Section 1: 10-K (10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
☒
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 001-38827
CORTLAND BANCORP
(Exact Name of Registrant as Specified in its Charter)
Ohio
(State or Other Jurisdiction
of Incorporation or Organization)
194 West Main Street, Cortland, Ohio
(Address of Principal Executive Offices)
34-1451118
(I.R.S. Employer
Identification No.)
44410
(Zip Code)
Registrant’s telephone number, including area code: (330) 637-8040
Securities registered pursuant to Section l2(b) of the Act: None
Securities registered pursuant to Section l2(g) of the Act:
Common Stock, no par value
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ☐ Yes ☒ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ☐ Yes ☒ No
Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section l3 or l5(d) of the Securities Exchange Act of l934 during the
preceding l2 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past
90 days. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically Interactive Data File required to be submitted pursuant to Rule405 of Regulation S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) is not contained herein, and will not be
contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. ☒
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging
growth company. See the definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of
the Exchange Act.:
Large accelerated filer
Non-accelerated filer
Emerging growth company
☐
☐
☐
Accelerated filer
Smaller reporting company
☒
☒
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised
financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ☐ Yes ☒ No
Based upon the closing price of the registrant’s common stock on June 30, 2018, the aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $95,540,332. For purposes of this response, directors and executive officers are considered the affiliates of the issuer at that date.
The number of shares outstanding of the issuer’s classes of common stock as of March 1, 2019: 4,349,624 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2019 Annual Meeting of Shareholders to be held on May 2, 2019 are incorporated by reference into Part III.
Form 10-K for the Year Ended December 31, 2018
Table of Contents
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
PART I
PART II
Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
PART III
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services
PART IV
Item 15.
EXHIBIT INDEX
SIGNATURES
Exhibits and Financial Statement Schedules
Form 10-
K
Page
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12
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21
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24
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99
100
101
104
Item l. Business
CORTLAND BANCORP
PART I
THE CORPORATION
Cortland Bancorp (the Company) was incorporated under the laws of the State of Ohio in 1984, as a one bank holding company registered under the
Bank Holding Company Act of 1956, as amended (BHC Act). The principal activity of the Company is to own, manage and supervise The Cortland
Savings and Banking Company (Cortland Bank or the Bank). The Company owns all of the outstanding shares of the Bank.
The Company has made an election to be a financial holding company. The Company is regulated by the Board of Governors of the Federal
Reserve System (Federal Reserve) and the Consumer Financial Protection Bureau (CFPB). The BHC Act provides generally for “umbrella”
regulation of financial holding companies such as the Company by the Federal Reserve Board, and for functional regulation of banking activities by
bank regulators, securities activities by securities regulators, and insurance activities by insurance regulators. The Company is also under the
jurisdiction of the Securities and Exchange Commission (SEC) and is subject to the disclosure and regulatory requirements of the Securities Act of
1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the SEC.
The business of the Company and the Bank is not seasonal to any significant extent and is not dependent on any single customer or group of
customers. The Company operates as a single line of business.
NEW RESOURCES LEASING CO.
New Resources Leasing Co. was formed in December 1987 under Ohio law as a separate entity to handle the function of commercial and consumer
leasing. The wholly owned subsidiary has been inactive since incorporation.
CORTLAND BANK
Cortland Bank is a full service, state-chartered bank engaged in commercial and retail banking. The Bank’s services include checking accounts,
savings accounts, time deposit accounts, commercial, mortgage and installment loans, night depository, automated teller services, safe deposit
boxes and other miscellaneous services normally offered by commercial banks. Commercial lending includes commercial, financial loans, real estate
construction and development loans, commercial real estate loans, small business lending and trade financing. Consumer lending includes
residential real estate, home equity and installment lending. Cortland Bank also offers a variety of Internet and mobile banking options.
Full service banking business is conducted at a total of fourteen offices, seven of which are located in Trumbull County, Ohio. The remaining
offices are located throughout Portage, Ashtabula, Summit, Cuyahoga and Mahoning Counties in Ohio. There is also a financial service center
located in Fairlawn, Ohio, in Summit County.
The Bank’s main administrative and banking office is located at 194 West Main Street, Cortland, Ohio.
The Bank, as a state-chartered banking organization and member of the Federal Reserve, is subject to periodic examination and regulation by the
Federal Reserve, the State of Ohio Division of Financial Institutions (Ohio Division) and the CFPB. These examinations, which include such areas as
capital, liquidity, asset quality, management practices and other aspects of the Bank’s operations, are primarily for the protection of the Bank’s
depositors. In addition to these regular examinations, the Bank must furnish periodic reports to regulatory authorities containing a full and accurate
statement of its affairs. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (FDIC).
The Bank provides brokerage and investment services through an arrangement with LPL Financial. Under this arrangement, financial advisors can
offer customers an extensive range of investment products and services, including estate planning, qualified retirement plans, mutual funds,
annuities, life insurance, fixed income and equity securities, equity research and recommendations, and asset management services to customers
through the brand Cortland Private Wealth Management.
3
CSB MORTGAGE COMPANY, INC.
CSB Mortgage Company, Inc. (CSB) was formed as an Ohio corporation in December 2011. It is a wholly-owned subsidiary of Cortland Bank and
functioned as the originator of wholesale mortgage loans and the seller of company-wide mortgage loans in the secondary mortgage market. It has
been inactive since 2013.
COMPETITION
The Bank actively competes with state and national banks located in Northeastern Ohio and Western Pennsylvania. It also competes for deposits,
loans and other service business with a large number of other financial institutions, such as savings and loan associations, credit unions, insurance
companies, consumer finance companies and commercial finance companies. Also, money market mutual funds, brokerage houses and similar
institutions provide in a relatively unregulated environment many of the financial services offered by banks. In the opinion of management, the
principal methods of competition are the rates of interest charged on loans, the rates of interest paid on deposit funds, the fees charged for services,
and the convenience, availability, timeliness and quality of the customer services offered.
EMPLOYEES
As of December 31, 2018, the Company, through the Bank, employed 144 full-time and 22 part-time employees. The Company provides its
employees with a full range of benefit plans and considers its relations with its employees to be satisfactory.
GENERAL LENDING POLICY
The Bank’s lending policy is designed to provide a framework which will meet the credit needs and interests of the community and the Bank. It is
the Bank’s objective to make loans to credit-worthy customers that benefit their interests. The loans made by the Bank are subject to the guidelines
established in the loan policy that is approved by the Bank’s Board of Directors.
There are times when the Bank will go beyond its lending territory to accommodate people who have been customers of the Bank and have moved
out of the lending area. There are also times when excess funds are available and it is profitable to participate in loans with other banks or to
participate in large projects for community development.
Each lending relationship is reviewed and graded in 6 categories, which are (1) ability to pay, (2) financial condition, (3) management ability, (4)
collateral and guarantors, (5) loan structure, and (6) industry and economics.
Further information can be found in Management’s Discussion and Analysis of Financial Condition and Results of Operations, Item 7.
SUPERVISION AND REGULATION
The Company and the Bank are subject to federal and state banking laws that are intended to protect depositors and borrowers, not shareholders.
Changes in federal and state banking laws, including statutes, regulations, and policies of the bank regulatory agencies, could have a material
adverse impact on our business and prospects. Federal and state laws applicable to holding companies and their financial institution subsidiaries
regulate the range of permissible business activities, investments, reserves against deposits, capital levels, lending activities and practices, the
nature and amount of collateral for loans, establishment of branches, mergers, dividends, and a variety of other important matters. The Company
and the Bank are subject to detailed, complex, and sometimes overlapping federal and state statutes and regulations affecting routine banking
operations. These statutes and regulations include, but are not limited to, state usury and consumer credit laws, the Truth-in-Lending Act and
Regulation Z, the Equal Credit Opportunity Act and Regulation B, the Fair Credit Reporting Act, the Truth in Savings Act, and the Community
Reinvestment Act. In addition to minimum capital requirements, federal law imposes other safety and soundness standards having to do with such
things as internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset
growth, asset quality, earnings, and compensation and benefits. The following discussion of bank supervision and regulation is qualified in its
entirety by reference to the statutory and regulatory provisions discussed.
The Company is a financial holding company and a bank holding company within the meaning of the BHC Act. As such, the Company is subject to
regulation, supervision, and examination by the Federal Reserve, acting primarily through the Federal Reserve Bank of Cleveland. The Company is
required to file annual reports and other information with the Federal Reserve. The Bank is subject to regulation and supervision by the Ohio
Division and, as a member bank of the Federal Reserve, by the Federal Reserve. The Bank is examined periodically by the Federal Reserve and by
the Ohio Division to test compliance with various regulatory requirements. If as a result of examination, the Federal Reserve or the Ohio Division
determines that a bank’s financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the
bank’s operations are unsatisfactory, or that the bank or its management is in violation of any law or regulation, the bank regulatory agencies may
take a number of
4
remedial actions. In addition, the Bank is subject to the regulations of the CFPB, established by the Dodd-Frank Wall Street Reform and Consumer
Protection Act enacted in July 2010 (the Dodd-Frank Act). The CFPB has broad powers to adopt and enforce consumer protection
regulations. Bank regulatory agencies make regular use of their authority to take formal and informal supervisory actions against banks and bank
holding companies for unsafe or unsound practices in the conduct of their businesses and for violations of any law, rule, or regulation, or any
condition imposed in writing by the appropriate federal banking regulatory authority. Potential supervisory and enforcement actions include
appointment of a conservator or receiver, issuance of a cease-and-desist order that could be judicially enforced, termination of a bank’s deposit
insurance, imposition of civil money penalties, issuance of directives to increase capital, entry into formal or informal agreements, including
memoranda of understanding, issuance of removal and prohibition orders against institution-affiliated parties, and enforcement of these actions
through injunctions or restraining orders.
Regulation of financial holding companies. A bank holding company must serve as a source of financial and managerial strength for its subsidiary
banks and must not conduct operations in an unsafe or unsound manner. The Federal Reserve requires all bank holding companies to maintain
capital at or above prescribed levels. Federal Reserve policy requires that a bank holding company provide capital to its subsidiary banks during
periods of financial stress or adversity and that the bank holding company maintain the financial flexibility and capital-raising capacity to obtain
additional resources for assisting subsidiary banks. Bank holding companies may also be required under certain circumstances to give written
notice to and receive approval from the Federal Reserve before purchasing or redeeming common stock or other equity securities or paying
dividends.
Acquisitions. The BHC Act requires every bank holding company to obtain approval of the Federal Reserve to acquire ownership or control of any
voting shares of another bank or bank holding company, if after the acquisition the acquiring company would own or control more than 5% of the
shares of the other bank or bank holding company (unless the acquiring company already owns or controls a majority of the shares); acquire all or
substantially all of the assets of another bank; or merge or consolidate with another bank holding company. The Federal Reserve will consider
anticompetitive effects of the proposed transaction, capital adequacy and other financial and managerial factors, along with the subsidiary banks’
performance under the Community Reinvestment Act of 1977. Approval of the Ohio Division is also necessary to acquire control of an Ohio-
chartered bank.
The BHC Act, the Change in Bank Control Act, and the Federal Reserve Regulation Y require advance approval of the Federal Reserve to acquire
“control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of a class of
voting securities of the bank holding company. Under certain circumstances, control may also be presumed to exist if a person acquires 10% or
more, but less than 25%, of any class of voting securities.
Interstate banking and branching. Section 613 of the Dodd-Frank Act amended the interstate branching provisions of the Riegle-Neal Interstate
Banking and Branching Efficiency Act of 1994. The amendments authorize a state or national bank to open a de novo branch in another state if the
law of the state where the branch is to be located would permit a bank chartered by that state to open the branch. Section 607 of the Dodd-Frank
Act requires that a bank holding company be well capitalized and well managed as a condition to approval of an interstate bank acquisition and that
an acquiring bank be and remain well capitalized and well managed as a condition to approval of an interstate bank merger.
Nonbanking activities. With some exceptions, the Bank Holding Company Act prohibits a bank holding company from acquiring or retaining direct
or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company or from engaging
directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal
exceptions to these prohibitions involve non-bank activities that, by statute or by Federal Reserve regulation or order, are held to be closely related
to the business of banking or of managing or controlling banks. A bank holding company may become a financial holding company if the holding
company meets “well-capitalized” and “well-managed” requirements of the Federal Reserve and each of its subsidiary banks is well capitalized
under the Federal Deposit Insurance Corporation Improvement Act of 1991 prompt corrective action provisions, is well managed, and has at least a
satisfactory rating under the Community Reinvestment Act, by filing a declaration that the bank holding company elects to become a financial
holding company. The Company is a financial holding company. No regulatory approval is required for a financial holding company to acquire a
company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in
nature, as determined by the Federal Reserve.
Activities that are “financial in nature” include:
•
•
•
securities underwriting, dealing and market making;
sponsoring mutual funds and investment companies;
insurance underwriting and agency;
5
• merchant banking; and
•
activities that the Federal Reserve Board has determined to be closely related to banking.
If a financial holding company or a subsidiary bank fails to meet all requirements for the holding company to maintain financial holding company
status, material restrictions may be placed on the activities of the holding company and on the ability of the holding company to enter into certain
transactions or obtain regulatory approvals. The holding company could also lose its financial holding company status and be required to divest
ownership or control of all banks owned by the financial holding company. If restrictions are imposed on the activities of a financial holding
company, such restrictions may not be made publicly available pursuant to confidentiality regulations of the banking regulators.
Economic Growth, Regulatory Relief and Consumer Protection Act
On May 25, 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the "Regulatory Relief Act") was signed into law. The
Regulatory Relief Act was designed to provide regulatory relief for banking organizations, particularly for all but the very largest, those with assets
in excess of $250 billion. Bank holding companies with assets of less than $100 billion are no longer subject to enhanced prudential standards, and
those with assets between $100 billion and $250 billion will be relieved of those requirements in 18 months, unless the Federal Reserve Board takes
action to maintain those standards. Certain regulatory requirements applied only to banks with assets in excess of $50 billion and so did not apply
to Cortland even before the enactment of the Regulatory Relief Act.
The Regulatory Relief Act also provides that the banking regulators must adopt regulations implementing the provision that banking organizations
with assets of less than $10 billion are permitted to satisfy capital standards and be considered "well capitalized" under the prompt corrective action
framework if their leverage ratios of tangible assets to average consolidated assets is between 8% and 10%, unless the bank's federal banking
agency determines that the organization's risk profile warrants a more stringent leverage ratio. The Federal Reserve Board, the Office of the
Comptroller of the Currency (OCC) and the FDIC have proposed for comment the leverage ratio framework for any banking organization with total
consolidated assets of less than $10 billion, limited amounts of certain types of assets and off-balance sheet exposures, and a community bank
leverage ratio greater than 9%. The community bank leverage ratio would be calculated as the ratio of tangible equity capital divided by average
total consolidated assets. Tangible equity capital would be defined as total bank equity capital or total holding company equity capital, as
applicable, prior to including minority interests, and excluding accumulated other comprehensive income, deferred tax assets arising from net
operating loss and tax credit carry forwards, goodwill and other intangible assets (other than mortgage servicing assets). Average total assets
would be calculated in a manner similar to the current tier 1 leverage ratio denominator in that amounts deducted from the community bank leverage
ratio numerator would also be excluded from the community bank leverage ratio denominator.
The Federal Reserve Board, the OCC and the FDIC also adopted a rule providing banking organizations the option to phase in over a three-year
period the day-one adverse effects on regulatory capital that may result from the adoption of new current expected credit loss methodology
accounting under U. S. generally accepted accounting principles.
The Regulatory Relief Act also relieves bank holding companies and banks with assets of less than $100 billion in assets from certain record-
keeping, reporting and disclosure requirements.
Capital. Risk-based capital requirements. Financial institutions and their holding companies are required to maintain capital as a way of absorbing
losses that can, as well as losses that cannot, be predicted. The Federal Reserve has adopted risk-based capital guidelines for financial holding
companies as well as state banks that are members of the Federal Reserve Bank. The Office of the Comptroller of the Currency and the FDIC have
adopted risk-based capital guidelines for national banks and state non-member banks, respectively. The guidelines provide a systematic analytical
framework which makes regulatory capital requirements sensitive to differences in risk profiles among banking organizations, takes off-balance
sheet exposures expressly into account in evaluating capital adequacy and minimizes disincentives to holding liquid, low-risk assets. Capital levels
as measured by these standards are also used to categorize financial institutions for purposes of certain prompt corrective action regulatory
provisions.
The risk-based capital guidelines adopted by the federal banking agencies are based on the “International Convergence of Capital Measurement
and Capital Standard” (Basel I), published by the Basel Committee on Banking Supervision (Basel Committee). Capital rules adopted by the United
States banking regulators applicable to smaller banking organizations, including the Company and the Bank, became effective commencing on
January 1, 2015. Compliance with the minimum capital requirements was required effective on January 1, 2015, whereas a new capital conservation
buffer and deductions from common equity capital phased in from January 1, 2016, through January 1, 2019, and most deductions from common
equity tier 1 capital phased in from January 1, 2015, through January 1, 2019.
6
The rules include (a) a minimum common equity tier 1 capital ratio of at least 4.5%, (b) a minimum Tier 1 capital ratio of 6.0%, (c) a minimum total
capital ratio of 8.0%, and (d) a minimum leverage ratio (Tier 1 capital to average assets) of 4%.
Common equity capital for the common equity tier 1 capital ratio includes common stock (plus related surplus) and retained earnings, plus limited
amounts of minority interests in the form of common stock, less the majority of certain regulatory deductions.
Tier 1 capital includes common equity capital as defined for the common equity tier 1 capital ratio, plus certain non-cumulative preferred stock and
related surplus, cumulative preferred stock and related surplus and trust preferred securities that have been grandfathered (but which are not
permitted going forward), and limited amounts of minority interests in the form of additional Tier 1 capital instruments, less certain deductions.
Tier 2 capital, which can be included in the total capital ratio, includes certain capital instruments (such as subordinated debt) and limited amounts
of the allowance for loan and lease losses, subject to new eligibility criteria, less applicable deductions.
The deductions from common equity tier 1 capital include goodwill and other intangibles, certain deferred tax assets, mortgage-servicing assets
above certain levels, gains on sale in connection with a securitization, investments in a banking organization’s own capital instruments and
investments in the capital of unconsolidated financial institutions (above certain levels).
For institutions with less than $250 billion in assets, the final rules also allow a one-time opportunity to permanently opt-out of a requirement to
include all components of accumulated other comprehensive income in the capital calculation. To avoid the possibility of extreme market volatility in
determining capital adequacy, the Company and the Bank have elected to opt-out.
Under the guidelines, capital is compared to the relative risk related to the balance sheet. To derive the risk included in the balance sheet, one of
several risk weights is applied to different balance sheet and off-balance sheet assets, primarily based on the relative credit risk of the
counterparty. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings
and other factors.
In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, a bank’s assets, including certain off-
balance sheet assets (e.g., recourse obligations, direct credit substitutes, residual interests), are multiplied by a risk weight factor assigned by the
regulations based on perceived risks inherit in the type of asset. Higher levels of capital are required for asset categories believed to present greater
risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently
unwritten first lien one-to four-family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, a risk weight of
150% is assigned to certain past due loans and commercial loans that qualify as high-volatility commercial real estate (HVCRE) exposures under
federal regulations, and a risk weight of between 0% and 600% is assigned to permissible equity interest, depending on certain specified factors.
Amendments included in the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Regulatory Relief Act”), enacted in May
2018, provide that federal banking regulators may not impose higher capital standards on HVCRE exposures unless they are for acquisition,
development or construction (ADC) and expand the exclusions from the current definition of an HVCRE exposure by (1) including loans for (a) the
acquisition or refinancing of existing income-producing real property if the cash flow of the property is sufficient to support the debt service and
expenses of the property and (b) for improvements to existing income-producing real property if the cash flow of the property is sufficient to
support the debt service and expenses of the property and (2) by counting paid development expenses and contributed real property or
improvements towards the borrower's contributed capital. This new two-prong test provides lenders with the flexibility to terminate the HVCRE
ADC designation and release the borrower's additional capital without the need for refinancing. The Regulatory Relief Act also gives lenders
discretion to determinate when and if the two-prong test has been satisfied based on the lenders' own underwriting criteria.
The rules also place restrictions on the payment of capital distributions, including dividends, and certain discretionary bonus payments to
executive officers if the company does not hold a capital conservation buffer of greater than 2.5% composed of common equity tier 1 capital above
its minimum risk-based capital requirements, or if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was
less than 2.5% at the beginning of the quarter. The capital conservation buffer phased in starting on January 1, 2016, at 0.625% and, effective
January 1, 2019, is currently fully phased in at 2.5%.
In addition to the capital requirements applicable to bank holding companies generally, the Federal Reserve requires financial holding companies to
be “well-capitalized” under Federal Reserve standards. Pursuant to the Federal Reserve's Small Bank Holding Company Policy (SBHC Policy),
however, a holding company with assets of less than $3 billion and meeting certain other requirements is not required to comply with the
consolidated capital requirements. At December 31, 2018, the Company was deemed to be a small bank holding company under the SBHC Policy.
The Bank must, however, comply with the capital requirements for banks.
7
The Regulatory Relief Act requires the federal banking agencies, including the Federal Reserve Board, to establish for institutions with assets of
less than $10 billion of assets a "community bank leverage ratio" (the ratio of a bank's tangible equity capital to average total consolidated assets)
of between 8 to 10%. A "qualifying community bank" with capital exceeding the specified requirement will be considered compliant with all
applicable regulatory capital and leverage requirements, including the requirement to be "well capitalized." On November 21, 2018, the federal
banking agencies issued a notice of proposed rulemaking seeking comment on a proposal that would create an alternative, voluntary, capital
framework for qualifying institutions that will deem an institution to be well capitalized so long as the institution maintains a leverage ratio of at least
9%. After the rule is finalized, a financial institution could elect to be subject to this new simplified capital requirement. At December 31, 2018, the
Company and the Bank exceeded each of its capital requirements.
Prompt corrective action. In addition to the capital adequacy requirements set forth above, every insured financial institution is classified into one
of five categories based upon the institution’s capital ratios, the results of regulatory examinations of the institution and whether the institution is
subject to enforcement agreements with its regulatory authorities. The categories are “well capitalized,” “adequately capitalized,”
“undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.”
The capital of the Company and the Bank as of December 31, 2018 were as follows:
December 31, 2018
CET1 capital (to risk-weighted assets)
Consolidated
Bank
Tier 1 capital (to risk-weighted assets)
Consolidated
Bank
Total capital (to risk-weighted assets)
Consolidated
Bank
Tier 1 capital (to average assets)
Consolidated
Bank
(Amounts in thousands)
Actual
Amount
Ratio
Minimum required for capital
adequacy purposes (1)
Ratio
Amount
To be well-capitalized
under prompt corrective
action regulations
Amount
Ratio
$
68,574
64,928
12.01 % $
11.44 %
25,700
25,548
4.5 %
4.5 % $
N/A
36,903
73,574
64,928
12.88 %
11.44 %
34,267
34,064
6.0 %
6.0 %
N/A
45,419
77,856
75,210
13.63 %
13.25 %
45,689
45,419
8.0 %
8.0 %
N/A
56,774
73,574
64,928
10.72 %
9.51 %
27,452
27,304
4.0 %
4.0 %
N/A
34,130
N/A
6.5 %
N/A
8.0 %
N/A
10.0 %
N/A
5.0 %
(1) Currently not required for the Company as a small bank holding company under the SBHC Policy.
A bank with a capital level that might qualify for well capitalized or adequately capitalized status may nevertheless be treated as though the bank is
in the next lower capital category if the bank’s primary federal banking supervisory authority determines that an unsafe or unsound condition or
practice warrants that treatment. A bank’s operations can be significantly affected by its capital classification under the prompt corrective action
rules. For example, a bank that is not well capitalized generally is prohibited from accepting brokered deposits and offering interest rates on deposits
higher than the prevailing rate in its market without advance regulatory approval. These deposit-funding limitations can have an adverse effect on
the bank’s liquidity. At each successively lower capital category, an insured depository institution is subject to additional restrictions.
Undercapitalized banks are required to take specified actions to increase their capital or otherwise decrease the risks to the federal deposit insurance
fund. Bank regulatory agencies generally are required to appoint a receiver or conservator within 90 days after a bank becomes critically
undercapitalized, with a leverage ratio of less than 2%. The Federal Deposit Insurance Act provides that a federal bank regulatory authority may
require a bank holding company to divest itself of an undercapitalized bank subsidiary if the agency determines that divestiture will improve the
bank’s financial condition and prospects.
In order to be “well-capitalized,” a bank must have a common equity tier 1 capital ratio of at least 6.5%, a total risk-based capital ratio of at least 10%,
a Tier 1 risk-based capital ratio of at least 8% and a leverage ratio of at least 5%, and the bank must not be subject to any written agreement, order,
capital directive or prompt corrective action directive to meet and maintain a specific capital level or any capital measure. The Company’s
management believes that the Bank meets the ratio requirements to be deemed “well-capitalized” according to the guidelines described above.
Federal deposit insurance. Deposits in the Bank are insured by the FDIC up to applicable limits through the Deposit Insurance Fund. Insured banks
must pay deposit insurance premiums assessed semiannually and paid quarterly. The general insurance limit is $250,000 per separately insured
depositor. This insurance is backed by the full faith and credit of the United States Government.
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As insurer, the FDIC is authorized to conduct examinations of and to require reporting by insured institutions, including the Bank, to prohibit any
insured institution from engaging in any activity the FDIC determines to pose a threat to the deposit insurance fund, and to take enforcement
actions against insured institutions. The FDIC may terminate insurance of deposits of any institution if it finds that the institution has engaged in
unsafe and unsound practices, is in an unsafe or unsound condition or has violated any applicable law, regulation, rule, order or condition imposed
by the FDIC or other regulatory agency.
The FDIC assesses a quarterly deposit insurance premium on each insured institution based on risk characteristics of the institution and may also
impose special assessments in emergency situations. The premiums fund the Deposit Insurance Fund (DIF). Pursuant to the Dodd-Frank Act, the
FDIC has established 2.0% as the designated reserve ratio (DRR), which is the amount in the DIF as a percentage of all DIF insured deposits. In
March 2016, the FDIC adopted final rules designed to meet the statutory minimum DRR of 1.35% by September 30, 2020, the deadline imposed by
the Dodd-Frank Act. The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets of less than $10 billion of the increase in
the statutory minimum DRR to 1.35% from the former statutory minimum of 1.15%. Although the FDIC's new rules reduced assessment rates on all
banks, they imposed a surcharge on banks with assets of $10 billion or more to be paid until the DRR reaches 1.35%. The DRR reached 1.36% at
September 30, 2018. The rules also provide assessment credits to banks with assets of less than $10 billion for the portion of their assessments that
contribute to the increase of the DRR to 1.35%. Such credits will be applied when the reserve ratio is at least 1.38%. The rules further changed the
method of determining risk-based assessment rates for established banks with less than $10 billion in assets to better ensure that banks taking on
greater risks pay more for deposit insurance than banks that take on less risk.
As of September 30, 2018, the Deposit Insurance Fund reserve ratio exceeded the required minimum of 1.35% set by the Dodd-Frank Act. Small
banks, such as the Bank, with total assets less than $10 billion, will receive credits to offset the portion of their assessments that helped to raise the
Deposit Insurance Fund reserve ratio from 1.15 percent to 1.35 percent. The total amount of small bank credits is estimated to be approximately $750
million. When the Deposit Insurance Fund reserve ratio is at or above 1.38%, the FDIC has stated that it will automatically apply credits to reduce a
small bank's regular assessment up to the entire amount of the assessment.
In addition, all FDIC-insured institutions are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation,
which was established by the government to recapitalize a predecessor to the DIF. These assessments will continue until the Financing
Corporation bonds mature in September 2019. The Financing Corporation has projected that the last assessment will be collected on the March 29,
2019, FDIC invoice.
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines that the institution has engaged or is
engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law,
regulation, order, or any condition imposed in writing by or written agreement with the FDIC.
Reciprocal Deposits. The Regulatory Relief Act amended the Federal Deposit Insurance Act to exclude reciprocal deposits of an insured depository
institution from certain limitations on prohibited brokered deposits. A well-capitalized and well-managed bank may now hold reciprocal deposits in
an amount that does not exceed the lesser of $5 billion or 20% of the depository institution's total liabilities without those reciprocal deposits being
treated as brokered deposits. Reciprocal deposits are defined in the Regulatory Relief Act as deposits that a bank receives through a deposit
placement network with the same maturity (if any) and in the same aggregate amount as deposits (other than deposits obtained through a deposit
broker) placed by the bank in another network bank. The amendment will also have the effect of lowering deposit insurance premiums for well-
capitalized banks that use deposit placement networks.
Transactions with affiliates. The Bank must comply with section 23A and section 23B of the Federal Reserve Act, establishing rules for
transactions by member banks with affiliates. These provisions protect banks from abuse in financial transactions with affiliates. Generally, section
23A and section 23B of the Federal Reserve Act (1) limit the extent to which a bank or its subsidiaries may lend to or engage in various other kinds
of transactions with any one affiliate to an amount equal to 10% of the institution’s capital and surplus (2) limit the aggregate of covered
transactions with all affiliates to 20% of capital and surplus, (3) impose strict collateral requirements on loans or extensions of credit by a bank to an
affiliate, (4) impose restrictions on investments by a subsidiary bank in the stock or securities of its holding company, (5) impose restrictions on the
use of a holding company’s stock as collateral for loans by the subsidiary bank, and (6) require that affiliate transactions be on terms substantially
the same as those provided to a non-affiliate.
Loans to insiders. The authority of the Bank to extend credit to insiders –meaning executive officers, directors, and greater than 10% shareholders
– or to entities those persons control, is subject to section 22(g) and section 22(h) of the Federal Reserve Act and Regulation O of the Federal
Reserve. These laws require that insider loans be made on terms substantially similar to those offered to unaffiliated individuals, place limits on the
amount of loans a bank may make to insiders based in part on the bank’s capital position, and require specified approval procedures. Loans to an
individual insider may not exceed the general legal limit on loans to any one
9
borrower. The aggregate of all loans to all insiders may not exceed the bank’s unimpaired capital and surplus. Insider loans exceeding the greater of
5% of capital or $25,000 must be approved in advance by a majority of the board, with any interested director not participating in the voting. Loans
to executive officers are subject to additional limitations based on the purpose of the loan. A violation of these restrictions could result in the
assessment of substantial civil money penalties, the imposition of a cease-and-desist order, or other regulatory sanctions.
Loans to one borrower. Under Ohio law, the total loans and extensions of credit by an Ohio-chartered bank to a person outstanding at any time
generally may not exceed 15% of the bank’s unimpaired capital, plus 10% of unimpaired capital for loans and extensions of credit fully secured by
readily marketable collateral.
Dividends and Distributions. Current federal banking regulations impose restrictions on the Bank's ability to pay dividends to the Company. These
restrictions include a limit on the amount of dividends that may be paid in a given year without prior approval of the Federal Reserve and a
prohibition on paying dividends that would cause the Bank's total capital to be less than the required minimum levels under the capital requirements
imposed by the Federal Reserve. The capital rules also limit the payment of dividends if the Bank does not maintain the capital conservation buffer.
Ohio law also limits the amount of dividends that may be paid in any given year without prior approval of the Ohio Superintendent of Financial
Institutions. The Bank's regulators may prohibit the payment of dividends at any time if the regulators determine the dividends represent unsafe
and/or unsound banking practices, or reduce the Bank's total capital below adequate levels.
The Company's ability to pay dividends to its shareholders may also be restricted. A financial holding company is required by law and Federal
Reserve policy to act as a source of financial strength to each of its banking subsidiaries. The Federal Reserve may require the Company to commit
resources or contribute additional capital to the Bank, which could restrict the amount of cash available for dividends.
The Federal Reserve has also issued a policy statement with regard to the payment of cash dividends by financial holding companies and other
bank holding companies. The policy statement provides that, as a matter of prudent banking, the holding company should not maintain a rate of
cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends, and the prospective rate of
earnings retention appears to be consistent with the holding company's capital needs, asset quality and overall financial condition. Accordingly, a
financial holding company should not pay cash dividends that exceed its net income or can only be funded in ways that weaken the holding
company's financial health, such as by borrowing.
Executive and incentive compensation. SEC regulations require the Company to provide various disclosures about executive compensation and,
through required stock exchange rules, require the Company to permit its shareholders to have non-binding votes on executive
compensation. Through stock exchange rules required by law, the Company's Compensation Committee must meet certain independence
standards, and the Compensation Committee must consider the independence of its advisers.
Consumer protection laws and regulations. Banks are subject to regular examination to ensure compliance with federal statutes and regulations
applicable to their business, including consumer protection statutes and implementing regulations. Potential penalties under these laws include, but
are not limited to, fines. The Dodd-Frank Act established the CFPB, which has extensive regulatory and enforcement powers over consumer
financial products and services. The CFPB has adopted numerous rules with respect to consumer protection laws, amending some existing
regulations and adopting new ones, and has commenced enforcement actions. The following are just some of the consumer protection laws
applicable to the Bank:
• Community Reinvestment Act of 1977: imposes a continuing and affirmative obligation to fulfill the credit needs of its entire community,
including low- and moderate-income neighborhoods.
• Equal Credit Opportunity Act: prohibits discrimination in any credit transaction on the basis of any of various criteria.
• Truth in Lending Act: requires that credit terms are disclosed in a manner that permits a consumer to understand and compare credit terms
more readily and knowledgeably.
•
Fair Housing Act: makes it unlawful for a lender to discriminate in its housing-related lending activities against any person on the basis of
any of certain criteria.
• Home Mortgage Disclosure Act: requires financial institutions to collect data that enables regulatory agencies to determine whether the
financial institutions are serving the housing credit needs of the communities in which they are located.
• Real Estate Settlement Procedures Act: requires that lenders provide borrowers with disclosures regarding the nature and cost of real
estate settlements and prohibits abusive practices that increase borrowers' costs.
•
Privacy provisions of the Gramm-Leach-Bliley Act: requires financial institutions to establish policies and procedures to restrict the
sharing of non-public customer data with non-affiliated parties and to protect customer information from unauthorized access.
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The banking regulators also use their authority under the Federal Trade Commission Act to take supervisory or enforcement action with respect to
unfair or deceptive acts or practices by banks that may not necessarily fall within the scope of specific banking or consumer finance law.
In October 2017, the CFPB issued a final rule (Payday Rule) with respect to certain consumer loans to be effective on January 16, 2018, although
compliance with most sections to be required starting on August 19, 2019. The first major part of the rule makes it an unfair and abusive practice for
a lender to make short-term and longer-term loans with balloon payments (with certain exceptions) without reasonably determining that the
borrower has the ability to repay the loan. The second major part of the rule applies to the same types of loans as well as longer-term loans with an
annual percentage rate greater than 36 percent that are repaid directly from the borrower's account. The rule states that it is an unfair and abusive
practice for the lender to withdraw payment from the borrower's account after two consecutive payment attempts have failed, unless the lender
obtains the consumer's new and specific authorization to make further withdrawals from the account. The rule also requires lenders to provide
certain notices to the borrower before attempting to withdraw payment on a covered loan from the borrower's account.
On February 6, 2019, the CFPB issued two proposals with respect to the Payday Rule. First, the CFPB proposed to delay the compliance date for
the mandatory underwriting provisions of the Payday Rule to November 19, 2020. It has requested comments on the proposed delay to be made
within 30 days. Second, the CFPB proposed to rescind provisions of the Payday Rule that (1) provide that it is an unfair and abusive practice for a
lender to make a covered short-term or longer-term balloon-payment loan without reasonably determining that the consumer has the ability to repay
the loan according to its terms; (2) prescribe mandatory underwriting requirements for making the ability-to-repay determination; (3) provide
exemptions of certain loans from the mandatory underwriting requirements; and (4) provide related definitions, reporting and recordkeeping
requirements. The CFPB has requested comments to be made within 90 days on this proposal. These proposals do not change the provisions of
the Payday Rule that address lender payment practices with respect to covered loans. The CFPB also stated that it will be considering other
changes to the Payday Rule in response to requests received for exemptions of certain types of lenders or loan products and may commence
separate additional rulemaking initiatives.
The Company does not currently expect the Payday Rule to have a material effect on the Company's financial condition or results of operation.
Monetary policy. The earnings of financial institutions are affected by the policies of regulatory authorities, including monetary policy of the
Federal Reserve. An important function of the Federal Reserve is regulation of aggregate national credit and money supply, relying on measures
such as open market transactions in securities, establishment of the discount rate on bank borrowings, and changes in reserve requirements against
bank deposits. These methods are used in varying combinations to influence overall growth and distribution of financial institutions’ loans,
investments, and deposits, and they also affect interest rates charged on loans or paid on deposits. Monetary policy is influenced by many factors,
including inflation, unemployment, short-term and long-term changes in the international trade balance, and fiscal policies of the United States
government. Federal Reserve Board monetary policy has had a significant effect on the operating results of financial institutions in the past and it
will continue to influence operating results in the future.
Anti-money laundering and anti-terrorism legislation. The Bank Secrecy Act of 1970 requires financial institutions to maintain records and report
transactions to prevent the financial institutions from being used to hide money derived from criminal activity and tax evasion. The Bank Secrecy
Act establishes (a) record-keeping requirements to assist government enforcement agencies with tracing financial transactions and flow of funds,
(b) reporting requirements for Suspicious Activity Reports and Currency Transaction Reports to assist government enforcement agencies with
detecting patterns of criminal activity, (c) enforcement provisions authorizing criminal and civil penalties for illegal activities and violations of the
Bank Secrecy Act and its implementing regulations, and (d) safe harbor provisions that protect financial institutions from civil liability for their
cooperative efforts.
The Treasury’s Office of Foreign Asset Control administers and enforces economic and trade sanctions against targeted foreign countries, entities,
and individuals based on U.S. foreign policy and national security goals. As a result, financial institutions must scrutinize transactions to ensure
that they do not represent obligations of or ownership interests in entities owned or controlled by sanctioned targets.
The USA PATRIOT Act of 2001 requires financial institutions to establish due diligence policies, procedures, and controls reasonably designed to
detect and report money laundering through correspondent accounts and private banking accounts, share information with law enforcement about
individuals, entities, and organizations engaged in or suspected of engaging in terrorist acts or money laundering activities, and comply with
regulations setting forth minimum standards regarding customer identification. These regulations require financial institutions to implement
reasonable procedures for verifying the identity of any person seeking to open an account, maintain records of the information used to verify the
person’s identity, and consult lists of known or suspected terrorists and terrorist organizations provided to the financial institution by government
agencies.
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Volcker Rule. The Company has no investments prohibited by the Volcker Rule and does not engage in any of the trading activities governed by
the Volcker Rule.
