Progress 2018 ANNUAL REPORT

Transcription

1 Progress 2018 ANNUAL REPORT

2

3 A MESSAGE FROM THE CHIEF EXECUTIVE OFFICER Merchants Bank saw 2018 as a year of transition. We made a number of changes throughout the organization designed to make our Bank stronger and more competitive for years to come. Our Board of Directors and Management team developed a Strategic Plan that focused on long-term, profitable growth, corresponding contribution to our capital base and improved shareholder value. We promoted and hired several accomplished bankers throughout our organization which enables us to reorganize our management structure, thereby providing new ideas and creating a more efficient operation. We expanded our Executive Management Team to provide stronger leadership and enhance communications to all departments. The initiatives implemented during 2018 resulted in record earnings for the second consecutive year and provides a solid foundation for the future. Two years ago, our goal was to be in the upper tier of our peers in earnings, while maintaining a strong credit culture. I am proud to say our team accomplished that goal during We continue to focus on serving the needs of our customers and communities every day while providing our shareholders with an acceptable level of return that they deserve. MERCHANTS BANK EXECUTIVE MANAGEMENT TEAM Rocco A. Del Vecchio V. Daniel Smoker Larry G. Rice, Jr. Kathleen Eckhart Mark Jobes

4 A MESSAGE FROM THE CHAIRMAN PROGRESS Progress is our keyword to highlight what our Bank achieved in Our focus on customer experience drove many new initiatives enhancing our communications, delivery, and products. At the beginning of the year, we introduced our new social media platform on Facebook. Regular posts help us achieve customer education, awareness, and product knowledge. We added a new element with the social platform that provides economic and real estate news. We grew followers by 86% over 12 months and increased social engagements, such as likes and shares. PRODUCT / TECHNOLOGY The Bank introduced newly formatted statements giving customers a modern appearance and easier management of their bank accounts. The new format also allows us to provide educational or promotional content in both print and digital formats. In keeping with the customer experience and product enhancements, the Bank now provides customers with two-way fraud text alerts, giving customers an interactive experience to quickly respond to potential fraud threats. Several new mortgage products were introduced fulfilling our product compliment for new and existing customers. We expanded our network with new real estate developers and real estate agents to broaden our market exposure. COMMUNITY We continue our mission to support our communities. Each year, our employees volunteer their professional and personal time to the community, helping local soup kitchens, municipalities, area schools, and countless non-profits. New in 2018, we collaborated a bank-wide and community blood drive to support Miller-Keystone Blood Center. Our efforts collected 19 units to support 22 community hospitals and their patients. Overall, the bank supported over 200 organizations, events, clubs, schools, and municipalities with sponsorships or donations totaling more than $130,000. Additionally, the bank continued financial literacy education to area youth. 4 Richard M. Hotchkiss Chairman of the Board

5 FINANCIAL HIGHLIGHTS (Dollars in thousands, except per share data) Selected Financial Condition Data: Total assets $395,957 $393,386 $372,759 $340,892 $352,596 Net loans 234, , , , ,771 Deposits 338, , , , ,466 Stockholders equity 32,790 31,193 29,573 29,241 28,622 Book value per share Selected Operations Data: Net income $3,623 $2,405 $1,736 $1,771 $1,785 Earnings per share Dividends per share Net interest income 13,030 11,752 10,554 10,263 10,065 Loan loss provision Noninterest income 1,666 1,566 1,609 1,716 1,768 Noninterest expense 9,823 9,339 9,944 9,645 9,520 Other Selected Data: Return on average assets 0.92% 0.62% 0.49% 0.50% 0.51% Return on average equity Net interest margin (tax equivalent) Efficiency Ratio (tax equivalent) Equity to assets Allowance for loan losses to loans Net charge-offs to average loans

