Item 2
– Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)
This Quarterly Report should be read in conjunction with the more detailed and comprehensive disclosures included in the Annual Report on Form 10-K for the year ended December 31, 201
6 and Forms 10-Q for the quarters ended March 31, 2017 and June 30, 2017 for FNCB Bancorp, Inc. and subsidiaries (collectively “FNCB”). In addition, please read this section in conjunction with the consolidated financial statements and notes to consolidated financial statements contained elsewhere herein.
FNCB
is in the business of providing customary retail and commercial banking services to individuals, businesses and local governments within its primary market area located in Northeastern Pennsylvania.
FORWARD-LOOKING STATEMENTS
FNCB
may from time to time make written or oral “forward-looking statements,” including statements contained in our filings with the Securities and Exchange Commission (“SEC”), in reports to shareholders, and in our other communications, which are made in good faith by us pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include statements with respect to
FNCB’s beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond our control). The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause FNCB’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in our markets; the effects of, and changes in trade, monetary, corporate tax and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the timely development of and acceptance of new products and services; the ability of FNCB to compete with other institutions for business; the composition and concentrations of FNCB’s lending risk and the adequacy of our reserves to manage those risks; the valuation of FNCB’s investment securities; the ability of FNCB to pay dividends or repurchase common shares; the ability of FNCB to retain key personnel; the impact of any pending or threatened litigation against FNCB; the marketability of shares of FNCB stock and fluctuations in the value of FNCB’s share price; the effectiveness of FNCB’s system of internal controls; the ability of FNCB to attract additional capital investment; the impact of changes in financial services’ laws and regulations (including laws concerning capital adequacy, taxes, banking, securities and insurance); the impact of technological changes and security risks upon our information technology systems; changes in consumer spending and saving habits; the nature, extent, and timing of governmental actions and reforms, and the success of FNCB at managing the risks involved in the foregoing and other risks and uncertainties, including those detailed in FNCB’s filings with the SEC.
FNCB
cautions that the foregoing list of important factors is not all inclusive. Readers are also cautioned not to place undue reliance on any forward-looking statements, which reflect management’s analysis only as of the date of this report, even if subsequently made available by FNCB on its website or otherwise. FNCB does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of FNCB to reflect events or circumstances occurring after the date of this report.
Readers should carefully review the risk factors described in the Annual Report and other documents that
FNCB periodically files with the SEC, including its Form 10-K for the year ended December 31, 2016.
CRITICAL ACCOUNTING POLICIES
In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of condition and results of operations for the periods indicated. Actual results could differ significantly from those estimates.
FNCB
’s accounting policies are fundamental to understanding management’s discussion and analysis of its financial condition and results of operations. Management has identified the policies on the determination of the allowance for loan and lease losses (“ALLL”), securities’ valuation and impairment evaluation, the valuation of other real estate owned (“OREO”) and income taxes to be critical, as management is required to make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available.
The judgments used by management in applying the critical accounting policies discussed below may be affected by
changes and/or deterioration in the economic environment, which may impact future financial results. Specifically, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the ALLL in future periods, and the inability to collect on outstanding loans could result in increased loan losses. In addition, the valuation of certain securities in FNCB’s investment portfolio could be negatively impacted by illiquidity or dislocation in marketplaces resulting in significantly depressed market prices thus leading to impairment losses.
Allowance for Loan and Lease Losses
Management evaluates the credit quality of
FNCB’s loan portfolio on an ongoing basis, and performs a formal review of the adequacy of the ALLL on a quarterly basis. The ALLL is established through a provision for loan losses charged to earnings and is maintained at a level management considers adequate to absorb estimated probable losses inherent in the loan portfolio as of the evaluation date. Loans, or portions of loans, determined by management to be uncollectible are charged off against the ALLL, while recoveries of amounts previously charged off are credited to the ALLL.
Determining the amount of the ALLL is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, qualitative factors, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. Banking regulators, as an integral part of their examination of
FNCB, also review the ALLL, and may require, based on their judgments about information available to them at the time of their examination, that certain loan balances be charged off or require that adjustments be made to the ALLL. Additionally, the ALLL is determined, in part, by the composition and size of the loan portfolio.
The ALLL consists of two components, a specific component and a general component. The specific component relates to loans that are classified as impaired. For such loans, an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans and is based on historical loss experience adjusted by qualitative factors. The general reserve component of the ALLL is based on pools of unimpaired loans segregated by loan segment and risk rating categories of “Pass”, “Special Mention” or “Substandard and Accruing.” Historical loss factors and various qualitative factors are applied based on the risk profile in each risk rating category to determine the appropriate reserve related to those loans. Substandard loans on nonaccrual status above the $100 thousand loan relationship threshold and all loans considered troubled debt restructurings (“TDRs”) are classified as impaired.
See N
ote 4, “Loans” of the notes to consolidated financial statements included in Item 1 hereof for additional information about the ALLL.
Securities Valuation
and Evaluation for Impairment
Management utilizes various inputs to determine the fair value of its investment portfolio. To the extent they exist, unadjusted quoted market prices in active markets (Level 1) or quoted prices for similar assets or models using inputs that are observable, either directly or indirectly (Level 2) are utilized to determine the fair value of each investment in the portfolio. In the absence of observable inputs or if markets are illiquid, valuation techniques are used to determine fair value of any investments that require inputs that are both unobservable and significant to the fair value measurement (Level 3). For Level 3 inputs, valuation techniques are based on various assumptions, including, but not limited to, cash flows, discount rates, adjustments for nonperformance and liquidity, and liquidation values. A significant degree of judgment is involved in valuing investments using Level 3 inputs. The use of different assumptions could have a positive or negative effect on
FNCB’s financial condition or results of operations. See Note 3, “Securities” and Note 11, “Fair Value Measurements” of the notes to consolidated financial statements included in Item 1 hereof for additional information about FNCB’s securities valuation techniques.
On a quarterly basis, management evaluates individual investment securities
in an unrealized loss position for other than temporary impairment (“OTTI”). The analysis of OTTI requires the use of various assumptions, including but not limited to, the length of time an investment’s fair value is less than book value, the severity of the investment’s decline, any credit deterioration of the issuer, whether management intends to sell the security, and whether it is more likely than not that FNCB will be required to sell the security prior to recovery of its amortized cost basis. Debt investment securities deemed to have OTTI are written down by the impairment related to the estimated credit loss, and the non-credit related impairment loss is recognized in other comprehensive income. FNCB did not recognize OTTI charges on investment securities for the nine months ended September 30, 2017 and 2016 within the consolidated statements of income.
Refer to
Note 3, “Securities” of the notes to consolidated financial statements included in Item 1 hereof for additional information about valuation of securities.
Other Real Estate Owned
OREO consists of property acquired by foreclosure, abandonment or conveyance of deed in-lieu of foreclosure of a loan, and bank premises that
are no longer used for operation or for future expansion. OREO is held for sale and is initially recorded at fair value less costs to sell at the date of acquisition or transfer, which establishes a new cost basis. Upon acquisition of the property through foreclosure or deed-in-lieu of foreclosure, any adjustment to fair value less estimated selling costs is recorded to the ALLL. The determination is made on an individual asset basis. Bank premises no longer used for operations or future expansion are transferred to OREO at fair value less estimated selling costs with any related write-down included in non-interest expense. Subsequent to acquisition, valuations are periodically performed and the assets are carried at the lower of cost or fair value less cost to sell. Fair value is determined through external appraisals, current letters of intent, broker price opinions or executed agreements of sale, unless management determines that conditions exist that warrant an adjustment to the value. Costs relating to the development and improvement of the OREO properties may be capitalized; holding period costs and any subsequent changes to the valuation allowance are charged to expense as incurred.
Income Taxes
The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity
’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in FNCB’s consolidated financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could impact our consolidated financial condition or results of operations.
FNCB
records an income tax provision or benefit based on the amount of tax, including alternative minimum tax, currently payable or receivable and the change in deferred tax assets and liabilities. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial and tax reporting purposes. Management conducts quarterly assessments of all available positive and negative evidence to determine the amount of deferred tax assets that will more likely than not be realized. FNCB establishes a valuation allowance for deferred tax assets and records a charge to income if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, management considers past operating results, estimates of future taxable income based on approved business plans, future capital requirements and ongoing tax planning strategies. This evaluation process involves significant management judgment about assumptions that are subject to change from period to period depending on the related circumstances. The recognition of deferred tax assets requires management to make significant assumptions and judgments about future earnings, the periods in which items will impact taxable income, future corporate tax rates, and the application of inherently complex tax laws. The use of different estimates can result in changes in the amounts of deferred tax items recognized, which may result in equity and earnings volatility because such changes are reported in current period earnings.
FNCB uses the current statutory tax rate of 34.0% to value its deferred tax assets and liabilities.
On September 27, 2017, the Trump Administration released a tax reform framework that includes a reduction in the U.S. corporate income tax rate to 20.0%. If corporate tax rates are reduced, management expects FNCB would be required to record an initial charge against earnings to lower the carrying amount of its net deferred tax asset, and then, going forward, would record lower tax provisions on an ongoing basis. The House of Representatives is currently working on a draft of the bill, which is expected to be addressed by Congress later in 2017. It is too early to determine if any of the proposals on tax reform are actionable, or if acted upon, the specific tax reforms that would be implemented. Accordingly, management cannot assess the effect that any tax reform measure effectuated would have on FNCB’s operating results or financial position at the present time.
In connection with determining the income tax provision or benefit,
management considers maintaining liabilities for uncertain tax positions and tax strategies that it believes contain an element of uncertainty. Periodically, management evaluates each of FNCB’s tax positions and strategies to determine whether a liability for uncertain tax benefits is required. As of September 30, 2017, and December 31, 2016, management determined that FNCB did not have any uncertain tax positions or tax strategies and that no liability was required to be recorded.
Refer to
Note 6, “Income Taxes” of the notes to consolidated financial statements included in Item 1 hereof for additional information about income taxes.
New Authoritative Accounting Guidance
and Accounting Guidance to be Adopted in Future Periods
Refer to Note 2, “New Authoritative Accounting Guidance” of the notes to consolidated financial statements included in Item 1 hereof for information
about new authoritative accounting guidance issued during the three months ended September 30, 2017, not previously reported, that will be adopted by FNCB in future periods.
Executive Summary
The following overview should be read in conjunction with this MD&A in its entirety.
On June 30, 2016, First National Community Bancorp, Inc., the parent company of First National Community Bank, announced that following receipt of required regulatory approvals from the Pennsylvania Department of Banking and Securities, First National Community Bank had completed a charter conversion from a national bank to a Pennsylvania state bank, and as a result of the conversion, First National Community Bank changed its legal name to FNCB Bank. Both the charter conversion and legal name change became effective June 30, 2016. On October 4, 2016, First National Community Bancorp, Inc., the parent company of FNCB Bank, filed an amendment to its articles of incorporation to change its name, effective October 17, 2016, to FNCB Bancorp, Inc. The Board of Directors of FNCB also amended the bylaws of FNCB, effective October 17, 2016, to reflect the new name.
FNCB recorded
consolidated net income of $2.3 million, or $0.14 per diluted common share, for the three-month period ended September 30, 2017, an increase of $0.3 million compared to net income of $2.0 million, or $0.12 per diluted common share, for the comparable three months of 2016. Net income for the nine months ended September 30, 2017 was $6.3 million, or $0.37 per diluted common share, an increase of $1.5 million, compared to net income of $4.8 million, or $0.29 per diluted common share, for the same period of 2016. The annualized return on average equity was 9.27% and 8.87%, respectively, for the three- and nine-month periods ended September 30, 2017, compared to 8.46% and 6.95%, respectively, for the comparable periods in 2016. For the three and nine months ended September 30, 2017, the annualized return on average assets was 0.80% and 0.74%, respectively, and 0.73% and 0.58%, respectively, for the same periods of 2016. FNCB paid dividends to holders of common stock of $0.03 per share for the three months ended September 30, 2017, totaling $0.09 per share for the year-to-date period of 2017. Dividends paid to holders of common stock were $0.02 per share and $0.06 per share for the three and nine months ended September 30, 2016, respectively. On October 25, 2017, the board of directors of FNCB declared a dividend of $0.04 per share for the fourth quarter of 2017, an increase of 33.3% compared the third quarter of 2017 and the fourth quarter of 2016. The fourth quarter dividend is payable on December 15, 2017 to shareholders of record as of December 1, 2017.