Ohio Banking Law. As a bank chartered under the laws of the State of Ohio, the Bank is governed by the laws of the State of Ohio and the
regulations of the Ohio Department of Commerce Division of Financial Institutions (“ODFI”). In 2017, the State of Ohio completed a substantial re-
writing of Ohio’s banking laws that became effective on January 1, 2018. One of the primary purposes of the revision of the law was to adopt one
universal bank charter for depository institutions chartered by the state, rather than having separate types of state depository institution charters
with different powers and limitations for banks, savings banks and savings and loan associations. The result is that all Ohio-chartered depository
institutions are now considered to have full commercial bank powers, unless an institution elects to continue to be governed by federal restrictions
applicable to federal savings and loan associations and federal savings banks. While the most substantial changes in the law affect institutions
chartered by Ohio as savings banks or savings and loan associations prior to the effectiveness of the new law, some changes also apply to
institutions, like the Bank, that were chartered as commercial banks prior to the change in the law. The changes for all Ohio-chartered banks include
provisions allowing Ohio-chartered banks to exercise the same powers, perform all acts, and provide all services that are permitted for federally
chartered depository institutions, with the exception of laws and regulations dealing with interest rates, thereby enhancing opportunities for Ohio-
chartered banks to compete with other financial institutions. Other provisions clarify previous laws addressing, or allow more flexibility with respect
to, corporate governance matters, mergers and acquisitions and additional reliance on Ohio corporate law generally.
AVAILABLE INFORMATION
The Company files an annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports
with the SEC pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934 Amended. The Company’s website is www.cortlandbank.com. The
Company makes available through its website, free of charge, the reports filed with the SEC, as soon as reasonably practicable after such material is
electronically filed, or furnished to, the SEC. The SEC also maintains a website that contains reports, proxy and information statements, and other
information regarding issuers that file electronically with the SEC at www.sec.gov. The public may read and copy any materials filed with the
Commission at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549, on official business days during the hours of 10:00 am
to 3:00 pm. The public may obtain information on the operation of the Public Reference Room by calling the Commission at 1-800-SEC-0330.
Item 1A. Risk Factors
Like all financial companies, the Company’s business and results of operations are subject to a number of risks, many of which are outside of our
control. In addition to the other information in this report, readers should carefully consider that the following important factors could materially
impact our business and future results of operations.
Economic, Political and Market Risks
Changes in national and local economic and political conditions could adversely affect our earnings, through declines in deposits and loan
demand and as our borrowers’ ability to repay loans and the value of the collateral securing our loans decline.
Our success depends, in part, on economic and political conditions, local and national, as well as governmental fiscal and monetary
policies. Conditions such as inflation, recession, unemployment, changes in interest rates and money supply and other factors beyond our control
may adversely affect our deposits and loan demand, which could adversely affect our earnings and financial condition. Since substantially all of our
loans are to individuals and businesses in Ohio, any decline in the economy of this market area could have a materially adverse effect on our credit
risk and on our deposit and loan levels. In addition, such conditions may adversely affect the ability of our borrowers to repay their loans and the
value of collateral securing the loans, which could adversely affect our earnings. Recent changes in government, particularly the change in the U.S.
President, could bring changes in all of such factors. Economic turmoil in Europe and Asia, trade negotiations and wars, and changes in oil
production in the Middle East affect the economy and stock prices in the United States. The timing and circumstances of the United Kingdom
leaving the European Union (Brexit) and their effects on the U.S. are unknown. Because we have a significant amount of real estate loans, a decline
in the value of real estate could have a material adverse effect on us. As of December 31, 2018, 81.5% of our loan portfolio consisted of commercial,
commercial real estate, real estate construction and installment, all of which are generally viewed as having more risk of default than residential real
estate loans and all of which, with the exception of installment loans, are typically larger than residential real estate loans. Residential real estate
loans held in the portfolio are typically originated using conservative underwriting standards that do not include sub-prime lending.
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Adverse changes in the financial markets may adversely impact our results of operations.
While we generally invest in securities issued by U.S. government agencies and sponsored entities and U.S. state and local governments with
limited credit risk, certain investment securities we hold possess higher credit risk since they represent beneficial interests in structured investments
collateralized by residential mortgages, debt obligations and other similar asset-backed assets. Regardless of the level of credit risk, all investment
securities are subject to changes in market value due to changing interest rates, implied credit spreads and credit ratings.
Changes in interest rates could adversely affect our financial condition and results of operations.
Our results of operations depend substantially on our net interest income, which is the difference between (i) the interest earned on loans, securities
and other interest-earning assets and (ii) the interest paid on deposits and borrowings. These rates are highly sensitive to many factors beyond our
control, including general economic conditions, inflation, recession, unemployment, money supply and the policies of various governmental and
regulatory authorities. If the interest we pay on deposits and other borrowings increases at a faster rate than the interest we receive on loans and
other investments, our net interest income and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the
interest we receive on loans and other investments falls more quickly than the interest we pay on deposits and borrowings. While we have taken
measures intended to manage the risks of operating in a changing interest rate environment, there can be no assurance that these measures will be
effective in avoiding undue interest rate risk.
Increases in interest rates also can affect the value of loans and other assets, including our ability to realize gains on the sale of assets. We
originate loans for sale and for our portfolio. Increasing interest rates may reduce the origination of loans for sale and consequently the fee income
we earn on such sales. Further, increasing interest rates may adversely affect the ability of borrowers to pay the principal or interest on loans and
leases, resulting in an increase in non-performing assets and a reduction of income recognized.
A transition away from LIBOR as a reference rate for financial contracts could negatively affect our income and expenses and the value of
various financial contracts.
LIBOR is used extensively in the U.S. and globally as a benchmark for various commercial and financial contracts, including adjustable rate
mortgages, corporate debt, interest rate swaps and other derivatives. LIBOR is set based on interest rate information reported by certain banks,
which may stop reporting such information after 2021. It is uncertain at this time whether LIBOR will change or cease to exist or the extent to which
those entering into financial contracts will transition to any other particular benchmark. Other benchmarks may perform differently than LIBOR or
alternative benchmarks have performed in the past or have other consequences that cannot currently be anticipated. It is also uncertain what will
happen with instruments that rely on LIBOR for future interest rate adjustments and which remain outstanding if LIBOR ceases to exist.
Currently less than 15% of the Company’s loans are floating on a LIBOR index. When a LIBOR substitute becomes effective, our existing notes
with those borrowers allow a conversion to another index. We are uncertain as to the performance of any substitute index compared to LIBOR,
therefore, cannot project any financial consequence to such conversion.
Operational Risks
The Company has operational risk.
The Company has many types of operational risk, including those discussed in more detail elsewhere in this Risk Factors section, such as cyber-
related risks, insufficient allowances for loan losses, errors in estimates in the preparation of financial statements, and risks related to future
expansion. The Company also has reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders and unauthorized
transactions by employees, and operational errors, including clerical or record-keeping errors and errors resulting from faulty or disabled computer
or telecommunications systems.
The Company's operations may be disrupted by events beyond our control, including spikes in transaction volume or customer activity, electrical
or telecommunications outages or natural disasters. If our policies and systems designed to mitigate such problems fail to operate well, such
failures could result in reputational damage, regulatory intervention and civil litigation, leading to financial loss or liability. Negative public opinion
could result from the Company's actual or alleged conduct with respect to a variety of its activities, including lending practices, corporate
governance and acquisitions. Negative public opinion can adversely affect the Company's ability to attract and keep customers.
The Company relies on vendors for certain processes. The Company is exposed to the risk that its vendors may be unable to fulfill their contractual
obligations or will suffer from the same risks as the Company has and that their business continuity systems may be inadequate, resulting in
damage to the Company's reputation, loss of business, regulatory enforcement actions and civil litigation.
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Failures or material breaches in security of our systems or those of third-party service providers may have a significant effect on our business.
We collect, process and store sensitive consumer data by utilizing computer systems and telecommunications networks operated by both us and
third-party service providers. The Bank’s necessary dependence upon automated systems to record and process the Bank’s transactions poses
the risk that technical system flaws, employee errors, tampering or manipulation of those systems, or attacks by third parties will result in losses and
may be difficult to detect. We have security and backup and recovery systems in place, as well as a business continuity plan, to ensure the
computer systems will not be inoperable, to the extent possible. Our inability to use or access these information systems at critical points in time
could unfavorably impact the timeliness and efficiency of our business operations. In recent years, some banks have experienced denial of service
attacks in which individuals or organizations flood the bank's website with extraordinarily high volumes of traffic, with the goal and effect of
disrupting the ability of the bank to process transactions. Other businesses have been victims of ransomware attacks in which the business
becomes unable to access its own information and is presented with a demand to pay a ransom in order to once again have access to its
information. We could be adversely affected if one of our employees causes a significant operational break-down or failure, either as a result of
human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems. We may not be able to prevent
employee errors or misconduct, and the precautions we take to detect this type of activity might not be effective in all cases. The Bank is further
exposed to the risk that the third-party service providers may be unable to fulfill their contractual obligations (or will be subject to the same risks as
the Bank). These disruptions may interfere with service to the Bank’s customers. We are also at risk of the impact of natural disasters, terrorism
and international hostilities on our systems or for the effects of outages or other failures involving power or communications systems operated by
others.
In addition, there have been instances where financial institutions have been victims of fraudulent activity in which criminals pose as customers to
initiate wire and automated clearinghouse transactions out of customer accounts. The recent massive breach of the systems of a credit bureau
presents additional threats as criminals now have more information about a larger portion of our country's population than past breaches have
involved, which could be used by criminals to pose as customers initiating transfers of money from customer accounts. Although we have policies
and procedures in place to verify the authenticity of our customers, we cannot assure that such policies and procedures will prevent all fraudulent
transfers.
We have implemented security controls to prevent unauthorized access to the computer systems and require our third-party service providers to
maintain similar controls. However, management cannot be certain that these measures will be successful. A security breach of the computer
systems and loss of confidential information, such as customer account numbers and related information, could result in a loss of customers’
confidence and, thus, loss of business. We could also lose revenue if competitors gain access to confidential information about our business
operations and use it to compete with us.
Further, we may be affected by data breaches at retailers and other third parties who participate in data interchanges with us and our customers that
involve the theft of customer credit and debit card data, which may include the theft of our debit card PIN numbers and commercial card information
used to make purchases at such retailers and other third parties. Such data breaches could result in us incurring significant expenses to reissue
debit cards and cover losses, which could result in a material adverse effect on our results of operations.
Our assets at risk for cyber-attacks include financial assets and non-public information belonging to customers. We use several third-party vendors
who have access to our assets via electronic media. Certain cyber security risks arise due to this access, including cyber espionage, blackmail,
ransom, and theft.
All of the types of cyber incidents discussed above could result in damage to our reputation, loss of customer business, costs of incentives to
customers or business partners in order to maintain their relationships, litigation, increased regulatory scrutiny and potential enforcement actions,
repairs of system damage, increased investments in cybersecurity (such as obtaining additional technology, making organizational changes,
deploying additional personnel, training personnel and engaging consultants), increased insurance premiums, and loss of investor confidence and
a reduction in our stock price, all of which could result in financial loss and material adverse effects on our results of operations and financial
condition.
Our allowance for loan losses may be insufficient.
We maintain an allowance for loan losses to provide for probable loan losses based on management’s quarterly analysis of the loan portfolio. The
preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires
management to make significant estimates that affect the financial statements. One of our most critical estimates is the level of the allowance for loan
losses. Due to the inherent nature of these estimates, we cannot provide absolute assurance that we will not be required to charge earnings for
significant unexpected loan losses. For more information on the sensitivity of these estimates, refer to the discussion of our “Critical Accounting
Policies” in this report.
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We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses within the loan portfolio. We make
various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of
the real estate and other assets serving as collateral for the repayment of loans. In deciding whether to extend credit or enter into other transactions
with customers and counterparties, we may rely on information provided to us by customers and counterparties, including financial statements and
other financial information. We may also rely on representations of customers and counterparties as to the accuracy and completeness of that
information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to a
business, we may assume that the customer’s audited financial statements conform with GAAP and present fairly, in all material respects, the
financial condition, results of operations and cash flows of the customer. We may also rely on the audit report covering those financial statements.
Our financial condition, results of operations and cash flows could be negatively impacted to the extent that we rely on financial statements that do
not comply with GAAP or on financial statements and other financial information that are materially misleading.
Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by
considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative
to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including
changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. We cannot fully predict the amount or
timing of losses or whether the loss allowance will be adequate in the future. If our assumptions prove to be incorrect, our allowance for loan losses
may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions could have a material adverse impact on our financial
condition and results of operations. In addition, federal and state regulators periodically review our allowance for loan losses as part of their
examination process and may require management to increase the allowance or recognize further loan charge-offs based on judgments different than
those of management. Any increase in the provision for loan losses would decrease our pretax and net income. Moreover, the Financial Accounting
Standards Board has changed its requirements for establishing the allowance for loan losses. The new guidance is effective for annual reporting
periods and interim reporting periods within those annual periods, beginning after December 15, 2019. Management is currently evaluating the
impact of the adoption of this accounting guidance on the Bank's allowance for loan losses.
When we loan money, we incur a risk of losses if our borrowers do not repay their loans.
In deciding whether to extend credit, we may rely on information provided by or on behalf of our borrowers, including financial statements and
other financial information. Although we regularly review our credit exposure to specific clients, as well as industries, default risk may arise from
events or circumstances that we have not detected, such as fraud. We may also fail to receive full information with respect to the risks of a
borrower. In addition, when we have extended credit against collateral, we may find that we have inadequate collateral, such as when there are
sudden declines in market value of the collateral or due to fraud with respect to such collateral. If such events occur, it could result in loss of
revenue and have an adverse effect on our business, results of operations and financial condition.
If we foreclose on collateral property and own the underlying real estate, we may be subject to the increased costs associated with the
ownership of real property, resulting in reduced revenues.
We may have to foreclose on collateral property to protect our investment and may thereafter own and operate such property, in which case we will
be exposed to the risks inherent in the ownership of real estate. The amount that we, as a mortgagee, may realize after a default is dependent upon
factors outside of our control, including, but not limited to: (i) general or local economic conditions; (ii) neighborhood values; (iii) interest rates;
(iv) real estate tax rates; (v) operating expenses of the mortgaged properties; (vi) supply of and demand for rental units or properties; (vii) ability to
obtain and maintain adequate occupancy of the properties; (viii) zoning laws; (ix) governmental rules, regulations and fiscal policies; and (x) acts of
God. Certain expenditures associated with the ownership of real estate, principally real estate taxes and maintenance costs, may adversely affect the
income from the real estate. Therefore, the cost of operating a real property may exceed the rental income earned from such property, and we may
have to advance funds in order to protect our investment, or we may be required to dispose of the real property at a loss. The foregoing
expenditures and costs could adversely affect our ability to generate revenues, resulting in reduced levels of profitability.
Environmental liability associated with commercial lending could have a material adverse effect on our business, financial condition and
results of operations.
In the course of our business, we may acquire, through foreclosure, commercial properties securing loans that are in default. There is a risk that
hazardous substances could be discovered on those properties. In this event, we could be required to remove the substances from and remediate
the properties at our cost and expense. The cost of removal and environmental remediation could be substantial. We may not have adequate
remedies against the owners of the properties or other responsible parties and could find it difficult or impossible to sell the affected properties.
These events could have a material adverse effect on our financial condition and results of operation.
15
The Bank may be required to repurchase loans it has sold or indemnify loan purchasers under the terms of the sale agreements, which could
adversely affect the Company's liquidity, results of operations and financial condition.
When the Bank sells a mortgage loan, it may agree to repurchase or substitute a mortgage loan if it is later found to have breached any
representation or warranty the Bank made about the loan or if the borrower is later found to have committed fraud in connection with the origination
of the loan. The Bank's underwriting policies and procedures may not prevent every breach or fraud. Repurchases or indemnifications may have an
adverse effect on the Company's financial condition and results of operations.
We may lose business due to trends of consumers deciding not to use banks to complete financial transactions or depositing funds
electronically with banks outside of our market area, which could negatively affect our net financial condition and results of operations.
Technology and other changes allow parties to complete financial transactions without banks. For example, consumers can pay bills and transfer
funds directly without banks. Consumers can also shop for higher deposit interest rates at banks across the country, which may offer higher rates
because they have few or no physical branches and open deposit accounts electronically. This process could result in the loss of fee income, as
well as the loss of client deposits and the income generated from those deposits, in addition to increasing our funding costs.
We operate in an extremely competitive market, and our business will suffer if we are unable to compete effectively.
In our market area, we encounter significant competition from other banks, savings and loan associations, credit unions, mortgage banking firms,
securities brokerage firms, asset management firms and insurance companies. The increasingly competitive environment is a result primarily of
changes in regulation and the accelerating pace of consolidation among financial service providers. The Company is smaller than many of our
competitors. Many of our competitors have substantially greater resources and lending limits than we do and may offer services that we do not or
cannot provide. The OCC has recently announced that it will accept applications for national bank charters from non-depository financial
technology companies engaged in banking activities. Another increasingly competitive factor in the financial services industry is the competition
to attract and retain talented employees, resulting in increased expenses.
The preparation of financial statements requires management to make estimates about matters that are inherently uncertain.
Management’s accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our
management must exercise judgment in selecting and applying many of these accounting policies and methods in order to ensure that they comply
with generally accepted accounting principles and reflect management’s judgment as to the most appropriate manner in which to record and report
our financial condition and results of operations. One of the most critical estimates is the level of the allowance of loan losses. Due to the inherent
nature of these estimates, we cannot provide absolute assurance that we will not significantly increase the allowance for loan losses or sustain loan
losses that are significantly higher than the provided allowance.
Increases in FDIC insurance premiums may have a material adverse effect on our earnings.
We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are a significant number of
financial institution failures or changes in the method of calculating premiums, we may be required to pay higher FDIC premiums. Increases in FDIC
insurance premiums may materially adversely affect our results of operations and our ability to continue to pay dividends on our common shares at
the current rate or at all.
The loss of key members of our senior management team could adversely affect our business.
We believe that our success depends largely on the efforts and abilities of our senior management. Their experience and industry contacts
significantly benefit us. In addition, our success depends in part upon senior management’s ability to implement our business strategy. The
competition for qualified personnel in the financial services industry is intense, and the loss of services of any of our senior executive officers or an
inability to continue to attract, retain and motivate key personnel could adversely affect our business. We cannot assure you that we will be able to
retain our existing key personnel or attract additional qualified personnel.
Loss of key employees may disrupt relationships with certain customers.
Our business is primarily relationship-driven in that many of our key employees have extensive customer relationships. Loss of a key employee with
such customer relationships may lead to the loss of business if the customers were to follow that employee to a competitor. While we believe our
relationships with our key producers is good, we cannot guarantee that all of our key personnel will remain with our organization. Loss of such key
personnel, should they enter into an employment relationship with one of our competitors, could result in the loss of some of our customers.
16
Our ability to pay cash dividends is limited.
We are dependent primarily upon the earnings of our operating subsidiaries for funds to pay dividends on our common shares. The payment of
dividends by us and our subsidiaries is subject to certain regulatory restrictions. As a result, any payment of dividends in the future will be
dependent, in large part, on our ability to satisfy these regulatory restrictions and our subsidiaries’ earnings, capital requirements, financial
condition and other factors. Although our financial earnings and financial condition have allowed us to declare and pay periodic cash dividends to
our shareholders, there can be no assurance that our dividend policy or size of dividend distribution will continue in the future.
Trading in our common shares is very limited, which may adversely affect the time and the price at which you can sell your Company common
shares.
Although the common shares of the Company are quoted on the OTC Market, trading in the Company’s common shares is not active, and the
spread between the bid and the asked price is often wide.
As a result, you may be unable or purchase our common shares at the volume, price and time you desire. The limited trading market for our common
shares may cause fluctuations in the market value of our common shares to be exaggerated, leading to price volatility in excess of that which would
occur in a more active trading market. In addition, even if a more active market of our common stock develops, we cannot assure you that such a
market will continue.
Factors that may affect the volatility of our stock include:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
our actual or anticipated operating and financial results, including how those results vary from the expectations of management,
securities analysts and investors;
changes in financial estimates or publication of research reports and recommendations by financial analysts or actions taken by rating
agencies with respect to other financial institution;
failure to declare dividends on our common stock from time to time;
reports in the press or investment community generally or relating to our reputation or the financial services industry;
developments in our business or operations or in the financial sector generally;
any future offerings by us of our common stock;
legislative or regulatory changes affecting our industry generally or our business and operations specifically;
the operating and stock price performance of companies that investors consider to be comparable to us;
announcements of strategic developments, acquisitions, restructurings, dispositions, financings and other material events by us or
our competitors
expectations of (or actual) equity dilution, including the actual or expected dilution to various financial measures, including
earnings per share, that may be caused by this offering;
actions by our current shareholders, including future sales of common shares by existing shareholders, including our directors and executive officers;
proposed or final regulatory changes or developments;
anticipated or pending regulatory investigations, proceedings, or litigation that may involve or affect us; and
other changes in U.S. or global financial markets, global economies and general market conditions, such as interest or foreign exchange
rates, stock, commodity, credit or asset valuations or volatility.
17
Our organizational documents may have the effect of discouraging a third party from acquiring us.
Our articles of incorporation and code of regulations contain provisions, including a staggered board of directors and a supermajority vote
requirement, that make it more difficult for a third party to gain control or acquire us without the consent of the board of directors. These provisions
could also discourage proxy contests and may make it more difficult for dissident shareholders to elect representatives as directors and take other
corporate actions.
Future expansion may adversely affect our financial condition and results of operations.
We may acquire other financial institutions or parts of institutions in the future and may open new branches. We also may consider and enter into
new lines of business or offer new products or services. Expansions of our business involve a number of expenses and risks, including:
•
•
•
•
•
•
•
•
•
the time and costs associated with identifying and evaluating potential acquisitions or new products or services;
the potential inaccuracy of estimates and judgments used to evaluate credit, operations, management and market risk with respect to the
target institutions;
the time and costs of evaluating new markets, hiring local management and opening new offices, and the delay between commencing these
activities and the generation of profits from the expansion;
our ability to finance an acquisition or other expansion and the possible dilution to our existing shareholders;
the diversion of management’s attention to the negotiation of a transaction and the integration of the operations and personnel of the
combining businesses;
entry into unfamiliar markets;
the possible failure of the introduction of new products and services into our existing business;
the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on our results
of operations; and
the risk of loss of key employees and customers.
We may incur substantial costs to expand, and we can give no assurance that such expansion will result in the levels of profits we expect. Neither
can we assure that integration efforts for any future acquisitions will be successful. We may issue equity securities in connection with acquisitions,
which could dilute the economic and voting interests of our existing shareholders. We may also lose customers as we close one or more branches
as part of a plan to expand into other areas or become more productive from other branches.
We may be compelled to seek additional capital in the future but may not be able to access capital when needed.
Should we experience significant loan losses, we may need additional capital. In addition, we may elect to raise additional capital to support our
business, to finance acquisitions, if any, or for other purposes. Our ability to raise additional capital, if needed, will depend on our financial
performance, conditions in the capital markets, economic conditions and a number of other factors, many of which are outside of our control. There
can be no assurance, therefore, that we can raise additional capital at all or on terms acceptable to us. If we cannot raise additional capital when
needed or desired, it may have a material adverse effect on our financial condition, results of operations and prospects.
A default by another larger financial institution could adversely affect financial markets generally.
The commercial soundness of many financial institutions may be closely interrelated as a result of relationships between the institutions. As a
result, concerns about, or a default or threatened default by, one institution could lead to significant market-wide liquidity and credit problems,
losses or defaults by other institutions. This “systemic risk” may adversely affect our business.
Legal, Regulatory and Accounting Change Risks
The enactment of new legislation or regulations may significantly affect our financial condition and results of operations.
The Company is subject to regulations and supervision of the Federal Reserve, and the Bank is subject to regulation and supervision of the ODFI,
the Federal Reserve, the FDIC and the CFPB. The regulations are designed to protect customers and the Deposit Insurance Fund. Regulations
governing financial institutions are constantly undergoing change. New regulations or amendments could adversely affect the Company's
business. Regulatory agencies have great discretion in connection with their supervisory and enforcement activities, including the imposition of
restrictions on the operation of an institution, the classification of assets held by an
18
institution and the appropriateness of an institution's allowance for loan losses. In addition, actions by regulatory agencies could cause us to
devote significant time and resources to compliance and defense of the Company's business and may lead to penalties that materially affect the
Company.
In recent years, Congress and the banking regulators have increased their focus on the financial services industry. The laws and regulations
adopted have subjected the Company and the Bank to additional restrictions, oversight and costs that may have an impact on the financial
condition and results of operations of the Company. In 2013, the Company's and the Bank's primary federal regulator established a new
comprehensive capital framework for U.S. banking organizations. The new capital rules became effective for the Bank on January 1, 2015, subject to
a phase-in period. Any future changes to capital requirements may have an adverse effect on our capital ratios.
The current President of the United States and Congress have taken steps to change laws and regulations applicable to financial institutions,
including the Company and the Bank. While those steps are generally intended to lessen regulatory burden on financial institutions, the results of
such efforts are not yet known, and even the reduction of regulatory restrictions could have an adverse effect on the Company and the Bank and
the Company's shareholders if such lessening of restrictions increases competition within the financial services industry or the Company's market
area.
Further information about government regulation of the Company and the Bank may be found under the heading, "SUPERVISION AND
REGULATION" in "ITEM 1. BUSINESS" of this Form 10-K.
Changes in accounting standards could materially impact the Company’s consolidated financial statements.
The Company’s accounting policies and methods are fundamental to how our financial condition and results of operations are recorded and
reported. The accounting standard setters, including the Financial Accounting Standards Board, the SEC, and other regulatory bodies, from time to
time may change the financial accounting and reporting standards that govern the preparation of the Company’s consolidated financial statements.
These changes can be hard to predict and can materially impact how the Company records and reports financial condition and results of operations.
In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in changes to previously reported
financial results, or a cumulative charge to retained earnings. Management may be required to make difficult, subjective, or complex judgments
about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions.
In June 2016, FASB issued a new accounting standard for recognizing current expected credit losses, commonly referred to as CECL. CECL will
result in earlier recognition of credit losses and requires consideration of not only past and current events but also reasonable and supportable
forecasts that affect collectability. The Company will be required to comply with the new standard in the first quarter of 2020. Upon adoption of
CECL, credit loss allowances may increase, which would decrease retained earnings and regulatory capital. The federal banking regulators have
adopted a regulation that will allow banks to phase in the day-one impact of CECL on regulatory capital over three years. CECL implementation
poses operational risk, including the failure to properly transition internal processes or systems, which could lead to call report errors, financial
misstatements, or operational losses.
Changes in tax laws could adversely affect our performance.
We are subject to extensive federal, state and local taxes, including income, excise, sales/use, payroll, franchise, withholding and ad valorem taxes.
Changes to our taxes could have a material adverse effect on our results of operations. In addition, our customers are subject to a wide variety of
federal, state and local taxes. Changes in taxes paid by our customers, including changes in the deductibility of mortgage loan related expenses, may
adversely affect their ability to purchase homes or consumer products, which could adversely affect their demand for our loans and deposit
products. In addition, such negative effects on our customers could result in defaults on the loans we have made and decrease the value of
mortgage-backed securities in which we have invested.
On December 22, 2017, H.R.1, formally known as the "Tax Cuts and Jobs Act," was enacted into law. This new tax legislation, among other changes,
limits the amount of state, federal and local taxes that taxpayers are permitted to deduct on their individual tax returns and eliminates other
deductions in their entirety. Such limits and eliminations may result in customer defaults on loans we have made and decrease the value of
mortgage-backed securities in which we have invested.
The Company undertakes no obligation and disclaims any intention to publish revised information or updates to forward-looking statements
contained in the above risk factors or in any other statement made at any time by any director, officer, employee or other representative of the
Company unless and until any such revisions or updates are required to be disclosed by applicable securities laws or regulations.
Item 1B. Unresolved Staff Comments — Not applicable to the Company because it is a smaller reporting company.
19
Item 2. Properties
The Company’s operations are conducted at 194 West Main Street, Cortland, Ohio.
Full service banking business is conducted at a total of fourteen offices, including:
BRISTOL
6090 State Route 45
Bristolville, Ohio 44402
330-889-3062
BROOKFIELD
7202 Warren-Sharon Road
Brookfield, Ohio 44403
330-448-6814
CANFIELD
3615 Boardman-Canfield Road
Canfield, Ohio 44406
330-941-5867
CORTLAND
194 West Main Street
Cortland, Ohio 44410
330-637-8040
HUBBARD
890 West Liberty Street
Hubbard, Ohio 44425
330-534-2265
HUDSON
75 S. Main St.
Hudson, OH 44236
330-342-1100
MANTUA
11661 State Route 44
Mantua, Ohio 44255
330-274-3111
NILES PARK PLAZA
815 Youngstown-Warren Road
Suite 1
Niles, Ohio 44446
330-652-8700
NORTH LIMA
9001 Market Street
North Lima, Ohio 44452
330-758-5884
STRONGSVILLE
14357 Pearl Road
Strongsville, Ohio 44136
440-238-5917
VIENNA
4434 Warren-Sharon Road
Vienna, Ohio 44473
330-394-1438
WARREN
2935 Elm Road
Warren, Ohio 44483
330-372-1520
WILLIAMSFIELD
5917 U.S. Route 322
Williamsfield, Ohio 44093
440-293-7502
WINDHAM
8950 Maple Grove Road
Windham, Ohio 44288
330-326-2340
The Bank’s main and administrative office is located at 194 West Main Street, Cortland, Ohio. The Bank leases one financial service center in
Fairlawn, Ohio. The Hubbard, Niles Park Plaza, Hudson and Strongsville offices are leased, while all of the other offices are owned by the Bank.
Item 3. Legal Proceedings
The Bank is involved from time to time in legal actions arising in the ordinary course of the Bank’s business. In the opinion of management, the
outcomes from such legal proceedings, either individually or in the aggregate, are not expected to have any material effect on the Company.
Item 4. Mine Safety Disclosures – Not applicable
Executive Officers of the Registrant
The names, ages and positions of the executive officers as of March 1, 2019 are as follows:
Name
James M. Gasior
Timothy Carney
David J. Lucido
Stanley P. Feret
Age
59
53
61
58
Position Held
President, Chief Executive Officer and Director
Executive Vice President, Chief Operations Officer and Director
Senior Vice President and Chief Financial Officer
Senior Vice President and Chief Lending Officer
Principal Occupation and Business Experience of Executive Officers
During the past five years the business experience of each of the executive officers has been as follows:
Mr. Gasior has been President and Chief Executive Officer of the Company and the Bank since November 2, 2009. Mr. Gasior is a director of the
Company and the Bank since November 2005.
Mr. Carney has been Executive Vice President and Chief Operating Officer of the Company and the Bank since November 2, 2009. Mr. Carney is a
director of the Company and the Bank since November 2009.
Mr. Lucido was appointed Senior Vice President and Chief Financial Officer of the Company and the Bank on January 18, 2010.
Mr. Feret was appointed Senior Vice President and Chief Lending Officer of the Company and the Bank on March 10, 2010.
20
PART II
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
The following is information regarding market information, holders and dividends.
The Company files quarterly reports on Form 10-Q, an annual report on Form 10-K, current reports on Form 8-K, and proxy statements, as well as
any amendments to those reports and statements, with the SEC pursuant to section 13(a) or (15)d of the Exchange Act. In 2019, the Company’s
quarterly reports will be filed within 40 days of the end of each quarter, and the Company’s annual report will be filed within 75 days of the end of
the year. Any person may access these reports and statements free of charge, as soon as reasonably practicable after such material is electronically
filed with or furnished to the SEC, by visiting our web site at www.cortlandbank.com or by writing to:
Deborah L. Eazor
Cortland Bancorp
194 West Main Street
Cortland, Ohio 44410
The SEC also maintains a website at www.sec.gov where our filings and other information may be obtained free of charge.
The Company’s common shares began trading on the NASDAQ Capital Markets stock exchange under the symbol CLDB in March 2019. The
following brokerage firms are registered market makers in the Company’s common shares:
D.A. Davidson & Co.
5050 Blazer Parkway, Suite 103
Dublin, OH 43017
Telephone: 800-394-9230
Raymond James & Associates, Inc.
880 Carillon Parkway
St. Petersburg, FL 33716
Telephone: 800-248-8863
Sandler O’Neill & Partners, L.P.
1251 Avenue of the Americas, 6th FL
New York, NY 10020
Telephone: 800-635-6855
The following table shows the dividends declared during the periods indicated and the prices at which the common shares of the Company have
actually been purchased and sold in market transactions. The range of market prices is compiled from data available from the OTCQX, the exchange
on which the shares traded in the years presented. The data may not necessarily represent all transactions. As of March 1, 2019, the Company had
approximately 1,169 shareholders of record.
2018
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
2017
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
2016
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
High
Price Per Share
Low
Close
Cash Dividends
Declared Per Share
24.30 $
26.00
26.00
26.00
21.00 $
19.25
19.00
18.93
19.00 $
16.25
16.25
17.50
20.50 $
23.46
20.80
20.40
17.95 $
17.00
17.94
17.50
15.35 $
14.65
14.15
15.11
20.50 $
24.40
24.31
23.15
20.50 $
19.25
18.00
18.60
17.50 $
15.61
15.00
15.40
0.11
0.16
0.11
0.11
0.08
0.08
0.08
0.15
0.07
0.07
0.07
0.07
$
$
$
21
For current share prices, please access our website at www.cortlandbank.com.
The Bank is subject to a dividend restriction that generally limits the amount of dividends that can be paid by an Ohio state-chartered bank. Under
the Ohio Banking Code, cash dividends may not exceed net profits as defined for that year combined with retained net profits for the two preceding
years less any required transfers to surplus. Under this formula, the amount available for payment of dividends in 2019 is $8.2 million plus 2019
profits retained up to the date of the dividend declaration.
For the convenience of shareholders, the Company has established a plan whereby shareholders may have their dividends automatically reinvested
in the common shares of the Company. Participation in the plan is completely voluntary and shareholders may withdraw at any time.
Shareholder and General Inquiries
Cortland Bancorp
194 West Main Street
Cortland, Ohio 44410
(330) 637-8040
Attention: Deborah L. Eazor
Vice President
DEazor@cortlandbank.com
Transfer Agent
American Stock Transfer & Trust Company, LLC
6201 15th Avenue
Brooklyn, NY 11219
(888) 509-4619
Please contact our transfer agent directly for assistance in changing your address, elimination of duplicate mailings, transferring shares or replacing
lost, stolen or destroyed share certificates. Other questions regarding your status as a shareholder of the Company may be addressed to the
Company as indicated above.
The following table shows information relating to the repurchase of shares of the Company’s common stock during the quarter ended December 31,
2018:
Total
Number of
Shares
Purchased
Average Price
Paid Per Share
12,456 $
—
—
12,456 $
23.10
—
—
23.10
Total Number of
Shares
Purchased
as Part of
Publicly
Announced
Plans or
Programs
Maximum
Number of
Shares That May
Yet Be
Purchased Under
the Plans or
Programs*
12,456
—
—
12,456
219,056
219,056
—
—
October
November
December
Total
*
On January 23, 2018, the Company’s Board of Directors approved a Stock Repurchase Program. The program allowed the Company to
purchase up to 100,000 shares and expired on December 31, 2018. On May 22, 2018 the Company’s Board of Directors approved an increase in
the number of shares authorized for repurchase under the January 23, 2018 plan by 200,000 shares bringing the total to 300,000 shares
authorized, which expired on December 31, 2018. On December 18, 2018, the Company’s Board of Directors approved a Stock Repurchase
Program allowing the Company to purchase up to 300,000 shares. This program is effective January 1, 2019 and will expire on December 31,
2019. (See footnote 18 to the Consolidated Financial Statements.)
22
The Company did not sell any of its shares without registration during 2018, 2017 or 2016.
Item 6. Selected Financial Data
SUMMARY OF OPERATIONS
Total interest income
Total interest expense
Net interest income (NII)
Provision for loan losses
NII after loss provision
Investment security gains (losses), including impairment losses
Mortgage banking gains
Other income
Total non-interest income
Total non-interest expenses
Income before tax expense
Federal income tax expense
Net income
PER COMMON SHARE DATA (1)
Earnings per share, basic and diluted
Cash dividends declared per share
Book value
BALANCE SHEET DATA
Assets
Investment securities
Loans held for sale
Loans
Allowance for loan losses
Deposits
Borrowings
Subordinated debt
Shareholders’ equity
AVERAGE BALANCES
Assets
Investment securities
Loans
Loans held for sale
Deposits
Borrowings
Subordinated debt
Shareholders’ equity
ASSET QUALITY RATIOS
Loan charge-offs
Recoveries on loans
Net charge-offs
Net charge-offs as a percentage of average total loans
Loans 30+ days delinquent as a percentage of total loans
Nonperforming loans
Nonperforming securities
Other real estate owned
Total nonperforming assets
Allowance for loan losses as a percentage of non-performing loans
Nonperforming assets as a percentage of:
Total assets
Equity plus allowance for loan losses
Tier I capital
FINANCIAL RATIOS
Return on average equity
Return on average assets
Effective tax rate
Average equity-to-average asset ratio
Tangible equity ratio
Cash dividend payout ratio
Net interest margin
(In thousands of dollars, except for ratios and per share amounts)
Years Ended December 31,
2018
2017
2016
2015
2014
27,749
4,383
23,366
725
22,641
(21 )
974
4,739
5,692
18,083
10,250
1,415
$
23,492 $
3,190
22,555 $
2,918
20,302
100
20,202
7
1,074
4,085
5,166
18,601
6,767
2,417
19,637
50
19,587
419
1,248
2,930
4,597
18,186
5,998
1,127
21,113 $
2,607
18,506
455
18,051
64
785
3,060
3,909
16,363
5,597
1,219
8,835
$
4,350 $
4,871 $
4,378
$
$
2.03
0.49
14.92
0.99 $
0.39
13.94
1.11 $
0.28
13.05
0.97 $
0.24
12.87
$
$
714,666
139,504
1,040
514,392
4,198
604,419
30,206
5,155
64,918
672,506
148,938
471,600
1,927
559,921
35,866
5,155
61,520
$
(1,338 )
233
(1,105 )
$
0.23 %
0.41 %
$
10,140
—
—
711,101 $
162,422
2,780
487,490
4,578
585,851
48,678
5,155
61,630
636,915 $
168,654
412,450
2,801
527,653
33,777
5,155
59,998
(840 ) $
450
(390 ) $
0.09 %
0.24 %
5,114 $
895
—
655,184 $
179,219
4,554
419,768
4,868
539,850
43,202
5,155
57,670
608,298 $
166,690
385,667
4,506
496,917
36,292
5,155
58,923
(614 ) $
238
(376 ) $
0.10 %
1.04 %
8,286 $
825
—
612,443 $
162,035
4,033
394,254
5,194
496,404
44,499
5,155
56,684
568,897 $
166,155
356,105
2,504
454,920
43,761
5,155
56,625
(723 ) $
260
(463 ) $
0.13 %
1.80 %
11,542 $
778
61
20,665
2,884
17,781
1,638
16,143
915
440
2,772
4,127
15,499
4,771
902
3,869
0.85
0.18
12.33
568,932
170,108
632
360,185
5,202
456,761
44,759
5,155
55,852
542,542
175,000
325,747
814
428,468
46,886
5,155
53,648
(594 )
394
(200 )
0.06 %
2.22 %
9,237
779
40
$
$
$
$
$
$
$
$
$
10,140
$
6,009 $
9,111 $
12,381 $
10,056
41.40 %
89.52 %
58.75 %
45.00 %
56.32 %
1.42 %
14.67
13.78
14.36 %
1.31
13.80
9.15
10.72
24.14
3.76
0.85 %
9.08
8.78
7.25 %
0.68
35.72
9.42
10.77
39.39
3.59
1.39 %
14.57
13.88
8.27 %
0.80
18.79
9.69
10.46
25.23
3.63
2.02 %
20.01
19.99
7.73 %
0.77
21.78
9.95
10.62
24.74
3.65
1.77 %
16.47
17.13
7.21 %
0.71
18.91
9.89
10.66
21.18
3.67
(1)
Basic earnings per common share are based on weighted average shares outstanding. Diluted earnings per share is after consideration of common stock equivalent. Cash dividends per
common share are based on actual cash dividends declared. Book value per common share is based on shares outstanding at each period end.
