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, 2020
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 No. 001-33384
ESSA Bancorp, Inc.
(Exact name of registrant as specified in its charter)
Pennsylvania
20-8023072
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
200 Palmer Street, Stroudsburg, Pennsylvania
18360
(Address of Principal Executive Offices)
(Zip Code)
(570) 421-0531
(Registrant’s telephone number)
N/A
(Former name or former address, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common
ESSA
Nasdaq Stock Market LLC
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 requirements for the past 90 days. YES ☒ NO ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). YES ☒ NO ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filers,” “accelerated filers,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO ☒
As of August 7, 2020, there were 10,950,575 shares of the Registrant’s common stock, par value $0.01 per share, outstanding.
Table of Contents
Page
Part I. Financial Information
Item 1.
Financial Statements (unaudited)
2
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
39
Item 3
Quantitative and Qualitative Disclosures About Market Risk
48
Item 4
Controls and Procedures
Part II. Other Information
Legal Proceedings
49
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
50
Item 4.
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
51
Signature Page
52
Financial Statements
ESSA BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
June 30,
September 30,
2020
2019
(dollars in thousands)
ASSETS
Cash and due from banks
$
159,983
48,426
Interest-bearing deposits with other institutions
10,861
3,816
Total cash and cash equivalents
170,844
52,242
Investment securities available for sale, at fair value
295,228
313,393
Loans receivable (net of allowance for loan losses of $14,330 and $12,630)
1,423,132
1,328,653
Regulatory stock, at cost
18,581
11,579
Premises and equipment, net
14,286
14,335
Bank-owned life insurance
40,310
39,601
Foreclosed real estate
412
240
Intangible assets, net
858
1,066
Goodwill
13,801
Deferred income taxes
4,782
5,122
Other assets
26,883
19,395
TOTAL ASSETS
2,009,117
1,799,427
LIABILITIES
Deposits
1,484,835
1,342,830
Short-term borrowings
138,713
107,701
Other borrowings
150,827
140,581
Advances by borrowers for taxes and insurance
15,242
6,700
Other liabilities
25,815
12,107
TOTAL LIABILITIES
1,815,432
1,609,919
STOCKHOLDERS’ EQUITY
Preferred Stock ($0.01 par value; 10,000,000 shares authorized, none issued)
—
Common stock ($0.01 par value; 40,000,000 shares authorized, 18,133,095 issued;
10,960,357 and 11,321,417 outstanding at June 30, 2020 and September 30,
2019, respectively)
181
Additional paid in capital
181,366
181,161
Unallocated common stock held by the Employee Stock Ownership Plan (ESOP)
(7,463
)
(7,803
Retained earnings
109,912
102,465
Treasury stock, at cost; 7,172,738 and 6,811,678 shares outstanding at
June 30, 2020 and September 30, 2019, respectively
(90,396
(85,216
Accumulated other comprehensive income (loss)
85
(1,280
TOTAL STOCKHOLDERS’ EQUITY
193,685
189,508
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
See accompanying notes to the unaudited consolidated financial statements.
CONSOLIDATED STATEMENT OF OPERATIONS
For the Three Months Ended
For the Nine Months Ended
(dollars in thousands, except per
share data)
INTEREST INCOME
Loans receivable, including fees
13,763
14,297
41,958
42,246
Investment securities:
Taxable
1,768
2,258
5,670
7,270
Exempt from federal income tax
45
57
141
287
Other investment income
277
388
941
1,194
Total interest income
15,853
17,000
48,710
50,997
INTEREST EXPENSE
2,211
3,770
8,772
10,713
588
673
1,582
2,922
854
842
2,598
2,030
Total interest expense
3,653
5,285
12,952
15,665
NET INTEREST INCOME
12,200
11,715
35,758
35,332
Provision for loan losses
1,300
400
2,175
1,876
NET INTEREST INCOME AFTER PROVISION FOR LOAN
LOSSES
10,900
11,315
33,583
33,456
NONINTEREST INCOME
Service fees on deposit accounts
558
834
2,163
2,481
Services charges and fees on loans
325
288
985
894
Loan swap fees
627
1,200
Realized and unrealized gain (loss) on equity securities
(3
3
Trust and investment fees
298
260
1,045
734
Gain on sale of investment securities available for sale, net
1
381
44
Gain on sale of loans, net
647
791
Earnings on Bank-owned life insurance
233
242
709
726
Insurance commissions
195
217
641
612
Other
(2
18
102
562
Total noninterest income
2,883
1,862
8,014
6,056
NONINTEREST EXPENSE
Compensation and employee benefits
5,714
5,878
18,029
18,037
Occupancy and equipment
1,033
1,024
3,169
3,162
Professional fees
457
434
1,449
1,604
Data processing
1,113
925
3,215
2,758
Advertising
114
140
348
499
Federal Deposit Insurance Corporation (FDIC) premiums
154
238
492
607
(Gain) loss on foreclosed real estate
(5
35
61
(69
Amortization of intangible assets
68
74
208
235
482
770
1,746
2,048
Total noninterest expense
9,130
9,518
28,717
28,881
Income before income taxes
4,653
3,659
12,880
10,631
Income taxes
876
2,286
1,716
NET INCOME
3,777
3,047
10,594
8,915
Earnings per share
Basic
0.37
0.29
1.02
0.83
Diluted
Dividends per share
0.11
0.10
0.33
0.30
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Net income
Other comprehensive (loss) income
Investment securities available for sale:
Unrealized holding gain
1,091
4,089
6,763
14,011
Tax effect
(228
(859
(1,419
(2,944
Reclassification of gains recognized in net income
(1
(381
(44
80
9
Net of tax amount
863
3,229
5,043
11,032
Derivative and hedging activities adjustments:
Changes in unrealized holding losses on derivatives included in net income
(2,353
(1,034
(4,705
(2,097
494
988
440
Reclassification adjustment for losses (gains) on derivatives included in net income
108
(258
(746
(23
55
(11
157
(1,774
(1,020
(3,678
(2,246
Total other comprehensive (loss) income
(911
2,209
1,365
8,786
Comprehensive income
2,866
5,256
11,959
17,701
4
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
Unallocated
Accumulated
Common Stock
Additional
Total
Number of
Paid In
Stock Held by
Retained
Treasury
Comprehensive
Stockholders’
Shares
Amount
Capital
the ESOP
Earnings
Stock
Income (Loss)
Equity
(dollars in thousands except share data)
Balance, March 31, 2019
11,408,935
180,857
(8,029
97,821
(83,864
(3,329
183,637
Net Income
Other comprehensive income
Cash dividends declared ($0.10 per share)
(1,062
Stock based compensation
71
Allocation of ESOP stock
62
113
175
Balance, June 30, 2019
180,990
(7,916
99,806
(1,120
188,077
Balance, March 31, 2020
11,105,887
181,218
(7,576
107,265
(88,418
996
193,666
Other comprehensive loss
Cash dividends declared ($0.11 per share)
(1,130
82
148
Allocation of forfeited incentive shares
(2,442
31
(31
Purchase of common stock
(143,088
(1,947
Balance, June 30, 2020
10,960,357
5
Balance, September 30, 2018
11,782,718
180,765
(8,255
94,112
(77,707
(9,910
179,186
Cash dividends declared ($0.30 per share)
(3,217
421
188
339
527
Allocation of treasury shares to incentive plan
31,601
(384
384
Reclassification of equity investment securities
(4
(405,384
(6,541
Balance, September 30, 2019
11,321,417
Cash dividends declared ($0.33 per share)
(3,437
Change in accounting principal for adoption of ASU 2016-02
290
415
179
340
519
30,692
(389
385
(391,752
(5,565
6
CONSOLIDATED STATEMENT OF CASH FLOWS
OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for depreciation and amortization
809
825
Amortization and accretion of discounts and premiums, net
1,485
2,255
Net gain on sale of investment securities, available for sale
Realized and unrealized loss (gain) on equity securities
(791
Origination of residential real estate loans for sale
(19,112
Proceeds on sale of residential real estate loans
19,903
Compensation expense on ESOP
Amortization of right-of-use asset
660
Increase in accrued interest receivable
(763
(137
(Decrease) increase in accrued interest payable
(173
578
Earnings on bank-owned life insurance
(709
(726
Deferred federal income taxes
911
Decrease in accrued pension liability
(443
(358
Loss (gain) on foreclosed real estate, net
Other, net
2,678
1,621
Net cash provided by operating activities
17,115
16,827
INVESTING ACTIVITIES
Certificate of deposit maturities
250
Proceeds from sale of investment securities
24,009
45,721
Proceeds from principal repayments and maturities
44,409
33,994
Purchases
(44,623
(20,729
Increase in loans receivable, net
(97,349
(2,566
Redemption of regulatory stock
8,166
14,201
Purchase of regulatory stock
(15,168
(13,716
Proceeds from sale of foreclosed real estate
111
1,020
Purchase of residential real estate loans
(22,298
Purchase of premises, equipment and software
(871
(551
Net cash (used for) provided by investing activities
(81,316
35,326
FINANCING ACTIVITIES
Increase (decrease) in deposits, net
142,005
(7,812
Net increase (decrease) in short-term borrowings
31,012
(58,476
Proceeds from other borrowings
55,661
89,600
Repayment of other borrowings
(45,415
(75,650
Increase in advances by borrowers for taxes and insurance
8,542
7,102
Purchase of treasury shares
Dividends on common stock
Net cash provided by (used for) financing activities
182,803
(54,994
Increase (decrease) in cash and cash equivalents
118,602
(2,841
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
43,539
CASH AND CASH EQUIVALENTS AT END OF YEAR
40,698
SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash Paid:
Interest
13,125
15,087
8
Noncash items:
Transfers from loans to foreclosed real estate
344
315
Initial recognition of operating right-of-use asset
(7,272
Initial recognition of operating lease liability
7,272
Unrealized holding gains
6,383
13,971
7
Notes to Consolidated Financial Statements
(unaudited)
1.
Nature of Operations and Basis of Presentation
The consolidated financial statements include the accounts of ESSA Bancorp, Inc. (the “Company”), its wholly owned subsidiary, ESSA Bank & Trust (the “Bank”), and the Bank’s wholly owned subsidiaries, ESSACOR Inc.; Pocono Investments Company; ESSA Advisory Services, LLC; Integrated Financial Corporation; and Integrated Abstract Incorporated, a wholly owned subsidiary of Integrated Financial Corporation. The primary purpose of the Company is to act as a holding company for the Bank. The Bank’s primary business consists of the taking of deposits and granting of loans to customers generally in Monroe, Northampton, Lehigh, Delaware, Chester, Montgomery, Lackawanna, and Luzerne Counties, Pennsylvania. The Bank is a Pennsylvania chartered savings bank and is subject to regulation and supervision by the Pennsylvania Department of Banking and Securities and the Federal Deposit Insurance Corporation (the “FDIC”). The investment in the Bank on the parent company’s financial statements is carried at the parent company’s equity in the underlying net assets.
