Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements in this section and elsewhere in this quarterly report on Form 10-Q are forward-looking statements. Citizens & Northern Corporation and its wholly-owned subsidiaries (collectively, the Corporation) intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995. Forward-looking statements, which are not historical facts, are based on certain assumptions and describe future plans, business objectives and expectations, and are generally identifiable by the use of words such as, "should", “likely”, "expect", “plan”, "anticipate", “target”, “forecast”, and “goal”. These forward-looking statements are subject to risks and uncertainties that are difficult to predict, may be beyond management’s control and could cause results to differ materially from those expressed or implied by such forward-looking statements. Factors which could have a material, adverse impact on the operations and future prospects of the Corporation include, but are not limited to, the following:
● the effect of the novel coronavirus (COVID-19) and related events
● changes in monetary and fiscal policies of the Federal Reserve Board and the U. S. Government, particularly related to changes in interest rates
● changes in general economic conditions
● legislative or regulatory changes
● downturn in demand for loan, deposit and other financial services in the Corporation’s market area
● increased competition from other banks and non-bank providers of financial services
● technological changes and increased technology-related costs
● changes in accounting principles, or the application of generally accepted accounting principles
● failure to achieve merger-related synergies and difficulties in integrating the business and operations of acquired institutions
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
CORONAVIRUS (COVID-19) RESPONSE AND PAYCHECK PROTECTION PROGRAM
The Corporation’s Pandemic Committee has been very active since March 2020, providing frequent communication with employees and clients by telephone, video conference, email and digital tools, while substantially limiting business travel. As of March 31, 2021, branches were fully open with additional health and safety requirements to comply with federal and Pennsylvania health mandates, including, among other things, daily deep cleaning, nonsurgical face mask requirements and strict social distancing measures.
Emergency restrictions on the activities of businesses and individuals have resulted in significant adverse economic effects and a significant number of layoffs and furloughs of employees nationwide and in the regions in which the Corporation operates. The ultimate effect of COVID-19 on the local or broader economy is not known nor is the ultimate length of the restrictions described and any accompanying effects. Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its economic impact, the total impact on the Corporation’s loan portfolio is not determinable.
Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) provides that, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States under the National Emergencies Act terminates (the “applicable period”), the Corporation may elect to suspend U.S. GAAP for loan modifications related to the pandemic that would otherwise be categorized as troubled debt restructurings (TDRs) and suspend any determination of a loan modified as a result of the effects of the pandemic as being a TDR, including impairment for accounting purposes. The suspension is applicable for the term of the loan modification that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019. The suspension is not applicable to any adverse impact on the credit of a borrower that is not related to the pandemic.
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On December 27, 2020, the President of the United States signed into law the Consolidated Appropriations Act, 2021 (the “CAA”), which both funds the federal government until September 30, 2021 and broadly addresses additional COVID-19 responses and relief. Among the additional relief measures included are certain extensions to elements of the CARES Act, including extension of temporary relief from troubled debt restructurings established under Section 4013 of the CARES Act to the earlier of a) January 1, 2022, or b) the date that is 60 days after the date on which the national COVID-19 emergency terminates.
In addition, the banking regulators and other financial regulators, on March 22, 2020 and revised April 7, 2020, issued a joint interagency statement titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of the COVID-19 pandemic. Pursuant to the interagency statement, loan modifications that do not meet the conditions of Section 4013 of the CARES Act may still qualify as a modification that does not need to be accounted for as a TDR. Specifically, the agencies confirmed with the Financial Accounting Standards Board (“FASB”) staff that short-term modifications made in good faith in response to the pandemic to borrowers who were current prior to any relief are not TDRs under U.S. GAAP. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. Appropriate allowances for loan and lease losses are expected to be maintained. With regard to loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to the pandemic as past due because of the deferral. The interagency statement also states that during short-term pandemic-related loan modifications, these loans generally should not be reported as nonaccrual.
To work with clients impacted by COVID-19, the Corporation is offering short-term loan modifications on a case-by-case basis to borrowers who were current in their payments at the inception of the loan modification program. Prior to merging with the Corporation on July 1, 2020, Covenant Financial Inc. (“Covenant”) had a similar program in place, and these modified loans have been incorporated into the Corporation’s program. These efforts have been designed to assist borrowers as they deal with the current crisis and help the Corporation mitigate credit risk. For loans subject to the program, each borrower is required to resume making regularly scheduled loan payments at the end of the modification period and the deferred amounts will be moved to the end of the loan term. Consistent with Section 4013 of the CARES Act, the modified loans have not been reported as past due, nonaccrual or as TDRs at March 31, 2021. Most of the modifications under the program became effective in March or the second quarter 2020 and provided a deferral of interest or principal and interest for 90-to-180 days. Most of the loans for which deferrals were granted returned to full payment status prior to March 31, 2021, while additional deferrals have been granted on certain loans. At March 31, 2021, there were 25 loans in deferral status subject to CARES Act Section 4013 guidance with a total recorded investment of $26,044,000. A breakdown of these loans along with a summary of their risk ratings, is as follows:
Deferrals Remaining
As of March 31, 2021
(Dollars in Thousands)
Number
Purchased
of
Special
Credit
Loans
Pass
Mention
Substandard
Impaired
Total
COVID-19-related loan modifications:
Commercial
Accommodation and food services - hotels
5
$
9,186
$
10,349
$
0
$
0
$
19,535
Lessors of residential buildings and dwellings
3
0
0
55
1,557
1,612
Lessors of nonresidential buildings (except miniwarehouses)
1
0
0
0
1,411
1,411
Transportation and warehousing
4
1,197
0
0
0
1,197
Religious organizations
2
757
0
0
0
757
Real estate rental and leasing - other
1
438
0
0
0
438
Total commercial
16
11,578
10,349
55
2,968
24,950
Residential mortgage
9
619
0
475
0
1,094
Consumer
0
0
0
0
0
0
Total
25
$
12,197
$
10,349
$
530
$
2,968
$
26,044
For the loans in the table above, the deferral periods as of March 31, 2021 expire in the second or third quarters of 2021. The Corporation will continue to evaluate requests for additional deferrals on a case-by-case basis.
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The recorded investment in Paycheck Protection Program (“PPP”) loans at March 31, 2021 of $137.8 million included a first draw amount of $71.7 million and a second draw amount of $66.1 million with contractual principal balances totaling $73.0 million and $69.0 million, respectively, adjusted by net deferred loan origination fees and a market rate adjustment on PPP loans acquired from Covenant. The recorded investment of $71.7 million in first draw PPP loans at March 31, 2021 decreased $60.6 million from $132.3 million at December 31, 2020, reflecting the impact of loans forgiven and repaid by the SBA. The term of the first draw PPP loans is two years, with repayment from the SBA to occur sooner to the extent the loans are forgiven. Second draw PPP loans have terms of five years, with repayment from the SBA to occur sooner to the extent the loans are forgiven.
Capital Strength
While it is difficult to estimate the future impact of COVID-19, the Corporation, including the principal subsidiary, Citizens & Northern Bank (“C&N Bank”), entered the crisis from a position of strength. This is especially apparent in the capital ratios, which are at levels that demonstrate the capacity to absorb significant losses if they arise while continuing to meet the requirements to be considered well capitalized.
C&N Bank’s leverage ratio (Tier 1 capital to average assets) at March 31, 2021 of 10.66% is significantly higher than the well-capitalized threshold of 5%, an excess capital amount of $122.3 million. Similarly, the total capital to risk-weighted assets ratio at March 31, 2021 is 16.51%, which exceeds the well-capitalized threshold of 10%, an excess capital amount of $95.6 million.
Additional details regarding the Corporation’s and C&N Bank’s regulatory capital position are provided in the “Stockholders’ Equity and Capital Adequacy” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”).
EARNINGS OVERVIEW
Net income was $0.55 per diluted share in the first quarter 2021, up $0.12 (27.9%) from $0.43 in the fourth quarter 2020 and up $0.25 (83.3%) from $0.30 in the first quarter 2020. As described below, earnings of $0.55 per share for the first quarter 2021 were 7.8% higher than fourth quarter 2020 non-U.S. GAAP earnings per share of $0.51 as adjusted to exclude the impact of merger-related expenses, loss on prepayment of borrowings and net gains on available-for-sale debt securities. First quarter 2021 earnings per share were 77.4% higher than first quarter 2020 non-U.S. GAAP earnings per share of $0.31 as adjusted to exclude the impact of merger-related expenses.
The following table provides a reconciliation of the Corporation’s unaudited earnings results under U.S. generally accepted accounting principles (U.S. GAAP) to comparative non-U.S. GAAP results excluding merger-related expenses, loss on prepayment of borrowings and net gains on available-for-sale debt securities. Management believes disclosure of unaudited earnings results for the periods presented, adjusted to exclude the impact of these items, provides useful information to investors for comparative purposes.