For more information see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8, Financial
Statements and Supplementary Data.
23
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following schedules show average balances of interest-earning and noninterest-earning assets and liabilities, and shareholders’ equity for the
years indicated. Also shown are the related amounts of interest earned or paid and the related average yields or interest rates paid for the years
indicated. The averages are based on daily balances.
Average
Balance
Outstanding
2018
Interest
Earned
or Paid
(Fully taxable equivalent basis in thousands of dollars)
2017
Yield
or
Rate
Average
Balance
Outstanding
Interest
Earned
or Paid
Yield
or
Rate
Average
Balance
Outstanding
2016
Interest
Earned
or Paid
Yield
or
Rate
Interest-earning assets:
Interest-earning deposits and other earning assets
$
8,564 $
162 1.89 %
$
8,668 $
98 1.13 %
$
8,233 $
44 0.54 %
Investment securities (Note 1, 2, 3):
Taxable
Nontaxable
Total investment securities
Trading securities (Note 1, 2, 3)
Loans (Note 1, 2, 3, 4)
Total interest-earning assets
Noninterest-earning assets:
Cash and due from banks
Premises and equipment
Other assets
Total assets
Interest-bearing liabilities:
Deposits:
Interest-bearing demand deposits
Savings
Time
Total interest-bearing deposits
Borrowings:
Securities sold under agreement to repurchase
Subordinated debt
Federal Home Loan Bank advances - short term
Federal Home Loan Bank advances - long term
Total borrowings
Total interest-bearing liabilities
Noninterest-bearing liabilities:
Demand deposits
Other liabilities
Shareholders' equity
Total liabilities and shareholders' equity
Net interest income
Net interest rate spread (Note 5)
Net interest margin (Note 6)
93,372 2,270 2.43 %
55,566 1,851 3.33 %
148,938 4,121 2.77 %
— — %
473,527 23,830 5.03 %
631,029 $ 28,113 4.46 %
—
101,768 2,229 2.19 %
66,886 2,853 4.26 %
168,654 5,082 3.01 %
— — %
415,251 19,257 4.64 %
592,573 $ 24,437 4.12 %
—
104,274 2,121 2.03 %
58,387 2,647 4.53 %
162,661 4,768 2.93 %
94 2.33 %
390,173 18,570 4.76 %
565,096 $ 23,476 4.15 %
4,029
7,277
9,089
25,111
$ 672,506
7,804
9,193
27,345
$ 636,915
7,844
9,038
26,320
$ 608,298
$ 197,856 $ 1,378 0.70 %
97 0.09 %
112,508
120,986 2,052 1.70 %
431,350 3,527 0.82 %
751 0.45 %
$ 168,536 $
90 0.08 %
114,261
128,251 1,730 1.35 %
411,048 2,571 0.63 %
435 0.32 %
$ 137,505 $
78 0.07 %
113,125
134,523 1,580 1.17 %
385,153 2,093 0.54 %
1,679
5,155
18,899
15,288
41,021
6 0.33 %
189 3.61 %
374 1.98 %
287 1.88 %
856 2.09 %
472,371 $ 4,383 0.93 %
2,018
5,155
16,917
14,842
38,932
7 0.33 %
138 2.64 %
175 1.03 %
299 2.01 %
619 1.59 %
449,980 $ 3,190 0.71 %
2,249
5,155
13,550
20,493
41,447
7 0.31 %
112 2.13 %
73 0.54 %
633 3.09 %
825 1.99 %
426,600 $ 2,918 0.68 %
128,571
10,044
61,520
$ 672,506
116,605
10,332
59,998
$ 636,915
111,764
11,011
58,923
$ 608,298
$ 23,730
$ 21,247
$ 20,558
3.53 %
3.76 %
3.41 %
3.59 %
3.47 %
3.63 %
Note 1 –
Note 2 –
Includes both taxable and tax-exempt securities and loans.
The amounts are presented on a fully taxable equivalent basis using the statutory rate of 21% in 2018 and 34% in 2017 and 2016, and
have been adjusted to reflect the effect of disallowed interest expenses related to carrying tax-exempt assets. The tax equivalent
income adjustment for loans and investment securities and trading was $7,000 and $357,000, respectively, for December 31, 2018;
$14,000 and $931,000, respectively, for December 31, 2017; and $16,000 and $905,000, respectively, for December 31, 2016.
24
Note 3 –
Note 4 –
Note 5 –
Note 6 –
Average balance outstanding includes the average amount outstanding of all non-accrual investment securities and loans. Investment
securities consist of average total principal adjusted for amortization of premium and accretion of discount and include both taxable
and tax-exempt securities. Loans consist of average total loans, including loans held for sale, less average unearned income.
Interest earned on loans includes net loan fees of $725,000 in 2018, $443,000 in 2017 and $684,000 in 2016.
Net interest rate spread represents the difference between the yield on earning assets and the rate paid on interest-bearing liabilities.
Net interest margin is calculated by dividing the net interest income by total interest-earning assets.
FINANCIAL REVIEW
The following is management’s discussion and analysis of the financial condition and results of operations of the Company. The discussion should
be read in conjunction with the Consolidated Financial Statements and related notes and summary financial information included elsewhere in this
annual report.
NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. In addition to historical information,
certain information included in this discussion and other materials filed or to be filed by the Company with the SEC (as well as information included
in oral statements or other written statements made or to be made by the Company) may contain forward-looking statements that involve risks and
uncertainties. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or similar
terminology identify forward-looking statements. These statements reflect management’s beliefs and assumptions, and are based on information
currently available to management.
Economic circumstances, the Company’s operations and actual results could differ significantly from those discussed in any forward-looking
statements. Some of the factors that could cause or contribute to such differences are changes in the economy and interest rates either nationally or
in the Company’s market area, including the impact of the impairment of securities; political actions, including failure of the United States Congress
to raise the federal debt ceiling or the imposition of changes in the federal budget; changes in customer preferences and consumer behavior;
increased competitive pressures or changes in either the nature or composition of competitors; changes in the legal and regulatory environment;
changes in factors influencing liquidity, such as expectations regarding the rate of inflation or deflation, currency exchange rates, and other factors
influencing market volatility; changes in assumptions underlying the establishment of reserves for possible loan losses, reserves for repurchase of
mortgage loans sold and other estimates; and risks associated with other global economic, political and financial factors.
While actual results may differ significantly from the results discussed in the forward-looking statements, the Company undertakes no obligation to
update publicly any forward-looking statement for any reason, even if new information becomes available.
Critical Accounting Policies and Estimates
The discussion and analysis of the Company’s financial condition and results of operation are based upon the Consolidated Financial Statements,
which have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP). The preparation of these consolidated
financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and
expenses, and related disclosures of contingent assets and liabilities at the date of the Company’s consolidated financial statements. Actual results
may differ from these estimates under different assumptions or conditions.
Certain accounting policies involve significant judgments and assumptions by management which has a material impact on the carrying value of
certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions
used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances.
Management believes the following are critical accounting policies that require the most significant judgments and estimates used in the
preparation of the Company’s consolidated financial statements.
25
Accounting for the Allowance for Loan Losses
The determination of the allowance for loan losses and the resulting amount of the provision for loan losses charged to operations reflects
management’s current judgment about the credit quality of the loan portfolio and takes into consideration changes in lending policies and
procedures, changes in economic and business conditions, changes in the nature and volume of the portfolio and, in the terms of loans, changes in
the experience, ability and depth of lending management, changes in the volume and severity of past due, non-accrual and adversely classified or
graded loans, changes in the quality of the loan review system, changes in the value of underlying collateral for collateral-dependent loans, the
existence and effect of any concentrations of credit and the effect of competition, legal and regulatory requirements and other external factors. The
nature of the process by which we determine the appropriate allowance for loan losses requires the exercise of considerable judgment. While
management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors
beyond our control, including the performance of the loan portfolio, the economy, changes in interest rates and the view of the regulatory
authorities toward loan classifications. The allowance is increased by the provision for loan losses and decreased by charge-offs when management
believes the uncollectibility of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance. A weakening of the economy or
other factors that adversely affect asset quality could result in an increase in the number of delinquencies, bankruptcies or defaults and a higher
level of non-performing assets, net charge offs, and provision for loan losses in future periods.
The Company’s allowance for loan losses methodology consists of three elements: specific valuation allowances based on probable losses on
specific loans; valuation allowances based on historical loan loss experience for similar loans with similar characteristics and trends; and general
valuation allowances based on general economic conditions and other qualitative risk factors both internal and external to the Company. These
elements support the basis for determining allocations between the various loan categories and the overall adequacy of our allowance to provide
for probable losses inherent in the loan portfolio.
With these methodologies, a general allowance is established for each loan type based on historical losses for each loan type in the portfolio.
Additionally, management allocates a specific allowance for “Impaired Credits,” which is based on current information and events; it is probable the
Company will not collect all amounts due according to the original contractual terms of the loan agreement. The level of the general allowance is
established to provide coverage for management’s estimate of the credit risk in the loan portfolio by various loan segments not covered by the
specific allowance. Additional information regarding allowance for credit losses can be found in Item 8, Note 3 to the Consolidated Financial
Statements and elsewhere in this Management’s Discussion and Analysis.
Investment Securities and Impairment
The classification and accounting for investment securities is discussed in detail in Item 8, Notes 1 and 2 of the Consolidated Financial Statements.
Investment securities must be classified as held-to-maturity, available-for-sale, or trading. The appropriate classification is based partially on our
ability to hold the securities to maturity and largely on management’s intentions, if any, with respect to either holding or selling the securities. The
classification of investment securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Unrealized
gains and losses on trading securities, if any, flow directly through earnings during the periods in which they arise, whereas available-for-sale
securities are recorded as a separate component of shareholders’ equity (accumulated other comprehensive income or loss) and do not affect
earnings until realized. The fair values of our investment securities are generally determined by reference to quoted market prices and reliable
independent sources. At each reporting date, the Company assesses whether there is an “other-than-temporary” impairment to the Company’s
investment securities. Such impairment must be recognized in current earnings rather than in other comprehensive income (loss).
The Company reviews investment debt securities on an ongoing basis for the presence of other-than-temporary impairment (OTTI) with formal
reviews performed quarterly. OTTI losses on individual investment securities are recognized in accordance with FASB ASC topic 320, Investments –
Debt and Equity Securities. The purpose of this ASC is to provide greater clarity to investors about the credit and noncredit component of an
OTTI event and to communicate more effectively when an OTTI event has occurred. This ASC amends the OTTI guidance in GAAP for debt
securities, improves the presentation and disclosure of OTTI on investment securities and changes the calculation of the OTTI recognized in
earnings in the financial statements. This ASC does not amend existing recognition and measurement guidance related to OTTI of equity securities.
For debt securities, ASC topic 320 requires an entity to assess whether it has the intent to sell the debt security or it is more-likely-than-not that it
will be required to sell the debt security before its anticipated recovery. If either of these conditions is met, an OTTI on the security must be
recognized.
In instances in which a determination is made that a credit loss (defined as the difference between the present value of the cash flows expected to
be collected and the amortized cost basis) exists but the entity does not intend to sell the debt security and it is not more-likely-than-not that the
entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis (i.e., the amortized cost basis
less any current-period credit loss), ASC topic 320 changes the presentation and amount of the OTTI recognized in the income statement.
26
In these instances, the impairment is separated into the amount of the total impairment related to the credit loss and the amount of the total
impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings.
The amount of the total impairment related to all other factors is recognized in other comprehensive income (loss). The total OTTI is presented in
the income statement with an offset for the amount of the total OTTI that is recognized in other comprehensive income (loss). In determining the
amount of impairment related to credit loss, the Company uses a third party discounted cash flow model, several inputs for which require estimation
and judgment. Among these inputs are projected deferral and default rates and estimated recovery rates. Realization of events different than that
projected could result in a large variance in the values of the securities.
Additional information regarding investment securities can be found in Item 8, Notes 2 and 11 to the Consolidated Financial Statements and
elsewhere in this Management’s Discussion and Analysis.
Income Taxes
The provision for income taxes is based on income reported for financial statement purposes and differs from the amount of taxes currently payable,
since certain income and expense items are reported for financial statement purposes in different periods than those for tax reporting purposes.
Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, the Company assesses
the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial and regulatory guidance in the
context of the Company’s tax position.
The Company accounts for income taxes using the asset and liability approach, the objective of which is to establish deferred tax assets and
liabilities for the temporary differences between the financial reporting basis and tax basis of our assets and liabilities at enacted tax rates expected
to be in effect when such amounts are realized or settled. The Company conducts periodic assessments of deferred tax assets, including net
operating loss carryforwards, to determine if it is more-likely-than-not that they will be realized. In making these assessments, the Company
considers taxable income in prior periods, projected future taxable income, potential tax planning strategies and projected future reversals of
deferred tax items. These assessments involve a certain degree of subjectivity which may change significantly depending on the related
circumstances.
CORPORATE PROFILE
The Company, with total assets of approximately $714.7 million at December 31, 2018, is a bank holding company headquartered in Cortland, Ohio
whose principle activity is to manage, supervise and otherwise serve as a source of strength to the Bank.
Cortland Bank is a state-chartered bank engaged in commercial and retail banking services. The Bank offers a full range of financial services to its
local communities with an ongoing strategic focus on commercial banking relationships.
The Bank’s results of operations depend primarily on net interest income, which, in part, is a direct result of the market interest rate environment.
Net interest income is the difference between the interest income earned on interest-earning assets and the interest paid on interest-bearing
liabilities. Net interest income is affected by the shape of the market yield curve, the repricing of interest-earning assets and interest-bearing
liabilities and the prepayment rate of mortgage-related assets. Results of operations may be affected significantly by general and local economic
conditions, particularly those with respect to changes in market interest rates, credit quality, governmental policies and actions of regulatory
authority.
2018 OVERVIEW
In 2018, the Company’s net income was $8.8 million compared to $4.4 million in 2017. Amid rigorous regulatory standards and an uncertain
economy, the Company continues to follow its core strategic direction. Operating results reflect its commitment to growing loans and deposits in
the markets in which it operates and in producing consistent positive earnings.
With the passage of the Tax Cuts and Jobs Act (“Tax Act”), tax law for corporations had several material changes effective beginning in 2018. The
most significant change was the reduction in the corporate tax rate from 34% to 21%. Because this reduced rate was signed into law in December
2017, generally accepted accounting principles required recognition of the lower rate on the Company’s deferred tax position as of December 31,
2017. As the Company is in a net deferred tax asset position, the reduction of this benefit resulted in a $1.2 million additional charge to federal
income tax expense in the Company’s 2017 Consolidated Statements of Income. The comparison of 2018 results to 2017 was significantly affected
by both of these tax events.
27
Highlights of 2018 financial results:
• Diluted earnings per share (EPS) was $2.03 for the full year 2018, compared to $0.99 per diluted share for 2017.
• The efficiency ratio was 64.82% for 2018, versus 72.92% for 2017.
•
•
For 2018, NIM was 3.76%, compared to 3.59% for twelve months ended 2017.
For 2018, net interest income was $23.4 million, compared to $20.3 million for 2017.
• Average total deposits grew 6% to $560.0 million at December 31, 2018, compared to $527.7 million at the end of 2017.
• Average total loans increased 14% to $471.6 million compared to $412.5 million at December 31, 2017.
• Nonperforming assets were 1.42% of total assets at December 31, 2018, compared to 0.85% at December 31, 2017.
• The allowance for loan losses was 0.82% of total loans at December 31, 2018, compared to 0.94% a year earlier.
• The Company remained well-capitalized with total risk-based capital to risk-weighted assets of 14.19% and tangible equity to tangible
assets of 9.08%.
In the midst of earnings pressures brought on by economic instability, interest rate compression and increased competition, the Company devoted
substantial attention in 2018 and 2017 to profit improvement measures and balance sheet positioning. The Company’s management team continues
to focus on measures designed to maintain capital and to provide for adequate liquidity for lending and business development purposes. New
strategies are being pursued to improve market penetration and product expansion, with the objective of increasing both the interest income and
non-interest income revenue base.
Total shareholders’ equity at December 31, 2018 was $64.9 million, representing a ratio of equity capital to total assets of 9.1%. In comparison, total
shareholders’ equity was $61.6 million at December 31, 2017, representing a ratio of equity capital to total assets of 8.7%. A component of
shareholders’ equity is accumulated other comprehensive income (loss), which includes the net after-tax impact of unrealized gains or losses on
investment securities classified as available-for-sale. Net unrealized losses on available-for-sale investment securities, net of tax, were $3.7 million at
December 31, 2018, compared with net unrealized losses, net of tax, of $1.8 million at December 31, 2017. Such unrealized gains or losses represent
the difference, net of applicable income tax effect, between the estimated fair value and amortized cost of investment securities classified as
available-for-sale and is driven by market interest rates.
Return on average equity was 14.36% in 2018, compared to 7.25% in 2017, while return on average assets measured 1.31% in 2018 and 0.68% in 2017.
Adjusted for nonrecurring items, the return on average assets and return on average equity in 2018 were 1.08% and 11.84% compared to 0.74% and
7.83% for the full year 2017. Book value per share increased by $0.98 to $14.92 at December 31, 2018 from $13.94 at December 31, 2017. The price of
the Company’s common shares traded in a range between a low of $20.40 and a high of $26.00, closing the year at $20.50 per share.
The Company continues to maintain capital sufficient to be deemed well capitalized under all regulatory measures. In the current regulatory
environment, regulatory oversight bodies expect banks to maintain ratios above the statutory levels as a margin of safety.
CERTAIN NON-GAAP MEASURES
Certain financial information has been determined by methods other than GAAP. Specifically, certain financial measures are based on core earnings
rather than net income. Core earnings exclude income, expense, gains and losses that either are not reflective of ongoing operations or that are not
expected to reoccur with any regularity or reoccur with a high degree of uncertainty and volatility. Such information may be useful to both investors
and management and can aid them in understanding the Company’s current performance trends and financial condition. Core earnings are a
supplemental tool for analysis and not a substitute for GAAP net income. Reconciliation from GAAP net income to the non-GAAP measure of core
earnings is referenced as part of management’s discussion and analysis of quarterly and year-to-date financial results of operations.
Core earnings, which exclude non-recurring items, were $7.3 million in 2018 and $4.7 million in 2017 and 2016. Core earnings per share were $1.68 in
2018 and $1.07 in 2017 and 2016.
28
The following is a reconciliation between core earnings and earnings under GAAP:
GAAP earnings
Investment gains not in the ordinary course of business (net of tax) *
Net losses from the extinguishment of debt (net of tax) **
Gains recognized on Bank Owned Life Insurance policy (tax free)***
Change in corporate tax rate
Recognition (reversal) of deferred tax valuation allowance
Core earnings
GAAP earnings per share
Investment gains not in the ordinary course of business (net of tax) *
Net losses from the extinguishment of debt (net of tax) **
Gains recognized on Bank Owned Life Insurance policy (tax free)***
Change in corporate tax rate
Recognition (reversal) of deferred tax valuation allowance
Core earnings per share
(Amounts in thousands, except per share data)
Years Ended December 31,
2018
2017
2016
$
$
$
$
8,835 $
—
—
(1,548 )
—
28
7,315 $
2.03 $
—
—
(0.36 )
—
0.01
1.68 $
4,350 $
—
—
(898 )
1,246
—
4,698 $
0.99 $
—
—
(0.20 )
0.28
—
1.07 $
4,871
(191 )
160
—
—
(93 )
4,747
1.11
(0.05 )
0.03
—
—
(0.02 )
1.07
Gains to offset the early payoff penalties on FHLB long-term notes.
*
** Loss on the early payoff of FHLB long term debt.
*** This is the amount of proceeds received on life insurance policies upon the death of former executives that exceeded the cash value of the
policies.
BALANCE SHEET COMPOSITION
The following table illustrates, during the years presented, the mix of the Company’s funding sources and the assets in which those funds are
invested as a percentage of the Company’s average total assets at December 31 for the periods indicated. Average assets totaled $672.5 million in
2018 compared to $636.9 million in 2017 and $608.3 million in 2016.
Sources of Funds:
Deposits:
Non-interest bearing
Interest bearing
Long-term debt and other borrowings
Subordinated debt
Other non-interest bearing liabilities
Shareholders' equity
Total
Uses of Funds:
Loans, including loans held for sale
Investment securities
Interest-earning deposits and other earning assets
Bank-owned life insurance
Partnerships and other investments
Other non-interest earning assets
Total
2018
December 31,
2017
2016
19.1 %
64.1
5.3
0.8
1.5
9.2
100.0 %
70.4 %
22.2
1.3
2.3
1.7
2.1
100.0 %
18.3 %
64.6
5.3
0.8
1.6
9.4
100.0 %
65.2 %
26.5
1.4
2.7
1.4
2.8
100.0 %
18.4 %
63.3
6.0
0.8
1.8
9.7
100.0 %
64.1 %
27.4
1.4
2.8
1.0
3.3
100.0 %
Deposits continue to be the Company’s primary source of funding. During 2018, the relative mix of deposits has remained steady with interest-
bearing being the main source. Average non-interest bearing deposits totaled 23.0% of total average deposits in 2018, compared to 22.1% in 2017
and 22.5% in 2016. Additional information regarding deposits can be found in Item 8, Note 5 to the Consolidated Financial Statements and
elsewhere in this Management’s Discussion and Analysis.
29
The Company primarily invests funds in loans and securities. Loans continue to be the focus of the Company’s asset allocation. Average securities
decreased $19.8 million, or 11.7%, to $148.9 million during 2018 from $168.7 million in 2017, while average loans increased by $58.2 million, or 14.0%,
to $473.5 million during 2018 from $415.3 million in 2017.
ASSET QUALITY
The Company’s management regularly monitors and evaluates trends in asset quality. Loan review practices and procedures require detailed
monthly analysis of delinquencies, nonperforming assets and other sensitive credits. Loans are moved to non-accrual status once they reach 90
days past due or when analysis of a borrower’s creditworthiness indicates the collection of interest and principal is in doubt. Nonperforming loans
include loans in non-accrual status, restructured loans and real estate acquired in satisfaction of debts previously contracted.
Additionally, as part of the Company’s loan review process, management routinely evaluates risks which could potentially affect the ability to
collect loan balances in their entirety. Reviews of individual credits, aggregate account relationships or any concentration of credits in particular
industries are subject to a detailed loan review.
Gross income that would have been recorded in 2018 on these nonperforming loans, had they been in compliance with their original terms, was
$654,000. Interest income that actually was included in income on these loans amounted to $505,000. In addition to nonperforming loans,
nonperforming assets include nonperforming investment securities. At December 31, 2017, there were two investments classified as nonperforming
and both of these investments were sold in June 2018. Gross income that would have been recorded in the first six months of 2018 on
nonperforming investments, had they been in compliance with their original terms, was $21,000. Interest income that actually was included in income
on these investments during this period amounted to $25,000, a higher amount due to interest collected upon sale. There are no accruing loans
which are contractually past due 90 days or more as to principal or interest payments.
The following table depicts the trend in these potentially problematic asset categories:
Non-accrual loans:
Commercial
Commercial real estate
Residential real estate
Consumer - home equity
Consumer - other
Total non-accrual loans
Investment securities
Other real estate owned
Troubled debt restructured loans
Nonperforming assets
Loans past due greater than 30 days
or on nonaccrual
Non-accrual loans as a percentage of total loans
Nonperforming assets as a percentage of total assets
Nonperforming assets as a percentage of equity capital
plus allowance for loan losses
2018
2017
(Amounts in thousands)
December 31,
2016
2015
2014
$
$
$
1,291 $
512
310
120
—
2,233
—
—
7,907
10,140 $
— $
506
247
129
—
882
895
—
4,232
6,009 $
— $
1,458
1,265
55
—
2,778
825
—
5,508
9,111 $
1,196 $
2,176
1,252
262
—
4,886
778
61
6,656
12,381 $
1,824
2,247
1,331
149
6
5,557
779
40
3,680
10,056
2,493 $
1,409 $
4,533 $
7,242 $
8,201
2018
2017
December 31,
2016
2015
2014
0.43 %
1.42 %
0.18 %
0.85 %
0.66 %
1.39 %
1.24 %
2.02 %
1.54 %
1.77 %
14.67 %
9.08 %
14.57 %
20.01 %
16.47 %
As of December 31, 2018, there were $8.7 million in loans not included in this table where known information about borrowers’ possible credit
problems caused management to have some doubts as to the ability of these borrowers to comply with present loan payment terms and which may
result in disclosure of such loans in this table.
Loans accounted for on a non-accrual basis ranged from a high of $5.6 million in 2014 to a low of $882,000 in 2017. Non-accrual loans in 2018 of $2.2
million is slightly lower than the average of the past five years, which is $3.3 million. In 2015, non-accrual loans were mainly impacted by loans to
one related group in both the commercial and commercial real estate categories, which were resolved favorably in 2016. In 2014 to 2016, non-accrual
loans were impacted by one residential real estate loan for $1.0 million which paid off in 2017. The total of all loans past due more than 30 days or on
non-accrual ranged from a low of $1.4 million in 2017
30
to a high of $8.2 million in 2014. Loans charged-off, net of recoveries, was $1.1 million in 2018, compared to $390,000 for 2017, $376,000 for 2016,
$463,000 for 2015, and $200,000 for 2014. The resulting ratios do not indicate any trends of concern from management’s perspective.
Troubled-debt restructured loans are loans that have been modified when economic concessions have been granted to borrowers who have
experienced or are expected to experience financial difficulties. In 2018, $4.2 million in new troubled debt restructurings were added. In 2015, $3.2
million in new troubled debt restructurings were added. There were none added in 2017 or 2016.
Past due loans, potential problem loans, as well as loans on non-accrual have all been stable, helping to require a provision of $725,000 in 2018
which is lower than the net charge-off of $1.1 million (of which previously had a specific reserve of $625,000). In 2017 and 2016, the provision for
loan losses was $100,000 and $50,000, respectively. Additional information regarding loans can be found in Item 8, Note 3 to the Consolidated
Financial Statements and elsewhere in this Management’s Discussion and Analysis.
At December 31, 2017, there was $895,000 of the Company’s holdings in trust preferred securities considered to be in non-accrual status. The
quarterly interest payments for both of its investments in trust preferred securities had been placed in “payment in kind” status. Payment in kind
status results in a temporary delay in the payment of interest. As a result of a delay in the collection of the interest payments, management placed
these securities in non-accrual status. They were sold in 2018.
RESULTS OF OPERATIONS
Net interest income
Tax equivalent income adjustment for investment securities
Tax equivalent income adjustment for loans
Net interest income on a fully taxable equivalent basis
Interest and dividends on investment securities
Tax equivalent income adjustment for investment securities
Investment securities income on a fully taxable equivalent basis
Interest and fees on loans
Tax equivalent income adjustment for loans
Loan income on a fully taxable equivalent basis
(Amounts in thousands)
December 31,
2018
2017
2016
$
$
$
$
$
$
23,366 $
357
7
23,730 $
3,764 $
357
4,121 $
20,302 $
931
14
21,247 $
4,151 $
931
5,082 $
23,823 $
7
23,830 $
19,243 $
14
19,257 $
19,637
905
16
20,558
3,957
905
4,862
18,554
16
18,570
Analysis of Net Interest Income - Years Ended December 31, 2018 and 2017
Net interest income, the principal source of the Company’s earnings, is the amount by which interest and fees generated by interest-earning assets,
primarily loans and investment securities, exceed the interest cost of deposits and borrowed funds. On a fully taxable equivalent basis, net interest
income measured $23.7 million for 2018 and $21.2 million for 2017. The resulting net interest margin was 3.76% for 2018 and 3.59% for 2017.
The increase in interest income, on a fully taxable equivalent basis, of $3.7 million is the product of a 6.5% year-over-year increase in average
earning assets along with a 34 basis point increase in yield. The increase in interest expense of $1.2 million was a product of a 22 basis point
increase in rates paid and a 5.0% increase in average interest-bearing liabilities. The net result was a 11.7% increase in net interest income on a fully
taxable equivalent basis, and a 17 basis point increase in the Company’s net interest margin on a growing asset base with a different mix. The key
driver to the margin expansion was the loan beta exceeding the deposit beta by 20 basis points.
On a fully taxable equivalent basis, income on investment securities decreased by $961,000, or 18.9%. The average invested balances in these
securities decreased by $19.7 million, or 11.7%, from the levels of a year ago. The decrease in the average balance of investment securities was
accompanied by a 24 basis point decrease in the tax equivalent yield of the portfolio. The Company will continue attempting to redeploy liquidity
into loans which generate greater yields than securities, thus sacrificing securities balances when beneficial. The lower corporate tax rate effective
in 2018 had a 22 basis point impact on the tax equivalent yield, otherwise security yields were comparable among periods. Additional information
regarding investment securities can be found in Item 8, Notes 2 and 11 to the Consolidated Financial Statements and elsewhere in this
Management’s Discussion and Analysis.
31
On a fully taxable equivalent basis, income on loans increased by $4.6 million, or 23.7%, for 2018 compared to the same period in 2017. A $58.3
million increase in the average balance of the loan portfolio, or 14.0%, was accompanied by a 39 basis point increase in the portfolio’s tax equivalent
yield. Despite four rate increases by the Federal Reserve Open Market Committee, strong competition for good credits has kept pressure on offering
rates. Higher than usual prepayment fees contributed 5 basis points to the loan yield. The commercial loan portfolio housed the majority of the
increase in balances. Additional information regarding loans can be found in Item 8, Note 3 to the Consolidated Financial Statements and elsewhere
in this Management’s Discussion and Analysis.
Other interest income increased by $64,000, or 65.3%, from the same period a year ago. The average balance of interest-earning deposits decreased
by $104,000, or 1.2%. The yield increased by 76 basis points from 2017 to 2018, reflecting the recent increases in the federal funds rate. Management
intends to remain fully invested, minimizing on-balance sheet liquidity.
Average interest-bearing demand deposits and money market accounts increased by $29.3 million, or 17.4%, while average savings balances
decreased by $1.8 million, or 1.5%. Total interest paid on interest-bearing demand deposits and money market accounts was $1.4 million, a $627,000
increase from last year. The average rate paid increased 25 basis points from 2017 to 2018. Total interest paid on savings accounts was $97,000, a
$7,000 increase from last year. The average rate paid on savings accounts increased 1 basis point from 2017 to 2018. The average balance of time
deposit products decreased by $7.3 million, or 5.7%, as the average rate paid increased by 35 basis points, from 1.35% to 1.70%. Interest expense
increased on time deposits by $322,000 from the prior year. The current low-rate environment offers little opportunity for time deposit customers,
except for periodic special rates offered on a limited basis. Time deposits also include wholesale funds obtained at generally higher rates than in-
market accounts. Additional information regarding deposits can be found in Item 8, Note 5 to the Consolidated Financial Statements and elsewhere
in this Management’s Discussion and Analysis.
Average borrowings and subordinated debt increased by $2.1 million while the average rate paid on borrowings increased by 50 basis points. Cost
of borrowings continues to rise in tandem with the Federal funds rate, resulting in higher interest expense, despite comparable borrowing levels.
Management continues to utilize short-term borrowings to bridge liquidity gaps. Additional information regarding FHLB Advances and Other
Borrowings and Subordinated Debt can be found in Item 8, Notes 6 and 7 to the Consolidated Financial Statements and elsewhere in this
Management’s Discussion and Analysis.
Analysis of Net Interest Income - Years Ended December 31, 2017 and 2016
Net interest income, the principal source of the Company’s earnings, is the amount by which interest and fees generated by interest-earning assets,
primarily loans and investment securities, exceed the interest cost of deposits and borrowed funds. On a fully taxable equivalent basis, net interest
income measured $21.2 million for 2017 and $20.6 million for 2016. The resulting net interest margin was 3.59% for 2017 and 3.63% for 2016.
The increase in interest income, on a fully taxable equivalent basis, of $961,000 was the product of a 4.9% year-over-year increase in average earning
assets along with a 3 basis point decrease in yield. The increase in interest expense of $272,000 was a product of a 3 basis point increase in rates
paid and a 5.5% increase in average interest-bearing liabilities. The net result was a 3.4% increase in net interest income on a fully taxable equivalent
basis, and a 4 basis point decrease in the Company’s net interest margin on a growing asset base with a different mix.
On a fully taxable equivalent basis, income on investment securities available-for-sale and trading increased by $220,000, or 4.5%. The average
invested balances in these securities increased by $2.0 million, or 1.2%, from the levels of a year ago. The increase in the average balance of
investment securities was accompanied by an 8 basis point increase in the tax equivalent yield of the portfolio. The trading account was liquidated
at the end of the second quarter of 2016. The Company continued attempting to redeploy liquidity into loans which generate greater yields than
securities. Any reinvestment into the securities portfolio may serve to decrease the yield due to the current low rate environment although many
economists project a rising rate environment on the horizon. Additional information regarding investment securities can be found in Item 8, Notes 2
and 11 to the Consolidated Financial Statements and elsewhere in this Management’s Discussion and Analysis.
On a fully taxable equivalent basis, income on loans increased by $687,000, or 3.7%, for 2017 compared to the same period in 2016. A $25.1 million
increase in the average balance of the loan portfolio, or 6.4%, was accompanied by a 12 basis point decrease in the portfolio’s tax equivalent yield.
Despite the rise in short term interest rates, strong competition for good credits had kept offering rates lower. In addition, the amortization of the
existing portfolio at higher rates decreased the effective yield. The commercial loan portfolio housed the majority of the increase in balances.
Additional information regarding loans can be found in Item 8, Note 3 to the Consolidated Financial Statements and elsewhere in this
Management’s Discussion and Analysis.
32
Other interest income increased by $54,000, or 122.7%, from the same period a year ago. The average balance of interest-earning deposits increased
by $435,000, or 5.3%. The yield increased by 59 basis points from 2016 to 2017, reflecting increases in the federal funds rate. Management intended
to remain fully invested, minimizing on-balance sheet liquidity.
Average interest-bearing demand deposits and money market accounts increased by $31.0 million, or 22.6%, while average savings balances
increased by $1.1 million, or 1.0%. Total interest paid on interest-bearing demand deposits and money market accounts was $751,000, a $316,000
increase from last year. The average rate paid increased 13 basis points from 2016 to 2017. Total interest paid on savings accounts was $90,000, a
$12,000 increase from last year. The average rate paid on savings accounts increased 1 basis point from 2016 to 2017. The average balance of time
deposit products decreased by $6.3 million, or 4.7%, as the average rate paid increased by 18 basis points, from 1.17% to 1.35%. Interest expense
increased on time deposits by $150,000 from the prior year. The low-rate environment offered little opportunity for time deposit customers, except
for periodic special rates offered on a limited basis. Time deposits also include wholesale funds obtained at generally higher rates than in-market
accounts. Additional information regarding deposits can be found in Item 8, Note 5 to the Consolidated Financial Statements and elsewhere in this
Management’s Discussion and Analysis.
Average borrowings and subordinated debt decreased by $2.5 million while the average rate paid on borrowings decreased by 39 basis points. The
Company elected to pay off two of its longest maturity FHLB notes in January 2016, $4.5 million at an average rate of 4%. Of the $419,000 in
securities gains in 2016, $289,000 was generated to offset the $242,000 prepayment penalty on this early payoff. Alternative funding of $3.5 million at
1.44% was used to replace the borrowings. Including a December 2016 maturity of $2 million at 4.07%, $13.5 million at an average rate of 4.15%
matured in 2017. Refinancings for $12 million at an average rate of 1.37% served to reduce funding costs in 2017 and beyond. Management
continued to utilize short-term borrowings to bridge liquidity gaps. Additional information regarding FHLB Advances and Other Borrowings and
Subordinated Debt can be found in Item 8, Notes 6 and 7 to the Consolidated Financial Statements and elsewhere in this Management’s Discussion
and Analysis.
The following table provides a detailed analysis of changes in net interest income on a tax equivalent basis, identifying that portion of the change
that is due to a change in the volume of average assets and liabilities outstanding versus that portion which is due to a change in the average yields
on earning assets and average rates on interest-bearing liabilities. Changes in interest due to both rate and volume which cannot be segregated
have been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.