ESSACOR, Inc. is a Pennsylvania corporation that has been used to purchase properties at tax sales that represent collateral for delinquent loans of the Bank and is currently inactive. Pocono Investment Company is a Delaware corporation formed as an investment company subsidiary to hold and manage certain investments, including certain intellectual property. ESSA Advisory Services, LLC is a Pennsylvania limited liability company owned 100 percent by ESSA Bank & Trust. ESSA Advisory Services, LLC is a full-service insurance benefits consulting company offering group services such as health insurance, life insurance, short-term and long-term disability, dental, vision, and 401(k) retirement planning as well as individual health products. Integrated Financial Corporation is a Pennsylvania corporation that provided investment advisory services to the general public and is currently inactive. Integrated Abstract Incorporated is a Pennsylvania corporation that provided title insurance services and is currently inactive. All significant intercompany accounts and transactions have been eliminated in consolidation.
The unaudited consolidated financial statements reflect all adjustments, which in the opinion of management, are necessary for a fair presentation of the results of the interim periods and are of a normal and recurring nature. Operating results for the three and nine month periods ended June 30, 2020 and 2019 are not necessarily indicative of the results that may be expected for the year ending September 30, 2020.
2.
Earnings per Share
The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation for the three and nine month periods ended June 30, 2020 and 2019.
Three Months Ended
Nine Months Ended
Weighted-average common shares outstanding
18,133,095
Average treasury stock shares
(7,076,709
(6,724,160
(6,924,021
(6,498,995
Average unearned ESOP shares
(741,156
(786,420
(752,513
(797,778
Average unearned non-vested shares
(54,735
(48,107
(50,204
(48,562
Weighted average common shares and common stock
equivalents used to calculate basic earnings per share
10,260,495
10,574,408
10,406,357
10,787,760
Additional common stock equivalents (nonvested stock)
used to calculate diluted earnings per share
234
257
equivalents used to calculate diluted earnings per share
10,260,729
10,406,614
At June 30, 2020 there were 42,520 shares of nonvested stock outstanding at an average weighted price of $16.15 per share that were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive. At June 30, 2019 there were 39,718 shares of nonvested stock outstanding at an average weighted price of $16.01 per share that were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive.
3.
Use of Estimates in the Preparation of Financial Statements
The accounting principles followed by the Company and its subsidiaries and the methods of applying these principles conform to U.S. generally accepted accounting principles (“GAAP”) and to general practice within the banking industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the Consolidated Balance Sheet date and related revenues and expenses for the period. Actual results could differ from those estimates.
4.
Accounting Pronouncements
Adoption of New Standards
In February 2016, the FASB issued Accounting Standards Update (ASU) 2016-02, Leases. The new leases standard applies a right-of-use (ROU) model that requires a lessee to record, for all leases with a lease term of more than 12 months, an asset representing its right to use the underlying asset and a liability to make lease payments. For leases with a term of 12 months or less, a practical expedient is available whereby a lessee may elect, by class of underlying asset, not to recognize an ROU asset or lease liability. At inception, lessees must classify all leases as either finance or operating based on five criteria. Balance sheet recognition of finance and operating leases is similar, but the pattern of expense recognition in the income statement, as well as the effect on the statement of cash flows, differs depending on the lease classification.
The new leases standard requires a lessor to classify leases as either sales-type, direct financing or operating, similar to existing U.S. GAAP. Classification depends on the same five criteria used by lessees plus certain additional factors. The subsequent accounting treatment for all three lease types is substantially equivalent to existing U.S. GAAP for sales-type leases, direct financing leases, and operating leases. However, the new standard updates certain aspects of the lessor accounting model to align it with the new lessee accounting model, as well as with the new revenue standard under Topic 606.
Lessees and lessors are required to provide certain qualitative and quantitative disclosures to enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.
The new leases standard addresses other considerations including identification of a lease, separating lease and non-lease components of a contract, sale and leaseback transactions, modifications, combining contracts, reassessment of the lease term, and re-measurement of lease payments. It also contains comprehensive implementation guidance with practical examples
ASU 2016-02 was adopted by us on October 1, 2019 and initially required transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. In January 2018, the FASB issued ASU 2018-01, Leases (Topic 842), which provides an optional transition practical expedient to not evaluate under Topic 842 existing or expired land easements that were not previously accounted for as leases under the current lease guidance in Topic 840. In July 2018, the FASB issued ASU 2018-11, “Leases (Topic 842) - Targeted Improvements,” which, among other things, provides an additional transition method that would allow entities to not apply the guidance in ASU 2016-02 in the comparative periods presented in the financial statements and instead recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. In December 2018, the FASB also issued ASU 2018-20, “Leases (Topic 842) - Narrow-Scope Improvements for Lessors,” which provides for certain policy elections and changes lessor accounting for sales and similar taxes and certain lessor costs. In March 2019, the FASB issued ASU 2019-01, Leases (Topic 842): Codification Improvements, which addresses 1) determining the fair value of the underlying asset by the lessor that are not manufacturers or dealers (generally financial institutions and captive finance companies), and 2) lessors that are depository and lending institutions should classify principal and payments received under sales-type and direct financing leases within investing activities in the cash flow statement
Upon adoption of ASU 2016-02, ASU 2018-01, ASU 2018-11, ASU 2018-20, and ASU 2019-01 on October 1, 2019, we recognized right-of-use assets and related lease liabilities totaling $7.3 million and $7.3 million, respectively.
We elected to apply certain practical expedients provided under ASU 2016-02 whereby we will not reassess (i) whether any expired or existing contracts are or contain leases, (ii) the lease classification for any expired or existing leases and (iii) initial direct costs for any existing leases. We also did not apply the recognition requirements of ASU 2016-02 to any short-term leases (as defined by related accounting guidance). We utilized the modified-retrospective transition approach prescribed by ASU 2018-11.
Recent Accounting Pronouncements
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted for annual and interim
periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this Update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting units fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. A public business entity that is a U.S. Securities and Exchange Commission (SEC) filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. A public business entity that is not an SEC filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2020. All other entities, including not-for-profit entities, that are adopting the amendments in this Update should do so for their annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2021. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes the Disclosure Requirements for Fair Value Measurements. The Update removes the requirement to disclose the amount of and reasons for transfers between Level I and Level II of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level III fair value measurements. The Update requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level III fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level III fair value measurements. This Update is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. This Update is not expected to have a significant impact on the Company’s financial statements.
In August 2018, the FASB issued ASU 2018-14, Compensation – Retirement Benefits (Topic 715-20). This Update amends ASC 715 to add, remove and clarify disclosure requirements related to defined benefit pension and other postretirement plans. The Update eliminates the requirement to disclose the amounts in accumulated other comprehensive income expected to be recognized as part of net periodic benefit cost over the next year. The Update also removes the disclosure requirements for the effects of a one-percentage-point change on the assumed health care costs and the effect of this change in rates on service cost, interest cost and the benefit obligation for postretirement health care benefits. This Update is effective for public business entities for fiscal years ending after December 15, 2020, and must be applied on a retrospective basis. For all other entities, this Update is effective for fiscal years ending after December 15, 2021. This Update is not expected to have a significant impact on the Company’s financial statements.
10
In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which affects a variety of topics in the Codification and applies to all reporting entities within the scope of the affected accounting guidance. Topic 326, Financial Instruments – Credit Losses amendments are effective for SEC registrants for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other public business entities, the effective date is for fiscal years beginning after December 15, 2020, and for all other entities, the effective date is for fiscal years beginning after December 15, 2021. Topic 815, Derivatives and Hedging amendments are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020. For entities that have adopted the amendments in Update 2017-12, the effective date is as of the beginning of the first annual period beginning after the issuance of this Update. Topic 825, Financial Instruments amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.
In May 2019, the FASB issued ASU 2019-05, Financial Instruments – Credit Losses, Topic 326, which allows entities to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost upon adoption of the new credit losses standard. To be eligible for the transition election, the existing financial asset must otherwise be both within the scope of the new credit losses standard and eligible for the applying the fair value option in ASC 825-10.3. The election must be applied on an instrument-by-instrument basis and is not available for either available-for-sale or held-to-maturity debt securities. For entities that elect the fair value option, the difference between the carrying amount and the fair value of the financial asset would be recognized through a cumulative-effect adjustment to opening retained earnings as of the date an entity adopted ASU 2016-13. Changes in fair value of that financial asset would subsequently be reported in current earnings. For entities that have not yet adopted ASU 2016-13, the effective dates and transition requirements are the same as those in ASU 2016-13. For entities that have adopted ASU 2016-13, ASU 2019-05 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted once ASU 2016-13 has been adopted. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.
In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). The Update defers the effective dates of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. This Update also amends the mandatory effective date for the elimination of Step 2 from the goodwill impairment test under ASU No. 2017-04, Intangibles ‒ Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (Goodwill), to align with those used for credit losses. Furthermore, the ASU provides a one-year deferral of the effective dates of the ASUs on derivatives and hedging and leases for companies that are not public business entities. The Company qualifies as a smaller reporting company and does not expect to early adopt these ASUs.
In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, to clarify its new credit impairment guidance in ASC 326, based on implementation issues raised by stakeholders. This Update clarified, among other things, that expected recoveries are to be included in the allowance for credit losses for these financial assets; an accounting policy election can be made to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions instead of the prepayment assumptions applicable immediately prior to the restructuring event; and extends the practical expedient to exclude accrued interest receivable from all additional relevant disclosures involving amortized cost basis. The effective dates in this Update are the same as those applicable for ASU 2019-10. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), to simplify the accounting for income taxes, change the accounting for certain tax transactions, and make minor improvements to the codification. This Update provides a policy election to not allocate consolidated income taxes when a member of a consolidated tax return is not subject to income tax and provides guidance to evaluate whether a step-up in tax basis of goodwill relates to a business combination in which book goodwill was recognized or a separate transaction. The Update also changes current guidance for making an intraperiod allocation, if there is a loss in continuing operations and gains outside of continuing operations; determining when a deferred tax liability is recognized after an investor in a foreign entity transitions to or from the equity method of accounting; accounting for tax law changes and year-to-date losses in interim periods; and determining how to apply the income tax guidance to franchise taxes that are partially based on income. For public business entities, the amendments in this Update are effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2020. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. This Update is not expected to have a significant impact on the Company’s financial statements.
In January 2020, the FASB issued ASU 2020-1, Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815), to clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the measurement alternative in accordance with Topic 321 immediately before applying or upon discontinuing the equity method. The amendments also clarify
11
that, for the purpose of applying paragraph 815-10-15-141(a) an entity should not consider whether, upon the settlement of the forward contract or exercise of the purchased option, individually or with existing investments, the underlying securities would be accounted for under the equity method in Topic 323 or the fair value option, in accordance with the financial instruments guidance in Topic 825. An entity also would evaluate the remaining characteristics in paragraph 815-10-15-141 to determine the accounting for those forward contracts and purchased options. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. This Update is not expected to have a significant impact on the Company’s financial statements.
In January 2020, the FASB issued ASU 2020-2, Financial Instruments – Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842), February 2020, to add and amend SEC paragraphs in the Accounting Standards Codification to reflect the issuance of SEC Staff Accounting Bulletin No. 119, related to the new credit losses standard, and comments by the SEC staff related to the revised effective date of the new leases standard. This ASU is effective upon issuance. This did not have a significant impact on the Company’s financial statements.