The $0.3 million, or 12.6
%, increase in earnings for the third quarter of 2017, as compared to the same quarter of 2016, was primarily due to increases in net interest income and non-interest income of $0.6 million and $0.3 million, respectively, coupled with a decrease of $0.2 million in non-interest expense. Partially offsetting these positive fluctuations was a provision for loan and lease losses of $0.5 million as compared to a credit for loan and lease losses of $0.2 million in 2016, and an increase of $0.1 million in income tax expense.
Year-to-date net income increased $1.
5 million, or 30.8%, comparing the nine months ended September 30, 2017 and 2016. The improvement in earnings was due primarily to an increase in net interest income of $1.4 million, or 6.2%, coupled with a decrease in the provision for loan and lease losses of $0.4 million, an increase in non-interest income of $0.5 million and a decrease in non-interest expense of $0.1 million. These improvements were partially offset by an increase in income tax expense of $0.9 million.
Total assets
decreased $38.5 million, or 3.2%, to $1.157 billion at September 30, 2017 from $1.196 billion at December 31, 2016. The change in total assets primarily resulted from a $68.6 million, or 61.0%, reduction in cash and cash equivalents, which was driven by a $31.9 million reduction in total deposits, coupled with the repayment of borrowed funds of $18.2 million. The decrease in total deposits was primarily attributable to the anticipated exit of short-term funds in the first quarter of 2017 related to the sale of a municipal utility in December 2016. The remainder of the reduction in cash and cash equivalents resulted from reinvestment into interest-earning assets, as net loans increased by $27.8 million, or 3.8%, and available-for-sale securities increased $6.0 million, or 2.2%.
Total shareholders
’ equity increased $7.1 million, or 7.9%, to $97.5 million at September 30, 2017 from $90.4 million at December 31, 2016. The capital improvement resulted primarily from net income for the first nine months of 2017 of $6.3 million, coupled with a $1.7 million increase in accumulated other comprehensive income, which resulted from appreciation in the fair value of available-for-sale securities net of the tax impact of the appreciation.
With a focus on diversity, furthering FNCB
’s strategic goals and strengthening corporate governance, on September 27, 2017, the board of directors of FNCB and the Bank elected three new independent members to the boards of both entities and approved the formation of a community advisory board. The addition of the new members extends both boards to 12 directors. The advisory board will consist of members from Northeastern Pennsylvania and the Lehigh Valley who will advise, support and serve as liaisons for the Bank in developing and furthering relationships with businesses and the community in our market area. The board of directors expects to fill advisory board positions in 2018. In addition to expanding the board and approving the formation of an advisory board, on September 27, 2017, the Board of Directors approved revisions to its Corporate Governance Guidelines to set a retirement age for FNCB’s and the Bank’s directors and executive officers. According to the approved revisions, no person can be nominated to serve as a Director after he or she has passed his or her 80
th
birthday. In the event that a director turns the age of 80 during his or her term as a Director, he or she may serve the remaining time of his or her term until his or her successor is duly elected and qualified or until the earlier of his or her death, resignation or removal. In addition, FNCB’s and the Bank’s executive officers are now subject to a mandatory retirement age of 75. Such retirement age may be waived for the President and Chief Executive Officer for strategic planning purposes in the sole discretion of the Board of Directors of FNCB and the Bank.
Throughout
the last quarter of 2017, and in preparation for 2018, management continues to be focused on developing strategies aimed at improving long-term financial performance by improving efficiency, increasing net interest income through commercial and retail loan growth initiatives, and developing additional sources of non-interest income. On January 20, 2017, FNCB opened a loan production office in Allentown, Lehigh County, Pennsylvania, and began offering its retail and commercial lending products in this new market area. Additionally, in order to facilitate loan growth initiatives, on March 7, 2017, FNCB opened a lending center immediately adjacent to its main office in Dunmore, Lackawanna County, Pennsylvania, which houses part of its commercial and retail lending units.
As part of its responsibilities, management regularly evaluates FNCB
’s delivery system and facilities including analyzing each office’s operating efficiency, location, foot traffic, structure and design. As a result of these evaluations, on May 1, 2017, FNCB announced that the Bank will implement a comprehensive branch network improvement program that will focus on strengthening, better positioning and expanding its market coverage by developing new state-of-the-art customer facilities, as well as relocating and consolidating select locations. In accordance with the branch network improvement program, on June 30, 2017, FNCB consolidated its branch office located at 1127 Texas Palmyra Highway, Honesdale, Wayne County, Pennsylvania with its branch located at 1001 Main Street, Honesdale, Pennsylvania.
As part of this network improvement program, FNCB announced its intention to relocate three branches located in Luzerne County, Pennsylvania to a new location
. The three branches that will be relocated are: 1) a branch located at 734 San Souci Parkway, Hanover Township, Pennsylvania; 2) a branch located at 27 North River Street, Plains, Pennsylvania; and 3) a branch located at 3 Old Boston Road, Pittston, Pennsylvania. These three branches will be relocated into a brand-new facility to be built in the Richland 315 development located at 1150 Route 315, Wilkes-Barre (Plains Township), Luzerne County, Pennsylvania. FNCB currently leases the three branches, as well as the aforementioned Honesdale branch, that was consolidated, and will lease the future Luzerne County facility. FNCB does not expect to incur any significant disposal costs on either the Wayne County or Luzerne County branch consolidations. The construction of this project is expected to begin in the fourth quarter of 2017 and be completed in the second quarter of 2018, at which time the consolidation will occur. The three existing branches will continue to operate as full-service branches until that time.
Following continued analysis of FNCB
’s locations and facilities, on September 27, 2017, the Board of Directors approved the purchase of the Bank’s corporate center located at 200 South Blakely Street, Dunmore, Pennsylvania, for $2.15 million. FNCB has been leasing this property since 1994. The purchase, which is scheduled to be finalized in January 2018, will be funded by cash generated by operations and is anticipated to reduce occupancy expenses in excess of $100,000 annually.
The program also calls for the continued evaluation of FNCB
’s delivery systems. In the second quarter of 2017, FNCB commenced a project to upgrade its entire automated teller machine network. In addition, management plans to evaluate the development of new state-of-the-art facilities on properties already owned by FNCB located in Taylor Borough, Lackawanna County, Pennsylvania and in Dunmore, Lackawanna County, Pennsylvania.
Summary of Performance
Net Interest Income
Net interest income is the difference between (i) interest income
, interest and fees on interest-earning assets, and (ii) interest expense, interest paid on deposits and borrowed funds. Net interest income represents the largest component of FNCB’s operating income and, as such, is the primary determinant of profitability. Net interest income is impacted by variations in the volume, rate and composition of earning assets and interest-bearing liabilities, changes in general market rates and the level of non-performing assets. Interest income is shown on a fully tax-equivalent basis and is calculated by adjusting tax-free interest using a marginal tax rate of 34.0% in order to equate the yield to that of taxable interest rates.
Since the first 25-basis point increase in the federal funds target rate on December 16, 2015, the Federal Open Market Committee (“FOMC”) increased the target rate a total of 75 basis points in three 25-basis point actions on December 14, 2016, March 15, 2017 and June 14, 2017. These actions resulted in corresponding increases in the national prime rate. At
September 30, 2017, the national prime rate was 4.25%, 75 basis points higher than 3.50% at September 30, 2016. FNCB experienced an increase in loan yields in the third quarter and year-to-date period of 2017 as compared to the same periods of 2016, as variable- and adjustable-rate loans have begun to reprice upward. The increase in market interest rates has also led to notable increases in funding costs, specifically FHLB borrowings. Deposit costs have also begun to increase, but to a lesser extent.
Net interest income on a tax-equivalent basis increased $0.
6 million, or 7.9%, to $8.5 million for the three months ended September 30, 2017 from $7.9 million for the comparable period of 2016. Tax-equivalent interest income increased $0.8 million, or 9.2%, to $9.7 million for the three months ended September 30, 2017 from $8.9 million for the same period of 2016. Partially offsetting the increase in tax-equivalent interest income was an increase in interest expense of $0.2 million, or 18.0%, which largely reflected an increase in interest expense paid on deposits, partially offset by a reduction in interest on borrowed funds. Tax-equivalent net interest margin, a key measurement used in the banking industry to measure income from earning assets relative to the cost to fund those assets, is calculated by dividing tax-equivalent net interest income by average interest-earning assets. FNCB’s tax-equivalent net interest margin improved 13 basis points to 3.27% for the third quarter of 2017 from 3.14% for the same quarter of 2016. Additionally, the tax-equivalent margin for the third quarter of 2017 was a 6-basis point improvement compared to 3.21% for the second quarter of 2017. Rate spread, the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities shown on a fully tax-equivalent basis, was 3.18% for the three months ended September 30, 2017, an increase of 12 basis points compared to 3.06% for the same period of 2016. FNCB’s tax-equivalent net interest margin and spread for the nine months ended September 30, 2017 each improved by 5 basis points as compared to the same period of 2016.
The $0.
8 million increase in tax-equivalent interest income comparing the third quarters of 2017 and 2016 was due primarily to an improvement in the tax-equivalent yield on earning assets of 19 basis points, which contributed $580 thousand to the increase in tax-equivalent interest income. Specifically, the tax-equivalent yields on loans, investment securities, and interest-bearing deposits with banks increased by 22 basis points, 21 basis points, and 78 basis points, respectively, contributing $414 thousand, $151 thousand, and $15 thousand, respectively, to the improvement in tax-equivalent interest income. Additionally, the average balance of earning assets increased by $36.8 million, which resulted in a corresponding increase in tax-equivalent interest income of $240 thousand. The increase was concentrated in the average balance of investment securities, which grew $29.6 million, or 11.3%, to $290.9 million for the three months ended September 30, 2017 from $261.3 million for the same three months of 2016, as the investment portfolio played a more prominent role in FNCB’s mix of earning assets. In addition, average loans grew $6.2 million, or 0.8%, comparing the third quarters of 2017 and 2016, contributing $45 thousand to the increase in tax-equivalent interest income.
Partially offsetting the improvement in tax-equivalent interest income was a $
195 thousand increase in interest expense comparing the third quarters of 2017 and 2016, which largely reflected a 7-basis point increase in the cost of funds to 0.59% for the three months ended September 30, 2017 from 0.52% for the comparable period of 2016. Partially offsetting the higher funding costs was a reduction in the average balance of borrowed funds. Interest expense paid on deposits for the third quarter of 2017 increased $239 thousand over the comparable quarter of 2016, which was driven by a 10-basis point increase in the average rate paid on deposits, resulting in an increase in interest expense of $223 thousand. When comparing the third quarter of 2017 with that of 2016, the increase in rates paid on interest-bearing demand deposits, savings deposits, and time deposits increased by 16 basis points, 3 basis points, and 4 basis points, respectively. The increase in rates was coupled with increases in the average balance of interest-bearing deposits of $55.2 million, or 7.5%, which also contributed to the increase in interest expense by $16 thousand. Partly offsetting the increase in interest expense paid on interest-bearing deposits was a decrease of $44 thousand in interest paid on borrowed funds, driven entirely by a reduction in the average balance of $30.6 million, or 29.5%, to $73.2 million for the three months ended September 30, 2017 from $103.8 million for the same three months of 2016. The decrease in average borrowed funds led to a decrease in interest expense of $128 thousand, which was partly offset by a 37-basis point increase in the average rate paid on borrowed funds, resulting in an increase in interest expense of $84 thousand.
For the
nine months ended September 30, 2017, net interest income on a tax-equivalent basis increased $1.4 million, or 5.9%, to $24.8 million from $23.4 million for the comparable period in 2016. Comparing the year-to-date periods of 2017 and 2016, tax-equivalent interest income increased $1.7 million, or 6.4%, while interest expense increased $0.3 million, or 10.8%. The increase in tax-equivalent interest income primarily reflected an increase in the tax-equivalent yield on earning assets, coupled with a strong growth in average earning assets. The tax-equivalent yield on earning assets, impacted by FOMC actions, improved 8 basis points to 3.63% for the nine months ended September 30, 2017 from 3.55% for the same period of 2016. The increase resulted from increases in the yields on loans, investment securities, and interest-bearing deposits of 13 basis points, 16 basis points, and 53 basis points, respectively, contributing $789 thousand, $331 thousand, and $32 thousand, respectively, to the improvement in tax-equivalent interest income. The average balance of interest-earning assets increased $41.1 million, or 4.1%, comparing the year-to-date period of 2017 with that of 2016, which resulted in a $555 thousand increase in tax-equivalent interest income. The average balances of investment securities grew $26.8 million, or 10.2%, to $289.1 million for the nine months ended September 30, 2017 from $262.3 million for the same period of 2016, which resulted in additional interest income of $535 thousand. In addition the average balance of interest-bearing deposits in other banks increased $15.6 million and resulted in an increase in interest income of $100 thousand comparing the nine-month periods ended September 30, 2017 and 2016. Slightly offsetting these volume increases was an $80 thousand decrease in interest income due to a $1.3 million, or 0.2%, reduction in the average balance of loans to $728.4 million for the nine months ended September 30, 2017 from $729.7 million for the same nine-month period of 2016.
