Companies: 10,793     total market cap: $139.151 T
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Penns Woods Bancorp
PWOD
#8424
Rank
$0.22 B
Marketcap
๐Ÿ‡บ๐Ÿ‡ธ United States
Country
$30.00
Share price
0.00%
Change (1 day)
4.86%
Change (1 year)
๐Ÿฆ Banks๐Ÿ’ณ Financial services
Categories
  1. Penns Woods Bancorp
  2. Quarterly Reports (10-Q)
  3. Submitted on 2020-11-09

Penns Woods Bancorp - 10-Q quarterly report FY


Text size:
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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 September 30, 2020. 
☐Transition report pursuant to Section 13 or 15 (d) of the Exchange Act

For the Transition Period from                    to                   .

No. 0-17077
(Commission File Number)

PENNS WOODS BANCORP INC.
(Exact name of Registrant as specified in its charter) 
Pennsylvania300 Market Street, P.O. Box 96723-2226454
(State or other jurisdiction ofWilliamsport(I.R.S. Employer Identification No.)
incorporation or organization)Pennsylvania17703-0967
(Address of principal executive offices)(Zip Code)
 
(570) 322-1111
Registrant’s telephone number, including area code


Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Common stock, $5.55 par valuePWODThe Nasdaq Global Select Market

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

Indicate by check mark whether the registrant has submitted electronically 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 definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large accelerated filer☐Accelerated filer☒
  Non-accelerated filer☐   Smaller reporting company☒
Emerging growth company☐

If an emerging growth company, indicate by check mark if 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 ☒
On November 1, 2020 there were 7,051,783 shares of the Registrant’s common stock outstanding.


PENNS WOODS BANCORP, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

  Page
  Number
 
   
3
   
3
  
4
  
5
  
6
 
8
  
9
   
34
   
51
   
51
   
 
   
52
   
52
   
52
   
52
   
52
   
52
   
53
   
54
  
55
2

Part I.  FINANCIAL INFORMATION
Item 1.  Financial Statements
PENNS WOODS BANCORP, INC.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
September 30,December 31,
(In Thousands, Except Share Data)20202019
ASSETS:  
Noninterest-bearing balances$34,987 $24,725 
Interest-bearing balances in other financial institutions191,285 23,864 
Total cash and cash equivalents226,272 48,589 
Investment debt securities, available for sale, at fair value149,675 148,619 
Investment equity securities, at fair value1,291 1,261 
Investment securities, trading35 51 
Restricted investment in bank stock, at fair value15,006 13,528 
Loans held for sale6,647 4,232 
Loans1,349,140 1,355,544 
Allowance for loan losses(13,429)(11,894)
Loans, net1,335,711 1,343,650 
Premises and equipment, net32,886 32,929 
Accrued interest receivable8,540 5,246 
Bank-owned life insurance33,474 29,253 
Goodwill17,104 17,104 
Intangibles724 898 
Operating lease right-of-use asset3,184 4,154 
Deferred tax asset3,409 3,338 
Other assets6,821 12,471 
TOTAL ASSETS$1,840,779 $1,665,323 
LIABILITIES:  
Interest-bearing deposits$1,057,562 $989,259 
Noninterest-bearing deposits434,248 334,746 
Total deposits1,491,810 1,324,005 
Short-term borrowings15,009 4,920 
Long-term borrowings153,534 161,920 
Accrued interest payable1,491 1,671 
Operating lease liability3,219 4,170 
Other liabilities13,287 13,655 
TOTAL LIABILITIES1,678,350 1,510,341 
SHAREHOLDERS’ EQUITY:  
Preferred stock, no par value, 3,000,000 shares authorized; no shares issued
— — 
Common stock, par value 5.55, 22,500,000 shares authorized; 7,527,605 and 7,520,740 shares issued; 7,047,380 and 7,040,515 outstanding
41,820 41,782 
Additional paid-in capital52,268 51,487 
Retained earnings81,127 76,583 
Accumulated other comprehensive loss:  
Net unrealized gain on available for sale securities4,440 2,455 
Defined benefit plan(5,118)(5,232)
Treasury stock at cost, 480,225
(12,115)(12,115)
TOTAL PENNS WOODS BANCORP, INC. SHAREHOLDERS' EQUITY162,422 154,960 
Non-controlling interest7 22 
TOTAL SHAREHOLDERS' EQUITY162,429 154,982 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY$1,840,779 $1,665,323 

See accompanying notes to the unaudited consolidated financial statements.
3

PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
Three Months Ended September 30,Nine Months Ended September 30,
(In Thousands, Except Per Share Data)2020201920202019
INTEREST AND DIVIDEND INCOME:    
Loans, including fees$14,080 $15,426 $43,403 $45,595 
Investment securities:    
Taxable925 998 2,958 2,899 
Tax-exempt170 167 484 520 
Dividend and other interest income212 493 747 1,345 
TOTAL INTEREST AND DIVIDEND INCOME15,387 17,084 47,592 50,359 
INTEREST EXPENSE:    
Deposits2,569 3,165 8,406 8,336 
Short-term borrowings8 7 37 790 
Long-term borrowings965 1,009 2,893 2,739 
TOTAL INTEREST EXPENSE3,542 4,181 11,336 11,865 
NET INTEREST INCOME11,845 12,903 36,256 38,494 
PROVISION FOR LOAN LOSSES645 360 2,040 1,035 
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES11,200 12,543 34,216 37,459 
NON-INTEREST INCOME:    
Service charges388 622 1,249 1,776 
Net debt securities gains, available for sale1,013 189 1,220 200 
Net equity securities (losses) gains— (21)30 44 
Net securities (losses) gains, trading(2)2 (16)15 
Bank-owned life insurance156 143 492 434 
Gain on sale of loans1,449 583 2,921 1,246 
Insurance commissions101 93 320 346 
Brokerage commissions224 353 779 1,032 
Debit card income352 333 936 1,032 
Other354 525 1,162 1,420 
TOTAL NON-INTEREST INCOME4,035 2,822 9,093 7,545 
NON-INTEREST EXPENSE:    
Salaries and employee benefits5,465 5,488 16,362 16,512 
Occupancy599 638 1,927 2,085 
Furniture and equipment837 885 2,525 2,421 
Software amortization257 234 743 629 
Pennsylvania shares tax340 285 948 863 
Professional fees608 585 1,888 1,834 
Federal Deposit Insurance Corporation deposit insurance271 — 650 504 
Marketing61 98 170 233 
Intangible amortization53 62 174 202 
Other1,216 1,266 4,041 4,131 
TOTAL NON-INTEREST EXPENSE9,707 9,541 29,428 29,414 
INCOME BEFORE INCOME TAX PROVISION5,528 5,824 13,881 15,590 
INCOME TAX PROVISION1,051 1,170 2,563 2,741 
CONSOLIDATED NET INCOME$4,477 $4,654 $11,318 $12,849 
Less: Net income attributable to noncontrolling interest5 4 13 10 
NET INCOME ATTRIBUTABLE TO PENNS WOODS BANCORP, INC.$4,472 $4,650 $11,305 $12,839 
EARNINGS PER SHARE - BASIC$0.63 $0.66 $1.61 $1.82 
EARNINGS PER SHARE - DILUTED$0.63 $0.66 $1.61 $1.82 
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 7,045,336 7,037,055 7,042,578 7,036,181 
WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED7,045,336 7,037,055 7,042,578 7,036,181 
DIVIDENDS DECLARED PER SHARE$0.32 $0.31 $0.96 $0.94 
See accompanying notes to the unaudited consolidated financial statements.
4



PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)
 
 Three Months Ended September 30,Nine Months Ended September 30,
(In Thousands)2020201920202019
Net Income$4,472 $4,650 $11,305 $12,839 
Other comprehensive income:    
Change in unrealized gain on available for sale securities1,324 1,261 3,733 6,056 
Tax effect(278)(265)(784)(1,272)
Net realized gain on available for sale securities included in net income(1,013)(189)(1,220)(200)
Tax effect213 40 256 42 
   Amortization of unrecognized pension gain52 46 144 140 
        Tax effect(11)(9)(30)(29)
Total other comprehensive income287 884 2,099 4,737 
Comprehensive income$4,759 $5,534 $13,404 $17,576 
 
See accompanying notes to the unaudited consolidated financial statements.
5

PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)



 Three months ended:
COMMON STOCKADDITIONAL
PAID-IN CAPITAL		RETAINED EARNINGSACCUMULATED OTHER
COMPREHENSIVE LOSS 		TREASURY STOCKNON-CONTROLLING INTERESTTOTAL
SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)SHARESAMOUNT
Balance, June 30, 20207,522,573 $41,792 $51,956 $78,910 $(965)$(12,115)$30 $159,608 
Net income4,472 5 4,477 
Other comprehensive income287 287 
Stock-based compensation 239 239 
Dividends declared ($0.32 per share)
(2,255)(2,255)
Common shares issued for employee stock purchase plan1,055 6 15 21 
Director Compensation Plan3,977 22 58 80 
Distributions to noncontrolling interest (28)(28)
Balance, September 30, 20207,527,605 $41,820 $52,268 $81,127 $(678)$(12,115)$7 $162,429 


COMMON STOCKADDITIONAL
PAID-IN CAPITAL		RETAINED EARNINGSACCUMULATED OTHER
COMPREHENSIVE LOSS 		TREASURY STOCKNON-CONTROLLING INTERESTTOTAL
SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)SHARESAMOUNT
Balance, June 30, 20197,519,344 $41,773 $51,067 $73,565 $(2,783)$(12,115)$14 $151,521 
Net income4,650 4 4,654 
Other comprehensive income884 884 
Stock-based compensation185 185 
Dividends declared ($0.31 per share)
(2,206)(2,206)
Common shares issued for employee stock purchase plan782 4 38 42 
Stock split fractional shares(2,330)(19)(19)
Balance, September 30, 20197,517,796 $41,758 $51,290 $76,009 $(1,899)$(12,115)$18 $155,061 








6





PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)



Nine months ended:
COMMON STOCKADDITIONAL
PAID-IN CAPITAL		RETAINED EARNINGSACCUMULATED OTHER
COMPREHENSIVE LOSS		TREASURY STOCKNON-CONTROLLING INTERESTTOTAL
SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)SHARESAMOUNT
Balance, December 31, 20197,520,740 $41,782 $51,487 $76,583 $(2,777)$(12,115)$22 $154,982 
Net income   11,305   13 11,318 
Other comprehensive income    2,099  2,099 
Stock-based compensation 675 675 
Dividends declared ($0.96 per share)
   (6,761)  (6,761)
Common shares issued for employee stock purchase plan2,888 16 48    64 
Director Compensation Plan3,977 22 5880 
Distributions to noncontrolling interest(28)(28)
Balance, September 30, 20207,527,605 $41,820 $52,268 $81,127 $(678)$(12,115)$7 $162,429 

COMMON STOCKADDITIONAL
PAID-IN CAPITAL		RETAINED EARNINGSACCUMULATED OTHER
COMPREHENSIVE LOSS 		TREASURY STOCKNON-CONTROLLING INTERESTTOTAL
SHAREHOLDERS’ EQUITY
(In Thousands, Except Per Share Data)SHARESAMOUNT
Balance, December 31, 20187,517,547 $41,763 $50,737 $69,787 $(6,636)$(12,115)$8 $143,544 
Net income   12,839   10 12,849 
Other comprehensive income  4,737  4,737 
Stock-based compensation498 498 
Dividends declared ($0.94 per share)
   (6,617)  (6,617)
Common shares issued for employee stock purchase plan2,579 14 55    69 
Stock split fractional shares(2,330)(19)(19)
Balance, September 30, 20197,517,796 $41,758 $51,290 $76,009 $(1,899)$(12,115)$18 $155,061 




See accompanying notes to the unaudited consolidated financial statements.
7

PENNS WOODS BANCORP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED) 
Nine Months Ended September 30,
(In Thousands)20202019
OPERATING ACTIVITIES:  
Net Income$11,318 $12,849 
Adjustments to reconcile net income to net cash provided by operating activities:  
Depreciation and amortization2,310 1,904 
Gain on sale of premise and equipment(14)— 
Amortization of intangible assets174 202 
Provision for loan losses2,040 1,035 
Stock based compensation675 498 
Accretion and amortization of investment security discounts and premiums382 499 
Net securities gains, available for sale(1,220)(200)
Originations of loans held for sale(95,661)(41,601)
Proceeds of loans held for sale96,167 43,908 
Gain on sale of loans(2,921)(1,246)
Net equity securities gains(30)(44)
Net securities losses (gains), trading16 (15)
Proceeds from the sale of trading securities— 78 
Purchases of trading securities— (74)
Earnings on bank-owned life insurance(492)(434)
(Increase) decrease in deferred tax asset(599)180 
Other, net2,756 (1,766)
Net cash provided by operating activities14,901 15,773 
INVESTING ACTIVITIES:  
Proceeds from sales of available for sale securities37,252 16,289 
Proceeds from calls and maturities of available for sale securities567 3,089 
Purchases of available for sale securities(35,524)(28,611)
Net decrease in loans5,692 18,625 
Acquisition of premises and equipment(2,830)(1,798)
Proceeds from the sale of premises and equipment336 — 
Proceeds from the sale of foreclosed assets226 502 
Purchase of bank-owned life insurance(3,970)(30)
Proceeds from bank-owned life insurance death benefit248 — 
Investment in limited partnership(628)— 
Proceeds from redemption of regulatory stock2,881 13,659 
Purchases of regulatory stock(4,359)(8,299)
Net cash (used for) provided by investing activities(109)13,426 
FINANCING ACTIVITIES:  
Net increase in interest-bearing deposits68,303 105,989 
Net increase in noninterest-bearing deposits99,502 6,515 
Proceeds from long-term borrowings35,000 50,000 
Repayment of long-term borrowings(43,333)(32,608)
Net increase (decrease) in short-term borrowings10,089 (161,878)
Finance lease principal payments(53)(70)
Dividends paid(6,761)(6,617)
Issuance of common stock144 69 
Net cash provided by (used for) financing activities162,891 (38,600)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS177,683 (9,401)
CASH AND CASH EQUIVALENTS, BEGINNING48,589 66,742 
CASH AND CASH EQUIVALENTS, ENDING$226,272 $57,341 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:  
Interest paid$11,516 $11,349 
Income taxes paid2,375 3,125 
Non-cash investing and financing activities:
Right-of-use lease assets obtained in exchange for lessee finance lease liabilities— 6,026 
Right-of-use lease assets obtained in exchange for lessee operating lease liabilities— 4,298 
Transfer of loans to foreclosed real estate207 525 
See accompanying notes to the unaudited consolidated financial statements.
8

PENNS WOODS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 

Note 1.  Basis of Presentation
 
The consolidated financial statements include the accounts of Penns Woods Bancorp, Inc. (the “Company”) and its wholly-owned subsidiaries: Woods Investment Company, Inc., Woods Real Estate Development Company, Inc., Luzerne Bank, and Jersey Shore State Bank (Jersey Shore State Bank and Luzerne Bank are referred to together as the “Banks”) and Jersey Shore State Bank’s wholly-owned subsidiary, The M Group, Inc. D/B/A The Comprehensive Financial Group (“The M Group”).  The Company also owns a controlling interest in United Insurance Solutions, LLC. All significant inter-company balances and transactions have been eliminated in the consolidation.

