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FIRST NATIONAL COMMUNITY BANCORP, INC.
102 EAST DRINKER STREET, DUNMORE, PA 18512
1.877.879.3622 | fncb.com
Simply a better bank.TM
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2013
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annual
annual
FIRST NATIONAL COMMUNITY BANCORP, INC.report
report
report
FIRST NATIONAL COMMUNITY BANCORP, INC.
FIRST NATIONAL COMMUNITY BANCORP, INC.
2013AR-33114-CoverArtwork.pdf 2 4/4/2014 9:40:48 AM
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STRATEGY
STRATEGY
ORGANIC LOAN GENERATION
CORE DEPOSIT GROWTH
OPERATIONAL EFFICIENCIES
ASSET QUALITY IMPROVEMENT
ENHANCE CUSTOMER EXPERIENCE
IMPROVE SHAREHOLDER VALUE
Wealth Management Services
fncb.com/wealthmanagementservices | 570.348.4321
At FNCB Wealth Management Services, our goal is to make sure your Financial Advisor is
working hard to make your life easy again. With dedicated people working together, with
commitment from INVEST Financial Corporation’s experienced back office team and state-of-
the-art technology, you can rest assured that your Financial Advisor is being provided some of
the best support, resources and tools the industry has to offer.
FNCB Wealth Management Services is able to provide you with access to well researched
investment advice, asset management, trust and administrative services, insurance and
estate strategies. These varied services are coordinated from one office to help ensure all
aspects of your financial well-being are working in your best interests. It is the goal of FNCB
Wealth Management Services to ensure that not only are your needs met but also the needs
of your heirs during all aspects of their lives.
Since 1997, FNCB Wealth Management Services has been a leading provider of business
retirement plans in the region. Through INVEST Financial Corporation, FNCB Wealth Manage-
ment Services utilizes the resources of the finest investment management, administrators,
and trust service providers available in the country. With more than $250 Million in retirement
plan assets under management, our local team works to help companies offer cost-effective
plans that run efficiently and help meet the evolving needs of both owners and employees.
We have earned our reputation as a leader by maintaining a high level of professional integrity
and building long-term relationships based on mutual respect and strict adherence to the
fundamental principles of needs-based investing.
At FNCB Wealth Management Services, we believe that:
You are entitled to consistent and objective investment
advice from knowledgeable Professionals.
Investment advice should be appropriate to your financial
circumstances and investment goals – based on your
personal risk tolerance.
You should conduct business with representatives whose
only motivation is serving your best interests.
INVEST Financial Corporation member FINRA/SIPC, a registered investment adviser, is not affiliated with
First National Community Bank or FNCB Wealth Management Services. INVEST and its affiliated insurance
agancies offer securities, advisory services, and certain Insurance products. Products are: Not FDIC
insured; Not deposits, obligations of, or guaranteed by any bank; Subject to investment risk, including
the possible loss of principal amount invested.
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To Our Shareholders,
Customers & Friends:
Our team’s focused efforts throughout 2013 resulted in meaningful
improvement in First National Community Bancorp, Inc.’s (the “Company”)
financial position, as well as four consecutive quarters of positive
earnings and improved operating results compared to prior year periods.
Effective execution of our business strategy, which is focused on organic
loan generation, core deposit growth, operational efficiencies, and asset
quality improvement, drove the improved performance.
Despite a less than robust economic recovery across our market area
during 2013, we generated net loan growth of nearly 9% compared to
2012, reflecting strong activity in our residential real estate and
commercial loan portfolios, as well as solid gains in our consumer lending
portfolio. Our commitment to sound underwriting and credit monitoring
practices, as well as effective work-out strategies, led to solid
improvement in asset quality during 2013. Also, we continued to progress
at reducing operating expenses and establishing efficiencies throughout
our organization. We believe that this demonstrates significant progress in
returning First National Community Bank (“FNCB” or the “Bank”) to a
position of competitive strength within our targeted service area, and
enables our team to focus on financially sound opportunities to grow
your Company.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2013 ANNUAL REPORT | 1
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results
results
4% total ASSET growth
10% TOTAL LOAN GROWTH
34% REDUCTION IN NON - PERFORMING LOANS
16% DECREASE IN NON - INTEREST EXPENSE
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Overview of 2013 Results
Our 2013 results were indicative of consistent and effective execution of our business
strategy. Our net income of $6.4 million, or $0.39 per basic and diluted share, was
significantly improved from the prior year net loss of $13.7 million, or $(0.83) per basic
and diluted share. Our improved bottom line in 2013 was the result of a number of
factors, including: a credit for loan and lease losses of $6.3 million, compared with a
provision for loan and lease losses of $4.1 million in 2012; an increase in non-interest
income of $5.0 million resulting from increased gains on the sale of securities and a
gain on the sale of other assets and increases in other income; as well as a decrease
in non-interest expense of $6.8 million primarily due to successful cost containment
initiatives and reduced reliance on outside consultants.
solid results in 2013 were reflective of consistent
and effective execution throughout the Company.
Our total assets grew by 3.7% in 2013 to $1.0 billion, an increase of $35.5 million,
which was driven by strong loan growth and a 9.9% increase in our securities portfolio.
This reversed a three-year trend of managed balance sheet shrinkage which
strengthened our capital position. The fact that we are once again focused on growing
earning assets demonstrates our belief that we have made substantial progress in
addressing these matters. Our earning asset growth was funded primarily by a $30.1
million increase in total deposits, which totaled $884.7 million at December 31, 2013.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2013 ANNUAL REPORT | 3
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FINANCIAL INFORMATION
(dollars in thousands)
FINANCIAL CONDITION
Total loans
Total deposits
2013
2012
2011
2010
2009
$643,372
$597,775
$679,521
$757,936
$939,565
Loan Portfolio Composition
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Residential Real Estate
Commercial Real Estate
$114,925
$218,524
Construction, land acquisition & development
$ 24,382
Commercial and industrial
Consumer
State and political subdivision
$127,021
$118,645
$ 39,875
Deposit Composition
2013
2012
2011
2010
2009
2013
6.20%
18.44%
17.86%
19.74%
33.97%
3.79%
2013
$884,698
$854,613
$957,136
$982,436
$1,071,608
2012
5.44%
18.37%
15.09%
18.35%
37.07%
5.68%
2012
$ 90,228
$221,591
$ 32,502
$109,693
$109,783
$ 33,978
Non-interest bearing demand
Interest-bearing demand
Savings
Time > $100,000
Other Time
$157,550
$334,742
$ 87,806
$161,959
$142,641
16.12%
17.81%
18.31%
37.84%
9.92%
$131,476
$321,863
$ 83,101
$144,844
$173,329
19.59%
14.86%
16.37%
36.38%
9.39%
FINANCIAL PERFORMANCE
Net Income
2013
2012
2011
2010
2009
$ 6,382
($13,711)
($ 335)
($31,720)
($44,316)
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2013 ANNUAL REPORT | 4
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FINANCIAL INFORMATION
(dollars in thousands)
Non-interest income
Non-interest expense
2013
2012
2011
2010
2009
$9,283
$4,283
$12,949
$1,282
($12,001)
2013
2012
2011
2010
2009
ASSET QUALITY
$34,948
$41,738
$41,380
$41,564
$38,022
Nonperforming loans
as a percentage of total loans
Total delinquent loans
as a percentage of total loans
2013
2012
2011
2010
2009
0.99%
1.62%
2013
2012
2011
2010
2009
2.93%
2.77%
3.74%
1.54%
2.13%
4.03%
4.43%
3.16%
Allowance for loan and lease losses
as a percentage of total loans
Allowance for loan and lease losses
as a percentage of nonperforming loans
2013
2012
2011
2010
2009
2.18%
3.10%
3.07%
2.98%
2.40%
2013
2012
2011
2010
2009
219.87%
190.92%
104.60%
79.68%
86.44%
RISK-BASED CAPITAL
Tier 1 Leverage Ratio (Bank)
(Tier 1 capital/average assets)
Total risk-based capital ratio (Bank)
(Total risk-based capital/risk-weighted assets)
2013
2012
2011
2010
2009
8.32%
7.20%
7.20%
6.06%
7.28%
2013
2012
2011
2010
2009
13.43%
11.79%
11.73%
9.83%
10.20%
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2013 ANNUAL REPORT | 5
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Strong Loan Growth
Building our loan portfolio, a key strategic initiative during 2013, will continue in 2014. As a
means to this end, we invested in hiring a new, highly-experienced Chief Lending Officer
with more than 30 years of credit administration, commercial lending and management
experience. Our Chief Lending Officer is charged with the responsibility of leading the
Bank’s commercial lending and business development teams, along with developing and
managing business relationships with commercial customers. Our elevated efforts to build
loan volume in 2013 were successful, as new loan originations substantially exceeded
maturities and payoffs. Loans, net of allowance for loan and lease losses, were $629.9
million at December 31, 2013, an increase of $50.5 million compared to 2012.
Elevated efforts to build loan volume were successful as
new loan originations exceeded maturities and payoffs.
Our commercial and industrial loans grew by $17.3 million, or 15.8%, to $127.0 million
during 2013. This growth was driven in part by our successful effort to acquire the floor
plan financing business of a large automobile dealership located within our service area.
Residential real estate loans grew by $24.7 million, or 27.4%, to $114.9 million at December
31, 2013. We generally underwrite fixed-rate residential mortgage loans for sale in the
secondary market. However, in the second half of 2012, we started retaining 15- and
20-year mortgages in our loan portfolio to provide additional interest income based on their
underlying yields. We extended this strategy to 30-year mortgages in the second half of
2013. Our consumer loan portfolio grew $8.9 million, or 8.1%, during 2013 to $118.6 million
at year end. This growth was concentrated in indirect lending activities generated through
automobile dealer customers and was favorably influenced by the new automobile
dealership floor plan relationship obtained in 2013.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2013 ANNUAL REPORT | 6
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GROWTH
GROWTH
27% residential LOANS
16% COMMERCIAL LOANS
8% CONSUMER LOANS
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Asset Quality Continued
to Strengthen in 2013
We continued to realize measurable progress in addressing problem credit issues throughout
2013, through work-out activity on non-performing loans, as well as successful efforts to
reduce our holdings of foreclosed properties. At December 31, 2013, our ratio of
non-performing loans to total loans had declined to 0.99%, an improvement of 11 basis points
compared to 1.10% at September 30, 2013, and a 63 basis point improvement from our ratio at
the prior year end. Non-performing loans at December 31, 2013 were $6.4 million, a reduction
of $3.3 million, or 34.0%, from the 2012 year end, demonstrating significant progress made in
improving asset quality. We believe that the Bank’s asset quality has returned to being a core
operating strength and compares well to averages for peer banks. In fact, the significant
progress that was made in regard to asset quality metrics in 2013 enabled the Bank to reduce
loan loss reserves by recording a credit for loan and lease losses of $6.3 million during the
year. Furthermore, even after reducing our reserves, the Bank’s allowance for loan and lease
losses as a percentage of non-performing loans was 220% at December 31, 2013, up from
192% at December 31, 2012. It’s worth noting, that our non-performing loans are now at their
lowest level since December 31, 2006, and have been reduced by more than 77% from their
peak level of $28.4 million at December 31, 2010.
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Non-performing loans are now at their lowest level since
2006, reduced by more than 77% since their peak in 2010.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2013 ANNUAL REPORT | 8
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Our More Efficient Operating Profile
Aligning our operating cost structure with our business model has been an important
management objective during the last two years. This is a primary aspect of positioning the
Bank to realize consistent profitability and sustained value creation. In 2013, our focused cost
containment efforts in addition to the planned reduction in the use of outside consultants
contributed to a $6.8 million, or 16.3%, decrease in our total non-interest expense from $41.7
million to $34.9 million. Along with the significant reductions in professional fees, we were able
to substantially reduce salary and employee benefit costs, legal expense and expenses
associated with other real estate owned. Lower salary and employee benefit costs reflected a
nearly 13% reduction in staffing that was implemented at the end of 2012 as we took definitive
steps to match our workforce to business activity levels.
Aligning operating cost structure with our business
created consistent profitability and sustained value.
Despite the substantial progress achieved at reducing non-interest expense in 2013, there is
more to do and we remain committed to bringing additional efficiency to our business model.
In the fourth quarter of 2013, we established a Profitability Enhancement Program for the Bank,
and a primary aspect of this initiative involves identifying additional opportunities for
non-interest expense reduction. Our primary objectives for this initiative include: achieving an
efficiency ratio that ranks in the top 50% of peer banking institutions by December 31, 2014;
identifying the resources and framework needed to execute profit enhancement initiatives; and
implementing an optimal organizational structure that enables FNCB to realize sustained
profitability, continuous process improvement and ongoing non-interest expense management.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2013 ANNUAL REPORT | 9
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STRENGTH
STRENGTH
A Stronger Capital Position at Year End
An important part of the Bank’s Consent Order (the “Order”) with the Office of the Comptroller
of the Currency (“OCC”), entered into in 2010, is the requirement that the Bank maintain
elevated capital levels, including a leverage ratio equal to or exceeding 9% and a total
risk-based capital ratio equal to or exceeding 13%. Among the actions that we initiated to fulfill
this requirement was the development and continued execution of a capital strategy designed
to bring the Bank into full compliance with the capital thresholds established by our agreement
with the OCC. Our capital strategy includes a variety of actions to build capital including:
capital accretion through current earnings; reducing or managing risk-weighted assets on our
balance sheet; reducing the Bank’s assets through sales of branch offices, loans or other real
estate owned; or pursuing other strategic initiatives. While this remains an ongoing process,
we are pleased to report that we have realized considerable progress in raising our capital
levels and meeting the OCC requirements.
The Bank’s total risk-based capital at December 31, 2013, was $90.0 million, or 13.43% of
risk-weighted assets. Our 164 basis point improvement moved the Bank’s total risk-based
capital ratio above the 13% required by the Consent Order. Our leverage ratio also improved in
2013, increasing 112 basis points to 8.32% at December 31, 2013. While still remaining below
the 9% minimum required by the Consent Order, strategies to further improve this ratio will
continue to be executed in 2014.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2013 ANNUAL REPORT | 10
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Core Service Area Redefined
On January 24, 2014, we completed a transaction whereby we sold certain assets and
liabilities of the Marshalls Creek and Stroudsburg branches, both located in Monroe County,
to ESSA Bank and Trust (“ESSA”), concluding an agreement that was initiated in August 2013.
Our decision to divest the Monroe County retail banking activities to ESSA was the result of a
strategic determination that we could realize greater return on investment by focusing on the
core markets where we already have significant brand awareness as well as sizable deposit
market share. We expect that the financial benefits from this transaction, including improved
operating efficiency and enhanced profitability, will be realized in our 2014 results. The
transaction will also bolster the Bank’s capital position, which will be reflected in our first
quarter 2014 period-end balance sheet.
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Costly and Distracting
Litigation Resolved
The Court of Common Pleas for Lackawanna County entered an Order Granting Preliminary
Approval of Proposed Settlement subject to notice to shareholders, related to a shareholder
derivative lawsuit that was initiated in May 2012. This suit alleged a variety of complaints
against certain present and former directors and officers of the Company, and named the
Company as a nominal defendant. In March 2014, the Court issued a Final Order and
Judgment for the matter granting approval of a Stipulation of Settlement (the “Settlement”),
dismissing all claims against the Company and the individual defendants. As part of the
Settlement, there was no admission of liability by the individual defendants. This litigation was
both very costly and a significant distraction for our Board, as well as our management team.
We’re pleased to be able to put this matter behind us so that our Board can focus on guiding
a successful completion of the Bank’s turnaround.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2013 ANNUAL REPORT | 11
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STATUS
STATUS
Consent Order and
Written Agreement Status
FNCB remains under the Order from our primary regulator, the OCC, initiated on September 1,
2010 and, the Company remains under a Written Agreement (the “Agreement”) with the Federal
Reserve Bank of Philadelphia, dated November 24, 2010. These agreements require us to
undertake certain actions within designated timeframes, and to operate in compliance with a
variety of provisions. Since agreeing to the issuance of the Order and the Agreement we have
taken steps to improve the condition, policies and procedures of FNCB and the Company, and
we have realized a substantial degree of progress toward being in full compliance with the
requirements. We have implemented organization-wide best practices, which enhanced our
operational effectiveness and helped us to regain a competitive posture, which we believe is
reflected in our improved results for 2013. We believe that FNCB and the Company have met
most of the regulatory provisions of the Order and the Agreement. Our hope is that meeting
the remaining requirements will lead to termination of the Order and the Agreement, and
FNCB’s and the Company’s return to normal regulatory status.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2013 ANNUAL REPORT | 12
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Well Positioned for the Next Step
We believe that, by any measure, FNCB made great strides in 2013 with four profitable
quarters, improved asset quality which meets or exceeds industry averages, and a
substantially streamlined operating cost structure. In addition, we returned to a growth posture
which significantly increased earning assets, and we leveraged our historic market strength in
Northeastern Pennsylvania to grow deposits which provides abundant cost-effective funding.
The success we realized in 2013 reflects the application of sound policies and procedures,
effective risk management, and a long-term perspective on value creation. It also reflects more
than three years of hard work by our dedicated team in turning around a financial institution
that was, and remains, an important part of the fabric of this community. For more than 100
years FNCB has been here for the residents of Northeastern Pennsylvania, providing financing
to buy a home, to start a business, or to buy a new car. This Bank has been here for our
customers, and it is clear to us that while we worked through a challenging period of time, our
customers, shareholders and employees have all supported the Bank. We greatly appreciate
the support that we continue to receive from all of our stakeholders. We are obviously pleased
that the Bank’s improved operating performance in 2013 was reflected in an increase in the
Company’s common stock valuation from the 2012 year end. We remain excited by our
prospects for the remainder of 2014, and the opportunity to build value in your Company.
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Yours truly,
Dominick L. DeNaples
Chairman of the Board
Steven R. Tokach
President and Chief Executive Officer
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2013 ANNUAL REPORT | 13
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First National Community Bancorp., Inc. | Officers & Directors
OFFICERS
DIRECTORS
Dominick L. DeNaples
Chairman of the Board
Steven R. Tokach
President and
Chief Executive Officer
Michael J. Cestone, Jr.
Secretary
James M. Bone, Jr., CPA
Executive Vice President
Chief Financial Officer
Dominick L. DeNaples
Dr. Louis A. DeNaples, Jr.
Steven R. Tokach
Joseph J. Gentile
Michael J. Cestone, Jr.
Thomas J. Melone, CPA
Joseph Coccia
John P. Moses, Esquire
John R. Thomas - Director Emeritus
First National Community Bank | Directors
Dominick L. DeNaples
Chairman of the Board
Steven R. Tokach
President and
Chief Executive Officer
Michael J. Cestone, Jr.
Secretary
Joseph Coccia
Louis A. DeNaples1
Joseph J. Gentile
Thomas J. Melone, CPA
Dr. Louis A. DeNaples, Jr.
John P. Moses, Esquire
John R. Thomas - Director Emeritus
1Elected to Bancorp Board of Directors in December 2013 and nominated
for reelection in 2014; service may be subject to regulatory non-objection.
First National Community Bank | Bank Officers
Steven R. Tokach
President and
Chief Executive Officer
Gerard A. Champi
Chief Operating Officer
Joseph A. Castrogiovanni
Senior Vice President
Regional Commercial Lending Manager
Richard F. Post, Jr.
Senior Vice President
Senior Special Assets Officer
Cathy J. Conrad
Senior Vice President
Credit Administration Officer
Donald H. Ryan
Senior Vice President
Human Resources Officer
James M. Bone, Jr., CPA
Executive Vice President
Chief Financial Officer
Donna M. Czerw
Senior Vice President
Retail Banking Operations Manager
Stephanie A. Westington, CPA
Senior Vice President
Controller
Joseph J. Earyes, CPA
First Senior Vice President
Chief Retail Banking & Operations Officer
Mary G. Cummings
Senior Vice President
General Counsel
Brian C.Mahlstedt
First Senior Vice President
Chief Lending Officer
Paul S. Dunda
Senior Vice President
Applications Services Manager
Patrick J. Barrett
Senior Vice President
Regional Commercial Lending Manager
Lisa L. Kinney
Senior Vice President
Retail Lending Officer
Joseph D. Angelella
Vice President
Relationship Manager III
Ryan J. Barhight
Vice President
Credit Analyst Supervisor
Richard D. Drust
Vice President
Retail Banking Sales Manager
2013AR-040414-FINAL.pdf 16 4/4/2014 4:54:33 PM
First National Community Bank | Bank Officers (continued)
Joan M. Dwyer
Vice President
Organizational Development/Staffing Officer
Mary Ann Gardner
Vice President
Compliance Officer
Dawn D. Gronski
Vice President
Compensation/Benefits Officer
Nancy A. Jeffers
Vice President
Relationship Manager III
Thomas C. Lunney
Vice President
Property/Purchasing Manager
Madolyn A. MacArthur
Vice President
Community Office Manager III
Philip E. Ogren
Vice President
Technology Services Officer
Karen M. Weller
Vice President
Retail Banking Sales Coordinator
James S. Worobey
Vice President
Workout Officer II
Angelo Ambrosecchia
Assistant Vice President
Small Business Officer II
Roger R. Anderson
Assistant Vice President
SmalI Business Officer I
Elizabeth M. Benkoski
Assistant Vice President
Retail Training Coordinator
Eileen R. Farber-Bonk
Assistant Vice President
Community Office Manager III
Frank J. Kost
Assistant Vice President
Applications Services Analyst
Sharon A. Martin
Assistant Vice President
Loan Administration Supervisor
Richard D. Padula
Assistant Vice President
Mortgage Origination Supervisor
Domnick M. Pasqualichio
Assistant Vice President
Relationship Manager II
Eileen A. Sennett
Assistant Vice President
Deposit Operations Manager
Amy M. Kelley
Banking Officer
Accounting Manager
Christine E. Klime
Banking Officer
Credit Analyst III
Larae L. Krushinski
Banking Officer
Credit Administration Supervisor
Christopher P. Kunz
Banking Officer
Telecommunications Manager
Jennifer Jenner
Banking Officer
Bank Card Relationship Manager
Walter M. Jurgiewicz
Banking Officer
System & Desktop Services Manager
Jenny J. Severs
Assistant Vice President
Indirect/Consumer Lending Manager
Marcella K. Miller
Banking Officer
BSA Manager
Bernice A. Shipp
Assistant Vice President
Community Office Manager III
Lucy E. Singer
Assistant Vice President
Community Office Manager III
Debra A. Skurkis
Assistant Vice President
Community Office Manager III
Karen M. Smith
Assistant Vice President
Relationship Manager I
Ashley M. Tomko
Assistant Vice President
Consumer/ Mortgage Processing Supervisor
Amy L. Richards
Banking Officer
Relationship Manager I
Kelly Sukel
Banking Officer
Indirect/Consumer Lending Underwriter II
Ronald S. Honick
Audit Manager
Germaine T. Helcoski
Assistant Auditor
William A. McGuigan
Assistant Auditor
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banking
wayne
Honesdale Rt. 6
Honesdale
MOBILE
Download the free FNCB
Mobile App today in the
iTunes App or GooglePlay
Stores.
ONLINE
Safe, Secure, Online Banking
www.fncb.com
COMMUNITY OFFICE
Dunmore-Main
102 East Drinker Street, Dunmore, PA
570.346.7667
lackawanna
Clarks
Green Dickson
City
Dunmore MAIN
Scranton
Wheeler
Ave.