The incr
ease in interest expense of $0.3 million also reflected the FOMC actions as both deposit and borrowing costs have risen in response. The cost of deposits increased 5 basis points from 0.37% for the nine months ended September 30, 2016, to 0.42% for the same period of 2017. In addition, the cost of borrowed funds increased 38 basis points from 1.35% for the year-to-date period of 2016 to 1.73% for the comparable period of 2017. The increases in rates paid on deposits and borrowed funds led to increases in interest expense of $443 thousand and $265 thousand, respectively. These rate increases were partially offset by a decline in the average balance of borrowed funds of $36.9 million, or 33.1%, to $74.6 million for the nine months ended September 30, 2017 from $111.5 million for the nine months ended September 30, 2016, which resulted in a reduction in interest expense paid of $431 thousand. The aforementioned factors resulted in a moderate increase in the cost of interest-bearing liabilities of 3 basis points to 0.53% from 0.50% when comparing the nine months ended September 30, 2017 and 2016, respectively.
Net interest income depends upon the relative amount
s of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them. The following tables present certain information about FNCB’s consolidated statements of financial condition and consolidated statements of income for the three- and nine-month periods ended September 30, 2017 and 2016, and reflect the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are calculated by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are derived from average daily balances. The yields include amortization of fees which are considered adjustments to yields.
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Three Months Ended
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September 30, 2017
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September 30, 2016
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Average
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Yield/
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Average
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Yield/
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(dollars in thousands)
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Balance
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Interest
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Cost
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Balance
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Interest
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Cost
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Assets
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Earning assets (2)(3)
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Loans-taxable (4)
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$
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700,729
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$
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7,266
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4.15
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%
|
|
$
|
685,038
|
|
|
$
|
6,751
|
|
|
|
3.94
|
%
|
Loans-tax free (4)
|
|
|
38,109
|
|
|
|
470
|
|
|
|
4.93
|
%
|
|
|
47,620
|
|
|
|
526
|
|
|
|
4.42
|
%
|
Total loans (1)(2)
|
|
|
738,838
|
|
|
|
7,736
|
|
|
|
4.19
|
%
|
|
|
732,658
|
|
|
|
7,277
|
|
|
|
3.97
|
%
|
Securities-taxable
|
|
|
290,348
|
|
|
|
1,998
|
|
|
|
2.75
|
%
|
|
|
260,431
|
|
|
|
1,650
|
|
|
|
2.53
|
%
|
Securities-tax free
|
|
|
600
|
|
|
|
11
|
|
|
|
7.33
|
%
|
|
|
905
|
|
|
|
14
|
|
|
|
6.19
|
%
|
Total securities (1)(5)
|
|
|
290,948
|
|
|
|
2,009
|
|
|
|
2.76
|
%
|
|
|
261,336
|
|
|
|
1,664
|
|
|
|
2.55
|
%
|
Interest-bearing deposits in other banks
|
|
|
7,499
|
|
|
|
24
|
|
|
|
1.28
|
%
|
|
|
6,448
|
|
|
|
8
|
|
|
|
0.50
|
%
|
Total earning assets
|
|
|
1,037,285
|
|
|
|
9,769
|
|
|
|
3.77
|
%
|
|
|
1,000,442
|
|
|
|
8,949
|
|
|
|
3.58
|
%
|
Non-earning assets
|
|
|
101,181
|
|
|
|
|
|
|
|
|
|
|
|
107,762
|
|
|
|
|
|
|
|
|
|
Allowance for loan and lease losses
|
|
|
(8,578
|
)
|
|
|
|
|
|
|
|
|
|
|
(8,752
|
)
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,129,888
|
|
|
|
|
|
|
|
|
|
|
$
|
1,099,452
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and shareholders' equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing demand deposits
|
|
$
|
489,950
|
|
|
|
483
|
|
|
|
0.39
|
%
|
|
$
|
424,088
|
|
|
|
244
|
|
|
|
0.23
|
%
|
Savings deposits
|
|
|
102,281
|
|
|
|
35
|
|
|
|
0.14
|
%
|
|
|
99,273
|
|
|
|
27
|
|
|
|
0.11
|
%
|
Time deposits
|
|
|
200,418
|
|
|
|
425
|
|
|
|
0.85
|
%
|
|
|
214,070
|
|
|
|
433
|
|
|
|
0.81
|
%
|
Total interest-bearing deposits
|
|
|
792,649
|
|
|
|
943
|
|
|
|
0.48
|
%
|
|
|
737,431
|
|
|
|
704
|
|
|
|
0.38
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Borrowed funds and other interest-bearing liabilities
|
|
|
73,168
|
|
|
|
337
|
|
|
|
1.84
|
%
|
|
|
103,821
|
|
|
|
381
|
|
|
|
1.47
|
%
|
Total interest-bearing liabilities
|
|
|
865,817
|
|
|
|
1,280
|
|
|
|
0.59
|
%
|
|
|
841,252
|
|
|
|
1,085
|
|
|
|
0.52
|
%
|
Demand deposits
|
|
|
156,483
|
|
|
|
|
|
|
|
|
|
|
|
152,319
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
10,325
|
|
|
|
|
|
|
|
|
|
|
|
11,006
|
|
|
|
|
|
|
|
|
|
Shareholders' equity
|
|
|
97,263
|
|
|
|
|
|
|
|
|
|
|
|
94,875
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholder's equity
|
|
$
|
1,129,888
|
|
|
|
|
|
|
|
|
|
|
$
|
1,099,452
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income/interest rate spread (6)
|
|
|
|
|
|
|
8,489
|
|
|
|
3.18
|
%
|
|
|
|
|
|
|
7,864
|
|
|
|
3.06
|
%
|
Tax-equivalent adjustment
|
|
|
|
|
|
|
(164
|
)
|
|
|
|
|
|
|
|
|
|
|
(184
|
)
|
|
|
|
|
Net interest income as reported
|
|
|
|
|
|
$
|
8,325
|
|
|
|
|
|
|
|
|
|
|
$
|
7,680
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest margin (7)
|
|
|
|
|
|
|
|
|
|
|
3.27
|
%
|
|
|
|
|
|
|
|
|
|
|
3.14
|
%
|
(1)
|
Interest income is presented on a tax-equivalent basis using a 34% rate for 2017 and 2016.
|
(2)
|
Loans are stated net of unearned income.
|
(3)
|
Nonaccrual loans are included in loans within earning assets
|
(4)
|
Loan fees included in interest income are not significant
|
(5)
|
The yields for securities that are classified as available for sale is based on the average historical amortized cost.
|
(6)
|
Interest rate spread represents the difference between the average yield on interest earning assets and the cost of interest bearing liabilities and is presented on a tax equivalent basis.
|
(7)
|
Net interest income as a percentage of total average interest earning assets.
|
|
|
Nine Months Ended
|
|
|
|
September 30, 2017
|
|
|
September 30, 2016
|
|
|
|
Average
|
|
|
|
|
|
|
Yield/
|
|
|
Average
|
|
|
|
|
|
|
Yield/
|
|
(dollars in thousands)
|
|
Balance
|
|
|
Interest
|
|
|
Cost
|
|
|
Balance
|
|
|
Interest
|
|
|
Cost
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earning assets (2)(3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans-taxable (4)
|
|
$
|
687,744
|
|
|
$
|
20,783
|
|
|
|
4.03
|
%
|
|
$
|
681,638
|
|
|
$
|
19,913
|
|
|
|
3.90
|
%
|
Loans-tax free (4)
|
|
|
40,686
|
|
|
|
1,462
|
|
|
|
4.79
|
%
|
|
|
48,060
|
|
|
|
1,623
|
|
|
|
4.50
|
%
|
Total loans (1)(2)
|
|
|
728,430
|
|
|
|
22,245
|
|
|
|
4.07
|
%
|
|
|
729,698
|
|
|
|
21,536
|
|
|
|
3.94
|
%
|
Securities-taxable
|
|
|
287,639
|
|
|
|
5,791
|
|
|
|
2.68
|
%
|
|
|
261,271
|
|
|
|
4,944
|
|
|
|
2.52
|
%
|
Securities-tax free
|
|
|
1,418
|
|
|
|
64
|
|
|
|
5.98
|
%
|
|
|
1,033
|
|
|
|
45
|
|
|
|
5.81
|
%
|
Total securities (1)(5)
|
|
|
289,057
|
|
|
|
5,855
|
|
|
|
2.70
|
%
|
|
|
262,304
|
|
|
|
4,989
|
|
|
|
2.54
|
%
|
Interest-bearing deposits in other banks
|
|
|
19,781
|
|
|
|
146
|
|
|
|
0.98
|
%
|
|
|
4,189
|
|
|
|
14
|
|
|
|
0.45
|
%
|
Total earning assets
|
|
|
1,037,268
|
|
|
|
28,246
|
|
|
|
3.63
|
%
|
|
|
996,191
|
|
|
|
26,539
|
|
|
|
3.55
|
%
|
Non-earning assets
|
|
|
100,422
|
|
|
|
|
|
|
|
|
|
|
|
108,140
|
|
|
|
|
|
|
|
|
|
Allowance for loan and lease losses
|
|
|
(8,526
|
)
|
|
|
|
|
|
|
|
|
|
|
(8,737
|
)
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,129,164
|
|
|
|
|
|
|
|
|
|
|
$
|
1,095,594
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and shareholders' equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing demand deposits
|
|
$
|
492,367
|
|
|
|
1,248
|
|
|
|
0.34
|
%
|
|
$
|
421,040
|
|
|
|
673
|
|
|
|
0.21
|
%
|
Savings deposits
|
|
|
102,447
|
|
|
|
102
|
|
|
|
0.13
|
%
|
|
|
96,340
|
|
|
|
62
|
|
|
|
0.09
|
%
|
Time deposits
|
|
|
199,897
|
|
|
|
1,163
|
|
|
|
0.78
|
%
|
|
|
212,100
|
|
|
|
1,274
|
|
|
|
0.80
|
%
|
Total interest-bearing deposits
|
|
|
794,711
|
|
|
|
2,513
|
|
|
|
0.42
|
%
|
|
|
729,480
|
|
|
|
2,009
|
|
|
|
0.37
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Borrowed funds and other interest-bearing liabilities
|
|
|
74,588
|
|
|
|
966
|
|
|
|
1.73
|
%
|
|
|
111,451
|
|
|
|
1,132
|
|
|
|
1.35
|
%
|
Total interest-bearing liabilities
|
|
|
869,299
|
|
|
|
3,479
|
|
|
|
0.53
|
%
|
|
|
840,931
|
|
|
|
3,141
|
|
|
|
0.50
|
%
|
Demand deposits
|
|
|
154,828
|
|
|
|
|
|
|
|
|
|
|
|
148,659
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
10,665
|
|
|
|
|
|
|
|
|
|
|
|
14,012
|
|
|
|
|
|
|
|
|
|
Shareholders' equity
|
|
|
94,372
|
|
|
|
|
|
|
|
|
|
|
|
91,992
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholder's equity
|
|
$
|
1,129,164
|
|
|
|
|
|
|
|
|
|
|
$
|
1,095,594
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income/interest rate spread (6)
|
|
|
|
|
|
|
24,767
|
|
|
|
3.10
|
%
|
|
|
|
|
|
|
23,398
|
|
|
|
3.05
|
%
|
Tax-equivalent adjustment
|
|
|
|
|
|
|
(519
|
)
|
|
|
|
|
|
|
|
|
|
|
(567
|
)
|
|
|
|
|
Net interest income as reported
|
|
|
|
|
|
$
|
24,248
|
|
|
|
|
|
|
|
|
|
|
$
|
22,831
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest margin (7)
|
|
|
|
|
|
|
|
|
|
|
3.18
|
%
|
|
|
|
|
|
|
|
|
|
|
3.13
|
%
|
(1)
|
Interest income is presented on a tax-equivalent basis using a 34% rate for 2017 and 2016.
|
(2)
|
Loans are stated net of unearned income.
|
(3)
|
Nonaccrual loans are included in loans within earning assets
|
(4)
|
Loan fees included in interest income are not significant
|
(5)
|
The yields for securities that are classified as available for sale is based on the average historical amortized cost.
|
(6)
|
Interest rate spread represents the difference between the average yield on interest earning assets and the cost of interest bearing liabilities and is presented on a tax equivalent basis.
|
(7)
|
Net interest income as a percentage of total average interest earning assets.
|
Rate Volume Analysis
The most significant impact on net income between periods is derived from the interaction of changes in the volume and rates earned or paid on interest-earning assets and interest-bearing liabilities. The volume of earning assets, specifically loans and investments, compared to the volume of interest-bearing liabilities represented by deposits and borrowings, combined with the spread, produces the changes in net interest income between periods. Components of interest income and interest expense are presented on a tax-equivalent basis using the statutory federal income tax rate of 34%.