6 PERFORMANCE growth in commercial loans, $5.3 million net growth in residential mortgage loans offset by a $0.9 million net reduction in consumer loans. MNB Corporation (the Corporation) reported record net income of $3,623,000, or $3.20 per share, for the year ended December 31, 2018, compared to $2,405,000, or $2.12 per share, for the year ended December 31, The primary contributors to the Corporation s improvement in earnings were reduced federal income tax rates, four separate quarter-point rate increases by the Federal Reserve Bank during the year, growth in average loans outstanding, and margin expansion. Total investments were $134.6 million at December 31, 2018, an increase of $2.1 million, compared to December 31, The increase is due to purchases of government agency and municipal bonds, repayments of mortgage-backed securities, maturities and calls of municipal and corporate bonds, offset by an increase in unrealized losses on available for sale debt securities. Total deposits increased $7.6 million to $338.9 million at December 31, 2018, compared to $331.3 million at December 31, During the second half of 2018, The improvement in the net interest margin was driven by an increase in the yield on average earning assets and controlling the cost of funds. The yield on average earning assets increased by 0.22% while the average cost to fund earning assets increased by 0.03%. Variable rate assets such as Prime-based loans and Libor and Prime Rate-indexed investments contributed to increased asset yields. Further reductions in outstanding certificates of deposit and growth in average balances held in core checking, savings and money market accounts helped to limit increases in the cost of funds. RETURN ON AVERAGE ASSETS 1.00% 0.92% 0.85% 0.70% 0.55% Strong growth in revenue and solid expense management drove record net income and annualized returns of 0.92% on average assets and 11.78% on average equity. This is a significant increase over the 2017 annualized return of 0.62% on average assets and 7.83% on average equity. 0.62% 0.51% 0.25% TOTAL LOANS (BEFORE ALLOWANCE FOR LOAN LOSSES) 250,000 Thousands $ 200,000 Thousands $ The Corporation s net loan portfolio increased $8.7 million to $234.7 million at December 31, 2018, up from $226.0 million at December 31, Loan originations for the year, including advances on lines of credit, totaled $56.2 million compared with $64.6 million in The 2018 growth in outstanding loan balances was primarily due to $4.8 million net 0.49% 0.40% Balance Sheet Summary Total assets at December 31, 2018 were $396.0 million compared to $393.4 million at December 31, The increase in total assets was due to a $9.2 million increase in total loans, a $2.1 million increase in investment securities, and partially offset by a $6.5 million decrease in interest-bearing deposits in banks. 0.50% $190,063 $193,483 $213,843 $228,145 $237, , ,000 50, Residential 1-4 Family Commercial Real Estate Commercial & Industrial 2018 Consumer

7 TOTAL DEPOSITS In May of 2018, Congress passed the Economic Growth, Regulatory Relief and Consumer Protection Act which is intended to give regulatory capital relief to small community banks that meet certain minimum capital standards. The new rules are in proposal form as of this writing, and if fully implemented as currently written, would require community banks to maintain a Tier 1 leverage ratio of 9% in order to be considered well-capitalized. As of December 31, 2018, Merchants Bank s Tier 1 leverage ratio of 9.03% is in compliance with the new standard and the Corporation intends to remain compliant in future periods. Compliance with this new standard greatly reduces the burden of calculating capital ratios under Basel III, and related reporting requirements. 300,000 $298,466 $284,293 $312, $331,281 $338, , ,000 0 Checking Savings MMA CDs the Corporation closed all of its securities sold under agreements to repurchase accounts, transferring balances primarily to interest-bearing checking accounts. Excluding these balance transfers, total deposits declined by $9.2 million. This decrease was primarily due to a $3.8 million decrease in certificates of deposit, a $2.2 million decrease in money market balances, and a $5.4 million decrease in interest checking offset by a $2.9 million increase in noninterest bearing checking accounts. Core deposits, defined as checking, savings, and money market accounts, represents 86.8% of deposits at December 31, 2018, compared to 85.4% at December 31, BOOK VALUE PER SHARE $ $25.26 $25.81 $ $ Borrowed funds, excluding securities sold under agreements to repurchase, increased $10.2 million to $23.3 million at December 31, Short-term borrowings from the Federal Home Loan Bank were $9.2 million at December 31, The Corporation did not have such borrowings at December 31, Stockholders equity increased $1.6 million during the year due to net income earned, offset by dividends paid to stockholders, and an increase in unrealized losses on available for sale securities. Book value per share at December 31, 2018 was $28.94 compared to $27.53 at December 31, As of December 31, 2018, Merchants Bank, the Corporation s wholly owned subsidiary, reported the following regulatory capital ratios: Tier 1 leverage rate of 9.03%; Common equity tier 1 and Tier 1 riskbased capital ratios of 14.37%; and a Total risk-based capital ratio of 15.41%. All ratios remain well above the regulatory minimum ratios of 5%, 6.5%, 8% and 10%, respectively, for a well-capitalized financial institution STOCKHOLDERS' EQUITY 40,000 30,000 Thousands $ Thousands $ 400,000 $28,622 $29,241 $29, $31,193 $32,790 20,000 10,

