both periods, the nonperforming portfolio balance was comprised primarily of collateralized commercial loans.

 

Foreclosed real estate represents real estate acquired to satisfy debts owed to PeoplesBank and is included in the Other Assets category on the Corporation’s balance sheet. The carrying amount of foreclosed real estate as of June 30, 2017, net of allowance, totaled $68,000 compared to $2,705,000 at year-end 2016. The decrease is attributable to the sale of three properties (two commercial and one residential) during the first quarter of 2017.

 

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Troubled debt restructurings pertain to loans whose terms have been modified to include a concession that we would not ordinarily consider due to the debtor’s financial difficulties. Concessions granted under a troubled debt restructuring typically involve a reduction of interest rate lower than the current market rate for new debt with similar risk, the deferral of payments or extension of the stated maturity date. Troubled debt restructurings are evaluated for impairment if they have been restructured during the most recent calendar year, or if they cease to perform in accordance with the modified terms. As of June 30, 2017, the accruing troubled debt restructuring portfolio balance totaled $3,447,000, compared to $3,664,000 at year-end 2016. The decrease was a result of one loan being transferred from accruing to non-accrual status and principal repayments on the remaining loans within the accruing troubled debt restructuring portfolio.

 

Allowance for Loan Losses

 

Although the Corporation believes that it maintains sound credit policies, certain loans deteriorate and must be charged off as losses. The allowance for loan losses is maintained to absorb losses inherent in the portfolio. The allowance is increased by provisions charged to expense and is reduced by loan charge-offs, net of recoveries. The allowance is based upon management’s continuous evaluation of the loan portfolio coupled with a formal review of adequacy on a quarterly basis, which is subject to review and approval by the Board.

 

The allowance for loan losses consists primarily of three components: specific allowances for individually impaired commercial loans; allowances calculated for pools of loans; and an unallocated component, which reflects the margin of imprecision inherent in the assumptions that underlie the evaluation of the adequacy of the allowance. The Corporation uses an internal risk rating system to evaluate individual loans. Loans are segmented into industry groups or pools with similar characteristics, and an allowance for loan losses is allocated to each segment based on quantitative factors such as recent loss history (two-year rolling average of net charge-offs) and qualitative factors, such as the results of internal and external credit reviews, changes in the size and composition of the loan portfolio, adequacy of collateral, and general economic conditions. Determining the level of the allowance for probable loan losses at any given period is subjective, particularly during deteriorating or uncertain economic periods, and requires that we make estimates using assumptions. There is also the potential for adjustment to the allowance as a result of regulatory examinations.

 

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The following table presents an analysis of the activity in the allowance for loan losses for the three and six months ended June 30, 2017 and 2016:

 

Table 10 - Analysis of Allowance for Loan Losses

 

(dollars in thousands)   2017      2016 
Balance-January 1,  $14,992     $12,704 
             
Provision charged to operating expense   1,475      1,600 
             
Loans charged off:            
Commercial, financial and agricultural   146      686 
Real estate - residential mortgages   0      24 
Consumer and home equity    10      93 
Total loans charged off   156      803 
Recoveries:            
Commercial, financial and agricultural   94      4 
Real estate - residential mortgages   5      0 
Consumer and home equity   5      53 
Total recoveries   104      57 
Net charge-offs   52      746 
Balance-June 30,  $16,415     $13,558 
             
Ratios:            
Allowance for loan losses as a % of total period-end loans   1.21%     1.16%
Annualized net charge-offs as a % of average total loans   0.01%      0.13%
Allowance for loan losses as a % of nonperforming loans   227.24%      536.50%

 

The allowance for loan losses increased $2,857,000 or 21 percent from June 30, 2016 to June 30, 2017. The increase in the allowance was primarily attributable to the $86,129,000 or 16 percent increase in loans, net of deferred fees, over the same 12 month period.