RECONCILIATION OF NET INCOME AND
DILUTED EARNINGS PER SHARE TO NON-U.S.
GAAP MEASURE
(Dollars In Thousands, Except Per Share Data) (Unaudited)
1st Quarter 2021
1st Quarter 2020
Income
Diluted
Income
Diluted
Before
Earnings
Before
Earnings
Income
Income
Per
Income
Income
Per
Tax
Tax
Net
Common
Tax
Tax
Net
Common
Provision
Provision
Income
Share
Provision
Provision
Income
Share
Results as Presented Under U.S. GAAP
$
10,897
$
2,110
$
8,787
$
0.55
$
4,982
$
816
$
4,166
$
0.30
Add: Merger-Related Expenses (1)
0
0
0
141
29
112
Adjusted Earnings (Non-U.S. GAAP)
$
10,897
$
2,110
$
8,787
$
0.55
$
5,123
$
845
$
4,278
$
0.31
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4th Quarter 2020
Income
Diluted
Before
Earnings
Income
Income
Per
Tax
Tax
Net
Common
Provision
Provision
Income
Share
Results as Presented Under U.S. GAAP
$
8,251
$
1,481
$
6,770
$
0.43
Add: Merger-Related Expenses (1)
182
38
144
Add: Loss on Prepayment of Borrowings (1)
1,636
344
1,292
Net Gains on Available-for-Sale Debt Securities (1)
(144)
(30)
(114)
Adjusted Earnings (Non-U.S. GAAP)
$
9,925
$
1,833
$
8,092
$
0.51
(1) Income tax has been allocated based on a marginal income tax rate of 21%.
Additional highlights related to the Corporation’s first quarter of 2021 and 2020 unaudited earnings are presented below.
First quarter 2021 net income was $8,787,000. In comparison, first quarter 2020 net income was $4,166,000, and excluding merger-related expenses, adjusted (non-U.S. GAAP) earnings were $4,278,000. Other significant variances were as follows:
● First quarter 2021 net interest income of $20,083,000 was $5,801,000 higher than the first quarter 2020 total, reflecting the impact of growth mainly attributable to the Covenant acquisition. Average outstanding loans increased $466.1 million, and average total deposits increased $570.9 million. The net interest margin for the first quarter 2021 was 4.00% as compared to 3.83% for the first quarter 2020. The average yield on earning assets of 4.33% for the first quarter 2021 was down 0.22% from the first quarter 2020, while the average rate on interest-bearing liabilities of 0.47% in the first quarter 2021 was 0.54% lower than the comparable first quarter 2020 average rate. Interest and fees on PPP loans totaled $1,988,000 in the first quarter 2021, including fees of $1,645,000 as a significant portion of 1st Draw loans were repaid by the SBA based on forgiveness to the underlying borrowers. Accretion and amortization of purchase accounting adjustments had a net positive impact on net interest income of $952,000 in the first quarter 2021 as compared to a net positive impact of $417,000 in the first quarter 2020.
● The provision for loan losses was $259,000 in the first quarter 2021 as compared to $1,528,000 in the first quarter 2020. The first quarter 2021 provision included a net charge of $182,000 related to specific loans (increase in specific allowances on loans of $199,000, partially offset by net recoveries of $17,000), an increase of $92,000 in the unallocated portion of the allowance and a credit of $15,000 attributable to decreases in the collectively determined portion of the allowance for loan losses. In the first quarter 2020, the provision included the effects of recording a specific allowance of $1,193,000 on a commercial loan for which a charge-off of $2,219,000 was subsequently recorded in the third quarter 2020.
● Noninterest income for the first quarter 2021 was up $1,501,000 from the first quarter 2020 total. Significant variances included the following:
o Net gains from sales of loans of $1,064,000 for the first quarter 2021 were up $749,000 from the total for the first quarter 2020. The increase reflects an increase in volume of mortgage loans sold, due mainly to the impact of historically low interest rates on the housing market and refinancing activity.
o Other noninterest income totaled $1,472,000, an increase of $411,000 from the first quarter 2020. Income from tax credits of $765,000, an increase of $262,000 compared to the first quarter 2020, was due to higher PA Educational Improvement Tax Credit Program donations. In the first quarter 2021, fee income for providing credit enhancement on sale of mortgage loans increased $100,000 and income from a full-service title agency acquired from Covenant increased $47,000.
o Loan servicing fees, net, were $248,000 in the first quarter 2021, an increase of $262,000 over the first quarter 2020 total. The fair value of servicing rights increased $75,000 in the first quarter 2021 as compared to a reduction in fair value of $126,000 in the first quarter 2020.
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o Interchange revenue from debit card transactions totaled $881,000 in the first quarter 2021, an increase of $150,000 over the first quarter 2020 total.
o Trust revenue of $1,626,000 increased $147,000 reflecting the impact of growth in trust assets under management including the impact of market value appreciation.
o Service charges on deposit accounts of $1,015,000 in the first quarter 2021 were down $235,000 from the first quarter 2020 amount, as the volume of consumer and business overdraft activity fell.
● Noninterest expense, excluding merger-related expenses, increased $2,797,000 in the first quarter 2021 over the first quarter 2020 amount. Significant variances included the following:
o Salaries and employee benefits of $8,895,000 increased $1,517,000, reflecting an increase in personnel due to the Covenant acquisition.
o Other noninterest expense increased $646,000. Within this category, donations increased $279,000 relating to the PA Educational Improvement Tax Credit Program, FDIC insurance increased $140,000, other operational losses totaling $123,000 increased $83,000, amortization of core deposit intangibles increased $72,000 related to the Covenant acquisition, and the provision for credit losses on mortgage loans sold with credit enhancement increased $60,000.
o Net occupancy and equipment expense increased $201,000, primarily reflecting an increase due to the Covenant acquisition.
o Professional fees increased $168,000 related to recruiting services and SBA processing professional fees.
o Data processing and telecommunications expenses increased $156,000, including the impact of growth related to the Covenant acquisition, increased costs from outsourced support services and other increases in software licensing and maintenance costs.
● The income tax provision of $2,110,000 for the first quarter 2021 was up $1,294,000 from $816,000 for the first quarter 2020, reflecting higher pre-tax income.
More detailed information concerning fluctuations in the Corporation’s earnings results and other financial information are provided in other sections of Management’s Discussion and Analysis.
ACQUISITION OF COVENANT FINANCIAL, INC.
The Corporation’s acquisition of Covenant was completed July 1, 2020. Covenant was the parent company of Covenant Bank, which operated banking offices in Bucks and Chester Counties of Pennsylvania. Pursuant to the transaction, Covenant merged with and into the Corporation and Covenant Bank merged with and into C&N Bank. Total purchase consideration was $63.3 million, including common stock with a fair value of $41.6 million and cash of $21.7 million. The acquisition of Covenant follows the acquisition of Monument Bancorp, Inc. (“Monument”) on April 1, 2019. Monument was the parent company of Monument Bank, with banking and lending offices in Bucks County, Pennsylvania. The total transaction value of the Monument acquisition was $42.7 million.
In connection with the Covenant acquisition, effective July 1, 2020, the Corporation recorded goodwill of $24.1 million and a core deposit intangible asset of $3.1 million. Assets acquired included loans valued at $464.2 million, cash and due from banks of $97.8 million, bank-owned life insurance valued at $11.2 million and securities valued at $10.8 million. Liabilities assumed included deposits valued at $481.8 million, borrowings valued at $64.0 million and subordinated debt valued at $10.1 million. The assets purchased and liabilities assumed in the acquisition were recorded at their preliminary estimated fair values at the time of closing and may be adjusted for up to one year subsequent to the acquisition. There were no adjustments to the fair values of assets acquired and liabilities assumed in the Covenant acquisition in the first quarter 2021.