8 Results of Operations For the year ended December 31, 2018, net interest income increased $1.28 million to $13.03 million, a 10.9% increase from $11.75 million earned for the same period in The improvement in net interest income for the comparative periods was largely due to increasing yields on loans and investments, growth in average earning assets, and controlling the cost of funds. The increase in yield on average earning assets exceeded the rise in the Corporation s cost of funds due to reduced reliance on higher costing certificates of deposit along with growth in non-interest checking accounts. The growth in average earning assets was solely due to an $11.6 million increase in average total loans offset by a $1.9 million decrease in average investments and interest bearing balances with banks. The Corporation s average tax equivalent net interest margin expanded 20 basis points to 3.53% for the year ended December 31, 2018, compared to 3.33% for the comparable period in The weighted average tax equivalent yield on earning assets increased to 3.82% in 2018 from 3.60% in 2017, primarily as a result of four Prime rate increases along with increasing rates in the Treasury yield curve. The weighted average rate paid on interest-bearing balances increased by 4 basis points to 0.39% in 2018 versus 0.35% in Non-Interest income totaled $1,666,000 for 2018, an increase of $100,000 compared to the same period in Income from gains on the sale of newly originated residential mortgage loans accounted for $88,000 of the increase in non-interest income. The remaining growth was primarily derived from miscellaneous other fees and income, offset by a $31,000 net loss in the sale of investment securities in 2018 versus a $17,000 net gain in Thousands $ 15,000 10,000 5, % 4.25% 3.50% 2.75% 2.00% 12,000 NET INTEREST INCOME $10,065 $10,263 $10,554 $11,752 $13, % NET INTEREST MARGIN (Tax Equivalent) 3.30% 3.30% 3.33% 3.53% ANNUAL OPERATING COSTS Noninterest expenses increased by $484,000 in 2018 to $9,823,000 compared to $9,339,000 in 2017, an increase of 5.18%. The majority of the increase was due to a $454,000 increase in salaries and wages expense due to merit increases as well as several new hires in the Commercial Loan, Compliance and Deposit Operations Departments. Data processing expense increased $69,000 to $703,000 for the year ended December 31, 2018 versus $634,000 for the comparable period in All other operating expenses decreased by $39,000. Thousands $ 9,000 6,000 3,000 0 $9,520 $9,645 $9,944 $9,339 $9,

9 For the year ended December 31, 2018, the Corporation s non-interest expense as a percentage of average assets was 2.49% compared to 2.41% for the comparable period in The efficiency ratio (noninterest expense divided by the sum of tax equivalent net interest income and non-interest income) was 65.59% for the period ended December 31, 2018 compared to 67.72% for the similar period in Income tax expense totaled $609,000 for the year ended December 31, 2018, down $560,000 from $1,169,000 expensed in the comparable period in Income tax expense for 2017 was inflated due to a one-time deferred tax asset valuation adjustment totaling $337,000 due to the Tax Cuts and Jobs Act passed by Congress in December, The remainder of the change was due to growth in income before provision for taxes, and the corporate tax rate cut from 34% to 21% related to the Tax Cuts and Jobs Act. Without this tax cut, income tax expense would have been approximately $370,000 higher. Asset Quality The Corporation s total nonaccrual loans at December 31, 2018 were $1,577,000, or 0.66% of total loans, compared to $2,083,000 at December 31, The decline in nonaccrual loans was primarily due to the repayment of nonaccrual loan balances totaling $682,000 and the charge-off of loan balances totaling $193,000. There were no assets held in other real estate for both periods ending December 31, 2018 and At December 31, 2018, impaired loans totaled $2,297,000 with related specific reserves of $97,000 compared with impaired loans of $3,187,000 and specific reserves of $12,000 at December 31, % 90.00% 80.00% 70.00% 60.00% 50.00% 77.62% 78.16% EFFICIENCY RATIO 78.57% 67.72% 65.59% , and to $.20 to shareholders of record as of May 2, Total dividends were $.79 in 2018 compared to $.72 in In January, 2019, the Corporation announced a $.20 dividend per share to shareholders of record as of February 1, The board of directors will continue to evaluate dividend policy on a regular basis, and when possible, reward shareholders for the confidence they place in the Corporation s directors. At December 31, 2018, the Corporation s allowance for loan losses was 1.10% of total loans, an increase from 0.94% at December 31, The Corporation recorded provisions for loan losses of $641,000 for the year ended December 31, 2018 versus $405,000 in The Corporation had net charge-offs of $186,000 for the year ended December 31, 2018 versus $99,000 in Declaration of Dividend The Corporation increased its dividend twice in 2018, to $.19 to shareholders of record as of February 2, 9