The interim financial statements are unaudited, but in the opinion of management reflect all adjustments necessary for the fair presentation of results for such periods.  The results of operations for any interim period are not necessarily indicative of results for the full year.  These financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

In reference to the attached financial statements, all adjustments are of a normal recurring nature pursuant to Rule 10-01(b) (8) of Regulation S-X.
 
Note 2.  Accumulated Other Comprehensive Gain (loss)

The changes in accumulated other comprehensive gain (loss) by component shown net of tax and parenthesis indicating debits, as of September 30, 2020 and 2019 were as follows:
 Three Months Ended September 30, 2020Three Months Ended September 30, 2019
(In Thousands)Net Unrealized Gain on Available
for Sale Securities		Defined
Benefit 
Plan		TotalNet Unrealized
Gain on Available
for Sale Securities		Defined
Benefit 
Plan		Total
Beginning balance$4,194 $(5,159)$(965)$2,419 $(5,202)$(2,783)
Other comprehensive gain before reclassifications1,046 — 1,046 996 — 996 
Amounts reclassified from accumulated other comprehensive (loss) gain(800)41 (759)(149)37 (112)
Net current-period other comprehensive income
246 41 287 847 37 884 
Ending balance$4,440 $(5,118)$(678)$3,266 $(5,165)$(1,899)
 Nine Months Ended September 30, 2020Nine Months Ended September 30, 2019
(In Thousands)Net Unrealized Gain on Available for Sale SecuritiesDefined
Benefit 
Plan		TotalNet Unrealized Gain on Available
for Sale Securities		Defined
Benefit 
Plan		Total
Beginning balance$2,455 $(5,232)$(2,777)$(1,360)$(5,276)$(6,636)
Other comprehensive gain before reclassifications2,949 — 2,949 4,784 — 4,784 
Amounts reclassified from accumulated other comprehensive (loss) gain(964)114 (850)(158)111 (47)
Net current-period other comprehensive income
1,985 114 2,099 4,626 111 4,737 
Ending balance$4,440 $(5,118)$(678)$3,266 $(5,165)$(1,899)



9

The reclassifications out of accumulated other comprehensive loss shown, net of tax and parenthesis indicating debits to net income, as of September 30, 2020 and 2019 were as follows:
Details about Accumulated Other Comprehensive Loss ComponentsAmount Reclassified from Accumulated Other Comprehensive LossAffected Line Item
 in the Consolidated 
Statement of Income
Three Months Ended September 30, 2020Three Months Ended September 30, 2019
Net unrealized gain on available for sale securities$1,013 $189 Net debt securities gains (losses), available for sale
Income tax effect(213)(40)Income tax provision
Total reclassifications for the period$800 $149 
Net unrecognized pension costs$(52)$(46)Salaries and employee benefits
Income tax effect11 9 Income tax provision
Total reclassifications for the period$(41)$(37)
Details about Accumulated Other Comprehensive Loss ComponentsAmount Reclassified from Accumulated Other Comprehensive LossAffected Line Item
 in the Consolidated 
Statement of Income
Nine months ended September 30, 2020Nine months ended September 30, 2019
Net unrealized gain on available for sale securities$1,220 $200 Net debt securities gains, available for sale
Income tax effect(256)(42)Income tax provision
Total reclassifications for the period$964 $158 
Net unrecognized pension costs$(144)$(140)Salaries and employee benefits
Income tax effect30 29 Income tax provision
Total reclassifications for the period$(114)$(111)

Note 3.  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. 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 unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), which deferred the effective date for ASC 350, Intangibles – Goodwill and Other, for smaller reporting companies to fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. This Update is not expected to have a significant impact on the Company’s financial statements.

10

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.

In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Derivatives and Hedging (Topic 815), and Financial Instruments (Topic 825), 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. 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. Furthermore, the ASU provides a one-year deferral of the effective dates of the ASUs on derivatives and hedging 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 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 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. 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 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. The Company qualifies as a smaller reporting company and does not expect to early adopt ASU 2016-13.

In November 2019, the FASB issued ASU 2019-09, Financial Services ‒ Insurance (Topic 944), which defers the effective date of the amendments in Update 2018-12, Financial Services ‒ Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts. For public business entities that meet the definition of an SEC filer, excluding entities eligible to be smaller reporting companies, as defined by the SEC, the amendments in Update 2018-12 are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. Early application of the amendments in Update 2018-12 is permitted. For all other entities, the amendments in Update 2018-12 are effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024. Early application of the amendments in Update 2018-12 is permitted. This Update is not expected to have a significant impact on the Company’s financial statements.

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
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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 qualifies as a smaller reporting company and does not expect to early adopt these ASUs.

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 was 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 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
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interim periods within those years. Other amendments are effective upon issuance of this ASU. 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 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. It is too early to predict whether a new rate index replacement and the adoption of the ASU will have a material impact on the Company’s financial statements.

In August 2020, the FASB issued ASU 2020-6, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40), which simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts on an entity’s own equity. This ASU removes from U.S. GAAP the separation models for (1) convertible debt with a cash conversion feature and (2) convertible instruments with a beneficial conversion feature. As a result, entities will not separately present in equity an embedded conversion feature in such debt. Instead, they will account for a convertible debt instrument wholly as debt, and for convertible preferred stock wholly as preferred stock (i.e., as a single unit of account), unless (1) a convertible instrument contains features that require bifurcation as a derivative under ASC 815 or (2) a convertible debt instrument was issued at a substantial premium. This ASU requires entities to provide expanded disclosures about the terms and features of convertible instruments, how the instruments have been reported in the entity’s financial statements, and information about events, conditions, and circumstances that can affect how to assess the amount or timing of an entity’s future cash flows related to those instruments. The amendments in this ASU are effective for public business entities that are not smaller reporting companies, for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. For all other entities, this ASU is effective for fiscal years beginning after December 15, 2023, and interim periods within those fiscal years. The guidance may be early adopted for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. This Update is not expected to have a significant impact on the Company’s financial statements.

Note 4. Per Share Data

There are no convertible securities which would affect the denominator in calculating basic and dilutive earnings per share. There were a total of 864,300 stock options, with an average exercise price of $28.20, outstanding on September 30, 2020. These options were excluded, on a weighted average basis, in the computation of diluted earnings per share for the three and nine month periods due to the average market price of common shares of $20.84 and $24.20, respectively, exceeding the exercise price of the options issued. There were a total of 635,550 stock options outstanding for the same period end in 2019 that had an average exercise price of $29.30 and were excluded, on a weighted average basis, in the computation of diluted earnings per share because the quarterly average closing market price of common shares was $28.44 for the period.
 Three Months Ended September 30,Nine Months Ended September 30,
 2020201920202019
Weighted average common shares issued7,525,561 7,517,280 7,522,803 7,516,406 
Weighted average treasury stock shares(480,225)(480,225)(480,225)(480,225)
Weighted average common shares outstanding - basic 7,045,336 7,037,055 7,042,578 7,036,181 
Dilutive effect of outstanding stock options— — — — 
Weighted average common shares outstanding - basic and diluted
7,045,336 7,037,055 7,042,578 7,036,181 
 







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Note 5. Investment Securities
 
The amortized cost, gross unrealized gains and losses, and fair values of our investment securities portfolio at September 30, 2020 and December 31, 2019 are as follows:
 September 30, 2020
  GrossGross 
 AmortizedUnrealizedUnrealizedFair
(In Thousands)CostGainsLossesValue
Available for sale (AFS):    
Mortgage-backed securities$2,267 $25 $— $2,292 
State and political securities84,873 5,136 (13)89,996 
Other debt securities56,915 969 (497)57,387 
Total debt securities$144,055 $6,130 $(510)$149,675 
Investment equity securities:
Other equity securities$1,300 $11 $(20)$1,291 
Trading:
Other equity securities$50 $— $(15)$35 
 December 31, 2019
  GrossGross 
 AmortizedUnrealizedUnrealizedFair
(In Thousands)CostGainsLossesValue
Available for sale (AFS):    
Mortgage-backed securities$4,956 $56 $(46)$4,966 
State and political securities79,064 3,299 (77)82,286 
Other debt securities61,492 401 (526)61,367 
Total debt securities$145,512 $3,756 $(649)$148,619 
Investment equity securities:
Other equity securities$1,300 $— $(39)$1,261 
Trading:
Other equity securities$50 $3 $(2)$51 

The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time, that the individual debt securities have been in a continuous unrealized loss position, at September 30, 2020 and December 31, 2019.
 September 30, 2020
 Less than Twelve MonthsTwelve Months or GreaterTotal
  Gross Gross Gross
 FairUnrealizedFairUnrealizedFairUnrealized
(In Thousands)ValueLossesValueLossesValueLosses
Available for sale (AFS):
Mortgage-backed securities$— $— $— $— $— $— 
State and political securities4,179 (6)904 (7)5,083 (13)
Other debt securities9,682 (260)3,271 (237)12,953 (497)
Total debt securities$13,861 $(266)$4,175 $(244)$18,036 $(510)
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 December 31, 2019
 Less than Twelve MonthsTwelve Months or GreaterTotal
  Gross Gross Gross
 FairUnrealizedFairUnrealizedFairUnrealized
(In Thousands)ValueLossesValueLossesValueLosses
Available for sale (AFS):
Mortgage-backed securities$— $— $2,115 $(46)$2,115 $(46)
State and political securities7,958 (40)224 (37)8,182 (77)
Other debt securities13,373 (216)14,258 (310)27,631 (526)
Total debt securities$21,331 $(256)$16,597 $(393)$37,928 $(649)
 
At September 30, 2020, there were a total of 18 securities in a continuous unrealized loss position for less than twelve months and 4 individual securities that were in a continuous unrealized loss position for twelve months or greater.

The Company reviews its position quarterly and has determined that, at September 30, 2020, the declines outlined in the above table represent temporary declines and the Company does not intend to sell and does not believe it will be required to sell these securities before recovery of their cost basis, which may be at maturity.  The Company has concluded that the unrealized losses disclosed above are not other than temporary but are the result of interest rate changes, sector credit ratings changes, or company-specific ratings changes that are not expected to result in the non-collection of principal and interest during the period.

The amortized cost and fair value of debt securities at September 30, 2020, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities since borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(In Thousands)Amortized CostFair Value
Due in one year or less$10,744 $10,812 
Due after one year to five years66,984 68,131 
Due after five years to ten years56,013 60,132 
Due after ten years10,314 10,600 
Total$144,055 $149,675 

Total gross proceeds from sales of debt securities available for sale for the three and nine months ended September 30, 2020 were $32,089,000 and $37,252,000 respectively, compared to 2019 totals of $8,157,000 and 16,289,000.

The following table represents gross realized gains and losses from the sales of debt securities available for sale:
 Three Months Ended September 30,Nine Months Ended September 30,
(In Thousands)2020201920202019
Available for sale (AFS):
Gross realized gains:    
Mortgage-backed securities$— $— $83 $— 
State and political securities839 190 943 204 
Other debt securities174 — 194 4 
Total gross realized gains$1,013 $190 $1,220 $208 
Gross realized losses:    
State and political securities$— $1 $— $3 
Other debt securities— — — 5 
Total gross realized losses$— $1 $— $8 

There were no impairment charges included in gross realized losses for the three and nine months ended September 30, 2020 and 2019, respectively.

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Investment securities with a carrying value of approximately $124,542,000 and $74,163,000 at September 30, 2020 and December 31, 2019, respectively, were pledged to secure certain deposits, repurchase agreements, and for other purposes as required by law.

At September 30, 2020 and December 31, 2019, we had $1,291,000 and $1,261,000, respectively, in equity securities recorded at fair value. The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,Nine Months Ended September 30,
(In Thousands)2020201920202019
Net gains (losses) recognized in equity securities during the period($— $(21)$30 $44 
Less: Net gains realized on the sale of equity securities during the period— — — — 
Unrealized gains recognized in equity securities held at reporting date$— $(21)$30 $44 

Net gains and losses on trading account securities are as follows for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,Nine Months Ended September 30,
(In Thousands)2020201920202019
Net gains on sale transactions$— $— $— $8 
Net mark-to-market (losses) gains(2)2 (16)7 
Net (loss) gain on trading account securities$(2)$2 $(16)$15 

Note 6. Loans

Management segments the Banks' loan portfolio to a level that enables risk and performance monitoring according to similar risk characteristics.  Loans are segmented based on the underlying collateral characteristics.  Categories include commercial, financial, and agricultural, real estate, and installment loans.  Real estate loans are further segmented into three categories: residential, commercial, and construction, while installment loans are classified as either consumer automobile loans or other installment loans.

The following table presents the related aging categories of loans, by segment, as of September 30, 2020 and December 31, 2019:
 September 30, 2020
  Past DuePast Due 90  
  30 To 89Days Or MoreNon- 
(In Thousands)CurrentDays& Still AccruingAccrualTotal
Commercial, financial, and agricultural$171,344 $245 $— $1,565 $173,154 
Real estate mortgage:     
Residential590,275 2,581 595 1,667 595,118 
Commercial348,644 429 196 6,452 355,721 
Construction43,142 — — 58 43,200 
Consumer automobile loans159,810 374 — 17 160,201 
Other consumer installment loans20,294 373 — 3 20,670 
 1,333,509 $4,002 $791 $9,762 1,348,064 
Net deferred loan fees and discounts1,076    1,076 
Allowance for loan losses(13,429)   (13,429)
Loans, net$1,321,156    $1,335,711 
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 December 31, 2019
  Past DuePast Due 90  
  30 To 89Days Or MoreNon- 
(In Thousands)CurrentDays& Still AccruingAccrualTotal
Commercial, financial, and agricultural$153,737 $249 $30 $2,197 $156,213 
Real estate mortgage:     
Residential615,580 4,881 1,529 1,266 623,256 
Commercial355,597 775 164 6,725 363,261 
Construction37,871 131 — 65 38,067 
Consumer automobile loans149,703 709 — 105 150,517 
Other consumer installment loans22,124 579 324 16 23,043 
 1,334,612 $7,324 $2,047 $10,374 1,354,357 
Net deferred loan fees and discounts1,187    1,187 
Allowance for loan losses(11,894)   (11,894)
Loans, net$1,323,905    $1,343,650 
 
The following table presents interest income the Banks would have recorded if interest had been recorded based on the original loan agreement terms and rate of interest for non-accrual loans and interest income recognized on a cash basis for non-accrual loans for the three and nine months ended September 30, 2020 and 2019:
 Three Months Ended September 30,
 20202019
(In Thousands)Interest Income That
Would Have Been
Recorded Based on
Original Term and Rate		Interest
Income
Recorded on
a Cash Basis		Interest Income That
Would Have Been
Recorded Based on
Original Term and Rate		Interest
Income
Recorded on
a Cash Basis
Commercial, financial, and agricultural$2 $14 $51 $49 
Real estate mortgage:    
Residential14 2 76 76 
Commercial52 — 68 30 
Construction— — 1 1 
Consumer automobile loans— — — — 
Other consumer installment loans— — 1 1 
 $68 $16 $197 $157 
 Nine Months Ended September 30,
 20202019
(In Thousands)Interest Income That
Would Have Been
Recorded Based on
Original Term and Rate		Interest
Income
Recorded on
a Cash Basis		Interest Income That
Would Have Been
Recorded Based on
Original Term and Rate		Interest
Income
Recorded on
a Cash Basis
Commercial, financial, and agricultural$37 $14 $108 $132 
Real estate mortgage:    
Residential27 2 142 118 
Commercial116 — 233 104 
Construction1 — 3 3 
Consumer automobile loans2 3 3 2 
Other consumer installment loans3 — 2 1 
 $186 $19 $491 $360 




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Impaired Loans

Impaired loans are loans for which it is probable the Banks will not be able to collect all amounts due according to the contractual terms of the loan agreement.  The Banks individually evaluate such loans for impairment and do not aggregate loans by major risk classifications.  The definition of “impaired loans” is not the same as the definition of “non-accrual loans,” although the two categories overlap.  The Banks may choose to place a loan on non-accrual status due to payment delinquency or uncertain collectability, while not classifying the loan as impaired. Factors considered by management in determining impairment include payment status and collateral value.  The amount of impairment for these types of loans is determined by the difference between the present value of the expected cash flows related to the loan, using the original interest rate, and its recorded value, or as a practical expedient in the case of collateralized loans, the difference between the fair value of the collateral and the recorded amount of the loan.  When foreclosure is probable, impairment is measured based on the fair value of the collateral.