 

Net charge-offs for the first six months of 2017 were $52,000 compared to $746,000 of net charge-offs for the same period of 2016. During the first six months of 2017, there were $156,000 charge-offs as compared to $803,000 during the same period in 2016. The risks and uncertainties associated with prolonged sluggish growth, weak economic and business conditions, or the erosion of real estate values can adversely affect our borrowers’ ability to service their loans, causing significant fluctuations in the level of charge-offs and provision expense from one period to another. The provision for loan losses for the first six months of 2017 was $1,475,000, compared to $1,600,000 for the same period of 2016. The allowance as a percentage of total loans was 1.21 percent at June 30, 2017, as compared to 1.18 percent at December 31, 2016, and 1.16 percent at June 30, 2016. The unallocated portion of the allowance was $1,504,000 or 9 percent of the total allowance as of June 30, 2017, as compared to $1,761,000 or 12 percent of the total allowance as of December 31, 2016.

 

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Liquidity Risk Management

 

Maintaining adequate liquidity provides the Corporation with the ability to meet financial obligations to depositors, loan clients, employees, and shareholders on a timely and cost effective basis in the normal course of business. Additionally, adequate liquidity provides funds for growth and business opportunities as they arise. Liquidity is generated from transactions relating to both the Corporation’s assets and liabilities. The primary sources of asset liquidity are funds received from client loan payments, investment maturities and cash inflows from mortgage-backed securities, and the net proceeds of asset sales. The primary sources of liability liquidity are deposit growth, and funds obtained from short-term borrowings and long-term debt. The Consolidated Statements of Cash Flows, included in this report, present the changes in cash from operating, investing and financing activities. At June 30, 2017, we believe that liquidity was adequate based upon the potential liquidation of unpledged available-for-sale securities with a fair value totaling approximately $51,193,000 and available credit from the Federal Home Loan Bank of Pittsburgh totaling approximately $306,722,000. The Corporation’s loan-to-deposit ratio was 102 percent as of June 30, 2017, as compared to a 101 percent loan-to-deposit ratio as of December 31, 2016, and a 97 percent loan-to-deposit ratio as of June 30, 2016.

 

Off-Balance Sheet Arrangements

 

The Corporation’s financial statements do not reflect various commitments that are made in the normal course of business, which may involve some liquidity risk. These commitments consist primarily of commitments to grant new loans, unfunded commitments under existing loan facilities, and letters of credit issued under the same standards as on-balance sheet instruments. Unused commitments on June 30, 2017, totaled $497,475,000 and consisted of $363,061,000 in unfunded commitments under existing loan facilities, $110,883,000 to grant new loans and $23,531,000 in letters of credit. Generally these commitments have fixed expiration dates or termination clauses and are for specific purposes. Accordingly, 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.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

The most significant market risk to which the Corporation is exposed is interest rate risk. The primary business of the Corporation and the composition of its balance sheet consist of investments in interest earning assets (primarily loans and securities), which are funded by interest bearing liabilities (deposits and borrowings), all of which have varying levels of sensitivity to changes in market interest rates. Changes in rates also have an impact on the Corporation’s liquidity position and could affect its ability to meet obligations and continue to grow.

 

The Corporation employs various management techniques to minimize its exposure to interest rate risk. An Asset Liability Management Committee, consisting of key financial and senior management personnel, meets on a regular basis. The Committee is responsible for reviewing the interest rate sensitivity and liquidity positions of the Corporation, reviewing projected sources and uses of funds, approving asset and liability management policies, monitoring economic conditions, and overseeing the formulation and implementation of strategies regarding balance sheet positions.

 

Simulation of net interest income is performed for the next twelve-month period. A variety of interest rate scenarios are used to measure the effects of sudden and gradual movements upward and downward in the yield curve. These results are compared to the results obtained in a flat or unchanged interest rate scenario. Simulation of net interest income is used primarily to measure the Corporation’s short-term earnings exposure to rate movements. A “shock” is an immediate upward or downward movement of interest rates. The shocks do not take into account changes in client behavior that could result in changes to mix and/or volumes in the balance sheet, nor do they account for competitive pricing over the forward 12-month period. The Corporation applies these interest rate “shocks” to its financial instruments up and down 100, 200, 300, and 400 basis points. A 300 and 400 basis point decrease in interest rates cannot be simulated at this time due to the historically low interest rate environment.