Keyser Village
Rt. 315
Back
Mountain
Pittston
Exeter
Plains
Daleville
Kingston Wilkes-Barre
Nanticoke
Hanover
Township
luzerne
Hazleton
Simply a better bank.TM
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Back Mountain
1919 Memorial Hwy
Shavertown, PA
570.674.3622
Clarks Green
269 East Grove Street
Clarks Green
PA 570.586.3622
Daleville
Route 502 & 435
Daleville, PA
570.848.3622
Dickson City
934 Main Street
Dickson City, PA
570.348.6478
Dunmore-Wheeler
1219 Wheeler Avenue
Dunmore, PA
570.207.7300
Exeter
1625 Wyoming Avenue
Exeter, PA
570.603.1000
Hanover Township
734 San Souci Parkway
Hanover Township, PA
570.270.3622
Hazleton
340 West Broad Street
Hazleton, PA
570.501.3622
Honesdale
1001 Main Street
Honesdale, PA
570.253.1096
Honesdale Route 6
1127 Texas Palmyra Hwy.
Honesdale, PA
570.251.8840
Keyser Village
1743 North Keyser Avenue
Scranton, PA
570.348.4880
Kingston
754 Wyoming Avenue
Kingston, PA
570.283.3622
Nanticoke
194 South Market Street
Nanticoke, PA
570.258.3622
Pittston
1700 North Twp. Blvd.
Pittston, PA
570.655.3622
Plains
27 North River Road
Plains, PA
570.825.3622
Route 315
3 Old Boston Road
Pittston, PA
570.602.3622
Scranton
419-421 Spruce Street
Scranton, PA
570.348.6468
Wilkes-Barre
1 North Main Street
Wilkes-Barre
PA 570.831.1000
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 000-53869
FIRST NATIONAL COMMUNITY BANCORP, INC.
(Exact Name of Registrant as Specified in Its Charter)
Pennsylvania
(State or Other Jurisdiction
of Incorporation or Organization)
102 E. Drinker St., Dunmore, PA
(Address of Principal Executive Offices)
23-2900790
(I.R.S. Employer
Identification No.)
18512
(Zip Code)
Registrant’s telephone number, including area code (570) 346-7667
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1.25 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: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data
File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for
such shorter period that the registrant was required to submit and post such files). YES NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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 this 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 or a smaller reporting
company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check
one)
Large Accelerated Filer
Non-Accelerated Filer
(Do not check if a smaller reporting company)
Accelerated Filer
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No
The aggregate market value of the voting and non-voting common stock of the registrant, held by non-affiliates was $53,375,272 at June 30, 2013.
State the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 16,517,319 shares of
common stock as of March 21, 2014.
APPLICABLE ONLY TO CORPORATE REGISTRANTS
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Items 10, 11, 12, 13 and 14 is incorporated by reference into Part III hereof from portions of the Proxy Statement for
the registrant’s 2014 Annual Meeting of Shareholders.
Contents
PART I ....................................................................................................................................................................... 3
Item 1. Business ..................................................................................................................................................... 3
Item 1A. Risk Factors. ............................................................................................................................................ 18
Item 1B. Unresolved Staff Comments. ................................................................................................................... 27
Item 2. Properties. ................................................................................................................................................. 27
Item 3. Legal Proceedings..................................................................................................................................... 29
Item 4. Mine Safety Disclosures. ......................................................................................................................... 30
PART II .................................................................................................................................................................... 30
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity
Securities. ................................................................................................................................................................. 30
Item 6. Selected Financial Data ............................................................................................................................ 33
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations .................. 34
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. ................................................................ 65
Item 8. Financial Statements and Supplementary Data. ....................................................................................... 67
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................ 121
Item 9A. Controls and Procedures ........................................................................................................................ 122
Item 9B. Other Information .................................................................................................................................. 122
PART III ................................................................................................................................................................ 123
Item 10. Directors, Executive Officers and Corporate Governance. ................................................................... 123
Item 11. Executive Compensation. ...................................................................................................................... 123
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
................................................................................................................................................................................ 123
Item 13. Certain Relationships and Related Transactions, and Director Independence. ..................................... 123
Item 14. Principal Accounting Fees and Services. .............................................................................................. 123
PART IV ................................................................................................................................................................ 124
Item 15. Exhibits and Financial Statement Schedules ......................................................................................... 124
2
PART 1
Item 1. Business
Overview
The Company
First National Community Bancorp, Inc., incorporated in 1997, is a Pennsylvania business corporation and a registered bank holding
company headquartered in Dunmore, Pennsylvania. In this report the terms “Company,” “we,” “us,” and “our” refer to First National
Community Bancorp, Inc. and its subsidiaries, unless the context requires otherwise. In certain circumstances, however, First National
Community Bancorp, Inc. uses the term “Company” to refer to itself.
The Company became an active bank holding company on July 1, 1998 when it acquired ownership of First National Community Bank
(the “Bank”). The Bank is a wholly-owned subsidiary of the Company. The Company’s primary activity consists of owning and
operating the Bank, which provides practically all of the Company’s earnings as a result of its banking services.
As a result of criticism received from banking regulators in connection with their examination process during 2010, the Company has
taken steps to remediate and improve its lending policies and its credit administration function, including developing and implementing
new policies and procedures, particularly related to risk management. The Company has also been advised by its regulators that it must
increase its regulatory capital. For more information regarding the supervision and regulation of the Company, refer to the section
entitled “Supervision and Regulation – Supervisory Actions,” in this Item 1 to this Annual Report on Form 10-K.
The Company had net income of $6.3 million in 2013, a net loss of $13.7 million and $335 thousand in 2012 and 2011, respectively.
Total assets were $1.0 billion, $968 thousand and $1.1 billion at December 31, 2013, 2012 and 2011, respectively.
The Bank
Established as a national banking association in 1910, as of December 31, 2013 the Bank operated 21 full-service branch offices within
four contiguous counties, Lackawanna, Luzerne, Wayne and Monroe, its primary market area located in the Northeast section of the
state.
On August 16, 2013, the Bank entered into a Branch Purchase and Deposit/Loan Assumption Agreement with ESSA Bank and Trust
(“ESSA”), the wholly owned subsidiary of ESSA Bancorp, Inc., for ESSA to acquire certain assets and liabilities of the Bank’s
Marshalls Creek and Stroudsburg branches, both of which are located in Monroe County, Pennsylvania. The transaction included the
real property of the Marshalls Creek branch and closed on January 24, 2014. The real property of the Stroudsburg branch was not sold as
part of this agreement.
Retail Banking
The Bank provides a wide variety of retail banking products and services to individuals and businesses including Image Checking and E-
Statements. Deposit products include various checking, savings and certificate of deposit products, as well as a line of preferred
products for higher-balance customers. The Bank also participates in the Certificate of Deposit Account Registry (“CDARs”) program,
which allows customers to secure Federal Deposit Insurance Corporation (“FDIC”) insurance on balances in excess of the standard
limitations. The Bank’s current participation in CDARs is limited by the FDIC while it is subject to the Consent Order from the Office
of the Comptroller of the Currency and a Written Agreement with the Federal Reserve Bank of Philadelphia.
The Bank also offers customers the convenience of 24-hour banking, seven days a week, through FNCB Online via a secure website
https://www.fncb.com. FNCB Online’s product suite includes Bill Payment, Finance Works, Funds Transfer and POP Money (person to
person transfers), and Purchase Rewards. FNCB Online can also be accessed through the Bank’s mobile application. Customers can also
access money from their deposit accounts by using their debit card to make purchases or cash withdrawals from any of the Bank’s
automated teller machines (“ATMs”) located in each of the Bank’s branch offices as well as additional locations. FNCB’s mobile
deposit, available to personal banking customers with access to FNCB Online Banking and an eligible deposit account, allows customers
to make deposits anywhere at any time. The customer first selects the deposit check feature, photographs the front and back of the check,
chooses the account and confirms the amount. The check is then processed electronically from start to finish.
Through FNCB Online, customers can directly access their accounts, open new accounts and apply for a mortgage or obtain a pre-
qualification approval through the Bank’s Mortgage Center. Telephone Banking (Account Link), a service that provides customers with
the ability to access account information, perform related account transfers, and apply for a loan through the use of a touch tone
3
telephone, is also available. The Bank offers overdraft Bounce Protection, Savings Overdraft Protection and Instant Money loans which
provide customers with an added level of protection against unanticipated cash flow emergencies and account reconciliation errors.
FNCB Business Online is a menu driven product that provides the Bank’s business customers direct access to their account information
and the ability to perform internal and external transfers and process Direct Deposit payroll transactions for employees, 24 hours a day, 7
days a week, from their place of business. Remote Deposit Capture allows business customers the ability to process daily check deposits
to their accounts through an online image capture environment. Business customers can access money from their deposit account by
using their “business” debit card, providing a faster, more convenient way to make purchases, track business expenses and manage
finances.
Lending Activities
The Bank offers a variety of loans, including residential real estate loans, construction, land acquisition and development loans,
commercial real estate loans, commercial and industrial loans, loans to state and political subdivisions, and consumer loans, generally to
individuals and businesses in its primary market area. These lending activities are described in further detail below.
Residential Mortgage Loans
The Bank offers fixed- and variable-rate one- to four-family residential loans. The Bank also offers a rate lock product that allows
borrowers to lock in their interest rate at the time of application as well as at the time of commitment. During 2013 and 2012, the
number of customers who exercised the option to lock the rate was minimal. At December 31, 2013, one- to four-family residential
mortgage loans totaled $114.9 million, or 17.9%, of the Bank’s total loan portfolio.
One- to four-family mortgage loans are originated generally for sale in the secondary market. During the year ended December 31,
2013, the Bank sold $12.6 million of one- to four-family mortgages. The Bank retains servicing rights on these mortgages.
Construction, Land Acquisition and Development Loans
The Bank offers interim construction financing secured by residential property for the purpose of constructing one- to four-family
homes. The Bank also offers interim construction financing for the purpose of constructing residential developments and various
commercial properties including shopping centers, office complexes and single purpose owner occupied structures and for land
acquisition. At December 31, 2013, construction, land acquisition and development loans of $24.4 million represented 3.8% of the total
loan portfolio.
Commercial Real Estate Loans
At December 31, 2013, commercial real estate loans totaled $218.5 million, or 34.0%, of the Bank’s total loan portfolio. Commercial
real estate mortgage loans represent the largest portion of the Bank’s total loan portfolio and loans in this portfolio generally have larger
loan balances. The commercial real estate loan portfolio is secured by a broad range of real estate, including but not limited to, office
complexes, shopping centers, hotels, warehouses, gas stations, convenience markets, residential care facilities, nursing care facilities,
restaurants, multifamily housing, farms and land subdivisions.
Commercial and Industrial Loans
The Bank generally offers commercial loans to individuals and businesses located in its primary market area. The commercial loan
portfolio includes lines of credit, dealer floor plan lines, equipment loans, vehicle loans, improvement loans and term loans. These loans
are primarily secured by vehicles, machinery and equipment, inventory, accounts receivable, marketable securities, deposit accounts and
real estate. At December 31, 2013, commercial and industrial loans totaled $127.0 million, or 19.7%, of the Bank’s total loan portfolio.
Consumer Loans
Consumer loans include both secured and unsecured installment loans, lines of credit and overdraft protection loans. The Bank is also in
the business of underwriting indirect auto loans which are originated through various auto dealers in northeastern Pennsylvania and
dealer floor plan loans. Generally, the Bank also offers home equity loans and lines of credit with a maximum combined loan-to-value
ratio of 90%, based on the appraised value of the property. Home equity loans have fixed rates of interest and are for terms up to 15
years. Equity lines of credit have adjustable interest rates and are based upon the prime interest rate. At December 31, 2013, consumer
loans totaled $118.6 million, or 18.4%, of the total loan portfolio.
4
State and Political Subdivision Loans
The Bank originates state and political subdivision loans primarily to municipalities in the Bank’s market area. At December 31, 2013,
state and political subdivision loans totaled $39.9 million, or 6.2%, of the Bank’s loan portfolio.
For more information regarding the Company’s loan portfolio and lending policies, please refer to Note 2 “Summary of Significant
Accounting Polices” to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.
Wealth Management
Wealth management services are available at the Bank. Customers are able to access alternative deposit products such as mutual funds,
annuities, stocks, and bonds directly for purchase from an outside provider.
Deposit Activities
In general, deposits, borrowings and loan repayments are the major sources of the Bank’s funds for lending and other investment
purposes. The Bank grows its deposits within its market area primarily by offering a wide selection of deposit accounts. Deposit
account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate,
among other factors. In determining the terms of the Bank’s deposit accounts, the Bank considers the interest rates offered by its
competitors, the interest rates available on borrowings, its liquidity needs and customer preferences. The Bank regularly reviews its
deposit mix and deposit pricing as part of its asset/liability management, taking into consideration rates offered by competitors in its
market area.
Competition
The Company faces substantial competition in originating loans and in attracting deposits from a significant amount of financial
institutions operating in its market area, many with a statewide or regional presence, and in some cases, a national presence. The
competition comes principally from other banks, savings institutions, credit unions, mortgage banking companies and, with respect to
deposits, institutions offering investment alternatives, including money market funds and online savings accounts. The increased
competition has resulted from changes in the legal and regulatory guidelines, as well as from economic conditions. The cost of
regulatory compliance remains high for community banks as compared to their larger competitors that are able to achieve economies of
scale. As discussed above and in Note 17, “Regulatory Matters” to the consolidated financial statements included in Item 8 to this
Annual Report on Form 10-K, the Company and the Bank are subject to extensive regulation and supervision, including regulations that
limit the type and scope of activities, such as the Order and Agreement (hereinafter defined).
As a result of consolidation in the banking industry, some of the Bank’s competitors and their respective affiliates are larger and may
enjoy advantages such as greater financial resources, a wider geographic presence, a wider array of services, or more favorable pricing
alternatives and lower origination and operating costs. The Company considers its major competition to be local commercial banks as
well as other commercial banks with branches in the Company’s market area. Competitors may offer deposits at higher rates and loans
with lower fixed rates, more attractive terms and less stringent credit structures than the Company has been able to offer. The growth and
profitability of the Company depend on its continued ability to successfully compete.
Supervision and Regulation
We participate in a highly regulated industry and are subject to a variety of statutes, regulations and policies, as well as ongoing
regulatory supervision and review. These laws, regulations and policies are subject to frequent change and we take measures to comply
with applicable requirements.
Supervisory Actions
The Bank is under a Consent Order (the “Order”) from the Office of the Comptroller of the Currency (“OCC”) dated September 1, 2010.
The Company is also subject to a Written Agreement (the “Agreement”) with the Federal Reserve Bank of Philadelphia (the “Reserve
Bank”) dated November 24, 2010.
OCC Consent Order. The Bank, pursuant to a Stipulation and Consent to the Issuance of a Consent Order dated September 1, 2010,
without admitting or denying any wrongdoing, consented and agreed to the issuance of the Order by the OCC, the Bank’s primary
regulator. The Order requires the Bank to undertake certain actions within designated timeframes, and to operate in compliance with the
provisions thereof during its term. The Order is based on the results of an examination of the Bank as of March 31, 2009. Since the
examination, management has engaged in ongoing discussions with the OCC and has taken steps to improve the condition, policies and
5
procedures of the Bank. Compliance with the Order is monitored by a committee (the “Committee”) of at least three directors, none of
whom is an employee or controlling shareholder of the Bank or its affiliates or a family member of any such person. The Committee is
required to submit written progress reports to the OCC on a monthly basis. The Committee has submitted each of the required monthly
progress reports with the OCC. The members of the Committee are John P. Moses, Joseph Coccia, Joseph J. Gentile and Thomas J.
Melone. The material provisions of the Order are set forth below with a description of the status of the Bank’s effort to comply with
such provisions:
(i) By October 31, 2010, the Board of Directors of the Bank (the “Board”) was required to adopt and implement a three-year strategic
plan (“Strategic Plan”) which must be submitted to the OCC for review and prior determination of no supervisory objection; the
Strategic Plan must establish objectives for the Bank’s overall risk profile, earnings performance, growth, balance sheet mix, off-balance
sheet activities, liability structure, capital adequacy, reduction in the volume of nonperforming assets, product line development, and
market segments that the Bank intends to promote or develop, and is to include strategies to achieve those objectives; if the Strategic
Plan involves the sale or merger of the Bank, it must address the timeline and steps to be followed to provide for a definitive agreement
within 90 days after the receipt of a determination of no supervisory objection;
The Bank has developed a Strategic Plan that it believes complies with the Order requirements. A three-year Strategic Plan for the
period January 1, 2011 to December 31, 2013 was prepared and submitted to the OCC for review. On an annual basis, the Bank
prepares an updated and revised Strategic Plan. Strategic Plans for the periods January 1, 2012 to December 31, 2014 and January 1,
2013 to December 31, 2015 were submitted to the OCC for review. The Strategic Plan for the period January 1, 2014 to December 31,
2016 is in process, and the Bank expects to submit it to the OCC for review in the near term.
(ii) by October 31, 2010, the Board was required to adopt and implement a three year capital plan (“Capital Plan”), which must be
submitted to the OCC for review and prior determination of no supervisory objection;
The Bank has developed a Capital Plan that it believes complies with the Order requirements to ensure that the Bank’s leverage ratio
equals or exceeds 9% and the Bank’s total risk-based capital ratio equals or exceeds 13%. This Capital Plan for the period January 1,
2011 through December 31, 2013 and its annual update and revisions for 2012 and 2013 were submitted to the OCC for review. The
annual update and revision to the Capital Plan is in process in conjunction with the annual budget and strategic planning initiatives.
Management expects to forward the 2014-2016 Capital Plan to the OCC for review in the near term.
(iii) by November 30, 2010, the Bank was required to achieve and thereafter maintain a total risk-based capital equal to at least 13% of
risk-weighted assets and a Tier 1 capital equal to at least 9% of adjusted total assets;
The Bank’s total risk-based capital ratio was 13.43% at December 31, 2013, which was above the 13% required by the Order. The
Bank’s leverage capital ratio was 8.32% at December 31, 2013, which was below the 9% required by the Order. The Bank’s total risk-
based capital increased 164 basis points, while the Bank’s leverage ratio increased 112 basis points at December 31, 2013 compared to
December 31, 2012. The Bank continues to execute its Capital Plan and has engaged an outside financial advisory firm to assist the
Bank in taking appropriate actions to achieve and maintain compliance with the capital requirements of the Order. Appropriate actions
or combinations of actions may include capital accretion through current earnings, raising additional capital, reducing the Bank’s assets
through sales of branch offices, loans or other real estate owned, or pursuing other strategic transactions.
(iv) the Bank may not pay any dividend or capital distribution unless it is in compliance with the higher capital requirements required by
the Order, the Capital Plan, applicable legal requirements and, then only after receiving a determination of no supervisory objection from
the OCC;
The Board has acknowledged the prohibition on payment of dividends or any other capital distributions without the prior written consent
of the OCC. The Bank has not paid any dividends or capital distributions since the effective date of the Order.
(v) by November 15, 2010, the Committee must have reviewed the Board and the Board’s committee structure; by November 30, 2010,
the Board was required to prepare or cause to be prepared an assessment of the capabilities of the Bank’s executive officers to perform
their past and current duties, including those required to respond to the most recent examination report, and to perform annual
performance appraisals of each officer;
The Committee completed its review of the Board and the Board committee structure on November 10, 2010 by reviewing the Board
Structure Study report completed by an independent consultant engaged by the Committee. The report was forwarded to the OCC on
November 24, 2010. The Company is in the process of implementing those recommendations.
The Board completed its assessment of the capabilities of the Bank’s executive officers upon receipt of a management study, completed
by an independent consultant (“Management Study”), on October 13, 2010. The Management Study was forwarded to the OCC on
6
October 29, 2010. The Board of Directors completed a successful search for President and Chief Executive Officer in December 2011.
Since the effective date of the Order, other changes have been made to the executive management team related to the size and
complexity of the organization.
Annual performance appraisals are prepared for each officer based on established and timely management goals to confirm that each
officer is performing the duties outlined in his or her job description.
(vi) by October 31, 2010, the Board was required to adopt, implement and thereafter ensure compliance with a comprehensive conflict of
interest policy (the “Conflict of Interest Policy”) applicable to the Bank’s and the Company’s directors, executive officers, principal
shareholders and their affiliates and such person’s immediate family members and their related interests, employees, and by
November 30, 2010, was required to review existing relationships with such persons to identify those, if any, not in compliance with the
policy; and review all subsequent proposed transactions with such persons or modifications of transactions;
The Bank’s Conflict of Interest Policy has been revised to provide comprehensive guidance and a review was conducted of existing
relationships to ensure compliance with the policy. The revised policy was approved by the Board on September 29, 2010 and
forwarded to the OCC on October 7, 2010. Additional revisions were approved by the Board on April 29, 2011, October 24, 2012, May
22, 2013 and November 14, 2013.
(vii) by October 31, 2010, the Board was required to develop, implement and ensure adherence to policies and procedures for Bank
Secrecy Act (“BSA”) compliance; and account opening and monitoring procedures compliance;
The Board believes it has developed and implemented a written program of policies and procedures to provide for compliance with the
requirements of the BSA as well as compliance with account opening and monitoring procedures.
(viii) by October 31, 2010, the Board was required to ensure the BSA audit function is supported by an adequately staffed department or
third party firm; to adopt, implement and ensure compliance with an independent BSA audit; and to assess the capabilities of the BSA
officer and supporting staff to perform present and anticipated duties;
The Board believes that the Bank’s BSA audit function is adequately staffed; and the BSA Officer and staff have been assessed to
determine their ability to implement and maintain compliance with the BSA policies and programs detailed above.
(ix) by October 31, 2010, the Board was required to adopt, implement and ensure adherence to a written credit policy (the “Loan
Policy”), including specified features, to improve the Bank’s loan portfolio management;
The Bank’s written Loan Policy has been revised to improve guidance and control over the Bank’s lending functions. The revised
policy was approved by the Board on October 27, 2010. Additional revisions were approved by the Board on November 24, 2010, July
27, 2011, October 27, 2011, March 28, 2012, June 27, 2012, October 11, 2012, July 24, 2013 and February 26, 2014.
(x) the Board was required to take certain actions to resolve certain credit and collateral exceptions;
The Board believes that it has taken action to appropriately address the credit and collateral exceptions concerns detailed in the Order.
(xi) by October 31, 2010, the Board was required to establish an effective, independent and ongoing loan review system to review, at
least quarterly, the Bank’s loan and lease portfolios to assure the timely identification and categorization of problem credits; by
October 31, 2010, to adopt and adhere to a program for the maintenance of an adequate allowance for loan and lease losses (“ALLL”),
and to review the adequacy of the Bank’s ALLL at least quarterly;
The Board has established an independent and ongoing loan review program on a quarterly basis that it believes provides for the timely
identification and categorization of problem credits.
The ALLL policy and methodologies have been reviewed and revised to determine the appropriate level of the ALLL, including
documenting the analysis in accordance with generally accepted accounting principles in the United States (“GAAP”) and other
applicable regulatory guidelines. The revised policy was approved by the Board on October 27, 2010 and is updated on an annual
basis. The Board reviews the ALLL methodology analysis on a quarterly basis as part of the financial reporting process.
(xii) by October 31, 2010, the Board was required to adopt and the Bank implement and adhere to a program to protect the Bank’s
interest in criticized assets; and the Bank may only extend additional credit (including renewals) to a borrower whose loans are criticized
under specified circumstances;
7
The Board committed to a program to reduce the Bank’s risk exposure to criticized assets by implementing a detailed monthly reporting
and monitoring process. The Board believes that this program has resulted in a reduction in criticized assets.