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TABLE I – QUARTERLY FINANCIAL DATA
For the Three Months Ended :
(Dollars In Thousands, Except Per Share Data)
March 31,
December 31,
September 30,
June 30,
March 31,
(Unaudited)
2021
2020
2020
2020
2020
Interest income
$
21,754
$
21,859
$
21,751
$
16,513
$
17,037
Interest expense
1,671
2,104
2,469
2,267
2,755
Net interest income
20,083
19,755
19,282
14,246
14,282
Provision (credit) for loan losses
259
620
1,941
(176)
1,528
Net interest income after provision (credit) for loan losses
19,824
19,135
17,341
14,422
12,754
Noninterest income
6,782
6,565
6,970
5,528
5,281
Net gains on securities
0
144
25
0
0
Loss on prepayment of borrowings
0
1,636
0
0
0
Merger-related expenses
0
182
6,402
983
141
Other noninterest expenses
15,709
15,775
14,648
12,274
12,912
Income before income tax provision
10,897
8,251
3,286
6,693
4,982
Income tax provision
2,110
1,481
438
1,255
816
Net income
$
8,787
$
6,770
$
2,848
$
5,438
$
4,166
Net income attributable to common shares
$
8,722
$
6,727
$
2,830
$
5,405
$
4,146
Basic earnings per common share
$
0.55
$
0.43
$
0.18
$
0.39
$
0.30
Diluted earnings per common share
$
0.55
$
0.43
$
0.18
$
0.39
$
0.30
CRITICAL ACCOUNTING POLICIES
The presentation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect many of the reported amounts and disclosures. Actual results could differ from these estimates.
Allowance for Loan Losses – A material estimate that is particularly susceptible to significant change is the determination of the allowance for loan losses. The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. Management believes the allowance for loan losses is adequate and reasonable. Note 7 to the unaudited consolidated financial statements provides an overview of the process management uses for evaluating and determining the allowance for loan losses, and additional discussion of the allowance for loan losses is provided in a separate section later in Management’s Discussion and Analysis. Given the very subjective nature of identifying and valuing loan losses, it is likely that well-informed individuals could make materially different assumptions, and could, therefore calculate a materially different allowance value. While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.
Business Combinations – We account for business combinations under the purchase method of accounting. The application of this method of accounting requires the use of significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed in order to properly allocate purchase price consideration between assets that are amortized, accreted or depreciated from those that are recorded as goodwill. Our estimates of the fair values of assets acquired and liabilities assumed are based upon assumptions that we believe to be reasonable.
Fair Value of Debt Securities – Another material estimate is the calculation of fair values of the Corporation’s debt securities. For most of the Corporation’s debt securities, the Corporation receives estimated fair values of debt securities from an independent valuation service, or from brokers. In developing fair values, the valuation service and the brokers use estimates of cash flows, based on historical performance of similar instruments in similar interest rate environments. Based on experience, management is aware that estimated fair values of debt securities tend to vary among brokers and other valuation services.
NET INTEREST INCOME
The Corporation’s primary source of operating income is net interest income, which is equal to the difference between the amounts of interest income and interest expense. Tables II, III and IV include information regarding the Corporation’s net interest income for the
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three-month periods ended March 31, 2021 and 2020. In each of these tables, the amounts of interest income earned on tax-exempt securities and loans have been adjusted to a fully taxable-equivalent basis. Accordingly, the net interest income amounts reflected in these tables exceed the amounts presented in the consolidated financial statements. The discussion that follows is based on amounts in the related Tables.
For the three-month periods, fully taxable equivalent net interest income was $20,356,000 in 2021, which was $5,850,000 (40.3%) higher than in 2020. Interest income was $4,766,000 higher in 2021 as compared to 2020, while interest expense was lower by $1,084,000 in comparing the same periods. The increase in net interest income reflects the impact of growth mainly attributable to the Covenant acquisition. Table IV shows the net effect of changes in volume resulted in an increase in net interest income of $5,801,000, while changes in interest rates had a net positive impact of $49,000. As presented in Table III, the Net Interest Margin was 4.00% in 2021 as compared to 3.83% in 2020, and the “Interest Rate Spread” (excess of average rate of return on earning assets over average cost of funds on interest-bearing liabilities) increased to 3.86% in 2021 from 3.54% in 2020. The average yield on earning assets of 4.33% was 0.22% lower in 2021 as compared to 2020, while the average rate on interest-bearing liabilities decreased 0.54% between periods.
Income from purchase accounting-related adjustments in the first quarter 2021 had a positive effect on net interest income of $952,000, including an increase in income on loans of $430,000 and net reductions in interest expense on time deposits and borrowed funds totaling $522,000. The positive impact to the first quarter 2021 net interest margin from purchase accounting adjustments was 0.19%. In comparison, the positive impact to the first quarter 2020 net interest margin was $417,000, or 0.11%.
INTEREST INCOME AND EARNING ASSETS
Interest income totaled $22,027,000 in 2021, an increase of $4,766,000 (27.6%) from 2020. Interest and fees from loans receivable increased $5,008,000, or 33.3%, in 2021 as compared to 2020. Table IV shows the increase in interest on loans includes $5,917,000 related to an increase in average volume, offset by a decrease of $909,000 attributable to a decrease in average rate. Included in the positive volume variance is interest and fees from PPP loans totaling $1,998,000 in the first quarter 2021 with no corresponding amount in the first quarter 2020.
Average outstanding loans receivable increased $466,101,000 (39.9%) to $1,634,586,000 in 2021 from $1,168,485,000 in 2020. The increase in loans outstanding is due largely to the Covenant acquisition and the significant growth of PPP loans over the course of 2020 and the first quarter 2021. The average balance of PPP loans totaled $138,564,000 in the first quarter 2021.
The average yield on loans in the first quarter 2021 was 4.97%, down from 5.18% in the first quarter 2020, as rates on variable rate loans and rates on recent new loan originations have decreased due to decreases in market interest rates throughout most of 2020. Further, yields on loans acquired from Covenant reflect market yields at the acquisition date (July 1, 2020), which were lower than the Corporation’s average portfolio yield before the transaction. The average yield on loans in the first quarter 2021 was also affected by the comparatively low average yield on 2nd Draw PPP loans with a total average balance of $34,197,000 and a yield of 2.21%. The yield on 1st Draw PPP loans of 7.04% helped to bolster the average yield on loans in the first quarter 2021 as previously deferred fees were recognized in income upon the SBA’s repayment of loans based on forgiveness of the underlying borrowers.
Interest income from available-for-sale debt securities decreased $219,000 (10.3%) in 2021 from 2020. Total average available-for-sale debt securities (at amortized cost) in 2021 increased slightly to $335,265,000 from $335,007,000 in 2020. The average balance of tax-exempt securities increased $47,682,000, while the average balance of mortgage-backed securities and other taxable securities decreased $47,424,000. The average yield on available-for-sale debt securities was 2.32% for 2021, down from 2.56% in 2020. The reduction in yield on available-for-sale securities is a result of faster amortization on mortgage-backed securities and purchases of lower yielding securities at recent market rates.
Income from interest-bearing due from banks totaled $50,000 in 2021, a decrease of $31,000 (38.3%) from $81,000 in 2020. The average yield on interest-bearing due from banks dropped to 0.22% in 2021 from 1.68% in 2020, consistent with the decrease in market rates. The average balance increased $73,218,000 as increases in deposits and funds from loan repayments outpaced uses of funds for purchases of securities and repayments of borrowings.
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INTEREST EXPENSE AND INTEREST-BEARING LIABILITIES
For the three-month periods, interest expense decreased $1,084,000 to $1,671,000 in 2021 from $2,755,000 in 2020. Interest expense on deposits decreased $877,000, as the average rate on interest-bearing deposits decreased to 0.38% in 2021 from 0.89% in 2020. The decrease in average rates on deposits includes decreases of 0.91% on time deposits, 0.22% on money market accounts, 0.18% on interest checking accounts and 0.05% on saving accounts.
Average total deposits increased $570,867,000, including the impact of deposits assumed in the Covenant acquisition, PPP-related activity and funding from other government stimulus programs.
Interest expense on total borrowed funds decreased $207,000 in 2021 as compared to 2020. The average balance of total borrowed funds decreased to $83,755,000 in the first quarter 2021 from $115,447,000 in the first quarter 2020, while the average rate on borrowed funds decreased to 1.90% in the first quarter 2021 from 2.09% in the first quarter 2020. The decrease in average balance and rate on borrowed funds includes the impact of the prepayment of higher cost borrowings of $48.0 million completed in December 2020.
Interest expense on short-term borrowings decreased $183,000 to $15,000 in 2021 from $198,000 in 2020. The average balance of short-term borrowings decreased to $14,365,000 in 2021 from $44,882,000 in 2020. The average rate on short-term borrowings decreased to 0.42% in 2021 from 1.77% in 2020, reflecting the impact of lower short-term market rates in 2021.
Interest expense on long-term borrowings (FHLB advances) decreased $161,000 to $134,000 in 2021 from $295,000 in 2020. The average balance of long-term borrowings was $52,847,000 in 2021, down from an average balance of $64,065,000 in 2020. Borrowings are classified as long-term within the Tables based on their term at origination or assumption in business combinations. The average rate on long-term borrowings was 1.03% in 2021 compared to 1.85% in 2020.