In March 2020, the FASB issued ASU 2020-3, Codification Improvements to Financial Instruments. This ASU was issued to improve and clarify various financial instruments topics, including the current expected credit losses (CECL) standard issued in 2016. The ASU includes seven issues that describe the areas of improvement and the related amendments to GAAP; they are intended to make the standards easier to understand and apply and to eliminate inconsistencies, and they are narrow in scope and are not expected to significantly change practice for most entities. Among its provisions, the ASU clarifies that all entities, other than public business entities that elected the fair value option, are required to provide certain fair value disclosures under ASC 825, Financial Instruments, in both interim and annual financial statements. It also clarifies that the contractual term of a net investment in a lease under Topic 842 should be the contractual term used to measure expected credit losses under Topic 326. Amendments related to ASU 2019-04 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is not permitted before an entity’s adoption of ASU 2016-01. Amendments related to ASU 2016-13 for entities that have not yet adopted that guidance are effective upon adoption of the amendments in ASU 2016-13. Early adoption is not permitted before an entity’s adoption of ASU 2016-13. Amendments related to ASU 2016-13 for entities that have adopted that guidance are effective for fiscal years beginning after December 15, 2019, including interim periods within those years. Other amendments are effective upon issuance of this ASU. This Update is not expected to have a significant impact on the Company’s financial statements.
In January 2020, the FASB issued ASU 2020-4, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, March 2020, to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls reference rate reform, if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. The amendments in this ASU are effective for all entities upon issuance through December 31, 2022. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.
12
5.
Investment Securities
The amortized cost, gross unrealized gains and losses, and fair value of investment securities available for sale are summarized as follows (in thousands):
June 30, 2020
Amortized
Cost
Gross
Unrealized
Gains
Losses
Fair Value
Available for Sale
Fannie Mae
102,317
3,432
(104
105,645
Freddie Mac
72,970
2,421
75,388
Governmental National Mortgage Association
19,477
538
(88
19,927
Total mortgage-backed securities
194,764
6,391
(195
200,960
Obligations of states and political subdivisions
21,145
761
21,906
U.S. government agency securities
7,991
86
8,077
Corporate obligations
49,299
650
(571
49,378
Other debt securities
14,626
436
(155
14,907
287,825
8,324
(921
September 30, 2019
126,672
987
(554
127,105
80,639
453
(331
80,761
18,590
182
(198
18,574
225,901
1,622
(1,083
226,440
19,860
356
20,212
6,454
6,688
43,121
594
(581
43,134
17,036
84
(201
16,919
312,372
2,890
(1,869
The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three and nine months ended June 30, 2020 and 2019.
(in thousands)
Three Months Ended June 30, 2020
Three Months Ended June 30, 2019
Net gains recognized during the period on equity securities
Less: Net gains recognized during the period on equity securities sold
during the period
Unrealized gains recognized during the reporting period on equity
securities still held at the reporting date
Nine Months Ended June 30, 2020
Nine Months Ended June 30, 2019
Net (losses) gains recognized during the period on equity securities
Unrealized (losses) gains recognized during the reporting period on equity
13
The amortized cost and fair value of debt securities at June 30, 2020, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands):
Available For Sale
Due in one year or less
2,045
Due after one year through five years
23,428
23,833
Due after five years through ten years
83,329
85,008
Due after ten years
179,023
184,342
For the three months ended June 30, 2020, the Company realized no gross gains or gross losses on proceeds from the sale of investment securities. For the nine months ended June 30, 2020, the Company realized gross gains of $420,000 and gross losses of $39,000 on proceeds from the sale of investment securities of $24.0 million. For the three months ended June 30, 2019, the Company realized gross gains of $93,000 and gross losses of $92,000 on proceeds from the sale on investment securities of $15.3 million. For the nine months ended June 30, 2019, the Company realized gross gains of $268,000 and gross losses of $224,000 on proceeds from the sale on investment securities of $45.7 million.
The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position (in thousands):
Securities
Less than Twelve
Months
Twelve Months or
Greater
Fair
Value
2,470
6,406
(73
8,876
3,981
(55
3,606
(33
7,587
21
12,651
(151
7,594
(420
20,245
3,985
19,450
(240
21,591
(681
41,041
5,568
(6
45,867
(548
51,435
32
765
29,661
30,426
345
8,242
(197
8,587
2,159
2,063
12,015
(576
14,078
14
3,493
(16
6,132
(185
9,625
121
14,393
(32
101,917
(1,837
116,310
The Company’s investment securities portfolio contains unrealized losses on securities, including mortgage-related instruments issued or backed by the full faith and credit of the United States government, or generally viewed as having the implied guarantee of the U.S. government, other mortgage backed securities, debt obligations of a U.S. state or political subdivision, U.S. government agency securities, corporate obligations, other debt securities and equity securities.
The Company reviews its position quarterly and has asserted that at June 30, 2020, the declines outlined in the above table represent temporary declines and the Company would not be required to sell the above securities before their anticipated recovery in market value.
The Company has concluded that any impairment of its investment securities portfolio is not other than temporary but is the result of interest rate changes that are not expected to result in the non-collection of principal and interest during the period.
6.
Loans Receivable, Net and Allowance for Loan Losses
Loans receivable consist of the following (in thousands):
Real estate loans:
Residential
605,307
597,514
Construction
10,305
5,672
Commercial
508,056
480,647
142,489
55,559
77,792
71,828
Home equity loans and lines of credit
42,159
45,156
Auto loans
48,920
81,983
2,434
2,924
1,437,462
1,341,283
Less allowance for loan losses
14,330
12,630
Net loans
Included in Commercial loans in the above table are 637 loans totaling $75.6 million originated by the Company under the Payroll Protection Program during the quarter ended June 30, 2020. These loans are guaranteed by the Small Business Administration and mature in two years.
Purchased loans acquired in a business combination are recorded at fair value on their purchase date without a carryover of the related allowance for loan losses.
The following table presents additional information regarding loans acquired and accounted for in accordance with ASC 310-30 (in thousands):
Acquired Loans
with Specific
Evidence or
Deterioration in
Credit Quality
(ASC 310-30)
Outstanding balance
1,198
1,392
Carrying amount
1,112
1,299
The following tables show the amount of loans in each category that were individually and collectively evaluated for impairment at the dates indicated (in thousands):
Total Loans
Individually
Evaluated for
Impairment
Loans Acquired
with Deteriorated
Collectively
3,951
601,356
11,479
495,465
2,480
140,009
271
41,888
139
48,781
18,333
1,418,017
15
4,281
593,233
2,633
476,715
448
55,111
Obligations of states and political sub divisions
44,756
583
81,400
2,893
8,376
1,331,608
The Company maintains a loan review system that allows for a periodic review of our loan portfolio and the early identification of potential impaired loans. Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. Specific loan loss allowances are established for identified losses based on a review of such information. A loan evaluated for impairment is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans identified as impaired are evaluated independently. The Company does not aggregate such loans for evaluation purposes. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral-dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring.
A loan is considered to be a troubled debt restructuring (“TDR”) loan when the Company grants a concession to the borrower that it would not otherwise consider because of the borrower’s financial condition. Such concessions include the reduction of interest rates, forgiveness of principal or interest, or other modifications of interest rates that are less than the current market rate for new obligations with similar risk. TDR loans that are in compliance with their modified terms and that yield a market rate at the time of modification may be removed from TDR status after one year of performance.
16
The following tables include the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount at the dates indicated, if applicable (in thousands):
Recorded
Investment
Unpaid
Principal
Balance
Associated
Allowance
With no specific allowance recorded:
Real estate loans
3,563
4,691
11,257
12,676
2,312
2,388
252
347
46
120
53
17,443
20,275
With an allowance recorded:
423
28
222
910
40
168
19
93
99
42
890
1,640
192
Total:
5,114
13,586
2,556
387
219
Total Impaired Loans
21,915
17
Real Estate Loans
3,935
5,309
2,385
4,269
354
475
465
Auto Loans
161
248
22
7,250
10,788
346
398
36
294
56
94
223
422
426
144
1,126
1,358
5,707
4,563
698
674
12,146
The following table represents the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired (in thousands):
For the Three Months Ended June 30,
Average
Income
Recognized
3,602
3,451
5,108
3,856
2,323
460
244
231
130
11,364
8,133
361
574
291
823
202
802
1,900
3,963
4,025
5,290
4,147
2,491
1,283
241
159
332
12,166
10,033
For the Nine Months Ended June 30,
3,800
3,728
3,203
3,425
54
1,260
253
204
101
8,660
7,721
304
846
239
126
97
285
128
778
1,495
4,104
4,574
3,442
3,551
1,357
535
255
258
320
9,438
9,216
The Company uses a ten-point internal risk-rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized and are aggregated as Pass-rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are fundamentally sound yet exhibit potentially unacceptable credit risk or deteriorating trends or characteristics which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans that are 90 or more days past due are considered Substandard. Loans in the Doubtful category have all the weaknesses inherent in loans classified as Substandard with the added characteristic that their weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Loans in the Loss category are considered uncollectible and of little value that their continuance as bankable assets is not warranted. Certain residential real estate loans, construction loans, home equity loans and lines of credit, auto loans and other consumer loans are underwritten and structured using standardized criteria and characteristics, primarily payment performance, and are normally risk rated and monitored collectively on a monthly basis. These are typically loans to individuals in the consumer categories and are delineated as either performing or non-performing.
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To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. The Bank’s commercial loan officers are responsible for the timely and accurate risk rating recommendation for the loans in their portfolios at origination and on an ongoing basis. The Bank’s commercial loan officers perform an annual review of all commercial relationships $750,000 or greater. Confirmation of the appropriate risk grade is included in the review on an ongoing basis. The Bank engages an external consultant to conduct loan reviews on at least a semi-annual basis. Generally, the external consultant reviews commercial relationships greater than $1,000,000 and/or all criticized relationships. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.