In accordance with the requirements of the Order, the Bank has not extended any additional credit to, or for the benefit of, any borrower
who has a loan or other extension of credit that either has been charged off or criticized without the prior approval of the Bank’s Board,
or loan committee under specified circumstances, since the date of the Order.
(xiii) by October 31, 2010, the Board was required to adopt and ensure adherence to action plans for each piece of other real estate
owned;
The Board committed to action plans for each piece of other real estate owned centered around a robust reporting and monitoring
process. The Board believes that this program has resulted in a substantial reduction in other real estate owned balances.
(xiv) by November 30, 2010, the Board was required to develop, implement and ensure adherence to a policy for effective monitoring
and management of concentrations of credit;
The Board believes it developed and implemented a written concentration management program consistent with OCC Bulletin 2006-46
on November 24, 2010. This program was forwarded to the OCC on November 30, 2010. Loan concentration analysis reports are
prepared and reviewed quarterly by the Board as part of the Bank’s loan portfolio management practices.
(xv) by October 31, 2010, the Board was required to revise and implement the Bank’s Other than Temporary Impairment Policy;
The Board believes that the Other Than Temporary Impairment Policy has been reviewed and revised so that the quarterly other-than-
temporary impairment ("OTTI") analysis process identifies and measures OTTI in accordance with GAAPand supervisory guidance,
including Financial Accounting Standards Board Accounting Standards Codification 320-10-35 (Recognition and Presentation of Other-
than-Temporary Impairments), OCC Bulletin 2009-11 dated April 17, 2009, "Other-than-Temporary Impairment Accounting" and OCC
Call Report Instructions.
(xvi) by October 31, 2010, the Board was required to take action to maintain adequate sources of stable funding and liquidity and a
contingency funding plan; by October 31, 2010, the Board was required to adopt, implement and ensure compliance with an
independent, internal audit program;
The Board believes that it has taken action to maintain adequate sources of stable funding and liquidity and developed an appropriate
contingency funding plan for the Bank. A Liquidity Funding policy that addresses liquidity needs, funding sources and contingency
funding was approved by the Board on November 24, 2010 and has been implemented and is reviewed and updated annually.
Additional policies related to liquidity, funding and contingency funding have since been created and are updated annually since the
Order was executed.
The Board believes that it has taken appropriate steps to adopt, implement and comply with an independent, adequately-staffed internal
audit program.
(xvii) take actions to correct cited violations of law; and adopt procedures to prevent future violations and address compliance
management.
The Board and management believe that they have taken appropriate action to correct cited violations and adopted procedures designed
to prevent future violations and address compliance management.
Federal Reserve Agreement. On November 24, 2010, the Company entered into the Agreement with the Reserve Bank. The Agreement
requires the Company to undertake certain actions within designated timeframes, and to operate in compliance with the provisions
thereof during its term. The material provisions of the Agreement are set forth below with a description of the status of the Company’s
efforts to comply with such provision:
(i) the Company’s Board was required to take appropriate steps to fully utilize the Company’s financial and managerial resources to
serve as a source of strength to the Bank, including taking steps to ensure that the Bank complies with its Consent Order entered into
with the OCC;
The Company has taken, and continues to take, steps the Board believes are appropriate to use the Company’s financial and managerial
resources to serve as a source of strength to the Bank. The steps the Bank has taken to comply with the Order are discussed above.
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(ii) the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the
Division of Banking Supervision and Regulation (the “Director”) of the Federal Reserve Board;
The Company has acknowledged the prohibition on payment of dividends without the prior written consent of the Reserve Bank and
Director. The Company has not paid any dividends since the effective date of the Agreement.
(iii) the Company may not take dividends or other payments representing a reduction of the Bank’s capital without the prior written
approval of the Reserve Bank;
The Company has acknowledged the prohibition on taking dividends or any other capital distributions from the Bank without the prior
written consent of the Reserve Bank. The Bank has not paid and the Company has not received any dividends or capital distributions
from the Bank since the effective date of the Agreement.
(iv) the Company and its nonbank subsidiary may not make any payment of interest, principal or other amounts on the Company’s
subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director;
The Company has acknowledged the prohibition on any payment related to the Company’s subordinated debentures and trust preferred
securities without the written approval of the Reserve Bank and Director. The Company has not made any payments of interest, principal
or other amounts on the Company’s subordinated debentures or trust preferred securities since the effective date of the Agreement.
(v) the Company may not make any payment of interest, principal or other amounts on debt owed to insiders of the Company without
the prior written approval of the Reserve Bank and Director;
The Company has acknowledged the prohibition on any payment related to the debt owed to insiders of the Company without the
written approval of the Reserve Bank and Director. The Company has not made any payments related to debt owed to insiders since the
effective date of the Agreement.
(vi) the Company and its nonbank subsidiary may not incur, increase or guarantee any debt without the prior written approval of the
Reserve Bank;
The Company has acknowledged the prohibition on incurring, increasing or guaranteeing any debt without the written approval of the
Reserve Bank other than permitted borrowings from the FHLB. The Company has not incurred, increased or guaranteed any debt since
the effective date of the Agreement.
(vii) the Company may not purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank;
The Company has acknowledged the prohibition on purchasing or redeeming any shares of its stock without the written approval of the
Reserve Bank. The Company has not purchased or redeemed any shares of its stock since the effective date of the Agreement.
(viii) the Company was required to submit to the Reserve Bank, by January 23, 2011, an acceptable written plan to maintain sufficient
capital at the Company on a consolidated basis. Thereafter, the Company must notify the Reserve Bank within 45 days of the end of any
quarter in which the Company’s capital ratios fall below the approved capital plan’s minimum ratios, and submit an acceptable written
plan to increase the Company’s capital ratios above the capital plan’s minimums;
The Company has developed a Capital Plan that it believes is acceptable and maintains sufficient capital at the Company on a
consolidated basis. The Capital Plan was submitted to the Reserve Bank on January 11, 2011. The Capital Plan has since been updated
at least annually and forwarded to the Reserve Bank. The annual update and revision to the Capital Plan is in process in conjunction with
the annual budget and strategic planning initiatives.
The Bank’s total risk-based capital ratio was 13.43% at December 31, 2013, which was above the 13% minimum required by the Order.
Given the inability to achieve the minimum leverage ratio as stated in the capital requirements of the Order at the Bank level, the
Company continues to update the Reserve Bank on a quarterly basis of its plans to increase its capital ratios above the Capital Plan
minimums.
(ix) the Company was required to immediately take all actions necessary to ensure that: (1) each regulatory report accurately reflects the
Company’s condition on the date for which it is filed and all material transactions between the Company and its subsidiaries; (2) each
such report is prepared in accordance with its instructions; and (3) all records indicating how the report was prepared are maintained for
supervisory review;
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The Company believes that it has taken actions to ensure that all required regulatory reports are filed to accurately reflect its financial
condition on the date filed, are prepared in accordance with instructions and that records detailing how the reports were filed are
maintained and available for supervisory review.
(x) the Company was required to submit to the Reserve Bank, by January 23, 2011, acceptable written procedures to strengthen and
maintain internal controls to ensure all required regulatory reports and notices filed with the Board of Governors are accurate and filed in
accordance with the instructions for preparation;
The Company believes that it has designed effective written procedures and strengthened internal controls so that all required Board of
Governors reports and notices filed are accurate and in accordance with instructions. The written procedures were provided to the
Reserve Bank on January 21, 2011.
(xi) the Company was required to submit to the Reserve Bank, by January 8, 2011, a cash flow projection for 2011, reflecting the
Company’s planned sources and uses of cash, and submit a cash flow projection for each subsequent calendar year at least one month
prior to the beginning of such year;
The Company created a cash flow projection for 2011 and submitted it to the Reserve Bank on January 7, 2011 in accordance with
requirements of the Agreement. Similar projections for 2012, 2013, and 2014 were provided to the Reserve Bank within the time
requirements prescribed in the Agreement.
(xii) the Company must comply with: (1) the notice provisions of Section 32 of the FDI Act and Subpart H of Regulation Y in
appointing any new director or senior executive officer or changing the duties of any senior executive officer; and (2) the restrictions on
indemnification and severance payments of Section 18(k) of the FDI Act and Part 359 of the FDIC’s regulations;
The Company has acknowledged the notice requirements on the appointment of any new director or senior executive officer. The
Company has filed the appropriate notice for each new director or senior executive officer since the date of the Agreement.
The Company acknowledges the restriction on indemnification and severance payments. The Company has not made any such
indemnification or severance payments since the effective date of the Agreement without obtaining prior regulatory non-objections from
the OCC and regulatory concurrence from the FDIC as required by Part 359.
(xiii) the Board must submit written progress reports within 30 days of the end of each calendar quarter.
The Company’s Board has filed each of the required written progress reports with the Reserve Bank since the Agreement was executed.
Since entering into the Order and the Agreement, the Company has incurred expenses in an effort to comply with the terms of these
agreements. In particular, the Company has incurred expenses in connection with developing and implementing policies and procedures
and hiring additional personnel as required by the Order and the Agreement.
During the years ended December 31, 2013 and 2012, the Company incurred approximately $0.4 million and $0.6 million, respectively,
of expenses related to entering into and complying with these regulatory agreements, consisting primarily of professional and consulting
fees. In addition, the Order and the Agreement place restrictions on the Company’s ability to borrow funds and to pay interest and
dividends to its security holders. In the future, the Company may continue to experience increased costs related to compliance with
these regulatory agreements and also expects to face certain restrictions on its operations for as long as it continues to operate under the
Order and the Agreement. The Company expects, however, that future compliance expenses will decrease from the 2013 level, because
the majority of the expenses incurred to date are related to development and implementation of processes and policies that, once those
policies and processes are finalized and implemented, are not expected to recur.
The Order and the Agreement have not and are not expected to have an impact on the Company’s ability to attract and maintain deposits
or the Company’s cost of funds. In order to meet the increased capital requirements imposed under the Order and the Agreement,
however, unless the Company is able to raise additional capital, the Company could be limited in the aggregate amount of loans it can
have outstanding, which may constrain loan growth. While it is not anticipated that the Order and the Agreement will have an impact on
the Company’s net interest margin, the overall cost of compliance with the Order and the Agreement will continue to impact profitability
at least through the end of 2014.
The Company
The Company is a bank holding company registered with, and subject to regulation by, the Reserve Bank and the Federal Reserve Board
(“FRB”). The Bank Holding Company Act of 1956, as amended (the “BHCA”) and other federal laws subject bank holding companies
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to restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including
regulatory enforcement actions for violations of laws and regulations and unsafe and unsound banking practices.
The BHCA requires approval of the FRB for, among other things, the acquisition by a proposed bank holding company of control of
more than five percent (5%) of the voting shares, or substantially all the assets, of any bank or the merger or consolidation by a bank
holding company with another bank holding company. The BHCA also generally permits the acquisition by a bank holding company of
control or substantially all the assets of any bank located in a state other than the home state of the bank holding company, except where
the bank has not been in existence for the minimum period of time required by state law; but if the bank is at least 5 years old, the FRB
may approve the acquisition.
With certain limited exceptions, a bank holding company is prohibited from acquiring control of any voting shares of any company
which is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or
controlling banks or furnishing services to or performing services for its authorized subsidiaries. A bank holding company may,
however, engage in, or acquire an interest in a company that engages in, activities that the FRB has determined by order or regulation to
be so closely related to banking or managing or controlling banks as to be properly incident thereto. In making such a determination, the
FRB is required to consider whether the performance of such activities can reasonably be expected to produce benefits to the public,
such as convenience, increased competition or gains in efficiency, which outweigh possible adverse effects, such as undue concentration
of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The FRB is also empowered to
differentiate between activities commenced de novo and activities commenced by the acquisition, in whole or in part, of a going
concern. Some of the activities that the FRB has determined by regulation to be closely related to banking include making or servicing
loans, performing certain data processing services, acting as a fiduciary or investment or financial advisor, and making investments in
corporations or projects designed primarily to promote community welfare.
Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of
credit to the bank holding company or any of its subsidiaries, or investments in the stock or other securities thereof, and on the taking of
such stock or securities as collateral for loans to any borrower. Further, a holding company and any subsidiary bank are prohibited from
engaging in certain tie-in arrangements in connection with the extension of credit. A subsidiary bank may not extend credit, lease or sell
property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that: (i) the customer obtain or
provide some additional credit, property or services from or to such bank other than a loan, discount, deposit or trust service; (ii) the
customer obtain or provide some additional credit, property or service from or to the bank holding company or any other subsidiary of
the bank holding company; or (iii) the customer not obtain some other credit, property or service from competitors, except for reasonable
requirements to assure the soundness of credit extended.
The Gramm Leach-Bliley Act of 1999 (the “GLB Act”) allows a bank holding company or other company to certify status as a financial
holding company, which allows such company to engage in activities that are financial in nature, that are incidental to such activities, or
are complementary to such activities without further approval. The Company has not elected to become a financial holding company.
The GLB Act enumerates certain activities that are deemed financial in nature, such as underwriting insurance or acting as an insurance
principal, agent or broker, underwriting, dealing in or making markets in securities, and engaging in merchant banking under certain
restrictions. It also authorizes the FRB to determine by regulation what other activities are financial in nature, or incidental or
complementary thereto.
The Bank
The Bank, as a national bank, is a member of the Federal Reserve System and its accounts are insured up to the maximum legal limit by
the Deposit Insurance Fund of the FDIC. The Bank is subject to regulation, supervision and regular examination by the OCC. The
regulations of these agencies and the FDIC govern most aspects of the Bank’s business, including required reserves against deposits,
loans, investments, mergers and acquisitions, borrowing, dividends and location and number of branch offices. State laws may also
apply to the Bank to the extent that federal law does not preempt the state law. The laws and regulations governing the Bank generally
have been promulgated to protect depositors and the Deposit Insurance Fund, and not for the purpose of protecting shareholders.
Branching and Interstate Banking. The federal banking agencies are authorized to approve interstate bank merger transactions without
regard to whether such transactions are prohibited by the law of any state, unless the home state of one of the banks has opted out of the
interstate bank merger provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”)
by adopting a law after the date of enactment of the Riegle-Neal Act and before June 1, 1997 that applies equally to all out-of-state
banks and expressly prohibits merger transactions involving out-of-state banks. Interstate bank mergers are also subject to the
nationwide and statewide insured deposit concentration limitations described in the Riegle-Neal Act.
The Dodd-Frank Act authorizes national and state banks to establish de novo branches in other states to the same extent as a bank
chartered by that state would be so permitted. Previously, banks could only establish branches in other states if the host state expressly
11
permitted out-of-state banks to establish branches in that state. Pennsylvania law had previously permitted banks chartered in
Pennsylvania to branch in other states without limitation, thereby permitting national banks in Pennsylvania to establish branches
anywhere in the state, but only permitted out of state banks to branch in Pennsylvania if the home state of the out of state bank permits
Pennsylvania banks to establish de novo branches. The branching provisions of the Dodd-Frank Act could result in more banks from
other states establishing de novo branches in the Bank’s market area.
USA Patriot Act and BSA. Under the BSA, a financial institution is required to have systems in place to detect certain transactions,
based on the size and nature of the transaction. Financial institutions are generally required to report cash transactions involving more
than $10,000 to the United States Treasury. In addition, financial institutions are required to file suspicious activity reports for
transactions that involve more than $5,000 and that the financial institution knows, suspects or has reason to suspect, involves illegal
funds, is designed to evade the requirements of the BSA or has no lawful purpose. Under the Uniting and Strengthening America by
Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act, commonly referred to as the “USA Patriot Act” or the
“Patriot Act,” financial institutions are subject to prohibitions against specified financial transactions and account relationships, as well
as enhanced due diligence standards intended to detect, and prevent, the use of the United States financial system for money laundering
and terrorist financing activities. The Patriot Act requires financial institutions, including banks, to establish anti-money laundering
programs, including employee training and independent audit requirements, meet minimum standards specified by the act, follow
minimum standards for customer identification and maintenance of customer identification records, and regularly compare customer lists
against lists of suspected terrorists, terrorist organizations and money launderers. The OCC has required the Bank to strengthen its
internal policies and procedures with respect to BSA compliance, and the Bank continues to develop and implement policies designed to
satisfy this requirement.
Capital Adequacy Requirements. The FRB and OCC have adopted risk based capital adequacy and leverage capital adequacy
requirements pursuant to which they assess the adequacy of capital in examining and supervising banks and bank holding companies and
in analyzing bank regulatory applications. Risk-based capital requirements determine the adequacy of capital based on the risk inherent
in various classes of assets and off-balance sheet items.
National banks are expected to meet a minimum ratio of total qualifying capital (the sum of core capital (Tier 1) and supplementary
capital (Tier 2)) to risk weighted assets of 8%. At least half of this amount (4%) must be core capital (Tier 1). Tier 1 Capital generally
consists of the sum of common shareholders’ equity and perpetual preferred stock (subject in the case of the latter to limitations on the
kind and amount of such stock which may be included as Tier 1 Capital), less goodwill, without adjustment for changes in the fair value
of securities classified as “available for sale” in accordance with Accounting Standards Codification (“ASC”) Topic 320, Investments-
Debt and Equity Securities. Tier 2 Capital consists of the following: hybrid capital instruments; perpetual preferred stock that is not
otherwise eligible to be included as Tier 1 Capital; term subordinated debt and intermediate-term preferred stock; and, subject to
limitations, general ALLL. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics, with
the categories ranging from 0% (requiring no risk-based capital) for assets such as cash, to 100% for the bulk of assets that are typically
held by a bank, including certain multi-family residential and commercial real estate loans, commercial business loans and consumer
loans. Residential first mortgage loans on one-to-four family residential real estate and certain seasoned multi-family residential real
estate loans, which are not 90 days or more past-due or non-performing and which have been made in accordance with prudent
underwriting standards are assigned a 50% level in the risk-weighing system, as are certain privately-issued mortgage-backed securities
representing indirect ownership of such loans. Off-balance sheet items also are adjusted to take into account certain risk characteristics.
In addition to the risk-based capital requirements, the OCC has established a minimum 3.0% leverage capital ratio (Tier 1 Capital to
total adjusted assets) requirement for the most highly-rated banks, with an additional cushion of at least 100 to 200 basis points for all
other banks, which effectively increases the minimum leverage capital ratio for such other banks to 4.0% - 5.0% or more. The highest-
rated banks are those that maintain a strong capital position and have well diversified risk, including no undue interest rate risk exposure,
excellent asset quality, high liquidity, good earnings and, in general, those which are considered a strong banking organization. A bank
having less than the minimum leverage capital ratio requirement is required, within 60 days of the date as of which it fails to comply
with such requirement, to submit a reasonable plan describing the means and timing by which the bank will achieve its minimum
leverage capital ratio requirement. A bank that fails to file such plan is deemed to be operating in an unsafe and unsound manner, and
could subject the bank to a cease-and-desist order. Any insured depository institution with a leverage capital ratio that is less than 2.0%
is deemed to be operating in an unsafe or unsound condition pursuant to Section 8(a) of the Federal Deposit Insurance Act (the “FDIA”)
and is subject to potential termination of deposit insurance. However, such an institution will not be subject to an enforcement
proceeding solely on account of its capital ratios, if it has entered into and is in compliance with a written agreement to increase its
leverage capital ratio and to take such other action as may be necessary for the institution to be operated in a safe and sound manner.
The capital regulations also provide, among other things, for the issuance of a capital directive, which is a final order issued to a bank
that fails to maintain minimum capital or to restore its capital to the minimum capital requirement within a specified time period. Such a
directive is enforceable in the same manner as a final cease-and-desist order.
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The capital ratios described above are the minimum levels that the federal banking regulators expect. State and federal regulators have
the discretion to require the Bank to maintain higher capital levels based upon its concentrations of loans, the risk of lending or other
activities, the performance of its loan and investment portfolios and other factors. Failure to maintain such higher capital expectations
could result in a lower composite regulatory rating, which would impact deposit insurance premiums and could affect its ability to
borrow and costs of borrowing, and could result in additional or more severe enforcement actions. In respect of institutions with high
concentrations of loans in areas deemed to be higher risk, or during periods of significant economic stress, regulators may require an
institution to maintain a higher level of capital, and/or to maintain more stringent risk management measures, than those required by
these regulations.
The Bank’s total capital to risk-weighted assets ratio at December 31, 2013 and 2012 was 13.43% and 11.79%, respectively. The Tier I
capital to risk-weighted assets ratio at December 31, 2013 and 2012 was 12.17% and 10.52%, respectively. The Tier I capital to average
assets ratio at December 31, 2013 and 2012 was 8.32% and 7.20%, respectively. Under the Order, the Bank was required to achieve a
total capital ratio of 13% and a Tier I capital to average assets ratio of 9% by November 30, 2010. As of December 31, 2013, the Bank
met the 13.00% minimum requirement for the total risk-based capital ratio but did not achieve the 9.0% minimum requirement for the
Tier 1 leverage ratio. The Company continues to explore various options to improve its regulatory capital ratios. The Company’s total
capital ratio at December 31, 2013 and 2012 was 11.58% and 10.20%, respectively. The Tier I capital to risk-weighted assets at
December 31, 2013 and 2012 was 6.88% and 5.95%, respectively. The Tier I capital to average assets at December 31, 2013 and 2012
was 4.71% and 4.07%, respectively.
Changes in Capital Requirements. In December 2010, the Basel Committee on Banking Supervision released its final framework for
strengthening international capital and liquidity regulation (“Basel III”). The regulations adopted by the U.S. federal bank regulatory
agencies, when fully phased-in, will require bank holding companies and their bank subsidiaries to maintain more capital, with a greater
emphasis on common equity. The Basel III final capital framework, among other things, (i) introduces as a new capital measure “Common
Equity Tier 1” (“CET1”), (ii) specifies that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified
requirements, (iii) defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the
other components of capital and (iv) expands the scope of the adjustments as compared to existing regulations.
When fully phased-in, Basel III requires banks to maintain (i) as a newly adopted international standard, a minimum ratio of CET1 to risk-
weighted assets of at least 4.5%, plus a “capital conservation buffer” of 2.5 %; (ii) a minimum ratio of Tier 1 capital to risk-weighted assets
of at least 6.0%, plus the capital conservation buffer, or 8.5%; (iii) a minimum ratio of Total (Tier 1 plus Tier 2) capital to risk-weighted
assets of at least 8.0% plus the capital conservation buffer, or 10.5%; and (iv) as a newly adopted international standard, a minimum
leverage ratio of 3%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed
as the average for each quarter of the month-end ratios for the quarter).
Basel III also provides for a “countercyclical capital buffer,” generally to be imposed when national regulators determine that excess
aggregate credit growth becomes associated with a buildup of systemic risk that would be a CET1 add-on to the capital conservation buffer
in the range of 0% to 2.5% when fully implemented. The capital conservation buffer is designed to absorb losses during periods of
economic stress.
Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer (or below the
combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) may face constraints on their ability to
pay dividends, to effect equity repurchases and pay discretionary bonuses to executive officers, which constraints vary based on the amount
of the shortfall.
The Basel III final framework provides for a number of new deductions from and adjustments to CET1. These include, for example, the
requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-
consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories
in the aggregate exceed 15% of CET1.