10 FINANCIAL TABLE OF CONTENTS PAGE INDEPENDENT AUDITOR S REPORT 11 CONSOLIDATED FINANCIAL STATEMENTS: BALANCE SHEET 12 STATEMENT OF INCOME 13 STATEMENT OF COMPREHENSIVE INCOME 14 STATEMENT OF SHAREHOLDERS EQUITY 15 STATEMENT OF CASH FLOWS 16 NOTES TO FINANCIAL STATEMENTS 17 10

11 INDEPENDENT AUDITORS REPORT To the Board of Directors and Shareholders MNB Corporation We have audited the accompanying consolidated financial statements of MNB Corporation and its subsidiary, which comprise the consolidated balance sheet as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income, shareholders equity and cash flows for the years then ended, and the related notes to the consolidated financial statements. MANAGEMENT S RESPONSIBILITY FOR THE FINANCIAL STATEMENTS Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. AUDITORS RESPONSIBILITY Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. OPINION In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MNB Corporation and its subsidiary as of December 31, 2018 and 2017, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Wilkes-Barre, Pennsylvania February 25,

12 CONSOLIDATED BALANCE SHEET DECEMBER 31, 2018 AND 2017 (dollars in thousands) ASSETS: Cash and cash equivalents $ 1,246 $ 4,160 Interest-bearing deposits in banks 3,615 10,141 Investments: Securities held-to-maturity 16,424 19,010 Securities available-for-sale 118, ,484 Total investment securities 134, ,494 Restricted equity securities 1, Loans held for sale Loans 237, ,145 Allowance for loan losses (2,600) (2,145) Net loans 234, ,000 Premises and equipment, net 7,430 7,566 Accrued interest receivable 1,492 1,311 Cash surrender value of bank-owned life insurance 9,193 8,986 Other assets 1,998 1,654 TOTAL $ 395,957 $ 393,386 LIABILITIES: Deposits: Interest-bearing $ 295,626 $ 290,899 Noninterest-bearing 43,239 40,382 Total deposits 338, ,281 Securities sold under agreements to repurchase - 16,760 Federal Home Loan Bank short-term borrowings 9,200 - Federal Home Loan Bank long-term borrowings 14,065 13,065 Accrued interest payable Other liabilities Total liabilities 363, ,193 SHAREHOLDERS EQUITY: Common stock, $0.125 par value; 1,156,247 shares issued Additional paid-in capital 7,596 7,596 Retained earnings 28,933 26,205 Treasury stock at cost, 23,374 shares (682) (682) Accumulated other comprehensive loss (3,202) (2,071) Total shareholders equity 32,790 31,193 TOTAL $ 395,957 $ 393,386 See Notes to Consolidated Financial Statements 12