Management evaluates individual loans in all of the commercial segments for possible impairment if the loan is greater than $100,000 and if the loan is either on non-accrual status or has a risk rating of substandard or worse.  Management may also elect to measure an individual loan for impairment if less than $100,000 on a case-by-case basis.

Mortgage loans on one-to-four family properties and all consumer loans are large groups of smaller-balance homogeneous loans and are measured for impairment collectively with the exception of loans identified as troubled debt restructurings. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired.  Management determines the significance of payment delays on a case-by-case basis taking into consideration all circumstances surrounding the loan and the borrower including the length of the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed.  Interest income for impaired loans is recorded consistent to the Banks' policy.

The following table presents the recorded investment, unpaid principal balance, and related allowance of impaired loans by segment as of September 30, 2020 and December 31, 2019:
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September 30, 2020
RecordedUnpaid PrincipalRelated
(In Thousands)InvestmentBalanceAllowance
With no related allowance recorded:   
Commercial, financial, and agricultural$1,820 $4,607 $— 
Real estate mortgage:   
Residential4,305 4,305 — 
Commercial4,113 4,113 — 
Construction60 60 — 
Consumer automobile loans— — — 
Installment loans to individuals— — — 
 10,298 13,085 — 
With an allowance recorded:   
Commercial, financial, and agricultural15 15 — 
Real estate mortgage:   
Residential1,272 1,272 187 
Commercial3,092 3,092 920 
Construction— — — 
Consumer automobile loans— — — 
Installment loans to individuals— — — 
 4,379 4,379 1,107 
Total:   
Commercial, financial, and agricultural1,835 4,622 — 
Real estate mortgage:   
Residential5,577 5,577 187 
Commercial7,205 7,205 920 
Construction60 60 — 
Consumer automobile loans— — — 
Installment loans to individuals— — — 
 $14,677 $17,464 $1,107 
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 December 31, 2019
 RecordedUnpaid PrincipalRelated
(In Thousands)InvestmentBalanceAllowance
With no related allowance recorded:   
Commercial, financial, and agricultural$2,285 $5,072 $— 
Real estate mortgage:   
Residential5,008 5,008 — 
Commercial5,035 5,035 — 
Construction65 65 — 
Consumer automobile loans— — — 
Installment loans to individuals— — — 
 12,393 15,180 — 
With an allowance recorded:   
Commercial, financial, and agricultural— — — 
Real estate mortgage:   
Residential1,168 1,200 211 
Commercial3,540 3,590 1,104 
Construction— — — 
Consumer automobile loans130 130 62 
Installment loans to individuals16 16 16 
 4,854 4,936 1,393 
Total:   
Commercial, financial, and agricultural2,285 5,072 — 
Real estate mortgage:   
Residential6,176 6,208 211 
Commercial8,575 8,625 1,104 
Construction65 65 — 
Consumer automobile loans130 130 62 
Installment loans to individuals16 16 16 
 $17,247 $20,116 $1,393 

The following table presents the average recorded investment in impaired loans and related interest income recognized for the three and nine months ended September 30, 2020 and 2019:
 Three Months Ended September 30,
 20202019
(In Thousands)Average
Investment in
Impaired Loans		Interest Income
Recognized on an
Accrual Basis on
Impaired Loans		Interest Income
Recognized on a
Cash Basis on
Impaired Loans		Average
Investment in
Impaired Loans		Interest Income
Recognized on an
Accrual Basis on
Impaired Loans		Interest Income
Recognized on a
Cash Basis on
Impaired Loans
Commercial, financial, and agricultural$1,543 $33 $14 $5,236 $1 $49 
Real estate mortgage:       
Residential5,117 63 2 5,006 26 76 
Commercial6,587 71 — 9,037 30 31 
Construction54 1 — 70 — 1 
Consumer automobile147 — — 37 — — 
Other consumer installment loans— — — 5 — — 
 $13,448 $168 $16 $19,391 $57 $157 
20

 Nine Months Ended September 30,
 20202019
(In Thousands)Average
Investment in
Impaired Loans		Interest Income
Recognized on an
Accrual Basis on
Impaired Loans		Interest Income
Recognized on a
Cash Basis on
Impaired Loans		Average
Investment in
Impaired Loans		Interest Income
Recognized on an
Accrual Basis on
Impaired Loans		Interest Income
Recognized on a
Cash Basis on
Impaired Loans
Commercial, financial, and agricultural$1,849 $34 $14 $5,269 $3 $131 
Real estate mortgage:      
Residential5,535 177 2 4,584 81 115 
Commercial7,577 118 — 10,053 91 100 
Construction60 1 — 72 — 3 
Consumer automobile111 1 3 45 — 1 
Other consumer installment loans4 — — 11 — — 
$15,136 $331 $19 $20,034 $175 $350 

Troubled Debt Restructurings

The loan portfolio also includes certain loans that have been modified in a Troubled Debt Restructuring (“TDR”), where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties.  These concessions typically result from loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions.  Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.

There were no loan modifications considered to be TDRs completed during the three and nine months ended September 30, 2020. There were five loan modifications considered TDRs completed during the nine months ended September 30, 2019. Loan modifications that are considered TDRs completed during the three and nine months ended September 30, 2019 were as follows:
Three Months Ended September 30,
2019
(In Thousands, Except Number of Contracts)Number
of
Contracts		Pre-Modification Outstanding Recorded InvestmentPost-Modification Outstanding Recorded Investment
Commercial, financial, and agricultural— $— $— 
Real estate mortgage:
Residential1 2,059 2,059 
Commercial— — — 
 1 $2,059 $2,059 
 Nine Months Ended September 30,
 2019
(In Thousands, Except Number of Contracts)Number
of
Contracts		Pre-Modification
Outstanding
Recorded
Investment		Post-Modification
Outstanding
Recorded
Investment
Commercial, financial, and agricultural2 $4,014 $4,014 
Real estate mortgage:   
Residential1 2,059 2,059 
Commercial2 2,862 2,862 
 5 $8,935 $8,935 
There were two loan modifications considered to be TDRs made during the twelve months previous to September 30, 2020 that defaulted during the nine months ended September 30, 2020. The defaulted loan types and recorded investments at September
21

30, 2020 are as follows: one commercial real estate loan with a recorded investment of $1,040,000, and one commercial and agricultural loans with a recorded investment of $640,000. There were no loan modifications considered to be TDRs made during the twelve months previous to September 30, 2019 that defaulted during the nine months ended September 30, 2019.

Troubled debt restructurings amounted to $12,218,000 and $13,282,000 as of September 30, 2020 and December 31, 2019, respectively.

The amount of foreclosed residential real estate held at September 30, 2020 and December 31, 2019, totaled $376,000 and $493,000, respectively. Consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process at September 30, 2020 and December 31, 2019, totaled $446,000 and $32,000, respectively.

The Company began offering short-term loan modifications to provide relief to borrowers during the COVID-19 national emergency. The CARES Act along with a joint agency statement issued by federal and state banking agencies, provides that short-term modifications made in a good faith basis in response to COVID-19 who were current at the time the modification program is implemented do not need to be accounted for as TDRs. Loan modifications and payment deferrals have been at historical high levels as the impact of the pandemic continues. As of September 30, 2020, the loan modification/deferral program in place has generated deferrals of up to 180 days that have been granted on 1,530 loans with 1,395 loans remaining in their deferral period with an aggregate outstanding balance of $230,326,000. These loan modifications met applicable requirements to not be considered troubled debt restructurings. The number of customers seeking loan modifications or payment deferrals may increase as the effects of the pandemic continue.

Internal Risk Ratings

Management 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 currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a substandard classification. 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 greater than 90 days past due are evaluated for substandard classification.  Loans in the doubtful category exhibit the same weaknesses found in the substandard loans, however, the weaknesses are more pronounced.  Such loans are static and collection in full is improbable.  However, these loans are not yet rated as loss because certain events may occur which would salvage the debt.  Loans classified loss are considered uncollectible and charge-off is imminent.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Banks have a structured loan rating process with several layers of internal and external oversight.  Generally, consumer and residential mortgage loans are included in the pass category unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event.  An external semi-annual loan review of large commercial relationships is performed, as well as a sample of smaller transactions. The 2020 loan review has an aggregate commercial relationship threshold of $1,750,000 which can consist of outstanding loans, commercial real estate mortgages and outstanding commitments. Detailed reviews, including plans for resolution, are performed on loans classified as substandard, doubtful, or loss on a quarterly basis.

The following table presents the credit quality categories identified above as of September 30, 2020 and December 31, 2019:
 September 30, 2020
 Commercial, Financial, and AgriculturalReal Estate MortgagesConsumer automobileOther consumer installment loans 
(In Thousands)ResidentialCommercialConstructionTotals
Pass$167,073 $592,131 $341,309 $43,041 $160,184 $20,667 $1,324,405 
Special Mention4,516 1,320 7,960 40 — — 13,836 
Substandard1,565 1,667 6,452 119 17 3 9,823 
$173,154 $595,118 $355,721 $43,200 $160,201 $20,670 $1,348,064 
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 December 31, 2019
 Commercial, Financial, and AgriculturalReal Estate MortgagesConsumer automobile Other consumer installment loans 
(In Thousands)ResidentialCommercialConstructionTotals
Pass$149,349 $618,350 $348,864 $37,931 $150,517 $23,039 $1,328,050 
Special Mention3,174 2,436 5,080 — — — 10,690 
Substandard3,690 2,470 9,317 136 — 4 15,617 
 $156,213 $623,256 $363,261 $38,067 $150,517 $23,043 $1,354,357 

Allowance for Loan Losses

An allowance for loan losses (“ALL”) is maintained to absorb losses from the loan portfolio.  The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated future loss experience, and the amount of non-performing loans.

The Banks' methodology for determining the ALL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (previously discussed) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance.  The total of the two components represents the Banks' ALL.

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate.  Allowances are segmented based on collateral characteristics previously disclosed, and consistent with credit quality monitoring.  Loans that are collectively evaluated for impairment are grouped into two classes for evaluation.  A general allowance is determined for “Pass” rated credits, while a separate pool allowance is provided for “Criticized” rated credits that are not individually evaluated for impairment.

For the general allowances, historical loss trends are used in the estimation of losses in the current portfolio.  These historical loss amounts are modified by other qualitative factors.  A historical charge-off factor is calculated utilizing a twelve quarter moving average.  However, management may adjust the moving average time frame by up to four quarters to adjust for variances in the economic cycle. Management has identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience.  The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry and/or geographic standpoint.

Loans in the criticized pools, which possess certain qualities or characteristics that may lead to collection and loss issues, are closely monitored by management and subject to additional qualitative factors.  Management also monitors industry loss factors by loan segment for applicable adjustments to actual loss experience.

Management reviews the loan portfolio on a quarterly basis in order to make appropriate and timely adjustments to the ALL.  When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.













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Activity in the allowance is presented for the three and nine months ended September 30, 2020 and 2019:
 Three Months Ended September 30, 2020
 Commercial, Financial, and AgriculturalReal Estate MortgagesConsumer automobileOther consumer installment  
(In Thousands)ResidentialCommercialConstructionUnallocatedTotals
Beginning Balance$1,953 $4,478 $3,335 $150 $2,214 $127 $720 $12,977 
Charge-offs— (6)— — (200)(33)— (239)
Recoveries9 1 — — 10 26 — 46 
Provision17 (24)(290)20 (27)135 814 645 
Ending Balance$1,979 $4,449 $3,045 $170 $1,997 $255 $1,534 $13,429 
 
 Three Months Ended September 30, 2019
 Commercial, Financial, and AgriculturalReal Estate MortgagesConsumer automobileOther consumer installment  
(In Thousands)ResidentialCommercialConstructionUnallocatedTotals
Beginning Balance$1,584 $5,749 $3,523 $132 $1,435 $240 $1,338 $14,001 
Charge-offs— (114)— — (34)(73)— (221)
Recoveries43 2 — 2 14 48 — 109 
Provision159 4 (12)22 (41)27 201 360 
Ending Balance$1,786 $5,641 $3,511 $156 $1,374 $242 $1,539 $14,249 
 
tNine Months Ended September 30, 2020
 Commercial, Financial, and AgriculturalReal Estate MortgagesConsumer automobileOther consumer installment  
(In Thousands)ResidentialCommercialConstructionUnallocatedTotals
Beginning Balance$1,779 $4,306 $3,210 $118 $1,780 $278 $423 $11,894 
Charge-offs(22)(174)— — (289)(215)— (700)
Recoveries32 48 — 5 17 93 — 195 
Provision190 269 (165)47 489 99 1,111 2,040 
Ending Balance$1,979 $4,449 $3,045 $170 $1,997 $255 $1,534 $13,429 
 Nine Months Ended September 30, 2019
 Commercial, Financial, and AgriculturalReal Estate MortgagesConsumer automobileOther consumer installment  
(In Thousands)ResidentialCommercialConstructionUnallocatedTotals
Beginning Balance$1,680 $5,616 $4,047 $143 $1,328 $259 $764 $13,837 
Charge-offs(80)(251)(150)— (172)(235)— (888)
Recoveries84 3 1 10 74 93 — 265 
Provision102 273 (387)3 144 125 775 1,035 
Ending Balance$1,786 $5,641 $3,511 $156 $1,374 $242 $1,539 $14,249 

The shift in allocation of the loan provision is primarily due to changes in the credit metrics within the loan portfolio and the economic uncertainty caused by the COVID-19 pandemic. The increase in the loan provision within the unallocated segment is the result of the uncertainty that has been caused by the COVID-19 pandemic.