The federal banking regulators issued a final rulemaking in July 2013 (the “Basel III Rule”) to implement Basel III under regulations
substantially consistent with the above. The Basel III Rule also includes, as part of the definition of CET1 capital, a requirement that
banking institutions include the amount of Accumulated Other Comprehensive Income (“AOCI,” which primarily consists of unrealized
gains and losses on available for sale securities, that are not required to be treated as OTTI, net of tax) in calculating regulatory capital,
unless the institution makes a one-time opt-out election from this provision in connection with the filing of its first regulatory reports after
applicability of the Basel III Rule to that institution. The Basel III Rule also imposes a 4% minimum leverage ratio.
The Basel III Rule also makes changes to the manner of calculating risk weighted assets. It imposes methodologies for determining risk
weighted assets, including revisions to recognition of credit risk mitigation, such as a greater recognition of financial collateral and a wider
range of eligible guarantors. They also include risk weighting of equity exposures and past due loans; and higher (greater than 100%) risk
13
weighting for certain commercial real estate exposures that have higher credit risk profiles, including higher loan to value and equity
components.
As discussed below, the Basel III Rules also integrate the new capital requirements into the prompt corrective action provisions under
Section 38 of the FDIA.
In general, the Basel III Rules will become applicable to the Company and Bank on January 1, 2015. The Company and Bank currently
expect to elect to exclude AOCI in calculating regulatory capital with the filing of their respective first regulatory reports after applicability
of the Basel III Rule to them, although reserving the right to elect to include AOCI in the calculation of regulatory capital. Additionally, the
Company expects its outstanding subordinated notes will cease to qualify as capital for regulatory purposes when the new capital definitions
under the Basel III Rule become applicable to the Company and Bank. Overall, the Company believes that implementation of the Basel III
Rule will not have a material adverse effect on the Company’s or Bank’s capital ratios, earnings, shareholder’s equity, or its ability to pay
dividends, effect stock repurchases or pay discretionary bonuses to executive officers.
Prompt Corrective Action. Under Section 38 of the FDIA, each federal banking agency is required to implement a system of prompt
corrective action for institutions which it regulates. The federal banking agencies have promulgated substantially similar regulations to
implement the system of prompt corrective action established by Section 38 of the FDIA. Under the regulations, a bank will be deemed
to be: (i) “well capitalized” if it has a total risk based capital ratio of 10.0% or more, a Tier 1 risk based capital ratio of 6.0% or more, a
leverage capital ratio of 5.0% or more and is not subject to any written capital order or directive; (ii) “adequately capitalized” if it has a
total risk based capital ratio of 8.0% or more, a Tier 1 risk based capital ratio of 4.0% or more and a Tier 1 leverage capital ratio of 4.0%
or more (3.0% under certain circumstances) and does not meet the definition of “well capitalized;” (iii) “undercapitalized” if it has a
total risk based capital ratio that is less than 8.0%, a Tier 1 risk based capital ratio that is less than 4.0% or a leverage capital ratio that is
less than 4.0% (3.0% under certain circumstances); (iv) “significantly undercapitalized” if it has a total risk based capital ratio that is less
than 6.0%, a Tier 1 risk based capital ratio that is less than 3.0% or a leverage capital ratio that is less than 3.0%; and (v) “critically
undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%.
The Basel III Rule also resulted in a change in the prompt corrective action capital requirements, effective in 2015. Under Basel III, an
institution would be deemed to be: (i) “well capitalized” if it has a total risk based capital ratio of 10.0% or more, a Tier 1 risk based
capital ratio of 8.0% or more, a CET1 risk based capital ratio of 6.5% or more, and a leverage capital ratio of 5.0% or more; (ii)
“adequately capitalized” if it has a total risk based capital ratio of 8.0% or more, a Tier 1 risk based capital ratio of 6.0% or more, a
CET1 risk based capital ratio of 4.5% or more, and a leverage capital ratio of 4.0% or more; (iii) “undercapitalized” if it has a total risk
based capital ratio of less than 8.0%, a Tier 1 risk based capital ratio of less than 6.0%, a CET1 risk based capital ratio of less than 4.5%,
and a leverage capital ratio of less than 4.0%; (iv) “significantly undercapitalized” if it has a total risk based capital ratio of less than
6.0%, a Tier 1 risk based capital ratio of less than 4.0%, a CET1 risk based capital ratio of less than 3.0%, and a leverage capital ratio of
less than 3.0%; and (v) “critically undercapitalized” if it has a ratio of tangible equity to total assets that is less than or equal to 2.0%.
Tangible equity would be defined for this purpose as Tier 1 capital (common equity tier 1 capital plus any additional Tier 1 capital
elements) plus any outstanding perpetual preferred stock that is not already included in Tier 1 capital.
An institution generally must file a written capital restoration plan which meets specified requirements with an appropriate federal
banking agency within 45 days of the date the institution receives notice or is deemed to have notice that it is undercapitalized,
significantly undercapitalized or critically undercapitalized. A federal banking agency must provide the institution with written notice of
approval or disapproval within 60 days after receiving a capital restoration plan, subject to extensions by the applicable agency.
An institution that is required to submit a capital restoration plan must concurrently submit a performance guaranty by each company
that controls the institution. Such guaranty will be limited to the lesser of (i) an amount equal to 5.0% of the institution’s total assets at
the time the institution was notified or deemed to have notice that it was undercapitalized or (ii) the amount necessary at such time to
restore the relevant capital measures of the institution to the levels required for the institution to be classified as adequately capitalized.
Such a guaranty will expire after the federal banking agency notifies the institution that it has remained adequately capitalized for each
of four consecutive calendar quarters. An institution that fails to submit a written capital restoration plan within the requisite period,
including any required performance guaranty, or fails in any material respect to implement a capital restoration plan, will be subject to
the restrictions in Section 38 of the FDIA applicable to significantly undercapitalized institutions.
A “critically undercapitalized institution” is to be placed in conservatorship or receivership within 90 days unless the FDIC formally
determines that forbearance from such action would better protect the deposit insurance fund. Unless the FDIC or other appropriate
federal banking regulatory agency makes specific further findings and certifies that the institution is viable and is not expected to fail, an
institution that remains critically undercapitalized on average during the fourth calendar quarter after the date it becomes critically
undercapitalized must be placed in receivership. The general rule is that the FDIC will be appointed as receiver within 90 days after a
bank becomes critically undercapitalized unless extremely good cause is shown and an extension is agreed to by the federal regulators.
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In general, good cause is defined as capital which has been raised and is imminently available for infusion into the bank except for
certain technical requirements which may delay the infusion for a period of time beyond the 90 day time period.
Immediately upon becoming undercapitalized, an institution becomes subject to the provisions of Section 38 of the FDIA, which (i)
restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the
condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the
growth of the institution’s assets; and (v) require prior approval of certain expansion proposals. The appropriate federal banking agency
for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of
these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the Deposit Insurance Fund,
subject in certain cases to specified procedures. These discretionary supervisory actions include: requiring the institution to raise
additional capital; restricting transactions with affiliates; requiring divestiture of the institution or the sale of the institution to a willing
purchaser; and any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive
supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions.
Additionally, under Section 11(c)(5) of the FDIA, a conservator or receiver may be appointed for an institution if: (i) an institution’s
obligations exceed its assets; (ii) there is substantial dissipation of the institution’s assets or earnings as a result of any violation of law or
any unsafe or unsound practice; (iii) the institution is in an unsafe or unsound condition; (iv) there is a willful violation of a cease-and-
desist order; (v) the institution is unable to pay its obligations in the ordinary course of business; (vi) losses or threatened losses deplete
all or substantially all of an institution’s capital, and there is no reasonable prospect of becoming “adequately capitalized” without
assistance; (vii) there is any violation of law or unsafe or unsound practice or condition that is likely to cause insolvency or substantial
dissipation of assets or earnings, weaken the institution’s condition, or otherwise seriously prejudice the interests of depositors or the
insurance fund; (viii) an institution ceases to be insured; (ix) the institution is undercapitalized and has no reasonable prospect that it
will become adequately capitalized, fails to become adequately capitalized when required to do so, or fails to submit or materially
implement a capital restoration plan; or (x) the institution is critically undercapitalized or otherwise has substantially insufficient capital.
As previously mentioned, the Basel III Rules integrate the new capital requirements into the prompt corrective action category
definitions. As of January 1, 2015, the following capital requirements will apply to the Company for purposes of Section 38 of the
FDIA.
Capital Category
Well capitalized
Adequately capitalized
Undercapitalized
Significantly undercapitalized
Critically undercapitalized
Total
Risk-Based
Capital Ratio
>/= 10.0%
>/= 8.0%
< 8.0%
< 6.0%
N/A
Tier I
Common Equity
Risk-Based
Capital Ratio
>/= 8.0%
>/= 6.0%
< 6.0%
< 4.0%
N/A
Tier I
Leverage
Tangible Equity
Supplemental
Capital Ratio
>/= 6.5%
>/= 4.5%
< 4.5%
< 3.0%
N/A
Ratio
>/= 5.0%
>/= 4.0%
< 4.0%
< 3.0%
N/A
to Assets
Leverage Ratio
N/A
N/A
N/A
N/A
Less than 2.0%
N/A
>/= 3.0%
< 3.0%
N/A
N/A
Regulatory Enforcement Authority. Federal banking law grants substantial enforcement powers to federal banking regulators. This
enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal
orders and to initiate injunctive actions against banking organizations and institution-affiliated parties. In general, these enforcement
actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide
the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.
The Bank and its “institution-affiliated parties,” including its management, employees, agents, independent contractors, consultants such
as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs, are subject to potential civil
and criminal penalties for violations of law, regulations or written orders of a governmental agency. In addition, regulators are provided
with greater flexibility to commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement
actions include the termination of deposit insurance and cease-and-desist orders. Such orders may, among other things, require
affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or
guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or
contracts, or take other actions as determined by the ordering agency to be appropriate.
Under provisions of the federal securities laws, a determination by a court or regulatory agency that certain violations have occurred at a
company or its affiliates can result in fines, restitution, a limitation of permitted activities, disqualification to continue to conduct certain
activities and an inability to rely on certain favorable exemptions. Certain types of infractions and violations can also affect a public
company in its timing and ability to expeditiously issue new securities into the capital markets.
15
The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan
loss allowances for regulatory purposes.
As a result of the volatility and instability in the financial system in recent years, Congress, the bank regulatory authorities and other
government agencies have called for or proposed additional regulation and restrictions on the activities, practices and operations of
banks and their holding companies. While many of these proposals relate to institutions that have accepted investments from, or sold
troubled assets to, the Department of the Treasury or other government agencies, or otherwise participate in government programs
intended to promote financial stabilization, Congress and the federal banking agencies have broad authority to require all banks and
holding companies to adhere to more rigorous or costly operating procedures, corporate governance procedures, or to engage in
activities or practices which they might not otherwise elect. Any such requirement could adversely affect the Company’s business and
results of operations. The Company did not accept an investment by the Treasury Department in its preferred stock or warrants to
purchase common stock, and except for the temporary increases in deposit insurance for customer accounts, has not participated in any
of the programs adopted by the Treasury Department, FDIC or Federal Reserve.
The Dodd-Frank Act. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) made
significant changes to the bank regulatory structure and affects the lending, deposit, investment, trading and operating activities of
financial institutions and their holding companies. The Dodd-Frank Act requires a number of federal agencies to adopt a broad range of
new rules and regulations, and to prepare various studies and reports for Congress. The federal agencies are given significant discretion
in drafting these rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be
known for some time. Although it is not possible to determine the ultimate impact of this statute until the extensive rulemaking is
complete, the following provisions are considered to be of greatest significance to the Company:
•
Expands the authority of the FRB to examine bank holding companies and their subsidiaries, including insured depository
institutions;
• Requires a bank holding company to be well capitalized and well managed to receive approval of an interstate bank acquisition;
• Changes standards for federal preemption of state laws related to national banks and their subsidiaries;
•
Provides mortgage reform provisions regarding a customer’s ability to pay and making more loans subject to provisions for higher-
cost loans and new disclosures;
• Creates the Consumer Financial Protection Bureau (the “CFPB”) that has rulemaking authority for a wide range of consumer
protection laws that apply to all banks and has broad powers to supervise and enforce consumer protection laws;
• Creates the Financial Stability Oversight Council with authority to identify institutions and practices that might pose a systemic risk;
•
•
Introduces additional corporate governance and executive compensation requirements on companies subject to the Securities and
Exchange Act of 1934, as amended;
Permits FDIC-insured banks to pay interest on business demand deposits;
• Requires that holding companies and other companies that directly or indirectly control an insured depository institution to serve as
a source of financial strength;
• Makes permanent the $250 thousand limit for federal deposit insurance at all insured depository institutions; and
•
Permits national and state banks to establish interstate branches to the same extent as the branch host state allows establishment of
in-state branches.
Consumer Financial Protection Bureau. The Dodd-Frank Act created the CFPB, a new independent federal agency within the Federal
Reserve System, having broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection
laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting
Act, Fair Debt Collection Practices Act, the consumer financial privacy provisions of the Gramm-Leach-Bliley Act and certain other
statutes. The CFPB, which began operations on July 21, 2011, has examination and primary enforcement authority with respect to
depository institutions with $10 billion or more in assets. Smaller institutions, including the Bank, are subject to rules promulgated by
the CFPB but continue to be examined and supervised by federal banking regulators for compliance with federal consumer protection
16
laws and regulations. The CFPB also has authority to prevent unfair, deceptive or abusive practices in connection with the offering of
consumer financial products. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more
stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with
both the state and federal laws and regulations.
The CFPB has proposed or issued a number of important rules affecting a wide range of consumer financial products. Many of these
rules took effect in January 2014, which has created significant uncertainty for the Company and the financial services industry in
general. It is difficult to predict at this time the specific impact the Dodd-Frank Act and CFPB rulemakings will have on business. The
changes resulting from the Dodd-Frank Act and CFPB rulemakings may impact the profitability of business activities, limit the ability to
make, or the desirability of making, certain types of loans, including non-qualified mortgage loans, require financial institutions to
change certain of business practices, impose more stringent capital, liquidity and leverage ratio requirements or otherwise adversely
affect business or profitability. The changes may also require financial institutions to dedicate significant management attention and
resources to evaluate and make necessary changes to comply with the new statutory and regulatory requirements.
The CFPB has concentrated much of its rulemaking efforts on reforms related to residential mortgage transactions. In 2013, the CFPB
issued final rules related to a borrower’s ability to repay and qualified mortgage standards, mortgage servicing standards, loan originator
compensation standards, requirements for high-cost mortgages, appraisal and escrow standards and requirements for higher-priced
mortgages. Several of the CFPB’s rulemakings became effective in January 2014. In November 2013, the CFPB issued final rules
establishing integrated disclosure requirements for lenders and settlement agents in connection with most closed end, real estate secured
consumer loans. These rules will become effective in August 2015, and management continues to analyze their requirements to
determine the impact to the Company and the Bank. During 2014, the Bank expects the CFPB to focus its rulemaking efforts on
expanding the scope of information lenders must report in connection with mortgage and other housing-related loan applications under
the Home Mortgage Disclosure Act. These rules include significant regulatory and compliance changes and are expected to have a
broad impact on the financial services industry.
The final rule implementing the Dodd-Frank Act requirement that lenders determine whether a consumer has the ability to repay a
mortgage loan, which went into effect on January 10, 2014, establishes certain minimum requirements for creditors when making ability
to pay determinations, and establishes certain protections from liability for mortgages meeting the definition of “qualified mortgages.”
The rule affords greater legal protections for lenders making qualified mortgages that are not “higher priced.” Qualified mortgages must
generally satisfy detailed requirements related to product features, underwriting standards, and a points and fees requirement whereby
the total points and fees on a mortgage loan cannot exceed specified amounts or percentages of the total loan amount. Mandatory
features of a qualified mortgage include: (1) a loan term not exceeding 30 years and (2) regular periodic payments that do not result in
negative amortization, deferral of principal repayment, or a balloon payment. The rule creates special categories of qualified mortgages
originated by certain smaller creditors. The Bank’s current business strategy, product offerings, and profitability may change as the rule
is interpreted by the regulators and courts.
The final rules adopting new mortgage servicing standards, which took effect on January 10, 2014, impose new requirements regarding
force-placed insurance, mandate certain notices prior to rate adjustments on adjustable-rate mortgages, and establish requirements for
periodic disclosures to borrowers. These requirements will affect notices to be given to consumers as to delinquency, foreclosure
alternatives, modification applications, interest rate adjustments and options for avoiding “force-placed” insurance. Servicers will be
prohibited from processing foreclosures when a loan modification is pending, and must wait until a loan is more than 120 days
delinquent before initiating a foreclosure action. Servicers must provide direct and ongoing access to its personnel, and provide prompt
review of any loss mitigation application. Servicers must maintain accurate and accessible mortgage records for the life of a loan and
until one year after the loan is paid off or transferred. These new standards are expected to increase the cost and compliance risks of
servicing mortgage loans. We cannot predict the ultimate outcome of these inquiries, actions, or regulatory changes or the impact that
they could have on our financial condition, results of operations, or business.
FDIC Insurance Premiums. The FDIC maintains a risk-based assessment system for determining deposit insurance premiums. Four risk
categories (I-IV), each subject to different premium rates, are established based upon an institution’s status as well capitalized,
adequately capitalized or undercapitalized, and the institution’s supervisory rating.
The Dodd-Frank Act permanently increased the maximum deposit insurance amount for banks, savings institutions and credit unions to
$250,000 per depositor. The Dodd-Frank Act also broadened the base for FDIC insurance assessments. Assessments are now based on
a financial institution’s average consolidated total assets less tangible equity capital. The Dodd-Frank Act requires the FDIC to increase
the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the
FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. The Dodd-Frank Act
eliminated the statutory prohibition against the payment of interest on business checking accounts.
17
An insured institution is required to pay deposit insurance premiums on its assessment base in accordance with its risk category. There are
three adjustments that can be made to an institution’s initial base assessment rate: (1) a potential decrease for long-term unsecured debt,
including senior and subordinated debt and, for small institutions, a portion of Tier 1 capital; (2) a potential increase for secured liabilities
above a threshold amount; and (3) for non-Risk Category I institutions, a potential increase for brokered deposits above a threshold amount.
The FDIC may also impose special assessments from time to time.
During the year ended December 31, 2013, the Bank was considered risk category III for deposit insurance assessments and paid an
annual assessment rate of 0.0023 basis points on the assessment base of average consolidated total assets less the average tangible equity
during the assessment period.
Dividend Restrictions
The Company is a legal entity separate and distinct from the Bank. The Company’s revenues (on a parent company only basis) result
almost entirely from dividends paid by its subsidiary, the Bank, to the Company. The right of the Company, and consequently the right
of creditors and shareholders of the Company, to participate in any distribution of the assets or earnings of any subsidiary through the
payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the subsidiary (including depositors)
except to the extent that claims of the Company, in its capacity as a creditor, may be recognized. Additionally, the ability of the Bank to
pay dividends to the Company is subject to various regulatory restrictions. The Order currently prohibits the Bank from paying
dividends to the Company and the Agreement further prohibits the Company from taking dividend payments from the Bank.
Federal and state laws regulate the payment of dividends by the Company. Federal banking regulators have the authority to prohibit
banks and bank holding companies from paying a dividend if the regulators deem such payment to be an unsafe or unsound practice.
Currently, the Agreement with the Federal Reserve Bank prohibits the Company from paying dividends without prior approval from the
Reserve Bank.
Employees
As of December 31, 2013, the Company and the Bank employed 285 persons, including 50 part-time employees.
Available Information
The Company files reports, proxy and information statements and other information electronically with the SEC. You may read and
copy any materials that the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC
20549. Information may be obtained on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC
maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file
electronically with the SEC. The SEC’s website site address is http://www.sec.gov. The Company’s web site address is
http://www.fncb.com. The Company makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on
Form 8-K and amendments thereto available through its website at www.fncb.com. They may also be obtained free of charge as soon as
practicable after filing or furnishing them to the SEC upon request by sending an email to corporatesecretary@fncb.com. Further, the
Company will provide electronic or paper copies of the Company’s filings free of charge upon request. Information may also be
obtained via written request to First National Community Bancorp, Inc. Attention: Chief Financial Officer, 102 East Drinker Street,
Dunmore, PA 18512.
Item 1A. Risk Factors.
The Company is subject to extensive government regulation, supervision and possible regulatory enforcement actions, which
may subject us to higher costs and lower shareholder returns.
The banking industry is subject to extensive regulation and supervision that govern almost all aspects of its operations. The extensive
regulatory framework is primarily intended to protect the federal deposit insurance fund and depositors, not shareholders. The Company
and Bank are regulated and supervised by the OCC and the FRB. Compliance with applicable laws and regulations can be difficult and
costly and, in some instances, may put banks at a competitive disadvantage compared to less regulated competitors such as finance
companies, mortgage banking companies and leasing companies. The Company’s regulatory authorities have extensive discretion in
connection with their supervisory and enforcement activities, including with respect to the imposition of restrictions on the operation of
a bank or a bank holding company, the imposition of significant fines, the ability to delay or deny merger or other regulatory
applications, the classification of assets by a bank, and the adequacy of a bank’s allowance for loan losses, among other matters. The
Company’s industry is facing increased regulation and scrutiny; for instance, areas such as BSA compliance (including BSA and related
anti-money laundering regulations) and real estate-secured consumer lending (such as Truth-in-Lending regulations, changes in Real
Estate Settlement Procedures Act regulations, implementation of licensing and registration requirements for mortgage originators and
18
more recently, heightened regulatory attention to mortgage and foreclosure-related activities and exposures) are being confronted with
escalating regulatory expectations and scrutiny. Non-compliance with laws and regulations such as these, even in cases of inadvertent
non-compliance, could result in significant fines or sanctions. Furthermore, the Company and the Bank are subject to the requirements
of the Order and the Agreement, which regulatory agreements require that they take extra actions and meet certain standards by the dates
set forth in these agreements. As further described in Item 1 “Business – Supervision and Regulation – Supervisory Actions” to this
Annual Report on Form 10-K, neither the Bank nor the Company is yet in compliance with all of these requirements. Any failure to
comply with the Order or the Agreement and any failure to comply with, or any change in, any other applicable regulation and
supervisory requirement, or change in regulation or enforcement by such authorities, whether in the form of policies, regulations,
legislation, rules, orders, enforcement actions, or decisions, could have a material impact on the Company, the Bank and other affiliates,
and its operations. Federal economic and monetary policy may also affect the Company’s ability to attract deposits and other funding
sources, make loans and investments, and achieve satisfactory interest spreads. Any failure to comply with such regulation or
supervision could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a
material adverse effect on the Company’s business, financial condition and results of operations. In addition, compliance with any such
action could distract management’s attention from the Company’s operations, cause the Company to incur significant expenses, restrict
it from engaging in potentially profitable activities and limit its ability to raise capital.
The impact of recent legislation, proposed legislation, and government programs designed to stabilize the financial markets cannot be
predicted at this time, and such legislation is subject to change. In addition, the failure of financial markets to stabilize and a
continuation or worsening of current financial market conditions could materially and adversely affect the Company’s business, financial
condition, results of operations and access to capital.
New or changed legislation or regulation and regulatory initiatives could adversely affect the Company through increased
regulation and increased the costs of doing business.