13 CONSOLIDATED STATEMENT OF INCOME DECEMBER 31, 2018 AND 2017 (dollars in thousands, except per share data) INTEREST AND DIVIDEND INCOME: Interest and fees on loans $ 10,659 $ 9,700 Interest and fees on loans held for sale 16 8 Interest and dividends on investments: Taxable 2,553 2,241 Tax-exempt Dividends Other Total interest and dividend income 14,145 12,727 INTEREST EXPENSE: Deposits Borrowed funds Total interest expense 1, NET INTEREST INCOME 13,030 11,752 PROVISION FOR LOAN LOSSES NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 12,389 11,347 NONINTEREST INCOME: Service charges on deposit accounts Interchange income Other fees and income Earnings on bank-owned life insurance Gain (loss) on sales or disposals of: Loans Securities available-for-sale (31) (21) Premises and equipment - (43) Foreclosed assets - 32 Securities held-to-maturity - 38 Total noninterest income 1,666 1,566 NONINTEREST EXPENSE: Salaries and wages 4,694 4,240 Employee benefits 1,266 1,286 Occupancy and equipment 1,352 1,339 Data processing FDIC insurance Pennsylvania shares tax Other general and administrative 1,413 1,405 Total noninterest expense 9,823 9,339 INCOME BEFORE PROVISION FOR INCOME TAXES 4,232 3,574 PROVISION FOR INCOME TAXES 609 1,169 NET INCOME $ 3,623 $ 2,405 EARNINGS PER SHARE $ 3.20 $ 2.12 See Notes to Consolidated Financial Statements 13

14 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME DECEMBER 31, 2018 AND 2017 (dollars in thousands) NET INCOME $ 3,623 $ 2,405 OTHER COMPREHENSIVE INCOME (LOSS): Unrealized gains (losses) on securities: Unrealized (loss) gain arising during the period (1,245) 34 Less reclassification adjustment for losses (gains) realized in net income 31 (17) Amortization of unrealized gain for securities available-for-sale transferred to securities held-to-maturity (103) (178) Net unrealized loss on securities (1,317) (161) Tax effect Unrealized loss on securities, net of tax (1,040) (106) Defined benefit pension plan: Actuarial (loss) gain arising during period (199) 112 Less amortization of net actuarial loss Net defined benefit pension plan (115) 207 Tax effect 24 (70) Defined benefit pension plan, net of tax (91) 137 Total other comprehensive (loss) income (1,131) 31 TOTAL COMPREHENSIVE INCOME $ 2,492 $ 2,436 See Notes to Consolidated Financial Statements 14

15 CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY DECEMBER 31, 2018 AND 2017 (dollars in thousands) OUTSTANDING COMMON SHARES* COMMON STOCK ADDITIONAL PAID-IN CAPITAL RETAINED EARNINGS TREASURY STOCK ACCUMULATED OTHER COMPREHENSIVE LOSS TOTAL BALANCE AT JANUARY 1, ,132,873 $ 145 $ 7,596 $ 24,275 $ (682) $ (1,761) $ 29,573 Net income 2,405 2,405 Other comprehensive income Reclassification due to change in federal income tax rule 341 (341) - Cash dividend ($0.72 per share) (816) (816) BALANCE AT DECEMBER 31, ,132, ,596 26,205 (682) (2,071) 31,193 Net income 3,623 3,623 Other comprehensive loss (1,131) (1,131) Cash dividend ($0.79 per share) (895) (895) BALANCE AT DECEMBER 31, ,132,873 $ 145 $ 7,596 $ 28,933 $ (682) $ (3,202) $ 32,790 *$0.125 par value each; 200,000,000 shares authorized. 1,156,247 shares issued. See Notes to Consolidated Financial Statements 15