The Company grants commercial, industrial, residential, and installment loans to customers primarily throughout north-east and central Pennsylvania. Although the Company has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent on the economic conditions within this region.

The Company has a concentration of the following to gross loans at September 30, 2020 and 2019: 
 September 30,
 20202019
Owners of residential rental properties16.29 %15.41 %
Owners of commercial rental properties12.98 %12.19 %
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The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of September 30, 2020 and December 31, 2019:
 September 30, 2020
 Commercial, Financial, and AgriculturalReal Estate MortgagesConsumer AutomobileOther consumer installmentUnallocated 
(In Thousands)ResidentialCommercialConstructionTotals
Allowance for Loan Losses:       
Ending allowance balance attributable to loans:       
Individually evaluated for impairment$— $187 $920 $— $— $— $— $1,107 
Collectively evaluated for impairment1,979 4,262 2,125 170 1,997 255 1,534 12,322 
Total ending allowance balance$1,979 $4,449 $3,045 $170 $1,997 $255 $1,534 $13,429 
Loans:       
Individually evaluated for impairment$1,835 $5,577 $7,205 $60 $— $— $14,677 
Collectively evaluated for impairment171,319 589,541 348,516 43,140 160,201 20,670 1,333,387 
Total ending loans balance$173,154 $595,118 $355,721 $43,200 $160,201 $20,670 $1,348,064 

 December 31, 2019
 Commercial, Financial, and AgriculturalReal Estate MortgagesConsumer AutomobileOther consumer installmentUnallocated 
(In Thousands)ResidentialCommercialConstructionTotals
Allowance for Loan Losses:       
Ending allowance balance attributable to loans:       
Individually evaluated for impairment$— $211 $1,104 $— $62 $16 $— $1,393 
Collectively evaluated for impairment1,779 4,095 2,106 118 1,718 262 423 10,501 
Total ending allowance balance$1,779 $4,306 $3,210 $118 $1,780 $278 $423 $11,894 
Loans:       
Individually evaluated for impairment$2,285 $6,176 $8,575 $65 $130 $16  $17,247 
Collectively evaluated for impairment153,928 617,080 354,686 38,002 150,387 23,027  1,337,110 
Total ending loans balance$156,213 $623,256 $363,261 $38,067 $150,517 $23,043  $1,354,357 

Note 7.  Net Periodic Benefit Cost-Defined Benefit Plans

For a detailed disclosure on the Company’s pension and employee benefits plans, please refer to Note 13 of the Company’s Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2019.

The following sets forth the components of the net periodic benefit/cost of the domestic non-contributory defined benefit plan for the three and nine months ended September 30, 2020 and 2019, respectively:
Three Months Ended September 30,Nine Months Ended September 30,
(In Thousands)2020201920202019
Interest cost$161 $191 $481 $573 
Expected return on plan assets(330)(248)(956)(746)
Amortization of net loss52 46 144 140 
Net periodic benefit$(117)$(11)$(331)$(33)



25


Employer Contributions

The Company previously disclosed in its consolidated financial statements, included in the Annual Report on Form 10-K for the year ended December 31, 2019, that it expected to contribute a minimum of $500,000 to its defined benefit plan in 2020.  As of September 30, 2020, there were contributions of $1,250,000 made to the plan with additional contributions of at least $250,000 anticipated during the remainder of 2020.

Note 8.  Employee Stock Purchase Plan

The Company maintains an Employee Stock Purchase Plan (“Plan”).  The Plan is intended to encourage employee participation in the ownership and economic progress of the Company.  The Plan allows for up to 1,000,000 shares to be purchased by employees.  The purchase price of the shares is 95% of market value with an employee eligible to purchase up to the lesser of 15% of base compensation or $12,000 in market value annually.  During the nine months ended September 30, 2020 and 2019, there were 2,888 and 2,579 shares issued under the Plan, respectively.

Note 9.  Off-Balance Sheet Risk

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments are primarily comprised of commitments to extend credit, standby letters of credit, and credit exposure from the sale of assets with recourse.  These instruments involve, to varying degrees, elements of credit, interest rate, or liquidity risk in excess of the amount recognized in the Consolidated Balance Sheet.  The contract amounts of these instruments express the extent of involvement the Company has in particular classes of financial instruments.

The Company’s exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments.  The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.  The Company may require collateral or other security to support financial instruments with off-balance sheet credit risk.

Financial instruments whose contract amounts represent credit risk are as follows at September 30, 2020 and December 31, 2019:
(In Thousands)September 30, 2020December 31, 2019
Commitments to extend credit$189,556 $187,778 
Standby letters of credit10,186 9,638 
Credit exposure from the sale of assets with recourse8,495 6,826 
$208,237 $204,242 

Commitments to extend credit are legally binding agreements to lend to customers.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements.  The Company evaluates each customer’s credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Company, on an extension of credit is based on management’s credit assessment of the counterparty.

Standby letters of credit represent conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  These instruments are issued primarily to support bid or performance related contracts.  The coverage period for these instruments is typically a one year period with an annual renewal option subject to prior approval by management.  Fees earned from the issuance of these letters are recognized upon expiration of the coverage period.  For secured letters of credit, the collateral is typically Bank deposit instruments or customer business assets.

Note 10.  Fair Value Measurements

The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value.
26

Level I: Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
   
Level II: Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.
   
Level III: Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

This hierarchy requires the use of observable market data when available.

The following table presents the assets reported on the Consolidated Balance Sheet at their fair value on a recurring basis as of September 30, 2020 and December 31, 2019, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
 September 30, 2020
(In Thousands)Level ILevel IILevel IIITotal
Assets measured on a recurring basis:    
Investment securities, available for sale:    
Mortgage-backed securities$— $2,292 $— $2,292 
State and political securities— 89,996 — 89,996 
Other debt securities— 57,387 — 57,387 
Investment equity securities:
  Other equity securities1,291 — — 1,291 
Investment securities, trading:
  Other equity securities35 — — 35 

 December 31, 2019
(In Thousands)Level ILevel IILevel IIITotal
Assets measured on a recurring basis:    
Investment securities, available for sale:    
Mortgage-backed securities$— $4,966 $— $4,966 
State and political securities— 82,286 — 82,286 
Other debt securities— 61,367 — 61,367 
Investment equity securities:
  Other equity securities1,261 — — 1,261 
Investment securities, trading:
  Other equity securities51 — — 51 

The following table presents the assets reported on the Consolidated Balance Sheet at their fair value on a non-recurring basis as of September 30, 2020 and December 31, 2019, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. 
 September 30, 2020
(In Thousands)Level ILevel IILevel IIITotal
Assets measured on a non-recurring basis:    
Impaired loans$— $— $12,910 $12,910 
Other real estate owned— — 376 376 
27

 December 31, 2019
(In Thousands)Level ILevel IILevel IIITotal
Assets measured on a non-recurring basis:    
Impaired loans$— $— $15,854 $15,854 
Other real estate owned— — 413 413 

The following tables present a listing of significant unobservable inputs used in the fair value measurement process for items valued utilizing level III techniques as of September 30, 2020 and December 31, 2019: 
 September 30, 2020
 Quantitative Information About Level III Fair Value Measurements
(In Thousands)Fair ValueValuation Technique(s)Unobservable InputsRangeWeighted Average
Impaired loans$5,604 Discounted cash flowTemporary reduction in payment amount
3% to (59)%
(19)%
 7,306 
Appraisal of collateral (1)
Appraisal adjustments (1)
0% to (30)%
(8)%
Other real estate owned$376 
Appraisal of collateral (1)
Appraisal adjustments (1)
(20)%(20)%
(1) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.
 December 31, 2019
 Quantitative Information About Level III Fair Value Measurements
(In Thousands)Fair ValueValuation Technique(s)Unobservable InputsRangeWeighted Average
Impaired loans$6,950 Discounted cash flowTemporary reduction in payment amount
17% to (59)%
(24)%
 8,904 
Appraisal of collateral (1)
Appraisal adjustments (1)
—% to (30)%
(9)%
Other real estate owned$413 
Appraisal of collateral (1)
Appraisal adjustments (1)
(20)%(20)%
(1) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.

The discounted cash flow valuation technique is utilized to determine the fair value of performing impaired loans, while non-performing impaired loans utilize the appraisal of collateral method.

The significant unobservable inputs used in the fair value measurement of the Company’s impaired loans using the discounted cash flow valuation technique include temporary changes in payment amounts and the probability of default.  Significant increases (decreases) in payment amounts would result in significantly higher (lower) fair value measurements.  The probability of default is 0% for impaired loans using the discounted cash flow valuation technique because all defaulted impaired loans are valued using the appraisal of collateral valuation technique.

The significant unobservable input used in the fair value measurement of the Company’s impaired loans using the appraisal of collateral valuation technique include appraisal adjustments, which are adjustments to appraisals by management for qualitative factors such as economic conditions and estimated liquidation expenses.  The significant unobservable input used in the fair value measurement of the Company’s other real estate owned are the same inputs used to value impaired loans using the appraisal of collateral valuation technique. 

Note 11. Fair Value of Financial Instruments

The Company is required to disclose fair values for its financial instruments.  Fair values are made at a specific point in time, based on relevant market information and information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument.  Also, it is the Company’s general practice and intention to hold most of its financial instruments to maturity and not to engage in trading or sales activities.  Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.  These fair values are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.  Changes in assumptions can significantly affect the fair values.
28


Fair values have been determined by the Company using historical data and an estimation methodology suitable for each category of financial instruments.  The Company’s fair values, methods, and assumptions are set forth below for the Company’s other financial instruments.

As certain assets and liabilities, such as deferred tax assets, premises and equipment, and many other operational elements of the Company, are not considered financial instruments but have value, this fair value of financial instruments would not represent the full market value of the Company.

The fair values of the Company’s financial instruments not recorded at fair value on a recurring or nonrecurring basis are as follows at September 30, 2020 and December 31, 2019:
 CarryingFairFair Value Measurements at September 30, 2020
(In Thousands)ValueValueLevel ILevel IILevel III
Financial assets:     
Cash and cash equivalents (1)$226,272 $226,272 $226,272 $— $— 
Restricted investment in bank stock (1)15,006 15,006 15,006 — — 
Loans held for sale (1)6,647 6,647 6,647 — — 
Loans, net1,335,711 1,401,625 — — 1,401,625 
Bank-owned life insurance (1)33,474 33,474 33,474 — — 
Accrued interest receivable (1)8,540 8,540 8,540 — — 
Financial liabilities:     
Interest-bearing deposits$1,057,562 $1,123,505 $807,449 $— $316,056 
Noninterest-bearing deposits (1)434,248 434,248 434,248 — — 
Short-term borrowings (1)15,009 15,009 15,009 — — 
Long-term borrowings153,534 159,534 — — 159,534 
Accrued interest payable (1)1,491 1,491 1,491 — — 
(1) The financial instrument is carried at cost at September 30, 2020, which approximate the fair value of the instruments
 CarryingFairFair Value Measurements at December 31, 2019
(In Thousands)ValueValueLevel ILevel IILevel III
Financial assets:     
Cash and cash equivalents (1)$48,589 $48,589 $48,589 $— $— 
Restricted investment in bank stock (1)13,528 13,528 13,528 — — 
Loans held for sale (1)4,232 4,232 4,232 — — 
Loans, net1,343,650 1,346,395 — — 1,346,395 
Bank-owned life insurance (1)29,253 29,253 29,253 — — 
Accrued interest receivable (1)5,246 5,246 5,246 — — 
Financial liabilities:     
Interest-bearing deposits$989,259 $990,747 $611,374 $— $379,373 
Noninterest-bearing deposits (1)334,746 334,746 334,746 — — 
Short-term borrowings (1)4,920 4,920 4,920 — — 
Long-term borrowings161,920 163,931 — — 163,931 
Accrued interest payable (1)1,671 1,671 1,671 — — 
(1) The financial instrument is carried at cost at December 31, 2019, which approximate the fair value of the instruments

The methods and assumptions used by the Company in estimating fair values of financial instruments at September 30, 2020 is in accordance with ASC Topic 825, Financial Instruments, as amended by ASU 2016-01 which requires public entities to use exit pricing in the calculation of the above tables.




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Note 12.  Stock Options

In 2014, the Company adopted the 2014 Equity Incentive Plan designed to help the Company attract, retain, and motivate employees and non-employee directors. Incentive stock options, non-qualified stock options, and restricted stock may be granted as part of the plan.

As of January 1, 2020, the Company had a total of 625,800 stock options outstanding. During the period ended September 30, 2020, the Company issued 238,500 stock options with a strike price of $25.34 to a group of employees. The options granted in 2020 all expire ten years from the grant date. Of the 238,500 grants awarded in 2020, 119,300 of the options vest in 3 years while the 119,200 remaining options vest in five years.

Stock Options Granted
DateSharesForfeitedOutstandingStrike PriceVesting PeriodExpiration
March 11, 2020119,300 — 119,300 $25.34 3 years10 years
March 11, 2020119,200 — 119,200 25.34 5 years10 years
March 15, 2019120,900 (1,950)118,950 28.01 3 years10 years
March 15, 2019119,100 (1,800)117,300 28.01 5 years10 years
August 24, 201875,300 (1,950)73,350 30.67 3 years10 years
August 24, 2018149,250 (4,050)145,200 30.67 5 years10 years
January 5, 201818,750 — 18,750 30.07 3 years10 years
January 5, 201818,750 — 18,750 30.07 5 years10 years
March 24, 201769,375 (6,750)62,625 29.47 3 years10 years
March 24, 201735,625 — 35,625 29.47 5 years10 years
August 27, 201558,125 (22,875)35,250 28.02 5 years10 years

A summary of stock option activity is presented below:
September 30, 2020September 30, 2019
SharesWeighted Average Exercise PriceSharesWeighted Average Exercise Price
Outstanding, beginning of year625,800 $29.29 395,550 $30.08 
Granted238,500 25.34 240,000 28.01 
Exercised— — — — 
Forfeited— — — — 
Expired— — — — 
Outstanding, end of period864,300 $28.20 635,550 $29.30 
Exercisable, end of period97,875 $28.95 — $— 

The estimated fair value of options, including the effect of estimated forfeitures, is recognized as expense on a straightline basis over the options’ vesting periods while ensuring that the cumulative amount of compensation cost recognized at least equals the value of the vested portion of the award at that date. The Company determines the fair value of options granted using the Black-Scholes option-pricing model. The risk-free interest rate is based on the United States Treasury bond with a similar term to the expected life of the options at the grant date. Expected volatility was estimated based on the adjusted historic volatility of the Company’s shares. The expected life was estimated to equal the contractual life of the options. The dividend yield rate was based upon recent historical dividends paid on shares.