Changes in federal and state legislation and regulation may affect the Company’s operations. New and modified regulation, such as the
Dodd-Frank Act and Basel III, may have unforeseen or unintended consequences on the banking industry. The Dodd-Frank Act has
implemented, and is expected to further implement, significant changes to the U.S. financial system, including the creation of new
regulatory agencies (such as the Financial Stability Oversight Council to oversee systemic risk and the CFPB to develop and enforce
rules for consumer financial products), changes in retail banking regulations, and changes to deposit insurance assessments. For
example, the Dodd-Frank Act has implemented new requirements with respect to “qualified mortgages” and new mortgage servicing
standards that may increase costs associated with this business. For a more detailed description, see the section entitled “Business – The
Bank – Consumer Financial Protection Bureau” included in Item 1 of the Annual Report on Form 10-K.
Additionally, final rules to implement Basel III adopted in July 2013 revise risk-based and leverage capital requirements and also limit
capital distributions and certain discretionary bonuses if a banking organization does not hold a “capital conservation buffer.” The rule
will be effective for the Company on January 1, 2015, with some additional transition periods. This additional regulation could increase
compliance costs and otherwise adversely affect operations, for example, the Company expects that its existing outstanding subordinated
notes will cease to qualify as capital for regulatory purposes when the definition becomes applicable to the Company and the Bank,
which could make it more difficult to comply with capital requirements. For a more detailed description of the final rules, see the
description in Item 1 of this Annual Report on Form 10-K under the heading “Changes in Capital Adequacy Requirements”. The
potential also exists for additional federal or state laws or regulations, or changes in policy or interpretations, affecting many of the
Company’s operations, including capital levels, lending and funding practices, insurance assessments, and liquidity standards. The effect
of any such changes and their interpretation and application by regulatory authorities cannot be predicted, may increase the Company’s
cost of doing business and otherwise affect the Company’s operations, may significantly affect the markets in which the Company does
business, and could have a materially adverse effect on the Company.
We are also subject to the guidelines under the Gramm-Leach-Bliley Act (“GLBA”). The GLBA guidelines require, among other things,
that each financial institution develop, implement and maintain a written, comprehensive information security program containing
safeguards that are appropriate to the financial institution’s size and complexity, the nature and scope of the financial institution’s
activities and the sensitivity of any customer information at issue. In recent years there also has been increasing enforcement activity in
the areas of privacy, information security and data protection in the United States, including at the federal level. Compliance with these
laws, rules and regulations regarding the privacy, security and protection of customer and employee data could result in higher
compliance and technology costs. In addition, non-compliance could result in potentially significant fines, penalties and damage to the
Company’s reputation and brand.
19
The Company may not be able to successfully compete with others for business.
The Company competes for loans, deposits and investment dollars with numerous regional and national banks and other community
banking institutions, online divisions of banks located in other markets as well as other kinds of financial institutions and enterprises,
such as securities firms, insurance companies, savings associations, credit unions, mortgage brokers, and private lenders. There is also
competition for banking business from competitors outside of its market area. As noted above, the Company and the Bank are subject to
extensive regulations and supervision, including, in many cases, regulations that limit the type and scope of activities. Many competitors
have substantially greater resources than the Company, may offer certain services that the Bank does not provide, and operate under less
stringent regulatory environments. The differences in available resources and applicable regulations may make it harder for the
Company to compete profitably, reduce the rates that it can earn on loans and investments, increase the rates it must offer on deposits
and other funds, and adversely affect its overall financial condition and earnings. For additional discussion of the Company’s
competitive environment, see the section entitled “Business – Competition” included in Item 1 of the Annual Report on Form 10-K.
The economic environment continues to pose significant challenges for the Company and could adversely affect its financial
condition and results of operations.
The Company is operating in a challenging and uncertain economic environment. Financial institutions continue to be affected by
softness in the real estate market and constrained financial markets. There have been dramatic declines in the housing market, with
falling home prices, high levels of foreclosures and weak employment statistics in many parts of the country. While conditions appear to
have begun to improve since the depths of the financial crisis, generally and in the Company’s market area, should declines in real estate
values, home sales volumes, and financial stress on borrowers as a result of the uncertain economic environment re-emerge, such events
could have an adverse effect on our borrowers or their customers, which could adversely affect our financial condition and results of
operations. A worsening of these conditions would likely exacerbate the adverse effects on us and others in the financial institutions
industry. Deterioration in economic conditions in our markets could drive loan losses beyond that which is provided for in the
Company’s ALLL, which would necessitate further increases in the provision for loan and lease losses, and, in turn, reduce the
Company’s earnings and capital. The Company may also face the following risks in connection with the economic environment:
•
economic conditions that negatively affect housing prices and the job market have resulted, and may continue to result, in a
deterioration in credit quality of our loan portfolios, and such deterioration in credit quality has had, and could continue to
have, a negative impact on our business;
• market developments may affect consumer confidence levels and may reduce loan demand and cause adverse changes in
payment patterns, leading to a reduced asset base, as well as increases in delinquencies and default rates on loans and other
credit facilities;
the methodologies the Company uses to establish the ALLL rely on complex judgments, including forecasts of economic
conditions, that are inherently uncertain and may be inadequate;
low market interest rates, which have been projected to continue, may pressure our interest margins as interest-earning assets,
such as loans and investments, are reinvested or repriced at lower rates;
volatility in the market, and lower level of confidence in the banking system, could require the Bank to pay higher interest rates
to obtain deposits to meet the needs of its depositors and borrowers, resulting in reduced margin and net interest income. If
conditions worsen, it is possible that banks such as the Bank may be unable to meet the needs of their depositors and
borrowers, which could, in the worst case, result in the Bank being placed into receivership; and
compliance with increased regulation of the banking industry may increase our costs, limit our ability to pursue business
opportunities, and divert management efforts.
•
•
•
•
If these conditions or similar ones continue to exist or worsen, the Company could experience adverse effects on its financial condition.
The Company has previously identified material weaknesses in our internal control over financial reporting.
Management determined that the Company’s internal control over financial reporting was not effective at December 31, 2011, and had
also previously determined that disclosure controls and procedures and internal control over financial reporting were not effective as of
December 31, 2010.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a
reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or
detected on a timely basis.
20
In 2011, management identified a material weakness with respect to the financial close process. Management detected errors with
respect to accounting for other real estate owned (“OREO”), property taxes and the evaluation of subsequent events related to OREO
valuation. Corrections for these errors resulted in adjustments to increase expenses by approximately $1.2 million. As a result of these
errors, management concluded that the Company did not maintain effective controls over the financial close process.
The Company has implemented remediation efforts with respect to the material weakness at December 31, 2011, and management
concluded that its new internal controls are operating effectively. Although the Company did not identify any additional material
weaknesses in 2013 or 2012 and has taken steps to make the necessary improvements to remediate the material weaknesses it had
identified, we cannot be certain that other weaknesses will not be identified or that our remediation efforts will ensure that our
management designs, implements and maintains adequate controls over our financial processes and reporting in the future.
Any system of internal control, disclosure controls and corporate governance policies and procedures is inherently limited. The inherent
limitations of the Company’s system of internal control include the use of judgment in decision-making that can be faulty; breakdowns
can occur because of human error or mistakes; and controls can be circumvented by individual acts or by collusion of two or more
people. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and any
design may not succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitation of a cost-
effective control system, misstatements due to error or fraud may occur and may not be detected, which may have an adverse effect on
the Company’s business, results of operations or financial condition. Although prior material weaknesses have been remediated, any
material weaknesses identified in the future could result in restatements in the future and further increased regulatory scrutiny as well as
cause investors to lose confidence in reported financial information, which could have a negative effect on the trading value of the
Company’s stock and its ability to raise capital.
Management conducted an evaluation of the effectiveness of the system of internal control over financial reporting based on the
framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission in 1992. Based on this evaluation, management has concluded that the Company’s system of internal control over financial
reporting was effective as of December 31, 2013. Management’s assessment regarding internal control over financial reporting,
however, is not subject to attestation by the Company’s registered public accounting firm as a result of a provision of the Dodd-Frank
Act, which, among other things, permanently exempted non-accelerated filers, such as the Company, from complying with the
requirements of Section 404(b) of Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), which requires an issuer to include an attestation
report from its independent registered public accounting firm on the issuer’s internal control over financial reporting. If the Company’s
filing status changes and an attestation is required and the independent registered public accounting firm is unable to provide an
unqualified attestation report, or if material weaknesses are identified in the Company’s internal control over financial reporting,
investors could lose confidence in our financial information and the price of our common shares could decline.
The Company is subject to lending risk.
As of December 31, 2013, approximately 37.8% of the Company’s loan portfolio consisted of commercial real estate loans and
construction, land acquisition and development loans. These types of loans are generally viewed as having more risk of default than
residential real estate loans or consumer loans. These types of loans are also typically larger than residential real estate loans and
consumer loans. Because the Company’s loan portfolio contains a significant number of commercial real estate loans with relatively
large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. All non-
performing loans totaled $6.4 million, or 1.0% of total gross loans, as of December 31, 2013, and $9.7 million, or 1.6% of total gross
loans, as of December 31, 2012. Although non-performing asset levels decreased from the prior year, an increase in non-performing
loans could result in an increase in the provision for loan and lease losses and an increase in loan charge-offs, both of which could have a
material adverse effect on the Company’s financial condition and results of operations. The lending activities in which the Bank engages
carry the risk that the borrowers will be unable to perform on their obligations. As such, general economic conditions, nationally and in
the Company’s primary market area, will have a significant impact on its results of operations. To the extent that economic conditions
deteriorate, business and individual borrowers may be less able to meet their obligations to the Bank in full, in a timely manner, resulting
in decreased earnings or losses to the Bank. To the extent that loans are secured by real estate, adverse conditions in the real estate
market may reduce the ability of the borrower to generate the necessary cash flow for repayment of the loan, and reduce the ability to
collect the full amount of the loan upon a default. To the extent that the Bank makes fixed-rate loans, general increases in interest rates
will tend to reduce its spread as the interest rates the Company must pay for deposits would increase while interest income is flat.
Economic conditions and interest rates may also adversely affect the value of property pledged as security for loans.
The Company’s concentrations of loans, including those to insiders and related parties, may create a greater risk of loan defaults
and losses.
21
A substantial portion of the Company’s loans are secured by real estate in the Northeastern Pennsylvania market, and substantially all of
its loans are to borrowers in that area. The Company also has a significant amount of commercial real estate, commercial and industrial,
construction, land acquisition and development loans and land-related loans for residential and commercial developments. At December
31, 2013, $387.0 million, or 60.2%, of gross loans were secured by real estate, primarily commercial real estate. Management has taken
steps to mitigate the Company’s commercial real estate concentration risk by diversification among the types and characteristics of real
estate collateral properties, sound underwriting practices, and ongoing portfolio monitoring and market analysis. Of total gross loans,
$24.4 million, or 3.8%, were construction, land acquisition and development loans. Construction, land acquisition and development
loans have the highest risk of uncollectability. An additional $127.0 million, or 19.7%, of portfolio loans were commercial and industrial
loans not secured by real estate. Historically, commercial and industrial loans generally have had a higher risk of default than other
categories of loans, such as single family residential mortgage loans. The repayments of these loans often depend on the successful
operation of a business and are more likely to be adversely affected by adverse economic conditions. While the Company believes that
its loan portfolio is well diversified in terms of borrowers and industries, these concentrations expose the Company to the risk that
adverse developments in the real estate market, or in the general economic conditions in the Company’s general market area, could
increase the levels of non-performing loans and charge-offs, and reduce loan demand. In that event, the Company would likely
experience lower earnings or losses. Additionally, if, for any reason, economic conditions in its market area deteriorate, or there is
significant volatility or weakness in the economy or any significant sector of the area’s economy, the Company’s ability to develop
business relationships may be diminished, the quality and collectability of its loans may be adversely affected, the value of collateral
may decline and loan demand may be reduced.
Commercial real estate, commercial and industrial and construction, land acquisition and development loans tend to have larger balances
than single family mortgage loans and other consumer loans. Because the loan portfolio contains a significant number of commercial
and industrial loans, commercial real estate loans and construction, land acquisition and development loans with relatively large
balances, the deterioration of one or a few of these loans may cause a significant increase in non-performing assets. An increase in non-
performing loans could result in a loss of earnings from these loans, an increase in the provision for loan and lease losses, or an increase
in loan charge-offs, which could have an adverse impact on the Company’s results of operations and financial condition.
Guidance adopted by federal banking regulators provides that banks having concentrations in construction, land development or
commercial real estate loans are expected to have and maintain higher levels of risk management and, potentially, higher levels of
capital, which may adversely affect shareholder returns, or require us to obtain additional capital sooner than the Company otherwise
would. Excluded from the scope of this guidance are loans secured by non-farm nonresidential properties where the primary source of
repayment is the cash flow from the ongoing operations and activities conducted by the party, or affiliate of the party, who owns the
property.
Outstanding loans and line of credit balances to directors, officers and their related parties totaled $32.5 million as of December 31,
2013. Of those, loans in the amount of $90 thousand were not performing in accordance with the terms of the loan agreements. At
December 31, 2013, there were no other loans to directors, officers and their related parties that were categorized as criticized loans
within the Bank’s risk rating system, meaning they are considered to present a higher risk of collection than other loans. (For more
information regarding loans to officers and directors and/or their related parties, please refer to Note 14 — Related Party Transactions to
the consolidated financial statements included in Item 8 and Item 13, “Certain Relationships and Related Transactions, and Director
Independence” to this Annual Report on Form 10-K.)
The Company’s financial condition and results of operations would be adversely affected if the ALLL is not sufficient to absorb
actual losses or if increases to ALLL were required.
The lending activities in which the Bank engages carry the risk that the borrowers will be unable to perform on their obligations, and that
the collateral securing the payment of their obligations may be insufficient to assure repayment. The Company may experience
significant credit losses, which could have a material adverse effect on its operating results. The Company makes various assumptions
and judgments about the collectability of its loan portfolio, including the creditworthiness of its borrowers and the value of the real estate
and other assets serving as collateral for the repayment of many of its loans, which it uses as a basis to estimate and establish its reserves
for losses. In determining the amount of the ALLL, the Company reviews its loans and its loss and delinquency experience, and the
Company evaluates economic conditions. If these assumptions prove to be incorrect, the ALLL may not cover inherent losses in its loan
portfolio at the date of its financial statements. Material additions to the Company’s allowance or extensive charge-offs would materially
decrease its net income. At December 31, 2013, the ALLL totaled $14.0 million, representing 2.2% of total loans.
Although the Company believes it has underwriting standards to manage normal lending risks, it is difficult to assess the future
performance of its loan portfolio due to the current economic environment and the state of the real estate market. The assessment of
future performance of the loan portfolio is inherently uncertain. The Company can give no assurance that non-performing loans will not
increase or that non-performing or delinquent loans will not adversely affect the Company’s future performance.
22
In addition, federal regulators periodically review the Company’s ALLL and may require increases to the ALLL or further loan charge-
offs. Any increase in ALLL or loan charge-offs as required by these regulatory agencies could have a material adverse effect on the
Company’s results of operations and financial condition.
If the Company concludes that the decline in value of any of its debt investment securities is other than temporary, the Company
is required to write-down the security, to reflect credit-related impairments through a charge to earnings.
The Company reviews its investment securities portfolio at each quarter-end reporting period to determine whether the fair value is
below the current carrying value. When the fair value of any of the Company’s debt investment securities has declined below its
carrying value, the Company is required to assess whether the decline is an OTTI. If the Company concludes that the decline is other
than temporary, it is required to write down the value of that security to reflect the credit-related impairments through a charge to
earnings. Changes in the expected cash flows of securities in its portfolio and/or prolonged price declines in future periods may result in
impairment of the Company’s investment securities that is other than temporary, which would require a charge to earnings. Due to the
complexity of the calculations and assumptions used in determining whether an asset is impaired, any impairment disclosed may not
accurately reflect the actual impairment in the future. In addition, to the extent that the value of any of the Company’s investment
securities is sensitive to fluctuations in interest rates, any increase in interest rates may result in a decline in the value of such investment
securities.
The Company held approximately $2.1 million in capital stock of the Federal Home Loan of Pittsburgh (“FHLB”) as of December 31,
2013. The Company must own such capital stock to qualify for membership in the Federal Home Loan Bank system which enables it to
borrow funds under the FHLB advance program. If FHLB were to cease operations, the Company’s business, financial condition,
liquidity, capital and results of operations may be materially and adversely affected.
Changes in interest rates could reduce income, cash flows and asset values.
The Company’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference
between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing
liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Company’s control,
including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the FRB.
Changes in monetary policy, including changes in interest rates, could influence not only the interest the Company receives on loans and
securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) the Company’s ability to
originate loans and obtain deposits, (ii) the fair value of the Company’s financial assets and liabilities, and (iii) the average duration of
the Company’s mortgage-backed securities portfolio.
If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and
investments, the Company’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely
affected if the interest rates received on loans and investments fall more quickly than the interest rates paid on deposits and other
borrowings. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on the
Company’s financial condition and results of operations.
The Company may need to raise additional capital in the future, but that capital may not be available when it is needed and on
terms favorable to current shareholders.
Laws, regulations and banking regulators require the Company and Bank to maintain adequate levels of capital to support its operations.
In addition, capital levels are determined by the Company’s management and Board of Directors based on capital levels that they believe
are necessary to support the Company’s business operations. Also, pursuant to the Order and the Agreement, the Company and the Bank
are required to maintain increased capital levels in compliance with the Company’s revised capital plan. The Company regularly
evaluates its present and future capital requirements and needs and analyzes capital raising alternatives and options. Even if the
Company succeeds in meeting its current regulatory capital requirements, it may need to raise additional capital in the future to support
possible loan losses during future periods, to meet future regulatory capital requirements or for other reasons.
The Board of Directors may determine from time to time that the Company needs to raise additional capital by issuing additional
common shares or other securities. The Company is not restricted from issuing additional common shares, including securities that are
convertible into or exchangeable for, or that represent the right to receive, common shares. Because the Company’s decision to issue
securities in any future offering will depend on market conditions and other factors beyond its control, the Company cannot predict or
estimate the amount, timing or nature of any future offerings, or the prices at which such offerings may be affected. Such offerings will
likely be dilutive to common shareholders from ownership, earnings and book value perspectives. New investors also may have rights,
23
preferences and privileges that are senior to, and that adversely affect, its then current common shareholders. Additionally, if the
Company raises additional capital by making additional offerings of debt or preferred equity securities, upon liquidation, holders of the
Company’s debt securities and shares of preferred shares, and lenders with respect to other borrowings, will receive distributions of the
Company’s available assets prior to the holders of the Company’s common shares. Additional equity offerings may dilute the holdings
of existing shareholders or reduce the market price of the Company’s common shares, or both. Holders of the Company’s common
shares are not entitled to preemptive rights or other protections against dilution.
The Company cannot assure that additional capital will be available on acceptable terms or at all. Any occurrence that may limit the
Company’s access to the capital markets may adversely affect the Company’s capital costs and its ability to raise capital and, in turn, its
liquidity. Moreover, if the Company needs to raise capital, it may have to do so when many other financial institutions are also seeking
to raise capital and would have to compete with those institutions for investors. An inability to raise additional capital on acceptable
terms when needed could have a material adverse effect on the Company’s business, financial condition and results of operations.
Interruptions or security breaches of the Company’s information systems could negatively affect its financial performance or
reputation.
In conducting its business, the Company relies heavily on its information systems. The Company collects and stores sensitive data,
including proprietary business information and personally identifiable information of its customers and employees, in its data centers
and on its networks. The secure processing, maintenance and transmission of this information is critical to the Company’s operations
and business strategy. Maintaining and protecting those systems is difficult and expensive, as is dealing with any failure, interruption or
breach of those systems. Despite security measures, the Company’s information technology and infrastructure may be vulnerable to
security breaches, cyber attacks by hackers or breaches due to employee error, malfeasance or other disruptions. Any damage, failure or
breach could cause an interruption in the Company’s operations. Computer break-ins, phishing and other disruptions could also
jeopardize the security of information stored in and transmitted through the Company’s computer systems and network infrastructure.
The occurrence of any failures, interruptions or breaches could damage the Company’s reputation, disrupt operations and the services
provided to customers, cause a loss of confidence in the products and the services provided, cause the Company to incur additional
expenses, result in a loss of customer business and data, result in legal claims or proceedings, result in liability under laws that protect
the privacy of personal information, result in regulatory penalties, or expose the Company to other liability, any of which could have a
material adverse effect on the Company’s business, financial condition and results of operations and the Company’s competitive
position.
If the Company’s information technology is unable to keep pace with growth or industry developments or if technological
developments result in higher costs or less advantageous pricing, financial performance may suffer.
Effective and competitive delivery of the Company’s products and services increasingly depends on information technology resources
and processes, both those provided internally as well as those provided through third party vendors. In addition to better serving
customers, the effective use of technology can improve efficiency and help reduce costs. The Company’s future success will depend, in
part, upon its ability to address the needs of its customers by using technology to provide products and services to enhance customer
convenience, as well as to create efficiencies in its operations. There is increasing pressure to provide products and services at lower
prices. This can reduce net interest income and noninterest income from fee-based products and services. In addition, the widespread
adoption of new technologies could require us to make substantial capital expenditures to modify or adapt existing products and services
or develop new products and services. We may not be successful in introducing new products and services in response to industry trends
or developments in technology, or those new products may not achieve market acceptance. Many of the Company’s competitors have
greater resources to invest in technological improvements. Additionally, as technology in the financial services industry changes and
evolves, keeping pace becomes increasingly complex and expensive. There can be no assurance that the Company will be able to
effectively implement new technology-driven products and services, which could reduce its ability to compete effectively. As a result,
we could lose business, be forced to price products and services on less advantageous terms to retain or attract customers, or be subject
to cost increases.
As of the date of this report, the Company is not currently able to pay dividends on the common shares, or repurchase common
shares.
The Company conducts its principal business operations through the Bank and the cash that it uses to pay dividends is derived from
dividends paid to the Company by the Bank; therefore, its ability to pay dividends is dependent on the performance of the Bank and on
the Bank’s capital requirements. The Bank’s ability to pay dividends to the Company and the Company’s ability to pay dividends to its
shareholders are also limited by certain legal and regulatory restrictions. In particular, pursuant to the supervisory agreements that the
Company and the Bank have entered into with their regulators, the Company and the Bank are prohibited from declaring or paying any
24
dividends and the Company is also prohibited from taking dividends or other payments representing a reduction of the Bank’s capital
without prior regulatory approval.
The Company’s profitability depends significantly on economic conditions in the Commonwealth of Pennsylvania, specifically in
Lackawanna, Luzerne and Wayne Counties.
The Company’s success depends primarily on the general economic conditions in the Commonwealth of Pennsylvania and the specific
local markets in which the Company operates. Unlike larger national or other regional banks that are more geographically diversified,
the Company provides banking and financial services to customers primarily in the Lackawanna, Luzerne and Wayne County markets.
The local economic conditions in these areas have a significant impact on the demand for the Company’s products and services as well
as the ability of the Company’s customers to repay loans, the value of the collateral securing loans, and the stability of the Company’s
deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, severe
weather or natural disasters, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities
markets or other factors could impact these local economic conditions and, in turn, have a material adverse effect on the Company’s
financial condition and results of operations.
The Company relies on management and other key personnel and the loss of any of them may adversely affect its operations.
The Company believes each member of the senior management team is important to the Company’s success and the unexpected loss of
any of these persons could impair day-to-day operations as well as its strategic direction.
The Company’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most
activities engaged in by the Company can be intense and the Company may not be able to hire people or retain them. The unexpected
loss of services of one or more of the Company’s key personnel could have a material adverse impact on the Company’s business due to
the loss of their skills, knowledge of the Company’s market, years of industry experience and to the difficulty of promptly finding
qualified replacement personnel. The Company does not currently have employment agreements or non-competition agreements with
any of its senior officers though it expects to put such agreements in place in the future pending regulatory approval and non-objection.