16 CONSOLIDATED STATEMENT OF CASH FLOWS DECEMBER 31, 2018 AND 2017 (dollars in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 3,623 $ 2,405 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses Net amortization of securities 899 1,114 Loss on sale of available-for-sale securities Gain on sale of held-to-maturity securities - (38) Depreciation of premises and equipment Loss on disposal of premises and equipment - 43 Proceeds from sales of loans held for sale 11,295 5,956 Origination of loans held for sale (11,063) (5,868) Gain on sales of loans held for sale (261) (173) Provision for loss on foreclosed assets - 2 Gain on sales of foreclosed assets - (32) Deferred income tax expense Earnings on bank-owned life insurance (207) (207) Net change in: Accrued interest receivable (181) (120) Accrued interest payable 25 (27) Other assets (93) (140) Other liabilities (191) (234) Net cash provided by operating activities 5,031 4,146 CASH FLOWS FROM INVESTING ACTIVITIES: Net change in interest-bearing deposits in banks 6,526 (9,680) Proceeds from sales of securities available-for-sale 6,772 19,344 Proceeds from sales of securities held-to-maturity - 1,668 Proceeds from maturities/calls and principal repayments of securities available-for-sale 20,907 20,827 Proceeds from maturities/calls and principal repayments of securities held-to-maturity 2,390 1,955 Purchase of securities available-for-sale (34,430) (41,315) Purchase of securities held-to-maturity - (1,799) Redemption of restricted equity securities 726 1,098 Purchase of restricted equity securities (1,268) (807) Net increase in loans (9,370) (14,401) Proceeds from sales of foreclosed assets Purchase of premises and equipment (327) (186) Net cash used in investing activities (8,074) (22,529) CASH FLOWS FROM FINANCING ACTIVITIES: Net change in deposit accounts and securities sold under agreements to repurchase (9,176) 26,075 Dividends paid (895) (816) Net change in short-term borrowings 9,200 (5,600) Proceeds from long-term borrowings 2,000 - Repayment of long-term borrowings (1,000) (1,000) Net cash provided by financing activities ,659 (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (2,914) 276 CASH AND CASH EQUIVALENTS, BEGINNING 4,160 3,884 CASH AND CASH EQUIVALENTS, ENDING $ 1,246 $ 4,160 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year for: Interest $ 1,090 $ 1,002 Income taxes $ 478 $ 556 See Notes to Consolidated Financial Statements 16

17 MNB CORPORATION AND SUBSIDIARY Notes to Consolidated Financial Statements 1 Nature Of Operations And Summary Of Significant Accounting Policies Principles Of Consolidation The consolidated financial statements include the accounts of MNB Corporation (the Holding Company ) and its wholly-owned subsidiary, Merchants Bank of Bangor (the Bank ) and its subsidiary, MNB Investment Corp. (collectively referred to as the Corporation ). All significant intercompany balances and transactions have been eliminated in consolidation. Nature Of Operations The Bank operates under a state charter and provides a broad array of banking services through its community offices in Bangor, Pennsylvania and the surrounding communities. As a state bank, the Bank is subject to regulations by the Commonwealth of Pennsylvania and the Federal Reserve Bank of Philadelphia. The Holding Company is subject to regulation by the Federal Reserve Bank of Philadelphia. Use Of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ( GAAP ) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, the valuation of investment securities, and the determination of other-than-temporary impairment of investment securities. In connection with the determination of the allowance for loan losses, management generally obtains independent appraisals for significant properties. While management uses available information to recognize losses on loans, further reductions in the carrying amounts of loans may be necessary based on changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the Corporation to recognize additional losses based on their examination. Because of these factors, it is reasonably possible that the estimated losses on loans may change. The Corporation s investment securities are comprised of a variety of financial instruments. The fair values and possible other-than-temporary impairment of these securities are subject to various risks including changes in the interest rate environment and general economic conditions. Due to the increased level of these risks and their potential impact on the fair values and the need to recognize other-than-temporary impairment of the securities, it is possible that the amounts reported in the accompanying consolidated financial statements could change. Significant Group Concentrations Of Credit Risk The Corporation grants real estate, commercial, industrial and consumer loans to customers primarily in Northampton County, Pennsylvania. Although the Corporation has a diversified loan portfolio, a substantial portion of its debtors abilities to honor their contracts is dependent on the economic conditions in the sector in which the Corporation operates. Cash And Cash Equivalents For purposes of the consolidated statement of cash flows, cash and cash equivalents include, if applicable, cash and balances due from banks, federal funds sold and securities purchased under agreements to resell, all of which have original maturities of ninety days or less. Interest-Bearing Deposits In Banks Interest-bearing deposits in banks are carried at cost which approximates fair value. 17