Increase (decrease) in interest income:
Interest-earning deposits and other money markets
Investment securities:
Taxable
Nontaxable
Loans
Total interest income change
Increase (decrease) in interest expense:
Interest-bearing demand deposits
Savings deposits
Time deposits
Securities sold under agreements to repurchase
FHLB advances - short term
FHLB advances - long term
Subordinated debt
Total interest expense change
Increase (decrease) in net interest income on a
taxable equivalent basis
2018 Compared to 2017
Rate
Volume
Total
2017 Compared to 2016
Rate
Volume
Total
(Amounts in thousands)
$
(1 ) $
65 $
64
$
2 $
52 $
54
(193 )
(437 )
2,846
2,215
234
(565 )
1,727
1,461
41
(1,002 )
4,573
3,676
148
(1 )
(103 )
(1 )
23
8
—
74
479
8
425
—
176
(20 )
51
1,119
627
7
322
(1 )
199
(12 )
51
1,193
299
(106 )
1,172
1,367
112
1
(76 )
(1 )
22
(148 )
—
(90 )
(124 )
151
(485 )
(406 )
204
11
226
1
80
(186 )
26
362
175
45
687
961
316
12
150
—
102
(334 )
26
272
$
2,141 $
342 $ 2,483
$
1,457 $
(768 ) $
689
33
PROVISION FOR LOAN LOSSES, NON-INTEREST INCOME, NON-INTEREST EXPENSE & FEDERAL INCOME TAX
During 2018, 2017 and 2016, the amount charged to operations as a provision for loan losses was adjusted to account for charge-offs against the
allowance, as well as an increase in loan balances recorded in the portfolio, expected losses on specific problem loans and several qualitative
factors, including factors specific to the local economy and to industries operating in the local market. The Company had allocated a portion of the
allowance for a select few specific problem loans in 2017 and 2018, and has not experienced significant deterioration in any loan type, including the
residential real estate portfolios or the commercial loan portfolio, and accordingly has not added any special provision for these loan types. Past
due loans, potential problem loans, as well as loans on non-accrual have all been stable, helping to require a provision of $725,000 in 2018 which is
lower than the net charge-off of $1.1 million (of which previously had a specific reserve of $625,000) and required a provision of only $100,000 in the
2017. In 2017, there was a favorable ruling in a bankruptcy court surrounding the eventual sale of a business to which the Company lent funds,
resulting in a large recovery of amounts previously charged off. These recoveries displaced provisions throughout 2017. Provision expense levels
are in recognition of loan growth and a changing composition of the loan portfolio as the Company manages its balance sheet with a commercially-
oriented focus.
The following table provides a detailed analysis of non-interest income:
Fees for customer services
Mortgage banking gains, net
Earnings on bank-owned life insurance
Wealth management
Other real estate gains
Other non-interest income
Non-interest income, excluding investment gains
Investment securities available-for-sale (losses) gains, net
Trading securities losses, net
Total non-interest income
(Amounts in thousands)
December 31,
2017
2018
2016
$
$
2,273 $
974
1,869
39
—
558
5,713
(21 )
—
5,692
$
2,241 $
1,074
1,203
35
170
436
5,159
7
—
5,166
$
2,103
1,248
328
95
13
391
4,178
466
(47 )
4,597
Total non-interest income, excluding investment gains, increased by $554,000, or 10.7%, for 2018 compared to an increase of $981,000, or 23.5%, for
2017. After gains on investment securities and impairment losses, non-interest income increased by $526,000, or 10.2%, in 2018 compared to an
increase of $569,000, or 12.4%, in 2017.
Fees for customer services increased by $32,000, or 1.4%, in 2018, compared to an increase of $138,000, or 6.6%, in the prior year driven by customer
transactions on deposit accounts.
Mortgage banking gains totaled $974,000 in 2018, $1.1 million in 2017 and $1.2 million in 2016, reflective of a mortgage origination decrease of $5.9
million offset by the tightening of margins on loan sales since the rise in interest rates precipitated by the passage of tax reform.
Earnings on bank-owned life insurance increased by $666,000 in 2018 compared to an increase of $875,000 in 2017. Proceeds received on policies
upon the deaths of former executives exceeded the cash value of the policies by $1.5 million in 2018 and $898,000 in 2017. A gain of $170,000 was
recognized on the sale of property that was recorded as other real estate owned in 2017, with $13,000 recorded in 2016 and none in 2018.
Other sources of non-interest income increased by $126,000 in 2018 from the same period a year ago, and decreased by $15,000 in 2017 from 2016.
This latter income category is subject to fluctuation due to the non-recurring nature of some of the items.
Net gains on the sale of available-for-sale investment securities decreased by $28,000 in 2018 from year ago levels, reflecting the sale of the final two
corporate securities that were significantly devalued since 2008. Net gains on the sale of available-for-sale investment securities decreased by
$459,000 in 2017 from year ago levels. Included in the total in 2016 is $289,000 of gains generated to offset losses from the extinguishment of debt. In
2016, trading securities losses were $47,000, reflective of the decline in the secondary market activity for municipal securities in which the trading
account operated. In June 2016, the trading account was liquidated and remains dormant. Additional information regarding investment securities
can be found in Item 8, Notes 2 and 11 to the Consolidated Financial Statements and elsewhere in this Management’s Discussion and Analysis.
34
The following table provides a summary of non-interest expenses:
Salaries and employee benefits
Net occupancy and equipment
State and local taxes
FDIC insurance
Professional fees
Advertising and marketing
Net losses from the extinguishment of debt
Data processing fees
Other non-interest expense
Total non-interest expenses
(Amounts in thousands)
December 31,
2017
2018
2016
$
$
10,260 $
2,232
493
176
879
322
—
250
3,471
18,083
$
10,631 $
2,331
463
199
786
478
—
251
3,462
18,601
$
10,169
2,151
455
251
882
527
242
250
3,259
18,186
Total non-interest expenses decreased by $518,000, or 2.8%, in 2018. This compares to an increase of $415,000, or 2.3%, in 2017.
During 2018, expenditures for salaries and employee benefits decreased by $371,000, or 3.5%, and in 2017 increased by $462,000, or 4.5%. The
decrease in 2018 is mainly a result of a workforce realignment and a branch consolidation in latter 2017. The personnel increase for 2017 was partially
driven by new branches, and continuing initiatives to geographically expand mortgage origination, commercial lending and private banking, which
engages higher compensated employees. Full-time equivalent employment averaged 159 in 2018 compared to 160 in 2017 and 163 in 2016.
Salaries and employee benefits represent 56.7% of all non-interest expenses in 2018, 57.2% in 2017 and 55.9% in 2016. The following table details
components of these increases and decreases.
Salaries
Employee benefits
Deferred loan origination costs
Total
Amounts (in thousands)
December 31,
2017
2018
2016
2018
Percentages
December 31,
2017
$
$
(361 )
(39 )
(400 )
29
(371 )
$
$
330
122
452
10
462
$
$
813
115
928
(70 )
858
(4.3 )%
(1.5 )
(3.6 )
(6.9 )
(3.5 )%
4.1 %
4.8
4.3
(2.3 )
4.5 %
2016
11.2 %
4.7
9.6
19.6
9.2 %
Salary expense per employee averaged $49,000 in 2018 and $52,000 in 2017 and $49,000 in 2016. Average earning assets per employee measured
approximately $4.2 million in 2018 and $4.1 million in 2017 and $3.8 million in 2016.
Charges for insurance premiums paid to the FDIC decreased from 2016 amounts because of a reduction in assessment rates effective September 30,
2016. Deposits are insured by the FDIC up to a maximum amount, which is generally $250,000 per depositor subject to aggregation rules. As an
FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The Company recently learned that
credits from the FDIC may substantially reduce premiums in 2019. State and local taxes increased by $30,000, or 6.5%, in 2018, compared to an
increase of $8,000, or 1.8%, in 2017, reflecting the growing shareholders’ equity on which the state tax is based. In 2016, there was a one-time loss
from the extinguishment of debt of $242,000. This loss is related to the early payoff of long-term advances with the Federal Home Loan Bank and
was offset by securities gains. Additionally, payoff of this debt will result in annual savings in interest expense. All other categories of non-interest
expenses decreased $154,000, or 2.1%, in 2018 compared to an increase of $239,000, or 3.4%, in 2017. These expense categories are subject to
fluctuation due to non-recurring items. Contributing to increased expenses in 2017 were expenses relating to a new full-service branch which
opened in 2017 and continued investment into information technology relative to improved security monitoring, improved operational performance
and enhanced customer account analysis.
35
Income before federal income tax expense amounted to $10.3 million for 2018, compared to $6.8 million and $6.0 million for 2017 and 2016,
respectively. The effective tax rate was 13.8% in 2018, 35.7% in 2017 and 18.8% in 2016, resulting in income tax expense of $1.4 million in 2018, $2.4
million in 2017 and $1.1 million in 2016. The effective rate is affected by the current rate of profitability and tax-free components of the revenue
stream. The lower rate in 2018 is primarily affected by the change in corporate tax rate from 34% to 21%. The gains on bank-owned life insurance
mentioned previously were tax free and contributed to the lower effective tax rate in both 2018 and 2017. The increase in the effective tax rate in 2017
was also a result of the Tax Act, which increased the deferred tax charges by $1.2 million, or 18.4%. A $93,000 reversal of a deferred tax valuation
reserve, recognized in 2016, contributed to the lower effective tax rate in 2016.
The effective federal income tax rate varies from the applicable U.S. statutory federal income tax rate of 21% for 2018, and 34% for 2017 and 2016 due
to the following differences:
Provision at statutory rate
(Deduct) add tax effects of:
Earnings on bank-owned life insurance-net
Non-taxable interest income
Change in corporate tax rate
Low income housing tax credits
Deferred tax valuation (reversal) recognition
Non-deductible expenses
Federal income tax effective rate
2018
December 31,
2017
2016
21.00 %
34.00 %
34.00 %
(3.93 )
(3.11 )
—
(1.37 )
0.27
0.94
13.80 %
(6.11 )
(9.80 )
18.41
(2.21 )
—
1.43
35.72 %
(1.86 )
(10.47 )
—
(2.37 )
(1.55 )
1.04
18.79 %
Net income registered $8.8 million in 2018, $4.4 million in 2017 and $4.9 million in 2016, representing per share amounts of $2.03 in 2018, $0.99 in 2017
and $1.11 in 2016. Cash dividends of $0.49, $0.39 and $0.28 per share were paid to shareholders of record in 2018, 2017 and 2016, respectively.
The following table shows unaudited financial results by quarter:
For the 2018 quarter ended:
For the 2017 quarter ended:
(Amounts in thousands)
Interest income
Interest expense
Net interest income
Loan loss provision
Investment securities (losses) gains, net
Mortgage banking gains, net
Other income
Other expenses
Income before tax
Federal income tax expense
Net income
Net income per share
Net interest income (fully tax-equivalent
basis)
Net interest rate spread
Net interest margin
ALLOWANCE FOR LOAN LOSSES
Dec. 31
$ 7,489
1,236
6,253
75
—
203
752
4,643
2,490
466
$ 2,024
$ 0.47
Sept. 30
$ 6,962
1,148
5,814
75
—
272
876
4,529
2,358
386
$ 1,972
$ 0.46
June 30
$ 6,727
1,020
5,707
75
(41 )
261
2,357
4,585
3,624
322
$ 3,302
$ 0.75
Mar. 31
$ 6,571
979
5,592
500
20
238
754
4,326
1,778
241
$ 1,537
$ 0.35
$ 6,339
$ 5,900
$ 5,793
$ 5,698
783
848
June 30
Sept. 30
Dec. 31
Mar. 31
$ 6,129 $ 5,862 $ 5,805 $ 5,696
759
800
5,281 5,062 5,022 4,937
100 — —
—
9
194
697
4,603 4,665 4,686 4,647
1,625 2,484 1,468 1,190
1,604
190
21 $ 2,147 $ 1,182 $ 1,000
$
0.23
$
(7 )
(17 )
243
315
721 1,879
22
322
788
0.01 $ 0.49 $
0.26 $
337
286
3.68 %
3.95 %
3.48 %
3.73 %
3.52 %
3.74 %
3.43 %
3.62 %
$ 5,524 $ 5,301 $ 5,248 $ 5,174
3.43 %
3.61 %
3.45 %
3.65 %
3.39 %
3.56 %
3.36 %
3.52 %
The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best
estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, with the judgment of management, is
necessary to reserve for estimated loan losses on risks inherent in the loan portfolio. Accordingly, the methodology to establish the amount of the
allowance is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools, and specific loss
allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance for
loan losses is designed to account for credit deterioration as it occurs.
36
The Company’s allowance for loan loss methodology consists of three elements: (i) specific valuation allowances on probable losses on specific
loans; (ii) historical valuation allowances based on historical loan loss experience for similar loans with similar characteristics and trends; and
(iii) general valuation allowances based on general economic conditions and other qualitative risk factors both internal and external to the Company.
The allowances established for probable losses on specific loans are based on recurring analyses and evaluations of classified loans. Loans are
categorized into risk grade classifications based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability
to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. The Bank currently
divides the loan and lease portfolio into the following major categories: 1) Pooled Loans (unclassified) with similar risk characteristics; 2)
Substandard Loans (classified) defined as being inadequately protected by current sound net worth, paying capacity of the borrower, or pledged
collateral; 3) Special Mention (classified) defined as having potential weaknesses that deserve management’s close attention. If left uncorrected,
these potential weaknesses may, at some future date, result in the deterioration of the repayment prospects for the credit or the Bank’s credit
position; 4) Loss or doubtful loans (classified) have all the weaknesses of the previous classifications, with the added characteristic that the
weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values highly questionable and
improbable; and 5) Impaired Loans which generally include non-accrual loans. Once a loan is assigned a risk grade of classified, the loan review
officer assesses whether the loan is to be evaluated for impairment based on the Company policy. A portion of the allowance for loan loss is
specifically allocated to those loans which are evaluated for impairment and determined to be impaired. Specific valuation allowances are determined
by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions
affecting the borrower’s industry, among other things. If after review, the loan is not considered to be impaired, the loan is included with a pool of
similar loans that is assigned a valuation allowance calculated based on the historical loss experience and qualitative factors of the pool type. The
valuation allowance is calculated based on the historical loss experience of specific types of classified loans. The Company calculates historical
loss ratios for pools of loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans
in the pool. The historical loss ratios are updated quarterly based on actual charge-off experience.
A general valuation allowance is established for pools of homogeneous loans based upon the product of the historical loss ratio adjusted for
qualitative factors and the total dollar amount of the loans in the pool. Specific qualitative factors considered by management include trends in
volume or terms, changes in lending policy levels and trends in charge-offs, classification and non-accrual loans, concentrations of credit and local
and national economic factors. The Company’s pools of similar loans include similarly risk-graded groups of commercial loans, commercial real
estate loans, residential real estate loans, home equity loans and other consumer loans. Beginning at year-end 2017, due to their growing
significance, the pools of commercial and commercial real estate loans are also broken out further by industry sectors when analyzing the related
pools. These industry sectors include non-residential buildings; skilled nursing and nursing care; residential real estate lessors, agents and
managers; hotel and motels and trucking. Additional factors are used on pools of loans considered special mention; specifically, levels and trends
in classification, declining trends in financial performance, structure and lack of performance measures and migration from special mention to
substandard. For loans graded as substandard, a separate historical loss rate is calculated as a percent of charge-offs net of recoveries to the
balance of substandard loans, which results in a higher historical loss factor. This is also adjusted for the qualitative factors discussed previously.
Loans identified as losses by management, internal loan review and/or bank examiners are charged off. Furthermore, consumer loan accounts are
charged off in accordance with regulatory requirements.
The Company maintains an allowance for losses on unfunded commercial lending commitments to provide for the risk of loss inherent in these
arrangements. The allowance is computed using a methodology similar to that used to determine the allowance for loan losses. This allowance is
reported as a liability on the consolidated balance sheets within other liabilities, while the corresponding provision for these losses is recorded as a
component of other non-interest expenses. At both December 31, 2018 and 2017, this allowance was $84,000.
Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s
judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is
dependent upon a variety of factors beyond the Company’s control, including the performance of the Company’s loan portfolio, the economy,
changes in interest rates and the view of the regulatory authorities toward loan classifications.
Although management believes the Company uses the best information available to make allowance for loan loss determinations, future
adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial
determinations. Increased levels of job loss and high unemployment, home foreclosures and business failures could result in increased levels of
nonperforming assets and charge-offs, increased loan loss provisions and reductions in income. Additionally, as an integral part of their
examination process, bank regulatory agencies periodically review our allowance for loan losses. The banking agencies could require the
recognition of additions to the allowance for loan loss based on their judgment of information available to them at the time of their examination.
37
The following is an analysis of changes in the allowance for loan losses for the period ended:
Balance at beginning of year
Loan losses:
Commercial
Commercial real estate
Residential real estate
Consumer - home equity
Consumer - other
Total
Recoveries on previous loan losses:
Commercial
Commercial real estate
Residential real estate
Consumer - home equity
Consumer - other
Total
Net loan losses
Provision charged to operations
Balance at end of year
Ratio of net loan losses to average total loans outstanding
Ratio of loan loss allowance to total loans
2018
2017
(Amounts in thousands)
December 31,
2016
2015
2014
$
4,578
$
4,868
$ 5,194
$
5,202
$
3,764
(1,163 )
—
—
—
(175 )
(1,338 )
—
166
3
5
59
233
(1,105 )
725
4,198
0.23 %
0.82 %
$
—
(654 )
(14 )
(26 )
(146 )
(840 )
388
—
5
10
47
450
(390 )
100
4,578
0.09 %
0.94 %
—
(287 )
(35 )
(144 )
(148 )
(614 )
117
35
2
23
61
238
(376 )
50
$ 4,868
0.10 %
1.16 %
(470 )
(84 )
(45 )
—
(124 )
(723 )
134
10
37
17
62
260
(463 )
455
5,194
0.13 %
1.32 %
$
(123 )
(186 )
(93 )
(48 )
(144 )
(594 )
274
3
16
24
77
394
(200 )
1,638
5,202
0.06 %
1.44 %
$
$
The commercial charge-off in 2018 is related to loans (to one borrower) that were restructured to a new borrowing relationship with no principal
forgiveness, but with a substantial concession in interest rate. The below market rate triggered recognition of a charge-off equivalent to the
difference in present value of loan payments discounted at the market rate of interest. The charged off amount of $1.1 million is recorded as a loan
discount. As loan payments are made, interest is recognized at the market rate versus the negotiated rate via the amortization of the discount over
the various lives of the loans. There was $625,000 in specific reserve previously allocated to these loans at December 31, 2017. Included in the
$654,000 commercial real estate charge-off in 2017 is a loan for $352,000, which had a $148,000 specific reserve. The $470,000 commercial charge-off
in 2015 contains a $468,000 charge-off to an isolated credit relationship that already had a specific reserve recorded.
The following is an allocation of the year end allowance for loan losses and the percentage to total loans. The allowance has been allocated
according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories
of loans as of:
Commercial
Commercial real estate
Residential real estate
Consumer - home equity
Consumer - other
Total
2018
Balance
$ 1,232
2,414
314
115
123
$ 4,198
(Amounts in thousands)
December 31,
2016
2017
%
Balance
0.24 $ 1,591
2,702
0.47
117
0.06
70
0.02
98
0.03
2015
2014
Balance %
Balance %
Balance %
%
0.31 $ 1,394
3,072
0.55
163
0.02
150
0.01
89
0.02
0.29 $ 1,977 0.47 $ 2,064 0.52
2,754 0.70
0.63
229 0.06
0.03
60 0.02
0.03
95 0.02
0.02
2,926 0.70
153 0.04
52 0.01
86 0.02
$ 4,578
$ 4,868
$ 5,194
$ 5,202
The allocations of the allowance as shown in the previous table should not be interpreted as an indication that future loan losses will occur in the
same proportions or that the allocations indicate future loan loss trends. Furthermore, the portion allocated to each loan category is not the total
amount available for future losses that might occur within such categories since the total allowance is applicable to the entire portfolio, and
allocation of a portion of the allowance to one category of loans does not preclude availability to absorb losses in other categories.
38
LOAN PORTFOLIO
The following table represents the composition of the loan portfolio as of:
2018
Balance
$ 112,440
303,804
69,845
25,076
3,227
2017
Balance
%
21.9 $ 113,341
283,135
59.0
62,071
13.6
26,018
4.9
2,925
0.6
(Amounts in thousands)
December 31,
2016
2015
2014
Balance %
Balance %
%
23.3 $ 96,281 22.9 $ 84,613 21.5 $ 72,330 20.1
223,536 62.1
58.1
38,875 10.8
12.7
21,328 5.9
5.3
4,116 1.1
0.6
237,137 60.1
45,414 11.5
23,334 5.9
3,756 1.0
238,692 56.9
57,008 13.6
25,061 6.0
2,726 0.6
Balance %
$ 514,392
$ 487,490
$ 419,768
$ 394,254
$ 360,185
Commercial
Commercial real estate
Residential real estate
Consumer - home equity
Consumer - other
Total loans
The following schedule sets forth maturities based on remaining scheduled repayments of principal or next re-pricing opportunity for loans
(excluding residential real estate, consumer- home equity and consumer-other).
Commercial
Commercial real estate
Total loans
(Amounts in thousands)
December 31, 2018
1 Year or Less
Over 1 Year
to 5 Years
Over 5 Years
Total
$
$
77,469 $
101,960
179,429 $
17,855 $
121,136
138,991 $
17,116 $
80,708
97,824 $
112,440
303,804
416,244
The following schedule sets forth loans based on next re-pricing opportunity for floating and adjustable interest rate products, and by remaining
scheduled principal payments for loan products with fixed rates of interest. Residential real estate, consumer - home equity and consumer – other
loans have again been excluded.
Floating or adjustable rates of interest
Fixed rates of interest
Total loans
(Amounts in thousands)
December 31, 2018
Over 1 Year
1 Year or Less
$
173,142 $
6,287
179,429 $
$
99,591 $
137,224
236,815 $
Total
272,733
143,511
416,244
The Company recorded an increase of $26.9 million in the loan portfolio in 2018 from the level of $487.5 million recorded at December 31, 2017. Gross
loans as a percentage of earning assets stood at 77.6% as of December 31, 2018 and 73.6% at December 31, 2017. The loan-to-deposit ratio at
December 31, 2018 was 85.3% as compared to 83.7% at December 31, 2017. Despite the slow economic recovery in the region, the Bank posted year-
over-year growth in total loans of 5.5%. As the balance sheet is adequately structured to accommodate additional loan growth, management
remains committed to fulfilling the credit needs of creditworthy customers. Included in year-end total loans are 60-day or less loans closed in
December 2018 for $40.9 million, compared to $43.0 million in 2017. Absent the short-term year end transaction, the Company reported core loan year
over year growth of 6.5% and 14.0 %, respectively for 2018 and 2017. At December 31, 2018, the loan loss allowance of $4.2 million represented
approximately 0.8% of outstanding loans, and at December 31, 2017, the loan loss allowance of $4.6 million represented approximately 0.9% of
outstanding loans.
The portion of the loan portfolio represented by commercial loans (including commercial real estate) modestly decreased from 81.4% in 2017 to
80.9% in 2018. Consumer loans (including home equity loans) were approximately 5.5% of the loan portfolio in 2018 and 5.9% in 2017. Between 2017
and 2018, the balance of residential real estate loans in relationship to total loans increased slightly from 12.7% to 13.6%. However, year over year
balances grew $7.8 million or 12.5% as the bank placed quality, non-secondary market qualified and construction loans in the portfolio. The Bank’s
majority of mortgage originations are sold to the secondary market in order to take advantage of historically low interest rates as management does
not intend to take on material long term interest rate risk within the portfolio yields.
39
Commercial, commercial real estate and residential real estate loans continue to comprise the largest share of the Company’s loan portfolio. At the
end of 2018, commercial, commercial real estate and residential real estate loans comprised a combined 94.5% of the portfolio compared to 93.0% at
December 31, 2014, reflecting a consistent strategy of portfolio diversification over the five-year period. The loan portfolio at December 31, 2018 also
included home equity loans at 4.9% and consumer installment loans at 0.6%. These percentages compare to home equity loans at 5.9% and
consumer installment loans at 1.1% on December 31, 2014.
The commercial loan portfolio, which includes both commercial and commercial real estate (CRE) loans, is $416.2 million at December 31, 2018, an
increase of $19.7 million from the balance of $396.5 million recorded at December 31, 2017, and represents 5.0% growth. Commercial loans, including
lines of credit, decreased slightly by $901,000, or 0.8%, during the year and represented 21.9% of the portfolio, or a 1.4% composition decrease over
the prior period. CRE loans increased $20.7 million, or 7.3%, which substantially represents investment real estate supported by third-party rents
and leases along with other known Bank concentrations such as Skilled Nursing, Assisted Living, Residential Lessors (including Multi-family) and
Hotels that are classified as non-owner occupied CRE. At December 31, 2018, the total CRE portfolio consisted of 22.5% in owner-occupied real
estate and 77.5% in non-owner occupied real estate. The increase in CRE loans was a direct result of management taking strategic advantage of
competitive market conditions and the Bank’s considerable liquidity position since 2010. The CRE portfolio was also enhanced by lending into the
Skilled Nursing, Personal Health Care industries and Multi-family. In 2006, the federal banking regulatory agencies published interagency guidance
on CRE Concentration Risk Management stating that if total commercial real estate concentration exceeded 300% of a bank’s total capital (or if the
CRE portfolio increased by over 50% in the preceding 3 years), the portfolio may represent significant concentration risk and additional monitoring
may be required. The Bank’s CRE concentration, excluding owner-occupied real estate, as of December 31, 2018 was $235.5 million, which is 313.1%
of total unimpaired or risk-based capital, compared to 298.5% for 2017. Although the Company reflected 7.3% CRE balance growth and slightly
increased its concentration risk relative to capital, CRE reflected 18.6% growth in the prior year 2017. Management also believes that its current level
of credit review, portfolio monitoring and stress testing adequately assures that the Bank is mitigating CRE concentration levels. In a strategic effort
to diversify, the Bank continues to develop its commercial loans and, as such, the December 31, 2018 balance of $112.4 million represents 27.0% of
the total commercial loan portfolio, which approximates the period ended December 31, 2017 of 28.6%. However, excluding the year-end, 60-day or
less, cash-secured loans that were decreased by $2.1 million from 2017 to 2018, commercial loans grew by $1.2 million, or 1.7%, from 2017 to 2018. In
addition, residential loans grew by $7.8 million, or 12.5%, for the same period.
Loan personnel will continue to aggressively pursue both commercial and small business opportunities supported by product incentives and
marketing efforts. When necessary, management will continue to offer competitive fixed-rate and derivative pricing options on commercial real
estate products to qualifying customers in an effort to establish new business relationships, retain existing relationships, and capture additional
market share. The Bank’s lending function continues to provide business services to a wide array of medium and small businesses, including but
not limited to, commercial and industrial accounts such as health care facilities, grocery stores, manufacturers, trucking companies, physicians and
medical groups, service contractors, restaurants, hospitality industry companies, retailers, wholesalers, educational institutions and other political
subdivisions as well as commercial and residential real estate lessors, developers and builders.
Commercial and small business loans are originated by commercial loan personnel and other loan personnel assigned to the Bank’s offices within
various geographical regions. These loans are all processed in accordance with established business loan underwriting standards and practices.
The following table provides an overview of commercial loans by various business sectors reflecting the areas of largest concentration. It should be
noted that these are current loan balances including executed commitments to fund and do not reflect existing commitments that have not been
accepted or executed.
Non-residential building/apartment building
Residential real estate lessors, agents and
managers (including multi-family)
Skilled nursing
Hotels/motels
Trucking/courier services
2018
(Amounts in thousands)
December 31,
2017
2016
Balances
% of
Portfolio
Balances
% of
Portfolio
Balances
% of
Portfolio
$
97,411
23.40 $
79,918
20.16 $
70,399
21.02
50,496
33,818
30,378
24,487
12.13
8.12
7.30
5.88
51,431
26,805
22,072
21,613
12.97
6.76
5.57
5.45
27,016
29,929
23,285
21,329
8.07
8.93
6.95
6.37
40
The most substantial increase in concentrations growth by percentage since 2016 comes from residential real estate lessors, agents and managers
(including multi-family) and non-residential building/apartment building, which was a result of a 2016 strategic initiative into multi-family to further
diversify CRE into a growing market segment. This increase remains the second largest concentration relative to the total portfolio composition. The
single largest customer relationship had an aggregate balance at year end 2018 of $13.3 million compared to $14.8 million in 2017. This balance
represented approximately 3.2% of the total commercial and CRE portfolio in 2018 and 3.7% in 2017. It is important to note that within this
relationship, there is a 60-day or less note for the entire amount of $13.3 million in 2018 and $7 million in 2017, which were fully secured by
segregated deposit accounts with the Bank at the time of origination.
Since 2015, the price of oil declined significantly. This occurrence negatively affected several industries, particularly those whose revenues are
derived from oil and oil-related products. The Company reviewed its borrowers to identify and measure any potential credit losses relating to oil.
Nothing of significance was noted and no additional provisions are considered necessary.
The Bank continues to be active in home equity financing. Home equity term loans and credit lines (HELOCs) remain popular with consumers
wishing to finance home improvement costs, education expenses, vacations and consumer goods purchased at favorable interest rates. As first
mortgage refinancing and elimination of some eligible tax deductions impacted this product line in 2018, this portfolio reflected slight deterioration.
In order to improve customer retention and provide better overall loan diversification, management will continue to evaluate and reposition the
Company’s portfolio product offerings during 2019.
In the consumer lending area, the Company provides financing for a variety of consumer purchases, such as: fixed- and variable-rate amortizing
mortgage products that consumers utilize for home improvements; the purchase of consumer goods of all types; and education, travel and other
personal expenditures. The consolidation of credit card balances and other existing debt into term payouts continues to remain a popular financing
option among consumers. In an effort to increase consumer relationship banking, the Company implemented a Private Bank product line in 2016 that
focuses on high net worth and income consumers, the balances from which are modest and primarily reside in home equity lines.
Additional information regarding the loan portfolio can be found in Item 8, Notes 1, 3, 8, 11 and 14 to the Consolidated Financial Statements.
MORTGAGE BANKING
Since the May 2013 Taper Tantrum when mortgage rates rose dramatically, the Company shifted its focus from wholesale to retail origination. With
the majority of loans sold into the secondary market, the resulting gains have enhanced non-interest revenue. In 2018, the Company reported net
gains on saleable loans of $1.0 million, representing a modest decrease from the prior year’s balance of $1.1 million due to margin compression
caused by increasing interest rates and slightly less volume for secondary market loans. As originators were added in the retail footprint, as well as
expanding into adjacent markets, originations grew from $18.4 million in 2014 to a high of $76.0 million in 2016. As previously referenced, the
residential portfolio grew by $7.9 million, or 12.6%, with quality, non-secondary market qualified and construction loans. The Company continues to
diversify its portfolio with expansion into new geographic markets and new personnel within its footprint.
Currently, the Company is not retaining the servicing on loans sold. Although the Company’s primary strategy is to sell long-term residential
mortgages, loans are occasionally retained in the portfolio when requested by a customer or to enhance account relationships, and tend to be
variable rate or shorter term. The mix of portfolio retained to those sold to investors will vary from year to year.
The Company maintains reserves for mortgage loans sold to agencies and investors in the event that, either through error or disagreement between
the parties, the Company is required to indemnify the purchase. The reserves take into consideration risks associated with underwriting, key factors
in the mortgage industry, loans with specific reserve requirements, past due loans and potential indemnification by the Company. Reserves are
estimated based on consideration of factors in the mortgage industry, such as declining collateral values and rising levels of delinquency, default
and foreclosure, coupled with increased incidents of quality reviews at all levels of the mortgage industry seeking justification for pushing back
losses to loan originators and wholesalers. As of December 31, 2018 and 2017, the Company had reserves for mortgage loans sold of $700,000. For
the years ended December 31, 2018 and 2017, the Company did not repurchase any mortgage loans sold.
INVESTMENT SECURITIES
Investment securities are segregated into three separate portfolios: available-for-sale, held-to-maturity and trading. Each portfolio type has its own
method of accounting. The Company currently does not maintain a held-to-maturity portfolio. Securities classified as available-for-sale are those
that could be sold for liquidity, investment management, or similar reasons even though management has no present intentions to do so. Securities
available-for-sale are carried at fair value using the specific identification method. Changes in the unrealized gains and losses on available-for-sale
securities are recorded net of tax effect as a component of comprehensive income.
41
Held-to-maturity securities are recorded at historical cost and adjusted for amortization of premiums and accretion of discounts. Securities
designated by the Company as held-to-maturity tend to be higher yielding but less liquid either due to maturity, size or other characteristics of the
issue. The Company must have both the intent and the ability to hold such securities to maturity. The Company has no securities classified as held-
to-maturity.
Trading securities were an investment in obligations of states and political subdivisions and a short duration bond fund. Management had
purchased these securities principally for the purpose of selling them in the near term. Trading securities were carried at fair value with valuation
adjustments included in other non-interest income. The Company no longer has any investment in trading securities.
Securities the Company has designated as available-for-sale may be sold prior to maturity in order to fund loan demand, to adjust for interest rate
sensitivity, to reallocate bank resources or to reposition the portfolio to reflect changing economic conditions and shifts in the relative values of
market sectors. Available-for-sale securities tend to be more liquid investments and generally exhibit less price volatility as interest rates fluctuate.
Securities are evaluated periodically to determine whether a decline in their value is other-than-temporary. Management utilizes criteria such as the
magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-
temporary. The OTTI is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is
not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the
investment. Once a decline in value is determined to be an OTTI, the credit-related OTTI is recognized in earnings while the non-credit related OTTI
on securities not expected to be sold is recognized in other comprehensive income (loss).
The following table shows the fair value of available-for-sale securities by type of obligation at:
U.S. Treasury and U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed and related securities
Trust preferred securities
Total fair value of investment securities available-for-sale
Impairment Analysis of Investment Securities
(Amounts in thousands)
December 31,
2017
2018
$
9,002 $
51,658
76,263
—
3,205 $
72,116
83,625
895
$
136,923
$
159,841
$
2016
7,988
66,770
101,055
825
176,638
Item 8, Note 2 in the Notes to the Consolidated Financial Statements contains the accounting and disclosures for securities impairment.
Fair Value
Trust preferred securities, which are accounted for under FASB ASC Topic 325 Investments Other, were held in the investment portfolio until early
June 2018. Prior to the sale, the Company evaluated current available information in estimating the future cash flows of securities and determined
whether there had been favorable or adverse changes in estimated cash flows from the cash flows previously projected. The Company considered
the structure and term of the pool and the financial condition of the underlying issuers. Specifically, the evaluation incorporated factors such as
interest rates and appropriate risk premiums, the timing and amount of interest and principal payments and the allocation of payments to the various
note classes. Estimates of cash flows were based on the most recent trustee reports, announcements of deferrals or defaults, expected future default
rates and other relevant market information.
The Company enlisted the aid of an independent third party to perform the trust preferred securities valuations. The approach to determining fair
value involved the following process:
1. Estimate the credit quality of the collateral using average probability of default values for each issuer (adjusted for rating levels).
2. Consider the potential for correlation among issuers within the same industry for default probabilities (e.g. banks with other banks).
3. Forecast the cash flows for the underlying collateral and apply to each trust preferred security tranche to determine the resulting
distribution among the securities.
4. Discount the expected cash flows to calculate the present value of the security.
42
A summary of securities held at December 31, 2018, classified according to the earlier of next re-pricing or the maturity date and the weighted
average yield for each range of maturities, is set forth below. Fixed-rate mortgage-backed securities are classified by their estimated contractual cash
flow, adjusted for current prepayment assumptions. Actual maturities may differ from contractual maturities because borrowers may have the right
to call or prepay obligations with or without call or prepayment penalties.
U.S. Government agencies and corporations:
Maturing or repricing within one year
Maturing or repricing after one year but within five years
Maturing or repricing after five years but within ten years
Maturing or repricing after ten years
Total U.S. Government agencies and corporations
Obligations of states and political subdivisions:
Maturing or repricing within one year
Maturing or repricing after one year but within five years
Maturing or repricing after five years but within ten years
Maturing or repricing after ten years
Total obligations of states and political subdivisions
U.S. Government mortgage-backed and related securities:
Maturing or repricing within one year
Maturing or repricing after one year but within five years
Maturing or repricing after five years but within ten years
Maturing or repricing after ten years
Total U.S. Government mortgage-backed and related securities
Regulatory Stock
Maturing or repricing within one year
Maturing or repricing after one year but within five years
Maturing or repricing after five years but within ten years
Maturing or repricing after ten years
Total regulatory stock
(Amounts in thousands)
Fair Value
Weighted
Average
Yield (1)
$
$
$
$
$
$
$
$
—
344
8,658
—
9,002
—
142
323
51,193
51,658
—
11,976
6,570
57,717
76,263
—
—
—
2,581
2,581
— %
2.199
2.920
—
2.893 %
— %
6.732
3.435
3.275
3.285 %
— %
2.741
1.996
2.337
2.371 %
— %
—
—
5.886
5.886 %
(1) The weighted-average yield has been computed by dividing the total interest income adjusted for amortization of premium or accretion of
discount over the life of the security by the amortized cost of the securities outstanding. The weighted-average yield of tax-exempt
obligations of states and political subdivisions has been calculated on a fully taxable equivalent basis. The amount of adjustment to interest,
which is based on the statutory tax rate of 21%, was $356,000.
(2) Regulatory stock is included in the amount maturing or repricing after ten years, and although pays dividends, is not contractually obligated.
As of December 31, 2018, there were $8.7 million in callable U.S. Government agency securities and none in callable obligations of states and
political subdivisions that, given current and expected interest rate environments, have the possibility of being called within the one-year time
horizon. These securities are categorized according to their contractual maturities, with none classified as maturing or repricing within one year,
none classified as maturing after one year but within five years, $8.7 million classified as maturing after five years but within ten years and none of
the callable investments classified as maturing after 10 years.
As of December 31, 2018, there were no callable U.S. Government agency securities and $7.4 million in callable obligations of states and political
subdivisions that, given current and expected interest rate environments, have the possibility of being called within the time frame defined as after
one year but within five years. These securities are categorized according to their contractual maturities, with none maturing after one year but
within five years, none maturing after five years but within ten years and $7.4 million maturing after 10 years.
As of December 31, 2018, the carrying value of all investment securities totaled $139.5 million, a decrease of $22.9 million, or 14.1%, from the prior
year. The investment portfolio functions as the balancing factor among the swings in loans and deposits, along with changes in short term
borrowings. The investment portfolio represents 23.1% of each deposit dollar, down from 27.7% at the prior year end. The allocation between
single maturity investment securities and mortgage-backed securities shifted to a 45/55 split versus the 52/48 division of the previous year.
43
Holdings of Obligations of States and Political Subdivisions decreased by $20.5 million or 28.4%. This decrease was the result of sales of $18.1
million in early 2018 as part of a liquidity strategy.
Holdings of U.S. Government-sponsored mortgage-backed securities decreased by $11.1 million, or 16.4%. This decrease was primarily the result of
principal paydowns of $8.9 million.
Holdings of U.S. Government agencies and corporations increased $5.8 million, or 180.9%. This increase was due to purchases of $6.0 million.
Holdings of other securities remained relatively unchanged during the year.