The following table summarizes the effect that changes in volumes of earning assets and interest-bearing liabilities and the interest rates earned and paid on these assets and liabilities have on net interest income. The net change or mix component attributable to the combined impact of rate and volume changes has been allocated proportionately to the change due to volume and the change due to rate.
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2017 vs. 2016
|
|
|
2017 vs. 2016
|
|
|
|
Increase (Decrease)
|
|
|
Increase (Decrease)
|
|
|
|
Due to
|
|
|
Due to
|
|
|
Total
|
|
|
Due to
|
|
|
Due to
|
|
|
Total
|
|
(dollars in thousands)
|
|
Volume
|
|
|
Rate
|
|
|
Change
|
|
|
Volume
|
|
|
Rate
|
|
|
Change
|
|
Interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans - taxable
|
|
$
|
157
|
|
|
$
|
358
|
|
|
$
|
515
|
|
|
$
|
180
|
|
|
$
|
690
|
|
|
$
|
870
|
|
Loans - tax free
|
|
|
(112
|
)
|
|
|
56
|
|
|
|
(56
|
)
|
|
|
(260
|
)
|
|
|
99
|
|
|
|
(161
|
)
|
Total loans
|
|
|
45
|
|
|
|
414
|
|
|
|
459
|
|
|
|
(80
|
)
|
|
|
789
|
|
|
|
709
|
|
Securities - taxable
|
|
|
199
|
|
|
|
149
|
|
|
|
348
|
|
|
|
518
|
|
|
|
329
|
|
|
|
847
|
|
Securities - tax free
|
|
|
(5
|
)
|
|
|
2
|
|
|
|
(3
|
)
|
|
|
17
|
|
|
|
2
|
|
|
|
19
|
|
Total securities
|
|
|
194
|
|
|
|
151
|
|
|
|
345
|
|
|
|
535
|
|
|
|
331
|
|
|
|
866
|
|
Interest-bearing deposits in other banks
|
|
|
1
|
|
|
|
15
|
|
|
|
16
|
|
|
|
100
|
|
|
|
32
|
|
|
|
132
|
|
Total interest income
|
|
|
240
|
|
|
|
580
|
|
|
|
820
|
|
|
|
555
|
|
|
|
1,152
|
|
|
|
1,707
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing demand deposits
|
|
|
43
|
|
|
|
196
|
|
|
|
239
|
|
|
|
129
|
|
|
|
446
|
|
|
|
575
|
|
Savings deposits
|
|
|
1
|
|
|
|
7
|
|
|
|
8
|
|
|
|
4
|
|
|
|
36
|
|
|
|
40
|
|
Time deposits
|
|
|
(28
|
)
|
|
|
20
|
|
|
|
(8
|
)
|
|
|
(72
|
)
|
|
|
(39
|
)
|
|
|
(111
|
)
|
Total interest-bearing deposits
|
|
|
16
|
|
|
|
223
|
|
|
|
239
|
|
|
|
61
|
|
|
|
443
|
|
|
|
504
|
|
Borrowed funds and other interest-bearing liabilities
|
|
|
(128
|
)
|
|
|
84
|
|
|
|
(44
|
)
|
|
|
(431
|
)
|
|
|
265
|
|
|
|
(166
|
)
|
Total interest expense
|
|
|
(112
|
)
|
|
|
307
|
|
|
|
195
|
|
|
|
(370
|
)
|
|
|
708
|
|
|
|
338
|
|
Net interest income
|
|
$
|
352
|
|
|
$
|
273
|
|
|
$
|
625
|
|
|
$
|
925
|
|
|
$
|
444
|
|
|
$
|
1,369
|
|
Provision for Loan and Lease Losses
Management closely monitors the loan portfolio and the adequacy of the ALLL by considering underlying
financial performance of the borrower, collateral values and associated credit risks. Future material adjustments may be necessary to the provision for loan and lease losses and the ALLL if economic conditions or loan performance differ substantially from the assumptions management considered in its evaluation of the ALLL. The provision for loan and lease losses is an expense charged against net interest income to provide for probable losses attributable to uncollectible loans and is based on management’s analysis of the adequacy of the ALLL. A credit to loan and lease losses reflects the reversal of amounts previously charged to the ALLL.
FNCB recorded a provision for loan and lease losses of $543 thousand for the three months ended September 30, 2017, compared to a credit for loan and lease losses of $234 thousand for the same period of 2016. The provision recorded for the
third quarter of 2017 resulted primarily from strong loan growth, coupled with net charge-offs of $150 thousand, during the period. For the year-to-date periods ended September 30, 2017 and 2016, FNCB recorded provision expenses of $486 thousand and $858 thousand, respectively. The provision expense for the first nine months of 2017 reflected loan growth, coupled with net charge-offs recorded of $43 thousand.
Non-interest Income
Non-interest income totaled $
1.7 million for the three months ended September 30, 2017, an increase of $0.3 million, or 24.2%, from $1.4 million earned during the comparable period in 2016. When comparing the third quarters of 2017 and 2016, the increase in non-interest income primarily reflected increases in net gains on the sale of securities of $367 thousand, other income of $28 thousand, and loan-related fees of $11 thousand. Those increases were partially offset by decreases in net gains on the sale of other real estate owned of $32 thousand, net gains on the sale of SBA guaranteed loans of $28 thousand, and deposit service charges of $11 thousand.
For the
nine months ended September 30, 2017, non-interest income totaled $5.3 million, an increase of $0.5 million, or 10.4%, compared to $4.8 million for the same nine months of 2016. The improvement resulted primarily from an increase of $378 thousand in net gains on the sale of securities, coupled with increases in other income of $90 thousand. Additionally, net gains on the sale of other real estate owned SBA guaranteed loans each increased $28 thousand comparing the year-to-date periods of 2017 and 2016. In addition, FNCB recorded net gains on the sales of other repossessed assets of $47 thousand. Partially offsetting these positive factors were decreases in loan-related fees of $35 thousand and income from bank-owned life insurance of $27 thousand.
Non-interest Expense
For the three months ended
September 30, 2017, non-interest expense decreased $0.2 million, or 2.4%, to $6.4 million, from $6.6 million for the same three months of 2016. Comparing the three months ended September 30, 2017 and 2016, the decline in 2017 was due primarily to a decrease in occupancy expense of $85 thousand, resulting from a decrease in rent expense associated with long-term facilities planning, coupled with a reduction in legal expenses of $56 thousand, as outstanding litigation continues to be resolved. FNCB also experienced decreases of $39 thousand in regulatory assessments, $38 thousand in advertising expenses, and $18 thousand in other losses. Partially offsetting these decreases were increases in professional fees of $49 thousand and equipment expense of $45 thousand.
On a year-to-date basis, non-interest expense
declined $117 thousand, or 0.6%, comparing the nine months ended September 30, 2017 and 2016. Positive fluctuations within non-interest expense include a decrease in salaries and employee benefits of $297 thousand, or 2.9% due to open positions and a decline in severance costs, a decrease of $170 thousand, or 59.6% in legal expense, and a reduction of $132 thousand, or 20.9%, in regulatory assessments. During 2016, FNCB converted from a national charter to a state charter, which, along with improved risk profile, contributed to the reduction in regulatory expenses for the first nine months of 2017 as compared to 2016. In addition, the resolution of outstanding litigation continues to provide for reductions in legal expenses. Partially offsetting the decreases to non-interest expense were increases in occupancy and equipment expense of $266 thousand, or 20.5%, and $103 thousand, or 8.1%, in equipment expense, respectively, reflecting enhancements made to and expansion of infrastructure as part of FNCB’s network improvement program. In addition, FNCB experienced increases of $100 thousand in other losses due primarily to software abandonment costs, and $97 thousand in expenses of other real estate owned due primarily to valuation adjustments.
Provision for Income Taxes
FNCB
recorded a provision for income tax expense of $2.5 million for the nine months ended September 30, 2017, an increase of $0.9 million compared to an income tax expense of $1.6 million for the same nine months of 2016.
Management evaluates the carrying amount of its deferred tax assets on a quarterly basis, or more frequently, if necessary, in accordance with guidance set forth in ASC Topic 740 “
Income Taxes,” and applies the criteria in the guidance to determine whether it is more likely than not that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight of available evidence. If management determines based on available evidence, both positive and negative, that it is more likely than not that some portion or all the deferred tax asset will not be realized in future periods, a valuation allowance is calculated and recorded. These determinations are inherently subjective and depend upon management’s estimates and judgments used in their evaluation of both positive and negative evidence.
In evaluating available evidence, management considers, among other factors, historical financial performance, expectation of future earnings, the ability to carry back losses to r
ecoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. In assessing the need for a valuation allowance, management carefully weighs both positive and negative evidence currently available.
Management performed an evaluation of FNCB
’s deferred tax assets at September 30, 2017 taking into consideration both positive and negative evidence as of that date. Based on this evaluation, management believes that FNCB’s future taxable income will be sufficient to utilize deferred tax assets. FNCB’s core earnings in 2016 and the first nine months of 2017 were strong, and management believes projected future core earnings will continue to support the recognition of the deferred tax assets based on future growth projections. Accordingly, management concluded that no valuation allowance for deferred tax assets was required at September 30, 2017.
FNCB uses the current statutory tax rate of 34.0% to value its deferred tax assets and liabilities.
On September 27, 2017, the Trump Administration released a tax reform framework that includes a reduction in the U.S. corporate income tax rate to 20.0%. If corporate tax rates are reduced, management expects FNCB would be required to record an initial charge against earnings to lower the carrying amount of its net deferred tax asset, and then, going forward, would record lower tax provisions on an ongoing basis. The House of Representatives is currently working on a draft of the bill, which is expected to be addressed by Congress later in 2017. It is too early to determine if any of the proposals on tax reform are actionable, or if acted upon, the specific tax reforms that would be implemented. Accordingly, management cannot assess the effect that any tax reform measure effectuated would have on FNCB’s operating results or financial position at the present time.
FINANCIAL CONDITION
Assets
Total assets
decreased $38.5 million, or 3.2%, to $1.157 billion at September 30, 2017 from $1.196 billion at December 31, 2016. The change in total assets primarily resulted from a $68.6 million, or 61.0%, reduction in cash and cash equivalents, which largely reflected a decrease in total deposits of $31.9 million, or 3.2%, coupled with the repayment of borrowed funds of $18.2 million, or 23.1%. The decrease in total deposits was primarily attributable to the anticipated exit of short-term funds related to the sale of a municipal utility in December 2016. Available-for-sale securities increased $6.0 million, or 2.2%, and net loans increased $27.8 million, or 3.8%. Additional asset fluctuations included a decrease in other real estate owned of $1.0 million as foreclosed properties were sold, a $3.4 million reduction in net deferred tax assets, and a $1.5 million increase in other assets.
Cash and Cash Equivalents
Cash and cash equivalents
declined $68.6 million, or 61.0%, to $43.8 million at September 30, 2017 from $112.4 million at December 31, 2016. The significant reduction was due primarily to an anticipated decrease in deposits as noted above. FNCB paid dividends of $0.03 and $0.09 per share for the three and nine months ended September 30, 2017, respectively, an increase of 50.0% as compared to dividends of $0.02 and $0.06 for the respective periods of 2016.