Compensation expense for stock options is recognized using the fair value when the stock options are granted and is amortized over the options' vesting period. Compensation expense related to stock options was $239,000 and $675,000 for the three and nine months ended September 30, 2020 compared to $185,000 and $498,000 for the same period of 2019. As of September 30, 2020, a total of 97,875 stock options were exercisable and the weighted average years to expiration was 8.17 years years. The
30

fair value of options granted during the nine months ended September 30, 2020 was $1,343,000 or $5.63 per award. Total unrecognized compensation cost for non-vested options was $2,165,000 and will be recognized over their weighted average remaining vesting period of 1.45 years years.

Note 13.  Leases

The following table shows finance lease right of use assets and finance lease liabilities as of:
(In Thousands)Statement of Financial Condition classificationSeptember 30, 2020December 31, 2019
Finance lease right of use assetsPremises and equipment, net$5,307 $5,456 
Finance lease liabilitiesLong-term borrowings5,534 5,587 

The following table shows the components of finance and operating lease expense for the three and six months ended June 30, 2020 and 2019:
Three Months Ended September 30,Nine Months Ended September 30,
(In Thousands)2020201920202019
Finance Lease Cost:
Amortization of right-of-use asset$50 $65 $150 $194 
Interest expense53 56 159 168 
Operating lease cost76 99 243 271 
Variable lease cost— 1 — 3 
Total Lease Cost$179 $221 $552 $636 

A maturity analysis of operating and finance lease liabilities and reconciliation of the undiscounted cash flows to the total operating lease liability is as follows:
(In Thousands)OperatingFinance
2020$71 $70 
2021291 282 
2022298 283 
2023273 284 
2024263 290 
2025 and thereafter3,176 8,004 
Total undiscounted cash flows4,372 9,213 
Discount on cash flows(1,153)(3,679)
Total lease liability$3,219 $5,534 

The following table shows the weighted average remaining lease term and weighted average discount rate for both operating and finance leases outstanding as of September 30, 2020.
OperatingFinance
Weighted-average term (years)18.427.4
Weighted-average discount rate3.51 %3.77 %

Note 14.  Reclassification of Comparative Amounts

Certain comparative amounts for the prior period have been reclassified to conform to current period presentations. Such reclassifications had no effect on net income or shareholders’ equity.

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Note 15.  Subsequent Events

All events subsequent to the date of the consolidated financial statements through November 9, 2020, and for which U.S. GAAP requires adjustment or disclosure, have been adjusted or disclosed, including that the 2019 novel coronavirus (or COVID-19) has adversely affected, and may continue to adversely affect, economic activity globally, nationally, and locally.  In response to COVID-19, among other things, the Company has incurred loan rate modifications and payment deferrals of up to 180 days.  For further discussion, see COVID-19 Impact section of Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation.

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CAUTIONARY STATEMENT FOR PURPOSES OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Report contains certain “forward-looking statements” including statements concerning plans, objectives, future events or performance and assumptions and other statements which are other than statements of historical fact.  The Company cautions readers that the following important factors, among others, may have affected and could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward-looking statement made by or on behalf of the Company herein:  (i) the effect of changes in laws and regulations, including federal and state banking laws and regulations, with which the Company must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable; (ii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board, or of changes in the Company’s organization, compensation and benefit plans; (iii) the effect on the Company’s competitive position within its market area of the  increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services; (iv) the effect of changes in interest rates; (v) the negative impacts and disruptions of the COVID-19 pandemic and measures taken to contain its spread on our employees, customers, business operations, credit quality, financial position, liquidity and results of operations; (vi) the length and extent of the economic contraction as a result of the COVID-19 pandemic; or (vii) the effect of changes in the business cycle and downturns in the local, regional or national economies; and (viii) the Risk Factors identified in Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2019 and in other filings made by the Company under the Securities Exchange Act of 1934.

You should not put undue reliance on any forward-looking statements.  These statements speak only as of the date of this Quarterly Report on Form 10-Q, even if subsequently made available by the Company on its website or otherwise.  The Company undertakes no obligation to update or revise these statements to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q.

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

EARNINGS SUMMARY

Comparison of the Three and Nine Months Ended September 30, 2020 and 2019

Summary Results

Net income for the three and nine months ended September 30, 2020 were $4,472,000 and $11,305,000 compared to $4,650,000 and $12,839,000 for the same periods of 2019, Results for the three and nine months ended September 30, 2020 compared to 2019 were impacted by an increase in after-tax securities gains of $665,000 (from a gain of $134,000 to a gain of $799,000) for the three month period and $770,000 (from a gain of $205,000 to a gain of $975,000) for the nine month period. Basic and diluted earnings per share for the three and nine months ended September 30, 2020 were $0.63 and $1.61, respectively, compared to the corresponding periods of 2019 basic and diluted earnings per share of $0.66 and $1.82. Return on average assets and return on average equity were 0.97% and 11.05% for the three months ended September 30, 2020 compared to 1.10% and 12.18% for the corresponding period of 2019. Return on average assets and return on average equity were 0.85% and 9.57% for the nine months ended September 30, 2020 compared to 1.02% and 11.69% for the corresponding period of 2019. Net income from core operations (“core earnings”) was $3,673,000 and $10,330,000 for the three and nine months ended September 30, 2020, respectively, compared to $4,516,000 and $12,634,000 for the corresponding periods of 2019. Core basic and diluted earnings per share for the three and nine months ended September 30, 2020 were $0.52 and $1.47, respectively, compared to $0.64 and $1.80 basic and diluted for the corresponding periods of 2019.

Management uses the non-GAAP measure of net income from core operations in its analysis of the Company’s performance.  This measure, as used by the Company, adjusts net income by excluding significant gains or losses that are unusual in nature.  Because certain of these items and their impact on the Company’s performance are difficult to predict, management believes the presentation of financial measures excluding the impact of such items provides useful supplemental information in evaluating the operating results of the Company’s core businesses.  For purposes of this Quarterly Report on Form 10-Q, net income from core operations means net income adjusted to exclude after-tax net securities gains or losses. These disclosures should not be viewed as a substitute for net income determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.

Reconciliation of GAAP and Non-GAAP Financial Measures
(Dollars in Thousands, Except Per Share Data)Three Months Ended September 30,Nine Months Ended September 30,
2020201920202019
GAAP net income$4,472 $4,650 $11,305 $12,839 
Less: net securities gains, net of tax799 134 975 205 
Non-GAAP core earnings$3,673 $4,516 $10,330 $12,634 
Three Months Ended September 30,Nine Months Ended September 30,
 2020201920202019
Return on average assets (ROA)0.97 %1.10 %0.85 %1.02 %
Less: net securities gains, net of tax0.18 %0.03 %0.07 %0.01 %
Non-GAAP core ROA0.79 %1.07 %0.78 %1.01 %
Three Months Ended September 30,Nine Months Ended September 30,
 2020201920202019
Return on average equity (ROE)11.05 %12.18 %9.57 %11.69 %
Less: net securities gains, net of tax1.97 %0.36 %0.82 %0.20 %
Non-GAAP core ROE.9.08 %11.82 %8.75 %11.49 %
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Three Months Ended September 30,Nine Months Ended September 30,
 2020201920202019
Basic earnings per share (EPS)$0.63 $0.66 $1.61 $1.82 
Less: net securities gains, net of tax0.11 0.02 0.14 0.02 
Non-GAAP core operating EPS$0.52 $0.64 $1.47 $1.80 
Three Months Ended September 30,Nine Months Ended September 30,
 2020201920202019
Diluted EPS$0.63 $0.66 $1.61 $1.82 
Less: net securities gains, net of tax0.11 0.02 0.14 0.02 
Non-GAAP diluted core EPS$0.52 $0.64 $1.47 $1.80 
 

Interest and Dividend Income

Interest and dividend income for the three and nine months ended September 30, 2020 decreased to $15,387,000 and $47,592,000, respectively, compared to $17,084,000 and $50,359,000 for the same periods of 2019 as the interest rate environment remains at a level below historical levels. Loan portfolio income decreased due to a decrease in average rate paid on loans and a decrease in the average loan portfolio balance. Investment securities and dividend income decreased as the increase in the average portfolio balance was more than offset by a decrease in the average rate earned on the portfolio. The decrease in dividend and other interest income is due to a decrease in the amount of dividends received on restricted investment in bank stock held.

Interest and dividend income composition for the three and nine months ended September 30, 2020 and 2019 was as follows:
 Three Months Ended
 September 30, 2020September 30, 2019Change
(In Thousands)Amount% TotalAmount% TotalAmount%
Loans including fees$14,080 91.51 %$15,426 90.30 %$(1,346)(8.73)%
Investment securities:      
Taxable925 6.01 998 5.84 (73)(7.31)
Tax-exempt170 1.10 167 0.98 3 1.80 
Dividend and other interest income212 1.38 493 2.88 (281)(57.00)
Total interest and dividend income$15,387 100.00 %$17,084 100.00 %$(1,697)(9.93)%
 Nine Months Ended
 September 30, 2020September 30, 2019Change
(In Thousands)Amount% TotalAmount% TotalAmount%
Loans including fees$43,403 91.20 %$45,595 90.54 %$(2,192)(4.81)%
Investment securities:      
Taxable2,958 6.21 2,899 5.76 59 2.04 
Tax-exempt484 1.02 520 1.03 (36)(6.92)
Dividend and other interest income747 1.57 1,345 2.67 (598)(44.46)
Total interest and dividend income$47,592 100.00 %$50,359 100.00 %$(2,767)(5.49)%

Interest Expense

Interest expense for the three and nine months ended September 30, 2020 decreased $639,000 and $529,000, respectively, compared to the same periods of 2019. During the three and nine months ended September 30, 2020 interest-bearing deposit rates were significantly reduced. However, the decrease in deposit rates was offset by a significant increase in average interest-bearing deposit. Long-term borrowings have been utilized to lock in funding and historically low interest rates and to assist with the funding of the loan and investment portfolios.

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Interest expense composition for the three and nine months ended September 30, 2020 and 2019 was as follows:
 Three Months Ended
 September 30, 2020September 30, 2019Change
(In Thousands)Amount% TotalAmount% TotalAmount%
Deposits$2,569 72.53 %$3,165 75.70 %$(596)(18.83)%
Short-term borrowings8 0.23 7 0.17 1 14.29 
Long-term borrowings965 27.24 1,009 24.13 (44)(4.36)
Total interest expense$3,542 100.00 %$4,181 100.00 %$(639)(15.28)%
 Nine Months Ended
 September 30, 2020September 30, 2019Change
(In Thousands)Amount% TotalAmount% TotalAmount%
Deposits$8,406 74.15 %$8,336 70.26 %$70 0.84 %
Short-term borrowings37 0.33 790 6.66 (753)(95.32)
Long-term borrowings2,893 25.52 2,739 23.08 154 5.62 
Total interest expense$11,336 100.00 %$11,865 100.00 %$(529)(4.46)%

Net Interest Margin

The net interest margin (“NIM”) for the three and nine months ended September 30, 2020 was 2.76% and 2.97%, respectively, compared to 3.32% and 3.34% for the corresponding periods of 2019. The decrease in the net interest margin was driven by a decrease in the yield of the loan portfolio of 34 and 11 basis points ("bps"), while the the investment portfolio yield declined 56 and 60 bps, respectively, for the three and nine month periods during the current low interest rate environment. Further compressing the net interest margin was the significant increase of interest-bearing deposits. These deposits carry a current yield of a few basis points as commercial customers have received PPP funding and retail customers have received stimulus funding. Rates paid on interest-bearing liabilities were decreased over the three and nine months ended September 30, 2020 resulting in a decline in rate paid of 26 and 7 bps as compared to the three and nine months ended September 30, 2019. The rate paid on short-term borrowings decreased significantly as the balance consists primarily of securities sold under agreement to repurchase. These rate decreases will partially offset the decline in earning asset yield.


























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The following is a schedule of average balances and associated yields for the three and nine months ended September 30, 2020 and 2019:
 AVERAGE BALANCES AND INTEREST RATES
 Three Months Ended September 30, 2020Three Months Ended September 30, 2019
(In Thousands)Average Balance (1)InterestAverage RateAverage Balance (1)InterestAverage Rate
Assets:      
Tax-exempt loans (3)
$42,047 $386 3.65 %$66,617 $505 3.04 %
All other loans1,313,474 13,775 4.17 %1,317,964 15,027 4.57 %
Total loans (2)
1,355,521 14,161 4.16 %1,384,581 15,532 4.50 %
Taxable securities140,695 1,116 3.23 %137,394 1,284 3.79 %
Tax-exempt securities (3)
30,587 216 2.87 %25,769 211 3.32 %
Total securities171,282 1,332 3.16 %163,163 1,495 3.72 %
Interest-bearing deposits203,817 21 0.04 %36,853 207 2.25 %
Total interest-earning assets1,730,620 15,514 3.57 %1,584,597 17,234 4.37 %
Other assets121,901   101,318   
Total assets$1,852,521   $1,685,915   
Liabilities and shareholders’ equity:      
Savings$199,420 51 0.10 %$169,628 66 0.16 %
Super Now deposits273,190 489 0.71 %232,918 481 0.83 %
Money market deposits263,926 330 0.50 %237,362 581 0.98 %
Time deposits329,190 1,699 2.05 %370,229 2,037 2.21 %
Total interest-bearing deposits1,065,726 2,569 0.96 %1,010,137 3,165 1.26 %
Short-term borrowings17,517 8 0.18 %7,990 7 0.35 %
Long-term borrowings165,064 965 2.33 %169,017 1,009 2.26 %
Total borrowings182,581 973 2.12 %177,007 1,016 2.18 %
Total interest-bearing liabilities1,248,307 3,542 1.13 %1,187,144 4,181 1.39 %
Demand deposits424,753   324,940   
Other liabilities17,644   21,151   
Shareholders’ equity161,817   152,680   
Total liabilities and shareholders’ equity$1,852,521   $1,685,915   
Interest rate spread  2.44 %  2.98 %
Net interest income/margin $11,972 2.76 % $13,053 3.32 %
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 AVERAGE BALANCES AND INTEREST RATES
 Nine Months Ended September 30, 2020Nine Months Ended September 30, 2019
(In Thousands)Average Balance (1)InterestAverage RateAverage Balance (1)InterestAverage Rate
Assets:      
Tax-exempt loans (3)$46,476 $1,138 3.27 %$69,973 $1,592 3.04 %
All other loans1,304,207 42,504 4.35 %1,315,022 44,337 4.51 %
Total loans (2)1,350,683 43,642 4.32 %1,384,995 45,929 4.43 %
Taxable securities143,601 3,582 3.38 %131,451 3,934 4.05 %
Tax-exempt securities27,558 613 3.02 %26,813 658 3.32 %
Total securities171,159 4,195 3.32 %158,264 4,592 3.92 %
Interest-bearing deposits125,447 123 0.13 %18,050 310 2.30 %
Total interest-earning assets1,647,289 47,960 3.89 %1,561,309 50,831 4.36 %
Other assets116,868   109,278   
Total assets$1,764,157  $1,670,587   
Liabilities and shareholders’ equity:    
Savings$189,205 209 0.15 %$168,909 147 0.12 %
Super Now deposits248,327 1,322 0.71 %236,965 1,313 0.74 %
Money market deposits234,772 1,225 0.70 %242,630 1,649 0.91 %
Time deposits356,897 5,650 2.11 %335,456 5,227 2.08 %
Total interest-bearing deposits1,029,201 8,406 1.09 %983,960 8,336 1.13 %
Short-term borrowings13,195 37 0.37 %45,046 790 2.34 %
Long-term borrowings165,702 2,893 2.33 %153,684 2,739 2.24 %
Total borrowings178,897 2,930 2.19 %198,730 3,529 2.26 %
Total interest-bearing liabilities1,208,098 11,336 1.25 %1,182,690 11,865 1.32 %
Demand deposits378,889   318,602   
Other liabilities19,682   22,705   
Shareholders’ equity157,488   146,590   
Total liabilities and shareholders’ equity$1,764,157   $1,670,587   
Interest rate spread  2.64 %  3.04 %
Net interest income/margin $36,624 2.97 % $38,966 3.34 %