The Company is subject to claims and litigation pertaining to fiduciary responsibility.
From time to time, customers and shareholders make claims and take legal action pertaining to the Company’s performance of its
fiduciary responsibilities. Regardless of whether customer and shareholder claims and legal actions related to the Company’s
performance of its fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner
favorable to the Company they may result in significant financial liability and/or adversely affect the market perception of the Company
and its products and services as well as impact customer demand for those products and services. Moreover, as a result of the
restatement of its financial statements and revisions to many of its policies made for the periods ended December 31, 2009, March 31,
2010 and June 30, 2010, the Company may be at an increased risk for such litigation. For example, on May 24, 2012, a putative
shareholder by the name of Lori Gray filed a complaint in the Court of Common Pleas for Lackawanna County against certain present
and former directors of the Company (including all of the current directors except Steven R. Tokach and Thomas J. Melone) and
Demetrius & Company, LLC (“Demetrius”) alleging, inter alia, breach of fiduciary duty, abuse of control, corporate waste, unjust
enrichment and, in the case of Demetrius, professional negligence, negligent misrepresentation, breach of contract and aiding and
abetting breach of fiduciary duty. The Company was named as a nominal defendant. The Court approved the Stipulation of Settlement
related to this matter on February 4, 2014, however, the financial liability or reputational damage from this litigation or any other actions
could have a material adverse effect on the Company’s business, which, in turn, could have a material adverse effect on the Company’s
financial condition and results of operations. For additional discussion of the Company’s current legal matters, refer to Item 3, “Legal
Proceedings” to this Annual Report on Form 10-K.
The Company may be a defendant from time to time in a variety of litigation and other actions, which could have a material
adverse effect on its financial condition, results of operations and cash flows.
The Company has been and may continue to be involved from time to time in a variety of litigation matters arising out of its business.
An increased number of lawsuits, including purported class action lawsuits and other consumer driven litigation, have been filed and
will likely continue to be filed against financial institutions, which may involve substantial compensatory and/or punitive damages. We
believe the risk of litigation generally increases during downturns in the national and local economies. The Company’s insurance may
not cover all claims that may be asserted against it, and any claims asserted against it, regardless of merit or eventual outcome, may
harm the Company’s reputation and may cause it to incur significant expense. Should the ultimate judgments or settlements in any
litigation exceed the Company’s insurance coverage, they could have a material adverse effect on its financial condition, results of
25
operations and cash flows. In addition, the Company may not be able to obtain appropriate types or levels of insurance in the future, nor
may the Company be able to obtain adequate replacement policies with acceptable terms, if at all.
The Company may be subject to information-gathering requests, reviews, investigations and proceedings by government and
regulatory agencies.
The Company is or may become involved from time to time in information-gathering requests, reviews, investigations and proceedings
(both formal and informal) by government and regulatory agencies, including the SEC, OCC and FRB, regarding its business and
operations. Such matters may result in material adverse consequences, including without limitation, adverse judgments, settlements,
fines, penalties, injunctions or other actions, amendments and/or restatements of SEC filings and/or financial statements, as applicable,
and/or determinations of material weaknesses in its disclosure controls and procedures. This could lead to an enforcement proceeding by
such governmental or regulatory agency which, in turn, may result in one or more such material adverse consequences.
The price of the Company’s common shares may fluctuate significantly, which may make it difficult for investors to resell
common shares at a time or price they find attractive.
The Company’s share price may fluctuate significantly as a result of a variety of factors, many of which are beyond its control. These
factors include, in addition to those described above:
•
•
•
•
•
•
•
•
•
•
actual or anticipated quarterly fluctuations in operating results and financial condition;
changes in financial estimates or publication of research reports and recommendations by financial analysts or actions taken by
rating agencies with respect to the Company or other financial institutions;
speculation in the press or investment community generally or relating to the Company’s reputation or the financial services
industry;
strategic actions by the Company or its competitors, such as acquisitions, restructurings, dispositions or financings;
fluctuations in the stock price and operating results of the Company’s competitors;
future sales of the Company’s equity or equity-related securities;
proposed or adopted regulatory changes or developments;
anticipated or pending investigations, proceedings, audits or litigation that involve or affect us;
domestic and international economic factors unrelated to the Company’s performance; and
general market conditions and, in particular, developments related to market conditions for the financial services industry.
In addition, in recent years, the stock market in general has experienced extreme price and volume fluctuations. This volatility has had a
significant effect on the market price of securities issued by many companies, including for reasons unrelated to their operating
performance. These broad market fluctuations may adversely affect the Company’s share price, notwithstanding the Company’s
operating results. The Company expects that the market price of its common shares will continue to fluctuate and there can be no
assurances about the levels of the market prices for its common shares.
An active public market for the Company’s common stock does not currently exist. As a result, shareholders may not be able to
quickly and easily sell their common shares.
The Company’s common shares are currently quoted on OTC Markets Group, Inc. During the year ended December 31, 2013, an
average of 2,819 shares traded on a daily basis. There can be no assurance that an active and liquid market for the Company’s common
shares will develop, or if one develops that it can be maintained. The absence of an active trading market may make it difficult to
subsequently sell the Company’s common shares at the prevailing price, particularly in large quantities. For a further discussion, see
Item 5- “Market for Registrant’s Common Equity, Related Shareholder Matters, and Issuer Purchases of Equity Securities” to this
Annual Report on Form 10-K.
Changes in accounting standards could impact reported earnings.
From time to time there are changes in the financial accounting and reporting standards that govern the preparation of financial statements.
These changes can materially impact how the Company records and reports its financial condition and results of operations. In some
instances, the Company could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period
financial statements.
26
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
The Company currently conducts business from its main office located at 102 East Drinker Street, Dunmore, Pennsylvania, 18512 and
from its additional 18 branches located throughout Lackawanna, Luzerne, Wayne and Monroe counties. At December 31, 2013,
aggregate net book value of premises and equipment was $15.4 million. With the exception of potential remodeling of certain facilities
to provide for the efficient use of work space and/or to maintain an appropriate appearance, each property is considered reasonably
adequate for current and anticipated needs.
As previously mentioned, on August 16, 2013, the Bank entered into an agreement with ESSA under which ESSA acquired certain
assets and liabilities of the Bank’s Marshalls Creek and Stroudsburg branches, both of which are located in Monroe County,
Pennsylvania. The transaction, which closed on January 24, 2014, included the real property of the Marshalls Creek branch. The real
property of the Stroudsburg branch was not sold as part of the agreement, and was retained by the Bank. However, as of January 24,
2014, this property no longer operates as a retail banking office.
27
Property
Location
Ownership
Type of Use
1
2
3
4
5
6
7
8
9
102 East Drinker Street
Dunmore, PA
419-421 Spruce Street
Scranton, PA
934 Main Street
Dickson City, PA
1743 North Keyser Avenue
Scranton, PA
1 North Main Street
Wilkes-Barre, PA
1700 North Township Blvd.
Pittston, PA
754 Wyoming Avenue
Kingston, PA
1625 Wyoming Avenue
Exeter, PA
Route 502 & 435
Daleville, PA
10
27 North River Road
Plains, PA
11
169 North Memorial Highway
Own
Main Office/Branch
Own
Scranton Branch
Own
Dickson City Branch
Lease
Keyser Village Branch
Lease
Wilkes-Barre Branch
Lease
Pittston Plaza Branch
Lease
Kingston Branch
Lease
Exeter Branch
Lease
Daleville Branch
Lease
Plains Branch
Shavertown, PA
Lease
Back Mountain Branch
12
269 East Grove Street
Clarks Green, PA
13
734 Sans Souci Parkway
Own
Clarks Green Branch
Hanover Township, PA
Lease
Hanover Township Branch
14
194 South Market Street
Nanticoke, PA
Own
Nanticoke Branch
28
15
330-352 West Broad Street
Hazleton, PA
Own
Hazleton Branch
16
3 Old Boston Road
Pittston, PA
17
1001 Main Street
Honesdale, PA
18
301 McConnell Street
Stroudsburg, PA
Lease
Route 315 Branch
Own
Honesdale Branch
Own
Stroudsburg Branch
(effective 1/24/2014 not a retail branch)
19
1127 Texas Palmyra Highway
Honesdale, PA
Lease
Honesdale Route 6 Branch
20
5120 Milford Road
East Stroudsburg, PA
21
200 South Blakely Street
Dunmore, PA
Own
Marshalls Creek Branch
(sold 1/24/2014)
Lease
Administrative Center
22
107-109 South Blakely Street
Dunmore, PA
Own
Parking Lot
23
114-116 South Blakely Street
Dunmore, PA
Own
Parking Lot
24
1708 Tripp Avenue
Dunmore, PA
25
119-123 South Blakely Street
Own
Parking Lot
Dunmore, PA
Own
Parking Lot
26
Main Street
Taylor, PA
27
1219 Wheeler Avenue
Dunmore, PA
28
785 Keystone Industrial Park Road
Throop, PA
Own
Land
Lease
Lease
Wheeler Ave. Branch
Bank Offices
Item 3. Legal Proceedings.
On August 8, 2011, the Company announced that it had received document subpoenas from the SEC. The information requested
generally relates to disclosure and financial reporting by the Company and the restatement of the Company’s financial statements for the
year ended December 31, 2009, and the quarters ended March 31, 2010 and June 30, 2010. The Company is presently cooperating with
the SEC in this matter.
29
On May 24, 2012, a putative shareholder by the name of Lori Gray filed a complaint in the Court of Common Pleas in Lackawanna
County against certain present and former directors of the Company (including all of the current directors except Steven R. Tokach and
Thomas J. Melone) and Demetrius & Company, LLC (“Demetrius”) alleging, inter alia, breach of fiduciary duty, abuse of control,
corporate waste, unjust enrichment and, in the case of Demetrius, professional negligence, negligent misrepresentation, breach of
contract and aiding and abetting breach of fiduciary duty. The Company was named as a nominal defendant. The Board had appointed
a special committee in January 2012 to investigate the matters raised in the Gray complaint. The special committee retained independent
counsel to assist with its investigation. Following the investigation, the special committee found that the Board had not breached its
fiduciary duty to shareholders. Subsequently, the parties commenced settlement discussions and on December 18, 2013, the Court
entered an Order Granting Preliminary Approval of Proposed Settlement subject to notice to shareholders. On February 4, 2014, the
Court issued a Final Order and Judgment for the matter granting approval of a Stipulation of Settlement (the “Settlement”) and
dismissing all claims against the Company and its directors. As part of the Settlement, there was no admission of liability by the Board.
Pursuant to the Settlement, the Board, without admitting any fault, wrongdoing or liability, agreed to settle the derivative litigation for
$5 million, which is expected to be paid to the Company by the individual defendants in the first half of 2014. The directors have
reserved their rights to indemnification under the Company’s Articles of Incorporation and By-laws, resolutions adopted by the Board,
the Pennsylvania Business Corporation Law and any and all rights they have against the Company’s and the Bank’s insurance carriers.
The Company expects to indemnify the directors upon their request for indemnification. In addition, in conjunction with the Settlement,
the Company has accrued $2.5 million related to fees and costs of the plaintiff’s attorneys, which has been included in non-interest
expense for the year ended December 31, 2013.
On September 5, 2012, Fidelity and Deposit Company of Maryland (“F&D”) filed an action against the Company and its subsidiary,
First National Community Bank, as well as several current and former officers and directors of the Company, in the United States
District Court for the Middle District of Pennsylvania. F&D has asserted a claim for the rescission of a directors’ and officers’ insurance
policy and a bond that it had issued to the Company. On November 9, 2012, the Company and the Bank answered the claim and asserted
counterclaims. The Company and the other defendants are defending the claims. At this time, the matter is in a preliminary stage and the
Company cannot reasonably determine the outcome or potential range of loss in connection with this matter.
On August 13, 2013, Steven Antonik, individually, as Administrator of the Estate of Linda Kluska, William R. Howells, and Louise A.
Howells, on behalf of themselves and others similarly situated, filed a consumer protection class action against the Company and Bank
in the Lackawanna County Court of Common Pleas, seeking equitable, injunction and monetary relief to address an alleged pattern and
practice of wrong doing by the Bank relating to the repossession and sale of the Plaintiffs’ and class members’ financed motor
vehicles. This matter is in its early discovery stage. At this time the Company cannot reasonably determine the outcome or potential
range of loss.
On September 17, 2013, Charles Saxe, III individually and on behalf of all others similarity situated filed a consumer class action against
the Bank in the Lackawanna County Court of Common Pleas alleging violations of the Pennsylvania Uniform Commercial Code in
connection with the repossession and resale of financed vehicles. This matter is in its early discovery stage. At this time the Company
cannot reasonably determine the outcome or potential range of loss.
The Company has been subject to tax audits and is also a party to routine litigation involving various aspects of its business, such as
claims to enforce liens, condemnation proceedings on properties in which the Company holds security interests, claims involving the
making and servicing of real property loans and other issues incident to its business, none of which is expected to have a material
adverse impact on the consolidated financial condition, results of operations or liquidity of the Company.
Item 4. Mine Safety Disclosures.
Not Applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.
Market Prices of Stock and Dividends Paid
The Company’s common shares are quoted on the OTCQB operated by the OTC Markets Group, Inc., formerly referred to as the “Pink
Sheets” under the symbol “FNCB”. The principal market area for the Company’s shares is northeastern Pennsylvania, although shares
are held by residents of other states across the country. Quarterly market highs and lows and dividends paid for each of the past two
years are presented below. These prices represent actual transactions.
30
Quarter
First
Second
Third
Fourth
Quarter
First
Second
Third
Fourth
Holders
Market Price
High
Low
$
$
4.49
4.20
4.35
8.98
2013
2012
4.35
3.85
4.00
4.00
$
$
Dividends Paid
Per Share
2013
$
$
2.83
3.41
3.85
3.90
2.10
2.55
2.71
3.00
2012
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
As of February 28, 2014 there were 2,168 holders of record of the Company’s common shares.
Dividends
As of February 26, 2010, as a result of the Order and Agreement, the Company has suspended paying dividends indefinitely and will not
resume paying dividends without prior permission from the OCC and the Reserve Bank. For a further discussion of the Company’s
dividend limitations, refer to the section entitled “Capital Analysis” included in Item 7 “Management’s Discussion and Analysis” of this
Annual Report on Form 10-K.
Equity Compensation Plans
For more information regarding the Company’s equity compensation plans, see Part III, Item 12 “Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder Matters” to this Annual Report on Form 10-K.
Performance Graph
The following graph compares the cumulative total shareholder return (i.e. price change, reinvestment of cash dividends and stock
dividends received) on the Company’s common shares against the cumulative total return of the NASDAQ Stock Market (U.S.
Companies) Index, the SNL Bank Index for banks with $500 million to $1 billion in assets and the SNL Bank Index for banks with $1
billion to $5 billion in assets. The stock performance graph assumes that $100 was invested on December 31, 2008. The graph further
assumes the reinvestment of dividends into additional shares of the same class of equity securities at the frequency with which dividends
are paid on such securities during the relevant fiscal year. The yearly points marked on the horizontal axis correspond to December 31
of that year. The Company calculates each of the referenced indices in the same manner. All are market-capitalization-weighted
indices, so companies judged by the market to be more important (i.e. more valuable) count for more in all indices.
31
First National Community Bancorp, Inc.
Total Return Performance
First National Community Bancorp, Inc.
NASDAQ Composite
SNL Bank $1B-$5B
SNL Bank $500M-$1B
350
300
250
200
150
100
50
0
l
e
u
a
V
x
e
d
n
I
12/31/08
12/31/09
12/31/10
12/31/11
12/31/12
12/31/13
Index
First National Community Bancorp, Inc.
NASDAQ Composite
SNL Bank $1B-$5B
SNL Bank $500M-$1B
12/31/08
100.00
100.00
100.00
100.00
12/31/09
56.58
145.36
71.68
95.24
Period Ending
12/31/10
28.34
171.74
81.25
103.96
12/31/11
23.54
170.38
74.10
91.46
12/31/12
28.53
200.63
91.37
117.25
12/31/13
81.90
281.22
132.87
152.05
(*)
Source: SNL Financial LC, Charlottesville, VA © 2011. SNL Securities is a research and publishing firm specializing in the
collection and dissemination of data on the banking, thrift and financial services industries.
Purchase of Equity Securities by the Issuer or Affiliates Purchasers
None.
Recent Sales of Unregistered Securities
On November 27, 2013, the Board of Directors adopted the 2013 Employee Stock Grant Plan (the “2013 Stock Grant Plan”) under
which shares of common stock not to exceed 15,000 were authorized to be granted to employees. On December 2, 2013, the Company
granted 50 shares of the Company’s common stock to each active full and part time employee. There were 14,400 shares issued under
this grant at a cost of $4.26 per share. The total cost of these grants, which was included in salary expense in the Consolidated
Statements of Operations, amounted to $61 thousand for the year ended December 31, 2013. No additional shares were granted under
this plan. This share grant was effected without registration under the Securities Act in reliance upon Section 2(3) of the Securities Act,
as a non-sale distribution of securities by the Company. These shares were given to all employees of the Company as a share bonus and
not as individual incentive compensation or in lieu of a cash payment, with no investment decision on the part of the recipients or receipt
of value by the Company in return. There were no underwriters employed in the issuance of the securities or in connection with this
32
transaction, and no proceeds were received by the Company for this stock grant. There have been no sales of unregistered securities
during 2013.
Item 6. Selected Financial Data
The selected consolidated financial and other data and management’s discussion and analysis of financial condition and results of
operations set forth below and in Item 7 hereof is derived in part from, and should be read in conjunction with, the consolidated financial
statements and notes thereto contained elsewhere herein. Certain reclassifications have been made to prior years’ consolidated financial
statements to conform to the current year’s presentation. Those reclassifications did not impact net income.
(dollars in thousand, except per share data)
2013
2012
2011
2010
2009
For the Years Ended December 31,
Balance Sheet Data:
Total assets
Securities, available-for-sale
Securities, held-to-maturity
Net loans
Total deposits
Borrowed funds
Shareholders' equity
Income Statement Data:
Interest income
Interest expense
Net interest income before provision for loan and lease losses
Provision for loan and lease losses
Non-interest income (loss)
Non-interest expenses
Income (loss) before income taxes
Provision (credit) for income taxes
Net income (loss)
Earnings per share, basic and diluted
Capital and Related Ratios:
Cash dividends declared per share
Book value per share
Tier I leverage ratio
Total risk-based capital to risk-adjusted assets
Average equity to average total assets (1)
Tangible equity to tangible assets
Selected Performance Ratios:
Return on average assets (1)
Return on average equity (1)
Net interest margin (2)
Noninterest income/operating income (2)
Asset Quality Ratios:
Allowance for loan and lease losses/total loans
Nonperforming loans/total loans
Allowance for loan and lease losses/nonperforming loans
Net charge-offs/average loans
Loan loss provision/net charge-offs
*** Ratio is not meaningful for 2013.
$
1,003,808
$
968,274
$
1,102,639
$
1,167,298
$
1,366,332
203,867
2,308
629,880
884,698
62,433
33,578
185,361
2,198
579,396
854,613
53,903
36,925
185,475
2,094
659,044
957,136
83,571
39,925
251,072
1,994
735,813
982,436
137,604
32,055
252,946
1,899
917,516
1,071,608
217,467
63,084
$
32,953
$
37,027
$
42,936
$
55,471
$
64,398
7,176
25,777
(6,270)
9,283
34,948
6,382
-
6,382
0.39
9,218
27,809
4,065
4,283
41,738
(13,711)
-
(13,711)
(0.83)
13,867
29,069
523
12,949
41,830
(335)
-
(335)
(0.02)
21,868
33,603
25,041
1,282
41,564
(31,720)
-
(31,720)
(1.94)
25,196
39,202
42,089
(12,001)
38,022
(52,910)
(8,594)
(44,316)
(2.74)
$
-
$
-
$
-
$
-
$
0.17
2.04
4.71%
11.58%
3.60%
3.30%
0.67%
18.65%
3.22%
22.00%
2.18%
0.99%
219.87%
(0.28%)
***
2.24
4.07%
10.20%
3.97%
3.75%
(1.35%)
(34.09%)
3.28%
9.72%
3.10%
1.62%
190.92%
0.97%
63.88%
2.43
4.72%
11.35%
3.04%
3.55%
(0.03%)
(0.98%)
3.10%
21.82%
3.07%
2.93%
104.60%
0.31%
23.10%
1.95
4.27%
10.13%
4.10%
2.67%
(2.44%)
(59.44%)
3.07%
2.42%
2.98%
3.74%
79.58%
2.84%
100.47%
3.87
5.94%
10.54%
6.89%
4.49%
(3.29%)
(47.78%)
3.35%
(21.00%)
2.40%
2.77%
86.44%
2.87%
150.94%
(1) Average balances were calculated using average daily balances.
(2) Average balances for loans included nonaccrual loans. Tax-equivalent adjustments were calculated using the prevailing statutory rate of 34.0
percent.
33
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s discussion and analysis (“MD&A”) represents an overview of the financial condition and results of operations and
should be read in conjunction with our consolidated financial statements and notes thereto included in Item 8 of this report and Risk
Factors detailed in Item 1A of Part I of this report.
We are in the business of providing customary retail and commercial banking services to individuals and businesses. Our core market is
Northeastern Pennsylvania.
FORWARD-LOOKING STATEMENTS
The Company may from time to time make written or oral “forward-looking statements,” including statements contained in the
Company’s filings with the SEC, in its reports to shareholders, and in other communications by the Company, which are made in good
faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include statements with respect to the Company’s beliefs, plans, objectives, goals, expectations,
anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various
factors (some of which are beyond the Company’s control). The words “may,” “could,” “should,” “would,” “believe,” “anticipate,”
“estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements. The following
factors, among others, could cause the Company’s financial performance to differ materially from the plans, objectives, expectations,
estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the
strength of the local economies in the Company’s markets; the effects of, and changes in trade, monetary and fiscal policies and laws,
including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary
fluctuations; the timely development of and acceptance of new products and services; the ability of the Company to compete with other
institutions for business; the composition and concentrations of the Company’s lending risk and the adequacy of the Company’s reserves
to manage those risks; the valuation of the Company’s investment securities; the ability of the Company to pay dividends or repurchase
common shares; the ability of the Company to retain key personnel; the impact of any pending or threatened litigation against the
Company; the marketability of shares of the Company and fluctuations in the value of the Company’s share price; the impact of the
Company’s ability to comply with its regulatory agreements and orders; the effectiveness of the Company’s system of internal controls;
the ability of the Company to attract additional capital investment; the impact of changes in financial services’ laws and regulations
(including laws concerning capital adequacy, taxes, banking, securities and insurance); the impact of technological changes and security
risks upon the Company’s information systems; changes in consumer spending and saving habits; the nature, extent, and timing of
governmental actions and reforms, and the success of the Company at managing the risks involved in the foregoing and other risks and
uncertainties, including those detailed in the Company’s filings with the SEC.
The Company cautions that the foregoing list of important factors is not all inclusive. Readers are also cautioned not to place undue
reliance on any forward-looking statements, which reflect management’s analysis only as of the date of this report, even if subsequently
made available by the Company on its website or otherwise. The Company does not undertake to update any forward-looking statement,
whether written or oral, that may be made from time to time by or on behalf of the Company to reflect events or circumstances occurring
after the date of this report.