18 Investments Debt securities that management has the positive intent and ability to hold to maturity are classified as held-tomaturity and recorded at amortized cost. Securities not classified as held-to-maturity are classified as availablefor-sale and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive (loss) income. The Corporation has no trading securities. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their costs that are deemed to be credit-related are reflected in earnings as realized losses. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Declines in the fair value of available-for-sale securities that are deemed to be other-than-temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value, and (4) whether the Corporation intends to sell the security or if it is more likely than not that the Corporation will be required to sell the security before the recovery of its amortized cost basis. The credit-related impairment is recognized in earnings and is the difference between a security s amortized cost basis and the present value of expected future cash flows discounted at the security s effective interest rate. For debt securities classified as held-to-maturity, the amount of noncredit-related impairment is recognized in other comprehensive (loss) income and accreted over the remaining life of the debt security as an increase in the carrying value of the security. Restricted Equity Securities Restricted equity securities consist of investments in the Federal Home Loan Bank of Pittsburgh ( FHLB ), the Federal Reserve Bank of Philadelphia and the Atlantic Community Bankers Bank. Investments in these entities are restricted and carried at cost. The Corporation, as a member of the FHLB system, is required to maintain an investment in capital stock of the FHLB. Based on redemption provisions of the FHLB, the stock has no quoted market value and is carried at cost. Management considers whether this investment is impaired based on the ultimate recoverability of the cost basis rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of the cost includes (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes on the institutions and on the customer base of the FHLB, and (4) the liquidity of the FHLB. Management believes no impairment charge is necessary related to its investment in FHLB stock. Cash Surrender Value Of Bank Owned Life Insurance The Corporation is the owner and primary beneficiary of life insurance policies on certain employees. The earnings on the policies are recognized as a component of other income. The policies can be liquidated, if necessary, with tax costs associated. However, the Corporation intends to hold these policies and, accordingly, the Corporation has not provided for deferred income taxes on the earnings from the increase in cash surrender value. Loans Held For Sale Loans held for sale, primarily consisting of fixed-rate residential mortgages, are valued at the lower of cost or fair value, determined on an aggregate basis. The Corporation retains no interest, including servicing rights, in loans sold. Loans Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for unearned income, the allowance for loan losses, and any unamortized deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. The loan portfolio is segmented into commercial, residential and consumer loans. Commercial loans consist of the 18

19 following classes: commercial and industrial, commercial real estate (including multi-family of five or more units) and commercial construction. Residential loans include 1-4 family mortgage loans. Consumer loans include junior liens, home equity lines of credit, and personal installment loans. The segments of the Corporation s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. Common risk characteristics include loan type, collateral type and geographic location. For all classes of loans, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest is reversed against interest income. Interest received on nonaccrual loans, including impaired loans, generally is either applied against principal or reported as interest income, according to management s judgment as to the collectibility of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans is determined based on contractual due dates for loan payments. Allowance For Loan Losses The allowance for loan losses represents management s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Consumer loans are generally charged off no later than 120 days past due on a contractual basis, earlier in the event of bankruptcy, or if there is an amount deemed uncollectible. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Corporation s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. The allowance consists of specific, general, and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are classified as impaired, a specific allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis. The Corporation does not separately evaluate individual residential or consumer loans for impairment, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring. The estimated fair values of substantially all of the Corporation s impaired loans are measured based on the estimated fair value of the loan s collateral. For loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate-secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent 19

20 appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts include estimated costs to sell the property. For loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower s financial statements, inventory reports, accounts receivable agings, equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. The general component covers pools of loans by loan class including loans not considered impaired, as well as smaller balance homogeneous loans, such as residential real estate and consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates and expected loss given default derived from the Corporation s internal risk rating process for each of these categories of loans, adjusted for qualitative factors. These qualitative risk factors include: 1. Lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices. 2. National, regional, and local economic and business conditions as well as the condition of various market segments, including the value of underlying collateral for collateral dependent loans. 3. Nature and volume of the portfolio and terms of loans. 4. Experience, ability, and depth of lending management and staff. 5. Volume and severity of past due, classified and nonaccrual loans, as well as other loan modifications. 6. Existence and effect of any concentrations of credit and changes in the level of such concentrations. Each factor is assigned a value to reflect improving, stable or declining conditions based on management s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation. The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments, for commercial, residential and consumer loans. Credit quality risk ratings include classifications of pass, management attention, special mention, substandard, doubtful and loss. Loans classified as management attention have above average risk evidenced by a declining earnings trend, decreasing liquidity, and/or asset quality, increasing leverage and strained cash flow. Although payments are current, future developments may adversely affect future payment ability. Loans criticized as special mention have potential weaknesses that deserve management s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass. To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Corporation has a structured loan rating process encompassing both internal and external oversight. Generally, residential 1-4 family and consumer loans are included in the pass category unless on nonaccrual status at which time they are classified as substandard. The Corporation s commercial loan officers and credit administration are responsible for the timely and accurate risk rating of the commercial loans in their portfolio at origination and on an ongoing basis. An ongoing review of commercial loans is performed by the loan review officer. The Corporation also utilizes an external loan review consultant to conduct a loan review of its portfolio each year. The external consultant generally reviews all loan relationships exceeding a specified threshold. Loans whose terms are modified are classified as troubled debt restructurings if the Corporation grants such borrowers concessions, and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a temporary reduction in interest rate or an extension of a loan s stated maturity date. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after modification. Loans classified as 20