The following table presents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30,Nine Months Ended September 30,
(In Thousands)2020201920202019
Total interest income$15,387 $17,084 $47,592 $50,359 
Total interest expense3,542 4,181 11,336 11,865 
Net interest income11,845 12,903 36,256 38,494 
Tax equivalent adjustment127 150 368 472 
Net interest income (fully taxable equivalent)$11,972 $13,053 $36,624 $38,966 
 
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The following table sets forth the respective impact that both volume and rate changes have had on net interest income on a fully taxable equivalent basis for the three and nine months ended September 30, 2020 and 2019:
 Three Months Ended September 30,Nine Months Ended September 30,
 2020 vs. 20192020 vs. 2019
 Increase (Decrease) Due toIncrease (Decrease) Due to
(In Thousands)VolumeRateNetVolumeRateNet
Interest income:      
Tax-exempt loans$(209)$90 $(119)$(501)$47 $(454)
All other loans(47)(1,205)(1,252)(345)(1,488)(1,833)
Taxable investment securities30 (198)(168)187 (539)(352)
Tax-exempt investment securities37 (32)5 8 (53)(45)
Interest bearing deposits182 (368)(186)1,305 (1,492)(187)
Total interest-earning assets(7)(1,713)(1,720)654 (3,525)(2,871)
Interest expense:      
Savings deposits11 (26)(15)20 42 62 
Super Now deposits81 (73)8 43 (34)9 
Money market deposits59 (310)(251)(52)(372)(424)
Time deposits(205)(133)(338)345 78 423 
Short-term borrowings5 (4)1 (344)(409)(753)
Long-term borrowings(44)— (44)101 53 154 
Total interest-bearing liabilities(93)(546)(639)113 (642)(529)
Change in net interest income$86 $(1,167)$(1,081)$541 $(2,883)$(2,342)

Provision for Loan Losses

The provision for loan losses is based upon management’s quarterly review of the loan portfolio.  The purpose of the review is to assess loan quality, identify impaired loans, analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets served.  An external independent loan review is also performed annually for the Banks.  Management remains committed to an aggressive program of problem loan identification and resolution.

The allowance for loan losses is determined by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined.  Loss factors are based on management’s consideration of the nature of the portfolio segments, changes in mix and volume of the loan portfolio, and historical loan loss experience.  In addition, management considers industry standards and trends with respect to non-performing loans and its knowledge and experience with specific lending segments.

Although management believes it uses the best information available to make such determinations and that the allowance for loan losses is adequate at September 30, 2020, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations.  A downturn in the local economy, increased unemployment, and delays in receiving financial information from borrowers could result in increased levels of nonperforming assets, charge-offs, loan loss provisions, and reductions in income.  Additionally, as an integral part of the examination process, bank regulatory agencies periodically review the Banks' loan loss allowance.  The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

When determining the appropriate allowance level, management has attributed the allowance for loan losses to various portfolio segments; however, the allowance is available for the entire portfolio as needed.

The allowance for loan losses increased from $11,894,000 at December 31, 2019 to $13,429,000 at September 30, 2020. The increase in the allowance for loan losses was primarily driven by the economic uncertainity caused by the COVID-19 pandemic. At September 30, 2020 and December 31, 2019, the allowance for loan losses to total loans was 1.00% and 0.88%, respectively.

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The provision for loan losses totaled $645,000 and $2,040,000 for the three and nine months ended September 30, 2020, respectively, and the amounts for the corresponding 2019 periods were $360,000 and $1,035,000. The increase in the provision for loan losses for the three and nine months ended September 30, 2020 compared to the corresponding 2019 periods were primarily the result of the economic impact caused by the COVID-19 pandemic and the uncertainty for the future that it presents.

Nonperforming loans decreased to $10,553,000 at September 30, 2020 from $17,208,000 at September 30, 2019. The majority of nonperforming loans are centered on loans that are either in a secured position and have sureties with a strong underlying financial position or have a specific allocation for any impairment recorded within the allowance for loan losses. The ratio of nonperforming loans to total loans was 0.77% and 1.26% at September 30, 2020 and 2019, respectively, and the ratio of the allowance for loan losses to nonperforming loans was 129.17% and 82.80% at September 30, 2020 and 2019, respectively. Internal loan review and analysis coupled with changes in the loan portfolio composition and the impact of the COVID-19 pandemic dictated a provision for loan losses of $2,040,000 for the nine months ended September 30, 2020.

The following is a table showing total nonperforming loans as of:
 Total Nonperforming Loans
(In Thousands)90 Days Past DueNon-accrualTotal
September 30, 2020$791 $9,762 $10,553 
June 30, 20201,279 9,818 11,097 
March 31, 20201,503 9,797 11,300 
December 31, 20192,047 10,374 12,421 
September 30, 20191,304 15,904 17,208 
 
Non-interest Income

Total non-interest income for the three and nine months ended September 30, 2020 compared to the same periods in 2019 increased $1,213,000 to $4,035,000 and $1,548,000 to $9,093,000, respectively. Excluding net securities gains, non-interest income for the three and nine months ended September 30, 2020 increased $372,000 and increased $573,000, respectively, compared to the same periods in 2019. Gain on sale of loans increased as the low rate environment has led to an increase in refinancing activity. Service charges declined as the overdraft fee income has declined as a result of the impact of the COVID-19 pandemic. The decrease in brokerage commissions is due to a change in the product mix and reduced consumer activity during the COVID-19 pandemic. The decrease in debit card fees is a result of a decrease in debit card usage resulting from the impact of the COVID-19 pandemic. The fluctuation in other income results primarily from other fees associated with loans sold on the secondary market.

Non-interest income composition for the three and nine months ended September 30, 2020 and 2019 was as follows:
 Three Months Ended
 September 30, 2020September 30, 2019Change
(In Thousands)Amount% TotalAmount% TotalAmount%
Service charges$388 9.62 %$622 22.04 %$(234)(37.62)%
Net debt securities gains, available for sale1,013 25.11 189 6.70 824 (435.98)
Net equity securities (losses) gains— — (21)(0.74)21 100.00 
Net securities (losses) gains, trading(2)(0.05)2 0.07 (4)(200.00)
Bank-owned life insurance156 3.87 143 5.07 13 9.09 
Gain on sale of loans1,449 35.91 583 20.66 866 148.54 
Insurance commissions101 2.50 93 3.30 8 8.60 
Brokerage commissions224 5.55 353 12.51 (129)(36.54)
Debit card income352 8.72 333 11.80 19 5.71 
Other354 8.77 525 18.59 (171)(32.57)
Total non-interest income$4,035 100.00 %$2,822 100.00 %$1,213 42.98 %
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 Nine Months Ended
 September 30, 2020September 30, 2019Change
(In Thousands)Amount% TotalAmount% TotalAmount%
Service charges$1,249 13.74 %$1,776 23.54 %$(527)(29.67)%
Net debt securities gains, available for sale1,220 13.42 200 2.65 1,020 (510.00)
Net equity securities gains30 0.33 44 0.58 (14)31.82 
Net securities (losses) gains, trading(16)(0.18)15 0.20 (31)(206.67)
Bank-owned life insurance492 5.41 434 5.75 58 13.36 
Gain on sale of loans2,921 32.12 1,246 16.51 1,675 134.43 
Insurance commissions320 3.52 346 4.59 (26)(7.51)
Brokerage commissions779 8.57 1,032 13.68 (253)(24.52)
Debit card income936 10.29 1,032 13.68 (96)(9.30)
Other1,162 12.78 1,420 18.82 (258)(18.17)
Total non-interest income$9,093 100.00 %$7,545 100.00 %$1,548 20.52 %

Non-interest Expense

Total non-interest expense increased $166,000 and $14,000 for the three and nine months ended September 30, 2020 compared to the same periods of 2019. The decrease in salaries and employee benefits is attributable to employee layoffs during the second and third quarters of 2020 due to the COVID-19 pandemic. Furniture and equipment expenses for the nine month period have increased as maintenance costs have increased and older equipment was replaced. Software amortization increased due to updating software programs that require new licensing fee structures. Marketing expenses decreased as targeted direct mail marketing has replaced mass marketing. The fluctuation in professional fees consists primarily of an increase in legal and audit fees. The increase in deposit insurance reflects the assessment credits issued by the FDIC during 2019.

Non-interest expense composition for the three and nine months ended September 30, 2020 and 2019 was as follows:
 Three Months Ended
 September 30, 2020September 30, 2019Change
(In Thousands)Amount% TotalAmount% TotalAmount%
Salaries and employee benefits$5,465 56.30 %$5,488 57.52 %$(23)(0.42)%
Occupancy599 6.17 638 6.69 (39)(6.11)
Furniture and equipment837 8.62 885 9.28 (48)(5.42)
Software amortization257 2.65 234 2.45 23 9.83 
Pennsylvania shares tax340 3.50 285 2.99 55 19.30 
Professional fees608 6.26 585 6.13 23 3.93 
Federal Deposit Insurance Corporation deposit insurance271 2.79 — — 271 #DIV/0!
Marketing61 0.63 98 1.03 (37)(37.76)
Intangible amortization53 0.55 62 0.65 (9)(14.52)
Other1,216 12.53 1,266 13.26 (50)(3.95)
Total non-interest expense$9,707 100.00 %$9,541 100.00 %$166 1.74 %
41

 Nine Months Ended
 September 30, 2020September 30, 2019Change
(In Thousands)Amount% TotalAmount% TotalAmount%
Salaries and employee benefits$16,362 55.60 %$16,512 56.14 %$(150)(0.91)%
Occupancy1,927 6.55 2,085 7.09 (158)(7.58)
Furniture and equipment2,525 8.58 2,421 8.23 104 4.30 
Software amortization743 2.52 629 2.14 114 18.12 
Pennsylvania shares tax948 3.22 863 2.93 85 9.85 
Professional fees1,888 6.42 1,834 6.24 54 2.94 
Federal Deposit Insurance Corporation deposit insurance650 2.21 504 1.71 146 28.97 
Marketing170 0.58 233 0.79 (63)(27.04)
Intangible amortization174 0.59 202 0.69 (28)(13.86)
Other4,041 13.73 4,131 14.04 (90)(2.18)
Total non-interest expense$29,428 100.00 %$29,414 100.00 %$14 0.05 %

Provision for Income Taxes

Income taxes decreased $119,000 and $178,000 for the three and nine months ended September 30, 2020 compared to the same periods of 2019. The effective tax rate for the three and nine months ended September 30, 2020 was 19.01% and 18.46% compared to 20.01% and 17.58% for the same period of 2019. The Company currently is in a deferred tax asset position. Management has reviewed the deferred tax asset and has determined that the asset will be utilized within the appropriate carry forward period and therefore does not require a valuation allowance.

ASSET/LIABILITY MANAGEMENT

Cash and Cash Equivalents

Cash and cash equivalents increased $177,683,000 from $48,589,000 at December 31, 2019 to $226,272,000 at September 30, 2020, primarily as a result of the following activities during the nine months ended September 30, 2020.

Loans Held for Sale

Activity regarding loans held for sale resulted in sales proceeds trailing loan originations, less $2,921,000 in realized gains, by $2,415,000 for the nine months ended September 30, 2020.

Loans

Gross loans decreased $6,404,000 since December 31, 2019 due primarily to a decrease in both residential and commercial real estate mortgage categories. The decrease in the real estate mortgage portfolio was partially offset by the growth in commercial, financial and agricultural loans along with construction real estate mortgages and the consumer automobile loan segments.

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The allocation of the loan portfolio, by category, as of September 30, 2020 and December 31, 2019 is presented below:
 September 30, 2020December 31, 2019Change
(In Thousands)Amount% TotalAmount% TotalAmount%
Commercial, financial, and agricultural$173,154 12.83 %$156,213 11.52 %$16,941 10.84 %
Real estate mortgage:      
Residential595,118 44.11 623,256 45.98 (28,138)(4.51)%
Commercial355,721 26.37 363,261 26.80 (7,540)(2.08)%
Construction43,200 3.20 38,067 2.81 5,133 13.48 %
Consumer automobile loans160,201 11.87 150,517 11.10 9,684 6.43 %
Other consumer installment loans20,670 1.53 23,043 1.70 (2,373)(10.30)%
Net deferred loan fees and discounts1,076 0.09 1,187 0.09 (111)(9.35)%
Gross loans$1,349,140 100.00 %$1,355,544 100.00 %$(6,404)(0.47)%

The following table shows the amount of accrual and non-accrual TDRs at September 30, 2020 and December 31, 2019:
 September 30, 2020December 31, 2019
(In Thousands)AccrualNon-accrualTotalAccrualNon-accrualTotal
Commercial, financial, and agricultural$1,493 $69 $1,562 $— $2,190 $2,190 
Real estate mortgage:      
Residential4,020 — 4,020 4,089 144 4,233 
Commercial5,904 732 6,636 2,127 4,732 6,859 
 $11,417 $801 $12,218 $6,216 $7,066 $13,282 
 
Investments

The fair value of the investment debt securities portfolio at September 30, 2020 increased $1,056,000 since December 31, 2019 while the amortized cost of the portfolio decreased $1,457,000.  The decrease in the investment portfolio amortized value occurred within the mortgage-backed and other debt segments of the portfolio. The mortgage-backed segment was reduced as bonds prepaid due to the low interest rate environment. The other debt segment of the investment portfolio is primarily corporate bonds and this segment was reduced due to the negative economic impact of the COVID-19 pandemic. The municipal segment was increased as bonds with a final maturity of one to five years have been purchased. The portfolio continues to be actively managed in order to reduce interest rate and market risk. The unrealized losses within the debt securities portfolio are the result of market activity, not credit issues/ratings, as approximately 71.03% of the debt securities portfolio on an amortized cost basis is currently rated A or higher by either S&P or Moody’s.