Securities
FNCB
’s investment securities portfolio provides a source of liquidity needed to meet expected loan demand and interest income to increase profitability. Additionally, the investment securities portfolio is used to meet pledging requirements to secure public deposits and for other purposes. Management classifies investment securities as either held-to-maturity or available-for-sale at the time of purchase based on its intent. Held-to-maturity securities are carried at amortized cost, while available-for-sale securities are carried at fair value, with unrealized holding gains and losses reported as a component of shareholders’ equity in accumulated other comprehensive income (loss), net of tax. At September 30, 2017 and December 31, 2016, all securities were classified as available-for-sale. Decisions to purchase or sell investment securities are based upon management’s current assessment of long- and short-term economic and financial conditions, including the interest rate environment and asset/liability management, liquidity and tax-planning strategies. Securities with limited marketability and/or restrictions, such as FHLB of Pittsburgh stock, are carried at cost.
At
September 30, 2017, the investment portfolio was comprised principally of fixed-rate securities issued by U.S. government or U.S. government-sponsored agencies, which include mortgage-backed securities and residential and commercial collateralized mortgage obligations (“CMOs”), fixed-rate taxable obligations of state and political subdivisions, and corporate debt securities. Except for U.S. government and government-sponsored agencies, there were no securities of any individual issuer that exceeded 10.0% of shareholders’ equity at September 30, 2017.
The
following table presents the carrying value of available-for-sale securities, which are carried at fair value at September 30, 2017 and December 31, 2016:
Composition of the Investment Portfolio
|
|
September 30,
|
|
|
December 31,
|
|
(in thousands)
|
|
2017
|
|
|
2016
|
|
Available-for-sale securities
|
|
|
|
|
|
|
|
|
Obligations of U.S. government agencies
|
|
$
|
-
|
|
|
$
|
12,188
|
|
Obligations of state and political subdivisions
|
|
|
144,700
|
|
|
|
117,873
|
|
U.S. government/government-sponsored agencies:
|
|
|
|
|
|
|
|
|
Collateralized mortgage obligations - residential
|
|
|
35,272
|
|
|
|
18,084
|
|
Collateralized mortgage obligations - commerical
|
|
|
66,459
|
|
|
|
99,350
|
|
Mortgage-backed securities
|
|
|
22,522
|
|
|
|
20,576
|
|
Corporate debt securities
|
|
|
5,445
|
|
|
|
3,792
|
|
Asset-backed securities
|
|
|
3,512
|
|
|
|
-
|
|
Negotiable certificates of deposit
|
|
|
3,192
|
|
|
|
3,216
|
|
Equity securities
|
|
|
935
|
|
|
|
936
|
|
Total
|
|
$
|
282,037
|
|
|
$
|
276,015
|
|
Management monitors the investment portfolio regularly and adjusts the investment strategy to reflect changes in liquidity needs, asset/liability strategy and tax planning requirements.
FNCB currently has $50.4 million in net operating loss (“NOL”) carryovers, which it uses to offset any taxable income. Because of this tax position, there is no benefit from holding tax-exempt obligations of state and political subdivisions. Accordingly, management’s actions during recent periods with regard to managing the investment portfolio have reflected current tax planning initiatives focused on generating sustained taxable income to be able to reduce NOL carryovers.
During the third
quarter of 2017, FNCB sold 17 of its available-for-sale securities, including 14 U.S. government agency securities and three taxable obligations of state and political subdivisions. The securities sold had an aggregate amortized cost of $54.1 million. Gross proceeds received totaled $54.5 million, with net gains of $0.4 million realized upon the sales and included in non-interest income.
For the
nine months ended September 30, 2017, there were a total of 37 securities sold, comprised of 28 U.S. government agency securities, eight obligations of state and political subdivisions, and one corporate bond. Gross proceeds received on the sales and the aggregate amortized cost of the securities sold totaled $131.0 million and $129.6 million, respectively. Year-to-date net gains realized upon the sales amounted to $1.3 million and are included in non-interest income for the nine months ended September 30, 2017.
FNCB purchased
18 securities during the third quarter of 2017 totaling $53.4 million, including $51.6 million in U.S. government/ government-sponsored agency securities and $1.7 million in taxable obligations of state and political subdivisions. For the nine months ended September 30, 2017, FNCB purchased 65 securities totaling $139.5 million, including $35.8 million in taxable obligations of state and political subdivisions, $97.7 million in U.S. government /government-sponsored agency securities, $4.0 million of asset-backed securities, and $2.0 million in corporate debt securities.
The following table presents the maturities of available-for-sale securities, based on carrying value at
September 30, 2017 and the weighted average yields of such securities calculated on the basis of the amortized cost and effective yields weighted for the scheduled maturity of each security. The yields on tax-exempt obligations of state and political subdivisions are presented on a tax-equivalent basis using an effective interest rate of 34.0%. Because residential and commercial collateralized mortgage obligations, mortgage-backed securities, and asset-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following summary.
Maturity Distribution of the Investment Portfolio
|
|
September 30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-Backed
|
|
|
|
|
|
|
|
|
|
|
|
Within
|
|
|
>1 - 5
|
|
|
a6 - 10
|
|
|
Over
|
|
|
and Asset-Backed
|
|
|
No Fixed
|
|
|
|
|
|
(dollars in thousands)
|
|
One Year
|
|
|
Years
|
|
|
Years
|
|
|
10 Years
|
|
|
Securities
|
|
|
Maturity
|
|
|
Total
|
|
Available-for-sale securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of U.S. government agencies
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of state and political subdivisions
|
|
|
-
|
|
|
|
26,423
|
|
|
|
118,277
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
144,700
|
|
Yield
|
|
|
|
|
|
|
2.48
|
%
|
|
|
2.81
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.75
|
%
|
U.S. government/government-sponsored agencies:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized mortgage obligations - residential
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
35,272
|
|
|
|
-
|
|
|
|
35,271
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.80
|
%
|
|
|
|
|
|
|
2.80
|
%
|
Collateralized mortgage obligations - commercial
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
66,459
|
|
|
|
-
|
|
|
|
66,459
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.49
|
%
|
|
|
|
|
|
|
2.49
|
%
|
Mortgage-backed securities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
22,522
|
|
|
|
-
|
|
|
|
22,522
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.86
|
%
|
|
|
|
|
|
|
2.86
|
%
|
Corporate debt securities
|
|
|
-
|
|
|
|
-
|
|
|
|
4,100
|
|
|
|
1,345
|
|
|
|
-
|
|
|
|
-
|
|
|
|
5,445
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
6.63
|
%
|
|
|
9.50
|
%
|
|
|
|
|
|
|
|
|
|
|
7.20
|
%
|
Asset-backed securities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,512
|
|
|
|
-
|
|
|
|
3,512
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.45
|
%
|
|
|
|
|
|
|
2.45
|
%
|
Negotiable certificates of deposit
|
|
|
248
|
|
|
|
2,944
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,192
|
|
Yield
|
|
|
1.45
|
%
|
|
|
2.09
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.04
|
%
|
Equity securities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
935
|
|
|
|
935
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3.45
|
%
|
|
|
3.45
|
%
|
Total available-for-sale maturities
|
|
$
|
248
|
|
|
$
|
29,367
|
|
|
$
|
122,377
|
|
|
$
|
1,345
|
|
|
$
|
127,765
|
|
|
$
|
935
|
|
|
$
|
282,037
|
|
Weighted average yield
|
|
|
1.45
|
%
|
|
|
2.44
|
%
|
|
|
2.94
|
%
|
|
|
9.50
|
%
|
|
|
2.64
|
%
|
|
|
3.45
|
%
|
|
|
2.78
|
%
|
OTTI Evaluation
There was no OTTI recognized during the
nine months ended September 30, 2017 or 2016. For additional information regarding management’s evaluation of securities for OTTI, see Note 3, “Securities” of the notes to consolidated financial statements included in Item 1 hereof.
Investment in FHLB
of Pittsburgh stock has limited marketability and is carried at cost. FNCB’s investment in FHLB of Pittsburgh stock totaled $2.5 million and $3.3 million at September 30, 2017 and December 31, 2016, respectively. Management noted no indicators of impairment for the FHLB of Pittsburgh stock at September 30, 2017.
During the third quarter of 2017, FNCB purchased $1.2 million, representing a 4.9% interest, in the common stock of a privately-held bank holding company. The common stock was purchased as part of a private placement pursuant to an exemption from the registration requirements of the Securities Act of 1933 for offerings not involving any public offering. The common stock is not currently traded on any established market, and is not expected to be traded in the near future on any securities exchange or established over-the-counter market. FNCB has elected to account for this transaction as an investment in an equity security without a readily determinable fair value. An equity security without a readily determinable fair value shall be written down to its fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than its carrying value. The $1.2 million investment is included in other assets in the consolidated statements of financial condition at September 30, 2017. Management engaged an independent third party to provide a valuation of this investment as of September 30, 2017. The valuation indicated that the investment was not impaired and accordingly, no adjustment for impairment is required at September 30, 2017.
Loans
For the first nine months of 2017, FNCB experienced strong loan growth among real estate secured and consumer lending, only partially offset by a decline in the commercial and industrial and state and political subdivision segments, resulting in an increase in t
otal loans of 3.4%. Total loans grew to $756.9 million at September 30, 2017, a $28.1 million increase from $728.8 million at December 31, 2016. Commercial real estate and construction, land acquisition and development loans grew by 4.1% and 46.0%, respectively, during 2017, as the commercial lending team added depth and experience, and the Lehigh Valley loan production office was opened. Contributing to the strong growth in residential real estate loans during 2017, FNCB launched a “No Closing Costs Loan Sale” for its “WOW Mortgage,” a non-saleable, fixed-rate mortgage with terms of 7.5, 10 or 14.5 years, and its home equity loan products.
Historically, commercial lending activities have represented a si
gnificant portion of FNCB’s loan portfolio. Commercial lending includes commercial and industrial loans, commercial real estate loans and construction, land acquisition and development loans, and represented 56.4% and 56.7% of total loans at September 30, 2017 and December 31, 2016, respectively.
From a collateral standpoint, a majority of
FNCB’s loan portfolio consists of loans secured by real estate. Real estate secured loans, which include commercial real estate, construction, land acquisition and development, residential real estate loans and home equity lines of credit (“HELOCs”), increased $25.6 million, or 6.0%, to $455.7 million at September 30, 2017 from $430.1 million at December 31, 2016. The increase was attributable to both the residential and commercial real estate segments, as detailed above. Real estate secured loans as a percentage of total gross loans increase to 60.2% at September 30, 2017 as compared to 59.0% as of December 31, 2016.
Commercial and industrial loans
decreased $4.7 million, or 3.1%, during the first nine months of 2017 to $146.0 million at September 30, 2017 from $150.8 million at December 31, 2016. The decrease resulted primarily from the planned exit of a large commercial relationship during the first quarter of 2017. Commercial and industrial loans consist primarily of equipment loans, working capital financing, revolving lines of credit and loans secured by cash and marketable securities. Loans secured by commercial real estate increased $10.0 million, or 4.1%, to $253.8 million at September 30, 2017 from $243.8 million at December 31, 2016. Commercial real estate loans include long-term commercial mortgage financing and are primarily secured by first or second lien mortgages. Construction, land acquisition and development loans also increased $8.4 million, or 46.0%, to $26.8 million at September 30, 2017 from $18.4 million at December 31, 2016, as several large commercial projects were started, and existing projects approach completion.
Residential real estate loans totaled $
152.3 million at September 30, 2017, an increase of $8.0 million, or 5.5%, from $144.3 million at December 31, 2016. The components of residential real estate loans include fixed-rate and variable-rate mortgage loans. HELOCs are not included in this category but are included in consumer loans. FNCB primarily underwrites fixed-rate purchase and refinance of residential mortgage loans for sale in the secondary market to reduce interest rate risk and provide funding for additional loans. Additionally, FNCB offers a “WOW” mortgage product, which is a non-saleable mortgage with maturity terms of 7.5 to 14.5 years, and offers customers an attractive fixed interest rate, low closing costs and a guaranteed 30-day close.
Consumer loans
grew throughout the first nine months of 2017, increasing $10.9 million, or 8.5%, to $138.7 million at September 30, 2017 from $127.8 million at December 31, 2016.