CRITICAL ACCOUNTING POLICIES
In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported
amounts of assets and liabilities as of the date of the consolidated statements of condition and results of operations for the periods
indicated. Actual results could differ significantly from those estimates.
The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of its financial condition
and results of operations. The Company’s significant accounting policies are presented in Note 2 to the consolidated financial
statements. Management has identified the policies on the determination of the Allowance for Loan and Lease Losses (“ALLL”),
securities valuation and impairment evaluation, and valuation of other real estate owned (“OREO”) and income taxes to be critical, as
management is required to make subjective and/or complex judgments about matters that are inherently uncertain and could be most
subject to revision as new information becomes available.
The judgments used by management in applying the critical accounting policies discussed below may be affected by a further and
prolonged deterioration in the economic environment, which may result in changes to future financial results. Specifically, subsequent
evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the ALLL in future periods,
and the inability to collect on outstanding loans could result in increased loan losses. In addition, the valuation of certain securities in the
34
Company’s investment portfolio could be negatively impacted by illiquidity or dislocation in marketplaces resulting in significantly
depressed market prices thus leading to impairment losses.
Allowance for Loan and Lease Losses
Management continually evaluates the credit quality of the Company’s loan portfolio, and performs a formal review of the adequacy of
the ALLL on a quarterly basis. The ALLL is established through a provision for loan losses charged to earnings and is maintained at a
level management considers adequate to absorb estimated probable losses inherent in the loan portfolio as of the evaluation date. Loans,
or portions of loans, determined by management to be uncollectible are charged off against the ALLL, while recoveries of amounts
previously charged off are credited to the ALLL.
Determining the amount of the ALLL is considered a critical accounting estimate because it requires significant judgment and the use of
estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous
loans based on historical loss experience, qualitative factors, and consideration of current economic trends and conditions, all of which
may be susceptible to significant change. Various banking regulators, as an integral part of their examination of the Company, also
review the ALLL. Such regulators may require, based on their judgments about information available to them at the time of their
examination, that certain loan balances be charged off or require that adjustments be made to the ALLL. Additionally, the ALLL is
determined, in part, by the composition and size of the loan portfolio.
The ALLL consists of two components, a specific component and a general component. The specific component relates to loans that are
classified as impaired. For such loans an allowance is established when the discounted cash flows, collateral value or observable market
price of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans and is based on
historical loss experience adjusted by qualitative factors. The general reserve component of the ALLL is based on pools of unimpaired
loans segregated by loan segment and risk rating categories of “Pass”, “Special Mention” or “Substandard and Accruing.” Historical loss
factors and various qualitative factors are applied based on the risk profile in each risk rating category to determine the appropriate
reserve related to those loans. Substandard loans on nonaccrual status above the $100 thousand loan relationship threshold and all loans
considered troubled debt restructurings (“TDRs”) are classified as impaired.
See Note 2-“Summary of Significant Accounting Policies” and Note 5-“Loans” of the notes to consolidated financial statements
included in Item 8-“Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for additional information
about the ALLL.
Securities Valuation and Impairment Evaluation
Management utilizes various inputs to determine the fair value of its investment portfolio. To the extent they exist, unadjusted quoted
market prices in active markets (Level 1) or quoted prices for similar assets or models using inputs that are observable, either directly or
indirectly (Level 2) are utilized to determine the fair value of each investment in the portfolio. In the absence of observable inputs or if
markets are illiquid, valuation techniques are used to determine fair value of any investments that require inputs that are both
unobservable and significant to the fair value measurement (Level 3). For Level 3 inputs, valuation techniques are based on various
assumptions, including, but not limited to, cash flows, discount rates, adjustments for nonperformance and liquidity, and liquidation
values. A significant degree of judgment is involved in valuing investments using Level 3 inputs. The use of different assumptions
could have a positive or negative effect on the consolidated statements of financial condition or results of operations. See Note 4-
“Securities” and Note 18-“Fair Value Measurements” of the notes to consolidated financial statements included in Item 8 hereof for
additional information about the Company’s securities valuation techniques.
On a quarterly basis, management evaluates individual investment securities classified as held-to-maturity and available-for-sale having
unrealized losses to determine whether or not the security is other-than-temporarily-impaired (“OTTI”). The analysis of OTTI requires
the use of various assumptions, including but not limited to, the length of time an investment’s fair value is less than book value, the
severity of the investment’s decline, any credit deterioration of the issuer, whether management intends to sell the security, and whether
it is more-likely-than-not that the Company will be required to sell the security prior to recovery of its amortized cost basis. Debt
investment securities deemed to be OTTI are written down by the impairment related to the estimated credit loss, and the non-credit
related impairment loss is recognized in other comprehensive income. There were no OTTI charges on investment securities recognized
in 2013. The Company recognized OTTI charges on investment securities of $96 thousand and $798 thousand in 2012 and 2011,
respectively, within the consolidated statements of operations. For 2012 and 2011, the OTTI charges related to estimated credit losses on
pooled trust preferred securities. See Note 4-“Securities” of the notes to consolidated financial statements included in Item 8 hereof for
additional information about the Company’s OTTI charges.
35
Other Real Estate Owned
OREO consists of property acquired by foreclosure, abandonment or conveyance of deed in-lieu of foreclosure of a loan, and bank
premises that is no longer used for operation or for future expansion. OREO is held for sale and is initially recorded at fair value less
costs to sell at the date of acquisition or transfer, which establishes a new cost basis. Upon acquisition of the property through
foreclosure or deed-in-lieu of foreclosure, any write-down to fair value less estimated selling costs is charged to the ALLL. The
determination is made on an individual asset basis. Bank premises no longer used for operations or future expansion is transferred to
OREO at its fair value less estimated selling costs with any related write-down included in non-interest expense. Subsequent to
acquisition, valuations are periodically performed by management and the assets are carried at the lower of cost or fair value less cost to
sell. Fair value is determined through external appraisals, current letters of intent, broker price opinions or executed agreements of sale.
Costs relating to the development and improvement of the OREO properties may be capitalized; holding period costs and any
subsequent changes to the valuation allowance are charged to expense as incurred.
Income Taxes
The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and
deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements
or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated
financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could impact our consolidated
financial condition or results of operations.
The Company records an income tax provision or benefit based on the amount of tax currently payable or receivable and the change in
deferred tax assets and liabilities. Deferred income taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial and tax reporting purposes. Management conducts quarterly assessments of all available
evidence to determine the amount of deferred tax assets that will more-likely-than-not be realized. The available evidence used in
connection with these assessments includes taxable income in current and prior periods, cumulative losses in prior periods, projected
future taxable income, potential tax-planning strategies, and projected future reversals of deferred tax items. Management’s assumptions
and estimates take into consideration its interpretation of tax laws and possible outcomes of current and future audits conducted by tax
authorities. These assessments involve a certain degree of subjectivity which may change significantly depending on the related
circumstances.
In connection with determining the income tax provision or benefit, the Company considers maintaining liabilities for uncertain tax
positions and tax strategies that management believes contain an element of uncertainty. Periodically, the Company evaluates each of its
tax positions and strategies to determine whether a liability for uncertain tax benefits is required. As of December 31, 2013 and 2012, the
Company determined that it did not have any uncertain tax positions or tax strategies and that no liability was required to be recorded.
Note 2-“Summary of Significant Accounting Policies” and Note 13 - “Income Taxes” of the notes to consolidated financial statements
included in Item 8 hereof for additional discussion on the accounting for income taxes.
New Authoritative Accounting Pronouncements
Accounting Standards Update (“ASU”) No. 2011-11, Balance Sheet (Topic 210): “Disclosures about Offsetting Assets and Liabilities”
requires enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting
arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s
recognized assets and recognized liabilities within the scope of this update. The amendments require enhanced disclosures by requiring
improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either ASC
210-20-45 or ASC 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether
they are offset in accordance with either ASC 210-20-45 or ASC 815-10-45. The Company adopted ASU No. 2011-11 on January 1,
2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company.
ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350): “Testing Indefinite-Lived Intangible Assets for Impairment” simplifies
the guidance for testing the decline in realizable value (impairment) of indefinite-lived intangible assets other than goodwill. ASU No.
2012-02 allows an entity the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative
impairment test. An organization electing to perform a qualitative assessment is no longer required to calculate the fair value of an
indefinite-lived intangible asset unless the organization determines, based on a qualitative assessment, that it is “more likely than not”
that the asset is impaired. The Company adopted ASU 2012-02 on January 1, 2013. The adoption of this new guidance did not have an
effect on the operating results or financial position of the Company.
ASU No. 2013-01, Balance Sheet (Topic 210): “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” clarifies the
scope of transactions that are subject to the disclosures about offsetting, specifically that ordinary trade receivables and receivables are
36
not in the scope of ASU No. 2011-11. This update applies only to derivatives, repurchase agreements and reverse purchase agreements,
and securities borrowing and securities lending transactions that are offset in accordance with specific criteria contained in FASB
Accounting Standards Codification or subject to a master netting arrangement or similar agreement. The Company adopted ASU 2013-
01 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the
Company.
ASU No. 2013-02, Comprehensive Income (Topic 220): “Reporting of Amounts Reclassified Out of Accumulated Other
Comprehensive Income” improves the transparency of reporting these reclassifications. The new amendments require an organization to:
present either on the face of the statement where income is presented or in the notes to the financial statements the effects on the line
items of net income of significant amounts reclassified out of accumulated other comprehensive income; or cross reference to other
disclosures currently required under GAAP for other reclassification items to be reclassified directly to income in their entirety in the
same reporting period. The amendments apply to all public and private companies that report other comprehensive income. The
Company adopted ASU 2013-02 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results
or financial position of the Company; however, see Note 20 of the notes to the consolidated financial statements for additional
disclosures related to the adoption of ASU No. 2013-02.
Accounting Guidance to be Adopted in Future Periods
ASU 2013-11, Income Taxes (Topic 740): “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a
Similar Tax Loss, or a Tax Credit Carryforward Exists,” requires an unrecognized tax benefit, or a portion of an unrecognized tax
benefit, be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax
loss, or a tax credit carryforward. If a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at
the reporting date, the unrecognized tax benefit should be presented in the financial statements as a liability and not combined with
deferred tax assets. This guidance is effective prospectively for fiscal years, and interim periods within those years beginning after
December 15, 2014, with early adoption permitted. The Company is evaluating the effect the adoption of ASU 2013-11 on January 1,
2015 may have on the operating results or financial position of the Company.
ASU 2014-04, Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40): “Reclassification of Residential Real Estate
Collateralized Consumer Mortgage Loans upon Foreclosure,” clarifies that an in substance repossession or foreclosure occurs, and a
creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan,
upon either (a) the creditor obtaining legal title to residential real estate property upon completion of a foreclosure or (b) the borrower
conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of
foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both the
amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans
collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable
jurisdiction. This guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15,
2014, with early adoption permitted. The adoption of ASU 2014-04 on January 1, 2015 is not expected to have a material effect on the
operating results or financial position of the Company.
EXECUTIVE OVERVIEW
The following overview should be read in conjunction with the MD&A in its entirety.
During 2013, the Company experienced marked improvement in its asset quality, operating results and financial position. In 2012,
management was primarily focused on strategies aimed at reducing balance sheet risk and the levels of classified assets. Although
initiatives with respect to these areas continued into 2013, management began shifting its attention to addressing its core banking
performance and positioning the Company for sustainable growth over the long-term. In this regard, management initiated several key
actions in 2013:
• Enhanced the Company’s asset/liability and liquidity management process;
• Evaluated the Company’s branch network and property holdings to reduce excess capacity;
• Began to rebuild the loan portfolio through the development of new commercial relationships; and
• Organized a Profitability Enhancement Program focused on improving the Company’s operational efficiency.
In the first quarter of 2013, the Bank’s asset/liability management committee (“ALCO”) process was enhanced, including utilizing more
robust modeling and simulation techniques, in order to more effectively manage the Bank’s asset/liability and liquidity positions within
the current and expected interest rate environment and to improve its reporting in these areas.
37
Management monitors the ongoing profitability of each of the Bank’s branch offices. In addition, management evaluates its current
branch structure, administrative facilities and properties held for future expansion in relation to its current strategies and initiatives. In
this regard, the Company:
• Entered into a Branch Purchase and Deposit/Loan Assumption Agreement (the “Branch Purchase Agreement”) with ESSA
Bank and Trust (“ESSA”) for ESSA to acquire certain assets and liabilities of the Bank’s Marshalls Creek and Stroudsburg
branches, both located in Monroe County, Pennsylvania. The transaction, which closed on January 24, 2014, is expected to
improve operating efficiency and strengthen the Bank’s capital position;
• Transferred three vacant lots previously held for future expansion to OREO for disposition; and
• Executed a sale of one of its administrative facilities located in Luzerne County, Pennsylvania, which is expected to reduce
non-interest expense.
At the end of the second quarter of 2013, the Company hired a Chief Lending Officer with over 30 years of in-depth credit
administration, commercial lending and management experience. The Chief Lending Officer’s primary objectives are to lead the Bank’s
commercial lending and business development teams, as well as develop and manage business relationships with commercial customers.
In the fourth quarter, the Company established a Profitability Enhancement Program to focus management’s efforts on four key areas
within the Bank’s core business: 1) profit enhancement; 2) process improvement; 3) non-interest expense reduction; and 4)
organizational structure enhancements. The main committee is comprised of four subcommittees, or task groups, to oversee each of the
four core areas and is charged with the following goals:
• To achieve an efficiency ratio that ranks in the top 50.0% of peer banking institutions by December 31, 2014;
• To identify resources and define accountability needed to execute profit enhancement initiatives; and
• To implement an optimal organizational structure that will position the Bank for sustained profitability, continuous process
improvement and non-interest expense management.
In addition to the above new actions, management continued to reposition the balance sheet in order to reduce risk, improve asset quality
and strengthen the Company’s and Bank’s capital positions.
On May 24, 2012, a putative shareholder filed a complaint in the Court of Common Pleas for Lackawanna County (“Shareholder
Derivative Suit”) against certain present and former directors and officers of the Company (the “Individual Defendants”) alleging, inter
alia, breach of fiduciary duty, abuse of control, corporate waste, and unjust enrichment. The Company was named as a nominal
defendant. The parties to the Shareholder Derivative Suit commenced settlement discussions and on December 18, 2013, the Court
entered an Order Granting Preliminary Approval of Proposed Settlement subject to notice to shareholders. On February 4, 2014, the
Court issued a Final Order and Judgment for the matter granting approval of a Stipulation of Settlement (the “Settlement”) and
dismissing all claims against the Company and the Individual Defendants. As part of the Settlement, there was no admission of liability
by the Individual Defendants. Pursuant to the Settlement, the Individual Defendants, without admitting any fault, wrongdoing or
liability, agreed to settle the derivative litigation for $5.0 million. The $5.0 million Settlement payment will be made to the Company.
The Individual Defendants have reserved their rights to indemnification under the Company’s Articles of Incorporation and By-laws,
resolutions adopted by the Board, the Pennsylvania Business Corporation Law and any and all rights they have against the Company’s
and the Bank’s insurance carriers. In addition, in conjunction with the Settlement, the Company accrued $2.5 million related to fees and
costs of the plaintiff’s attorneys, which is included in non-interest expense in the consolidated statements of operations for the year
ended December 31, 2013.
The Company reported net income of $6.4 million in 2013 compared to a net loss of $13.7 million in 2012. Basic and diluted earnings
per share were $0.39 in 2013, while basic and diluted losses per share were $(0.83) in 2012. The $20.1 million improvement in earnings
resulted primarily from a $10.3 million positive change in the provision for loan and lease losses from a provision of $4.1 million in
2012 to a credit for loan and lease losses of $6.3 million in 2013. In addition, a $6.8 million, or 16.3%, reduction in non-interest expense
and a $5.0 million, or 116.7%, increase in non-interest income contributed to the earnings improvement. Partially offsetting these
positive factors was a $2.0 million, or 7.3%, decrease in net interest income. Return on average assets and return on average equity were
0.67% and 18.65%, respectively, in 2013 compared to (1.35)% and (34.09)%, respectively, in 2012.
Total assets increased $35.5 million, or 3.7%, to $1.0 billion at December 31, 2013 from $968.3 million at December 31, 2012. The
growth in the balance sheet was driven by a $50.5 million, or 8.7%, increase in net loans. In addition, securities available for sale
increased $18.5 million, or 10.0%. The growth in the loan and investment portfolios was funded by a $30.1 million increase in total
deposits, an $8.5 million increase in advances from the Federal Home Loan Bank of Pittsburgh (“FHLB”), and an $11.7 million decrease
in cash and cash equivalents.
38
Total shareholders’ equity decreased $3.3 million to $33.6 million at December 31, 2013 from $36.9 million at the end of 2012. Net
income of $6.4 million was more than entirely offset by a $9.8 million decrease in accumulated other comprehensive income, which
resulted entirely from changes in the fair value of available-for-sale securities. Despite the decrease in shareholders’ equity, the
Company’s and the Bank’s risk-based capital positions improved. The total risk-based capital ratios for the Company and the Bank were
11.58% and 13.43%, respectively, at December 31, 2013, compared to 10.20% and 11.79%, respectively, at December 31, 2012.
Similarly, Tier I capital to average assets ratio improved for the Company and Bank to 4.71% and 8.32%, respectively, at December 31,
2013, from 4.07% and 7.20%, respectively, at December 31, 2012.
Net Interest Income
2013 compared to 2012
Net interest income is the difference between (i) interest income - interest and fees on interest-earning assets, and (ii) interest expense -
interest paid on the Company’s deposits and borrowed funds. Net interest income represents the largest component of the Company’s
operating income and, as such, is the primary determinant of profitability. Net interest income is impacted by variations in the volume,
rate and composition of earning assets and interest-bearing liabilities, changes in general market rates and the level of non-performing
assets. Interest income is shown on a fully tax-equivalent basis and is calculated by adjusting tax-free interest using a marginal tax rate
of 34.0% in order to equate the yield to that of taxable interest rates. The tax-equivalent net interest margin is calculated by dividing tax-
equivalent net interest income by average interest-earning assets and is a key measurement used in the banking industry to measure
income from earning assets. During 2013, the Company’s earning assets re-priced downward at a faster pace than interest-bearing
liabilities. As a result, the Company’s tax-equivalent net interest margin contracted 6 basis points to 3.22% in 2013 from 3.28% in 2012.
Rate spread, the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities shown
on a fully tax-equivalent basis, was 3.10% in 2013, a decrease of 5 basis points compared to 3.15% in 2012.
Tax-equivalent net interest income decreased $2.4 million to $28.2 million in 2013 from $30.6 million in 2012. During 2013, lower
yields on interest-earning assets was the primary factor leading to the decline in net interest income. The yield on average earning assets
declined 23 basis points to 4.04% in 2013 from 4.27% in 2012, which resulted from a 27 basis point decrease in the tax-equivalent yield
on the loan portfolio and an 89 basis point reduction in the tax-equivalent yield on total securities. The 23 basis point decline in the tax-
equivalent yield on earning assets caused a $3.1 million decrease in tax-equivalent interest income, which was partially offset by a
decrease in interest expense of $821 thousand, resulting from an 18 basis point decline in the cost of average interest-bearing liabilities.
Also negatively impacting net interest income was a $57.9 million decrease in average earning assets, which was partially offset by
lower volume of average interest-bearing liabilities as compared to the previous year.
39
The federal funds rate and the national prime rate were unchanged at 0.25% and 3.25%, respectively, in 2013. However, increased
competition for loans within the Company’s market area exacerbated this already challenging rate environment and negatively impacted
loan yields in 2013. The tax-equivalent yield on the loan portfolio declined 27 basis points to 4.37% in 2013 from 4.64% in 2012.
Specifically, the yield on taxable loans decreased 24 basis points, while the yield on tax-free loans fell 112 basis points and caused
corresponding reductions in tax-equivalent interest income of $1.5 million and $410 thousand, respectively. The tax-equivalent yield on
the investment portfolio decreased 89 basis points to 3.77% in 2013 from 4.66% in 2012 and resulted in a corresponding decrease in
interest income of $1.2 million. Specifically, the yield on taxable and tax-free investments decreased 89 basis points and 10 basis points,
respectively, comparing 2013 and 2012. ALCO and investment strategies in 2013 involved mitigating credit risk, while lowering the
risk-based capital weighting of the portfolio. Management shifted the composition of the investment portfolio by de-emphasizing the
Company’s holdings of state and municipal obligations and increasing its holdings of U.S. government and government-sponsored
securities. Consequently, proceeds from sales and maturities of higher-yielding state and municipal obligations were reinvested into U.S.
government bonds and mortgage-backed securities having lower yields.
The decreases in tax-equivalent interest income attributable to lower loan and investment yields was partially mitigated by an 18 basis
point reduction in the Company’s cost of funds. The cost of interest-bearing demand deposits, savings deposits, time deposits over $100
thousand, and other time deposits decreased 5, 8, 6, and 18 basis points, respectively, comparing the years ended December 31, 2013 and
2012. These basis point reductions resulted in a combined decrease in interest expense of $625 thousand. In addition, the Company’s
borrowing costs declined 28 basis points to 5.00% in 2013 from 5.28% in 2012, which resulted in a $196 thousand decrease in interest
expense.
As previously mentioned, average earning assets decreased $57.9 million, or 6.2%, from $931.8 million in 2012 to $873.8 million in
2013, which was partially offset by a $56.4 million, or 6.9%, decrease in average interest-bearing liabilities. Despite the overall increase
in total loans, the loan portfolio averaged $16.5 million, or 2.5%, lower in 2013 as compared to 2012, as loan satisfactions outpaced
originations in the first half of year. Average investment securities totaled $197.3 million, a decrease of $1.9 million in 2013 compared
to 2012. The average balance of tax-free securities decreased $12.6 million, or 15.5%, while average taxable securities increased $10.7
million, or 9.1%, due to the repositioning of the portfolio. Average interest-bearing deposits in other banks declined $39.5 million as the
Company continued to utilize available liquidity. These changes in the average balances of earning assets resulted in a combined
decrease to tax-equivalent net interest income of $1.4 million.
Average interest-bearing liabilities totaled $765.7 million for the year ended December 31, 2013, a decrease of $56.4 million, or 6.9%,
comparing the years ending December 31, 2013 and 2012. Specifically, average interest-bearing deposits decreased $44.1 million, or
5.9%, in 2013 as compared to 2012, while average borrowed funds decreased $12.4 million, or 17.0%. The Company experienced
reductions in the average balances for all major deposit categories, except for interest-bearing demand deposits. Specifically, average
savings deposits, time deposits over $100 thousand, and other time deposits decreased $1.9 million, $9.6 million and $34.8 million,
respectively. Average interest-bearing demand deposits increased $2.3 million in 2013 compared to 2012. Changes in the average
balances of interest-bearing liabilities resulted in a combined decrease in interest expense of $1.2 million, which almost entirely offset
the negative impact from the decreases in volumes of average earning assets.
2012 compared to 2011
The Company’s tax-equivalent net interest margin improved 18 basis points to 3.28% in 2012 from 3.10% in 2011. Interest rate spread
on a fully tax-equivalent basis, was 3.15% in 2012, an increase of 15 basis points compared to 3.00% in 2011.
Net interest income on a tax-equivalent basis decreased $1.9 million to $30.6 million for 2012 compared with $32.5 million for 2011.