The Company considers various factors, which include examples from applicable accounting guidance, when analyzing the available for sale portfolio for possible other than temporary impairment.  The Company primarily considers the following factors in its analysis: length of time and severity of the fair value being less than carrying value; reduction of dividend paid (equities); continued payment of dividend/interest, credit rating, and financial condition of an issuer; intent and ability to hold until anticipated recovery (which may be maturity); and general outlook for the economy, specific industry, and entity in question.

The bond portion of the portfolio review is conducted with emphases on several factors.  Continued payment of principal and interest is given primary importance with credit rating and financial condition of the issuer following as the next most important.  Credit ratings were reviewed with the ratings of the bonds being satisfactory.  Bonds that were not currently rated were discussed with a third party and/or underwent an internal financial review. Each bond is reviewed to determine whether it is a general obligation bond, which is backed by the credit and taxing power of the issuing jurisdiction, or a revenue bond, which is only payable from specified revenues.  Based on the review undertaken by the Company, the Company determined that the decline in value of the various bond holdings were temporary and were the result of the general market downturns and interest rate/yield curve changes, not credit issues.  The fact that almost all of such bonds are general obligation bonds further solidified the Company’s determination that the decline in the value of these bond holdings is temporary.

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The fair value of the equity portfolio continues to fluctuate as the economic and political environment continues to impact stock pricing. The amortized cost of the available for sale equity securities portfolio has remained flat at $1,300,000 for September 30, 2020 and December 31, 2019 while the fair value increased $30,000 over the same time period.

The distribution of credit ratings by amortized cost and fair values for the debt security portfolio at September 30, 2020 follows:
 A- to AAAB- to BBB+Not RatedTotal
(In Thousands)Amortized CostFair ValueAmortized CostFair ValueAmortized CostFair ValueAmortized CostFair Value
Available for sale (AFS):        
Mortgage-backed securities $2,267 7$2,292 $— $— $— $— $2,267 $2,292 
State and political securities82,515 87,520 1,179 1,238 1,179 1,238 84,873 89,996 
Other debt securities17,537 16,301 19,689 21,162 19,689 19,924 56,915 57,387 
Total debt securities AFS$102,319 $106,113 $20,868 $22,400 $20,868 $21,162 $144,055 $149,675 
 
Financing Activities

Deposits

Total deposits increased $167,805,000 from December 31, 2019 to September 30, 2020. The increase in core deposits (deposits less time deposits) has provided relationship driven funding for the loan and investment portfolios. Driving deposit growth was the receipt of PPP funding by commercial customers, stimulus funding by retail customers, and customers becoming more risk adverse and seeking safety in a bank deposit. Emphasis during 2020 has been on increasing the utilization of electronic (internet and mobile) deposit banking among our customers. Utilization of internet and mobile banking has increased since the start of 2020 due to these efforts coupled with a change in consumer behavior due to the business and travel restrictions caused by the COVID-19 pandemic.

Deposit balances and their changes for the periods being discussed follow:
 September 30, 2020December 31, 2019Change
(In Thousands)Amount% TotalAmount% TotalAmount%
Demand deposits$434,248 29.11 %$334,746 25.28 %$99,502 29.72 %
NOW accounts268,463 18.00 218,605 16.51 49,858 22.81 
Money market deposits274,480 18.40 216,038 16.32 58,442 27.05 
Savings deposits202,781 13.59 176,732 13.35 26,049 14.74 
Time deposits311,838 20.90 377,884 28.54 (66,046)(17.48)
 Total deposits$1,491,810 100.00 %$1,324,005 100.00 %$167,805 12.67 %

Borrowed Funds

Total borrowed funds increased 1.02%, or $1,703,000, to $168,543,000 at September 30, 2020 compared to $166,840,000 at December 31, 2019. The decrease in long term borrowings occurred as fixed rate borrowings matured. Securities sold under agreement to repurchase have increased as customers balances have increased..
 September 30, 2020December 31, 2019Change
(In Thousands)Amount% TotalAmount% TotalAmount%
Short-term borrowings:      
FHLB repurchase agreements$— — %$— — %$— n/a
Securities sold under agreement to repurchase15,009 8.91 4,920 2.95 10,089 205.06 
Total short-term borrowings15,009 8.91 4,920 2.95 10,089 205.06 
Long-term borrowings:
Long-term FHLB borrowings148,000 87.80 156,333 93.70 (8,333)(5.33)
Long-term finance lease5,534 3.28 5,587 3.35 (53)(0.95)
Total long-term borrowings153,534 91.09 161,920 97.05 (8,386)(5.18)
Total borrowed funds$168,543 100.00 %$166,840 100.00 %$1,703 1.02 %

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Short-Term Borrowings

The following table provides further information in regards to secured borrowings that have been accounted for as repurchase agreements.
Remaining Contractual Maturity Overnight and Continuous
(In Thousands)September 30, 2020December 31, 2019
Investment debt securities pledged, fair value$22,797 $6,752 
Repurchase agreements15,009 4,920 

Capital

The adequacy of the Company’s capital is reviewed on an ongoing basis with reference to the size, composition, and quality of the Company’s resources and regulatory guidelines.  Management seeks to maintain a level of capital sufficient to support existing assets and anticipated asset growth, maintain favorable access to capital markets, and preserve high quality credit ratings.

Banking institutions are generally required to comply with risk-based capital guidelines set by bank regulatory agencies.  The risk-based capital rules are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and to minimize disincentives for holding liquid assets.  Specifically, each is required to maintain certain minimum dollar amounts and ratios of common equity tier I risk-based, tier I risk-based, total risk-based, and tier I leverage capital. In addition to the capital requirements, the Federal Deposit Insurance Corporation Improvements Act ("FDICIA") established five capital categories for banks ranging from “well capitalized” to “critically undercapitalized” for purposes of the FDIC's prompt corrective action rules. To be classified as “well capitalized” under the prompt corrective action rules, common equity tier I risk-based, tier I risked-based, total risk-based, and tier I leverage capital ratios must be at least 6.5%, 8%, 10%, and 5%, respectively.

Under existing capital rules, the minimum capital to risk-adjusted assets requirements for banking organizations, are a common equity tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”), a tier 1 capital ratio of 6.0% (8.0% to be considered “well capitalized”), and total capital ratio of 8.0% (10.0% to be considered “well capitalized”).  Under existing capital rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. 





















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The Company's capital ratios as of September 30, 2020 and December 31, 2019 were as follows:
 September 30, 2020December 31, 2019
(In Thousands)AmountRatioAmountRatio
Common Equity Tier I Capital (to Risk-weighted Assets)    
Actual$145,909 10.803 %$140,372 10.674 %
For Capital Adequacy Purposes60,779 4.500 59,179 4.500 
Minimum To Maintain Capital Conservation Buffer At Reporting Date94,544 7.000 92,056 7.000 
To Be Well Capitalized87,791 6.500 85,480 6.500 
Total Capital (to Risk-weighted Assets)    
Actual$156,697 11.992 %$149,748 11.387 %
For Capital Adequacy Purposes104,534 8.000 105,206 8.000 
Minimum To Maintain Capital Conservation Buffer At Reporting Date137,201 10.500 138,083 10.500 
To Be Well Capitalized130,668 10.000 131,508 10.000 
Tier I Capital (to Risk-weighted Assets)    
Actual$145,909 11.166 %$140,372 10.674 %
For Capital Adequacy Purposes78,404 6.000 78,905 6.000 
Minimum To Maintain Capital Conservation Buffer At Reporting Date111,072 8.500 111,782 8.500 
To Be Well Capitalized104,538 8.000 105,207 8.000 
Tier I Capital (to Average Assets)    
Actual$145,909 8.400 %$140,372 8.514 %
For Capital Adequacy Purposes69,480 4.000 65,949 4.000 
To Be Well Capitalized86,851 5.000 82,436 5.000 
 
Jersey Shore State Bank's capital ratios as of September 30, 2020 and December 31, 2019 were as follows:
 September 30, 2020December 31, 2019
(In Thousands)AmountRatioAmountRatio
Common Equity Tier I Capital (to Risk-weighted Assets)    
Actual$102,099 10.964 %$99,317 10.381 %
For Capital Adequacy Purposes41,905 4.500 43,052 4.500 
Minimum To Maintain Capital Conservation Buffer At Reporting Date65,185 7.000 66,970 7.000 
To Be Well Capitalized60,529 6.500 62,187 6.500 
Total Capital (to Risk-weighted Assets)    
Actual$110,264 11.841 %$106,093 11.089 %
For Capital Adequacy Purposes74,496 8.000 76,539 8.000 
Minimum To Maintain Capital Conservation Buffer At Reporting Date97,777 10.500 100,458 10.500 
To Be Well Capitalized93,121 10.000 95,674 10.000 
Tier I Capital (to Risk-weighted Assets)- - 
Actual$102,099 10.964 %$99,317 10.381 %
For Capital Adequacy Purposes55,873 6.000 57,403 6.000 
Minimum To Maintain Capital Conservation Buffer At Reporting Date79,154 8.500 81,321 8.500 
To Be Well Capitalized74,498 8.000 76,538 8.000 
Tier I Capital (to Average Assets)    
Actual$102,099 7.724 %$99,317 8.191 %
For Capital Adequacy Purposes52,874 4.000 48,501 4.000 
To Be Well Capitalized66,092 5.000 60,626 5.000 



46



Luzerne Bank's capital ratios as of September 30, 2020 and December 31, 2019 were as follows:
 September 30, 2020December 31, 2019
(In Thousands)AmountRatioAmountRatio
Common Equity Tier I Capital (to Risk-weighted Assets)    
Actual$39,887 10.623 %$38,340 10.577 %
For Capital Adequacy Purposes16,896 4.500 16,312 4.500 
Minimum To Maintain Capital Conservation Buffer At Reporting Date26,283 7.000 25,374 7.000 
To Be Well Capitalized24,406 6.500 23,562 6.500 
Total Capital (to Risk-weighted Assets)    
Actual$42,359 11.281 %$40,940 11.295 %
For Capital Adequacy Purposes30,039 8.000 28,997 8.000 
Minimum To Maintain Capital Conservation Buffer At Reporting Date39,426 10.500 38,058 10.500 
To Be Well Capitalized37,549 10.000 36,246 10.000 
Tier I Capital (to Risk-weighted Assets)    
Actual$39,887 10.623 %$38,340 10.577 %
For Capital Adequacy Purposes22,529 6.000 21,749 6.000 
Minimum To Maintain Capital Conservation Buffer At Reporting Date31,916 8.500 30,811 8.500 
To Be Well Capitalized30,038 8.000 28,999 8.000 
Tier I Capital (to Average Assets)    
Actual$39,887 7.946 %$38,340 8.653 %
For Capital Adequacy Purposes20,079 4.000 17,723 4.000 
To Be Well Capitalized25,099 5.000 22,154 5.000 

Liquidity; Interest Rate Sensitivity and Market Risk

The asset/liability committee addresses the liquidity needs of the Company to ensure that sufficient funds are available to meet credit demands and deposit withdrawals as well as to the placement of available funds in the investment portfolio.  In assessing liquidity requirements, equal consideration is given to the current position as well as the future outlook.

The following liquidity measures are monitored for compliance and were within the limits cited at September 30, 2020:

1.            Net Loans to Total Assets, 85% maximum
2.              Net Loans to Total Deposits, 100% maximum
3.              Cumulative 90 day Maturity GAP %, +/- 20% maximum
4.              Cumulative 1 Year Maturity GAP %, +/- 25% maximum

Fundamental objectives of the Company’s asset/liability management process are to maintain adequate liquidity while minimizing interest rate risk. The maintenance of adequate liquidity provides the Company with the ability to meet its financial obligations to depositors, loan customers, and shareholders. Additionally, it provides funds for normal operating expenditures and business opportunities as they arise.  The objective of interest rate sensitivity management is to increase net interest income by managing interest sensitive assets and liabilities in such a way that they can be repriced in response to changes in market interest rates.

The Banks, like other financial institutions, must have sufficient funds available to meet liquidity needs for deposit withdrawals, loan commitments and originations, and expenses. In order to control cash flow, the Banks estimate future cash flows from deposits, loan payments, and investment security payments. The primary sources of funds are deposits, principal and interest payments on loans and investment securities, FHLB borrowings, and brokered deposits. Management believes the Banks have adequate resources to meet their normal funding requirements.

Management monitors the Company’s liquidity on both a long and short-term basis, thereby providing management necessary information to react to current balance sheet trends. Cash flow needs are assessed and sources of funds are determined. Funding strategies consider both customer needs and economical cost. Both short and long-term funding needs are addressed by
47

maturities and sales of available for sale and trading investment securities, loan repayments and maturities, and liquidating money market investments such as federal funds sold. The use of these resources, in conjunction with access to credit, provides core funding to satisfy depositor, borrower, and creditor needs.

Management monitors and determines the desirable level of liquidity. Consideration is given to loan demand, investment opportunities, deposit pricing and growth potential, as well as the current cost of borrowing funds. The Company has a total current maximum borrowing capacity at the FHLB of $590,455,000. In addition to this credit arrangement, the Company has additional lines of credit with correspondent banks of $57,000,000. Management believes it has sufficient liquidity to satisfy estimated short-term and long-term funding needs. FHLB borrowings totaled $148,000,000 as of September 30, 2020.

Interest rate sensitivity, which is closely related to liquidity management, is a function of the repricing characteristics of the Company’s portfolio of assets and liabilities. Asset/liability management strives to match maturities and rates between loan and investment security assets with the deposit liabilities and borrowings that fund them. Successful asset/liability management results in a balance sheet structure which can cope effectively with market rate fluctuations. The matching process segments both assets and liabilities into future time periods (usually 12 months, or less) based upon when repricing can be effected. Repriceable assets are subtracted from repriceable liabilities for a specific time period to determine the “gap”, or difference. Once known, the gap is managed based on predictions about future market interest rates. Intentional mismatching, or gapping, can enhance net interest income if market rates move as predicted.  However, if market rates behave in a manner contrary to predictions, net interest income will suffer. Gaps, therefore, contain an element of risk and must be prudently managed. In addition to gap management, the Company has an asset/liability management policy which incorporates a market value at risk calculation which is used to determine the effects of interest rate movements on shareholders’ equity and a simulation analysis to monitor the effects of interest rate changes on the Company’s consolidated balance sheet.

The Company currently maintains a gap position of being asset sensitive.  The Company has strategically taken this position as it has decreased the duration of the earning asset portfolio by adding quality short and intermediate term loans such as home equity loans and the selling of long-term municipal bonds.  Lengthening of the liability portfolio is being undertaken to build protection in a rising rate environment.