The increase was attributable to the purchase of a pool of refinanced student loans of $5.0 million, in addition to seasonal increases within the indirect auto lending portfolio. Loans to state and municipal governments decreased $4.4 million, or 10.2%, to $39.3 million at September 30, 2017 from $43.7 million at December 31, 2016, due in part to the payoff of a large tax-anticipation note.
The following table summarizes loans receivable, net by category at
September 30, 2017 and December 31, 2016:
Loan Portfolio Detail
|
|
September 30,
|
|
|
December 31,
|
|
(in thousands)
|
|
2017
|
|
|
2016
|
|
Residential real estate
|
|
$
|
152,257
|
|
|
$
|
144,260
|
|
Commercial real estate
|
|
|
253,791
|
|
|
|
243,830
|
|
Construction, land acquisition and development
|
|
|
26,805
|
|
|
|
18,357
|
|
Commercial and industrial
|
|
|
146,048
|
|
|
|
150,758
|
|
Consumer
|
|
|
138,734
|
|
|
|
127,844
|
|
State and political subdivisions
|
|
|
39,271
|
|
|
|
43,709
|
|
Total loans, gross
|
|
|
756,906
|
|
|
|
728,758
|
|
Unearned income
|
|
|
(84
|
)
|
|
|
(48
|
)
|
Net deferred loan costs
|
|
|
2,667
|
|
|
|
2,569
|
|
Allowance for loan and lease losses
|
|
|
(8,862
|
)
|
|
|
(8,419
|
)
|
Loans, net
|
|
$
|
750,627
|
|
|
$
|
722,860
|
|
Under industry regulations, a concentration is considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly impacted by economic or other conditions. Typically
, industry guidelines require disclosure of concentrations of loans exceeding 10.0% of total loans outstanding. FNCB had no such concentrations at December 31, 2016, 2015 and 2014. In addition to industry guidelines, FNCB’s internal policy considers a concentration to exist in its loan portfolio if an aggregate loan balance outstanding to borrowers within a specific industry exceeds 25.0% of capital. However, management regularly reviews loans by all industry categories to determine if a potential concentration exists.
The following table presents industry concentrations within
FNCB’s loan portfolio at September 30, 2017 and December 31, 2016:
Loan Concentrations
|
|
September 30, 2017
|
|
|
December 31, 2016
|
|
(dollars in thousands)
|
|
Amount
|
|
|
% of Gross
Loans
|
|
|
Amount
|
|
|
% of Gross
Loans
|
|
Retail space/shopping centers
|
|
$
|
43,772
|
|
|
|
5.78
|
%
|
|
$
|
38,573
|
|
|
|
5.29
|
%
|
1-4 family residential investment properties
|
|
|
30,669
|
|
|
|
4.05
|
%
|
|
|
24,413
|
|
|
|
3.35
|
%
|
Automobile dealers
|
|
|
20,185
|
|
|
|
2.67
|
%
|
|
|
31,989
|
|
|
|
4.39
|
%
|
Asset Quality
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, net of unearned interest, deferred loan fees and costs, and reduced by the ALLL. The ALLL is established through a provision for loan and lease losses charged to earnings.
FNCB
has established and consistently applies loan policies and procedures designed to foster sound underwriting and credit monitoring practices. Credit risk is managed through the efforts of loan officers, the loan review function, and the Credit Risk Management and the ALLL committees, as well as oversight from the Board of Directors. Management continually evaluates its credit risk management practices to ensure it is reacting to problems in the loan portfolio in a timely manner, although, as is the case with any financial institution, a certain degree of credit risk is dependent in part on local and general economic conditions that are beyond management’s control.
Under
FNCB’s risk rating system, loans that are rated pass, special mention, substandard, doubtful, or loss are reviewed regularly as part of the risk management practices. The Credit Risk Management Committee, which consists of key members of management, finance, legal, retail lending and credit administration, meets monthly or more often as necessary to review individual problem credits and workout strategies and provides monthly reports to the Board of Directors.
A loan is considered impaired when it is probable that
FNCB will be unable to collect all amounts due (including principal and interest) according to the contractual terms of the note and loan agreement. For purposes of the analysis, all TDRs, loan relationships with an aggregate outstanding balance greater than $100 thousand rated substandard and non-accrual, and loans that are identified as doubtful or loss are considered impaired. Impaired loans are analyzed individually to determine the amount of impairment. For collateral-dependent loans, impairment is measured based on the fair value of the collateral supporting the loans. A loan is considered to be collateral dependent when repayment of the loan is expected to be provided through the liquidation of the collateral held. For impaired loans that are secured by real estate, external appraisals are obtained annually, or more frequently as warranted, to ascertain a fair value so that the impairment analysis can be updated. Should a current appraisal not be available at the time of impairment analysis, other sources of valuation may be used including, current letters of intent, broker price opinions or executed agreements of sale. For non-collateral-dependent loans, impairment is measured based on the present value of expected future cash flows, net of any deferred fees and costs, discounted at the loan’s original effective interest rate.
Loans to borrowers that are experiencing financial difficulty that are modified and result in
the granting of concessions to the borrowers are classified as TDRs and are considered to be impaired. Such concessions generally involve an extension of a loan’s stated maturity date, a reduction of the stated interest rate, payment modifications, capitalization of property taxes with respect to residential mortgage loans or a combination of these modifications. Non-accrual TDRs are returned to accrual status if principal and interest payments, under the modified terms, are brought current, are performing under the modified terms for six consecutive months, and management believes that collection of the remaining interest and principal is probable.
Non-performing loans are monitored on an ongoing basis as part of
FNCB’s loan review process. Additionally, work-out efforts for non-performing loans and OREO are actively monitored through the Credit Risk Management Committee. A potential loss on a non-performing asset is generally determined by comparing the outstanding loan balance to the fair value of the pledged collateral, less cost to sell.
Loans are placed on non-accrual when a loan is specifically determined to be impaired or when management believes that the collection of interest or principal is doubtful. This generally occurs when a default of interest or principal has existed for 90 days or more, unless
the loan is well secured and in the process of collection, or when management becomes aware of facts or circumstances that the loan would default before 90 days. FNCB determines delinquency status based on the number of days since the date of the borrower’s last required contractual loan payment. When the interest accrual is discontinued, all unpaid interest income is reversed and charged back against current earnings. Any subsequent cash payments received are applied, first to the outstanding loan amounts, then to the recovery of any charged-off loan amounts, with any excess treated as a recovery of lost interest. A non-accrual loan is returned to accrual status when the loan is current as to principal and interest payments, is performing according to contractual terms for six consecutive months and future payments are reasonably assured.
Management actively manages impaired loans in an effort to reduce loan balances by working with customers to develop strategies to resolve borrower difficulties, through sale or liquidation of collateral, foreclosure, and other appropriate means. Real estate values in
FNCB’s market area have appeared to stabilize. Employment conditions within the Scranton-Wilkes-Barre-Hazleton metropolitan statistical area, FNCB’s primary market area, have remained steady comparing data for September 2017 with that of September 2016. However, the unemployment rate in FNCB’s primary market area continues to be considerably higher than that of the Commonwealth of Pennsylvania. Management monitors employment and economic conditions within FNCB’s market area, as weakening of conditions could result in real estate devaluations and an increase in loan delinquencies, which could negatively impact asset quality and cause an increase in the provision for loan and lease losses.
Under the fair value of collateral method, the impaired amount of the loan is deemed to be the difference between the loan amount and the fair value of the collateral, less the estimated costs to sell.
For real estate secured loans, a factor of 10% is generally utilized to estimate costs to sell, which is based on typical cost factors, such as a 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process. If the valuation indicates that the fair value has deteriorated below the carrying value of the loan, the difference between the fair value and the principal balance is charged off. For impaired loans for which the value of the collateral less costs to sell exceeds the loan value, the impairment is considered to be zero.
The following
schedule presents information about non-performing assets and accruing TDRs at September 30, 2017 and December 31, 2016:
Non-performing
Assets and
Accruing TDRs
|
|
September 30,
|
|
|
December 31,
|
|
(in thousands)
|
|
2017
|
|
|
2016
|
|
Non-accrual loans
|
|
$
|
2,642
|
|
|
$
|
2,234
|
|
Loans
past due 90 days or more and still accruing
|
|
|
-
|
|
|
|
-
|
|
Total non-performing loans
|
|
|
2,642
|
|
|
|
2,234
|
|
Other real estate owned
|
|
|
1,088
|
|
|
|
2,048
|
|
Other non-performing assets
|
|
|
1,900
|
|
|
|
2,160
|
|
Total non-performing assets
|
|
$
|
5,630
|
|
|
$
|
6,442
|
|
|
|
|
|
|
|
|
|
|
Accruing TDRs
|
|
$
|
9,283
|
|
|
$
|
4,176
|
|
Non-performing loans as a percentage of gross loans
|
|
|
0.35
|
%
|
|
|
0.31
|
%
|
Tota
l non-performing assets decreased $0.8 million, or 12.6%, to $5.6 million at September 30, 2017 from $6.4 million at December 31, 2016. The decrease was primarily due to a decrease in other real estate owned of $1.0 million, or 46.9%. Non-accrual loans increased by $0.4 million, primarily attributable to one large commercial relationship, which was also modified as a TDR during the nine months ended September 30, 2017. FNCB’s ratio of non-performing loans to total gross loans increased to 0.35% at September 30, 2017 from 0.31% at December 31, 2016. FNCB’s ratio of non-performing assets as a percentage of shareholders’ equity improved to 5.8% at September 30, 2017 from 7.1% at December 31, 2016. Management continues to monitor non-accrual loans, delinquency trends and economic conditions within FNCB’s market area on an on-going basis in order to proactively address any collection related issues.
Other non-performing assets at
September 30, 2017 and December 31, 2016 include a classified account receivable secured by an evergreen letter of credit in the amount of $1.9 million, which arose as part of a settlement agreement for a large construction, land acquisition and development loan for a residential development project in the Pocono region of Monroe County, and has been included in other assets since 2011. The project was stalled due to a decline in real estate values in this area following the financial crisis of 2008. The agreement provides for payment to FNCB as real estate building lots are sold. To date, no lots have been sold; however, economic development in this market area has recently improved and construction activity related to this project by the developer has increased. Management has classified this asset as substandard due to the length of holding time and will continue to monitor this project closely. Also included in other non-performing assets at December 31, 2016 was foreclosed equipment of $260 thousand, which was sold during the nine months ended September 30, 2017, resulting in a net gain of $47 thousand that was included in non-interest income within the consolidated statements of income.
TDRs at
September 30, 2017 and December 31, 2016 were $10.2 million and $4.3 million, respectively. Accruing and non-accruing TDRs were $9.3 million and $0.9 million, respectively at September 30, 2017 and $4.2 million and $0.1 million, respectively at December 31, 2016. There were eight loan relationships modified as TDRs during the nine months ended September 30, 2017, which incorporated a total of fifteen individual loans. There were three loan relationships, comprised of eight commercial real estate loans totaling $5.3 million, and two loan relationships comprised of four commercial and industrial loans totaling $1.8 million that were modified under varying forms of forbearance agreements during the nine months ended September 30, 2017. Additional TDRs included two consumer loans totaling $85 thousand that had their terms extended and delinquent taxes capitalized, as well as one residential real estate loan in the amount of $63 thousand that had its terms extended. The commercial real estate modifications included a principal forbearance agreement for one loan in the amount of $4.0 million and reductions in required monthly principal payments resulting in balloon payments due at maturity for seven loans to two borrowers aggregating $1.2 million. The four commercial and industrial loan modifications involved the delay of required principal and interest payments for predefined time periods.
Approximately $0.8 million in specific reserves to the ALLL were established for TDRs at
September 30, 2017, of which $0.6 million represented specific reserves for loans modified during the nine months ended September 30, 2017. In addition, a charge-off in the amount of $0.3 million was recorded as part of the modification of three commercial and industrial loans aggregating $1.8 million to one borrower. All loans modified during 2017 are performing in accordance with their respective modified terms.
The average balance of impaired loans was $
11.3 million and $7.0 million for the nine months ended September 30, 2017 and 2016, respectively. FNCB recorded $108 thousand and $284 thousand of interest income on impaired loans for the three and nine months ended September 30, 2017, respectively and $46 thousand and $152 thousand for the three and nine months ended September 30, 2016.