Interest expense on subordinated debt increased $137,000 to $244,000 in 2021 from $107,000 in 2020. The average balance of subordinated debt increased to $16,543,000 in 2021 from $6,500,000 in 2020 as a result of subordinated debt agreements assumed in the Covenant transaction. The average rate incurred on subordinated debt was 5.98% in 2021, down from 6.62% in 2020.
More information regarding the terms of borrowed funds and subordinated debt is provided in Note 9 to the unaudited consolidated financial statements.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
TABLE II - ANALYSIS OF INTEREST INCOME AND EXPENSE
Three Months Ended
March 31,
Increase/
(In Thousands)
2021
2020
(Decrease)
INTEREST INCOME
Interest-bearing due from banks
$
50
$
81
$
(31)
Available-for-sale debt securities:
Taxable
1,113
1,588
(475)
Tax-exempt
801
545
256
Total available-for-sale debt securities
1,914
2,133
(219)
Loans receivable:
Taxable
17,493
14,461
3,032
Paycheck Protection Program - 1st Draw
1,812
0
1,812
Paycheck Protection Program - 2nd Draw
186
0
186
Tax-exempt
553
575
(22)
Total loans receivable
20,044
15,036
5,008
Other earning assets
19
11
8
Total Interest Income
22,027
17,261
4,766
INTEREST EXPENSE
Interest-bearing deposits:
Interest checking
221
243
(22)
Money market
306
263
43
Savings
55
64
(9)
Time deposits
696
1,585
(889)
Total interest-bearing deposits
1,278
2,155
(877)
Borrowed funds:
Short-term
15
198
(183)
Long-term
134
295
(161)
Subordinated debt
244
107
137
Total borrowed funds
393
600
(207)
Total Interest Expense
1,671
2,755
(1,084)
Net Interest Income
$
20,356
$
14,506
$
5,850
Note: Interest income from tax-exempt securities and loans has been adjusted to a fully tax-equivalent basis, using the Corporation’s marginal federal income tax rate of 21%
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
Table III - Analysis of Average Daily Balances and Rates
(Dollars in Thousands)
Three Months
Three Months
Ended
Rate of
Ended
Rate of
3/31/2021
Return/
3/31/2020
Return/
Average
Cost of
Average
Cost of
Balance
Funds %
Balance
Funds %
EARNING ASSETS
Interest-bearing due from banks
$
92,619
0.22
%
$
19,401
1.68
%
Available-for-sale debt securities,
at amortized cost:
Taxable
217,733
2.07
%
265,157
2.41
%
Tax-exempt
117,532
2.76
%
69,850
3.14
%
Total available-for-sale debt securities
335,265
2.32
%
335,007
2.56
%
Loans receivable:
Taxable
1,428,721
4.97
%
1,108,118
5.25
%
Paycheck Protection Program - 1st Draw
104,367
7.04
%
0
0.00
%
Paycheck Protection Program - 2nd Draw
34,197
2.21
%
0
0.00
%
Tax-exempt
67,301
3.33
%
60,367
3.83
%
Total loans receivable
1,634,586
4.97
%
1,168,485
5.18
%
Other earning assets
2,851
2.70
%
1,460
3.03
%
Total Earning Assets
2,065,321
4.33
%
1,524,353
4.55
%
Cash
23,796
18,042
Unrealized gain on securities
12,890
8,176
Allowance for loan losses
(11,739)
(10,015)
Bank-owned life insurance
30,154
18,677
Bank premises and equipment
21,348
17,732
Intangible Assets
56,288
29,607
Other assets
44,628
30,593
Total Assets
$
2,242,686
$
1,637,165
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Interest checking
$
355,993
0.25
%
$
227,069
0.43
%
Money market
406,841
0.31
%
200,691
0.53
%
Savings
213,437
0.10
%
168,971
0.15
%
Time deposits
370,555
0.76
%
381,621
1.67
%
Total interest-bearing deposits
1,346,826
0.38
%
978,352
0.89
%
Borrowed funds:
Short-term
14,365
0.42
%
44,882
1.77
%
Long-term
52,847
1.03
%
64,065
1.85
%
Subordinated debt
16,543
5.98
%
6,500
6.62
%
Total borrowed funds
83,755
1.90
%
115,447
2.09
%
Total Interest-bearing Liabilities
1,430,581
0.47
%
1,093,799
1.01
%
Demand deposits
484,286
281,893
Other liabilities
27,930
14,071
Total Liabilities
1,942,797
1,389,763
Stockholders' equity, excluding
other comprehensive income/loss
289,591
240,718
Accumulated other comprehensive income
10,298
6,684
Total Stockholders' Equity
299,889
247,402
Total Liabilities and Stockholders' Equity
$
2,242,686
$
1,637,165
Interest Rate Spread
3.86
%
3.54
%
Net Interest Income/Earning Assets
4.00
%
3.83
%
Total Deposits (Interest-bearing
and Demand)
$
1,831,112
$
1,260,245
(1) Annualized rates of return on tax-exempt securities and loans are presented on a fully taxable-equivalent basis, using the Corporation’s marginal federal income tax rate of 21%.
(2) Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings.
(3) Rates of return on earning assets and costs of funds are presented on an annualized basis.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
TABLE IV - ANALYSIS OF VOLUME AND RATE CHANGES
(In Thousands)
Three Months Ended 3/31/21 vs. 3/31/20
Change in
Change in
Total
Volume
Rate
Change
EARNING ASSETS
Interest-bearing due from banks
$
89
$
(120)
$
(31)
Available-for-sale debt securities:
Taxable
(267)
(208)
(475)
Tax-exempt
327
(71)
256
Total available-for-sale debt securities
60
(279)
(219)
Loans receivable:
Taxable
3,860
(828)
3,032
Paycheck Protection Program - 1st Draw
1,812
0
1,812
Paycheck Protection Program - 2nd Draw
186
0
186
Tax-exempt
59
(81)
(22)
Total loans receivable
5,917
(909)
5,008
Other earning assets
9
(1)
8
Total Interest Income
6,075
(1,309)
4,766
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Interest checking
103
(125)
(22)
Money market
186
(143)
43
Savings
14
(23)
(9)
Time deposits
(45)
(844)
(889)
Total interest-bearing deposits
258
(1,135)
(877)
Borrowed funds:
Short-term
(87)
(96)
(183)
Long-term
(45)
(116)
(161)
Subordinated debt
148
(11)
137
Total borrowed funds
16
(223)
(207)
Total Interest Expense
274
(1,358)
(1,084)
Net Interest Income
$
5,801
$
49
$
5,850
(1) Changes in income on tax-exempt securities and loans are presented on a fully tax-equivalent basis, using the Corporation’s marginal federal income tax rate of 21%.
(2) The change in interest due to both volume and rates has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amount of the change in each.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
NONINTEREST INCOME
TABLE V – COMPARISON OF NONINTEREST INCOME
(Dollars in Thousands)
Three Months Ended
March 31,
$
%
2021
2020
Change
Change
Trust revenue
$
1,626
$
1,479
$
147
9.9
%
Brokerage and insurance revenue
326
355
(29)
(8.2)
%
Service charges on deposit accounts
1,015
1,250
(235)
(18.8)
%
Interchange revenue from debit card transactions
881
731
150
20.5
%
Net gains from sales of loans
1,064
315
749
237.8
%
Loan servicing fees, net
248
(14)
262
N/M
Increase in cash surrender value of life insurance
150
104
46
44.2
%
Other noninterest income
1,472
1,061
411
38.7
%
Total noninterest income
$
6,782
$
5,281
$
1,501
28.4
%
N/M = Not Meaningful
Total noninterest income, in the first quarter 2021 increased $1,501,000 (28.4%) from the first quarter 2020 total. Changes of significance are discussed in the Earnings Overview section of Management’s Discussion and Analysis.
NONINTEREST EXPENSE
TABLE VI - COMPARISON OF NONINTEREST EXPENSE
(Dollars in Thousands)
Three Months Ended
March 31,
$
%
2021
2020
Change
Change
Salaries and employee benefits
$
8,895
$
7,378
$
1,517
20.6
%
Net occupancy and equipment expense
1,304
1,103
201
18.2
%
Data processing and telecommunications expense
1,380
1,224
156
12.7
%
Automated teller machine and interchange expense
337
297
40
13.5
%
Pennsylvania shares tax
491
422
69
16.4
%
Professional fees
547
379
168
44.3
%
Other noninterest expense
2,755
2,109
646
30.6
%
Total noninterest expense, excluding merger-related expenses
15,709
12,912
2,797
21.7
%
Merger-related expenses
0
141
(141)
(100.0)
%
Total noninterest expense
$
15,709
$
13,053
$
2,656
20.3
%
Total noninterest expenses in the first quarter 2021 increased $2,656,000 (20.3%) from the first quarter 2020 total. Changes of significance are discussed in the Earnings Overview section of Management’s Discussion and Analysis.