The following tables present the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard, and Doubtful or Loss within the internal risk rating system at June 30, 2020 and September 30, 2019 (in thousands):
Pass
Special
Mention
Substandard
Doubtful
or Loss
Commercial real estate loans
487,303
6,683
14,070
139,855
2,634
704,950
16,704
728,337
461,701
7,492
11,454
52,486
3,073
586,015
14,527
608,034
All other loans are underwritten and structured using standardized criteria and characteristics, primarily payment performance, and are normally risk rated and monitored collectively on a monthly basis. These are typically loans to individuals in the consumer categories and are delineated as either performing or non-performing. The following tables present the risk ratings in the consumer categories of performing and non-performing loans at June 30, 2020 and September 30, 2019 (in thousands):
Performing
Non-
performing
600,891
4,416
41,806
353
48,753
167
704,176
4,949
709,125
592,907
4,607
44,534
622
81,317
666
41
727,313
5,936
733,249
The Company further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following tables present the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of June 30, 2020 and September 30, 2019 (in thousands):
31-60 Days
61-89 Days
90 + Days
Past
Due and
Purchased
Credit Impaired
Current
Past Due
Accruing
Nonaccrual
Loans
598,797
1,259
835
6,510
495,110
89
334
11,411
11,834
236
139,495
2,833
2,994
Obligations of states and political
subdivisions
41,625
534
48,048
687
872
2,408
26
1,413,580
2,134
1,443
19,193
22,770
590,457
2,187
263
7,057
476,644
2,468
2,704
243
1,056
54,899
37
603
44,319
47
837
80,090
1,227
1,893
1,326,792
3,717
468
9,007
13,192
The allowance for loan losses is maintained at a level necessary to absorb loan losses that are both probable and reasonably estimable. Management, in determining the allowance for loan losses, considers the losses inherent in its loan portfolio and changes in the nature and volume of loan activities, along with the general economic and real estate market conditions. The allowance for loan losses consists of two elements: (1) an allocated allowance, which comprises allowances established on specific loans and class allowances based on historical loss experience and current trends, and (2) an unallocated allowance based on general economic conditions and other risk factors in our markets and portfolios. We maintain a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential impaired loans. Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. General loan loss allowances are based upon a combination of factors including, but not limited to, actual loan loss experience, composition of the loan portfolio, current economic conditions, management’s judgment and losses which are probable and reasonably estimable. In addition, for the three and nine months ended June 30, 2020, consideration was given and a credit provision was recorded for loans granted short term payment relief. The allowance is increased through provisions charged against current earnings and recoveries of previously charged-off loans. Loans that are determined to be uncollectible are charged against the allowance. While management uses available information to recognize probable and reasonably estimable loan losses, future loss provisions may be necessary, based on changing economic conditions. Payments received on impaired loans generally are either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. The allowance for loan losses as of June 30, 2020 was maintained at a level that represents management’s best estimate of losses inherent in the loan portfolio, and such losses were both probable and reasonably estimable.
In addition, the FDIC and the Pennsylvania Department of Banking and Securities, as an integral part of their examination process, have periodically reviewed our allowance for loan losses. The banking regulators may require that we recognize additions to the allowance based on its analysis and review of information available to it at the time of its examination.
Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the allowance for loan losses (“ALL”). When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.
The following table summarizes changes in the primary segments of the ALL for the three and nine months ended June 30, 2020 and 2019 (in thousands):
Home
Obligations of
States and
Loans and
Political
Lines of
Subdivisions
Credit
ALL balance at March 31, 2020
4,330
2,180
359
351
1,104
29
13,179
Charge-offs
(42
(21
(135
(15
(217
Recoveries
0
Provision
78
2,294
(1,206
185
(59
ALL balance at June 30, 2020
4,367
103
6,870
974
544
336
963
24
149
ALL balance at March 31, 2019
3,742
59
1,865
295
1,608
27
683
12,389
(49
(114
(229
(397
23
170
214
313
(96
ALL balance at June 30, 2019
4,029
3,624
1,901
338
328
1,528
772
12,606
ALL balance at September 30, 2019
4,243
3,806
1,870
343
329
1,384
(72
(54
(61
(717
(20
(924
77
358
449
189
3,041
(897
201
64
(62
(425
ALL balance at September 30, 2018
3,605
3,458
1,462
323
296
1,859
11,688
(322
(121
(27
(19
(967
(1,467
30
439
509
714
466
197
145
During the three months ended June 30, 2020 the Company recorded provision expense for the residential real estate loans, commercial real estate loans, obligations of states and political subdivisions, construction loans, home equity loans and lines of credit and other loan segments, due to either increased loan balances, changes in the loan mix within the pool, and/or charge-off activity in those segments. Provision expense was also recorded for possible loan losses due to the economic slowdown caused by COVID-19 restrictions. Credit provisions were recorded for loan loss for the commercial loans and auto loan segments.
During the nine months ended June 30, 2020 the Company recorded provision expense for the residential real estate loans, commercial real estate loans, obligations of states and political subdivisions, construction loans, home equity loans and lines of credit and other loan segments, due to either increased loan balances, changes in the loan mix within the pool, and/or charge-off activity in those segments. Provision expense was also recorded for possible loan losses due to the economic slowdown caused by COVID-19 restrictions. Credit provisions were recorded for loan loss for the commercial loans and auto loan segments.
During the three months ended June 30, 2019 the Company recorded provision expense for the residential real estate, construction loans, commercial, obligations of states and political subdivisions and home equity loans and lines of credit, due to either increased loan balances, changes in the loan mix within the pool, and/or charge-off activity in those segments. Credit provisions were recorded for loan loss for the commercial real estate, auto and other loan segments.
During the nine months ended June 30, 2019 the Company recorded provision expense for the all loans segments, due to either increased loan balances, changes in the loan mix within the pool, and/or charge-off activity in those segments.
The Company is closely monitoring all customer credit positions, particularly loans requesting payment relief. Such loans, as of June 30, 2020 amounted to approximately 12.4% of total loans outstanding, including $144.6 million in commercial real estate loans, $5.5 in commercial loans, $27.8 million in mortgage loans, $687,000 in auto loans. As the economic slowdown continues to evolve
due to COVID-19 restrictions, our customers may experience decreased cash flows, which may correlate to an inability to make timely loan payments. This, in turn may require further increases in our allowance for loan losses and increases in the level of charge-offs in our loan portfolio.
The following table summarizes the primary segments of the ALL, segregated into two categories, the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of June 30, 2020 and September 30, 2019 (in thousands):
evaluated for
impairment
4,339
6,830
892
921
14,138
4,207
3,750
1,864
1,240
12,382
The allowance for loan losses is based on estimates, and actual losses will vary from current estimates. Management believes that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date. Despite the above allocations, the allowance for loan losses is general in nature and is available to absorb losses from any loan segment.
The following is a summary of troubled debt restructuring granted during the nine months ended June 30, 2020 and 2019 (dollars in thousands):
For the Nine Months Ended June 30, 2020
Contracts
Pre-Modification
Outstanding
Post-Modification
Troubled Debt Restructurings
For the Nine Months Ended June 30, 2019
95
275
There were no new troubled debt restructurings granted for the three months ended June 30, 2020 and 2019.
The one new troubled debt restructuring granted for the nine months ended June 30, 2020, totaled $534,000 and was granted an interest rate concession.
Of the five new troubled debt restructurings granted for the nine months ended June 30, 2019, one loan totaling $14,000 was granted terms concessions, one loan totaling $81,000 was granted an interest rate concession, and three loans totaling $180,000 were granted term and rate concessions.
For the three and nine months ended June 30, 2020 and 2019, no loans defaulted on a restructuring agreement within one year of modification.
As of June 30, 2020, approximately 222 of our commercial clients had requested loan payment deferrals or payments of interest only on loans totaling $150.1 million. We have had similar request from approximately 169 mortgage customers and approximately 55 auto loan customers. In accordance with interagency guidance issued in March 2020, these short-term deferrals are not considered troubled debt restructurings (“TDRs”) unless the borrower was previously experiencing financial difficulty.
In addition, the risk-rating on COVID-19 modified loans did not change, and these loans will not be considered past due until after the deferral period is over and scheduled payments resume. The credit quality of these loans will be reevaluated after the deferral period ends.
At June 30, 2020, our non-performing assets were not yet materially impacted by the economic pressures of COVID-19, although there can be no assurance that our non-performing assets will not increase in the future. In addition, we will continue to closely monitor credit risk and our exposure to increased loan losses resulting from the impact of COVID-19 on our commercial and consumer clients.
.
7.
Deposits consist of the following major classifications (in thousands):
Non-interest bearing demand accounts
235,783
175,932
Interest bearing demand accounts
238,426
224,673
Money market accounts
351,463
364,635
Savings and club accounts
159,043
135,012
Certificates of deposit
500,120
442,578
25
8.
Net Periodic Benefit Cost-Defined Benefit Plan
For a detailed disclosure on the Bank’s pension and employee benefits plans, please refer to Note 12 of the Company’s Consolidated Financial Statements for the year ended September 30, 2019 included in the Company’s Annual Report on Form 10-K.
The following table comprises the components of net periodic benefit cost for the three and nine month periods ended June 30, 2020 and 2019 (in thousands):
Service Cost
Interest Cost
174
364
520
Expected return on plan assets
(268
(293
(807
(878
Amortization of unrecognized loss
Net periodic benefit cost
(147
(119
The Company’s board of directors adopted resolutions to freeze the status of the Defined Benefit Plan (“the plan”) effective February 28, 2017 (“the freeze date”). Accordingly, no additional participants will enter the plan after February 28, 2017; no additional years of service for benefit accrual purposes will be credited after the freeze date under the plan; and compensation earned by participants after the freeze date will not be taken into account under the plan.
9.
Equity Incentive Plan
The Company previously maintained the ESSA Bancorp, Inc. 2007 Equity Incentive Plan (the “Plan”). The Plan provided for a total of 2,377,326 shares of common stock for issuance upon the grant or exercise of awards. Of the shares that were available under the Plan, 1,698,090 were available to be issued in connection with the exercise of stock options and 679,236 were available to be issued as restricted stock. The Plan allowed for the granting of non-qualified stock options (“NSOs”), incentive stock options (“ISOs”), and restricted stock. Options granted under the plan were granted at no less than the fair value of the Company’s common stock on the date of the grant. As of the effective date of the 2016 Equity Incentive Plan (detailed below), no further grants will be made under the Plan and forfeitures of outstanding awards under the Plan will be added to the shares available under the 2016 Equity Incentive Plan.
The Company replaced the 2007 Equity Incentive Plan with the ESSA Bancorp, Inc. 2016 Equity Incentive Plan (the “2016 Plan”) which was approved by shareholders on March 3, 2016. The 2016 Plan provides for a total of 250,000 shares of common stock for issuance upon the grant or exercise of awards. The 2016 Plan allows for the granting of restricted stock, restricted stock units, ISOs and NSOs.
The Company classifies share-based compensation for employees and outside directors within “Compensation and employee benefits” in the Consolidated Statement of Operations to correspond with the same line item as compensation paid.
Restricted stock shares outstanding at June 30, 2020 vest over periods ranging from 3 to 39 months. The product of the number of shares granted and the grant date market price of the Company’s common stock determines the fair value of restricted shares under the Company’s restricted stock plan. The Company expenses the fair value of all share based compensation grants over the requisite service period.
For the three months ended June 30, 2020 and 2019, the Company recorded $82,000 and $71,000 of share-based compensation expense, respectively, comprised of restricted stock expense. For the nine months ended June 30, 2020 and 2019, the Company recorded $415,000 and $421,000 of share-based compensation expense, respectively, comprised of restricted stock expense. Expected future compensation expense relating to the restricted shares outstanding at June 30, 2020 is $649,000 over the remaining vesting period of 3.25 years.
The following is a summary of the status of the Company’s restricted stock as of June 30, 2020, and changes therein during the nine month period then ended:
Restricted Stock
Weighted-
average
Grant Date
Nonvested at September 30, 2019
34,963
16.13
Granted
33,367
16.19
Vested
(8,819
16.25
Forfeited
Nonvested at June 30, 2020
57,069
16.17
10.