The following table presents the changes in non-performing loans for the
three and nine months ended September 30, 2017 and 2016. Loan foreclosures represent recorded investment at time of foreclosure not including the effect of any guarantees:
Changes in Non-performing Loans
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
(in thousands)
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Balance, beginning of period
|
|
$
|
3,681
|
|
|
$
|
2,739
|
|
|
$
|
2,234
|
|
|
$
|
3,788
|
|
Loans newly placed on non-accrual
|
|
|
404
|
|
|
|
1,126
|
|
|
|
3,273
|
|
|
|
3,364
|
|
Changes in loans past due 90 days or more and still accruing
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Loans transferred to OREO
|
|
|
-
|
|
|
|
(940
|
)
|
|
|
(80
|
)
|
|
|
(1,177
|
)
|
Loans returned to performing status
|
|
|
(109
|
)
|
|
|
(3
|
)
|
|
|
(180
|
)
|
|
|
(147
|
)
|
Loans charged-off
|
|
|
(363
|
)
|
|
|
(171
|
)
|
|
|
(1,104
|
)
|
|
|
(1,991
|
)
|
Loan payments received
|
|
|
(971
|
)
|
|
|
(335
|
)
|
|
|
(1,501
|
)
|
|
|
(1,421
|
)
|
Balance, end of period
|
|
$
|
2,642
|
|
|
$
|
2,416
|
|
|
$
|
2,642
|
|
|
$
|
2,416
|
|
The additional interest income that would have been earned on non-accrual and restructured loans
had the loans been performing in accordance with their original terms for the three and nine months ended September 30, 2017 approximated $50 thousand and $116 thousand, respectively and $48 thousand and $175 thousand for the three and nine months ended September 30, 2016, respectively.
The following table
outlines accruing loan delinquencies and non-accrual loans as a percentage of gross loans at September 30, 2017 and December 31, 2016:
Loan Delinquencies and Non-
A
ccrual Loans
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Accruing:
|
|
|
|
|
|
|
|
|
30-59 days
|
|
|
0.28
|
%
|
|
|
0.37
|
%
|
60-89 days
|
|
|
0.18
|
%
|
|
|
0.13
|
%
|
90+ days
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
Non-accrual
|
|
|
0.35
|
%
|
|
|
0.31
|
%
|
Total delinquencies
|
|
|
0.81
|
%
|
|
|
0.81
|
%
|
Total delinquencies as a percentage of gross loans were 0.81% at both September 30, 2017 and December 31, 2016, primarily due to
increases in both non-accrual loans and loans 60-89 days delinquent of $0.4 million each, offset by a decrease in loans past due 30-59 days. In its evaluation of the ALLL, management considers a variety of qualitative factors including changes in the volume and severity of delinquencies.
Allowance for Loan and Lease Losses
The ALLL represents management
’s estimate of probable loan losses inherent in the loan portfolio. The ALLL is analyzed in accordance with GAAP and is maintained at a level that is based on management’s evaluation of the adequacy of the ALLL in relation to the risks inherent in the loan portfolio.
As part of its evaluation, management considers qualitative and environmental factors, including, but not limited to:
•
|
changes in national, local, and business economic conditions and developments, including the condition of various market segments;
|
•
|
changes in the nature and volume of the loan portfolio;
|
•
|
changes in lending policies and procedures, including underwriting standards, collection, charge-off and recovery practices and results;
|
•
|
changes in the experience, ability and depth of lending management and staff;
|
•
|
changes in the quality of the loan review system and the degree of oversight by the Board of Directors;
|
•
|
changes in the trend of the volume and severity of past due and classified loans, including trends in the volume of non-accrual loans, TDRs and other loan modifications;
|
•
|
the existence and effect of any concentrations of credit and changes in the level of such concentrations;
|
•
|
the effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the current loan portfolio; and
|
•
|
analysis of customers’ credit quality, including knowledge of their operating environment and financial condition.
|
Evaluations are intrinsically subjective, as the results are estimated based on management knowledge and experience and are subject to interpretation and modification as information becomes available or as future events occur. Management monitors the loan portfolio on an ongoing basis with emphasis on weakness in both the real estate market and the economy in general and its effect on repayment. Adjustments to the ALLL are made based on management
’s assessment of the factors noted above.
For purposes of
management’s analysis of the ALLL, all loan relationships with an aggregate balance greater than $100 thousand that are rated substandard and non-accrual, identified as doubtful or loss, and all TDRs are considered impaired and are analyzed individually to determine the amount of impairment. Circumstances such as construction delays, declining real estate values, and the inability of the borrowers to make scheduled payments have resulted in these loan relationships being classified as impaired. FNCB utilizes the fair value of collateral method for collateral-dependent loans and TDRs for which repayment depends on the sale of collateral. For non-collateral-dependent loans and TDRs, FNCB measures impairment based on the present value of expected future cash flows discounted at the loan’s original effective interest rate. With regard to collateral-dependent loans, appraisals are received at least annually to ensure that impairment measurements reflect current market conditions. Should a current appraisal not be available at the time of impairment analysis, other valuation sources including current letters of intent, broker price opinions or executed agreements of sale may be used. Only downward adjustments are made based on these supporting values. Included in all impairment calculations is a cost to sell adjustment of approximately 10%, which is based on typical cost factors, including a 6% broker commission, 1% transfer taxes and 3% various other miscellaneous costs associated with the sales process. Sales costs are periodically reviewed and revised based on actual experience. The ALLL analysis is adjusted for subsequent events that may arise after the end of the reporting period but before the financial reports are filed.
The ALLL equaled $8.
9 million at September 30, 2017, an increase of $0.5 million from $8.4 million at December 31, 2016. The increase resulted from a provision for loan and lease losses of $486 thousand for the nine months ended September 30, 2017, partially offset by net charge-offs of $43 thousand for the same period.
The ALLL consists of both specific and general components.
The component of the ALLL that is related to impaired loans that are individually evaluated for impairment, the guidance for which is provided by ASC 310
“Impairment of a Loan”
(“ASC 310”), was $0.8 million, or 8.7%, of the total ALLL at September 30, 2017, compared to $0.3 million, or 3.6%, of the total ALLL at December 31, 2016. The increase in reserves for loans individually evaluated for impairment resulted primarily from a reserve established for a large commercial and industrial loan relationship that was transferred to non-accrual and modified as a TDR during the nine months ended September 30, 2017. A general allocation of $8.1 million was calculated for loans analyzed collectively under ASC 450
“Contingencies”
(“ASC 450”), which represented 91.3% of the total ALLL of $8.5 million. Comparatively, at December 31, 2016, the general allocation for loans collectively analyzed for impairment amounted to $8.1 million, or 96.4%, of the total ALLL. The increase in general reserves primarily reflected an increase in total loans outstanding. The ratio of the ALLL to total loans at September 30, 2017 and December 31, 2016 was 1.17% and 1.15%, respectively, based on total loans of $756.9 million and $731.8 million, respectively.
The following table presents an allocation of the ALLL
by major loan category and percent of loans in each category to total loans at September 30, 2017 and December 31, 2016:
Allocation of the ALLL
|
|
September 30, 2017
|
|
|
December 31, 2016
|
|
|
|
|
|
|
|
Percentage
|
|
|
|
|
|
|
Percentage
|
|
|
|
|
|
|
|
of Loans
|
|
|
|
|
|
|
of Loans
|
|
|
|
|
|
|
|
in Each
|
|
|
|
|
|
|
in Each
|
|
|
|
|
|
|
|
Category
|
|
|
|
|
|
|
Category
|
|
|
|
Allowance
|
|
|
to Total
|
|
|
Allowance
|
|
|
to Total
|
|
(dollars in thousands)
|
|
Amount
|
|
|
Loans
|
|
|
Amount
|
|
|
Loans
|
|
Residential real estate
|
|
$
|
1,178
|
|
|
|
20.12
|
%
|
|
$
|
1,171
|
|
|
|
19.79
|
%
|
Commercial real estate
|
|
|
3,303
|
|
|
|
33.53
|
%
|
|
|
3,297
|
|
|
|
33.46
|
%
|
Construction, land acquisition and development
|
|
|
277
|
|
|
|
3.54
|
%
|
|
|
268
|
|
|
|
2.52
|
%
|
Commercial and industrial
|
|
|
2,363
|
|
|
|
19.30
|
%
|
|
|
1,736
|
|
|
|
20.69
|
%
|
Consumer
|
|
|
1,433
|
|
|
|
18.32
|
%
|
|
|
1,457
|
|
|
|
17.54
|
%
|
State and political subdivision
|
|
|
308
|
|
|
|
5.19
|
%
|
|
|
490
|
|
|
|
6.00
|
%
|
Total
|
|
$
|
8,862
|
|
|
|
100.00
|
%
|
|
$
|
8,419
|
|
|
|
100.00
|
%
|
The following table presents an analysis of
the ALLL by loan category for the three and nine months ended September 30, 2017 and 2016:
Reconciliation of the ALLL
|
|
For the Three Months Ended September 30,
|
|
|
For the Nine Months Ended September 30,
|
|
(in thousands)
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Balance at beginning of period
|
|
$
|
8,469
|
|
|
$
|
8,559
|
|
|
$
|
8,419
|
|
|
$
|
8,790
|
|
Charge-offs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential real estate
|
|
|
32
|
|
|
|
37
|
|
|
|
112
|
|
|
|
61
|
|
Commercial real estate
|
|
|
85
|
|
|
|
-
|
|
|
|
114
|
|
|
|
251
|
|
Construction, land acquisition and development
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Commercial and industrial
|
|
|
128
|
|
|
|
18
|
|
|
|
475
|
|
|
|
1,082
|
|
Consumer
|
|
|
132
|
|
|
|
134
|
|
|
|
438
|
|
|
|
652
|
|
State and political subdivisions
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total charge-offs
|
|
|
377
|
|
|
|
189
|
|
|
|
1,139
|
|
|
|
2,046
|
|
Recoveries of charged-off loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential real estate
|
|
|
16
|
|
|
|
2
|
|
|
|
28
|
|
|
|
4
|
|
Commercial real estate
|
|
|
38
|
|
|
|
1
|
|
|
|
43
|
|
|
|
4
|
|
Construction, land acquisition and development
|
|
|
-
|
|
|
|
-
|
|
|
|
421
|
|
|
|
9
|
|
Commercial and industrial
|
|
|
125
|
|
|
|
184
|
|
|
|
304
|
|
|
|
396
|
|
Consumer
|
|
|
48
|
|
|
|
167
|
|
|
|
300
|
|
|
|
475
|
|
State and political subdivisions
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total recoveries
|
|
|
227
|
|
|
|
354
|
|
|
|
1,096
|
|
|
|
888
|
|
Net charge-offs (recoveries)
|
|
|
150
|
|
|
|
(165
|
)
|
|
|
43
|
|
|
|
1,158
|
|
Provision (credit) for loan and lease losses
|
|
|
543
|
|
|
|
(234
|
)
|
|
|
486
|
|
|
|
858
|
|
Balance at end of period
|
|
$
|
8,862
|
|
|
$
|
8,490
|
|
|
$
|
8,862
|
|
|
$
|
8,490
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net charge-offs (recoveries) as a percentage of average loans
|
|
|
0.02
|
%
|
|
|
(0.02
|
%)
|
|
|
0.01
|
%
|
|
|
0.16
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan and lease losses as a percentage of gross loans at period end
|
|
|
1.17
|
%
|
|
|
1.17
|
%
|
|
|
1.17
|
%
|
|
|
1.17
|
%
|
Other Real Estate Owned
At
September 30, 2017, OREO consisted of 9 properties with an aggregate carrying value of $1.1 million, a decrease of $0.9 million from $2.0 million at December 31, 2016. FNCB foreclosed upon two residential real estate properties with a carrying value of $125 thousand during the nine months ended September 30, 2017. There was one sale and one partial sale of properties with an aggregate carrying value of $763 thousand during the nine months ended September 30, 2017, which resulted in a net gain of $57 thousand. During the nine months ended September 30, 2016, two properties with a carrying value of $950 thousand were foreclosed upon, and there were three sales and one partial sale of properties with an aggregate carrying value of $1.9 million, which resulted in a net gain on the sales of $29 thousand. The expenses related to maintaining OREO, not including adjustments to property values subsequent to foreclosure, and net of any income from operation of the properties, amounted to $38 thousand and $126 thousand for the three and nine months ended September 30, 2017, respectively, compared to $64 thousand and $166 thousand, respectively, for the same periods in 2016.