The current year mortgage-backed securities and related portfolio is comprised of investments in mortgage-backed securities of $56.6 million,
collateralized mortgage obligations of $12.0 million and U.S. Government-guaranteed small business administration (SBA) pools of $7.7 million. The
prior year mortgage-backed securities and related portfolio is comprised of investments in mortgage-backed securities of $67.7 million, collateralized
mortgage obligations of $6.3 million and U.S. Government-guaranteed small business administration pools of $9.7 million. Both the current and prior
year portfolios, other than the SBA pools, were comprised solely of fixed rate products and provides a desirable diversification of cash flows.
At December 31, 2018, a net unrealized loss of $3.7 million, net of tax, was included in shareholders’ equity as a component of other comprehensive
income, as compared to a net unrealized loss of $1.8 million, net of tax, as of December 31, 2017. Rising interest rates generally result in depreciation
in the market value of debt securities, while lower interest rates generally translate into more favorable market prices for debt securities.
At December 31, 2017 the Company held two investments considered to be structured notes with a fair value of $895,000. Both of these
investments were sold in June 2018. The Company has no investments in other derivative products.
Additional information regarding investment securities can be found in Item 8, Notes 1 and 2 to the Consolidated Financial Statements.
DEPOSITS
The Company’s deposits are primarily derived from the individuals and businesses located in its market area. Total deposits at year-end exhibited
an increase of 3.2% to $604.4 million at December 31, 2018, as compared to $585.9 million at December 31, 2017.
The Company’s deposit base consists of demand deposits, savings, money market and time deposit accounts. Noninterest-bearing deposits
increased 11.0% during 2018, while interest-bearing deposits increased by 1.1%.
At December 31, 2018, noninterest-bearing deposits were $136.9 million, or 22.7% of total deposits in 2018, compared to $123.3 million or 21.0% of
total deposits in 2017.
Core deposits, which are deposits exclusive of certificates of deposit greater than $250,000, brokered deposits, one-way CDAR’S and ICS deposits
and deposits through listed services represented 90.1% of total deposits at year-end 2018 compared to 88.9% in 2017.
The Company’s portfolio of certificates of deposit is sourced primarily from customers in the Bank’s immediate market area and includes an
insignificant amount of brokered deposits.
Average noninterest-bearing and interest-bearing checking accounts now comprise 33.0% of total deposits compared to 28.9% five years ago. The
largest shift, however, is the flow of funds from CD’s into money market accounts. The preference is to park funds into this demand account while
awaiting interest rate and market movement. This is reflective of the unwillingness of customers to commit to longer terms in the low interest rate
environment, and the expectation of rising rates on the horizon.
44
The following table depicts how the average deposit mix has shifted during this five-year time frame.
Checking
NOW
Money market
Savings
CDs
(In percentages)
December 31,
2018
2014
23.0
10.0
25.3
20.1
21.6
21.2
7.7
13.9
26.8
30.4
Additional information regarding interest-bearing deposits can be found in Item 8, Note 5 to the Consolidated Financial Statements.
OTHER ASSETS AND OTHER LIABILITIES
Premises and equipment totaled $10.2 million at December 31, 2018, an increase of $1.2 million from $9.0 million at December 31, 2017, reflecting the
ongoing investment in the upgrade of current facilities and equipment in 2018 with minimal additional investment in facilities in 2017. Bank-owned
life insurance had a cash surrender value of $15.7 million at December 31, 2018 and $17.7 million at December 31, 2017. The decrease from 2017 is due
mainly to a $2.3 million payout of the cash value of the policies triggered by the death of a former executive named on the policies. Comprising
approximately 20% of Tier 1 capital plus the allowance for loan losses, management may consider additional insurance purchases not to exceed a
25% ratio. In 2017, there was a $931,000 reduction in the cash value of a policy triggered by the death of a former executive, which was offset by
purchases of $900,000. Other assets increased to $18.3 million at December 31, 2018 from $17.2 million at December 31, 2017. Net deferred tax assets
measured $2.4 million at December 31, 2018 versus $2.9 million at December 31, 2017. At December 31, 2017, there was $904,000 in Alternative
Minimum Tax credits included in the deferred tax assets that, due to the change in tax law, was reclassified to Federal Income Taxes receivable
included in other assets, which increased by $625,000 from December 31, 2017.
In 2018, a $5.3 million investment in a partnership fund is included in other assets and $4.8 million at 2017, with an offsetting $2.9 million in other
liabilities in both 2018 and 2017, which is the commitment to fund this affordable housing investment. Also included in other assets is an investment
of $6.0 million in 2018 and $5.5 million in 2017 into privately managed pools of small business administration loans. Both of these investments are
intended to satisfy Community Reinvestment Act requirements.
Other liabilities measured $10.0 million at December 31, 2018 and $9.8 million at December 31, 2017. In addition to the commitment described above,
other major components are accrued interest on deposits and borrowings which measured $371,000 and $325,000 in 2018 and 2017. Accrued
expenses measured $5.7 million at December 31, 2018 and $5.4 million at December 31, 2017. Post-retirement benefits is the largest accrued expense
item, which measured $4.3 million at December 31, 2018 and $4.1 million at December 31, 2017.
ASSET-LIABILITY MANAGEMENT
The Company’s executive management and Board of Directors routinely review the Company’s balance sheet structure for stability, liquidity and
capital adequacy. The Company has defined a set of key control parameters which provide various measures of the Company’s exposure to
changes in interest rates. The Company’s asset-liability management goal is to produce a net interest margin that is relatively stable despite interest
rate volatility, while maintaining an acceptable level of earnings. Net interest income is the difference between total interest earned on a fully taxable
equivalent basis and total interest expensed. The net interest margin ratio expresses this difference as a percentage of average earning assets. In the
past five years, the net interest margin has averaged 3.66% ranging between 3.59% and 3.76% as depicted in the following table.
2018
2017
(In percentages)
December 31,
2016
2015
2014
Net interest margin
3.76
3.59
3.63
3.65
3.67
Included among the various measurement techniques used by the Company to identify and manage exposure to changing interest rates is the use
of computer-based simulation models. Computerized simulation techniques enable the Company to explore and measure net interest income
volatility under alternative asset deployment strategies, different interest rate environments, various product offerings and changing growth
patterns.
45
During 2018, the effective maturities of earning assets remained fairly stable with less than a 3 month decrease in average life, as rates in the credit
markets increased on the short end of the curve. Federal Reserve policy makers raised rates four times in 2018, with the resulting Fed Fund target
now at 2.50% to ease strains in the financial market, stimulate spending and help improve the recovery. During the year, management invested any
excess funds, with an allocation towards mortgage-backed securities for cash flow.
The computerized simulation techniques utilized by management provide a sophisticated measure of the degree to which the Company’s interest
sensitive assets and liabilities may be impacted by changes in the general level of interest rates. These analyses show the Company’s net interest
income remaining in an acceptable range within the economic and interest rate scenarios anticipated by management. As previously noted, the
Company’s net interest margin has remained in the range of 3.59% to 3.76% over the past five years, a period characterized by significant shifts in
the mix of earning assets and the direction and level of interest rates. The targeted Federal funds rate during that period ranged from a low of 1.50%
to 2.50%, as Federal Reserve monetary policy turned from guarding against deflation to warding off inflationary threats to attempting to recover
from a recession and softening the effects of the housing correction.
LIQUIDITY
The central role of the Company’s liquidity management is to (1) ensure sufficient liquid funds to meet the normal transaction requirements of its
customers, (2) take advantage of market opportunities requiring flexibility and speed, and (3) provide a cushion against unforeseen liquidity needs.
Liquidity risk arises from the possibility that the Company may not be able to satisfy current or future financial commitments or may become unduly
reliant on alternative funding sources. The objective of liquidity management is to ensure the Company has the ability to fund balance sheet growth
and meet deposit and debt obligations in a timely and cost-effective manner. Management monitors liquidity through a regular review of asset and
liability maturities, funding sources, and loan and deposit forecasts. The Company maintains strategic and contingency liquidity plans to ensure
sufficient available funding to satisfy requirements for balance sheet growth, properly manage capital markets funding sources and address
unexpected liquidity requirements.
Principal sources of on-balance sheet liquidity available to the Company include assets considered relatively liquid, such as interest-bearing
deposits in other banks, federal funds sold, and cash and due from banks, as well as cash flows from maturities and repayments of loans,
investment securities and mortgage-backed securities.
Principal repayments on mortgage-backed securities, collateralized mortgage obligations and small business administration pools, along with
investment securities maturing or called amounted to $12.2 million during 2018, representing 8.7% of the total combined portfolio, compared to $17.3
million, or 10.6%, of the portfolio a year ago. Loan amortization provides in excess of $50 million annually.
In order to address the concern of FDIC insurance of larger depositors, the Bank is a member of the Certificate of Deposit Account Registry Service
(CDARS®) program and the Insured Cash Sweep (ICS) program. Through CDARS®, the Bank’s customers can increase their FDIC insurance by up
to $50.0 million through reciprocal certificate of deposit accounts and likewise through ICS, they can accomplish the same through money market
savings accounts. This is accomplished by the Bank entering into reciprocal depository relationships with other member banks. The individual
customer’s large deposit is broken into amounts below $250,000 and placed with other banks that are members of the network. The reciprocal
member bank issues certificates of deposit or money market savings accounts in amounts that ensure that the entire deposit is eligible for FDIC
insurance. The Bank can also enter into one-way buy or sell transactions which are not reciprocated. At December 31, 2018, the Bank had $11.0
million in deposits in the CDARS® program, of which $8.0 million was executed as one-way buy transactions and $12.5 million of deposits in the
reciprocal ICS money market program. For regulatory purposes, reciprocal CDARS® and ICS are not considered brokered deposits.
Along with its liquid assets, the Bank has other sources of liquidity available to it which help to ensure that adequate funds are available as needed.
These other sources include, but are not limited to, the ability to obtain deposits through the adjustment of interest rates, the purchasing of federal
funds, correspondent bank lines of credit and access to the Federal Reserve Discount Window. The Bank is also a member of the Federal Home
Loan Bank of Cincinnati, which provides its largest source of liquidity. At December 31, 2018, the Bank had an additional $27.3 million available of
collateral-based borrowing capacity at FHLB of Cincinnati, supplementing the $4.6 million of availability with the Federal Reserve Discount window.
Additionally, the FHLB has committed a $33.0 million cash management line, of which nothing has been disbursed, subject to posting additional
collateral. The Bank, by policy, has access to approximately 20% of total deposits (increasing to 25% in 2019) in various forms of wholesale deposits
that could be used as an additional source of liquidity. At December 31, 2018, there was $39.2 million in outstanding balances in wholesale deposits
including internet-based deposits with access to an additional $81.7 million. The Company was also granted a total of $13.5 million in unsecured,
discretionary Federal Funds lines of credit with no funds drawn upon as of December 31, 2018. Unpledged securities of $81.8 million are also
available for borrowing under repurchase agreements or as additional collateral for FHLB lines of credit or to sell to generate liquidity.
46
The Company has other more limited sources of liquidity. In addition to its existing liquid assets, it can raise funds in the securities market through
debt or equity offerings or it can receive dividends from the Bank. Generally, the Bank may pay dividends without prior approval as long as the
dividend is not more than the total of the current calendar year-to-date earnings plus any earnings from the previous two years not already paid out
in dividends, as long as the Bank remains well-capitalized after the dividend payment. The amount available for dividends in 2019 is $8.2 million plus
2019 profits retained up to the date of the dividend declaration. Future dividend payments by the Bank to the Company are based upon future
earnings. The Company had cash of $240,000 at December 31, 2018 available to meet cash needs. It also held a $6.0 million note receivable, the cash
flow from which approximates the debt service on the Junior Subordinated Debentures. Cash is generally used by the Company to pay quarterly
interest payments on the debentures, to pay dividends to common shareholders, to fund operating expenses, and occasionally repurchase shares.
Cash and cash equivalents increased from $19.1 million in 2017 to $19.7 million in 2018. The following table details the cash flows from operating
activities for the years ended 2018, 2017 and 2016.
Net income
Adjustments to reconcile net income to net cash flow from operating
activities:
Depreciation, amortization and accretion
Provision for loan losses
Investment securities available-for-sale losses (gains), net
Decrease in trading account
Originations of mortgage banking loans held for sale
Proceeds from the sale of mortgage banking loans
Mortgage banking gains, net
Earnings on bank-owned life insurance
Other real estate gains
Changes in:
Deferred taxes
Equity compensation
Federal income tax receivable
Other assets and liabilities
Net cash flow from operating activities
(Amounts in thousands)
December 31,
2017
2018
2016
$
8,835 $
4,350 $
4,871
2,316
725
21
—
(45,813 )
48,527
(974 )
(1,869 )
—
1,008
214
(625 )
769
13,134 $
2,735
100
(7 )
—
(51,730 )
54,578
(1,074 )
(1,203 )
(170 )
1,218
143
(243 )
436
9,133 $
2,770
50
(466 )
8,134
(61,003 )
61,730
(1,248 )
(328 )
(13 )
(129 )
75
281
(622 )
14,102
$
Key variations stem from: 1) Substantial recoveries throughout 2016 and 2017 reduced the amount needed for provision for loan losses in 2017. The
2018 provision is reflective of the restructured loan previously referenced. The decreased provision for loan losses in 2016 is due to a favorable
outcome on a credit relationship which the specific reserve previously set aside was able to be used for other problem loans. 2) Gains were
recognized on the sale of available-for-sale investments of $466,000 in 2016, mainly to offset the loss on extinguishment of debt. 3) During 2016, the
trading account was fully liquidated, resulting in a $8.1 million decrease. 4) Earnings on bank-owned life insurance increased by $666,000 due to
gain on proceeds from a policy of $1.5 million in 2018 and $898,000 in 2017. 5) Change in deferred taxes is due to the Tax Act, which accounted for
$904,000 of the decrease in 2018 and $1.2 million of the decrease in 2017. Refer to the Consolidated Statements of Cash Flows in item 8 for a summary
of the sources and uses of cash for 2018, 2017 and 2016.
47
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Company has various obligations, including contractual obligations and commitments that may require future cash payments.
Contractual Obligations: The following table presents significant fixed and determinable contractual obligations to third parties by payment date.
Further discussion of the nature of each obligation is included in the referenced Item 8, Notes to the Consolidated Financial Statements.
Non-interest bearing deposits
Interest bearing deposits (a)
Average rate (b)
Time deposits (a)
Average rate (b)
Federal funds purchased and security
repurchase agreements (a)
Average rate (b)
FHLB advances (a)
Average rate (b)
Subordinated debt
Average rate (b)
Operating leases
(Amounts in thousands)
December 31, 2018
Payments Due in:
Three to Five
Years
Over Five
Years
One to Three
Years
$
$
—
—
$
—
—
—
—
One Year or
Less
$ 136,886
346,168
0.55 %
Total
$ 136,886
346,168
0.55 %
67,197
34,851
14,012
5,305
121,365
1.63 %
2.26 %
2.23 %
1.95 %
1.89 %
2,206
0.34 %
—
18,000
10,000
2.18 %
—
2.28 %
—
177
285
—
—
—
98
—
—
5,155
4.24 %
117
2,206
0.34 %
28,000
2.22 %
5,155
4.24 %
677
See Note
5
5
6
6
7
8
(a) Excludes present and future accrued interest.
(b) Variable-rate obligations reflect interest rates in effect at December 31, 2018.
The Company’s operating lease obligations represent short- and long-term lease and rental payments for the Bank’s branch facilities.
The Company also has obligations under its supplemental retirement plans as described in Item 8, Note 9 to the Consolidated Financial Statements.
The postretirement benefit payments represent actuarially-determined future benefit payments to eligible plan participants. The Company does not
have any commitments or obligations to the defined contribution retirement plan (401(k) plan) at December 31, 2018 due to the funded status of the
plan. Additional information regarding benefit plans can be found in Item 8, Note 9 to the Consolidated Financial Statements.
Off-balance sheet arrangements/commitments: The following table details the amounts and expected maturities of significant off-balance sheet
commitments. Additional information regarding commitments can be found in Item 8, Note 8 to the Consolidated Financial Statements.
One Year or
Less
One to
Three Years
(Amounts in thousands)
December 31, 2018
Three to
Five Years
Over Five
Years
Total
Commitments to extend credit:
Commercial (including commercial real estate)
Revolving home equity
Overdraft protection
Other
Residential real estate
Standby letters of credit
$
18,860 $
15,880
8,708
1,106
4,157
3,400
4,438 $
—
—
—
—
55
3,753 $
—
—
—
—
—
39,382 $
10,903
—
284
6,513
—
66,433
26,783
8,708
1,390
10,670
3,455
Commitments to extend credit, including loan commitments, standby letters of credit, and commercial letters of credit do not necessarily represent
future cash requirements since these commitments often expire without being drawn upon.
48
CAPITAL RESOURCES
Regulatory standards for measuring capital adequacy require banks and bank holding companies to maintain capital based on “risk-adjusted”
assets so that categories of assets of potentially higher credit risk require more capital backing than assets with lower risk. In addition, banks and
bank holding companies are required to maintain capital to support, on a risk-adjusted basis, certain off-balance sheet activities such as standby
letters of credit and interest rate swaps.
Common equity for the common equity tier 1 capital ratio includes common stock (plus related surplus) and retained earnings, plus limited amounts
of minority interests in the form of common stock, less the majority of certain regulatory deductions.
Tier 1 capital includes common equity as defined for the common equity tier 1 capital ratio, plus certain non-cumulative preferred stock and related
surplus, cumulative preferred stock and related surplus and trust preferred securities that have been grandfathered (but which are not permitted
going forward), and limited amounts of minority interests in the form of additional Tier 1 capital instruments, less certain deductions.
Tier 2 capital, which can be included in the total capital ratio, includes certain capital instruments (such as subordinated debt) and limited amounts
of the allowance for loan and lease losses, subject to new eligibility criteria, less applicable deductions.
The Federal Financial Institutions Examination Council (FFIEC) determines the risk weightings of direct credit substitutions that have been
downgraded below investment grade. Included in the definition of a direct credit substitute are mezzanine and subordinated tranches of trust
preferred securities and non-agency collateralized mortgage obligations. Following these guidelines results in an increase in total risk-weighted
assets with an attendant decrease in the risk-based capital and Tier 1 risk-based capital ratios.
The Company met all capital adequacy requirements to which it was subject as of December 31, 2018 and December 31, 2017.
In early September 2013, the regulatory bodies substantially revised the capital requirements for all banks, varying with the size of the institution.
The new requirements became effective January 1, 2015 and are to be phased in over four years (through January 1, 2019). The Company does not
expect a material change to its excess capital position currently enjoyed.
Additional information regarding regulatory matters, including capital requirements, can be found in Item 8, Note 13 to the Consolidated Financial
Statements and in the Supervision and Regulation portion of Item 1 - Business.
INTEREST RATE RISK
Interest rate risk is measured as the impact of interest rate changes on the Company’s net interest income. Components of interest rate risk comprise
re-pricing risk, basis risk and yield curve risk. Re-pricing risk arises due to timing differences in the re-pricing of assets and liabilities as interest rate
changes occur. Basis risk occurs when re-pricing assets and liabilities reference different key rates. Yield curve risk arises when a shift occurs in the
relationship among key rates across the maturity spectrum.
The effective management of interest rate risk seeks to limit the adverse impact of interest rate changes on the Company’s net interest margin,
providing the Company with the best opportunity for maintaining consistent earnings growth. Toward this end, management uses computer
simulation to model the Company’s financial performance under varying interest rate scenarios. These scenarios may reflect changes in the level of
interest rates, changes in the shape of the yield curve, and changes in interest rate relationships.
The simulation model allows management to test and evaluate alternative responses to a changing interest rate environment. Typically when
confronted with a heightened risk of rising interest rates, the Company will evaluate strategies that shorten investment and loan re-pricing intervals
and maturities, emphasize the acquisition of floating rate over fixed rate assets, and lengthen the maturities of liability funding sources. When the
risk of falling rates is perceived, management will consider strategies that shorten the maturities of funding sources, lengthen the re-pricing intervals
and maturities of investments and loans, and emphasize the acquisition of fixed rate assets over floating rate assets. The Company does not
currently use financial derivatives, such as interest rate options, caps, floors or other similar instruments. Interest rate swaps are currently used to
accommodate large commercial borrowers desiring longer term fixed rates.
Run-off rate assumptions for loans are based on the consensus speeds for the various loan types. Investment speeds are based on the
characteristics of each individual investment. Re-pricing characteristics are based upon actual information obtained from the Bank’s information
system data and other related programs. Actual results may differ from simulated results not only due to the timing, magnitude and frequency of
interest rate changes, but also due to changes in general economic conditions, changes in customer preferences and behavior, and changes in
strategies by both existing and potential competitors.
49
The following table shows the Company’s current estimate of interest rate sensitivity based on the composition of its balance sheet at December 31,
2018. For purposes of this analysis, short-term interest rates as measured by the federal funds rate and the prime lending rate are assumed to
increase (decrease) gradually over the next twelve months reaching a level 300 basis points higher (and 100 basis points lower) than the rates in
effect at December 31, 2018. Because rates on the short end of the curve are below 3%, it is not practical to review results to the degree of 300 basis
points lower. Under both the rising rate scenario and the falling rate scenario, the yield curve is assumed to exhibit a parallel shift.
During 2018, the Federal Reserve raised the federal funds rate four times. At December 31, 2018, the difference between the yield on the ten-year
Treasury and the three-month Treasury substantially decreased to a positive 24 from the positive 101 basis points that existed at December 31, 2017,
indicating that the yield curve had flattened. At December 31, 2018, rates peaked at the 30-year point on the Treasury yield curve. The yield curve
remains only slightly positively sloping with some inversion in the mid terms.
The base case against which interest rate sensitivity is measured assumes no change in short-term rates. The base case also assumes no growth in
assets and liabilities and no change in asset or liability mix. Under these simulated conditions, the base case projects net interest income of $24.9
million for the year ending December 31, 2019.
Change in interest rates:
Graduated increase of +300 basis points
Short-term rates unchanged (base case)
Graduated decrease of -100 basis points
(Amounts in thousands)
December 31, 2019
Net Interest
Income
$ Change
% Change
$
26,674 $
24,934
24,311
1,740
7.0 %
(623 )
(2.5 )%
The level of interest rate risk indicated is within limits that management considers acceptable. However, given that interest rate movements can be
sudden and unanticipated and are increasingly influenced by global events and circumstances beyond the purview of the Federal Reserve, no
assurances can be made that interest rate movements will not impact key assumptions and parameters in a manner not presently embodied by the
model.
It is management’s opinion that hedging instruments currently available are not a cost effective means of controlling interest rate risk for the
Company. Accordingly, the Company does not currently use financial derivatives, such as interest rate options, swaps, caps, floors or other similar
instruments, but does utilize swaps to accommodate large commercial borrowers that desire longer term fixed rates.
IMPACT OF INFLATION
Consolidated financial information included herein has been prepared in accordance with U.S. Generally Accepted Accounting Principles, which
require the Company to measure financial position and operating results in terms of historical dollars. Changes in the relative value of money due to
inflation are generally not considered. Neither the price, timing nor magnitude of changes directly coincides with changes in interest rates.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk – Not applicable to the Company because it is a smaller reporting company.
50
Item 8. Financial Statements and Supplementary Data
Consolidated Financial Statements included in this Annual Report:
Management’s Annual Report on Internal Control Over Financial Reporting
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2018 and 2017
Consolidated Statements of Income for the Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017 and 2016
Notes to Consolidated Financial Statements
52
53
55
56
57
58
59
60
51
MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a significant deficiency (as defined in Public Company Accounting Oversight Board Auditing Standard No. 5), or a
combination of significant deficiencies, that results in there being more than a remote likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected on a timely basis by management or employees in the normal course of performing their
assigned functions.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018. In making this
assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) 2013
Internal Control-Integrated Framework. Based on this assessment, management believes that, as of December 31, 2018, the Company’s internal
control over financial reporting was effective.
S.R. Snodgrass, P.C. has audited the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018, as stated in
their report dated March 7, 2019.
/s/ James M. Gasior
James M. Gasior
President and Chief Executive Officer
(Principal Executive Officer)
Cortland, Ohio
March 7, 2019
/s/ David J. Lucido
David J. Lucido
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
Cortland, Ohio
March 7, 2019
52
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of Cortland Bancorp
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Cortland Bancorp and subsidiaries (the “Company”) as of December 31, 2018
and 2017; the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the
three years in the period ended December 31, 2018; and the related notes to the consolidated financial statements (collectively, the financial
statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31,
2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity
with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the
Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated
Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 7, 2019, which
expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s
financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with
respect to the Company, in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange
Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included
performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing
procedures that respond to those risks.
Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also
included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of
the financial statements. We believe that our audits provide a reasonable basis for our opinion.
We have served as the Company’s auditor since 2008.
/s/ S.R. Snodgrass, P.C.
S.R. Snodgrass, P.C.
Cranberry Township, Pennsylvania
March 7, 2019
53
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of Cortland Bancorp
Opinion on Internal Control over Financial Reporting
We have audited Cortland Bancorp and subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2018, based on
criteria established in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway
Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2018, based on criteria established in Internal Control – Integrated Framework, issued by the Committee of Sponsoring
Organizations of the Treadway Commission in 2013.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the
consolidated balance sheets of the Company as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive
income, changes in shareholders equity, and cash flows for each of the three years in the period ended December 31, 2018, of the Company, and our
report dated March 7, 2019, expressed an unqualified opinion.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting in the accompanying Management’s Annual Report on Internal Control over Financial
Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a
public accounting firm registered with the PCAOB and are required to be independent with respect to the Company, in accordance with U.S. federal
securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included
obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other
procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A
company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the
company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
/s/ S.R. Snodgrass, P.C.
S.R. Snodgrass, P.C.
Cranberry Township, Pennsylvania
March 7, 2019
54
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
December 31,
2018
December 31,
2017
ASSETS
Cash and due from banks
Interest-earning deposits
Total cash and cash equivalents
Investment securities available-for-sale (Note 2)
Regulatory stock (Note 2)
Loans held for sale
Total loans (Note 3)
Less allowance for loan losses (Note 3)
Net loans
Premises and equipment (Note 4)
Bank-owned life insurance
Other assets
Total assets
LIABILITIES
Noninterest-bearing deposits
Interest-bearing deposits (Note 5)
Total deposits
Securities sold under agreements to repurchase (Note 6)
Federal Home Loan Bank advances - short-term (Note 6)
Federal Home Loan Bank advances - long term (Note 6)
Subordinated debt (Note 7)
Other liabilities
Total liabilities
SHAREHOLDERS’ EQUITY
Common stock - $5.00 stated value - authorized 20,000,000 shares; issued 4,728,267
shares in 2018 and 2017; outstanding shares, 4,349,624 in 2018 and 4,420,136 in 2017
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Treasury stock, at cost, 378,643 shares in 2018 and 308,131 shares in 2017
Total shareholders’ equity
Total liabilities and shareholders’ equity
$
$
$
$
11,333 $
8,359
19,692
136,923
2,581
1,040
514,392
(4,198 )
510,194
10,202
15,711
18,323
714,666 $
136,886 $
467,533
604,419
2,206
12,000
16,000
5,155
9,968
649,748
23,641
20,984
31,089
(3,656 )
(7,140 )
64,918
714,666 $
9,741
9,384
19,125
159,841
2,581
2,780
487,490
(4,578 )
482,912
9,038
17,650
17,174
711,101
123,291
462,560
585,851
2,678
32,000
14,000
5,155
9,787
649,471
23,641
20,928
24,403
(1,825 )
(5,517 )
61,630
711,101
See accompanying notes to consolidated financial statements
55
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
For the years ended December 31,
2017
2018
2016
$
23,823 $
19,243 $
18,554
INTEREST INCOME
Interest and fees on loans
Interest and dividends on investment securities:
Taxable interest
Nontaxable interest
Dividends
Other interest income
Total interest and dividend income
INTEREST EXPENSE
Deposits
Short-term borrowings
Federal Home Loan Bank advances - short term
Federal Home Loan Bank advances - long term
Subordinated debt
Total interest expense
Net interest income
PROVISION FOR LOAN LOSSES (Note 3)
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
NON-INTEREST INCOME
Fees for customer services
Investment securities available-for-sale (losses) gains, net (Note 2)
Trading security losses, net (Note 2)
Mortgage banking gains, net
Earnings on bank-owned life insurance
Wealth management
Other real estate gains
Other non-interest income
Total non-interest income
NON-INTEREST EXPENSES
Salaries and employee benefits
Occupancy and equipment
State and local taxes
FDIC insurance
Professional fees
Advertising and marketing
Net losses from the extinguishment of debt
Data processing fees
Other operating expenses
Total non-interest expenses
INCOME BEFORE FEDERAL INCOME TAX EXPENSE
Federal income tax expense (Note 10)
NET INCOME
EARNINGS PER SHARE BASIC AND DILUTED (Note 1)
CASH DIVIDENDS DECLARED PER SHARE
$
$
$
See accompanying notes to consolidated financial statements
56
2,118
1,494
152
162
27,749
3,527
6
374
287
189
4,383
23,366
725
22,641
2,273
(21 )
—
974
1,869
39
—
558
5,692
10,260
2,232
493
176
879
322
—
250
3,471
18,083
10,250
1,415
8,835 $
2.03 $
0.49 $
2,098
1,922
131
98
23,492
2,571
7
175
299
138
3,190
20,302
100
20,202
2,241
7
—
1,074
1,203
35
170
436
5,166
10,631
2,331
463
199
786
478
—
251
3,462
18,601
6,767
2,417
4,350 $
0.99 $
0.39 $
2,026
1,814
117
44
22,555
2,093
7
73
633
112
2,918
19,637
50
19,587
2,103
466
(47 )
1,248
328
95
13
391
4,597
10,169
2,151
455
251
882
527
242
250
3,259
18,186
5,998
1,127
4,871
1.11
0.28
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
Net income
Other comprehensive (loss) income:
Securities available for sale:
Unrealized holding (losses) gains on available-for-sale securities
Tax effect
Reclassification adjustment for net losses (gains) realized in net income
Tax effect
Total securities available-for-sale
Change in post-retirement obligations
Total other comprehensive (loss) income
Total comprehensive income
For the years ended December 31,
2018
2017
2016
$
8,835
$
4,350
$
4,871
(2,426 )
510
21
(4 )
(1,899 )
68
(1,831 )
7,004 $
$
2,153
(733 )
(7 )
3
1,416
14
1,430
5,780 $
(3,719 )
1,265
(466 )
158
(2,762 )
39
(2,723 )
2,148
See accompanying notes to consolidated financial statements
57
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Amounts in thousands, except per share data)
Common
Stock
Additional
Paid-in
Capital
Retained
Earnings
Accumulated Other
Comprehensive (Loss)
Income
Treasury
Stock
Total
Shareholders'
Equity
Balance at December 31, 2015
$
Net income
Other comprehensive loss
Cash dividend declared ($0.28 per share)
Equity compensation
Balance at December 31, 2016
Net income
Other comprehensive income
Reclassification of certain income tax effects
from accumulated other comprehensive income
Cash dividend declared ($0.39 per share)
Treasury shares purchased (13,463 shares)
Equity compensation
Balance at December 31, 2017
Net income
Other comprehensive loss
Cash dividend declared ($0.49 per share)
Treasury shares purchased (82,637 shares)
Equity compensation
Balance at December 31, 2018
23,641 $
—
—
—
—
23,641
—
—
20,833 $
—
—
—
45
20,878
—
—
17,851 $
4,871
—
(1,237 )
—
21,485
4,350
—
—
—
—
—
23,641
—
—
—
—
—
294
(1,726 )
—
—
24,403
8,835
—
(2,149 )
—
—
$ 23,641 $ 20,984 $ 31,089 $
—
—
—
50
20,928
—
—
—
—
56
(238 ) $
—
(2,723 )
—
—
(2,961 )
—
1,430
(294 )
—
—
—
(1,825 )
—
(1,831 )
—
—
—
(3,656 ) $
(5,403 ) $
—
—
—
30
(5,373 )
—
—
56,684
4,871
(2,723 )
(1,237 )
75
57,670
4,350
1,430
—
—
(247 )
103
(5,517 )
—
—
—
(1,781 )
158
—
(1,726 )
(247 )
153
61,630
8,835
(1,831 )
(2,149 )
(1,781 )
214
(7,140 ) $ 64,918
See accompanying notes to consolidated financial statements
58
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
Net cash flow from operating activities
Net income
Adjustments to reconcile net income to net cash flow from operating activities:
Depreciation, amortization and accretion
Provision for loan losses
Investment securities available-for-sale losses (gains), net
Originations of mortgage banking loans held for sale
Proceeds from the sale of mortgage banking loans
Mortgage banking gains, net
Decrease in trading account
Earnings on bank-owned life insurance
Other real estate gains
Changes in:
Interest receivable
Interest payable
Deferred taxes
Equity compensation
Federal income tax receivable
Other assets and liabilities
Net cash flow from operating activities
Cash deficit from investing activities
Purchases of available-for-sale securities
Proceeds from sale of available-for-sale securities
Proceeds from call, maturity and principal payments
on available-for-sale securities
Net increase in loans made to customers
Proceeds from sale of other real estate
Proceeds from bank-owned life insurance
Purchases of bank-owned life insurance
Contributions to partnership funds
Purchases of premises and equipment
Net cash deficit from investing activities
Cash flow from financing activities
Net increase in deposit accounts
Net change in short-term borrowings
Net change in Federal Home Loan Bank advances - short term
Proceeds from Federal Home Loan Bank advances - long term
Repayments of Federal Home Loan Bank advances - long term
Dividends paid
Treasury shares purchased
Net cash (deficit) flow from financing activities
Net change in cash and cash equivalents
Cash and cash equivalents
Beginning of period
End of period
Supplemental disclosures:
Cash paid during the period for:
Income taxes
Interest
Transfer of loans to other real estate owned
2018
For the years ended December 31,
2017
2016
$
8,835 $
4,350 $
4,871
2,315
725
21
(45,813 )
48,527
(974 )
—
(1,869 )
—
(62 )
46
1,008
214
(625 )
786
13,134
(14,643 )
21,418
12,173
(28,007 )
—
3,808
—
(1,547 )
(1,935 )
(8,733 )
18,568
(472 )
(20,000 )
8,000
(6,000 )
(2,149 )
(1,781 )
(3,834 )
567
2,735
100
(7 )
(51,730 )
54,578
(1,074 )
—
(1,203 )
(170 )
(152 )
37
1,218
143
(243 )
551
9,133
(44,962 )
44,801
17,255
(68,592 )
650
1,829
(900 )
(4,152 )
(802 )
(54,873 )
46,001
(24 )
9,000
12,000
(15,500 )
(1,726 )
(237 )
49,514
3,774
$
$
$
$
19,125
19,692
$
15,351
19,125
$
600 $
4,339 $
— $
1,050 $
3,153 $
480 $
2,770
50
(466 )
(61,003 )
61,730
(1,248 )
8,134
(328 )
(13 )
(401 )
33
(129 )
75
281
(254 )
14,102
(103,032 )
50,862
21,203
(25,937 )
121
280
—
(857 )
(799 )
(58,159 )
43,446
203
6,000
2,000
(9,500 )
(1,237 )
—
40,912
(3,145 )
18,496
15,351
625
2,885
47
See accompanying notes to consolidated financial statements
59
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and financial reporting policies of Cortland Bancorp (the Company), and its bank subsidiary, The Cortland Savings and Banking
Company (the Bank), reflect banking industry practices and conform to U.S. generally accepted accounting principles. A summary of the significant
accounting policies followed by the Company in the preparation of the accompanying consolidated financial statements is set forth below.
Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, the
Bank, CSB Mortgage Company, Inc. (dormant) and New Resources Leasing Co. (dormant). All significant intercompany balances and transactions
have been eliminated.
Industry Segment Information: The Company and its subsidiaries operate in the domestic banking industry which accounts for substantially all of
the Company’s assets, revenues and operating income. The Company, through the Bank, grants residential, consumer, and commercial loans and
offers a variety of saving plans to customers located primarily in the Northeastern Ohio and Western Pennsylvania area. Based on the analysis
performed by the Company, management has determined that the Company only has one operating segment, which is commercial banking. The
chief operating decision-makers use consolidated results to make operating and strategic decisions, and therefore are not required to disclose any
additional segment information.
Use of Estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 Consolidated Balance Sheet and the reported amounts of revenue and expenses during the reporting period. Actual results could differ
from those estimates.
Cash Flow: Cash and cash equivalents include cash on hand and amounts due from banks, both interest and non-interest bearing, but excludes the
liquid portion of the securities trading account. The Company reports net cash flows for customer loan transactions, deposit transactions and
deposits made with other financial institutions.
Investment Securities: Investments in debt securities are classified as held-to-maturity, available-for-sale or trading. Securities classified as held-to-
maturity are those that management has the positive intent and ability to hold to maturity. Securities classified as available-for-sale are those that
could be sold for liquidity, investment management, or similar reasons, even though management has no present intentions to do so. Securities
classified as trading are those that management has bought principally for the purpose of selling in the near term. The Company currently has no
securities classified as held-to-maturity or trading.
Available-for-sale securities are carried at fair value with unrealized gains and losses recorded as a separate component of shareholders’ equity, net
of tax. Realized gains or losses on dispositions are based on net proceeds and the adjusted carrying amount of securities sold, using the specific
identification method. Interest income includes amortization of purchase premium or discount and is amortized on the level-yield method without
anticipating payments, except for U.S. Government mortgage-backed and related securities where twelve months of historical prepayments are taken
into consideration.
The regulatory stock is carried at cost (its redeemable value) and the Company is required to hold such investments as a condition of membership in
order to transact business with the Federal Home Loan Bank (FHLB) of Cincinnati and the Federal Reserve Bank (FRB). The stock is bought from
and sold based upon its par value. The stock cannot be traded or sold in any market and as such is classified as restricted stock, carried at cost (its
redeemable value) and evaluated by management. The stock’s value is determined by the ultimate recoverability of the par value rather than by
recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the
following: (a) the significance of the decline in net assets of the FHLB and FRB as compared to the capital stock amount and the length of time this
situation has persisted, (b) commitments by the FHLB and FRB to make payments required by law or regulation and the level of such payments in
relation to the operating performance, (c) the impact of legislative and regulatory changes on the customer base of the FHLB and FRB and (d) the
liquidity position of the FHLB and FRB. The Company does not consider these investments to be other-than-temporarily impaired at December 31,
2018.
Other-than-Temporary Investment Security Impairment: Securities are evaluated periodically to determine whether a decline in value is other-than-
temporary. Management utilizes criteria such as the magnitude and duration of the decline, along with the reasons underlying the decline, to
determine whether the loss in value is other-than-temporary. The term “other-than-temporary” is not intended to indicate that the decline in value is
permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable and that there is a lack of evidence to
support a realizable value equal to or greater than the carrying value of the investment. Unrealized losses on available-for-sale investments have not
been recognized into income. However, once a decline in value is determined to be other-than-temporary, the credit related other-than-temporary
impairment (OTTI) is recognized in earnings while the non-credit related OTTI on securities not expected to be sold is recognized in other
comprehensive income (loss). Unrealized losses on trading securities are recognized in the Consolidated Statements of Income.