INCOME TAXES
The income tax provision in interim periods is based on the Corporation’s estimate of the effective tax rate expected to be applicable for the full year. The income tax provision for the first three months of 2021 was $2,110,000, which was $1,294,000 higher than the provision for the first three months of 2020 of $816,000. The effective tax rate (tax provision as a percentage of pre-tax income) was 19.4% in the first three months of 2021 compared to 16.4% in the first three months of 2020. The Corporation’s effective tax rates differ from the statutory rate of 21% in the first three months of 2021 and 2020 principally because of the effects of tax-exempt interest income, state income taxes and other permanent differences. The higher effective tax rate in the first three months of 2021 as compared to 2020 resulted mainly from an increase in state income taxes and a reduction in the proportion of tax-exempt interest income to total pre-tax income.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
The Corporation recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax basis of assets and liabilities. The net deferred tax asset at March 31, 2021 and December 31, 2020 represents the following temporary difference components:
March 31,
December 31,
(In Thousands)
2021
2020
Deferred tax assets:
Allowance for loan losses
$
2,305
$
2,154
Purchase accounting adjustments on loans
1,854
1,930
Net operating loss carryforward
866
896
Operating leases liability
702
724
Other deferred tax assets
2,611
3,089
Total deferred tax assets
8,338
8,793
Deferred tax liabilities:
Unrealized holding gains on securities
1,819
3,104
Defined benefit plans - ASC 835
30
32
Bank premises and equipment
1,140
1,216
Core deposit intangibles
811
840
Right-of-use assets from operating leases
702
724
Other deferred tax liabilities
306
172
Total deferred tax liabilities
4,808
6,088
Deferred tax asset, net
$
3,530
$
2,705
In connection with the Covenant merger, the Corporation received a net operating loss (“NOL”) available to be carried forward against federal taxable income of $4.6 million. Availability of the NOL does not expire; however, the amount that may be offset against taxable income is limited to approximately $563,000 per year and further limited annually to no more than 80% of taxable income without regard to the NOL. At December 31, 2020, the unused amount of the NOL was $4.3 million.
The Corporation regularly reviews deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of deferred tax assets ultimately depends on the existence of sufficient taxable income.
Management believes the recorded net deferred tax asset at March 31, 2021 is fully realizable; however, if management determines the Corporation will be unable to realize all or part of the net deferred tax asset, the Corporation would adjust the deferred tax asset, which would negatively impact earnings .
FINANCIAL CONDITION
This section includes information regarding the Corporation’s lending activities or other significant changes or exposures that are not otherwise addressed in Management’s Discussion and Analysis. Significant changes in the average balances of the Corporation’s earning assets and interest-bearing liabilities are described in the Net Interest Income section of Management’s Discussion and Analysis. Other significant balance sheet items, including securities, the allowance for loan losses and stockholders’ equity, are discussed in separate sections of Management’s Discussion and Analysis. There are no significant concerns that have arisen related to the Corporation’s off-balance sheet loan commitments or outstanding letters of credit at March 31, 2021, and management does not expect the amount of purchases of bank premises and equipment to have a material, detrimental effect on the Corporation’s financial condition in 2021.
At March 31, 2021, gross loans outstanding totaled $1,614,587,000, an increase of $447.1 million (38.3%) from March 31, 2020. A significant portion of the Corporation’s loan growth was attributable to the Covenant acquisition and to origination of PPP loans to businesses throughout the Corporation’s market areas. At March 31, 2021, commercial loans represented approximately 62% of the portfolio while residential mortgage loans totaled 37% of the portfolio.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
While the Corporation’s lending activities are primarily concentrated in its market areas, a portion of the Corporation’s commercial loan segment consists of participation loans. Participation loans represent portions of larger commercial transactions for which other institutions are the “lead banks”. Although not the lead bank, the Corporation conducts detailed underwriting and monitoring of participation loan opportunities. Participation loans are included in the “Commercial and industrial,” “Commercial loans secured by real estate”, “Political subdivisions” and “Other commercial” classes in the loan tables presented in this Form 10-Q. Total participation loans outstanding amounted to $60,457,000 at March 31, 2021, down from $65,741,000 at December 31, 2020. At March 31, 2021, the balance of participation loans outstanding includes a total of $35,889,000 to businesses located outside of the Corporation’s market areas. Also, included within participation loans are “leveraged loans,” meaning loans to businesses with minimal tangible book equity and for which the extent of collateral available is limited, though typically at the time of origination the businesses have demonstrated strong cash flow performance in their recent histories. Leveraged participation loans totaled $8,378,000 at March 31, 2021 and $8,437,000 at December 31, 2020.
Since 2009, the Corporation has originated and sold residential mortgage loans to the secondary market through the MPF Xtra program administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Xtra program consist primarily of conforming, prime loans sold to the Federal National Mortgage Association (Fannie Mae), a quasi-government entity. In 2014, the Corporation began to originate and sell residential mortgage loans to the secondary market through the MPF Original program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. Residential mortgages originated and sold through the MPF Original program consist primarily of conforming, prime loans sold to the Federal Home Loan Bank of Pittsburgh. In late 2019, the Corporation began to originate and sell larger-balance, nonconforming mortgages under the MPF Direct Program, which is also administered by the Federal Home Loan Banks of Pittsburgh and Chicago. The Corporation does not retain servicing rights for loans sold under the MPF Direct Program. Through March 31, 2021, the Corporation’s activity under the MPF Direct Program has been minimal.
For loan sales originated under the MPF programs, the Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan and reimburse a portion of fees received or reimburse the investor for a credit loss incurred on a loan, if it is determined that the representations and warranties have not been met. Such repurchases or reimbursements generally result from an underwriting or documentation deficiency. At March 31, 2021, the total outstanding balance of loans the Corporation has repurchased as a result of identified instances of noncompliance amounted to $1,698,000, and the corresponding total outstanding balance of repurchased loans at December 31, 2020 was $1,714,000.
At March 31, 2021, outstanding balances of loans sold and serviced through the MPF Xtra and Original programs totaled $295,504,000, including loans sold through the MPF Xtra program of $154,553,000 and loans sold through the Original program of $140,951,000. At December 31, 2020, outstanding balances of loans sold and serviced through the two programs totaled $278,857,000, including loans sold through the MPF Xtra program of $149,463,000 and loans sold through the Original Program of $129,394,000. Based on the fairly limited volume of required repurchases to date, no allowance has been established for representation and warranty exposures as of March 31, 2021 and December 31, 2020.
For loans sold under the Original program, the Corporation provides a credit enhancement whereby the Corporation would assume credit losses in excess of a defined First Loss Account (“FLA”) balance, up to specified amounts. The FLA is funded by the Federal Home Loan Bank of Pittsburgh based on a percentage of the outstanding balance of loans sold. At March 31, 2021, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $7,217,000, and the Corporation has recorded a related allowance for credit losses in the amount of $530,000 which is included in accrued interest and other liabilities in the accompanying consolidated balance sheets. At December 31, 2020, the Corporation’s maximum credit enhancement obligation under the MPF Original Program was $6,766,000, and the related allowance for credit losses was $500,000. Income related to providing the credit enhancement (included in other noninterest income in the consolidated statements of income) totaled $115,000 for the three months ended March 31, 2021 and $15,000 for the three months ended March 31, 2020. A provision for losses related to the credit enhancement obligation (included in other noninterest expense in the consolidated statements of income) of $30,000 was recorded in the three months ended March 31, 2021 with a credit for losses of $30,000 in the three months ended March 31, 2020. The Corporation does not provide a credit enhancement for loans sold through the Xtra program.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
The Corporation is a participating SBA lender. Under the terms of its arrangements with the SBA, the Corporation may originate loans to commercial borrowers, with full-or-partial guarantees by the SBA, subject to the SBA’s underwriting and documentation requirements. Covenant had also been a participating SBA lender. Pursuant to the Covenant acquisition, the Corporation acquired loans with partial SBA guarantees, or in some cases, loans where the SBA-guaranteed portion of the loans had been sold back to the SBA subject to ongoing compliance with SBA underwriting and documentation requirements. As part of its due diligence, the Corporation reviewed all the loans originated through the various SBA loan programs acquired from Covenant as of July 1, 2020 and recorded an allowance for SBA claim adjustments of $800,000. Determination of the allowance was subjective in nature and was based on the Corporation’s assessment of the credit quality of the loans and the quality of the documentation supporting compliance with SBA requirements. The Corporation’s total exposure related to SBA guarantees on loans originated by Covenant was $15,210,000 at March 31, 2021 and $17,041,000 at December 31, 2020 with an allowance for SBA claim adjustments (included in accrued interest and other liabilities in the consolidated balance sheets) of $730,000 at March 31, 2021 and December 31, 2020.