FNCB
actively markets OREO properties for sale through a variety of channels including internal marketing and the use of outside brokers/realtors. The carrying value of OREO is generally calculated at an amount not greater than 90% of the most recent fair market appraised value unless specific conditions warrant an exception. A 10% factor is generally used to estimate costs to sell, which is based on typical cost factors, such as 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process. The fair value is updated on an annual basis or more frequently if new valuation information is available. Further deterioration in the real estate market could result in additional losses on these properties. FNCB incurred valuation adjustments of $82 thousand and $322 thousand for the three and nine months ended September 30, 2017, $307 thousand of which is included in expense of other real estate owned in the consolidated statements of income. A $15 thousand valuation adjustment during the three and nine months ended September 30, 2017 was related to an investor loan, and accordingly reduced the liability owed to the investor. Valuation adjustments on OREO properties totaled $31 thousand and $169 thousand for the three and nine months ended September 30, 2016.
The following table presents the activity in OREO
for the three and nine months ended September 30, 2017 and 2016:
Activity in OREO
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
(in thousands)
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Balance, beginning of period
|
|
$
|
1,183
|
|
|
$
|
1,628
|
|
|
$
|
2,048
|
|
|
$
|
3,154
|
|
Property foreclosures
|
|
|
-
|
|
|
|
713
|
|
|
|
125
|
|
|
|
950
|
|
Valuation adjustments
|
|
|
(82
|
)
|
|
|
(31
|
)
|
|
|
(322
|
)
|
|
|
(169
|
)
|
Carrying value of OREO sold
|
|
|
(13
|
)
|
|
|
(245
|
)
|
|
|
(763
|
)
|
|
|
(1,870
|
)
|
Balance, end of period
|
|
$
|
1,088
|
|
|
$
|
2,065
|
|
|
$
|
1,088
|
|
|
$
|
2,065
|
|
The following
table presents a distribution of OREO at September 30, 2017 and December 31, 2016:
Distribution of OREO
|
|
September 30,
|
|
|
December 31,
|
|
(in thousands)
|
|
2017
|
|
|
2016
|
|
Land / lots
|
|
$
|
524
|
|
|
$
|
641
|
|
Commercial real estate
|
|
|
427
|
|
|
|
1,380
|
|
Residential real estate
|
|
|
137
|
|
|
|
27
|
|
Total other real estate owned
|
|
$
|
1,088
|
|
|
$
|
2,048
|
|
Liabilities
Total liabilities were $
1.060 billion at September 30, 2017, a decrease of $45.6 million, or 4.1%, from $1.105 billion at December 31, 2016. The decrease was primarily attributable to a $31.9 million outflow of deposits, coupled with a reduction of $13.2 million in Federal Home Loan Bank of Pittsburgh advances. The decrease in total deposits was due to a $20.7 million, or 2.5%, decrease in interest-bearing deposits to $820.8 million at September 30, 2017 from $841.4 million at December 31, 2016, along with an $11.3 million, or 6.5%, reduction in non-interest-bearing demand deposits to $162.4 million at September 30, 2017 from $173.7 million at December 31, 2016. The decrease in interest-bearing deposits primarily reflected the anticipated exit of short-term funds related to the sale of a municipal utility deposited during the fourth quarter of 2016. The decrease in non-interest bearing deposits was concentrated in business checking deposits.
On
September 1, 2017, FNCB accelerated a partial principal repayment in the amount of $5.0 million on the subordinated notes (“Notes”). This principal repayment was originally due and payable on September 1, 2018. By accelerating the principal repayment, FNCB is expected to save $225 thousand in interest expense related to the Notes.
Equity
Total shareholders
’ equity increased $7.1 million, or 7.9%, to $97.5 million at September 30, 2017 from $90.4 million at December 31, 2016. The capital improvement resulted from net income for the first nine months of 2017 of $6.3 million, coupled with a $1.7 million increase in accumulated other comprehensive income, which resulted from appreciation in the fair value of available-for-sale securities net of the tax impact of the appreciation. Book value per common share was $5.82 at September 30, 2017, an increase of $0.39 per share, or 7.2%, compared to $5.43 at December 31, 2016.
Liquidity
The term liquidity refers to the ability to generate suffic
ient amounts of cash to meet cash flow needs. Liquidity is required to fulfill the borrowing needs of FNCB’s credit customers and the withdrawal and maturity requirements of its deposit customers, as well as to meet other financial commitments. FNCB’s liquidity position is impacted by several factors, which include, among others, loan origination volumes, loan and investment maturity structure and cash flows, deposit demand and certificate of deposit maturity structure and retention. FNCB has liquidity and contingent funding policies in place that are designed with controls in place to provide advanced detection of potentially significant funding shortfalls,
establish methods for assessing and monitoring risk levels, and institute prompt responses that may alleviate a potential liquidity crisis. Management monitors FNCB’s liquidity position and fluctuations daily, forecasts future liquidity needs, performs periodic stress tests on its liquidity levels, and develops strategies to ensure adequate liquidity at all times.
The
statements of cash flows present the change in cash and cash equivalents from operating, investing and financing activities. Cash and due from banks and interest-bearing deposits in other banks are FNCB’s most liquid assets. At September 30, 2017, cash and cash equivalents totaled $43.8 million, a decrease of $68.6 million compared to $112.4 million at December 31, 2016. Net funds used in financing activities were $51.2 million for the nine months ended September 30, 2017, largely representing a decrease in deposits from customers of $31.9 million, net repayment of FHLB term and overnight borrowings of $13.2 million, and a principal reduction on subordinated debentures of $5.0 million. Investing activities used $24.9 million in net cash for the nine months ended September 30, 2017, driven primarily by a net increase in loans to customers of $30.1 million. Net cash provided by operating activities totaled $7.4 million.
Interest Rate
Risk
Interest Rate Sensitivity
Market risk is the risk to earnings and/or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices.
FNCB’s exposure to market risk is primarily interest rate risk associated with our lending, investing and deposit gathering activities, all of which are other than trading. Changes in interest rates affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. In addition, variations in interest rates affect the underlying economic value of our assets, liabilities and off-balance sheet items.
Asset and Liability Management
FNCB
manages these objectives through its Asset and Liability Management Committee (“ALCO”) and its Rate and Liquidity and Investment Committees, which consist of certain members of management and certain members of the finance unit. Members of the committees meet regularly to develop balance sheet strategies affecting the future level of net interest income, liquidity and capital. The major objectives of ALCO are to:
|
●
|
manage exposure to changes in the interest rate environment by limiting the changes in net interest margin to an acceptable level within a reasonable range of interest rates;
|
|
●
|
ensure adequate liquidity and funding;
|
|
●
|
maintain a strong capital base; and
|
|
●
|
maximize net interest income opportunities.
|
ALCO monitors
FNCB’s exposure to changes in net interest income over both a one-year planning horizon and a longer-term strategic horizon. ALCO uses net interest income simulations and economic value of equity (“EVE”) simulations as the primary tools in measuring and managing FNCB’s position and considers balance sheet forecasts, our liquidity position, the economic environment, anticipated direction of interest rates and FNCB’s earnings sensitivity to changes in these rates in its modeling. In addition, ALCO has established policy tolerance limits for acceptable negative changes in net interest income. Furthermore, as part of its ongoing monitoring, ALCO has been enhanced to require periodic back testing of modeling results, which involves after-the-fact comparisons of projections with FNCB’s actual performance to measure the validity of assumptions used in the modeling techniques.
Earnings at Risk and Economic Value at Risk Simulations
Earnings at Risk
Earnings-at-risk simulation measures the change in net interest income and net income under various interest rate scenarios.
Specifically, given the current market rates, ALCO looks at “earnings at risk” to determine anticipated changes in net interest income from a base case scenario with scenarios of +200, +400, and -100 basis points for simulation purposes. The simulation takes into consideration that not all assets and liabilities re-price equally and simultaneously with market rates (i.e., savings rate).
Economic Value at Risk
While earnings-at-risk simulation measures the short-term risk in the balance sheet, economic value (or portfolio equity) at risk measures the long-term risk by finding the net present value of the future cash flows from
FNCB’s existing assets and liabilities. ALCO examines this ratio regularly, and given the current rate environment, has utilized rate shocks of +200, +400, and -100 basis points for simulation purposes. Management recognizes that, in some instances, this ratio may contradict the “earnings at risk” ratio.
While ALCO regularly performs a wide variety of simulations under various strategic balance sheet and treasury yield curve scenarios, the following results reflect
FNCB’s sensitivity over the subsequent twelve months based on the following assumptions:
|
●
|
a
sset and liability levels using September 30, 2017 as a starting point;
|
|
●
|
c
ash flows are based on contractual maturity and amortization schedules with applicable prepayments derived from internal historical data and external sources; and
|
|
●
|
ca
sh flows are reinvested into similar instruments so as to keep interest-earning asset and interest-bearing liability levels constant.
|
The following table illustrates the simulated impact of
parallel and instantaneous interest rate shocks of +400 basis points, +200 basis points, and -100 basis points on net interest income and the change in economic value over a one-year time horizon from the September 30, 2017 levels:
|
|
Rates +200
|
|
|
Rates +400
|
|
|
Rates -100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Simulation
Results
|
|
|
Policy
Limit
|
|
|
Simulation
Results
|
|
|
Policy
Limit
|
|
|
Simulation
Results
|
|
|
Policy
Limit
|
|
Earnings at risk:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent change in net interest income
|
|
|
(0.8%
|
)
|
|
|
(10.0%
|
)
|
|
|
(3.5%
|
)
|
|
|
(20.0%
|
)
|
|
|
(4.1%
|
)
|
|
|
(5.0%
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Economic value at risk:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent change in economic value of equity
|
|
|
(3.3%
|
)
|
|
|
(20.0%
|
)
|
|
|
(7.5%
|
)
|
|
|
(35.0%
|
)
|
|
|
(7.4%
|
)
|
|
|
(10.0%
|
)
|
FNCB was liability rate sensitive at September 30, 2017, as a greater volume of interest-bearing liabilities than interest-earning assets will mature or reprice within a one-year time frame, due to a significant amount of non-maturity, interest-bearing de
posit balances at the end of the period. Accordingly, model results at September 30, 2017 indicate that FNCB’s net interest income and economic value of equity are expected to decrease 0.8% and 3.3%, respectively, under a +200-basis point interest rate shock. Due to significant earning asset growth in the third quarter of 2017, the results of the simulation model at September 30, 2017 improved in comparison to the results at June 30, 2017 which indicated net interest income and economic value of equity were expected to decrease 2.8% and 4.7%, respectively, given a +200-basis point rate shock.
This analysis does not represent a forecast for FNCB and should not be relied upon as being indicative of expected operating results. These simulations are based on numerous assumptions: the nature and timing of interest rate levels, prepayments on loans
and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacements of asset and liability cash flows, and other factors. While assumptions reflect current economic and local market conditions, FNCB cannot make any assurances as to the predictive nature of these assumptions, including changes in interest rates, customer preferences, competition and liquidity needs, or what actions ALCO might take in responding to these changes.
As previously mentioned, as part of its ongo
ing monitoring, ALCO requires periodic back testing of modeling results, which involves after-the-fact comparisons of projections with FNCB’s actual performance to measure the validity of assumptions used in the modeling techniques. As part of its quarterly review, management compared tax-equivalent net interest income recorded for the three months ended September 30, 2017 with tax-equivalent net interest income that was projected for the same three-month period. The variance between actual and projected tax-equivalent net interest income for the three-month period ended September 30, 2017 was $207 thousand, or 2.3%. Although the variance was deemed immaterial, ALCO performs a rate/volume analysis between actual and projected results in order to continue to improve the accuracy of it simulation models.
Off-Balance Sheet Arrangements
In the normal course of operations,
FNCB engages in a variety of financial transactions that, in accordance with GAAP, are not recorded in our consolidated financial statements or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions may be used for general corporate purposes or for customer needs. Corporate purpose transactions would be used to help manage credit, interest rate, and liquidity risk or to optimize capital. Customer transactions are used to manage customers’ requests for funding.
For the
three- and nine-month periods ended September 30, 2017, FNCB did not engage in any off-balance sheet transactions that would have or would be reasonably likely to have a material effect on its consolidated financial condition.