60
Loans: Loans are stated at the principal amount outstanding net of the unamortized balance of deferred loan origination fees and costs. Deferred
loan origination fees and costs are amortized as an adjustment to the related loan yield over the contractual life using the level-yield method.
Interest income on loans is accrued over the term of the loans based on the amount of principal outstanding. The accrual of interest is discontinued
on a loan when management determines that the collection of interest is doubtful. Generally, a loan is placed on non-accrual status once the
borrower is 90 days past due on payments, or whenever sufficient information is received to question the collectability of the loan or any time legal
proceedings are initiated involving a loan. Interest income accrued up to the date a loan is placed on non-accrual is reversed through interest
income. Cash payments received while a loan is classified as non-accrual are recorded as a reduction to principal or reported as interest income
according to management’s judgment as to the collectability of principal. A loan is returned to accrual status when either all of the principal and
interest amounts contractually due are brought current and future payments are, in management’s judgment, collectable, or when it otherwise
becomes well secured and in the process of collection. When a loan is charged-off, any interest accrued but not collected on the loan is charged
against earnings. The same treatment is applied to impaired loans, which means that it is probable that all amounts will not be collected according to
the contractual terms of the loan agreement.
Loans Held for Sale: The Company originates certain residential mortgage loans for sale in the secondary mortgage loan market. The Company
concurrently sells the rights to service the related loans. These loans are classified as loans held for sale, and carried at the estimated fair value
based on secondary market prices. Adjustments to the fair value of loans held for sale are included in “mortgage banking gains” in the
Consolidated Statements of Income. Deferred fees and costs related to loans held for sale are not amortized, but included in the cost basis at the
time of sale.
Allowance for Loan Losses (ALLL) and Allowance for Losses on Lending Related Commitments: Management establishes the allowance for loan
losses based upon its evaluation of the pertinent factors underlying the types and quality of loans in the portfolio. Commercial loans and
commercial real estate loans are reviewed on a regular basis with a focus on larger loans, along with loans which have experienced past payment or
financial deficiencies. Larger commercial loans and commercial real estate loans are evaluated for impairment in accordance with the Bank’s loan
review policy. These loans are analyzed to determine if they are impaired. All loans that are delinquent 90 days and are placed on non-accrual status
are evaluated on an individual basis. Allowances for loan losses on impaired loans are determined using the estimated future cash flows of the loan,
discounted to their present value using the loan’s effective interest rate, or in most cases, the estimated fair value of the underlying collateral. If the
analysis indicates a collection shortfall, a specific reserve is allocated to loans on an individual basis which are reviewed for impairment. The
remaining loans are evaluated and classified as groups of loans with similar risk characteristics.
Estimating the risk of loss and the amount of loss on any loan is necessarily subjective. Accordingly, the allowance is maintained by management at
a level considered adequate to cover possible losses that are currently anticipated. Estimates of credit losses should reflect consideration of all
significant factors that affect collectability of the portfolio. While historical loss experience provides a reasonable starting point, historical losses, or
even recent trends in losses are not, by themselves, a sufficient basis to determine the appropriate level for the ALLL. Management will also
consider any factors that are likely to cause estimated credit losses associated with the Bank’s current portfolio to differ from historical loss
experience. Factors include, but are not limited to, changes in lending policies and procedures, including underwriting standards and collection,
charge-offs, and recovery practices; changes in economic trends; changes in the nature and volume of the portfolio; changes in the experience and
ability of lending management and the depth of staff; changes in the trend, volume and severity of past-due and classified loans, and trends in the
volume of non-accrual loans; the existence and effect of any concentrations of credit and changes in the level of such concentrations; levels and
trends in classification; declining trends in performance; structure and lack of performance measures and migration between risk classifications.
Key risk factors and assumptions are updated to reflect actual experience and changing circumstances. While management may periodically allocate
portions of the ALLL for specific problem loans, the entire ALLL is available for any charge-offs that occur.
Certain collateral dependent loans are evaluated individually for impairment, based on management’s best estimate of discounted cash repayments
and the anticipated proceeds from liquidating collateral. The actual timing and amount of repayments and the ultimate realizable value of the
collateral may differ from management’s estimates.
The expected loss for certain other commercial credits utilizes internal risk ratings. These loss estimates are sensitive to changes in the customer’s
risk profile, the realizable value of collateral, other risk factors and the related loss experience of other credits of similar risk. Consumer credits
generally employ statistical loss factors, adjusted for other risk indicators, applied to pools of similar loans stratified by asset type. These loss
estimates are sensitive to changes in delinquency status and shifts in the aggregate risk profile.
61
The Company maintains an allowance for losses on unfunded commercial lending commitments to provide for the risk of loss inherent in these
arrangements. The allowance is computed using a methodology similar to that used to determine the allowance for loan losses. This allowance is
reported as a liability on the Consolidated Balance Sheets within other liabilities, while the corresponding provision for these losses is recorded as a
component of other operating expense.
Loan Charge-off Policies: Consumer loans are generally fully or partially charged down to the fair value of collateral securing the asset prior to the
loan becoming 180 days past due, unless the loan is well secured and in the process of collection. All other loans are generally charged down to the
net realizable value when the loan is 90 days past due.
Troubled Debt Restructurings (TDR): A loan is classified as a TDR when management grants a concession for other than an insignificant period of
time to the borrower that would not otherwise be considered, except in situations of economic difficulties. Management strives to identify
borrowers in financial difficulty early and work with them to modify to more affordable terms before their loan reaches non-accrual status. These
modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss
and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of either
interest or principal, management measures any impairment on the restructuring as noted above for impaired loans. In addition to the allowance for
the pooled portfolios, management has developed a separate allowance for loans that are identified as impaired through a TDR. These loans are
excluded from pooled loss forecasts and a separate reserve is provided under the accounting guidance for loan impairment.
Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is
computed generally on the straight-line method over the estimated useful lives (5 to 40 years) of the various assets. Maintenance and repairs are
expensed and major improvements are capitalized.
Other Real Estate: Real estate acquired through foreclosure or deed-in-lieu of foreclosure is included in other assets on the Consolidated Balance
Sheets. Such real estate is carried at fair value less estimated costs to sell. Any reduction from the carrying value of the related loan to fair value at
the time of acquisition is accounted for as a loan loss. Any subsequent reduction in fair value is reflected as a valuation allowance through a charge
to income. Costs of significant property improvements are capitalized, whereas costs relating to holding and maintaining the property are charged to
expense.
Cash Surrender Value of Life Insurance: Bank-owned life insurance (BOLI) represents life insurance on the lives of certain Company employees,
officers and directors who have provided positive consent allowing the Company to be the co-beneficiary of such policies. Since the Company is
the owner of the insurance policies, increases in the cash value of the policies, as well as its share of insurance proceeds received, are recorded in
noninterest income, and are not subject to income taxes. The cash surrender value of the policies is included on the Consolidated Balance Sheets.
The Company reviews the financial strength of the insurance carriers prior to the purchase of BOLI and quarterly thereafter. The amount of BOLI
with any individual carrier is limited to 15% of Tier I Capital. The Company has purchased BOLI to provide a long-term asset to offset long-term
benefit liabilities, while generating competitive investment yields.
Endorsement Split-Dollar Life Insurance Arrangement: The Company maintains a liability for the death benefit promised under split-dollar life
insurance arrangements.
Derivative Instruments: The Company enters into contracts for the future delivery of residential mortgage loans when interest rate locks are entered
into in order to economically hedge potential adverse effects of changes in interest rates. These contracts are derivative instruments. All derivative
instruments are recognized as either other assets or other liabilities at fair value in the Consolidated Balance Sheets.
Advertising and Marketing: The Company expenses advertising and marketing costs as incurred.
Income Taxes: A deferred tax liability or asset is determined at each balance sheet date. It is measured by applying currently enacted tax laws to
future amounts that result from differences in the financial statement and tax bases of assets and liabilities.
Other Comprehensive (Loss) Income: Accumulated other comprehensive (loss) income for the Company is comprised of unrealized holding (losses)
gains on available-for-sale securities, net of tax, and post-retirement obligations.
Per Share Amounts: Earnings per share is computed by dividing net income available to common shareholders by the weighted average number of
shares of common stock outstanding, net of any treasury shares, during the period. Diluted earnings per share is calculated by dividing net income
available to common shareholders by the weighted average number of shares of common stock outstanding, net of any treasury shares, after
consideration of the potential dilutive effect of common stock equivalents, based upon the treasury stock method using an average market price for
the period. The common stock equivalents are derived from unvested restricted share awards.
62
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 Company, (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 Company does not
maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
The following table sets forth the computation of basic earnings per common share:
Net income (amounts in thousands)
Weighted average common shares outstanding
Net effect of dilutive common share equivalents
Adjusted average shares outstanding - dilutive
Basic earnings per share
Dilutive earnings per share
Years ended December 31,
2018
2017
2016
$
$
$
$
8,835 $
4,357,760
6,474
4,364,234 $
2.03 $
2.03 $
4,350 $
4,407,254
4,220
4,411,474 $
0.99 $
0.99 $
4,871
4,406,005
1,264
4,407,269
1.11
1.11
Off-Balance Sheet Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans
and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before
considering customer collateral or ability to repay. Such financial instruments are recorded if and when they
are funded.
Revenue Recognition: Effective January 1, 2018, the Company adopted ASU 2014-09 Revenue from Contracts with Customers – Topic 606 and all
subsequent ASUs that modified ASC 606. The Company has elected to apply the standard utilizing the modified retrospective approach with a
cumulative effect of adoption for the impact from uncompleted contracts at the date of adoption. The implementation of the new standard had no
material impact to the measurement or recognition of revenue of prior periods.
Management determined that the primary sources of revenue emanating from interest income on loans and investments along with noninterest
revenue resulting from investment security gains, gains on the sale of loans, earnings on bank owned life insurance, wealth management and other
non-interest income are not within the scope of ASC 606. As a result, no changes were made during the period related to these sources of revenue.
The main types of non-interest income within the scope of the standard are as follows:
Service charges on deposit accounts – The Company has contracts with its deposit customers where fees are charged if the account balance falls
below predetermined levels defined as compensating balances. These agreements can be cancelled at any time by either the Company or the
deposit customer. Revenue from these transactions is recognized on a monthly basis as the Company has an unconditional right to the fee
consideration. The Company also has transaction fees related to specific transactions or activities resulting from a customer request or activity that
include non-sufficient fund fees, overdraft fees, continuous overdraft fees and other fees such as stop payment fees. All of these fees are
attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time, namely at the completion
of the requested service/transaction.
Fees, exchange, and other service charges- This is primarily comprised of debit card income, ATM fees, merchant services income, and other
service charges. Debit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed
through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-
Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit card
transactions, in addition to account management fees. Other service charges include cashier’s checks, check charges and other services. The
Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the
services are rendered or upon completion. Payment is typically received immediately or in the following month.
Gains (losses) on sale of other real estate owned – Gains and losses are recognized at the completion of the property sale when the buyer obtains
control of the real estate and all of the performance obligations of Company have been satisfied. Evidence of the buyer obtaining control of the
asset include transfer of the property title, physical possession of the asset, and the buyer obtaining control of the risks and rewards related to the
asset. In situations where the Company agrees to provide financing to facilitate the sale, additional analysis is performed to ensure that the contract
for sale identifies the buyer and seller, the asset to be transferred, payment terms, and that the contract has a true commercial substance and that
collection of amounts due from the buyer is reasonable. In situations where financing terms are not reflective of current market terms, the
transaction price is discounted impacting the gain/loss and the carrying value of the asset
63
The following table depicts the disaggregation of revenue derived from contracts with customers to depict the nature, amount, timing, and
uncertainty of revenue and cash flows.
Revenue stream
Service charges on deposit accounts:
Overdraft fees
Service charges
Other fees
Fees, exchange, and other service charges
Non-interest income (in-scope of Topic 606)
Non-interest income (out-of-scope of Topic 606)
Total non-interest income
(Amounts in thousands)
Year Ended
December 31, 2018
$
$
1,084
408
16
765
2,273
3,419
5,692
Reclassifications: Certain items in the financial statements for 2017 and 2016 have been reclassified to conform to the 2018 presentation. Such
reclassifications did not affect net income or shareholders’ equity.
Authoritative Accounting Guidance:
In January 2016, the FASB issued ASU (Accounting Standard Update) 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition
and Measurement of Financial Assets and Financial Liabilities. This Update applies to all entities that hold financial assets or owe financial
liabilities and is intended to provide more useful information on the recognition, measurement, presentation, and disclosure of financial
instruments. Among other things, this Update (a) requires equity investments (except those accounted for under the equity method of accounting
or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (b) simplifies
the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify
impairment; (c) eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not
public business entities; (d) eliminates the requirement for public business entities to disclose the method(s) 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; (e) requires public
business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (f) 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 (g) clarifies that an entity should evaluate the need for
a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets.
The Company’s adoption of this standard during the reporting period had no effect on the Consolidated Financial Statements. On a prospective
basis, the Company implemented changes to the measurement of the fair value of financial instruments using an exit price notion for disclosure
purposes included in Note 9 to the financial statements. The December 31, 2017, fair value of each class of financial instruments disclosure did not
utilize the exit price notion when measuring fair value and, therefore, would not be comparable to the December 31, 2018 disclosure.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The standard requires lessees to recognize the assets and liabilities that arise
from leases on the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease
liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. A short-term lease is defined as one in which
(a) the lease term is 12 months or less and (b) there is not an option to purchase the underlying asset that the lessee is reasonably certain to
exercise. For short-term leases, lessees may elect to recognize lease payments over the lease term on a straight-line basis. For public business
entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those years. For
all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal
years beginning after December 15, 2020. The amendments should be applied at the beginning of the earliest period presented using a modified
retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period. The Company is currently
assessing the practical expedients it may elect at adoption, but does not anticipate the amendments will have a significant impact on the financial
statements. Based on the Company’s preliminary analysis of its current portfolio, the impact to the Company’s balance sheet is estimated to result
in approximately $2 million, or less than 0.3%, increase in assets and liabilities. The Company also anticipates additional disclosures to be provided
at adoption.
64
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments
(“ASU 2016-13”), which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring
timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying
premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through
an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current
estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be effected for the
measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that
have taken place during the period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is
permitted for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be
through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is
adopted. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of
operations. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first
reporting period in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall
impact of the new guidance on the consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash
Payments (“ASU 2016-15”), which addresses eight specific cash flow issues with the objective of reducing diversity in practice. Among these
include recognizing cash payments for debt prepayment or debt extinguishment as cash outflows for financing activities; cash proceeds received
from the settlement of insurance claims should be classified on the basis of the related insurance coverage; and cash proceeds received from the
settlement of bank-owned life insurance policies should be classified as cash inflows from investing activities while the cash payments for
premiums on bank-owned policies may be classified as cash outflows for investing activities, operating activities, or a combination of investing and
operating activities. The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2017,
and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2018,
and interim periods within fiscal years beginning after December 15, 2019. Early adoption is permitted, including adoption in an interim period. If an
entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes
that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The amendments in this Update
should be applied using a retrospective transition method to each period presented. If it is impracticable to apply the amendments retrospectively
for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. The Company has
adopted the standard. See the Company’s Consolidated Statements of Cash Flows.
In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20). The amendments in this
Update shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be
amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to
be amortized to maturity. For public business entities, the amendments in this Update are effective for fiscal years, and interim periods within those
fiscal years, beginning after December 15, 2018. For all other entities, the amendments are effective for fiscal years beginning after December 15,
2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted, including adoption in an interim period.
If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that
includes that interim period. An entity should apply the amendments in this Update on a modified retrospective basis through a cumulative-effect
adjustment directly to retained earnings as of the beginning of the period of adoption. Additionally, in the period of adoption, an entity should
provide disclosures about a change in accounting principle. This Update is not expected to have a significant impact on the Company’s financial
statements.
In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718), which affects any entity that changes the terms or
conditions of a share-based payment award. This Update amends the definition of modification by qualifying that modification accounting does
not apply to changes to outstanding share-based payment awards that do not affect the total fair value, vesting requirements, or equity/liability
classification of the awards. The amendments in this Update are effective for all entities for annual periods, and interim periods within those annual
periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for (1) public business entities for
reporting periods for which financial statements have not yet been issued and (2) all other entities for reporting periods for which financial
statements have not yet been made available for issuance. The amendments in this Update should be applied prospectively to an award modified on
or after the adoption date. The Company has adopted this standard and has no significant impact on the Company’s financial statements.
65
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 850), the objective of which is to improve the financial reporting
of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. In addition, the
amendments in this Update make certain targeted improvements to simplify the application and disclosure of the hedge accounting guidance in
current general accepted accounting principles. For public business entities, the amendments in this Update are effective for fiscal years beginning
after December 15, 2018, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning
after December 15, 2019, and interim periods beginning after December 15, 2020. Early application is permitted in any period after issuance. For cash
flow and net investment hedges existing at the date of adoption, an entity should apply a cumulative-effect adjustment related to eliminating the
separate measurement of ineffectiveness to accumulated other comprehensive income with a corresponding adjustment to the opening balance of
retained earnings as of the beginning of the fiscal year that an entity adopts the amendments in this Update. The amended presentation and
disclosure guidance is required only prospectively. This Update is not expected to have a significant impact on the Company’s financial statements.
In January 2018, the FASB issued ASU 2018-01, Leases (Topic 842), which provides an optional transition practical expedient to not evaluate under
Topic 842 existing or expired land easements that were not previously accounted for as leases under the current lease guidance in Topic 840. An
entity that elects this practical expedient should evaluate new or modified land easements under Topic 842 beginning at the date the entity adopts
Topic 842; otherwise, an entity should evaluate all existing or expired land easements in connection with the adoption of the new lease requirements
in Topic 842 to assess whether they meet the definition of a lease. The effective date and transition requirements for the amendments are the same
as the effective date and transition requirements in ASU 2016-02. This Update is not expected to have a significant impact on the Company’s
financial statements.
In February 2018, the FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220). On December 22, 2017, the
U.S. federal government enacted a tax bill, H.R.1, An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on
the Budget for Fiscal Year 2018 (Tax Cuts and Jobs Act), which requires deferred tax liabilities and assets to be adjusted for the effect of a change
in tax laws. The amendments in this Update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded
tax effects resulting from the Tax Cuts and Jobs Act. The amendments in this Update are effective for all entities for fiscal years beginning after
December 15, 2018, and interim periods within those fiscal years. Early adoption of the amendments in this Update is permitted. The amendments in
this Update should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the
U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. The Company has elected to early adopt this standard as of
December 31, 2017, which resulted in a one-time cumulative effect adjustment of $294,000 between retained earnings and accumulated other
comprehensive loss on the Consolidated Balance Sheets. The adjustment had no impact on net income or any prior periods presented.
In June 2018, the FASB issued ASU 2018-07, Compensation – Stock Compensation (Topic 718), which simplified the accounting for nonemployee
share-based payment transactions. The amendments in this update expand the scope of Topic 718 to include share-based payment transactions for
acquiring goods and services from nonemployees. The amendments in this Update improve the following areas of nonemployee share-based
payment accounting; (a) the overall measurement objective, (b) the measurement date, (c) awards with performance conditions, (d) classification
reassessment of certain equity-classified awards, (e) calculated value (nonpublic entities only), and (f) intrinsic value (nonpublic entities only). The
amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods
within that fiscal year. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods
within fiscal years beginning after December 15, 2020. This Update is not expected to have a significant impact on the Company’s financial
statements.
ASU 2018-10, Codification Improvements to Topic 842, Leases, represents changes to clarify, correct errors in, or make minor improvements to the
Codification. The amendments in this ASU affect the amendments in ASU 2016-02, which are not yet effective, but for which early adoption upon
issuance is permitted. For entities that early adopted Topic 842, the amendments are effective upon issuance of this ASU, and the transition
requirements are the same as those in Topic 842. For entities that have not adopted Topic 842, the effective date and transition requirements will be
the same as the effective date and transition requirements in Topic 842. This Update is not expected to have a significant impact on the Company’s
financial statements.
66
In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements. This Update provides another transition method which
allows entities to initially apply ASC 842 at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained
earnings in the period of adoption. Entities that elect this approach should report comparative periods in accordance with ASC 840, Leases. In
addition, this Update provides a practical expedient under which lessors may elect, by class of underlying assets, to not separate nonlease
components from the associated lease component, similar to the expedient provided for lessees. However, the lessor practical expedient is limited to
circumstances in which the nonlease component or components otherwise would be accounted for under the new revenue guidance and both (a)
the timing and pattern of transfer are the same for the nonlease component(s) and associated lease component and (b) the lease component, if
accounted for separately, would be classified as an operating lease. If the nonlease component or components associated with the lease component
are the predominant component of the combined component, an entity should account for the combined component in accordance with ASC 606,
Revenue from Contracts with Customers. Otherwise, the entity should account for the combined component as an operating lease in accordance
with ASC 842. If a lessor elects the practical expedient, certain disclosures are required. This Update is effective for public business entities for
fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. For all other entities, the
amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15,
2020. This Update is not expected to have a significant impact on the Company’s financial statements.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes the Disclosure
Requirements for Fair Value Measurements. The Update removes the requirement to disclose the amount of and reasons for transfers between
Level I and Level II of the fair value hierarchy; the policy for timing of transfers between levels; and the valuation processes for Level III fair value
measurements. The Update requires disclosure of changes in unrealized gains and losses for the period included in other comprehensive income
(loss) for recurring Level III fair value measurements held at the end of the reporting period and the range and weighted average of significant
unobservable inputs used to develop Level III fair value measurements. This Update is effective for all entities for fiscal years, and interim periods
within those fiscal years, beginning after December 15, 2019. This Update is not expected to have a significant impact on the Company’s financial
statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40). This Update
addresses customers’ accounting for implementation costs incurred in a cloud computing arrangement that is a service contract and also adds
certain disclosure requirements related to implementation costs incurred for internal-use software and cloud computing arrangements. The
amendment aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the
requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an
internal-use software license). This Update is effective for public business entities for fiscal years beginning after December 15, 2019, and interim
periods within those fiscal years, with early adoption permitted. For all other entities, the amendments are effective for fiscal years beginning after
December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. The amendments in this Update can be applied either
retrospectively or prospectively to all implementation costs incurred after the date of adoption. This Update is not expected to have a significant
impact on the Company’s financial statements.
In October 2018, the FASB issued ASU 2018-16, Derivatives and Hedging (Topic 815). The amendments in this Update permit use of the
Overnight Index Swap (OIS) rate based on the Secured Overnight Financing Rate (SOFR) as a U.S. benchmark interest rate for hedge accounting
purposes under Topic 815, in addition to the interest rates on direct Treasury obligations of the U.S. government, the London Interbank Offered
Rate (LIBOR) swap rate, the OIS rate based on the Fed Funds Effective Rate, and the Securities Industry and Financial Markets Association
(SIFMA) Municipal Swap Rate. For entities that have not already adopted Update 2017-12, the amendments in this Update are required to be
adopted concurrently with the amendments in Update 2017-12. For public business entities that already have adopted the amendments in Update
2017-12, the amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. For all other
entities that already have adopted the amendments in Update 2017-12, the amendments are effective for fiscal years beginning after December 15,
2019, and interim periods within those fiscal years. Early adoption is permitted in any interim period upon issuance of this Update if an entity
already has adopted Update 2017-12. This Update is not expected to have a significant impact on the Company’s financial statements.
67
NOTE 2 - INVESTMENT SECURITIES
The following is a summary of investment securities available-for-sale and regulatory stock:
December 31, 2018
U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed securities
U.S. Government-sponsored collateralized mortgage obligations
U.S. Government-guaranteed small business administration pools
Total investment securities available-for-sale
Federal Home Loan Bank (FHLB) stock
Federal Reserve Bank (FRB) stock
Total regulatory stock
December 31, 2017
U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed securities
U.S. Government-sponsored collateralized mortgage obligations
U.S. Government-guaranteed small business administration pools
Trust preferred securities
Total investment securities available-for-sale
Federal Home Loan Bank (FHLB) stock
Federal Reserve Bank (FRB) stock
Total regulatory stock
(Amounts in thousands)
Gross
Unrealized
Gains
Gross
Unrealized
Losses
11 $
26
—
41
—
78 $
— $
—
— $
251 $
1,555
2,483
177
278
4,744 $
— $
—
— $
(Amounts in thousands)
Gross
Unrealized
Gains
Gross
Unrealized
Losses
1 $
740
6
—
—
—
747 $
— $
—
— $
140 $
324
1,404
161
256
723
3,008 $
— $
—
— $
Fair Value
9,002
51,658
56,587
11,976
7,700
136,923
2,355
226
2,581
Fair Value
3,205
72,116
67,668
6,302
9,655
895
159,841
2,355
226
2,581
Amortized Cost
$
9,242 $
53,187
59,070
12,112
7,978
141,589 $
2,355 $
226
2,581 $
Amortized Cost
$
3,344 $
71,700
69,066
6,463
9,911
1,618
162,102 $
2,355 $
226
2,581 $
$
$
$
$
$
$
Trading securities historically had been an investment in obligations of states and political subdivisions, government and agency bonds, short-term
government bonds and included cash equivalent investments for trading liquidity. In the second quarter of 2016, management decided to cease its
trading activities and liquidated the investments that were in the trading account. The current interest rate and economic environment mitigated the
opportunities to generate revenues with a trading strategy. Both realized and unrealized gains and losses for the year ended December 31, 2016 are
included in the Consolidated Statements of Income.
Unrealized gains
Unrealized losses
Net unrealized gains
Net realized losses
Trading securities losses, net
68
(Amounts in thousands)
2016
$
$
—
—
—
(47 )
(47 )
The amortized cost and fair value of debt securities at December 31, 2018, by contractual maturity, are shown below. Actual maturities will differ
from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Total
U.S. Government-sponsored mortgage-backed and related securities
Total investment securities available for sale
(Amounts in thousands)
Amortized Cost
Fair Value
$
$
— $
481
11,894
58,032
70,407
71,182
141,589 $
—
486
11,563
56,311
68,360
68,563
136,923
The following table sets forth the proceeds, gains and losses realized on securities sold or called for each of the years ended December 31:
Proceeds on securities sold
Gross realized gains
Gross realized losses
2018
(Amounts in thousands)
2017
2016
$
21,418 $
123
144
44,801 $
524
517
50,862
725
259
Investment securities with a carrying value of approximately $55.1 million at December 31, 2018 and $105.0 million at December 31, 2017 were pledged
to secure deposits and for other purposes. The remaining securities provide an adequate level of liquidity.
The following is a summary of the fair value of securities with unrealized losses and an aging of those unrealized losses at December 31, 2018:
U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed
securities
U.S. Government-sponsored collateralized
mortgage obligations
U.S. Government-guaranteed small business
administration pools
Total
Less than 12 Months
(Amounts in thousands)
12 Months or More
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
$
3,280 $
23,616
6 $
567
2,755 $
24,607
245 $
988
6,035 $
48,223
251
1,555
1,598
18
54,989
2,465
56,587
2,483
—
—
5,350
177
5,350
177
—
28,494 $
$
—
591 $
7,700
95,401 $
278
7,700
4,153 $ 123,895 $
278
4,744
69
The above table represents 121 investment securities where the fair value is less than the related amortized cost.
The following is a summary of the fair value of securities with unrealized losses and an aging of those unrealized losses at December 31, 2017:
U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed
securities
U.S. Government-sponsored collateralized
mortgage obligations
U.S. Government-guaranteed small business
administration pools
Trust preferred securities
Total
Less than 12 Months
(Amounts in thousands)
12 Months or More
Total
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
$
— $
7,430
— $
24
2,860 $
18,066
140 $
300
2,860 $
25,496
140
324
24,888
241
40,968
1,163
65,856
1,404
—
—
6,302
161
6,302
161
2,532
—
34,850 $
$
38
—
303 $
7,123
895
76,214 $
218
723
2,705 $
9,655
895
111,064 $
256
723
3,008
The above table represents 83 investment securities where the current value is less than the related amortized cost.
The unrealized losses at December 31, 2018 on the Company’s investments were caused by changes in market rates and related spreads. The
significant increase in unrealized losses began in early 2018 as a direct result of the spike in interest rates immediately following the passage of the
Tax Act. It is expected that the securities would not be settled at less than the amortized cost of the Company’s investment because the decline in
fair value is attributable to changes in interest rates and relative spreads and not credit quality. Also, the Company does not intend to sell those
investments and it is not more-likely-than-not that the Company will be required to sell the investments before recovery of its amortized cost basis
less any current period credit loss. The Company does not consider these investments to be other-than-temporarily impaired at December 31, 2018.
Securities Deemed to be Other-Than-Temporarily Impaired
The Company reviews investment debt securities on an ongoing basis for the presence of other-than-temporary impairment (OTTI) with formal
reviews performed quarterly.
For debt securities in an unrealized loss position, management assesses whether (a) it has the intent to sell the debt security or (b) it is more-likely-
than-not that it will be required to sell the debt security before its anticipated recovery. If either of these conditions is met, an OTTI on the security
must be recognized.
In instances in which a determination is made that a credit loss (defined as the difference between the present value of the cash flows expected to
be collected and the amortized cost basis) exists but the entity does not intend to sell the debt security and it is not more-likely-than-not that the
entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis (i.e., the amortized cost basis
less any current-period credit loss), the Company presents the amount of the OTTI recognized in the Consolidated Statements of Income.
In these instances, the impairment is separated into (a) the amount of the total impairment related to the credit loss, and (b) the amount of the total
impairment related to all other factors. The amount of the total OTTI related to the credit loss is recognized in earnings. The amount of the total
impairment related to all other factors is recognized in other comprehensive income. The total other-than-temporary impairment is presented in the
Consolidated Statements of Income with an offset for the amount of the total other-than-temporary impairment that is recognized in other
comprehensive income.
70
The following provides a cumulative rollforward of credit losses recognized in earnings for trust preferred securities held.
Beginning balance
Reduction for debt securities for which other-than-temporary impairment has
been previously recognized and there is no related other comprehensive
income
Credit losses on debt securities for which other-than-temporary impairment
has not been previously recognized
Additional credit losses on debt securities for which other-than-temporary
impairment was previously recognized
Sale of debt securities
Ending balance
(Amounts in thousands)
December 31,
2018
2017
2016
$
140 $
140 $
140
—
—
—
(140 )
— $
—
—
—
—
140 $
$
—
—
—
—
140
At December 31, 2017, there was $895,000 of investment securities considered to be in non-accrual status due to the delay in the collection of
interest payments. This balance was comprised of two trust preferred securities which were disposed of in the second quarter of the current
calendar year.
NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES
The Company, through the Bank, grants residential, consumer and commercial loans to customers located primarily in Northeastern Ohio and
Western Pennsylvania.
The following represents the composition of the loan portfolio for the period ending:
Commercial
Commercial real estate
Residential real estate
Consumer - home equity
Consumer - other
Total loans
(Amounts in thousands)
December 31,
2018
2017
Balance
%
Balance
%
$
$
112,440
303,804
69,845
25,076
3,227
514,392
21.9 $
59.0
13.6
4.9
0.6
$
113,341
283,135
62,071
26,018
2,925
487,490
23.3
58.1
12.7
5.3
0.6
Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses
inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Company has segmented loans in the portfolio by
product type. Loans are segmented into the following pools: commercial loans, commercial real estate loans, residential real estate loans and
consumer loans. The pools of commercial real estate loans and commercial loans are also broken down further by industry sectors when analyzing
the related pools. Using the largest concentrations as the qualifier, these industry sectors include non-residential buildings; skilled nursing and
nursing care; residential real estate lessors, agents and managers; hotel and motels, and trucking. The Company also sub-segments the consumer
loan portfolio into the following two classes: home equity loans and other consumer loans. Historical loss percentages for each risk category are
calculated and used as the basis for calculating allowance allocations. These historical loss percentages are calculated over multiple periods for all
portfolio segments. Management evaluates these results and utilizes the most reflective period in the calculation. Certain qualitative factors are then
added to the historical allocation percentage to get the adjusted factor.
71
These factors include, but are not limited to, the following:
Factor Considered:
Levels of and trends in charge-offs, classifications and non-accruals
Trends in volume and terms
Changes in lending policies and procedures
Experience, depth and ability of management, including loan review function
Economic trends, including valuation of underlying collateral
Concentrations of credit
Risk Trend:
Stable
Stable
Stable
Stable
Increasing
Decreasing
The following factors are analyzed and applied to loans internally graded with higher risk credit in addition to the above factors for non-classified
loans:
Factor Considered:
Levels and trends in classification
Declining trends in financial performance
Structure and lack of performance measures
Migration between risk categories
Risk Trend:
Stable
Stable
Stable
Stable
The provision charged to operations can be allocated to a loan classification either as a positive or negative value as a result of any material
changes to: net charge-offs or recoveries which influence the historical allocation percentage, qualitative risk factors or loan balances.
The following is an analysis of changes in the allowance for loan losses for the periods ended:
December 31, 2018
Balance at beginning of period
Loan charge-offs
Recoveries
Net loan recoveries (charge-offs)
Provision charged to operations
Balance at end of period
December 31, 2017
Balance at beginning of period
Loan charge-offs
Recoveries
Net loan recoveries (charge-offs)
Provision charged to operations
Balance at end of period
December 31, 2016
Balance at beginning of period
Loan charge-offs
Recoveries
Net loan recoveries (charge-offs)
Provision charged to operations
Balance at end of period
(Amounts in thousands)
Commercial
real estate
Residential
real estate
Consumer -
home equity
Consumer -
other
Total
2,702 $
—
166
166
(454 )
2,414 $
117 $
—
3
3
194
314 $
70 $
—
5
5
40
115 $
98 $
(175 )
59
(116 )
141
123 $
4,578
(1,338 )
233
(1,105 )
725
4,198
(Amounts in thousands)
Commercial
real estate
Residential
real estate
Consumer -
home equity
Consumer -
other
Total
3,072 $
(654 )
—
(654 )
284
2,702 $
163 $
(14 )
5
(9 )
(37 )
117 $
150 $
(26 )
10
(16 )
(64 )
70 $
89 $
(146 )
47
(99 )
108
98 $
4,868
(840 )
450
(390 )
100
4,578
(Amounts in thousands)
Commercial
real estate
Residential
real estate
Consumer -
home equity
Consumer -
other
Total
2,926 $
(287 )
35
(252 )
398
3,072 $
153 $
(35 )
2
(33 )
43
163 $
52 $
(144 )
23
(121 )
219
150 $
86 $
(148 )
61
(87 )
90
89 $
5,194
(614 )
238
(376 )
50
4,868
Commercial
$
1,591 $
(1,163 )
—
(1,163 )
804
1,232 $
$
$
$
Commercial
$
1,394 $
—
388
388
(191 )
1,591 $
Commercial
$
1,977 $
—
117
117
(700 )
1,394 $
72
The total allowance reflects management’s estimate of loan losses inherent in the loan portfolio at the Consolidated Balance Sheet date.
The following tables present a full breakdown by portfolio classification, the changes in the allowance for loan losses and the recorded investment
in loans for the periods ended December 31, 2018 and 2017:
December 31, 2018
Commercial
Commercial
real estate
Residential
real estate
Consumer -
home equity
Consumer -
other
Total
(Amounts in thousands)
Allowance for loan losses:
Ending allowance balance
attributable to loans:
Individually evaluated for
impairment
Collectively evaluated for
impairment
Total ending allowance
balance
Loan Portfolio:
Individually evaluated for
impairment
Collectively evaluated for
impairment
Total ending loan balance
$
$
$
$
— $
— $
— $
— $
— $
—
1,232
2,414
314
115
123
4,198
1,232 $
2,414 $
314 $
115 $
123 $
4,198
5,364 $
4,340 $
— $
— $
— $
9,704
107,076
112,440 $
299,464
303,804 $
69,845
69,845 $
25,076
25,076 $
3,227
3,227 $
504,688
514,392
December 31, 2017
Commercial
Commercial
real estate
Residential
real estate
Consumer -
home equity
Consumer -
other
Total
(Amounts in thousands)
Allowance for loan losses:
Ending allowance balance
attributable to loans:
Individually evaluated for
impairment
Collectively evaluated for
impairment
Total ending allowance
balance
Loan Portfolio:
Individually evaluated for
impairment
Collectively evaluated for
impairment
Total ending loan balance
$
$
$
$
625 $
— $
— $
— $
— $
625
966
2,702
117
70
98
3,953
1,591 $
2,702 $
117 $
70 $
98 $
4,578
5,581 $
4,664 $
— $
— $
— $
10,245
107,760
113,341 $
278,471
283,135 $
62,071
62,071 $
26,018
26,018 $
2,925
2,925 $
477,245
487,490
The commercial charge-off in 2018 related to loans that were restructured with no principal forgiveness with a new borrowing relationship, but with
a substantial concession in interest rate. The below market rate triggered recognition of a charge-off equivalent to the difference in present value of
loan payments discounted at the market rate of interest. The charged off amount of $1.1 million is recorded as a loan discount. As loan payments
are made, interest will be recognized at the market rate versus the negotiated rate via the amortization of the discount over the various lives of the
loans. There was $625,000 in specific reserve previously allocated to these loans at December 31, 2017.
73
The decrease in the provision for commercial real estate loans in 2018 is due mainly to a decrease in the concentration of credit factor. The recent
segmentation of the commercial real estate loan portfolio into its five largest concentrations has resulted in lower allocations to those segments.
The consumer-home equity and other household provisions remained fairly constant. The residential real estate provision increased relative to local
economic factors. The amount of net charge-offs also impacts the provision charged to operations for any category of loans. Charge-offs affect the
historical rate applied to each category, and the amount needed to replenish the amount charged-off, which impacted home equity and consumer
loans as well as commercial real estate loans. Along with the impact of classified loans, the amount of net charge-offs impacts the provision charged
to operations for any category of loans. Charge-offs affect the historical rate applied to each category, and the amount needed to replenish the
charge off to the allowance.
The following tables represent credit exposures by internally assigned grades for years ended December 31, 2018 and 2017, respectively. The
grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The
Company’s internal credit risk grading system is based on experiences with similarly graded loans.
The Company’s internally assigned grades are as follows:
•
•
•
Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying
collateral. Within this category, there are grades of exceptional, quality, acceptable and pass monitor.
Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.
Substandard – loans that have a well-defined weakness based on objective evidence and are characterized by the distinct possibility
that the Bank will sustain some loss if the deficiencies are not corrected.
• Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset but with the severity which makes
collection in full highly questionable and improbable, based on existing circumstances.