 

The following table summarizes the expected impact of interest rate shocks on net interest income as well as the Corporation’s policy limits at each level. All scenarios were within policy limits at June 30, 2017.

 

Change in Interest Rates  Annual Change in Net  % Change in Net  % Change
(basis points)  Interest Income (in thousands)  Interest Income  Policy Limit
 +100   $2,770    4.61%   (5.00)%
 -100   $(1,685)   (2.80)%   (5.00)%
                  
 +200   $5,414    9.00%   (15.00)%
 -200   $(3,512)   (5.84)%   (15.00)%
                  
 +300   $7,884    13.11%   (25.00)%
                  
 +400   $10,515    17.48%   (35.00)%

 

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Item 4. Controls and Procedures

 

The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Treasurer, of the effectiveness of its disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the evaluation, the Corporation’s Chief Executive Officer and Treasurer concluded that, as of June 30, 2017, the Corporation’s disclosure controls and procedures were effective. The Corporation’s disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that information required to be disclosed in the Corporation’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. A control system, no matter how well conceived and operated, must reflect the fact that there are resource constraints and that the benefits of controls must be considered relative to their costs, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

 

There has been no change in the Corporation’s internal control over financial reporting that occurred during the three and six months ended June 30, 2017, that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

 

Part II—OTHER INFORMATION

 

Item 1. Legal Proceedings

The Corporation and PeoplesBank are involved in routine litigation incidental to their business. In the opinion of management, there are no legal proceedings pending against the Corporation 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. Management is not aware of any adverse proceedings known or contemplated by government authorities.

 

Item 1A. Risk Factors

There have been no material changes to the risk factors as previously disclosed in Item 1A – Risk Factors – in our Annual Report on Form 10-K for the year ended December 31, 2016.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The Corporation relies on its subsidiary PeoplesBank, A Codorus Valley Company, for dividend distributions, which are subject to restrictions as reported in Note 8—Regulatory Matters of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2016.

 

The Corporation has a Share Repurchase Program (Program), which was authorized in 1995, and has been periodically amended, to permit the purchase of up to a maximum of 4.9 percent of the outstanding shares of the Corporation’s common stock at a price per share no greater than 200 percent of the latest quarterly published book value. For the six month period ended June 30, 2017 and the year ended December 31, 2016, the Corporation had not acquired any of its common stock under the Program.

 

Item 3. Defaults Upon Senior Securities

None

 

Item 4. Mine Safety Disclosures

This Item 4 is not applicable to the Corporation.

 

Item 5. Other Information

None

 

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Item 6. Exhibits

 

Exhibit

Number Description of Exhibit

3.1Amended Articles of Incorporation (Incorporated by reference to Exhibit 3.1 of the Registrant’s Quarterly Report on Form 10-Q for June 30, 2016 filed with the Commission on August 8, 2016)

 

3.2Amended By-laws (Incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 12, 2016)

 

31.1Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

31.2Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

32Certification of Principal Executive Officer and Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

101Financial statements from the Quarterly Report on Form 10-Q of Codorus Valley Bancorp, Inc. for the quarter ended June 30, 2017, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income (iii) the Consolidated Statements of Comprehensive Income (iv) the Consolidated Statements of Cash Flows, (v) the Consolidated Statements of Changes in Shareholder’s Equity, and (vi) the Notes to Consolidated Financial Statements – filed herewith.

 

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Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    Codorus Valley Bancorp, Inc.
    (Registrant)
     
August 7, 2017     /s/ Larry J. Miller  
Date   Larry J. Miller
    Chairman, President
    and Chief Executive Officer
    (Principal Executive Officer)

 

August 7, 2017     /s/ Charles T. Field  
Date   Charles T. Field, CPA
    Treasurer and Assistant Secretary
    (Principal Financial and Accounting Officer)

  

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