The following disclosures show the hierarchal disclosure framework associated within the level of pricing observations utilized in measuring assets and liabilities at fair value. The definition of fair value maintains the exchange price notion in earlier definitions of fair value but focuses on the exit price of the asset or liability. The exit price is the price that would be received to sell the asset or paid to transfer the liability adjusted for certain inherent risks and restrictions. Expanded disclosures are also required about the use of fair value to measure assets and liabilities.
Assets and Liabilities Required to be Measured and Reported at Fair Value on a Recurring Basis
The following tables provide the fair value for assets and liabilities required to be measured and reported at fair value on a recurring basis on the Consolidated Balance Sheet as of June 30, 2020 and September 30, 2019 by level within the fair value hierarchy (in thousands).
Recurring Fair Value Measurements at Reporting Date
Assets
Level I
Level II
Level III
Mortgage backed securities
U.S. government agencies
42,591
6,787
Total Debt Securities
288,441
Equity securities- financial services
Derivatives and hedging activities
2,232
Liabilities
7,609
35,342
7,792
Total debt securities
305,601
Equity securities-financial services
303
Liabilities:
1,011
The following table presents a summary of changes in the fair value of the Company’s Level III investments for the three and nine month periods ended June 30, 2020 and 2019 (in thousands).
Fair Value Measurement Using
Significant Unobservable Inputs
(Level III)
June 30, 2019
Beginning balance
7,821
7,733
Purchases, sales, issuances, settlements, net
(1,000
Total unrealized gain (loss):
Included in earnings
Included in other comprehensive income (loss)
(34
Transfers in and/or out of Level III
7,822
7,738
Included in other comprehensive (loss) income
Each financial asset and liability is identified as having been valued according to a specified level of input, 1, 2 or 3. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset, either directly or indirectly. Level 2 inputs include quoted prices for similar assets in active markets, and inputs other than quoted prices that are observable for the asset or liability. Level 3 inputs are unobservable inputs for the asset, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy, within which the fair value measurement in its entirety falls, has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset.
The measurement of fair value should be consistent with one of the following valuation techniques: market approach, income approach, and/or cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). For example, valuation techniques consistent with the market approach often use market multiples derived from a set of comparable. Multiples might lie in ranges with a different multiple for each comparable. The selection of where within the range the appropriate multiple falls requires judgment, considering factors specific to the measurement (qualitative and quantitative). Valuation techniques consistent with the market approach include matrix pricing. Matrix pricing is a mathematical technique used principally to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on a security’s relationship to other benchmark quoted securities. Most of the securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quoted market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Securities reported at fair value utilizing Level 1 inputs are limited to actively traded equity securities whose market price is readily available from the New York Stock Exchange or the NASDAQ exchange. A few securities are valued using Level 3 inputs, all of these are classified as available for sale and are reported at fair value using Level 3 inputs.
Assets and Liabilities Required to be Measured and Reported on a Non-Recurring Basis
The following tables provide the fair value for assets required to be measured and reported at fair value on a non recurring basis on the Consolidated Balance Sheet as of June 30, 2020 and September 30, 2019 by level within the fair value hierarchy:
Non-Recurring Fair Value Measurements at Reporting Date (in thousands)
Impaired loans
18,141
8,128
The following tables present additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value:
Quantitative Information about Level 3 Fair Value Measurements
Estimate
Valuation
Techniques
Unobservable
Input
Range
Appraisal of
collateral (1)
Appraisal
adjustments (2)
0% to 35%
(20.6%)
Foreclosed real estate owned
20% to 46%
(25.1%)
(20.3%)
20% to 35%
(26.6%)
(1)
Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not identifiable.
(2)
Appraisals may be adjusted by 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.
Foreclosed real estate is measured at fair value, less cost to sell at the date of foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value, less cost to sell. Income and expenses from operations and changes in valuation allowance are included in the net expenses from foreclosed real estate. Impaired loans are reported at fair value utilizing level three inputs. For these loans, a review of the collateral is conducted and an appropriate allowance for loan losses is allocated to the loan. At June 30, 2020, 106 impaired loans with a carrying value of $18.3 million were reduced by specific valuation allowance totaling $192,000 resulting in a net fair value of $18.1 million based on Level 3 inputs. At September 30, 2019, 138 impaired loans with a carrying value of $8.4 million were reduced by a specific valuation totaling $248,000 resulting in a net fair value of $8.1 million based on Level 3 inputs.
Assets and Liabilities not Required to be Measured and Reported at Fair Value
The following tables provide the carrying value and fair value for certain financial instruments that are not required to be measured or reported at fair value on the consolidated Balance Sheet at June 30, 2020 and September 30, 2019 by level within the fair value hierarchy:
Carrying Value
Total Fair
Financial assets:
Cash and cash equivalents
Loans receivable, net
1,424,064
Accrued interest receivable
6,988
Regulatory stock
Mortgage servicing rights
283
Bank owned life insurance
Financial liabilities:
984,715
504,370
1,489,085
157,779
Accrued interest payable
1,211
1,313,231
6,225
177
900,252
443,063
1,343,315
141,427
11.
Accumulated Other Comprehensive Income (Loss)
The activity in accumulated other comprehensive income (loss) for the three and nine month periods ended June 30, 2020 and 2019 is as follows (in thousands):
Accumulated Other
Comprehensive Income/(Loss)
Defined
Benefit
Pension Plan
Unrealized Gains
(Losses) on
Derivatives
Balance at March 31, 2020
(1,527
4,987
(2,464
Other comprehensive income (loss) before
reclassifications
(1,859
(996
Amounts reclassified from accumulated
other comprehensive income (loss)
Period change
Balance at June 30, 2020
5,850
(4,238
Balance at March 31, 2019
(477
(3,562
710
3,230
(817
2,413
(203
(204
Balance at June 30, 2019
(333
(310
Balance at September 30, 2019
807
(560
5,344
(3,717
1,627
Amounts reclassified from accumulated other
comprehensive income (loss)
(301
(262
Balance at September 30, 2018
(11,369
1,936
Other comprehensive income (loss) before reclassifications
11,067
(1,657
9,410
(35
(589
(624
Reclassification of certain income tax effects from accumulated
11,036
8,790
The following table presents significant amounts reclassified out of each component of accumulated other comprehensive income (loss) for the three and nine month periods ended June 30, 2020 and 2019 (in thousands):
Amount Reclassified from
Details About Accumulated Other Comprehensive Income (Loss) Components
Accumulated Other Comprehensive Income (Loss) for the Three Months Ended June 30,
Affected Line Item in the
Consolidated Statement of Income
Securities available for sale
Net securities gains reclassified into earnings
Related income tax expense
Net effect on accumulated other comprehensive income (loss)
for the period
Derivatives and hedging activities:
Interest expense, effective portion
(108
Short-term borrowings interest expense
(85
203
Total reclassification for the period
Accumulated Other Comprehensive Income (Loss) For the Nine Months Ended June 30,
Securities available for sale:
(80
(9
301
Net of tax
Derivative and hedging activities:
(50
746
(157
(39
589
262
624
12.
Derivatives and Hedging Activities
Risk Management Objective of Using Derivatives
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities and through the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to certain variable rate borrowings.
33
Fair Values of Derivative Instruments on the Consolidated Balance Sheet
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Balance Sheet as of June 30, 2020 and September 30, 2019 (in thousands).
Fair Values of Derivative Instruments
Asset Derivatives
As of June 30, 2020
As of September 30, 2019
Hedged Item
Notional
Sheet
Location
FHLB Advances
25,000
Other Assets
50,000
Commercial Loans
49,440
2,230
-
74,440
Liability Derivatives
410,000
Other Liabilities
4,603
35,000
513
Brokered Deposits
762
498
68,639
2,244
503,639
85,000
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest income and expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company has entered into interest rate swaps as part of its interest rate risk management strategy. These interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from a counterparty in exchange for the Company making fixed payments. As of June 30, 2020, the Company had forty nine interest rate swaps with a notional principal amount of $578.1 million associated with the Company’s cash outflows associated with various FHLB advances, brokered certificates and commercial loans.
For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions. The Company did not recognize any hedge ineffectiveness in earnings during the periods ended June 30, 2020 and 2019.
Amounts reported in accumulated other comprehensive income ( loss) related to derivatives that will be reclassified to interest income/expense as interest payments are made/received on the Company’s variable-rate assets/liabilities. During the three months ended June 30, 2020 and 2019, the Company had $108,000 of losses which resulted in an increase to interest expense and $258,000 of gains reclassified which resulted in a decrease to interest expense. During the nine months ended June 30, 2020 and 2019, the Company had $50,000 of losses which resulted in an increase to interest expense and $746,000 of gains reclassified which resulted in a decrease to interest expense. During the next twelve months, the Company estimates that $2.5 million will be reclassified as a increase to interest expense.
34
The table below presents the effect of the Company’s cash flow hedge accounting on Accumulated Other Comprehensive Income (Loss) for the three and nine month periods ended June 30, 2020 and 2019 (in thousands).
The Effect of Fair Value and Cash Flow Hedge Accounting on Accumulated Other Comprehensive Income (Loss)
Derivatives in Hedging Relationships
Loss Recognized in
OCI on Derivative
(Effective Portion)
Three Months Ended June 30,
Location of Gain
or (Loss)
Reclassified from
Accumulated OCI
into Income
(Loss) Gain Recognized in
Derivatives in Cash Flow Hedging Relationships
Interest Rate Products
(2,244
(1,292
Interest expense
Derivatives in Cash Flow
Hedging Relationships
Nine Months Ended June 30,
(Loss) Gain Recognized
in OCI on Derivative
(4,655
2,842
Credit-risk-related Contingent Features
The Company has agreements with its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations.
The Company also has agreements with certain of its derivative counterparties that contain a provision where if the Company fails to maintain its status as a well / adequately capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements.
As of June 30, 2020, the Company had derivatives in a net liability position and was required to post $7.2 million in collateral against its obligations under these agreements. As of September 30, 2019, the Company was required to post $710,000 in collateral against its obligations under these agreements. If the Company had breached any of these provisions at June 30, 2020 and September 30, 2019, it could have been required to settle its obligations under the agreements at the termination value.
13.
Contingent Liabilities
The Company and its subsidiaries are subject to various legal actions arising in the normal course of business. In the opinion of Management, the resolution of these legal actions is not expected to have a material adverse effect on the Company’s results of operations.
The Bank was named as a defendant in an action commenced on December 8, 2016 by one plaintiff who will also seek to pursue this action as a class action on behalf of the entire class of people similarly situated. The plaintiff alleges that a bank previously acquired by ESSA Bancorp received unearned fees and kickbacks in the process of making loans, in violation of the Real Estate Settlement Procedures Act. In an order dated January 29, 2018, the district court granted the Bank’s motion to dismiss the case. The plaintiff appealed the court’s ruling. In an opinion and order dated April 26, 2019, the appellate court reversed the district court’s order dismissing the plaintiff’s case against the Bank, and remanded the case back to the district court in order to continue the litigation. The litigation is now proceeding before the district court. On December 9, 2019, the Court permitted an amendment to the complaint to add two new plaintiffs to the case asserting similar claims. On May 21, 2020, the Court granted the plaintiffs’ motion for class certification. The case is currently stayed through late-September while the parties explore the possibility of a negotiated resolution to the case. If these discussions are not successful, the Bank will continue to defend against such allegations. To the extent that pending or threatened litigation could result in exposure to the Bank, the amount of such exposure is not currently estimable.