21 troubled debt restructurings are designated as impaired. An unallocated component is maintained to cover uncertainties that could affect management s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. In addition, federal regulatory agencies, as an integral part of their examination process, periodically review the Corporation s allowance for loan losses and may require the Corporation to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management s comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate. Transfers Of Financial Assets Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets. Premises And Equipment Land is carried at cost. Buildings and equipment are carried at cost, less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets which range from three to forty years. Foreclosed Assets Assets acquired through, or in lieu of, loan foreclosures are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in noninterest expense. There were no foreclosed assets held at December 31, 2018 and The recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process was $1.4 million at December 31, 2018 and $315 thousand at December 31, Revenue Recognition The Corporation earns income from various sources, including loans, investment securities, bank-owned life insurance, deposit accounts, and sales of assets. Interest income on loans is accrued on the unpaid principal balance and recorded daily. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. Other loan fees, including late charges, are recognized as they occur. Interest income on debt securities, including purchase premiums and discounts, is calculated using the interest method over the term of the securities. Dividends on equity securities are recorded when declared. Service charges on deposits include maintenance fees, and overdraft fees. Revenue is recognized when the Corporation s performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed. Payment for service charges on deposit accounts is received immediately or in the following month through a direct charge to customers accounts. Interchange income includes debit and credit card interchange fees from cardholder transactions which represent a percentage of the underlying transaction value and are recognized monthly, concurrently with the transaction processing services provided to the cardholder. 21

22 Other fees and income are transactional in nature and are recorded as they occur. Gains or losses on sales of assets are generally recognized when the asset has been legally transferred to the buyer and the Corporation has no continuing involvement with the asset. The Corporation does not generally finance the sale. Income Taxes Income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Corporation determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. The Corporation recognizes interest and penalties on income taxes as a component of income tax expense. Earnings Per Share Earnings per share is based on the weighted average number of shares of common stock outstanding and adjusted for stock dividends. The Corporation s basic and diluted earnings per share are the same since there are no dilutive shares of potential common stock outstanding. The weighted average of common shares outstanding was 1,132,873 for 2018 and Treasury Stock Treasury stock is recorded at cost. The subsequent disposition or sale of the treasury stock is recorded using the average cost method. Advertising & Marketing Advertising and marketing is expensed as incurred and was $41 thousand in 2018 and $63 thousand in Reclassifications Certain amounts related to 2017 have been reclassified to conform to the 2018 reporting format. Subsequent Events The Corporation has evaluated subsequent events for recognition or disclosure through February 25, 2019, the date the consolidated financial statements were available to be issued. Recent Accounting Standards In May 2014, the Financial Accounting Standards Board ( FASB ) issued Accounting Standards Update ( ASU ) No , Revenue from Contracts with Customers (Topic 606). ASU No establishes principles for recognizing revenue upon the transfer of promised goods or services to customers, in an amount that reflects the expected consideration received in exchange for those goods or services. ASU was effective for the Corporation in The adoption did not have a significant effect on the Corporation s consolidated financial statements as the recognition of interest income has been scoped out of the guidance and noninterest income recognition is similar to previous revenue recognition practices. The Corporation expanded its disclosures with respect to its noninterest income as a result of this guidance. In January 2016, the FASB issued ASU , Recognition and Measurement of Financial Assets and Liabilities. This makes significant changes in U.S. GAAP related to certain aspects of recognition, measurement, presentation and disclosure of financial instruments. Among other changes, the ASU (1) eliminates the requirement to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (2) requires use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (3) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (4) clarifies that an entity should evaluate 22