TABLE VII - SUMMARY OF LOANS BY TYPE
Summary of Loans by Type
(In Thousands)
March 31,
December 31,
2021
2020
2019
2018
2017
2016
Commercial:
Commercial loans secured by real estate
$
524,886
$
531,810
$
301,227
$
162,611
$
159,266
$
150,468
Commercial and industrial
155,828
159,577
126,374
91,856
88,276
83,854
Paycheck Protection Program - 1st Draw
71,708
132,269
0
0
0
0
Paycheck Protection Program - 2nd Draw
66,127
0
0
0
0
0
Political subdivisions
49,860
53,221
53,570
53,263
59,287
38,068
Commercial construction and land
45,307
42,874
33,555
11,962
14,527
14,287
Loans secured by farmland
10,897
11,736
12,251
7,146
7,255
7,294
Multi-family (5 or more) residential
54,049
55,811
31,070
7,180
7,713
7,896
Agricultural loans
2,460
3,164
4,319
5,659
6,178
3,998
Other commercial loans
16,315
17,289
16,535
13,950
10,986
11,475
Total commercial
997,437
1,007,751
578,901
353,627
353,488
317,340
Residential mortgage:
Residential mortgage loans - first liens
518,392
532,947
510,641
372,339
$
359,987
334,102
Residential mortgage loans - junior liens
25,402
27,311
27,503
25,450
25,325
23,706
Home equity lines of credit
39,083
39,301
33,638
34,319
35,758
38,057
1-4 Family residential construction
18,376
20,613
14,798
24,698
26,216
24,908
Total residential mortgage
601,253
620,172
586,580
456,806
447,286
420,773
Consumer
15,897
16,286
16,741
17,130
14,939
13,722
Total
1,614,587
1,644,209
1,182,222
827,563
815,713
751,835
Less: allowance for loan losses
(11,661)
(11,385)
(9,836)
(9,309)
(8,856)
(8,473)
Loans, net
$
1,602,926
$
1,632,824
$
1,172,386
$
818,254
$
806,857
$
743,362
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
PROVISION AND ALLOWANCE FOR LOAN LOSSES
The Corporation maintains an allowance for loan losses that represents management’s estimate of the losses inherent in the loan portfolio as of the balance sheet date and recorded as a reduction of the investment in loans. Note 7 to the unaudited consolidated financial statements provides an overview of the process management uses for evaluating and determining the allowance for loan losses.
While management uses available information to recognize losses on loans, changes in economic conditions may necessitate revisions in future years. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s allowance for loan losses. Such agencies may require the Corporation to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.
The allowance for loan losses was $11,661,000 at March 31, 2021, up from $11,385,000 at December 31, 2020. Table IX shows total specific allowances on impaired loans increased $199,000 to $1,124,000 at March 31, 2021 from $925,000 at December 31, 2020. This net increase included the impact of recording a specific allowance of $208,000 on a commercial loan with an outstanding principal balance of $1,283,000 in the first quarter of 2021.
Loans acquired from Covenant that were identified as having a deterioration in credit quality (purchased credit impaired, or PCI), were valued at $6,648,000 at July 1, 2020 and $6,479,000 at March 31, 2021. The remainder of the portfolio was deemed to be the performing component of the portfolio. Performing loans acquired from Covenant are presented net of a discount for credit losses of $4,664,000 at March 31, 2021 and $5,362,000 at December 31, 2020. This discount reflects an estimate of the present value of credit losses based on market expectations at the date of acquisition of $7,219,000, subsequently reduced as accretion has been recognized based on estimated and actual principal pay-downs.
Loans acquired from Monument that were identified as PCI were valued at $441,000 at April 1, 2019 and $304,000 at March 31, 2021. The remainder of the portfolio was deemed to be the performing component of the portfolio. Performing loans acquired from Monument are presented net of a discount for credit losses of $518,000 at March 31, 2021 and $617,000 at December 31, 2020. This discount reflects an estimate of the present value of credit losses based on market expectations at the date of acquisition of $1,914,000, subsequently reduced as accretion has been recognized based on estimated and actual principal pay-downs.
Table X shows the allowance for loan losses totaled 0.72% of gross loans outstanding at March 31, 2021, up from 0.69% at December 31, 2020 and down from levels in excess of 1.00% from 2016 to 2018. Table X also shows that the total of the allowance and the credit adjustment on purchased non-impaired loans, as a percentage of total loans plus the credit adjustment, was 1.04% at March 31, 2021, in line with ratios from the previous years.
The provision (credit) for loan losses by segment in the three-month periods ended March 31, 2021 and 2020 are as follows:
Three Months Ended
March 31,
March 31,
(In Thousands)
2021
2020
Commercial
$
242
$
1,318
Residential mortgage
(55)
198
Consumer
(20)
12
Unallocated
92
0
Total
$
259
$
1,528
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
The (credit) provision for loan losses is further detailed as follows:
Commercial segment
Three Months Ended
March 31,
March 31,
(In Thousands)
2021
2020
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs
$
193
$
1,175
Increase (decrease) in collectively determined portion of the allowance attributable to:
Changes in loan volume
142
7
Changes in historical loss experience factors
(49)
(21)
Changes in qualitative factors
(44)
157
Total provision for loan losses - Commercial segment
$
242
$
1,318
Residential mortgage segment
Three Months Ended
March 31,
March 31,
(In Thousands)
2021
2020
(Decrease) increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs
$
(10)
$
15
(Decrease) increase in collectively determined portion of the allowance attributable to:
Changes in loan volume
(7)
(14)
Changes in historical loss experience factors
(38)
(40)
Changes in qualitative factors
0
237
Total (credit) provision for loan losses - Residential mortgage segment
$
(55)
$
198
Consumer segment
Three Months Ended
March 31,
March 31,
(In Thousands)
2021
2020
(Decrease) increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs
$
(1)
$
20
(Decrease) increase in collectively determined portion of the allowance attributable to:
Changes in loan volume
(10)
(10)
Changes in historical loss experience factors
(10)
(6)
Changes in qualitative factors
1
8
Total (credit) provision for loan losses - Consumer segment
$
(20)
$
12
Total - All segments
Three Months Ended
March 31,
March 31,
(In Thousands)
2021
2020
Increase in total specific allowance on impaired loans, adjusted for the effect of net charge-offs
$
182
$
1,210
Increase (decrease) in collectively determined portion of the allowance attributable to:
Changes in loan volume
125
(17)
Changes in historical loss experience factors
(97)
(67)
Changes in qualitative factors
(43)
402
Sub-total
167
1,528
Unallocated
92
0
Total provision for loan losses - All segments
$
259
$
1,528
For the periods shown in the tables immediately above, the provision related to increases or decreases in specific allowances on impaired loans was affected by changes in the results of management’s assessment of the amount of probable or actual (charged-off) losses associated with a small number of larger, individual loans. This line item also includes net charge-offs or recoveries from smaller loans that had not been individually evaluated for impairment prior to charge-off.
In the tables immediately above, the portion of the net change in the collectively determined allowance attributable to loan growth was determined by applying the historical loss experience and qualitative factors used in the allowance calculation at the end of the preceding
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
period to the net increase or reduction in loans outstanding (excluding purchased loans and loans specifically evaluated for impairment) for the period.
The effect on the provision of changes in historical loss experience and qualitative factors, as shown in the tables above, was determined by: (1) calculating the net change in each factor used in determining the allowance at the end of the period as compared to the preceding period, and (2) applying the net change in each factor to the outstanding balance of loans at the end of the preceding period (excluding loans specifically evaluated for impairment).
In the three months ended March 31, 2021, net recoveries were $17,000, including recoveries of $28,000 and charge-offs of $11,000. Table X shows the average rate of net charge-offs as a percentage of loans was 0.00% in the three months ended March 31, 2021, and annual average rates ranging from a high of 0.16% in 2020 to a low of 0.02% in 2018.
Table X presents information related to past due and impaired loans, and loans that have been modified under terms that are considered troubled debt restructurings (TDRs). Total nonperforming loans as a percentage of outstanding loans was 1.45% at March 31, 2021, up from 1.42% at December 31, 2020, and nonperforming assets as a percentage of total assets was 1.07% at March 31, 2021, down from 1.10% at December 31, 2020. Table X presents data at the end of each of the years ended December 31, 2016 through 2020. Table X shows that total nonperforming loans as a percentage of loans of 1.45% at March 31, 2021, though up from December 31, 2020 and 2019, was lower than the corresponding year-end ratio from 2016 through 2018. Similarly, the March 31, 2021 ratio of total nonperforming assets as a percentage of assets of 1.07% was lower than the corresponding ratio from 2016 through 2018.