On May 29, 2020, the Bank was named as a defendant in a second action commenced by three plaintiffs who will also seek to pursue this action as a class action on behalf of the entire class of people similarly situated. The plaintiffs allege that a bank previously acquired by ESSA Bancorp received unearned fees and kickbacks from a different title company than the one involved in
the previously discussed litigation in the process of making loans. The Complaint alleges violations of the Real Estate Settlement Procedures Act, the Sherman Act, and the Racketeer Influenced and Corrupt Organizations Act. The litigation is in its early stages, and the Bank’s response to the Plaintiffs’ Complaint is due August 10. The Bank intends to defend against such allegations. To the extent that pending or threatened litigation could result in exposure to the Bank, the amount of such exposure is not currently estimable.
14.
Revenue Recognition
Effective October 1, 2018, the Company adopted ASU 2014-09 Revenue from Contracts with Customers- Topic 606 and all subsequent ASC’s that modified ASC 606. The Company elected to apply the standard utilizing the modified retrospective approach with a cumulative effect of adoption for the impact from uncompleted contracts as of the date of adoption.
The main types of non interest income within the scope of the standard are:
Trust and Investment Fees
Trust and asset management income is primarily comprised of fees earned from the management and administration of trusts and other customer assets. The Company’s performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based upon the month-end market value of the assets under management and the applicable fee rate. Payment is generally received a few days after month end through a direct charge to customer’s accounts. The Company does not earn performance-based incentives. Optional services such as real estate sales and tax return preparation services are also available to existing trust and asset management customers. The Company’s performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, at a point in time (i.e. as incurred). Payment is received shortly after services are rendered.
Service Charges on Deposit Accounts
Service charges on deposit accounts consist of account analysis fees (i.e. net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.
Fees, Exchange, and Other Service Charges
Fees, interchange, and other service charges are primarily comprised of debit card income, ATM fees, cash management income, and other services charges. Debit card income is primarily comprised of interchange fees earned whenever the Company’s debit cards are processed through card payment networks such as Mastercard. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a company ATM. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized when the services are rendered or upon completion., Payment is typically received immediately or in the following month.
Insurance Commissions
Insurance income primarily consists of commissions received on product sales. The Company acts as an intermediary between the Company’s customer and the insurance carrier. The Company’s performance obligation is generally satisfied upon the issuance of the policy. Shortly after the policy is issued, the carrier remits the commission payment to the Company, and the Company recognizes the revenue.
15. Leases
A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. On October 1, 2019, the Company adopted ASU No. 2016-02 “Leases”
(Topic 842) and all subsequent ASUs that modified Topic 842. For the Company, Topic 842 primarily affected the accounting treatment for operating lease agreements in which the Company is the lessee.
Lessee Accounting
Substantially all of the leases in which the Company is the lessee are comprised of real estate property for branches, ATM locations, and office space with terms extending through 2044. All of our leases are classified as operating leases, and therefore, were previously not recognized on the Company’s Consolidated Balance sheet. With the adoption of Topic 842, operating lease agreements are required to be recognized on the Consolidated Balance sheet as a right-of-use (“ROU”) asset and a corresponding lease liability.
The following table presents the Consolidated Balance Sheet classification of the Company’s ROU assets and lease liabilities. The Company elected not to include short-term leases (i.e., leases with initial terms of twelve months or less), or equipment leases (deemed immaterial) on the Consolidated Balance sheet.
Lease Right-of-Use Assets
Classification
Operating lease right-of-use assets
7,323
Total Lease Right-Of-Use Assets
Lease Liabilities
Operating lease Liabilities
7,384
Total Lease Liabilities
The calculated amount of the ROU assets and lease liabilities in the table above are impacted by the length of the lease term and the discount rate used to present value the minimum lease payments. The Company’s lease agreements often include one or more options to renew at the Company’s discretion. If at lease inception, the Company considers the exercising of a renewal option to be reasonably certain, the Company will include the extended term in the calculation of the ROU asset and lease liability. Regarding the discount rate, Topic 842 requires the use of the rate implicit in the lease whenever this rate is readily determinable. As this rate is rarely determinable, the Company utilizes its incremental borrowing rate at lease inception, on a collateralized basis, over a similar term. For operating leases existing prior to October 1, 2019, the rate for the remaining lease term as of October 1, 2019 was used.
Weighted average remaining lease term
Operating leases
13.6 years
Weighted average discount rate
2.39
%
The following table represents lease costs and other lease information. As the Company elected, for all classes of underlying assets, not to separate lease and non-lease components and instead to account for them as a single lease component, the variable lease cost primarily represents variable payments such as common area maintenance and utilities.
Lease Costs (in thousands)
Operating lease cost
259
Variable lease cost
Net lease cost
Nine Months Ended June 30,2020
780
171
951
Future minimum payments for finance leases and operating leases with initial or remaining terms of one year or more as of June 30, 2020 were as follows:
Twelve months Ended:
June 30, 2021
1,051
June 30, 2022
937
June 30, 2023
739
June 30, 2024
668
June 30, 2025
Thereafter
4,834
Total future minimum lease payments
8,756
Amounts representing interest
(1,372
Present Value of Net Future Minimum Lease Payments
38
Forward Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements, which can be identified by the use of such words as estimate, project, believe, intend, anticipate, plan, seek, expect and similar expressions. These forward-looking statements include:
•
statements of our goals, intentions and expectations;
statements regarding our business plans and prospects and growth and operating strategies;
statements regarding the asset quality of our loan and investment portfolios; and
estimates of our risks and future costs and benefits.
By identifying these forward-looking statements for you in this manner, we are alerting you to the possibility that our actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. Important factors that could cause our actual results and financial condition to differ from those indicated in the forward-looking statements include, among others, those discussed under “Risk Factors” in Part I, Item 1A of the Company’s Annual Report on Form 10-K and Part II, Item 1A of this and any previous Quarterly Report on Form 10-Q filed since our most recent Annual Report on Form 10-K, as well as the following factors:
significantly increased competition among depository and other financial institutions;
inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;
general economic conditions, either nationally or in our market areas, that are worse than expected;
adverse changes in the securities markets;
legislative or regulatory changes that adversely affect our business;
our ability to enter new markets successfully and take advantage of growth opportunities, and the possible short-term dilutive effect of potential acquisitions or de novo branches, if any;
changes in consumer spending, borrowing and savings habits;
changes in accounting policies and practices, as may be adopted by the bank regulatory agencies and the FASB; and
changes in our organization, compensation and benefit plans.
Further, the COVID-19 pandemic has caused local and national economic disruption and has had an impact on the Company’s operations and financial results. Given its ongoing and dynamic nature, it is difficult to predict what effects the pandemic will have on our business and results of operations in the future. The pandemic and related local and national economic disruption may, among other effects, result in a decline in demand for our products and services; increased levels of loan delinquencies, problem assets and foreclosures; branch closures, work stoppages and unavailability of personnel; and increased cybersecurity risks, as employees increasingly work remotely.
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
Comparison of Financial Condition at June 30, 2020 and September 30, 2019
Total Assets. Total assets increased by $209.7 million, or 11.7%, to $2.01 billion at June 30, 2020 from $1.80 billion at September 30, 2019 due primarily to increases in cash and due from banks, interest bearing deposits with other institutions and loans receivable partially offset by a decline in investment securities available for sale. At the onset of the pandemic slowdown, the Company moved quickly to build its liquidity as an offset to the economic uncertainty caused by the slowdown. The Company built a laddered maturity of, primarily FHLB borrowings, at attractive interest rates to support that liquidity. The Company will continue to maintain a strong liquidity position against the changing economic forecasts through daily monitoring.
Total Cash and Cash Equivalents. Total cash and cash equivalents increased $118.6 million, or 227.0%, to $170.8 million at June 30, 2020 from $52.2 million at September 30, 2019 as a result of pandemic-oriented balance sheet adjustments made to mitigate related risks.
Net Loans. Net loans increased $94.5 million, or 7.1%, to $1.42 billion at June 30, 2020 from $1.33 billion at September 30, 2019. During this period, residential loans increased $7.8 million to $605.3 million, construction loans increased $4.6 million to $10.3 million, commercial real estate loans increased $27.4 million to $508.1 million, commercial loans increased $86.9 million to $142.5 million, obligations of states and political subdivisions increased $6.0 million to $77.8 million, home equity loans and lines of credit decreased $3.0 million to $42.2 million, auto loans decreased $33.1 million to $48.9 million, and other loans decreased $490,000 to $2.4 million. The commercial loan increase included 637 loans totaling $75.6 million originated by the Company under the Payroll Protection Program.
Investment Securities Available for Sale. Investment securities available for sale decreased $18.2 million, or 5.8%, to $295.2 million at June 30, 2020 from $313.4 million at September 30, 2019.
Deposits. Deposits increased $142.0 million, or 10.6%, to $1.48 billion at June 30, 2020 from $1.34 billion at September 30, 2019 due primarily to an increase in interest bearing demand accounts, certificate of deposits, non-interest bearing demand accounts and savings and club accounts offset by a decrease in money markets accounts. Increases in non-interest bearing demand accounts of $59.9 million, interest bearing demand accounts of $13.8 million, certificates of deposit of $57.5 million and savings and club accounts of $24.0 million were offset in part by a decrease in money market accounts of $13.2 million. The overall increase in certificates of deposit, reflected an increase in brokered certificates of $82.1 million and a decrease in retail certificates of deposit of $23.2 million to $187.1 million.
Borrowed Funds. Borrowed funds increased by $41.3 million, or 16.6%, to $289.5 million at June 30, 2020, from $248.3 million at September 30, 2019. The increase in borrowed funds was due to an increase in short term borrowings of $31.0 million and an increase in other borrowings of $10.2 million. All borrowings at June 30, 2020 represent advances from the Federal Home Loan Bank of Pittsburgh (the “FHLB”) and were a result of pandemic-oriented balance sheet adjustments made to mitigate related risks.
Stockholders’ Equity. Stockholders’ equity increased by $4.2 million, or 2.2%, to $193.7 million at June 30, 2020 from $189.5 million at September 30, 2019. The increase in stockholders’ equity was primarily due to net income of $10.6 million, which was partially offset by an increase in treasury stock due to the repurchase by the Company of 391,752 shares of its common stock at an aggregate cost of $5.66 million under a previously disclosed stock repurchase plan and regular cash dividends of $0.11 per share, which reduced stockholders equity by $3.4 million. The Company suspended its stock repurchase activity on April 1, 2020 and did not resume repurchasing common stock until May 1, 2020.
Average Balance Sheets for the Three and Nine Months Ended June 30, 2020 and 2019
The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. All average balances are daily average balances, the yields set forth below include the effect of deferred fees and discounts and premiums that are amortized or accreted to interest income.