A market value at risk calculation is utilized to monitor the effects of interest rate changes on the Company’s balance sheet and more specifically shareholders’ equity.  The Company does not manage the balance sheet structure in order to maintain compliance with this calculation.  The calculation serves as a guideline with greater emphasis placed on interest rate sensitivity.  Changes to calculation results from period to period are reviewed as changes in results could be a signal of future events.  As of the most recent analysis, the results of the market value at risk calculation were within established guidelines due to the strategic direction being taken.

Interest Rate Sensitivity

In this analysis the Company examines the result of a 100, 200, 300, and 400 basis point change in market interest rates and the effect on net interest income. It is assumed that the change is instantaneous and that all rates move in a parallel manner.  Assumptions are also made concerning prepayment speeds on mortgage loans and mortgage securities.

The following is a rate shock forecast for the twelve month period ending September 30, 2021 assuming a static balance sheet as of September 30, 2020.
 Parallel Rate Shock in Basis Points
(In Thousands)-200-100Static+100+200+300+400
Net interest income$43,127 $46,332 $49,517 $51,642 $53,759 $55,648 $57,484 
Change from static(6,390)(3,185)— 2,125 4,242 6,131 7,967 
Percent change from static-12.90 %-6.43 %— 4.29 %8.57 %12.38 %16.09 %
 
The model utilized to create the report presented above makes various estimates at each level of interest rate change regarding cash flow from principal repayment on loans and mortgage-backed securities and/or call activity on investment securities.  Actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change.  In addition, the limits stated above do not necessarily represent the level of change under which management would undertake specific measures to realign its portfolio in order to reduce the projected level of change.  Generally, management believes the Company is well positioned to respond expeditiously when the market interest rate outlook changes.

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Inflation

The asset and liability structure of a financial institution is primarily monetary in nature.  Therefore, interest rates rather than inflation have a more significant impact on the Company’s performance.  Interest rates are not always affected in the same direction or magnitude as prices of other goods and services, but are reflective of fiscal policy initiatives or economic factors which are not measured by a price index.

COVID-19 Impact
Employees
The Company has undertaken various actions to maintain a safe work environment for employees during the pandemic, including supplying employees with hand sanitizer, face masks, disinfecting supplies, and gloves. The Company has also allowed approximately one-third of the workforce to work remotely in accordance with the Company’s pre-existing business continuity plans, while also maintaining data security and internal controls. Permitting employees to work remotely has allowed for increased social distancing capabilities within the Company’s buildings. To protect employees and customers and promote social distancing, branch lobbies were closed, other than by appointment, until early June at which time lobbies were reopened with sneeze guards in place and foot traffic being directed in a manner that encourages proper social distancing. During the lobby closure and continuing to today, drive-thru, mobile banking, and internet banking have become more popular channels for customers to complete transactions.
The change to a “drive-thru” only strategy until early June coupled with the mandated closure of nonessential businesses in Pennsylvania for a part of the second quarter led to a reduced workload in certain areas of the Company. As a result, approximately 80 employees were furloughed and other employees had their normal work week hours reduced. As businesses have been reopening, the Company has called back all but a few of the previously furloughed employees. Because the Company views its employees as a critical resource, it took certain steps to mitigate the negative impact on them of workforce disruption: for employees who were furloughed, the Company paid 100% of their health insurance premiums; employees who had hours reduced were paid based on their pre-reduction average normal working hours; and a bonus of $50 per week was paid to employees working in customer servicing areas.
Liquidity
The Company has focused on increasing balance sheet liquidity by means of increased levels of cash within the branches and ATMs, and within correspondent bank accounts. Deposit growth has provided liquidity as commercial customers received PPP funding, retail customers received stimulus funding, and customers became more risk averse and sought greater safety in bank deposits. In addition to the buildup in cash reserves, the Company has remaining borrowing capacity of approximately $499,455,000 with the FHLB and other correspondent banks. The Company anticipates slowly reducing the amount of cash reserves as the economy is reopened and the rate of infections declines. The Company believes that it currently has sufficient liquidity to meet customer needs and the Company’s financial obligations based on present circumstances.
Loans
The mandated closure of nonessential businesses and the closure or limited access to many government offices, including court houses, during a portion of the second quarter, has limited the addition of new loans to the portfolio; however loan demand during the third quarter has rebounded. Indirect auto lending was completely closed for several weeks beginning in late March 2020, and reopened on a full scale during the later part of the second quarter. Secondary mortgage market activity continues to flourish as individuals seek to refinance at historically low interest rates. As businesses continue to reopen, the Company anticipates utilizing its strong liquidity position to offer favorable lending terms to its customers to assist them in returning to normal operations and to grow their businesses.
The yield on the loan portfolio has declined, as the low rate environment has resulted in any new loans generated and any loans repricing to be at yields less than the historical average yield of the portfolio. The Company expects the loan portfolio yield to continue to decline due to the projected low rate environment caused by the COVID-19 pandemic. Looking forward, as in the past, the Company’s focus for building the loan portfolio will be on quality of the credit, not necessarily yield.
The Company participated in the Paycheck Protection Program (“PPP”). The Company booked $12.3 million in loans directly into the PPP and also utilized a third party to match customer needs with a lending outlet. This method did not result in the Company earning any processing fees under the PPP for loans extended by others, but was the quickest manner to service the greatest number of customers resulting in 586 customers obtaining $57.4 million in funding. The goal was to have as many customers as possible receive requested funding before PPP funding expired, even if the Company did not recognize fee income from making the loans.
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Loan modifications and payment deferrals have been at historical high levels as the impact of the pandemic continues. As of September 30, 2020 rate modifications or payment deferrals up to 180 days have been granted on loans with an aggregate balance of $230.3 million. Loan modifications met applicable requirements to not be considered troubled debt restructurings. The number of customers seeking loan modifications or payment deferrals may increase as the effects of the pandemic continue.
The Company has not to date experienced significant credit quality deterioration. However, the provision for loan losses for the three and nine months ended September 30, 2020 was increased to $645,000 and $2.0 million (from $360,000 and $1.0 million for the corresponding periods of 2019) and is expected to remain at levels above those historically reported. The increase in the provision for the three and nine months ended September 30, 2020 is the result of the uncertainty surrounding the strength of the economy as businesses reopen and communities in general attempt to return to pre-pandemic life. From an industry concentration perspective, the Company has minimal exposure to the hospitality and travel industries, which have been greatly affected by the pandemic. The Company does, however, have some potential exposure to student housing in markets such as State College and Williamsport, Pennsylvania; this potential exposure continues to be monitored and to date has not resulted in any credit quality concerns.
Investments
The Company’s investment portfolio is weighted toward municipal bonds and, to a lesser extent, corporate bonds. The credit quality of the investment portfolio continues to be monitored for impairment. The reinvestment of cash flows from the investment portfolio is being focused primarily on bonds with solid credit quality and a final maturity before 2027. The Company continues to limit investments in equity securities due to the significant fluctuations in pricing, uncertain economic future, and the belief that the adverse impact of the COVID-19 pandemic may continue for some time.
Deposits
The impact of the COVID-19 pandemic on the deposit portfolio has been lower rates with an increase in balances. Rates were significantly reduced toward the end of March and beginning April as the Federal Reserve took steps to mitigate the negative economic impact of the pandemic. Although rates have been reduced, in many cases the amount of the rate reduction on the deposit side has not coincided with the amount of rate reduction occurring within the loan portfolio because of the already historically low levels of deposit rates. In many cases, rates on non-maturity deposit products have reduced to levels below 10bps. Time deposits have experienced a significant reduction in rate, with rates for terms less than twelve months being below the current cost of overnight funding from the FHLB or other correspondent banks.
The deposit portfolio has experienced significant growth with a correlation drawn to the stimulus checks sent to certain taxpayers by the federal government under the CARES Act, PPP funding, and customers becoming more risk averse and seeking safety in bank deposits . Although the stimulus checks provided funding, lower debit and credit card usage has resulted in fewer withdrawals from deposit accounts.
Net Interest Margin
For the reasons noted in the loan, investment, and deposit sections above, the Company anticipates that the net interest margin will compress as the COVID-19 pandemic continues. Although the Company has taken actions to lower the cost of funding, the yield on earning assets continues to decrease due to the volume of loan modifications and the historically low interest rate environment. As the impact of the COVID-19 pandemic lessens, the Company does not anticipate significant increases in the net interest margin quickly. The Company anticipates granting favorable lending terms to assist the economic recovery of the communities in which the Company operates, while anticipated competition for deposits is expected to increase in funding costs.
Non-Interest Income
Two areas of non-interest income have experienced a significant reduction during the nine months ended September 30, 2020 due to the COVID-19 pandemic. Overdraft fees and debit card income have been reduced by approximately one-third. The mandated closure of nonessential businesses coupled with shelter in place orders during the end of the first quarter and into the second quarter have resulted in a reduction in the overall number and the amount of purchases by individuals. The Company anticipates that a return to historical levels for these two non-interest income items could be months after the COVID-19 pandemic wanes and consumer behavior may take significant time to return to normal. Buoying non-interest income during the nine months ended September 30, 2020 was the gain on sale of loans as the volume of mortgage refinancing has increased due to the historically low rates. The Company has focused on its mortgage business line and anticipates the strong third quarter to continue into the fourth quarter in this business line due to the number of individuals expected to refinance existing mortgages.
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Non-Interest Expense
The level of non-interest expense is not expected to change significantly due to the COVID-19 pandemic. Although the Company furloughed certain employees, any compensation expense savings was significantly offset by the Company’s paying 100% of the health insurance for furloughed employees and the weekly bonus being paid to customer service employees who remained working. Other expenses may remain above historical levels as items such as sanitizer, disinfectant, gloves, masks, sneeze guards, directional/social distancing signage, and other safety items continue to be purchased.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Market risk for the Company is comprised primarily of interest rate risk exposure and liquidity risk.  Interest rate risk and liquidity risk management is performed at both the level of the Company and the Banks.  The Company’s interest rate sensitivity is monitored by management through selected interest rate risk measures produced by an independent third party.  There have been no substantial changes in the Company’s gap analysis or simulation analysis compared to the information provided in the Annual Report on Form 10-K for the period ended December 31, 2019.  Additional information and details are provided in the “Liquidity, Interest Rate Sensitivity, and Market Risk” section of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Generally, management believes the Company is well positioned to respond in a timely manner when the market interest rate outlook changes.

Item 4.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An analysis was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2020.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2020 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Part II.  OTHER INFORMATION
Item 1.                           Legal Proceedings
 
None.

Item 1A.  Risk Factors
 
Certain risk factors are set forth in Part I, Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, as supplemented by the risk factor included in the Company's Form 10-Q for the quarter ended June 30, 2020.  Please refer to such filings for disclosures regarding the risks and uncertainties related to the Company’s business.

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

The following table provides certain information with respect to the Company's repurchase of common stock during the quarter ended September 30, 2020.
PeriodTotal
Number of
Shares (or
Units) Purchased		Average
Price Paid
per Share
(or Units) Purchased		Total Number of
Shares (or Units)
Purchased as Part of
Publicly Announced Plans or Programs		Maximum Number (or
Approximate Dollar Value)
of Shares (or Units) that
May Yet Be Purchased Under the Plans or Programs
Month #1 (July 1 - July 31, 2020)— — — 513,669 
Month #2 (August 1 - August 31, 2020)— — — 513,669 
Month #3 (September 1 - September 30, 2020)— — — 513,669 

On April 30, 2020, the Board of Directors extended the previously approved authorization to repurchase up to 723,000 shares, or approximately 10%, of the outstanding shares of the Company for an additional year to April 30, 2021.  As of September 30, 2020 there have been 209,331 shares repurchased under this plan.



Item 3.                           Defaults Upon Senior Securities
 
None.
 
Item 4.                           Mine Safety Disclosures
 
Not applicable.
 
Item 5.                           Other Information
 
None.
 
52
Table of Contents

Item 6.                           Exhibits
 
 Articles of Incorporation of the Registrant, as presently in effect (incorporated by reference to Exhibit 3(i) of the Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 2019).
 Bylaws of the Registrant (incorporated by reference to Exhibit 3(ii) of the Registrant's Quarterly Report on Form 10-Q for the period ended March 31, 2020).
 Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer.
 Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Financial Officer.
 Section 1350 Certification of Chief Executive Officer.
 Section 1350 Certification of Chief Financial Officer.
101 Interactive data file containing the following financial statements formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheet at September 30, 2020 and December 31, 2019; (ii) the Consolidated Statement of Income for the three and nine months ended September 30, 2020 and 2019; (iii) Consolidated Statement of Comprehensive Income for the three and nine months ended September 30, 2020 and 2019; (iv) the Consolidated Statement of Shareholders’ Equity for the three and nine months ended September 30, 2020 and 2019; (v) the Consolidated Statement of Cash Flows for the nine months ended September 30, 2020 and 2019 and (vi) the Notes to Consolidated Financial Statements. As provided in Rule 406T of Regulation S-T, this interactive data file shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, and shall not be deemed “filed” or part of any registration statement or prospectus for purposes of Section 11 or 12 under the Securities Act of 1933, or otherwise subject to liability under those sections.
53

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.
 
 PENNS WOODS BANCORP, INC.
 (Registrant)
  
Date:    November 9, 2020/s/ Richard A. Grafmyre
 Richard A. Grafmyre, Chief Executive Officer
 (Principal Executive Officer)
  
  
Date:November 9, 2020/s/ Brian L. Knepp
 Brian L. Knepp, President and Chief Financial Officer
 (Principal Financial Officer and Principal Accounting
 Officer)
54

EXHIBIT INDEX
 
Exhibit 3(i)Articles of Incorporation of the Registrant, as presently in effect (incorporated by reference to Exhibit 3(i) of the Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 2019).
Exhibit 3(ii)Bylaws of the Registrant (incorporated by reference to Exhibit 3(ii) of the Registrant's Quarterly Report on Form 10-Q for the period ended March 31, 2020).
Exhibit 31(i) Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer
Exhibit 31(ii) Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Financial Officer
Exhibit 32(i) Section 1350 Certification of Chief Executive Officer
Exhibit 32(ii) Section 1350 Certification of Chief Financial Officer
Exhibit 101 Interactive data file containing the following financial statements formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheet at September 30, 2020 and December 31, 2019; (ii) the Consolidated Statement of Income for the three and nine months ended September 30, 2020 and 2019; (iii) Consolidated Statement of Comprehensive Income for the three and nine months ended September 30, 2020 and 2019; (iv) the Consolidated Statement of Shareholders’ Equity for the three and nine months ended September 30, 2020 and 2019; (v) the Consolidated Statement of Cash Flows for the nine months ended September 30, 2020 and 2019 and (vi) the Notes to Consolidated Financial Statements. As provided in Rule 406T of Regulation S-T, this interactive data file shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, and shall not be deemed “filed” or part of any registration statement or prospectus for purposes of Section 11 or 12 under the Securities Act of 1933, or otherwise subject to liability under those sections.
55

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