•
Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted. This rating
does not mean that the assets have no recovery or salvage value but rather that the assets should be charged off now, even though
partial or full recovery may be possible in the future.
The following is a summary of credit quality indicators by internally assigned grade as of December 31, 2018 and 2017.
December 31, 2018
Pass
Special Mention
Substandard
Doubtful
Ending Balance
December 31, 2017
Pass
Special Mention
Substandard
Doubtful
Ending Balance
(Amounts in thousands)
Commercial
Commercial real estate
94,316 $
6,914
11,210
—
112,440 $
271,370
25,199
7,235
—
303,804
(Amounts in thousands)
Commercial
Commercial real estate
100,436 $
4,836
8,069
—
113,341 $
252,960
24,307
5,868
—
283,135
$
$
$
$
The Company evaluates the classification of consumer, home equity and residential loans primarily on a pooled basis. If the Company becomes
aware that adverse or distressed conditions exist that may affect a particular loan, the loan is downgraded following the above definitions of special
mention and substandard. Nonaccrual loans in these categories are evaluated for charge off or charge down, and the remaining balance has the
same allowance factor as pooled loans.
74
The following is a summary of consumer credit exposure as of December 31, 2018 and 2017.
December 31, 2018
Performing
Nonperforming
Total
December 31, 2017
Performing
Nonperforming
Total
Residential real
estate
(Amounts in thousands)
Consumer - home
equity
Consumer- other
$
$
69,535 $
310
69,845 $
24,956 $
120
25,076 $
3,227
—
3,227
Residential real
estate
(Amounts in thousands)
Consumer - home
equity
Consumer- other
$
$
61,824 $
247
62,071 $
25,889 $
129
26,018 $
2,925
—
2,925
Loans are considered to be nonperforming when they become 90 days past due or on nonaccrual status, though the Company may be receiving
partial payments of interest and partial repayments of principal on such loans. When a loan is placed in non-accrual status, previously accrued but
unpaid interest is recorded against interest income. Loans in foreclosure are considered nonperforming. At December 31, 2018, there were $288,000
of loans in the process of foreclosure.
The following is a summary of classes of loans on non-accrual status as of:
Commercial
Commercial real estate
Residential real estate
Consumer:
Consumer - home equity
Consumer - other
Total
(Amounts in thousands)
December 31,
2018
2017
$
$
1,291 $
512
310
120
—
2,233 $
—
506
247
129
—
882
Gross income that should have been recorded in income on nonaccrual loans was $191,000, $57,000 and $160,000 for the years ended December 31,
2018, 2017 and 2016, respectively. Actual interest included in income on these nonaccrual loans amounts to $42,000, $16,000 and $41,000 in 2018,
2017 and 2016, respectively.
Troubled Debt Restructuring
Nonperforming loans also include certain loans that have been modified in troubled debt restructurings (TDRs) where economic concessions have
been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the
Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or
other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after
considering the borrower’s sustained repayment performance for a reasonable period, generally six months.
75
There were no loans modified as TDRs during the years ended December 31, 2017 and 2016. The following presents, by class, information related to
loans modified in a TDR during the period ended December 31, 2018.
Commercial
Total restructured loans
Subsequently defaulted
(Dollar amounts in thousands)
December 31, 2018
Pre-
modification
recorded
investment
Post-
modification
recorded
investment
Number of
contracts
Increase in the
allowance
7 $
7 $
— $
5,373 $
5,373 $
—
4,210 $
4,210 $
—
—
The seven commercial loans were all to one new borrowing relationship. The loans were restructured with no principal forgiveness, but with a
substantial concession in interest rate. The below market rate triggered recognition of a charge-off equivalent to the difference in present value of
loan payments discounted at the market rate of interest. The charged off amount of $1.1 million is recorded as loan discount. As loan payments are
made, interest will be recognized at the market rate versus the negotiated rate via the amortization of the discount over the various lives of the loans.
The following is an aging analysis of the recorded investment of past due loans as of the periods ended December 31, 2018 and 2017:
30-59 Days
Past Due
60-89 Days
Past Due
90 Days Or
Greater
Total Past
Due
Current
Total Loans
Recorded
Investment >
90 Days and
Accruing
(Amounts in thousands)
$
$
14 $
—
36
—
17
67 $
— $
—
182
141
—
323 $
1,291 $
167
257
25
—
1,740 $
1,305 $
167
475
111,135 $
303,637
69,370
112,440 $
303,804
69,845
166
17
2,130 $
24,910
3,210
512,262 $
25,076
3,227
514,392 $
—
—
—
—
—
—
30-59 Days
Past Due
60-89 Days
Past Due
90 Days Or
Greater
Total Past
Due
Current
Total Loans
Recorded
Investment >
90 Days and
Accruing
(Amounts in thousands)
$
$
— $
173
240
—
15
428 $
— $
12
29
82
—
123 $
— $
390
216
28
—
634 $
— $
575
485
113,341 $
282,560
61,586
113,341 $
283,135
62,071
110
15
1,185 $
25,908
2,910
486,305 $
26,018
2,925
487,490 $
—
—
—
—
—
—
December 31, 2018
Commercial
Commercial real estate
Residential real estate
Consumer:
Consumer - home equity
Consumer - other
Total
December 31, 2017
Commercial
Commercial real estate
Residential real estate
Consumer:
Consumer - home equity
Consumer - other
Total
An impaired loan is a loan on which, based on current information and events, it is probable that a creditor will be unable to collect all amounts due
(including both interest and principal) according to the contractual terms of the loan agreement. However, an insignificant delay or insignificant
shortfall in amount of payments on a loan does not indicate that the loan is impaired.
When a loan is determined to be impaired, impairment should be measured based on the present value of expected future cash flows discounted at
the loan’s effective interest rate. However, as a practical expedient, the Company will measure impairment based on a loan’s observable market price,
or the fair value of the collateral if the loan is collateral dependent.
76
The following are the criteria for selecting individual loans / relationships for impairment analysis. Non-homogenous loans which meet the criteria
below are evaluated quarterly.
• All borrowers whose loans are classified doubtful by examiners and internal loan review
• All loans on non-accrual status
• Any loan in foreclosure
• Any loan with a specific reserve
• Any loan determined to be collateral dependent for repayment
•
Loans classified as troubled debt restructuring
Commercial loans and commercial real estate loans evaluated for impairment are excluded from the general pool of loans in the ALLL calculation
regardless if a specific reserve was determined. If management determines that the value of the impaired loan is less than the recorded investment in
the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an
allowance estimate or a charge-off to the allowance.
The following table presents the recorded investment and unpaid principal balances for impaired loans, excluding homogenous loans for which
impaired analyses are not necessarily performed, with the associated allowance amount, if applicable, at December 31, 2018 and 2017. Also
presented are the average recorded investments in the impaired balances and interest income recognized after impairment for the years ended
December 31, 2018, 2017 and 2016.
December 31, 2018
With no related allowance recorded:
Commercial
Commercial real estate
With an allowance recorded:
Commercial
Commercial real estate
Total:
Commercial
Commercial real estate
December 31, 2017
With no related allowance recorded:
Commercial
Commercial real estate
With an allowance recorded:
Commercial
Commercial real estate
Total:
Commercial
Commercial real estate
Recorded
Investment
(Amounts in thousands)
Unpaid Principal
Balance
Related Allowance
$
5,364 $
4,340
6,411 $
4,340
—
—
—
—
$
$
5,364 $
4,340 $
6,411 $
4,340 $
—
—
—
—
—
—
Recorded
Investment
(Amounts in thousands)
Unpaid Principal
Balance
Related Allowance
$
$
$
65 $
4,664
5,516
—
5,581 $
4,664 $
65 $
4,742
5,516
—
5,581 $
4,742 $
—
—
625
—
625
—
77
December 31, 2018
With no related allowance recorded:
Commercial
Commercial real estate
With an allowance recorded:
Commercial
Commercial real estate
Total:
Commercial
Commercial real estate
December 31, 2017
With no related allowance recorded:
Commercial
Commercial real estate
With an allowance recorded:
Commercial
Commercial real estate
Total:
Commercial
Commercial real estate
December 31, 2016
With no related allowance recorded:
Commercial
Commercial real estate
With an allowance recorded:
Commercial
Commercial real estate
Total:
Commercial
Commercial real estate
(Amounts in thousands)
Average Recorded
Investment
Interest Income
Recognized
4,231 $
4,405
911
—
5,142 $
4,405 $
25
293
46
—
71
293
(Amounts in thousands)
Average Recorded
Investment
Interest Income
Recognized
85 $
5,062
460
527
545 $
5,589 $
6
291
—
—
6
291
(Amounts in thousands)
Average Recorded
Investment
Interest Income
Recognized
146 $
6,072
279
1,209
425 $
7,281 $
8
335
—
85
8
420
$
$
$
$
$
$
$
$
$
78
NOTE 4 - PREMISES AND EQUIPMENT
The following is a summary of premises and equipment:
Land
Premises
Equipment
Leasehold improvements
Total premises and equipment
Less accumulated depreciation
Net book value
Depreciation expense was $771,000 in 2018, $880,000 in 2017 and $835,000 in 2016.
NOTE 5 - DEPOSITS
The following is a summary of interest-bearing deposits:
Demand
Money market
Savings
Time:
In denominations $250,000 or under
In denominations of over $250,000
Total
Stated maturities of time deposits were as follows:
2019
2020
2021
2022
2023
2024 and beyond
Total
$
$
$
$
(Amounts in thousands)
December 31,
2018
2017
2,984 $
10,346
10,760
480
24,570
14,368
10,202 $
2,746
9,914
9,711
264
22,635
13,597
9,038
(Amounts in thousands)
December 31,
2018
2017
54,901 $
179,430
111,837
101,146
20,219
467,533 $
50,410
171,783
113,078
108,761
18,528
462,560
(Amounts in thousands)
2018
$
$
67,197
18,716
16,135
8,025
5,987
5,305
121,365
The following is a summary of time deposits of $100,000 or more by remaining maturities:
Three months or less
Three to six months
Six to twelve months
One through five years
Over five years
Total
(Amounts in thousands)
December 31, 2018
Other Time
Deposits
Certificates of
Deposit
$
$
8,647
6,377
6,058
18,295
1,650
41,027
$
$
9,530
1,151
2,034
3,311
539
16,565
$
$
Total
18,177
7,528
8,092
21,606
2,189
57,592
79
NOTE 6 - FEDERAL HOME LOAN BANK (FHLB) ADVANCES AND OTHER SHORT-TERM BORROWINGS
The following is a summary of FHLB advances and other short-term borrowings:
FHLB advances - long-term:
Fixed rate payable and convertible fixed rate FHLB advances, with
monthly interest payments:
Due in 2018
Due in 2019
Due in 2020
Due in 2021
Total FHLB advances - long-term
FHLB advances - short-term:
Short-term
Cash management
Total FHLB advances - short-term
Total FHLB advances
Other short-term borrowings:
Securities sold under repurchase agreements
Total FHLB advances and other short-term borrowings
The following is a summary of FHLB advances – short term:
Weighted Average
Interest Rate
(Amounts in thousands)
December 31,
2018
2017
$
1.60 %
2.04 %
2.65 %
2.03 %
2.47 %
2.46 %
2.47 %
2.22 %
— $
6,000
6,000
4,000
16,000
8,000
4,000
12,000
28,000
0.34 %
2.08 % $
2,206
30,206 $
4,000
6,000
4,000
—
14,000
12,000
20,000
32,000
46,000
2,678
48,678
2018
(Amounts in thousands)
2017
2016
Average balance during the year
Average interest rate during the year
Maximum month-end balance during the year
Weighted average interest rate at year end
$
$
18,899
$
1.98 %
$
2.47 %
30,000
16,917
$
1.03 %
$
1.38 %
32,000
13,550
0.54 %
23,000
0.59 %
At December 31, 2018, FHLB advances were collateralized by FHLB stock owned by the Bank with a carrying value of $2.4 million, a blanket lien
against the Bank’s qualified mortgage loan portfolio of $71.6 million, $7.0 million in mortgage-backed securities and $3.8 million in U.S. Government-
guaranteed small business administration pools. In comparison, in the prior year FHLB advances were collateralized by FHLB stock owned by the
Bank with a carrying value of $2.4 million, a blanket lien against the Bank’s qualified mortgage loan portfolio of $64.7 million, $19.8 million in
mortgage-backed securities and $9.7 million in U.S. Government-guaranteed small business administration pools. Maximum borrowing capacities
from FHLB totaled $55.3 million and $57.0 million at December 31, 2018 and 2017, respectively.
At both December 31, 2018 and 2017, there were no FHLB fixed rate advances that were putable on or after certain specified dates at the option of
the FHLB.
The following is a summary of other short-term borrowings:
Average balance during the year
Average interest rate during the year
Maximum month-end balance during the year
Weighted average interest rate at year end
2018
(Amounts in thousands)
2017
2016
$
$
1,679
$
0.33 %
2,206
$
0.34 %
2,018
$
0.33 %
2,678
$
0.34 %
2,249
0.31 %
3,608
0.33 %
80
Securities sold under repurchase agreements represent arrangements the Bank has entered into with certain deposit customers within its local
market areas. These borrowings are collateralized with securities. At December 31, 2018 and 2017, securities allocated for this purpose, owned by the
Bank and held in safekeeping accounts at independent correspondent banks, amounted to $3.1 million and $3.4 million, respectively.
The following table provides additional detail regarding other short-term borrowings:
(Amounts in thousands)
Repurchase Agreements (Sweep)
Accounted for as Secured Borrowings
At December 31, 2018
At December 31, 2017
Remaining Contractual Maturity of the Agreements
Overnight and Continuous
Overnight and Continuous
$
$
$
3,066 $
3,066 $
2,206 $
3,414
3,414
2,678
Repurchase agreements:
U.S. Government-sponsored mortgage-backed securities
Total collateral carrying value
Total short-term borrowings
NOTE 7 - SUBORDINATED DEBT
In July 2007, a trust formed by the Company issued $5.0 million of floating rate trust preferred securities as part of a pooled offering of such
securities due December 2037. The Company owns all $155,000 of the common securities issued by the trust. The securities bear interest at the 3-
month LIBOR rate plus 1.45%. The rates at December 31, 2018 and 2017 were 4.24% and 3.04%, respectively. The Company issued subordinated
debentures to the trust in exchange for the proceeds of the trust preferred offering. The debentures represent the sole assets of this trust. The
Company may redeem the subordinated debentures, in whole or in part, at par.
The trust is not consolidated with the Company’s financial statements. Accordingly, the Company does not report the securities issued by the trust
as liabilities, but instead reports as liabilities the subordinated debentures issued by the Company and held by the trust. The subordinated
debentures qualify as Tier 1 capital for regulatory purposes in determining and evaluating the Company’s capital adequacy.
NOTE 8 – COMMITMENTS AND CONTINGENCIES
The Bank occupies office facilities under operating leases extending to 2028. Most of these leases contain an option to renew at the then fair rental
value for periods of five and ten years. These options enable the Bank to retain use of facilities in desirable operating areas. In most cases,
management expects that in the normal course of business, leases will be renewed or replaced by other leases. Rental and lease expense was
$184,000 for 2018, $230,000 for 2017 and $183,000 for 2016.
The following is a summary of remaining future minimum lease payments under current non-cancelable operating leases for office facilities:
Years ending:
December 31, 2019
December 31, 2020
December 31, 2021
December 31, 2022
December 31, 2023
Later years
Total
(Amounts in thousands)
$
$
177
169
116
54
44
117
677
At December 31, 2018, the Bank was required to maintain aggregate cash reserves amounting to $6.8 million in order to satisfy federal regulatory
requirements. The reserves are held in useable vault cash and interest-earning balances at the Federal Reserve Bank of Cleveland.
81
The Bank grants commercial and industrial loans, commercial and residential mortgage loans, and consumer loans to customers in Northeastern
Ohio and Western Pennsylvania. Although the Bank has a diversified portfolio, exposure to credit loss can be adversely impacted by downturns in
local economic and employment conditions. Approximately 0.28% of total loans are unsecured at December 31, 2018 and approximately 0.30% at
December 31 2017.
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Such instruments
involve, to varying degrees, elements of credit risk in excess of the amount recognized on the Consolidated Balance Sheets. The contract or
notional amounts on those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
In the event of nonperformance by the other party, the Company’s exposure to credit loss on these financial instruments is represented by the
contract or notional amount of the instrument. The Company uses the same credit policies in making commitments and conditional obligations as it
does for instruments recorded on the balance sheet. The amount and nature of collateral obtained, if any, is based on management’s credit
evaluation.
The following is a summary of such contractual commitments:
Commitments to extend credit:
Fixed rate
Variable rate
Standby letters of credit
(Amounts in thousands)
December 31,
2018
2017
$
31,225 $
74,050
3,455
32,749
60,508
3,600
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.
Generally, these financial arrangements have fixed expiration dates or other termination clauses and may require payment of a fee. Standby letters of
credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Since many of the
commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may
include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. The increase in commitments
is in line with the Company’s increased focus on commercial and industrial lending, and specifically lines of credit.
The Company also offers limited overdraft protection as a non-contractual courtesy which is available to businesses as well as individually/jointly
owned accounts in good standing for personal or household use. The Company reserves the right to discontinue this service without prior notice.
The following table is a summary of overdraft protection for the periods indicated:
Overdraft protection available on depositors' accounts
Balance of overdrafts included in loans
Average daily balance of overdrafts
Average daily balance of overdrafts as a percentage of available
(Amounts in thousands)
December 31,
2018
2017
$
$
8,708
116
104
1.19 %
9,637
103
115
1.19 %
Customer Derivatives - Interest Rate Swaps/Floors – The Company enters into interest rate swaps that allow our commercial loan customers to
effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. Under these agreements, the Company
enters into a variable-rate loan agreement with a customer in addition to an interest rate swap agreement, which serves to effectively swap the
customer’s variable-rate into a fixed-rate. The Company then enters into a corresponding swap agreement with a third party in order to economically
hedge its exposure through the customer agreement. The interest rate swaps with both the customers and third parties are not designated as
hedges under FASB ASC 815 and are not marked to market through earnings. As the interest rate swaps are structured to offset each other,
changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in an impact to earnings;
however, there may be fair value adjustments related to
82
credit quality variations between counterparties, which may impact earnings as required by FASB ASC 820. There was no effect on earnings in any
periods presented. At December 31, 2018, based upon the swap contract values, it was not necessary for any collateral to be pledged on the interest
rate swap, compared to December 31, 2017 where the company had one U.S. Government-sponsored mortgage-backed security pledged for
collateral on its interest rate swaps with the third-party financial institution with a fair value $1.4 million.
Summary information regarding these derivatives is presented below:
Notional Amount
December 31,
(Amounts in thousands)
Fair Value
December 31,
2018
2017
Interest Rate Paid
Interest Rate Received
2018
2017
Customer interest rate
swap
Maturing in 2020
Maturing in 2025
Maturing in 2026
Maturing in 2027
Maturing in 2028
Total
Third party interest rate
swap
Maturing in 2020
Maturing in 2025
Maturing in 2026
Maturing in 2027
Maturing in 2028
Total
$
$
$
$
2,410 $
4,930
1,946
13,790
6,395
29,471 $
2,504 1 Mo. Libor + Margin
1 Mo. Libor + Margin
5,288
1 Mo. Libor + Margin
2,064
1 Mo. Libor + Margin
14,197
—
1 Mo. Libor + Margin
24,053
Fixed
Fixed
Fixed
Fixed
Fixed
2,410 $
4,930
1,946
13,790
6,395
29,471 $
2,504
5,288
2,064
14,197
—
24,053
Fixed
Fixed
Fixed
Fixed
Fixed
1 Mo. Libor + Margin
1 Mo. Libor + Margin
1 Mo. Libor + Margin
1 Mo. Libor + Margin
1 Mo. Libor + Margin
$
$
$
$
(30 ) $
(28 )
(64 )
(54 )
268
92 $
30 $
28
64
54
(268 )
(92 ) $
The following table presents the fair values of derivative instruments in the Consolidated Balance Sheet.
December 31, 2018
Interest rate derivatives
December 31, 2017
Interest rate derivatives
NOTE 9 – BENEFIT PLANS
(Amounts in thousands)
Assets
Liabilities
Balance Sheet Location
Fair Value
Balance Sheet Location
Fair Value
Other assets
$
92
Other liabilities
$
Other assets
$
185
Other liabilities
$
(16 )
36
(44 )
209
—
185
16
(36 )
44
(209 )
—
(185 )
92
185
The Bank has a contributory defined contribution retirement plan (401(k) plan) which covers substantially all employees. Total expense under the
plan was $337,000 for 2018, $361,000 for 2017 and $349,000 for 2016. The Bank matches participants’ voluntary contributions up to 5% of gross pay.
Participants were able to make voluntary contributions to the plan up to a maximum of $18,000 with an additional $6,000 catch-up deferral for plan
participants over the age of 50. The Bank makes bi-weekly contributions to this plan equal to amounts accrued for plan expense.
The Company provides supplemental retirement benefit plans for the benefit of certain officers and non-officer directors. The plan for officers is
designed to provide post-retirement benefits to supplement other sources of retirement income such as social security and 401(k) benefits. The
benefits will be paid for a period of 15 years after retirement. Director Retirement Agreements provide for a benefit of $10,000 annually on or after the
director reaches normal retirement age, which is based on a combination of age and years of service. Director retirement benefits are paid over a
period of 10 years following retirement. The Company accrues the cost of these post-retirement benefits during the working careers of the officers
and directors. At December 31, 2018, the accumulated liability for these benefits totaled $3.5 million, with $2.9 million accrued for the officers’ plan
and $600,000 for the directors’ plan.
83
The following table reconciles the accumulated liability for the benefit obligation of these agreements:
Beginning balance
Benefit expense
Benefit payments
Ending balance
(Amounts in thousands)
Years Ended December 31,
2017
2018
2016
$
$
3,182 $
445
(162 )
3,465 $
2,957 $
387
(162 )
3,182 $
2,760
359
(162 )
2,957
Supplemental executive retirement agreements are unfunded plans and have no plan assets. The benefit obligation represents the vested net
present value of future payments to individuals under the agreements. The benefit expense, as specified in the agreements for the entire year 2019,
is expected to be approximately $352,000. The benefits expected to be paid in the next year are approximately $164,000.
The Bank has purchased insurance contracts on the lives of the participants in the supplemental retirement benefit plan and has named the Bank as
the beneficiary. Similarly, the Company has purchased insurance contracts on the lives of the directors with the Bancorp as beneficiary. While no
direct linkage exists between the supplemental retirement benefit plan and the life insurance contracts, it is management’s current intent that the
revenue from the insurance contracts be used as a funding source for the plan.
The Company accrues for the monthly benefit expense of postretirement cost of insurance for split-dollar life insurance coverage. The following
table presents the changes in the accumulated liability.
Beginning balance
Expense recorded
Other comprehensive income recorded
Ending balance
NOTE 10 - FEDERAL INCOME TAXES
(Amounts in thousands)
December 31,
2017
2018
2016
$
$
876 $
23
(68 )
831 $
840 $
50
(14 )
876 $
856
23
(39 )
840
With the passage of the Tax Cuts and Jobs Act (“Tax Act”), tax law for corporations had several material changes effective beginning in 2018. The
most significant change is the reduction in the corporate tax rate from 34% to 21%. Because this reduced rate was signed into law in December
2017, generally accepted accounting principles required recognition of the lower rate on the Company’s deferred tax position as of December 31,
2017. As the Company is in a net deferred tax asset position, the reduction of this benefit resulted in a $1.2 million additional charge to Federal
Income Tax expense in the Company’s 2017 Consolidated Statements of Income.
The composition of income tax expense is as follows:
Current
Deferred
Change in corporate tax rate
Total
(Amounts in thousands)
Years Ended December 31,
2017
2018
2016
$
$
407
1,008
—
1,415
$
$
1,199
(28 )
1,246
2,417
$
$
1,256
(129 )
—
1,127
84
The ability to realize the benefit of deferred tax assets is dependent upon a number of factors, including the generation of future taxable income, the
ability to carry back taxes paid in previous years, the ability to offset capital losses with capital gains, the reversal of deferred tax liabilities, and
certain tax planning strategies. A valuation allowance of $28,000 was established in 2018 to offset in its entirety capital losses. For years
subsequent to 2017, the ability to carry back taxes paid in previous years has been eliminated by the Tax Act.
The following is a summary of net deferred taxes included in other assets:
Gross deferred tax assets:
Allowance for loan and other real estate losses
Deferred loan origination cost - net
Impairment loss on securities
Deferred compensation
Capital loss carryforward
AMT credit carryforward
Unrealized loss on available-for-sale securities
Other items
Total gross deferred tax assets
Valuation allowance
Total net deferred tax assets
Gross deferred tax liabilities:
Premises and equipment
Other items
Total net deferred tax liabilities
Net deferred tax asset
(Amounts in thousands)
December 31,
2018
2017
$
$
882 $
232
—
727
28
—
980
390
3,239
(28 )
3,211
(477 )
(320 )
(797 )
2,414 $
961
234
29
668
—
904
475
333
3,604
—
3,604
(362 )
(325 )
(687 )
2,917
The Company had a deferred tax asset of $904,000 for unused credits related to Alternative Minimum Taxes (AMT) as of December 31, 2017. The
Tax Act eliminated the AMT for corporations beginning in 2018. After applying the allowable credits in 2018, the remaining unused credits of
$59,000 related to AMT have been reclassed to a receivable in other assets.
The following is a reconciliation of the valuation allowance for net deferred tax assets:
Valuation allowance at beginning of year
Capital loss carryover
Valuation allowance at end of year
85
(Amounts in thousands)
December 31,
2018
2017
$
$
— $
28
28 $
—
—
—
The following is a reconciliation between tax expense using the statutory tax rate of 21% for 2018 and 34% for 2017 and 2016 and the income tax
provision:
Statutory tax expense
Tax effect of non-taxable interest income
Tax effect of earnings on bank-owned life insurance-net
Tax effect of deferred tax valuation (reversal) provision
Change in corporate tax rate (1)
Tax effect of low-income housing credits
Tax effect of non-deductible expenses
Federal income tax expense
(Amounts in thousands)
Years Ended December 31,
2017
2016
2018
$
$
2,153 $
(319 )
(403 )
28
—
(140 )
96
1,415
$
2,301 $
(663 )
(414 )
—
1,246
(149 )
96
2,417
$
2,039
(628 )
(112 )
(94 )
—
(142 )
64
1,127
(1) The tax act lowers the base corporate tax rate from 35% to 21% which was applied to the existing deferred tax balance.
The related income tax (benefit) expense on investment securities gains amounted to $(4,000) for 2018, $3,000 for 2017 and $142,000 for 2016 and is
included in the federal income tax expense.
The Company prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is
more-likely-than-not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of
all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is
greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not
recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized
tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting
period in which that threshold is no longer met. The provision also provides guidance on the accounting for and disclosure of unrecognized tax
benefits, interest and penalties. There were no significant unrecognized tax benefits at December 31, 2018 and the Company does not expect any
significant increase in unrecognized tax benefits in the next twelve months. No interest or penalties were incurred for income taxes which would
have been recorded as a component of income tax expense.
There is currently no liability for uncertain tax positions and no known unrecognized tax benefits. The Company’s federal and state income tax
returns for taxable years through 2014 have been closed for purposes of examination by the Internal Revenue Service and the Ohio Department of
Revenue.
NOTE 11 – FAIR VALUE
Measurements
The Company groups assets and liabilities recorded at fair value into three levels based on the markets in which the assets and liabilities are traded
and the reliability of the assumptions used to determine fair value. A financial instrument’s level within the fair value hierarchy is based on the
lowest level of input that is significant to the fair value measurement (with level 1 considered highest and level 3 considered lowest). A brief
description of each level follows:
Level 1:
Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
Level 2:
Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the
reported date. The nature of these assets and liabilities include items for which quoted prices are available but which trade
less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly
observed.
Level 3:
Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way
markets and are measured using management’s best estimate of fair value, where inputs into the determination of fair value
require significant management judgment or estimation.
86
The following table presents the assets reported on the consolidated balance sheets at their fair value as of December 31, 2018 and December 31,
2017 by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is
significant to the fair value measurement.
(Amounts in thousands)
Interest rate derivatives
$
92 $
—
$
92 $
Description
ASSETS
U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed securities
U.S. Government-sponsored collateralized mortgage obligations
U.S. Government-guaranteed small business administration pools
Loans held for sale
Interest rate derivatives
LIABILITIES
Description
ASSETS
U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed securities
U.S. Government-sponsored collateralized mortgage obligations
U.S. Government-guaranteed small business administration pools
Trust preferred securities
Loans held for sale
Interest rate derivatives
LIABILITIES
Fair Value Measurements at December 31, 2018 Using
Significant
Other
Observable
Inputs
(Level 2)
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Unobservable Inputs
(Level 3)
December 31,
2018
$
9,002 $
51,658
56,587
11,976
7,700
1,040
92
$
—
—
—
—
—
1,040
—
9,002 $
51,658
56,587
11,976
7,700
—
92
(Amounts in thousands)
Fair Value Measurements at December 31, 2017 Using
December 31,
2017
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
$
3,205 $
72,116
67,668
6,302
9,655
895
2,780
185
— $
—
—
—
—
—
2,780
—
3,205 $
72,116
67,668
6,302
9,655
—
—
185
—
—
—
—
—
—
—
—
—
—
—
—
—
895
—
—
—
Interest rate derivatives
$
185 $
— $
185 $
87
The following tables present the changes in the Level 3 fair value category for the years ended December 31, 2018, 2017 and 2016. The Company
classifies financial instruments in Level 3 of the fair-value hierarchy when there is reliance on at least one significant unobservable input to the
valuation model. In addition to these unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of
inputs that are readily observable either directly or indirectly.
Beginning balance
Net realized/unrealized gains/(losses) included in:
Noninterest income
Other comprehensive income
Discount accretion (premium amortization)
Sales
Purchases, issuance, and settlements
Ending balance
Losses included in net income for the period relating
to assets held at period end
(Amounts in thousands)
December 31,
2017
Trust preferred
securities
2018
Trust preferred
securities
2016
Trust preferred
securities
$
895 $
—
723
—
(1,618 )
—
— $
— $
$
$
825 $
—
72
—
—
(2 )
895 $
— $
778
—
67
—
—
(20 )
825
—
The Company conducts OTTI analyses on a quarterly basis. The initial indication of other-than-temporary impairment for both debt and equity
securities is a decline in the fair value below the amount recorded for an investment. A decline in value that is considered to be other-than-
temporary is recorded as a loss within non-interest income in the Consolidated Statements of Income. In determining whether an impairment is other
than temporary, the Company considers a number of factors, including, but not limited to, the length of time and extent to which the market value
has been less than cost, recent events specific to the issuer, including investment downgrades by rating agencies and economic conditions of its
industry, and a determination that the Company does not intend to sell those investments and it is not more-likely-than-not that the Company will
be required to sell the investments before recovery of its amortized cost basis less any current period credit loss. Among the factors that are
considered in determining the Company’s intent and ability is a review of its capital adequacy, interest rate risk position and liquidity.
The Company also considers the issuer’s financial condition, capital strength and near-term prospects. In addition, for debt securities the Company
considers the cause of the price decline (general level of interest rates and industry- and issuer-specific factors), current ability to make future
payments in a timely manner and the issuer’s ability to service debt, the assessment of a security’s ability to recover any decline in market value,
the ability of the issuer to meet contractual obligations and the Company’s intent and ability to retain the security. All of the foregoing require
considerable judgment.
Trust Preferred Securities
Trust preferred securities, which are accounted for under FASB ASC Topic 325 Investments Other, were held in the investment portfolio until early
June 2018. Prior to the sale, the Company evaluated current available information in estimating the future cash flows of securities and determined
whether there had been favorable or adverse changes in estimated cash flows from the cash flows previously projected. The Company considered
the structure and term of the pool and the financial condition of the underlying issuers. Specifically, the evaluation incorporated factors such as
interest rates and appropriate risk premiums, the timing and amount of interest and principal payments and the allocation of payments to the various
note classes. Estimates of cash flows were based on the most recent trustee reports, announcements of deferrals or defaults, expected future default
rates and other relevant market information.
88
The following table details the breakdown of trust preferred securities for the periods indicated:
Total number of trust preferred securities
Par value
Number not considered OTTI
Par value
Number considered OTTI
Par value
Life-to-date impairment recognized in earnings
Life-to-date impairment recognized in other comprehensive income
Total life-to-date impairment
(Dollar amounts in
thousands)
December 31,
2017
$
$
$
$
$
2
1,939
1
903
1
1,036
140
723
863
The following table details the one debt security with other-than-temporary impairment, its credit rating at December 31, 2017 and the related losses
recognized in earnings:
(Dollar amounts in thousands)
Amount of
OTTI
related to
credit loss at
January 1,
2017
Additions in QTD
March 31,
2017
Additions in QTD
June 30,
2017
Additions in QTD
September 30,
2017
Additions in QTD
December 31,
2017
Amount of
OTTI
related to
credit loss at
December 31,
2017
Moody’s/Fitch
Rating
Caa2/CC
$
Trapeza IX B-1
140 $
— $
— $
— $
— $
140
The following table provides additional information related to the Company’s trust preferred securities as of December 31, 2017 used to evaluate
other-than-temporary impairments:
(Dollar amounts in thousands)
Deal
Class
PreTSL XXIII
Trapeza IX
Total
C-2
B-1
$
Amortized Cost Fair Value
758 $
860
1,618 $
336 $
559
895 $
$
Unrealized
Gain/(Loss)
Moody’s/
Fitch Rating
(422 ) Ba1/CCC
(301 ) Caa2/CC
(723 )
Number of
Issuers
Currently
Performing
90
30
Deferrals and
Defaults as a %
of Current
Collateral
Excess
Subordination as a
% of Current
Performing
Collateral
20.9 %
14.0
7.12 %
—
The market for these securities at December 31, 2017 was not active and markets for similar securities are also not active. The inactivity was
evidenced first by a significant widening of the bid-ask spread in the brokered markets in which trust preferred securities trade and then by a
significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive as new issuance is essentially
nonexistent. There are currently very few market participants who are willing and/or able to transact for these securities. The pooled market value
for these securities remains very depressed relative to historical levels. Although there has been marked improvement in the credit spread premium
in the corporate bond space, little improvement has been noted in the market for trust preferred securities.
Given conditions in the current debt markets and the absence of observable transactions in the secondary and the new issue markets, the Company
determined the following:
•
The few observable transactions and market quotations that are available are not reliable for purposes of determining fair value;
• An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes
the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique used at
measurement dates prior to 2008; and
89
•
The trust preferred securities will be classified within Level 3 of the fair value hierarchy because the Company determined that
significant judgments are required to determine fair value at the measurement date.
The Company enlisted the aid of an independent third party to perform the trust preferred security valuations. The approach to determining fair
value involved the following process:
1. Estimate the credit quality of the collateral using average probability of default values for each issuer (adjusted for rating levels).
2. Consider the potential for correlation among issuers within the same industry for default probabilities (e.g. banks with other banks).
3. Forecast the cash flows for the underlying collateral and apply to each trust preferred security tranche to determine the resulting
distribution among the securities, including prepayment and cures.
4. Discount the expected cash flows to calculate the present value of the security.
The following table presents the assets measured on a nonrecurring basis on the Consolidated Balance Sheets at their fair value as of December 31,
2017, by level within the fair value hierarchy. Impaired loans that are collateral dependent are written down to fair value through the establishment of
specific reserves. Techniques used to value the collateral that secure the impaired loans include: quoted market prices for identical assets classified
as Level 1 inputs; observable inputs, employed by certified appraisers, for similar assets classified as Level 2 inputs. In cases where valuation
techniques include inputs that are unobservable and are based on estimates and assumptions developed by management based on the best
information available under each circumstance, the asset valuation is classified as Level 3 inputs. Other real estate owned is carried at the lower of
cost or fair value less estimated costs to sell. There were no impaired loans carried at fair value in 2018.
Assets measured on a nonrecurring basis:
Impaired loans
Financial Instruments
(Amounts in thousands)
December 31, 2017
Level 1
Level 2
Level 3
Total
$
— $
— $
9,620 $
9,620
The Company discloses fair value information about financial instruments, whether or not recognized in the Consolidated Balance Sheets, for which
it is practicable to estimate the value. In cases where quoted market prices are not available, fair values are based on estimates using present value
or other estimation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of
future cash flows.
Such techniques and assumptions, as they apply to individual categories of the financial instruments, are as follows:
Investment securities available for sale – Fair values of securities are based on quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable securities. Prices on trust preferred securities were calculated using a
discounted cash-flow technique. Cash flows were estimated based on credit and prepayment assumptions. The present value of the projected cash
flows was calculated using a discount rate equal to the current yield used to accrete the beneficial interest.
Loans held for sale – Loans held for sale consist of residential mortgage loans originated for sale. Loans held for sale are recorded at fair value
based on what the secondary markets have offered on best efforts commitments.
Interest rate derivatives – The fair value is based on settlement values adjusted for credit risks associated with the counter parties and the Company
and observable market interest rate curves.
In addition, other assets and liabilities of the Company that are not defined as financial instruments are not included in the disclosures, such as
property and equipment. Also, non-financial instruments typically not recognized in financial statements nevertheless may have value but are not
included in the above disclosures. These include, among other items, the estimated earning power of core deposit accounts, the trained work force,
customer goodwill and similar items. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the
Company.
90
The carrying amounts and estimated fair values of the Company’s financial instruments are as follows:
ASSETS:
Cash and cash equivalents
Investment securities available-for-sale
Loans held for sale
Loans
Bank-owned life insurance
Accrued interest receivable
Interest rate derivatives
LIABILITIES:
Demand, savings and money market deposits
Time deposits
Short-term borrowings
Federal Home Loan Bank advances - short term
Federal Home Loan Bank advances - long term
Subordinated debt
Accrued interest payable
Interest rate derivatives
ASSETS:
Cash and cash equivalents
Investment securities available-for-sale
Loans held for sale
Loans
Bank-owned life insurance
Accrued interest receivable
Interest rate derivatives
LIABILITIES:
Demand, savings and money market deposits
Time deposits
Short-term borrowings
Federal Home Loan Bank advances - short term
Federal Home Loan Bank advances - long term
Subordinated debt
Accrued interest payable
Interest rate derivatives
$
$
$
$
(Amounts in thousands)
December 31, 2018
Carrying
Amount
Level 1
Level 2
Level 3
Fair Value
19,692 $
136,923
1,040
510,194
15,711
2,255
92
483,054 $
121,365
2,206
12,000
16,000
5,155
371
92
19,692 $
—
1,040
—
15,711
2,255
—
— $
136,923
—
—
—
—
92
483,054 $
—
2,206
—
—
—
371
—
— $
—
—
—
—
—
—
92
(Amounts in thousands)
December 31, 2017
— $
—
—
513,103
—
—
—
— $
122,295
—
11,987
15,880
4,620
—
—
19,692
136,923
1,040
513,103
15,711
2,255
92
483,054
122,295
2,206
11,987
15,880
4,620
371
92
Carrying
Amount
Level 1
Level 2
Level 3
Fair Value
19,125 $
—
2,780
—
17,650
2,193
—
458,562 $
—
2,678
—
—
—
325
—
— $
158,946
—
—
—
—
185
— $
—
—
—
—
—
—
185
— $
895
—
486,230
—
—
—
— $
128,624
—
31,982
13,880
4,785
—
—
19,125
159,841
2,780
486,230
17,650
2,193
185
458,562
128,624
2,678
31,982
13,880
4,785
325
185
19,125 $
159,841
2,780
482,912
17,650
2,193
185
458,562 $
127,289
2,678
32,000
14,000
5,155
325
185
91
The following table presents quantitative information about the Level 3 significant unobservable inputs for assets and liabilities measured at fair
value on a recurring and nonrecurring basis at December 31, 2017.