Average Balance
Interest Income/
Expense
Yield/Cost
Interest-earning assets:
Loans(1)
1,416,370
13,764
3.90
1,341,378
4.28
Taxable(2)
67,076
637
3.81
63,388
630
3.99
Exempt from federal income
tax(2)(3)
8,267
2.70
11,313
2.56
Total investment securities
75,343
681
3.69
74,701
3.77
Mortgage-backed securities
225,073
1,132
2.02
260,758
1,628
2.50
Federal Home Loan Bank stock
17,713
224
5.07
12,324
230
7.49
162,203
0.13
29,165
158
2.17
Total interest-earning assets
1,896,702
15,854
3.36
1,718,326
3.97
Allowance for loan losses
(13,520
(12,505
Noninterest-earning assets
123,200
109,212
Total assets
2,006,382
1,815,033
Interest-bearing liabilities:
NOW accounts
226,736
134
0.24
189,362
0.36
350,993
442
0.51
334,962
1,063
1.27
151,427
0.06
133,353
0.05
422,789
1,613
1.53
501,562
2,519
2.01
Borrowed funds
402,581
1.44
276,788
1,515
2.20
Total interest-bearing liabilities
1,554,526
3,654
0.94
1,436,027
1.48
Non-interest-bearing NOW
accounts
221,139
170,690
Non-interest-bearing liabilities
34,986
22,902
Total liabilities
1,810,651
1,629,619
195,731
185,414
Total liabilities and equity
Net interest income
Interest rate spread
2.42
2.49
Net interest-earning assets
342,176
282,299
Net interest margin(4)
2.58
2.73
Average interest-earning assets to
average interest-bearing liabilities
122.01
119.66
1,372,482
41,959
4.07
1,334,965
4.23
66,108
1,888
3.80
67,609
2,008
10,376
2.29
2.62
76,484
2,029
3.60
86,183
2,295
3.68
229,835
3,782
2.19
272,851
5,262
13,522
651
6.41
13,489
759
7.52
77,738
289
0.50
26,198
435
2.22
1,770,061
3.67
1,733,686
3.94
(13,005
(12,242
116,628
111,148
1,873,684
1,832,592
213,614
525
196,417
528
348,809
2,326
0.89
325,110
2,861
1.18
142,091
60
132,386
448,765
5,861
1.74
504,610
7,271
1.93
304,444
4,180
1.83
306,708
4,952
2.16
1,457,723
1,465,231
1.43
Accounts
162,904
59,349
20,476
1,679,976
1,648,611
193,708
183,981
2.51
312,338
268,455
2.69
2.72
121.43
118.32
_____________________
Non-accruing loans are included in the outstanding loan balances.
Available for sale securities are reported at fair value.
(3)
Yields on tax exempt securities have been calculated on a fully tax equivalent basis assuming a tax rate of 21.00% for the three and nine months ended June 30, 2020 and 2019.
(4)
Represents the difference between interest earned and interest paid, divided by average total interest earning assets.
Comparison of Operating Results for the Three Months Ended June 30, 2020 and June 30, 2019
Net Income. Net income increased $730,000, or 24.0%, to $3.8 million for the three months ended June 30, 2020 compared to net income of $3.0 million for the comparable period in 2019. The increase was primarily due to increases in net interest income and non-interest income along with a decrease in noninterest expense which was partially offset by increases in the provision for loan losses and the income tax provision.
Net Interest Income. Net interest income increased $485,000, or 4.1%, to $12.2 million for the three months ended June 30, 2020 compared to $11.7 million for the comparable period in 2019.
Interest Income. Interest income decreased $1.1 million, or 6.8%, to $15.9 million for the three months ended June 30, 2020 from $17.0 million for the comparable 2019 period. The decrease resulted from a decrease in the yield on interest earning assets of 61 basis points to 3.36% from 3.97% for the comparable 2019 period partially offset by an increase in the average balance of interest earnings assets of $178.4 million. The average balance of loans increased $75.0 million between the two periods. In addition, between the two periods, the average balance of investment securities increased $642,000, mortgage-backed securities decreased $35.7 million, FHLB stock increased $5.4 million and other interest earning assets increased $133.0 million.
Interest Expense. Interest expense decreased $1.6 million, or 30.9%, to $3.7 million for the three months ended June 30, 2020 from $5.3 million for the comparable 2019 period. The decrease resulted from a decrease in the cost of interest bearing liabilities of 54 basis points from 1.48% to 0.94% partially offset by an increase in the average balance of interest bearing liabilities of $118.5 million between the two periods. The interest expense decrease of $1.6 million for the three months ended June 30, 2020 was due primarily to an decrease in certificates of deposit expense of $906,000 and money market accounts of $621,000.
Provision for Loan Losses. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect a borrower’s ability to repay, the estimated value of any underlying collateral, peer group information and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are subject to interpretation and revision as more information becomes available or as future events occur. After an evaluation of these factors, management made a provision for loan losses of $1.3 million for the three month period ended June 30, 2020 compared to $400,000 for the three month period ended June 30, 2019. The allowance for loan losses was $14.3 million, or 1.00% of loans outstanding at June 30, 2020, compared to $12.6 million, or 0.94% of loans outstanding, at September 30, 2019. As the economic slowdown continues to evolve due to COVID-19 restrictions, our customers may experience decreased cash flows, which may correlate to an inability to make timely loan payments. This, in turn may require further increases in our allowance for loan losses and increases in the level of charge-offs in our loan portfolio.
Non-interest Income. Non-interest income increased $1.0 million, or 54.8%, to $2.9 million for the three months ended June 30, 2020 from $1.9 million at June 30, 2019. Increases in service changes and fees on loans of $37,000, loan swap fees of $627,000, trust and investment fees of $38,000 and gain on sale of loans, net, of $647,000 were partially offset by declines in other income of $20,000, Insurance commissions of $22,000 and service fees on deposit accounts of $276,000. The Company waived many deposit account service fees during the three months ended June 30, 2020 due to COVID-19 restrictions.
Non-interest Expense. Non-interest expense decreased $388,000, or 4.1%, to $9.1 million for the three months ended June 30, 2020 from $9.5 million for the comparable period in 2019. Decreases in compensation and employee benefits, FDIC premiums, foreclosed real estate, other, advertising, and intangible expenses were partially offset by increases in occupancy and equipment, professional fees, and data processing.
Income Taxes. Income tax expense increased $264,000 to $876,000 for the three months ended June 30, 2020 from $612,000 for the comparable 2019 period. The effective tax rate for the three months ended June 30, 2020 was 18.8% compared to 16.7% for the 2019 period.
43
Comparison of Operating Results for the Nine Months Ended June 30, 2020 and June 30, 2019
Net Income. Net income increased $1.7 million, or 18.8%, to $10.6 million for the nine months ended June 30, 2020 compared to net income of $8.9 million for the comparable period in 2019. The increase was primarily due to increases in net interest income and non-interest income along with a decrease in non-interest expense partially offset by increases in the provision for loan losses and the income tax provision.
Net Interest Income. Net interest income increased $426,000, or 1.2%, to $35.8 million for the nine months ended June 30, 2020 from $33.5 million for the comparable period in 2019.
Interest Income. Interest income decreased $2.3 million, or 17.3%, to $48.7 million for the nine months ended June 30, 2020 from $51.0 million for the comparable 2019 period. The decrease resulted primarily from a decrease of 27 basis points in earnings on interest bearing assets from 3.94% in 2019 to 3.67% in 2020 partially offset by an increase in the average balance of interest earnings assets of $36.4 million from the comparable 2019 period. The average balance of loans increased $37.5 million between the two periods. In addition, between the two periods, the average balance of investment securities decreased $9.7 million, mortgage-backed securities decreased $43.0 million, FHLB stock increased $33,000 and other interest earning assets increased $51.5 million.
Interest Expense. Interest expense decreased $2.7 million or 17.3%, to $13.0 million for the nine months ended June 30, 2020 from $15.7 million for the comparable 2019 period. The decrease resulted from a decrease in the cost of interest bearing liabilities of 25 basis points from 1.43% to 1.18% and a decrease in the average balance of interest bearing liabilities of $7.5 million between the two periods. The interest expense decrease of $2.7 million for the nine months ended June 30, 2020 was due primarily to decreases in money market expense of $535,000, certificates of deposit expense of $1.4 million and borrowed funds of $772,000.
Provision for Loan Losses. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect a borrower’s ability to repay, the estimated value of any underlying collateral, peer group information and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are subject to interpretation and revision as more information becomes available or as future events occur. After an evaluation of these factors, management made a provision for loan losses of $2.2 million for the nine month period ended June 30, 2020 compared to $1.9 million for the nine month period ended June 30, 2019. The allowance for loan losses was $14.3 million, or 1.00% of loans outstanding at June 30, 2020, compared to $12.6 million, or 0.94% of loans outstanding, at September 30, 2019. As the economic slowdown continues to evolve due to COVID-19 restrictions, our customers may experience decreased cash flows, which may correlate to an inability to make timely loan payments. This, in turn may require further increases in our allowance for loan losses and increases in the level of charge-offs in our loan portfolio.
Non-interest Income. Non-interest income increased $2.0 million, or 32.3%, to $8.0 million for the nine months ended June 30, 2020 from $6.1 million at June 30, 2019. Increases in service changes and fees on loans of $91,000, loan swap fees of $1.2 million, trust and investment fees of $311,000, gain on sale of investment securities available for sale, net, of $337,000 and gain on sale of loans, net, of $791,000 were partially offset by declines in other income of $460,000 and service fees on deposit accounts of $318,000.
Non-interest Expense. Non-interest expense decreased $164,000, or 0.6%, to $28.7 million for the nine months ended June 30, 2020 from $28.9 million for the comparable period in 2019. Decreases in compensation and employee benefits, professional fees, advertising, FDIC premiums, amortization of intangible assets and other expenses were partially offset by increases in and data processing and occupancy and equipment along with a decrease in gain on foreclosed real estate.
Income Taxes. Income tax expense increased $570,000 to $2.3 million for the nine months ended June 30, 2020 from $1.7 million for the comparable 2019 period. The effective tax rate for the nine months ended June 30, 2020 was 17.7% compared to 16.1% for the 2019 period.
The following table provides information with respect to the Bank’s non-performing assets at the dates indicated (dollars in thousands).
Non-performing assets:
Non-accruing loans
Non-accruing purchased credit impaired loans
Total non-performing loans
20,069
10,063
Other repossessed assets
Total non-performing assets
20,481
10,312
Ratio of non-performing loans to total loans
1.40
0.75
Ratio of non-performing loans to total assets
1.00
0.56
Ratio of non-performing assets to total assets
0.57
Ratio of allowance for loan losses to total loans
Loans are reviewed on a regular basis and are placed on non-accrual status when they become 90 days delinquent. When loans are placed on non-accrual status, unpaid accrued interest is fully reserved, and further income is recognized only to the extent received. Non-performing assets increased $10.2 million from September 30, 2019 to June 30, 2020. The primary reason for the increase in nonperforming assets at June 30, 2020 as compared to September 30, 2019 was the addition of two nonperforming commercial real estate loans totaling $9.3 million. These loans are well collateralized and carry personal guarantees. The number of nonperforming residential loans was 50 at June 30, 2020 compared to 52 at September 30, 2019. The $20.1 million of non-accruing loans at June 30, 2020 included 50 residential loans with an aggregate outstanding balance of $4.4 million, 48 commercial and commercial real estate loans with aggregate outstanding balances of $15.1 million and 51 consumer loans with aggregate balances of $532,000. Within the residential loan balance were $2.4 million of loans less than 90 days past due. In the quarter ended June 30, 2020, the Company identified 19 residential loans which, although paying as agreed, have a high probability of default. Foreclosed real estate increased $4,000 to $412,000 at June 30, 2020. Foreclosed real estate consists of 10 residential properties and one commercial property.