Total impaired loans of $18,158,000 at March 31, 2021 are up $340,000 from the corresponding amount at December 31, 2020 of $17,818,000. Purchased credit impaired loans, primarily acquired from Covenant, were included in impaired loans and had carrying values totaling $6,781,000 at March 31, 2021 and $6,841,000 at December 31, 2020. Table X shows that the total balance of impaired loans at March 31, 2021 was higher than the year-end amounts over the period 2016-2020, which ranged from a low of $5,486,000 in 2019 to the high of $17,818,000 at December 31, 2020. Similarly, total nonperforming assets of $24,873,000 at March 31, 2021 and $24,729,000 at December 31, 2020 were up from the prior periods mainly due to the inclusion of purchased credit impaired loans from the Covenant acquisition.
As reflected in Table X, total loans past due 30-89 days and still accruing interest amounted to $6,777,000 at March 31, 2021, up from $5,918,000 at December 31, 2020. This variance includes the effect of fluctuations in 30-89 day past due residential mortgage loans, which totaled $5,779,000 at March 31, 2021, up from $5,084,000 at December 31, 2020. Management monitors the status of delinquent residential mortgage loans on an ongoing basis and has considered delinquency trends, which were generally favorable through the first quarter 2021, in evaluating the allowance for loan losses at March 31, 2021.
Over the period 2016-2020 and the first three months of 2021, each period includes a few large commercial relationships that have required significant monitoring and workout efforts. As a result, a limited number of relationships may significantly impact the total amount of allowance required on impaired loans, and may significantly impact the amount of total charge-offs reported in any one period.
Management believes it has been conservative in its decisions concerning identification of impaired loans, estimates of loss, and nonaccrual status; however, the actual losses realized from these relationships could vary materially from the allowances calculated as of March 31, 2021. Management continues to closely monitor its commercial loan relationships for possible credit losses, and will adjust its estimates of loss and decisions concerning nonaccrual status, if appropriate.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
Tables VIII through X present historical data related to loans and the allowance for loan losses.
TABLE VIII - ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(Dollars In Thousands)
Three Months Ended
March 31,
March 31,
Years Ended December 31,
2021
2020
2020
2019
2018
2017
2016
Balance, beginning of year
$
11,385
$
9,836
$
9,836
$
9,309
$
8,856
$
8,473
$
7,889
Charge-offs:
Commercial
0
(17)
(2,343)
(6)
(165)
(132)
(597)
Residential mortgage
0
0
0
(190)
(158)
(197)
(73)
Consumer
(11)
(31)
(122)
(183)
(174)
(150)
(87)
Total charge-offs
(11)
(48)
(2,465)
(379)
(497)
(479)
(757)
Recoveries:
Commercial
14
0
16
6
317
4
35
Residential mortgage
2
3
44
12
8
19
3
Consumer
12
11
41
39
41
38
82
Total recoveries
28
14
101
57
366
61
120
Net recoveries (charge-offs)
17
(34)
(2,364)
(322)
(131)
(418)
(637)
Provision for loan losses
259
1,528
3,913
849
584
801
1,221
Balance, end of period
$
11,661
$
11,330
$
11,385
$
9,836
$
9,309
$
8,856
$
8,473
Net charge-offs as a % of average loans
0.00
%
0.00
%
0.16
%
0.03
%
0.02
%
0.05
%
0.09
%
TABLE IX - COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES
(In Thousands)
March 31,
As of December 31,
2021
2020
2019
2018
2017
2016
ASC 310 - Impaired loans
$
1,124
$
925
$
1,051
$
1,605
$
1,279
$
674
ASC 450 - Collective segments:
Commercial
5,594
5,545
3,913
3,102
3,078
3,373
Residential mortgage
4,046
4,091
4,006
3,870
3,841
3,890
Consumer
220
239
281
233
159
138
Unallocated
677
585
585
499
499
398
Total Allowance
$
11,661
$
11,385
$
9,836
$
9,309
$
8,856
$
8,473
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
TABLE X - PAST DUE AND IMPAIRED LOANS, NONPERFORMING ASSETS
AND TROUBLED DEBT RESTRUCTURINGS (TDRs)
(Dollars In Thousands)
March 31,
As of December 31,
2021
2020
2019
2018
2017
2016
Impaired loans with a valuation allowance
$
9,354
$
8,082
$
3,375
$
4,851
$
4,100
$
3,372
Impaired loans without a valuation allowance
2,023
2,895
1,670
4,923
5,411
7,488
Purchased credit impaired loans
6,781
6,841
441
0
0
0
Total impaired loans
$
18,158
$
17,818
$
5,486
$
9,774
$
9,511
$
10,860
Total loans past due 30-89 days and still accruing
$
6,777
$
5,918
$
8,889
$
7,142
$
9,449
$
7,735
Nonperforming assets:
Purchased credit impaired loans
$
6,781
$
6,841
$
441
$
0
$
0
$
0
Other nonaccrual loans
15,335
14,575
8,777
13,113
13,404
8,736
Total nonaccrual loans
22,116
21,416
9,218
13,113
13,404
8,736
Total loans past due 90 days or more and still accruing
1,285
1,975
1,207
2,906
3,724
6,838
Total nonperforming loans
23,401
23,391
10,425
16,019
17,128
15,574
Foreclosed assets held for sale (real estate)
1,472
1,338
2,886
1,703
1,598
2,180
Total nonperforming assets
$
24,873
$
24,729
$
13,311
$
17,722
$
18,726
$
17,754
Loans subject to troubled debt restructurings (TDRs):
Performing
$
302
$
166
$
889
$
655
$
636
$
5,803
Nonperforming
6,883
7,285
1,737
2,884
3,027
2,874
Total TDRs
$
7,185
$
7,451
$
2,626
$
3,539
$
3,663
$
8,677
Total nonperforming loans as a % of loans
1.45
%
1.42
%
0.88
%
1.94
%
2.10
%
2.07
%
Total nonperforming assets as a % of assets
1.07
%
1.10
%
0.80
%
1.37
%
1.47
%
1.43
%
Allowance for loan losses as a % of total loans
0.72
%
0.69
%
0.83
%
1.12
%
1.09
%
1.13
%
Credit adjustment on purchased non-impaired loans and allowance for loan losses
as a % of total loans and the credit adjustment (a)
1.04
%
1.05
%
0.93
%
1.12
%
1.09
%
1.13
%
Allowance for loan losses as a % of nonperforming loans
49.83
%
48.67
%
94.35
%
58.11
%
51.70
%
54.40
%
(a) Credit adjustment on purchased non-impaired loans at end of period
$
5,182
$
5,979
$
1,216
$
0
$
0
$
0
Allowance for loan losses
11,661
11,385
9,836
9,309
8,856
8,473
Total credit adjustment on purchased non-impaired loans at end of period and allowance for loan losses (1)
$
16,843
$
17,364
$
11,052
$
9,309
$
8,856
$
8,473
Total loans receivable
$
1,614,587
$
1,644,209
$
1,182,222
$
827,563
$
815,713
$
751,835
Credit adjustment on purchased non-impaired loans at end of period
5,182
5,979
1,216
0
0
0
Total (2)
$
1,619,769
$
1,650,188
$
1,183,438
$
827,563
$
815,713
$
751,835
Credit adjustment on purchased non-impaired loans and allowance for loan losses as a % of total loans and the credit adjustment (1)/(2)
1.04
%
1.05
%
0.93
%
1.12
%
1.09
%
1.13
%
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
LIQUIDITY
Liquidity is the ability to quickly raise cash at a reasonable cost. An adequate liquidity position permits the Corporation to pay creditors, compensate for unforeseen deposit fluctuations and fund unexpected loan demand. At March 31, 2021, the Corporation maintained overnight interest-bearing deposits with the Federal Reserve Bank of Philadelphia and other correspondent banks totaling $176,856,000. The Corporation’s cash position at March 31, 2021 was elevated, as in the first quarter 2021 growth in deposits and funds received from repayment of loans have outpaced purchases of securities, repayments of borrowings and other uses of cash.
The Corporation maintains overnight borrowing facilities with several correspondent banks that provide a source of day-to-day liquidity. Also, the Corporation maintains borrowing facilities with the Federal Home Loan Bank of Pittsburgh, secured by various mortgage loans.
The Corporation has a line of credit with the Federal Reserve Bank of Philadelphia’s Discount Window. Management intends to use this line of credit as a contingency funding source. As collateral for the line, the Corporation has pledged available-for-sale debt securities with a carrying value of $14,992,000 at March 31, 2021.