(Amounts in thousands)
Fair value at
December 31,
2017
Valuation
Technique
Trust preferred securities
$
895 Discounted Cash
Flow
Significant
Unobservable Input
Projected
Prepayments
Projected
Defaults
Description of Inputs
1) Trust preferred securities issued by banks subject to Dodd-Frank's
phase-out of trust preferred securities from Tier 1 Capital. All fixed
rate within one year; variable rate at increasing intervals depending on
spread.
2) Trust preferred securities issued by healthy, well capitalized banks
that have fixed rate coupons greater than 8%.
3) 1% annually for all other fixed rate issues and all variable rate
issues.
4) Zero for collateral issued by REITs and 2% for insurance
companies.
1) All deferring issuers that do not meet the criteria for curing, as
described below, are projected to default immediately.
2) Banks with high, near team default risk are identified using a
CAMELS model, and projected to default immediately. Healthy banks
are projected to default at a rate of 2% annually for 2 years, and
0.36% annually thereafter.
3) Insurance and REIT defaults are projected according to the
historical default rates exhibited by companies with the same credit
ratings. Historical default rates are doubled in each of the first two
years of the projection to account for current economic conditions.
Unrated issuers are assumed to have CCC- ratings.
Projected Cures
1) Deferring issuers that have definitive agreements to either be
acquired or recapitalized.
Projected
Recoveries
1) Zero for insurance companies, REITs and insolvent banks, and 10%
for projected bank deferrals lagged 2 years.
Discount Rates
1) Ranging from ~9.10% to ~14.74%, depending on each bond's
seniority and remaining subordination after projected losses.
Impaired loans
Cash Flow
Discount Rates
4,891
Range 4.50% to 5.38%
Weighted average 4.88 %
92
NOTE 12 - ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME
The following table presents the changes in accumulated other comprehensive loss or income by component net of tax for the years ended
December 31, 2018, 2017 and 2016.
Balance as of December 31, 2015
Other comprehensive (loss) income before reclassification
Amount reclassified from accumulated other comprehensive loss
Total other comprehensive income
Balance as of December 31, 2016
Other comprehensive income before reclassification
Reclassification of certain income tax effects from accumulated other comprehensive income
Amount reclassified from accumulated other comprehensive loss
Total other comprehensive income
Balance as of December 31, 2017
Other comprehensive (loss) income before reclassification
Amount reclassified from accumulated other comprehensive loss
Total other comprehensive (loss) income
Balance as of December 31, 2018
(a) All amounts are net of tax. Amounts in parentheses indicate debits.
(Amounts in thousands)
Unrealized gains
(losses) on
available-for-sale
securities (a)
Change in pension
and postretirement
obligations (a)
$
$
$
$
(147 ) $
(2,454 )
(308 )
(2,762 )
(2,909 ) $
1,420
(294 )
(4 )
1,122
(1,787 ) $
(1,916 )
17
(1,899 )
(3,686 ) $
(91 )
39
—
39
(52 )
14
—
—
14
(38 )
68
—
68
30
The following table presents significant amounts reclassified out of each component of accumulated other comprehensive loss or income for the
years ended December 31, 2018, 2017 and 2016.
2018
Amount reclassified from
accumulated other
comprehensive loss (a)
(Amounts in thousands)
December 31,
2017
Amount reclassified from
accumulated other
comprehensive loss (a)
2016
Amount reclassified from
accumulated other
comprehensive loss (a)
Affected line item in the
statement where net
income is presented
Details about other comprehensive income
or loss:
Unrealized gains on available-for-sale securities
$
(a) Amounts in parentheses indicate debits to net income.
$
NOTE 13 - REGULATORY MATTERS
(21 ) $
4
(17 ) $
7 $
(3 )
4 $
Investment
securities
available-for-sale
(losses)
gains, net
Federal income tax
expense
466
(158 )
308
The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines
and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under
regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk
weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate
regulatory action that could have a direct material effect on the financial statements.
93
The prompt corrective action regulations provide five categories, including well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If a bank is only
adequately capitalized, regulatory approval is required to, among other things, accept, renew or roll-over brokered deposits. If a bank is
undercapitalized, capital distributions and growth and expansion are limited, and plans for capital restoration are required.
In July 2013, the Board of Governors of the Federal Reserve Board and the FDIC approved the final rules implementing the Basel Committee on
Banking Supervision's capital guidelines for U.S. banks and their holding companies (commonly known as Basel III). Under the final rules, which
began for the Company and the Bank on January 1, 2015 and are subject to a phase-in period through January 1, 2019, minimum requirements will
increase for both the quantity and quality of capital held by the Company and the Bank. The rules include a new common equity Tier 1 capital to
risk-weighted assets ratio (CET1 ratio) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, which when fully phased-in,
effectively results in a minimum CET1 ratio of 7.0%. Basel III raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%
(which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5% when fully phased-in), effectively results in
a minimum total capital to risk-weighted assets ratio of 10.5% (with the capital conservation buffer fully phased-in), and requires a minimum leverage
ratio of 4.0%. Basel III also makes changes to risk weights for certain assets and off-balance-sheet exposures. Management expects that the capital
ratios for the Company and the Bank under Basel III will continue to exceed the well capitalized minimum capital requirements, as they currently
exceed the fully phased in 2019 requirements.
In addition to the capital requirements for bank holding companies generally, financial holding companies are also required to meet “well-
capitalized” requirements of the Federal Reserve Board. A bank holding company or financial holding company that is covered by the Federal
Reserve’s Small Bank Holding Company Policy is not required to comply with the consolidated capital requirements, although its bank subsidiaries
still must comply with the applicable capital requirements. As a bank holding company with assets of less than $1 billion and meeting certain other
requirements, the Company is covered by the Small Bank Holding Company Policy.
At December 31, 2018 and December 31, 2017, actual capital levels and minimum required levels for the Company, if it were not covered by the Small
Bank Holding Company Policy, were:
December 31, 2018
CET1 capital (to risk-weighted assets)
Tier 1 capital (to risk-weighted assets)
Total capital (to risk-weighted assets)
Tier 1 capital (to average assets)
December 31, 2017
CET1 capital (to risk-weighted assets)
Tier 1 capital (to risk-weighted assets)
Total capital (to risk-weighted assets)
Tier 1 capital (to average assets)
(Amounts in thousands)
Actual
Amount
Ratio
Minimum required for capital
adequacy purposes
Amount
Ratio
68,574
73,574
77,856
73,574
12.01 % $
12.88 %
13.63 %
10.72 %
25,700
34,267
45,689
27,452
(Amounts in thousands)
Actual
Minimum required for capital
adequacy purposes
Amount
Ratio
Amount
Ratio
63,455
68,455
73,116
68,455
11.97 % $
12.91 %
13.79 %
10.77 %
23,864
31,819
42,425
25,416
4.5 %
6.0 %
8.0 %
4.0 %
4.5 %
6.0 %
8.0 %
4.0 %
$
$
$5.0 million of trust preferred securities outstanding at December 31, 2018 and December 31, 2017, respectively, qualified as Tier 1 capital. Refer to
Note 7, “Subordinated Debt.”
The Bank met all capital requirements to be categorized as "well capitalized" at December 31, 2018 and December 31, 2017.
94
NOTE 14 - RELATED PARTY TRANSACTIONS
Certain directors, executive officers and companies with whom they are affiliated were loan customers during 2018. The following is an analysis of
such loans:
Total related-party loans at December 31, 2017
New related-party loans
Repayments or other
Total related-party loans at December 31, 2018
(Amounts in thousands)
$
$
4,230
2,997
(2,765 )
4,462
Deposit balances of executive officers, directors, and their affiliates at December 31, 2018 and 2017 were $8.4 million and $7.6 million, respectively.
The banking relationships were made in the ordinary course of business with the Bank.
NOTE 15 - CONDENSED FINANCIAL INFORMATION – PARENT COMPANY
Below is condensed financial information of Cortland Bancorp (parent company only). In this information, the Parent’s investment in subsidiaries is
stated at cost, including equity in the undistributed earnings of the subsidiaries, adjusted for any unrealized gains or losses on available-for-sale
securities.
BALANCE SHEETS
(Amounts in thousands)
ASSETS
Cash
Investment in bank subsidiary
Subordinated note from subsidiary bank
Other assets
Total assets
LIABILITIES
Other liabilities
Subordinated debt (Note 7)
Total liabilities
SHAREHOLDERS’ EQUITY
Common stock
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Treasury stock
Total shareholders’ equity
Total liabilities & shareholders’ equity
95
December 31,
2018
2017
$
$
$
$
240 $
61,272
6,000
3,538
71,050 $
977 $
5,155
6,132
23,641
20,984
31,089
(3,656 )
(7,140 )
64,918
71,050 $
261
58,028
6,000
3,489
67,778
993
5,155
6,148
23,641
20,928
24,403
(1,825 )
(5,517 )
61,630
67,778
STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
Dividends from bank subsidiary
Interest and dividend income
Other income
Interest on subordinated debt
Other expenses
Income before income tax and equity in undistributed earnings of
subsidiaries
Income tax benefit
Equity in undistributed earnings of subsidiaries
Net income
Comprehensive income
2018
Years ended December 31,
2017
2016
$
$
$
4,150 $
213
56
(189 )
(606 )
3,624
136
5,075
8,835 $
7,004 $
1,900 $
153
58
(138 )
(568 )
1,405
106
2,839
4,350 $
5,780 $
1,400
121
60
(112 )
(497 )
972
265
3,634
4,871
2,148
STATEMENTS OF CASH FLOWS
(Amounts in thousands)
Cash flow from operating activities
Net income
Adjustments to reconcile net income to net cash flow from operating
activities:
Equity in undistributed earnings of subsidiaries
Deferred tax benefit
Equity compensation
Change in other assets and liabilities
Net cash flow from operating activities
Cash deficit from financing activities
Dividends paid
Treasury shares purchased
Net cash deficit from financing activities
Net change in cash
Cash
Beginning of year
End of year
96
2018
Years ended December 31,
2017
2016
$
8,835 $
4,350 $
4,871
(5,075 )
(13 )
214
(52 )
3,909
(2,149 )
(1,781 )
(3,930 )
(21 )
(2,839 )
62
143
188
1,904
(1,726 )
(237 )
(1,963 )
(59 )
$
261
240 $
320
261 $
(3,634 )
(15 )
75
138
1,435
(1,237 )
—
(1,237 )
198
122
320
NOTE 16 - DIVIDEND RESTRICTIONS
The Bank is subject to a dividend restriction that generally limits the amount of dividends that can be paid by an Ohio state-chartered bank. Under
the Ohio Banking Code, cash dividends may not exceed net profits as defined for that year combined with retained net profits for the two preceding
years less any required transfers to surplus. Under this formula, the amount available for payment of dividends in 2019 is $8.2 million plus 2019
profits retained up to the date of the dividend declaration.
NOTE 17 – LITIGATION
The Bank is involved in legal actions arising in the ordinary course of business. In the opinion of management, the outcomes from these other
matters, either individually or in the aggregate, are not expected to have any material effect on the Company.
NOTE 18 – STOCK REPURCHASE PROGRAM
On January 26, 2016, the Company’s Board of Directors approved a program which allowed the Company to repurchase up to 100,000 shares, or
approximately 2.3% of the 4,404,783 shares outstanding at January 26, 2016, of the Company’s outstanding common stock. This program terminated
on December 31, 2016. The Company did not purchase any shares under this program. On January 24, 2017, the Company’s Board of Directors
approved a program which allowed the Company to repurchase up to 100,000 shares, or approximately 2.3% of the 4,420,055 shares outstanding at
January 24, 2017, of the Company’s outstanding common stock. This program terminated on December 31, 2017. The Company purchased 12,863
shares under this program. On January 23, 2018, the Company’s Board of Directors approved a program which allowed the Company to repurchase
up to 100,000 shares, or approximately 2.3% of the 4,420,136 shares outstanding at January 23, 2018, of the Company’s outstanding common stock.
On May 22, 2018 the Company’s Board of Directors approved an increase in the number of shares authorized for repurchase under the January 23,
2018 plan by 200,000 shares bringing the total to 300,000 shares authorized. This program terminated on December 31, 2018. The Company
purchased 80,944 shares under this program. On December 18, 2018, the Company’s Board of Directors approved a new program which allows the
Company to repurchase up to 300,000 shares, or approximately 6.9% of the 4,349,624 outstanding shares of common stock at December 18, 2018.
This program will terminate on December 31, 2019, or upon purchase of 300,000 shares if earlier or at any time without prior notice. Repurchased
shares are designated as treasury shares, available for general corporate purposes, including possible use in connection with the Company’s
dividend reinvestment program, employee benefit plans, acquisitions or other distributions. Based on the value of the Company’s stock on
December 31, 2018, the remaining authorization to repurchase the stock for the program is approximately $6.2 million.
NOTE 19 – EQUITY COMPENSATION
During 2015, the Company, created the 2015 Omnibus Equity Plan and The Director Equity Plan.
The Omnibus Equity Plan permits the award of up to 340,000 shares to the Company’s employees to promote the long-term financial success of the
Company, increasing shareholder value by providing employees the opportunity to acquire an ownership interest in the Company and enabling the
Company and its related entities to attract and retain the services of those upon whom the successful conduct of business depends. There were
12,593 restricted Board approved shares granted under the plan in calendar 2018 and 12,976 restricted Board approved shares granted under the
plan in calendar 2017. The Company is expensing the grant date fair value of all share-based compensation over the requisite vesting periods on a
prorated straight-line basis. In 2018 and 2017, compensation expense of $192,000 and $123,000, respectively, was recorded in the Consolidated
Statements of Income. As of December 31, 2018, there was $310,000 of total unrecognized compensation expense related to the non-vested shares
granted under the Plan. Shares awarded under this plan vest in equal thirds on the first three anniversaries of the award date if the employee
remains employed with Cortland Bancorp. The remaining cost is expected to be recognized over 17 months, which is the remainder of the three-year
tiered vesting period.
Granted shares are awarded upon meeting achievement of performance objectives derived from one or more of the performance criteria. The main
metrics used for the periods presented were three-year earnings per share growth and three-year total shareholder return each ranked versus a peer
group.
97
The following is the activity under the Omnibus Equity Plan during the period ended December 31, 2018:
Nonvested at January 1, 2018
Granted
Vested
Forfeited
Nonvested at December 31, 2018
Restricted Stock Units
Units
Price at Grant Date
20,814
12,593
(8,359 )
(1,457 )
23,591
$
$
17.02
22.01
16.71
18.92
19.68
The Director Equity Plan permits the award of up to 113,000 shares to nonemployee directors to promote the long-term financial success of the
Company, increasing shareholder value by enabling the Company and its related entities to attract and retain the services of those directors upon
whom the successful conduct of business depends. There were 989 Board approved shares granted under the plan in April 2018 with immediate
vesting, and 1,656 Board approved shares granted under the plan in March 2017 with immediate vesting. In 2018 and 2017, expense of $22,000 and
$30,000 was recorded in the Consolidated Statements of Income, respectively.
NOTE 20 – EXTINGUISHMENT OF DEBT
In January of 2016, the Company paid off two FHLB convertible fixed rate advances totaling $4.5 million with an average rate of 4.01% due in
2017. The Company incurred prepayment penalties of $242,000, or $160,000 after tax. The Earnings per Share effect of ($.04) was offset by gains
generated on investment securities sales during the same month. The Company used a combination of alternative wholesale borrowings at a rate of
1.44% and current liquidity to fund the early payoff, for an estimated annual interest expense savings of $130,000.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures - None
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. With the supervision and participation by management, including the Company’s principal
executive officer and principal financial officer, the effectiveness of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934 (the “Exchange Act”)) has been evaluated as of the end of the period covered by this report. Based upon
that evaluation, the Company’s principal executive officer and principal financial officer have concluded that these controls and procedures were
effective.
Management’s Annual Report on Internal Control Over Financial Reporting. The report on management’s assessment of internal control over
financial reporting is included in Item 8.
Changes in Internal Control Over Financial Reporting. Our Chief Executive Officer and Chief Financial Officer have concluded that there have been
no changes during the fourth quarter of 2018 in the Company’s internal control over financial reporting (as defined in Rules 13a-13 and 15d-15 of the
Exchange Act) that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.
S.R. Snodgrass, P.C., the Company’s registered public accounting firm, has audited the Company’s internal control over financial reporting as of
December 31, 2018. The audit report by S.R. Snodgrass, P.C. is located in Item 8 of this report.
Item 9B. Other Information – Not applicable.
98
PART III
Item l0. Directors, Executive Officers and Corporate Governance
Information relating to this item will be set forth in the Company’s definitive proxy statement to be filed on or about March 8, 2019 in connection
with the Annual Meeting of Shareholders to be held May 2, 2019 (the “Proxy Statement”). The information contained in the Proxy Statement under
the following captions is incorporated herein by reference: “Board Nominees,” “Continuing Directors,” “The Board of Directors and Committees of
the Board,” and “Section 16(a) Beneficial Ownership Reporting Compliance.”
Information relating to executive officers of the Company is set forth in Part I of this Form 10-K.
Item ll. Executive Compensation
Information relating to this item is incorporated herein by reference to the information in the Proxy Statement that is set forth under the following
captions of “Executive Compensation” and “Director Compensation in 2018.”
Item l2. Security Ownership of Certain Beneficial Owners and Management and Related Shareholders Matters
Information relating to this item is incorporated herein by reference to the information in the Proxy Statement that is set forth under the caption
“Share Ownership of Directors and Executive Officers.”
Information relating to equity compensation is incorporated herein by reference to the information in the Proxy Statement that is set forth under the
caption “Outstanding Equity Awards.”
Item l3. Certain Relationships and Related Transactions, and Director Independence
Information relating to this item is incorporated herein by reference to the information in the Proxy Statement that is set forth under the captions of
“Transactions with Related Persons” and “The Board of Directors and Committees of the Board.”
Item l4. Principal Accountant Fees and Services
Information relating to this item is incorporated herein by reference to the information in the Proxy Statement that is set forth under the caption
“Ratification of Independent Auditors.”
99
PART IV
Item l5. Exhibits, Financial Statement Schedules
(a)
l. Financial Statements
Included in Part II of this report:
Item 8. Financial Statements
Consolidated Financial Statements included in this Annual Report:
Management’s Annual Report on Internal Control Over Financial Reporting
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2018 and 2017
Consolidated Statements of Income for the Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017 and 2016
Notes to Consolidated Financial Statements
52
53
55
56
57
58
59
60
(a)
2. Financial Statement Schedules
Financial statements schedules are omitted because the required information is either not applicable, not required or is not shown in the
respective financial statements or in the notes thereto.
(a)
3. Exhibits Required by Item 601 of Regulation S-K
The exhibits filed or incorporated by reference as a part of this report are listed in the Index to Exhibits.
100
The following exhibits are filed or incorporated by reference as part of this report:
INDEX TO EXHIBITS
Exhibit
No.
3.1
3.2
4.1
4.2
*10.1
Exhibit Description
Restated Amended Articles of Cortland Bancorp reflecting amendment dated June
25, 1999. Note: filed for purposes of SEC reporting compliance only. This restated
document has not been filed with the State of Ohio.
Code of Regulations, as amended.
The rights of holders of equity securities are defined in portions of the Articles of
Incorporation as referenced in Exhibit 3.1
and the Code of Regulations as referenced in Exhibit 3.2
Agreement to furnish instruments and agreements defining rights of holders of
long-term debt
Group Term Carve Out Plan dated February 23, 2001, by The Cortland Savings and
Banking Company with each executive officer other than Rodger W. Platt and with
selected other officers, as amended by the August 2002 letter amendment
Incorporated by Reference
Form**
Exhibit
Filing
Date
Filed
Herewith
10-K(1)
3.1 03/16/06
8-K
3.2 05/30/17
10-K(1)
4.1 03/16/06
8-K
4.1 05/30/17
✓
10-K(1)
10.1 03/16/06
*10.1.1
Amendment of Group Term Carve Out Plan, dated October 28, 2014
8-K
10.1.1 11/03/14
10.2
10.3
*10.4
10.5
10.6
*10.7
*10.8
[Reserved]
[Reserved]
Amended Director Retirement Agreement between Cortland Bancorp and David C.
Cole, dated as of December 18, 2007
10-K
10.4 03/17/08
[Reserved]
[Reserved]
Amended Director Retirement Agreement between Cortland Bancorp and James E.
Hoffman III, dated as of December 18, 2007
10-K
10.7 03/17/08
Amended Director Retirement Agreement between Cortland Bancorp and Neil J.
Kaback, dated as of December 18, 2007
10-K
10.8 03/17/08
10.9
[Reserved]
Amended Director Retirement Agreement between Cortland Bancorp and Richard
B. Thompson, dated as of December 18, 2007
10-K
10.10 03/17/08
Amended Director Retirement Agreement between Cortland Bancorp and Timothy
K. Woofter, dated as of December 18, 2007
10-K
10.11 03/17/08
*10.10
*10.11
*10.12
Form of Split Dollar Agreement entered into by Cortland Bancorp and each of
Directors David C. Cole, James E. Hoffman III, and Timothy K. Woofter as of
February 23, 2001, as of March 1, 2004, with Director Neil J. Kaback, and as of
October 1, 2001, with Director Richard B. Thompson;
as amended on December 26, 2006, for Directors Cole, Hoffman, Thompson, and
Woofter;
*10.13
Director’s Retirement Agreement between Cortland Bancorp and Director Joseph
E. Koch, dated as of April 19, 2011
101
10-K(1)
10.12
03/16/06
10-K
10.12 03/15/07
8-K
10.13 04/22/11
Exhibit
No.
*10.14
*10.15
*10.16
*10.17
*10.18
*10.19
Exhibit Description
Incorporated by Reference
Form**
Exhibit
Filing
Date
Filed
Herewith
Split Dollar Agreement and Endorsement between Cortland Bancorp and Director
Joseph E. Koch, dated as of April 19, 2011
8-K
10.14 04/22/11
Form of Indemnification Agreement entered into by Cortland Bancorp with each of
its directors
10-K(1)
10.15 03/16/06
Endorsement Split Dollar Agreement between The Cortland Savings and Banking
Company and David J. Lucido, dated as of March 27, 2012
10-K
10.16 03/29/12
Eighth Amended Salary Continuation Agreement between The Cortland Savings
and Banking Company and Timothy Carney, dated as of December 28, 2018
Third Amended Salary Continuation Agreement between The Cortland Savings
and Banking Company and Lawrence A. Fantauzzi, dated as of December 3, 2008
Eighth Amended Salary Continuation Agreement between The Cortland Savings
and Banking Company and James M. Gasior, dated as of December 28, 2018
8-K
10.17 12/28/18
8-K
10.18 12/12/08
8-K
10.19 12/28/18
10.20
[Reserved]
10.21
[Reserved]
10.22
[Reserved]
*10.23
*10.24
*10.25
*10.26
Second Amended Salary Continuation Agreement between The Cortland Savings
and Banking Company and David J. Lucido dated as of December 28, 2018
8-K
10.23
12/28/18
Fifth Amended Split Dollar Agreement and Endorsement between The Cortland
Savings and Banking Company and Timothy Carney, dated as of December 28,
2018
Amended Salary Continuation Agreement between The Cortland Savings and
Banking Company and Stanley P. Feret, dated as of December 28, 2018
Fifth Amended Split Dollar Agreement and Endorsement between The Cortland
Savings and Banking Company and James M. Gasior, dated as of December 28,
2018
8-K
10.24 12/28/18
8-K
10.25 12/28/18
8-K
10.26 12/28/18
10.27
[Reserved]
10.28
[Reserved]
10.29
[Reserved]
*10.30
Endorsement Split Dollar Agreement between The Cortland Savings and Banking
Company and Stanley P. Feret, dated as of July 23, 2013
10-Q
10.30 08/13/13
*10.31.1
Severance Agreement between Cortland Bancorp and Tim Carney, dated as of
September 28, 2012, as amended November 24, 2015
*10.31.2
Severance Agreement between Cortland Bancorp and James Gasior, dated as of
September 28, 2012, as amended November 24, 2015
*10.31.3
Amended Severance Agreement between Cortland Bancorp and David J. Lucido,
dated as of December 28, 2018
10.32
[Reserved]
102
8-K
10.31.1 12/01/15
8-K
10.31.2 12/01/15
8-K
10.31.3 12/28/18
Exhibit
No.
10.33
[Reserved]
Exhibit Description
Incorporated by Reference
Form**
Exhibit
Filing
Date
Filed
Herewith
*10.34
Amended Severance Agreement between Cortland Bancorp and Stanley P. Feret,
dated as of December 28, 2018
*10.35
Annual Incentive Plan for Executive Officers
*10.36
2015 Omnibus Equity Plan
8-K
8-K
10.34 12/28/18
10.35 08/03/15
10-Q
10.36 08/11/15
10.36.1
Form of incentive stock option award under the 2015 Omnibus Equity Plan
10-Q
10.36.1 08/11/15
10.36.2
Form of nonqualified stock option award under the 2015 Omnibus Equity Plan
10-Q
10.36.2 08/11/15
10.36.3
Form of restricted stock award under the 2015 Omnibus Equity Plan
10-Q
10.36.3 08/11/15
*10.37
2015 Director Equity Plan
10-Q
10.37 08/11/15
10.37.1
Form of nonqualified stock option award under the 2015 Director Equity Plan
10-Q
10.37.1 08/11/15
10.37.2
2015 Director Equity Plan Restricted Stock Award Agreement
10-Q
10.37.2 08/11/15
11
Statement of re-computation of per share earnings
14
21
23
31.1
31.2
32
101
Code of Ethics
Subsidiaries of the Registrant
Consents of experts and counsel – Consent of independent registered public
accounting firm
Certification of the Chief Executive Officer under Rule 13a-14(a)
Certification of Chief Financial Officer under Rule 13a-14(a)
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
required under section 906 of the Sarbanes-Oxley Act of 2002
The following materials from Cortland Bancorp’s Annual Report on Form 10-K for
the year ended December 31, 2018, formatted in Extensible Business Reporting
Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements
of Income; (c) Consolidated Statements of Comprehensive Income; (d)
Consolidated Statements of Changes in Shareholders’ Equity; (e) Consolidated
Statements of Cash Flows; and (f) the Notes to Consolidated Financial Statements
tagged as blocks of text and in detail (included with this filing)
See Note 1
of Financial
Statements
10-K
14
3/17/08
✓
✓
✓
✓
✓
✓
Film number 06691632
(1)
* Management contract or compensatory plan or arrangement
**
SEC File No. 000-13814
Copies of any exhibits will be furnished to shareholders upon written request. Requests should be directed to Tim Carney, Secretary, Cortland
Bancorp, 194 West Main Street, Cortland, Ohio 44410.
103
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Date: March 7, 2019
CORTLAND BANCORP
By: /s/ James M. Gasior
James M. Gasior
President, Chief Executive Officer, Director
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ Timothy K. Woofter
Timothy K. Woofter
/s/ Thomas P. Perciak
Thomas P. Perciak
/s/ James M. Gasior
James M. Gasior
/s/ Timothy Carney
Timothy Carney
/s/ David C. Cole
David C. Cole
/s/ J. Martin Erbaugh
J. Martin Erbaugh
/s/ James E. Hoffman, III
James E. Hoffman, III
/s/ Neil J. Kaback
Neil J. Kaback
/s/ Joseph E. Koch
Joseph E. Koch
/s/ Joseph P. Langhenry
Joseph P. Langhenry
/s/ Richard B. Thompson
Richard B. Thompson
/s/ Anthony R. Vross
Anthony R. Vross
/s/ David J. Lucido
David J. Lucido
Director and Chairman of the Board
Director and Vice Chairman of the Board
President, Chief Executive Officer and
Director (Principal Executive Officer)
Director
Director
Director
Director
Director
Director
Director
Director
Director
Chief Financial Officer
(Principal Financial and Accounting Officer)
104
March 7, 2019
Date
March 7, 2019
Date
March 7, 2019
Date
March 7, 2019
Date
March 7, 2019
Date
March 7, 2019
Date
March 7, 2019
Date
March 7, 2019
Date
March 7, 2019
Date
March 7, 2019
Date
March 7, 2019
Date
March 7, 2019
Date
March 7, 2019
Date
CORTLAND BANCORP AND
THE CORTLAND SAVINGS AND BANKING COMPANY
BOARD OF DIRECTORS
TIMOTHY K. WOOFTER
Chairman of the Board
President and Chief Executive Officer, Stan-Wade Metal Products
Tank Manufacturer and Oil Equipment Distributor
THOMAS P. PERCIAK
Vice Chairman of the Board
Mayor, Strongsville, OH
Government
JAMES M. GASIOR
President and Chief Executive Officer
Cortland Bancorp and The Cortland Savings and Banking Company
TIMOTHY CARNEY
Executive Vice President and Chief Operating Officer
Cortland Bancorp and The Cortland Savings and Banking Company
ANTHONY R. VROSS
Executive, Simon Roofing
Commercial Roofing and Industrial Roof Maintenance
DAVID C. COLE
Partner and President, Cole Valley Motor Company
Automobile Dealership
J. MARTIN ERBAUGH
President, JM Erbaugh Co.
Investment Firm
JAMES E. HOFFMAN, III
Attorney, Hoffman and Walker
Law Firm
JOSEPH E. KOCH
President, Joe Koch Construction
Homebuilding, Developing and Remodeling Company
JOSEPH P. LANGHENRY
Managing Principal, Langhenry Venture Partners
Investment Firm
NEIL J. KABACK
Vice President, Cohen & Company, Ltd.
Accounting Firm
RICHARD B. THOMPSON
Executive, Therm-O-Link, Inc.
Electrical Wire and Cable Manufacturer
DIRECTOR EMERITUS
K. RAY MAHAN
CORTLAND BANCORP
EXECUTIVE OFFICERS
JAMES M. GASIOR
President and Chief Executive Officer
TIMOTHY CARNEY
Executive Vice President and Chief Operating Officer
DAVID J. LUCIDO
Senior Vice President and Chief Financial Officer
STANLEY P. FERET
Senior Vice President and Chief Lending Officer
105
THE CORTLAND SAVINGS AND BANKING COMPANY
JAMES M. GASIOR
President and Chief Executive Officer
TIMOTHY CARNEY
Executive Vice President and Chief Operating Officer
OFFICERS
JOSEPH G. JOHNSON
Senior Vice President
Credit Administration Officer
ROCCO PAGE
Senior Vice President
Mortgage Sales Manager
MARK CHUEY
Vice President
Retail Mortgage Banking Officer
DEBORAH L. EAZOR
Vice President
Operations Manager
JOAN M. FRANGIAMORE
Vice President
Controller
MELANIE CHRISTIE
Vice President
BSA/Compliance Officer/Director of Security
KAREN JINDRA
Vice President
Retail Mortgage Banking Officer
KEITH STINSON
Vice President
Retail Mortgage Banking Officer
PETER OPPERMAN
Vice President
Private Bank Officer/Summit County
MARK E. TAYLOR
Vice President
Commercial Banking Officer
JACQUELINE TREHARNE
Vice President
Mortgage Operations Manager
HEATHER J. BOWSER
Assistant Vice President
Collection Officer
BRENT MARAKAS
Assistant Vice President
Commercial Banking Portfolio Manager
STEPHEN LOWRY
Assistant Vice President
Commercial Banking Portfolio Manager
SHIRLEY A. WADE
Assistant Vice President
Executive Secretary
DAVID J. LUCIDO
Senior Vice President and Chief Financial Officer
STANLEY P. FERET
Senior Vice President and Chief Lending Officer
MICHAEL LIPKE
Senior Vice President
Special Assets/Loan Review
JULIANNA BEGALLA
Vice President
Marketing and Communications Officer
J. MICHAEL BRAINARD
Vice President
Commercial Banking Officer
NICOLE WHITSEL
Vice President
Risk Manager/Compliance
KEITH MROZEK
Vice President
Special Assets and Loan Review
JOHN HEWITT
Vice President
Senior Credit Analyst
MICHAEL KANE
Assistant Vice President
Private Bank Officer/Hudson
MICHELLE REILLY
Vice President, Assistant Treasurer
Mortgage Banking/ Funds Management
BARBARA R. SANDROCK
Vice President
Information Systems Manager
KAREN SHARP
Vice President
Mortgage Manager/Fairlawn
MICHAEL BANISH
Vice President
Treasury Management Sales Officer
CARRIE STACKHOUSE
Vice President
Commercial Banking Officer
JANET K. HOUSER
Assistant Vice President
Electronic Banking Specialist
DARLENE MACK
Assistant Vice President
Human Resources Manager
JAMES E. WELLINGTON
Vice President
Retail Mortgage Banking Officer
NATHANIEL J. MARSHALL
Vice President
Manager of Consumer and Private Bank Services
STANLEY MAGIELSKI
Vice President
Senior Commercial Banking Officer/Mahoning Valley Team Lead
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Section 2: EX-4.2 (EX-4.2)
106
Exhibit 4.2
CORTLAND BANCORP
194 West Main Street
Cortland, OH 44410
March 7, 2019
Securities and Exchange Commission
100 F Street, NE
Washington, D.C. 20549
Re: Cortland Bancorp Annual Report on Form 10-K for the year ended December 31, 2018
Ladies and Gentlemen:
Cortland Bancorp, an Ohio corporation, is today filing an Annual Report on Form 10-K for the year ended December 31, 2018 (the "Form 10-K"), as
executed on March 7, 2019.
Pursuant to the instructions relating to the Exhibits in Item 601(b)(4)(iii) of Regulation S-K, Cortland Bancorp hereby agrees to furnish the
Commission, upon request, copies of instruments and agreements defining the rights of holders of its long-term debt and of the long-term debt of
its consolidated subsidiaries, which are not being filed as exhibits to the Form 10-K. No such instrument or agreement represents long-term debt
exceeding 10% of the total assets of Cortland Bancorp and its subsidiaries on a consolidated basis.
Very truly yours,
/s/ James M. Gasior
James M. Gasior
President and Chief Executive Officer
(Principal Executive Officer)
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Section 3: EX-21 (EX-21)
SUBSIDIARIES OF THE REGISTRANT
The following lists the subsidiaries of Cortland Bancorp and the state of incorporation of each:
NAME
1) The Cortland Savings and Banking Company
2) New Resources Leasing Co.
3) Cortland Statutory Trust 1
The following is a subsidiary of The Cortland Savings and Banking Company:
NAME
1) CSB Mortgage Company, Inc.
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Section 4: EX-23 (EX-23)
INCORPORATED
Ohio
Ohio
Ohio
INCORPORATED
Ohio
Exhibit 21
Exhibit 23
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statements File Nos. 333-52831 and 333-207954 on Form S-8 and the Registration
Statement File No. 333-185114 on Form S-3 of our report dated March 7, 2019, relating to our audit of the consolidated financial statements and
internal control over financial reporting, which appears in the Annual Report to Shareholders, which is incorporated in this Annual Report on Form
10-K of Cortland Bancorp for the year ended December 31, 2018.
/s/ S.R. Snodgrass P.C.
S.R. Snodgrass P.C.
Cranberry Township, Pennsylvania
March 7, 2019
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Section 5: EX-31.1 (EX-31.1)
CERTIFICATION
Exhibit 31.1
I, James M. Gasior, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Cortland Bancorp;
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period
covered by this annual report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal controls over financial reporting, or caused such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such
evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most
recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 7, 2019
/s/ James M. Gasior
James M. Gasior
Title: Chief Executive Officer
(Principal Executive Officer)
Exhibit 31.2
(Back To Top)
Section 6: EX-31.2 (EX-31.2)
I, David J. Lucido, certify that:
1.
I have reviewed this annual report on Form 10-K of Cortland Bancorp;
CERTIFICATION
2.
3.
4.
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period
covered by this annual report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal controls over financial reporting, or caused such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such
evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most
recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 7, 2019
/s/ David J. Lucido
David J. Lucido
Title: Chief Financial Officer
(Principal Financial and Accounting Officer)
(Back To Top)
Section 7: EX-32 (EX-32)
CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER AND
CHIEF FINANCIAL OFFICER PURSUANT TO TITLE 18, UNITED
STATES CODE, SECTION 1350, AS ADOPTED PURSUANT
TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32
In connection with the Annual Report of Cortland Bancorp (the “Company”) on Form 10-K for the year ended December 31, 2018 as filed with
the Securities and Exchange Commission on the date hereof (the “Report”), I, James M. Gasior, the Chief Executive Officer of the Company, certify,
pursuant to Title 18, United States Code, Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Company.
/s/ James M. Gasior
Print Name: James M. Gasior
Title: Chief Executive Officer (Principal Executive Officer)
Date: March 7, 2019
In connection with the Annual Report of Cortland Bancorp (the “Company”) on Form 10-K for the year ended December 31, 2018 as filed with
the Securities and Exchange Commission on the date hereof (the “Report”), I, David J. Lucido, the Chief Financial Officer of the Company, certify,
pursuant to Title 18, United States Code, Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Company.
/s/ David J. Lucido
Print Name: David J. Lucido
Title: Chief Financial Officer (Principal Financial and
Accounting Officer)
Date: March 7, 2019
*
This certification is being furnished as required by Rule 13a-14(b) under the Securities Exchange Act of 1934 (the “Exchange Act”) and
Section 1350 of Chapter 63 of Title 18 of the United States Code, and shall not be deemed “filed” for purposes of Section 18 of the Exchange
Act or otherwise subject to the liability of that Section. This certification shall not be deemed to be incorporated by reference into any filing
under the Securities Act of 1933 or the Exchange Act, except as otherwise stated in such filing.
A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the
signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to and is
being retained by Cortland Bancorp and will be forwarded to the Securities and Exchange Commission or its staff upon request.
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