At June 30, 2020, the principal balance of troubled debt restructures (“TDRs”) was $3.0 million compared to $3.1 million at September 30, 2019. All of the $3.0 million of troubled debt restructures at June 30, 2020 are non-accrual loans.
As of June 30, 2020, TDRs were comprised of 15 residential loans totaling $2.3 million, three commercial and commercial real estate loans totaling $587,000 and nine consumer loans (home equity loans, home equity lines and credit, indirect auto and other loans) totaling $185,000.
For the three month period ended June 30, 2020, one loan was removed from non-performing TDR status. For the nine month period ended June 30, 2020, three loans were removed from non-performing TDR status.
Liquidity and Capital Resources
We maintain liquid assets at levels we consider adequate to meet both our short-term and long-term liquidity needs. We adjust our liquidity levels to fund deposit outflows, repay our borrowings and to fund loan commitments. We also adjust liquidity as appropriate to meet asset and liability management objectives.
Our primary sources of liquidity are deposits, prepayment and repayment of loans and mortgage-backed securities, maturities of investment securities and other short-term investments, and earnings and funds provided from operations, as well as access to FHLB advances and other borrowing sources. While scheduled principal repayments on loans and mortgage-backed securities are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competition. We set the interest rates on our deposits to maintain a desired level of total deposits.
A portion of our liquidity consists of cash and cash equivalents and borrowings, which are a product of our operating, investing and financing activities. At June 30, 2020, $170.8 million of our assets were invested in cash and cash equivalents. Our primary sources of cash are principal repayments on loans, proceeds from the maturities of investment securities, principal repayments of mortgage-backed securities and increases in deposit accounts and borrowings. As of June 30, 2020, we had $289.5 million in borrowings outstanding from the Pittsburgh FHLB. We have access to total FHLB advances of up to approximately $687.7 million.
At June 30, 2020, we had $211.5 million in loan commitments outstanding, which included, in part, $59.2 million in undisbursed construction loans and land development loans, $43.4 million in unused home equity lines of credit, $87.9 million in commercial lines of credit and commitments to originate commercial loans, $10.2 million in performance standby letters of credit and $10.8 million in other unused commitments which are primarily to originate residential mortgage loans and multifamily loans. Certificates of deposit due within one year of June 30, 2020 totaled $384.3 million, or 66.9% of certificates of deposit. If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before June 30, 2021. We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.
As reported in the Consolidated Statements of Cash Flow, our cash flows are classified for financial reporting purposes as operating, investing or financing cash flows. Net cash provided by operating activities was $17.1 million and $16.8 million for the nine months ended June 30, 2020 and 2019, respectively. These amounts differ from our net income because of a variety of cash receipts and disbursements that did not affect net income for the respective periods. Net cash (used for) provided by investing activities was $(81.3) million and $35.3 million for the nine months ended June 30, 2020 and 2019, respectively, principally reflecting our loan and investment security activities. Deposit and borrowing cash flows have comprised most of our financing activities, which resulted in net cash provided by (used for), of $182.8 million and $(55.0) million for the nine months ended June 30, 2020 and 2019, respectively.
Critical Accounting Policies
We consider accounting policies that require management to exercise significant judgment or discretion or make significant assumptions that have, or could have, a material impact on the carrying value of certain assets or on income, to be critical accounting policies. We consider the following to be our critical accounting policies:
Allowance for Loan Losses. The allowance for loan losses is the estimated amount considered necessary to cover credit losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses which is charged against income. In determining the allowance for loan losses, management makes significant estimates and has identified this policy as one of our most critical. The methodology for determining the allowance for loan losses is considered a critical accounting policy by management due to the high degree of judgment involved, the subjectivity of the assumptions utilized and the potential for changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses.
As a substantial amount of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans and discounted cash flow valuations of properties are critical in determining the amount of the allowance required for specific loans. Assumptions for appraisals and discounted cash flow valuations are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly impact the valuation of a property securing a loan and the related allowance determined. The assumptions supporting such appraisals and discounted cash flow valuations are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable on the related loans.
Management performs a quarterly evaluation of the adequacy of the allowance for loan losses. Consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal and external loan reviews and other relevant factors. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revision based on changes in economic and real estate market conditions.
The analysis of the allowance for loan losses has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. We also analyze historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general allocations. Actual loan losses may be significantly more than the allowance for loan losses we have established which could have a material negative effect on our financial results.
Goodwill and Intangible Assets. Goodwill is not amortized, but it is tested at least annually for impairment in the fourth quarter, or more frequently if indicators of impairment are present. If the estimated current fair value of a reporting unit exceeds its carrying value, no additional testing is required and an impairment loss is not recorded. The Company uses market capitalization and multiples of tangible book value methods to determine the estimated current fair value of its reporting unit. Based on this analysis, no impairment was recorded in 2020 or 2019.
The other intangibles assets are assigned useful lives, which are amortized on an accelerated basis over their weighted-average lives. The Company periodically reviews the intangible assets for impairment as events or changes in circumstances indicate that the carrying amount of such asset may not be recoverable. Based on these reviews, no impairment was recorded in 2020 or 2019.
Derivative Instruments and Hedging Activities. The Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.
Fair Value Measurements. We group our assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:
Level I – Valuation is based upon quoted prices for identical instruments traded in active markets.
Level II – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level III – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset.
We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in generally accepted accounting principles.
Fair value measurements for most of our assets are obtained from independent pricing services that we have engaged for this purpose. When available, we, or our independent pricing service, use quoted market prices to measure fair value. If market prices are not available, fair value measurement is based upon models that incorporate available trade, bid, and other market information. Subsequently, all of our financial instruments use either of the foregoing methodologies to determine fair value adjustments recorded to our financial statements. In certain cases, however, when market observable inputs for model-based valuation techniques may not be readily available, we are required to make judgments about assumptions market participants would use in estimating the fair value of financial instruments. The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management judgment is necessary to estimate fair value. In addition, changes in the market conditions may reduce the availability of quoted prices or observable data. When market data is not available, we use valuation techniques requiring more management judgment to estimate the appropriate fair value measurement. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, that could significantly affect the results of current or future valuations.
Other-than-Temporary Investment Security Impairment. Securities are evaluated periodically to determine whether a decline in their value is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.
Deferred Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. We consider the determination of this valuation allowance to be a critical accounting policy because of the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change. A valuation allowance for deferred tax assets may be required if the amount of taxes recoverable through loss carryback declines, or if we project lower levels of future taxable income. Such a valuation allowance would be established through a charge to income tax expense that would adversely affect our operating results.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements (as such term is defined in applicable Securities and Exchange Commission rules) that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits and borrowings. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, our Board of Directors has approved guidelines for managing the interest rate risk inherent in our assets and liabilities, given our business strategy, operating environment, capital, liquidity and performance objectives. Senior management monitors the level of interest rate risk on a regular basis and the asset/liability committee meets quarterly to review our asset/liability policies and interest rate risk position.
We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. The net proceeds from the Company’s stock offering increased our capital and provided management with greater flexibility to manage our interest rate risk. In particular, management used the majority of the capital we received to increase our interest-earning assets. There have been no material changes in our interest rate risk since September 30, 2019.
Under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this Report. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that, as of the end of the period covered by this Report, our disclosure controls and procedures were effective.
There were no changes made in the Company’s internal controls over financial reporting (as defined by rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) or in other factors that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting during the period covered by this Report.
Part II – Other Information
On May 29, 2020, the Bank was named as a defendant in a second action commenced by three plaintiffs who will also seek to pursue this action as a class action on behalf of the entire class of people similarly situated. The plaintiffs allege that a bank previously acquired by ESSA Bancorp received unearned fees and kickbacks from a different title company than the one involved in the previously discussed litigation in the process of making loans. The Complaint alleges violations of the Real Estate Settlement Procedures Act, the Sherman Act, and the Racketeer Influenced and Corrupt Organizations Act. The litigation is in its early stages, and the Bank’s response to the Plaintiffs’ Complaint is due August 10. The Bank intends to defend against such allegations. To the extent that pending or threatened litigation could result in exposure to the Bank, the amount of such exposure is not currently estimable.
There have been no material changes in the “Risk Factors” as disclosed in the Company’s response to Item 1A in Part 1 of its Annual Report on Form 10-K for the year ended September 30, 2019, filed on December 16, 2019, and its Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, filed on May 11, 2020.
Company Purchases of Common Stock
Month Ending
Total number of
shares purchased
Average price paid
per share
shares
purchased as
part of publicly
announced plans
or programs(1)
Maximum number
of shares that may
yet be purchased
under the plans or
programs
April 30, 2020
170,036
May 31, 2020
68,351
12.70
101,685
74,737
14.41
26,948
143,088
13.49
______________________
(1) On July 25, 2019 the Company announced the authorization of an eighth repurchase program for up to 500,000 shares of its common stock. This program has no expiration date. The Company suspended its stock repurchase activity on April 1, 2020 and did not resume repurchasing common stock until May 1, 2020.
Not applicable.
The following exhibits are either filed as part of this Report or are incorporated herein by reference:
3.1
Articles of Incorporation of ESSA Bancorp, Inc. (incorporated by reference to the Registration Statement on Form S-1 of ESSA Bancorp, Inc. (file no. 333-139157), originally filed with the Securities and Exchange Commission on December 7, 2006)
3.2
Bylaws of ESSA Bancorp, Inc. (incorporated by reference to the Registration Statement on Form S-1 of ESSA Bancorp, Inc. (file no. 333-139157), originally filed with the Securities and Exchange Commission on December 7, 2006)
Form of Common Stock Certificate of ESSA Bancorp, Inc. (incorporated by reference to the Registration Statement on Form S-1 of ESSA Bancorp, Inc. (file no. 333-139157), originally filed with the Securities and Exchange Commission on December 7, 2006)
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Interactive data files pursuant to Rule 405 of Regulation S-T, formatted in Inline XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Condition; (ii) the Consolidated Statement of Income; (iii) the Consolidated Statement of Changes in Stockholder Equity; (iv) the Consolidated Statement of Cash Flows; and (v) the Notes to Consolidated Financial Statements.
104
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
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.
ESSA BANCORP, INC.
Date: August 10, 2020
/s/ Gary S. Olson
Gary S. Olson
President and Chief Executive Officer
/s/ Allan A. Muto
Allan A. Muto
Executive Vice President and Chief Financial Officer