The Corporation’s outstanding, available, and total credit facilities at March 31, 2021 and December 31, 2020 are as follows:
Outstanding
Available
Total Credit
(In Thousands)
March 31,
December 31,
March 31,
December 31,
March 31,
December 31,
2021
2020
2021
2020
2021
2020
Federal Home Loan Bank of Pittsburgh
$
58,199
$
72,222
$
703,562
$
698,977
$
761,761
$
771,199
Federal Reserve Bank Discount Window
0
0
14,522
14,654
14,522
14,654
Other correspondent banks
0
0
45,000
45,000
45,000
45,000
Total credit facilities
$
58,199
$
72,222
$
763,084
$
758,631
$
821,283
$
830,853
At March 31, 2021, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of short-term borrowings of $8,000,000, long-term borrowings of $49,799,000 and a letter of credit of $400,000. At December 31, 2020, the Corporation’s outstanding credit facilities with the Federal Home Loan Bank of Pittsburgh consisted of short-term borrowings of $18,000,000, long-term borrowings of $53,822,000 and a $400,000 letter of credit. Additional information regarding borrowed funds is included in Note 9 to the unaudited consolidated financial statements.
Additionally, the Corporation uses “RepoSweep” arrangements to borrow funds from commercial banking customers on an overnight basis. If required to raise cash in an emergency situation, the Corporation could sell available-for-sale securities to meet its obligations or use repurchase agreements placed with brokers to borrow funds secured by investment assets. At March 31, 2021, the carrying value of available-for-sale securities in excess of amounts required to meet pledging or repurchase agreement obligations was $151,044,000.
Management believes the Corporation is well-positioned to meet its short-term and long-term funding obligations.
STOCKHOLDERS’ EQUITY AND CAPITAL ADEQUACY
In August 2018, the Federal Reserve Board issued an interim final rule that expanded applicability of the Board’s small bank holding company policy statement. The interim final rule raised the policy statement’s asset threshold from $1 billion to $3 billion in total consolidated assets for a bank holding company or savings and loan holding company that: (1) is not engaged in significant nonbanking activities; (2) does not conduct significant off-balance sheet activities; and (3) does not have a material amount of debt or equity securities, other than trust-preferred securities, outstanding. The interim final rule provides that, if warranted for supervisory purposes, the Federal Reserve may exclude a company from the threshold increase. Management believes the Corporation meets the conditions of the Federal Reserve’s small bank holding company policy statement and is therefore excluded from consolidated capital requirements at March 31, 2021; however, C&N Bank remains subject to regulatory capital requirements administered by the federal banking agencies.
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
Details concerning capital ratios at March 31, 2021 and December 31, 2020 are presented below. Management believes, as of March 31, 2021, that C&N Bank meets all capital adequacy requirements to which it is subject and maintains a capital conservation buffer (described in more detail below) that allows the Bank to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Further, as reflected in the table below, the Corporation’s and C&N Bank’s capital ratios at March 31, 2021 and December 31, 2020 exceed the Corporation’s Board policy threshold levels.
(Dollars in Thousands)
Minimum To Be
Minimum To Maintain
Well
Minimum
Capital Conservation
Capitalized Under
Minimum To Meet
Capital
Buffer at Reporting
Prompt Corrective
the Corporation's
Actual
Requirement
Date
Action Provisions
Policy Thresholds
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
March 31, 2021:
Total capital to risk-weighted assets:
Consolidated
$
265,515
18.03
%
N/A
N/A
N/A
N/A
N/A
N/A
$
154,644
≥10.5
%
C&N Bank
242,477
16.51
%
117,482
≥8
%
154,194
≥10.5
%
146,852
≥10
%
154,194
≥10.5
%
Tier 1 capital to risk-weighted assets:
Consolidated
236,790
16.08
%
N/A
N/A
N/A
N/A
N/A
N/A
125,188
≥8.5
%
C&N Bank
230,286
15.68
%
88,111
≥6
%
124,824
≥8.5
%
117,482
≥8
%
124,824
≥8.5
%
Common equity tier 1 capital to risk-weighted assets:
Consolidated
236,790
16.08
%
N/A
N/A
N/A
N/A
N/A
N/A
103,096
≥7
%
C&N Bank
230,286
15.68
%
66,083
≥4.5
%
102,796
≥7.0
%
95,454
≥6.5
%
102,796
≥7
%
Tier 1 capital to average assets:
Consolidated
236,790
10.88
%
N/A
N/A
N/A
N/A
N/A
N/A
174,138
≥8
%
C&N Bank
230,286
10.66
%
86,406
≥4
%
N/A
N/A
108,008
≥5
%
172,813
≥8
%
December 31, 2020:
Total capital to risk-weighted assets:
Consolidated
$
260,015
17.49
%
N/A
N/A
N/A
N/A
N/A
N/A
$
156,113
≥10.5
%
C&N Bank
236,943
15.98
%
118,602
≥8
%
155,665
≥10.5
%
148,252
≥10
%
155,665
≥10.5
%
Tier 1 capital to risk-weighted assets:
Consolidated
231,577
15.58
%
N/A
N/A
N/A
N/A
N/A
N/A
126,377
≥8.5
%
C&N Bank
225,058
15.18
%
88,951
≥6
%
126,015
≥8.5
%
118,602
≥8
%
126,015
≥8.5
%
Common equity tier 1 capital to risk-weighted assets:
Consolidated
231,577
15.58
%
N/A
N/A
N/A
N/A
N/A
N/A
104,075
≥7
%
C&N Bank
225,058
15.18
%
66,714
≥4.5
%
103,777
≥7.0
%
96,364
≥6.5
%
103,777
≥7
%
Tier 1 capital to average assets:
Consolidated
231,577
10.34
%
N/A
N/A
N/A
N/A
N/A
N/A
179,206
≥8
%
C&N Bank
225,058
10.12
%
88,959
≥4
%
N/A
N/A
111,199
≥5
%
177,919
≥8
%
Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. In addition, the Corporation and C&N Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities. Further, although the Corporation is no longer subject to the specific consolidated capital requirements described herein, the Corporation’s ability to pay dividends, repurchase stock or engage in other activities may be limited by the Federal Reserve if the Corporation fails to hold capital commensurate with its overall risk profile.
To avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization subject to the rule must hold a capital conservation buffer composed of common equity tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets. At March 31, 2021, the minimum risk-based capital ratios, and the capital ratios including the capital conservation buffer, are as follows:
Minimum common equity tier 1 capital ratio
4.5
%
Minimum common equity tier 1 capital ratio plus capital conservation buffer
7.0
%
Minimum tier 1 capital ratio
6.0
%
Minimum tier 1 capital ratio plus capital conservation buffer
8.5
%
Minimum total capital ratio
8.0
%
Minimum total capital ratio plus capital conservation buffer
10.5
%
A banking organization with a buffer greater than 2.5% over the minimum risk-based capital ratios would not be subject to additional limits on dividend payments or discretionary bonus payments; however, a banking organization with a buffer less than 2.5% would be
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CITIZENS & NORTHERN CORPORATION – FORM 10-Q
subject to increasingly stringent limitations as the buffer approaches zero. Also, a banking organization is prohibited from making dividend payments or discretionary bonus payments if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% as of the beginning of that quarter. Eligible net income is defined as net income for the four calendar quarters preceding the current calendar quarter, net of any distributions and associated tax effects not already reflected in net income. A summary of payout restrictions based on the capital conservation buffer is as follows:
Capital Conservation Buffer
Maximum Payout
(as a % of risk-weighted assets)
(as a % of eligible retained income)
Greater than 2.5%
No payout limitation applies
≤2.5% and >1.875%
60
%
≤1.875% and >1.25%
40
%
≤1.25% and >0.625%
20
%
≤0.625%
0
%
At March 31, 2021, C&N Bank’s Capital Conservation Buffer, determined based on the minimum total capital ratio, was 8.51%.
The Corporation’s total stockholders’ equity is affected by fluctuations in the fair values of available-for-sale debt securities. The difference between amortized cost and fair value of available-for-sale debt securities, net of deferred income tax, is included in Accumulated Other Comprehensive Income within stockholders’ equity. The balance in Accumulated Other Comprehensive Income related to unrealized gains (losses) on available-for-sale debt securities, net of deferred income tax, amounted to $6,847,000 at March 31, 2021 and $11,676,000 at December 31, 2020. Changes in accumulated other comprehensive income are excluded from earnings and directly increase or decrease stockholders’ equity. If available-for-sale debt securities are deemed to be other-than-temporarily impaired, unrealized losses are recorded as a charge against earnings, and amortized cost for the affected securities is reduced. Note 6 to the unaudited consolidated financial statements provides additional information concerning management’s evaluation of available-for-sale debt securities for other-than-temporary impairment at March 31, 2021.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.