During 2012, lower average securities and loan balances and lower yields on interest-earning assets negatively impacted our net interest
income. The yield on average earning assets declined 16 basis points to 4.27% in 2012 from 4.43% in 2011, which primarily resulted
from a 24 basis point decrease in the tax-equivalent yield on the loan portfolio. The effects of the decreased yields were partially offset
by a 31 basis point decline in the cost of average interest-bearing liabilities and lower volume of average interest-bearing liabilities as
compared to the previous year. The Federal Reserve kept interest rates stable during 2012 leaving the Federal Funds rate at 25 basis
points. The Company’s floating rate loans are largely indexed to the national prime rate and many of these loans are now at their floors
and will remain there until the prime rate moves up enough for their rates to adjust upward. In addition, most of the time deposits in the
Company’s funding portfolio matured and continued to renew at lower market rates in 2012.
40
Average loans totaled $653.0 million for the year ended December 31, 2012, a decrease of $70.7 million, or 9.8%, compared to the same
period for 2011. The reduction is primarily due to the net pay downs of commercial and industrial loans and real estate loans of $64.2
million and $19.0 million, respectively. During 2012, loan satisfactions continued to outpace originations. Several large commercial loan
relationships were lost upon the sale of the businesses. In addition, approximately $56.6 million in commercial loans to a related party,
which were fully secured by deposit accounts, were paid off during 2012. Interest income on a tax-equivalent basis for loans decreased
$5.0 million due to the decrease in average loans and a 24 basis point decrease in the average loan yield as loans continued to reset at
lower rates. In addition, competition within the Company’s market area escalated, causing pricing pressures that led to new loans being
originated at lower rates as compared to 2011, and the reduction of rates on existing loans in order to retain business.
Average investment securities totaled $199.2 million, a decrease of $33.6 million, or 14.4%, in 2012 compared to 2011. Interest income
on a tax equivalent basis for investment securities decreased $1.6 million, primarily due to reinvestment of pay downs and maturities
into more lower-yielding securities. Average interest-bearing deposits in other banks declined $12.4 million as the Company decreased
its holdings of liquid assets. Interest income on interest-bearing deposits in other banks increased $12 thousand as the 5 basis point
increase in the yield more than offset a $12.4 million decrease in volume.
Average interest-bearing liabilities totaled $822.2 million for the year ended December 31, 2012, a decrease of $147.5 million, or 15.2%,
during 2012 compared to the same period in 2011, due to a decrease in interest-bearing deposits of $108.3 million, or 12.6%, and a
decrease in borrowings of $39.1 million, or 35.0%.
The Company experienced reductions in the average balances for all major deposit categories. Specifically, average interest-bearing
demand deposits, savings deposits, time deposits over $100 thousand, and other time deposits decreased $35.3 million, $1.7 million,
$10.8 million and $60.6 million, respectively. During 2012, the Company continued its pricing strategy to reduce its cost of funds and to
direct deposit growth to short-term maturity products. The Company continued to reposition maturing longer term time deposits into
short-term products, whenever possible, and allowed the residual to run-off. The Company used a portion of the net proceeds received
from the loan and investment portfolios to fund deposit withdrawals and the maturities of the higher cost time deposits. The cost of
interest-bearing demand deposits, savings deposits, time deposits over $100 thousand, and other time deposits decreased 25, 14, 34, and
26 basis points respectively, from the same period in 2011. The average cost of interest-bearing deposits decreased by 30 basis points to
0.72% in 2012 from 1.02% in 2011. The decrease in the rate on interest-bearing deposits was driven primarily by the pricing decreases
that resulted from the Company’s pricing strategy. Average borrowed funds and other interest-bearing liabilities totaled $72.6 million
for the year ended December 31, 2012, a decrease of $39.1 million, or 35.0%, compared to 2011. During 2012, the Company continued
to employ its funds management plan implemented in 2010 and to pay off term borrowings. The Company used excess liquidity from
loan repayments and sales of investment securities to pay off a portion of its term borrowings. The Company did not enter into any new
term borrowings in 2012. The 71 basis point increase in the cost of borrowed funds for the year ended December 31, 2012 is primarily
attributable to the repayment during 2012 of maturing FHLB advances that were at lower rates, resulting in higher-rate borrowings
becoming a larger percentage of total borrowings and an increase in the related cost of borrowed funds.
Non-accrual loans
The interest income that would have been earned on non-accrual and restructured loans outstanding at December 31, 2013, 2012 and
2011 in accordance with their original terms approximated $572 thousand, $1.4 million, and $2.2 million, respectively. Interest income
on impaired loans of $366 thousand, $376 thousand, and $238 thousand was recognized based on payments received in 2013, 2012 and
2011.
41
The following table reflects the components of net interest income for each of the three years ended December 31, 2013, 2012 and 2011:
Year ended December 31,
Year ended December 31,
Year ended December 31,
Average
Balance
2013
Interest
Yield/
Cost
Average
Balance
2012
Interest
Yield/
Cost
Average
Balance
2011
Interest
Yield/
Cost
(dollars in thousands)
ASSETS
Earning Assets (2)(3)
Loans-taxable (4)
Loans-tax free (4)
Total Loans (1)(2)
Securities-taxable
Securities-tax free
Total Securities (1)(5)
Interest-bearing deposits in other
banks and federal funds sold
Total Earning Assets
$ 597,776
$ 25,744
38,694
2,050
636,470
27,794
128,508
2,476
68,780
4,965
197,288
7,441
40,067
103
873,825
35,338
Non-earning assets
Allowance for loan and lease losses
Total Assets
94,877
(18,613)
$ 950,089
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing Liabilities
Interest-bearing demand
deposits
Savings deposits
Time deposits over $100,000
Other time deposits
$ 302,258
559
85,872
90
160,728
1,301
156,639
2,214
Total Interest-bearing Deposits
705,497
4,164
Borrowed funds and other interest-
bearing liabilities
Total Interest-Bearing Liabilities
60,240
3,012
765,737
7,176
Demand deposits
Other liabilities
Shareholders' equity
Total Liabilities and
130,186
19,946
34,220
Shareholders Equity
$ 950,089
4.31%
5.30%
4.37%
1.93%
7.22%
3.77%
0.26%
4.04%
$ 619,151
$ 28,153
33,863
2,174
653,014
30,327
117,800
3,318
81,368
5,956
199,168
9,274
79,571
190
931,753
39,791
100,979
(20,526)
$ 1,012,206
4.55%
6.42%
4.64%
2.82%
7.32%
4.66%
0.24%
4.27%
$ 688,546
$ 32,831
35,150
2,479
723,696
35,310
123,854
3,198
108,955
7,717
232,809
10,915
91,932
178
1,048,437
46,403
103,685
(24,108)
$ 1,128,014
0.18%
0.10%
0.81%
1.41%
0.59%
5.00%
0.94%
$ 299,938
699
87,818
161
170,356
1,476
191,462
3,048
749,574
5,384
72,593
3,834
822,167
9,218
0.23%
0.18%
0.87%
1.59%
0.72%
5.28%
1.12%
$ 335,201
1,615
89,494
287
181,146
2,193
252,081
4,664
857,922
8,759
111,709
5,108
969,631
13,867
128,254
21,568
40,217
$ 1,012,206
107,763
16,301
34,319
$ 1,128,014
4.77%
7.05%
4.88%
2.58%
7.08%
4.69%
0.19%
4.43%
0.48%
0.32%
1.21%
1.85%
1.02%
4.57%
1.43%
Net Interest Income/Interest
Rate Spread (6)
Tax equivalent adjustment
Net interest income as reported
Net Interest Margin (7)
28,162
3.10%
30,573
3.15%
32,536
3.00%
(2,385)
$ 25,777
(2,764)
$ 27,809
(3,467)
$ 29,069
3.22%
3.28%
3.10%
Interest income is presented on a tax-equivalent basis using a 34% rate for 2013, 2012 and 2011.
(1)
(2) Loans are stated net of unearned income.
(3) Nonaccrual loans are included in loans within earning assets.
(4) Loan fees included in interest income are not significant.
(5) The yields for securities that are classified as available-for-sale is based on the average historical amortized cost.
(6)
Interest rate spread represents the difference between the average yield on interest earning assets and the cost of interest-bearing liabilities.
and is presented on a tax-equivalent basis.
(7) Net interest income on a tax-equivalent basis as a percentage of total average interest-earning assets.
Rate Volume Analysis
The most significant impact on net income between periods is derived from the interaction of changes in the volume and rates earned or
paid on interest-earning assets and interest-bearing liabilities. The volume of earning assets, specifically loans and investments,
compared to the volume of interest-bearing liabilities represented by deposits and borrowings, combined with the spread, produces the
changes in net interest income between periods. Components of interest income and interest expense are presented on a tax-equivalent
basis using the statutory federal income tax rate of 34%.
42
The following table shows the effect of changes in volume and interest rates on net interest income. The variance in interest income or
expense due to the combination of rate and volume has been allocated proportionately.
(in thousands)
Interest Income:
Loans - taxable
Loans - tax free
Total loans
Securities - taxable
Securities - tax free
Total securities
Interest-bearing deposits in other banks and
federal funds sold
Total interest income
Interest Expense:
Interest-bearing demand deposits
Savings deposits
Time deposits over $100,000
Other time deposits
Total interest-bearing deposits
Borrowed funds and other
interest-bearing liabilities
Total interest expense
December 31,
2013 vs. 2012
Increase (Decrease)
December 31,
2012 vs. 2011
Increase (Decrease)
Due to
Volume
Due to
Rate
Total
Change
Due to
Volume
Due to
Rate
Total
Change
$
(952)
$
(1,457)
$
(2,409)
$
(3,204)
$
(1,474)
$
(4,678)
286
(666)
280
(910)
(630)
(101)
(1,397)
5
(3)
(81)
(516)
(595)
(626)
(1,221)
(410)
(1,867)
(1,122)
(81)
(1,203)
14
(3,056)
(145)
(68)
(94)
(318)
(625)
(196)
(821)
(124)
(2,533)
(842)
(991)
(1,833)
(87)
(4,453)
(140)
(71)
(175)
(834)
(1,220)
(822)
(2,042)
(88)
(3,292)
(161)
(2,012)
(2,173)
(26)
(5,491)
(155)
(5)
(124)
(1,023)
(1,307)
(1,981)
(3,288)
(217)
(1,691)
281
251
532
38
(1,121)
(761)
(121)
(593)
(593)
(2,068)
707
(1,361)
(305)
(4,983)
120
(1,761)
(1,641)
12
(6,612)
(916)
(126)
(717)
(1,616)
(3,375)
(1,274)
(4,649)
Net Interest Income
$
(176)
$
(2,235)
$
(2,411)
$
(2,203)
$
240
$
(1,963)
(1) Changes in interest income and interest expense attributable to changes in both volume and rate have been allocated proportionately
to changes due to volume and changes due to rate.
Provision for Loan and Lease Losses
Management closely monitors the loan portfolio and the adequacy of the ALLL considering underlying borrower financial performance
and collateral values and associated credit risks. Future material adjustments may be necessary to the provision for loan and lease losses
and the ALLL if economic conditions or loan performance differ substantially from the assumptions management used in making its
evaluation of the ALLL. The provision for loan and lease losses is an expense charged against net interest income to provide for
probable losses attributable to uncollectible loans and is based on management’s analysis of the adequacy of the ALLL. A credit to loan
and lease losses reflects the reversal of amounts previously charged to the ALLL.
2013 compared to 2012
The Company recorded a credit for loan and lease losses of $6.3 million in 2013, compared to a provision of $4.1 million in 2012. The
release of reserves in 2013 reflected improved asset quality metrics, reductions in historical loss factors and net recoveries on previously
charged-off loans.
Non-performing loans decreased $3.3 million, or 34.0%, to $6.4 million at December 31, 2013 from $9.7 million at December 31, 2012.
The Company recorded net recoveries of $1.7 million for the year ended December 31, 2013, compared to net charge-offs of $6.4
million for the same period of 2012. Non-performing loans primarily consist of loans secured by real estate. Management closely
monitors the loan portfolio and the adequacy of the ALLL considering the underlying financial performance of the borrower, collateral
values and any increasing credit risks.
2012 compared to 2011
The provision for loan and lease losses was $4.1 million in 2012 as compared to $0.5 million in 2011. The increase primarily resulted
from an increase in charge-offs of classified credits, specifically one larger commercial credit totaling $3.1 million that was charged off
during the third quarter of 2012.
43
Non-Interest Income:
The following table lists the components of non-interest income for the years ended December 31, 2013, 2012 and 2011:
Non-Interest Income
(in thousands)
Deposit service charges
Net gain (loss) on the sale of securities
Other-than-temporary-impairment loss on securities
Net gain on the sale of loans held for sale
Net loss on the sale of classified loans
Net gain on the sale of other real estate owned
Gain on the sale of bank premises and equipment and other assets
Loan-related fees
Income from bank-owned life insurance
Other
Total non-interest income
2013 compared to 2012
2013
$
2012
$
2011
$
2,945
2,887
-
362
(223)
135
579
423
706
1,469
9,283
2,985
(1,712)
(96)
859
-
305
-
514
692
736
4,283
3,105
5,114
(798)
755
-
2,528
20
673
787
765
12,949
$
$
$
Total non-interest income increased $5.0 million, or 116.7%, to $9.3 million in 2013 from $4.3 million in 2012. The increase resulted
primarily from a $2.9 million net gain on the sale of investment securities in 2013 compared to a $1.7 million loss on the sale of
investment securities in 2012. Also favorably impacting non-interest income in 2013 was a gain on the sale of bank premises and
equipment and other assets of $579 thousand and an increase in other non-interest income of $733 thousand. These favorable factors
were partially offset by reductions in net gains on the sale of loans held for sale and OREO of $497 thousand and $170 thousand,
respectively, and a net loss of $223 thousand realized on the sale of classified loans.
In the fourth quarter of 2013, the Company sold one of its administrative centers located in Luzerne County, Pennsylvania. The property,
which had a net book value of $1.2 million was sold for $1.8 million, resulting in a net gain on the sale of $579 thousand. With regard to
other non-interest income, the $733 thousand, or 99.6%, increase primarily resulted from monies received from the settlement of an
insurance claim of $287 thousand and interest received from the IRS on federal income tax refunds of $312 thousand.
During the third quarter of 2012, the Company began holding 15- and 20-year mortgages in its portfolio rather than selling these loans
on the secondary market as part of its asset/liability strategy. Medium- and longer-term market interest rates rose in the second half of
2013, which directly impacted mortgage rates. Given the rise in mortgage rates, in the third quarter of 2013, management extended this
strategy to 30-year mortgages, which directly contributed to the 57.9% decrease in net gains on the sale of loans held for sale.
The Company recorded a net gain of $135 thousand on the sale of 13 OREO properties in 2013, compared to a net gain of $305
thousand on the sale of 17 OREO properties in 2012. The loss on the sale of classified loans of $223 thousand resulted from the sale of
six classified loans to a third party in the fourth quarter of 2013. There were no losses on the sale of classified loans recorded in 2012.
The Company continues to aggressively seek buyers for its OREO properties.
2012 compared to 2011
Total non-interest income decreased $8.7 million to $4.3 million in 2012 from $12.9 million in 2011. The 66.9% decrease resulted
primarily from a $1.7 million loss on the sale of investment securities in 2012 compared to a $5.1 million gain on the sale of investment
securities in 2011, coupled with a $2.2 million reduction in net gains on the sale of OREO to $305 thousand in 2012 from $2.5 million in
2011.
During 2012, the Company recorded a $1.7 million net loss on the sale of investment securities with an amortized cost of $47.8 million.
Specifically, the Company sold its entire holdings of private label collateralized mortgage obligations (“PLCMOs”) with an amortized
cost of $37.5 million and pooled trust preferred collateralized debt obligation securities (“PreTSLs”) with an amortized cost of $10.3
million. Management decided to sell these securities as part of its strategy to reduce the amount of market risk and levels of classified
assets on the balance sheet.
44
Non-Interest Expense
The following table lists the major components of non-interest expense for the years ended December 31, 2013, 2012 and 2011:
Non-Interest Expense
2013
2012
2011
$
$
$
(in thousands)
Salaries and employee benefits
Occupancy expense
Equipment expense
Advertising expense
Data processing expense
Regulatory assessments
Bank shares tax
Expense of other real estate owned
(Credit) provision for off-balance sheet commitments
Legal expense
Professional fees
Insurance expenses
Loan collection expenses
Legal settlements
Other operating expenses
Total non-interest expense
2013 compared to 2012
13,218
2,215
1,468
523
2,066
2,515
800
719
(246)
2,488
1,674
1,179
482
2,500
3,347
34,948
14,702
2,225
1,723
614
2,141
2,721
882
2,027
358
4,233
4,385
896
765
446
3,620
41,738
14,117
2,508
1,654
629
2,036
3,159
1,103
3,720
(423)
2,716
5,413
685
780
-
3,733
41,830
$
$
$
Cost containment efforts and the ability to reduce reliance on outside consultants contributed to a $6.8 million, or 16.3%, decrease in
total non-interest expense to $34.9 million in 2013 as compared to $41.7 million in 2012. Specifically, the Company recorded significant
reductions in professional fees, salaries and employee benefits, legal expense and expenses associated with OREO. These decreases
were partially offset by accrued legal settlement costs related to the shareholder derivative case and increased insurance expenses.
Professional fees decreased $2.7 million, or 61.8%, to $1.7 million in 2013 compared to $4.4 million in 2012. In addition, legal expense
declined $1.7 million, or 41.2%, to $2.5 million in 2013 from $4.2 million in 2012. The Company returned to current SEC reporting
status with the filing of its third quarter 2012 Form 10-Q and was able to reduce its reliance on outside consultants and attorneys.
Salaries and employee benefits expense equaled 37.8% of the Company’s total non-interest expense in 2013 compared to 35.2% in 2012.
Despite the increase in the ratio, salaries and employee benefits decreased $1.5 million, or 10.1%, to $13.2 million in 2013 from $14.7
million in 2012. At the end of 2012, the Company implemented a reduction in force and a voluntary separation program in an effort to
better align the number of employees with the reduced asset size of the bank and transaction volumes. Employees affected by the
reduction in force and employees opting for the voluntary separation program received separation packages that included separation pay
and medical benefit assistance for a period of time depending on their years of service, which were accrued for in 2012. In addition, as
part of its cost containment strategy, the Company evaluated positions that became vacant during 2013 and was able to further reduce
full-time equivalents. At December 31, 2013, the number of full-time equivalent employees was 260 as compared to 298 at December
31, 2012.
In 2012, the Board of Directors ratified an amendment to the defined contribution profit sharing plan to include the provisions under
section 401(k) of the Internal Revenue Code (“401(k)”). The 401(k) feature of the plan permits employees to make voluntary salary
deferrals, either pre-tax or Roth, up to the dollar limit prescribed by law. The Company may make discretionary matching contributions
equal to a uniform percentage of employee salary deferrals. Company discretionary matching contributions are determined each year by
management. For 2013 and 2012, the Company matched 50.0% of employee salary deferrals up to 4.0% for each employee. Company
matching contributions to the 401(k) Plan totaled $129 thousand and $41 thousand in 2013 and 2012, respectively.
Pursuant to the 2013 Employee Stock Grant Plan and the 2012 Employee Stock Grant Plan (“the 2012 Stock Grant Plan”), the Board of
Directors granted 50 shares of the Company’s common stock in both 2013 and 2012, respectively to each active full and part time
employee. There were 14,400 shares at a cost per share of $4.26 granted under the 2013 Stock Grant Plan and 15,050 shares at a cost per
share of $3.05 granted under the 2012 Stock Grant Plan. The total costs of these grants was $61 thousand and $46 thousand,
respectively, for the years ended December 31, 2013 and 2012, which were included in salaries and employee benefits expense.
45
Expenses associated with OREO further declined in 2013 as the number of properties held decreased and real estate values continued to
stabilize. Other real estate expense decreased by $1.3 million, or 64.5%, in 2013 as compared to 2012 primarily due to a $983 thousand
reduction in impairment charges. In addition, real estate taxes and professional fees associated with OREO properties decreased $165
thousand and $176 thousand, respectively, in 2013 as compared to 2012.
The Company recorded a credit for off-balance sheet commitments of $246 thousand in 2013, as compared to a provision of $358
thousand in 2012. The $604 thousand improvement resulted from decreases in historical loss factors used to estimate losses associated
with the Bank’s construction loan commitments.
Regulatory assessments, which include FDIC insurance assessment and OCC examination assessments, decreased $206 thousand, or
7.6%, for the year ended December 31, 2013 as compared to 2012. Based on its risk profile, the Bank was included in Risk Category III
for assessing the rate for FDIC insurance in 2013 and 2012.
As described in the Executive Overview of this MD&A, the parties to the Shareholder Derivative Suit, in which the Company is named
as nominal defendant, agreed to a Settlement, which was approved by the Court on February 4, 2014. As part of the Settlement, it was
agreed that $2.5 million would be paid to the Plaintiff’s attorneys for their fees and costs. The Company accrued for the $2.5 million,
which is included as a separate line item in non-interest expense in 2013.
2012 compared to 2011
Total non-interest expense decreased $92 thousand or 0.2%, to $41.7 million in 2012 as compared to 2011. The change in non-interest
expense resulted primarily from a $1.7 million decrease in OREO expense, a $1.0 million decrease in professional fees, a $0.4 million
decrease in the Regulatory assessments, and a $0.3 million decrease in occupancy expense. These decreases were partially offset by
increases in legal expenses of $1.5 million, the provision for off-balance sheet commitments of $0.8 million and salaries and benefits
expense of $0.6 million.
Other real estate expense decreased by $1.7 million, or 45.5%, in 2012 as compared to 2011 primarily due to a $1.1 million reduction in
impairment charges. In addition, real estate taxes and legal expenses decreased $0.4 million and $0.2 million, respectively, comparing
2012 to 2011. The reduction in impairment is primarily attributable to the stabilization of real estate values and a reduction in the
number of properties held in OREO.
Professional fee expense decreased $1.0 million in 2012 as compared to 2011. Despite the decrease, professional fee expense remained
elevated for the majority of 2012. Upon returning to current SEC reporting status with the filing with the filing of its third quarter 2012
Form 10-Q, the Company began reducing its reliance on outside consulting and professional services and expects these costs to continue
to decline in 2013.
Regulatory assessments, which include FDIC insurance expense and OCC examination expense, decreased $0.4 million in 2012 as a
result of the decline in the level of average assets.
Occupancy expense decreased $0.3 million, or 11.3%, in 2012 as compared to 2011. The decrease was primarily attributable to
reductions in repairs and maintenance and utility costs.
Regulatory oversight, SEC compliance-related costs and other legal matters continued to impact legal fees in 2012 and resulted in a $1.5
million increase in legal expense as compared to 2011.
The provision for off-balance sheet commitments increased $0.8 million and resulted in the Company recording a $0.4 million charge in
2012, compared to a $0.4 million credit in 2011. The increase in the provision is primarily attributable to an increase in the Bank’s
construction loan commitments.
Salary and employee benefit costs, which accounted for 35.2% of total non-interest expense in 2012, increased $0.6 million or 4.1% to
$14.7 million in 2012 compared to $14.1 million in 2011. Salary expense increased $0.5 million, which was attributable to annual
employee merit increases, a separation agreement entered into with the Company’s former Chief Financial Officer, several program
initiatives implemented in 2012, and stock grants to employees pursuant to the 2012 Stock Grant Plan. Employee benefits expense
increased $0.1 million, due primarily to the ratification of a 401 (k) feature to the Company’s profit sharing plan.
On August 24, 2012, the Bank entered into a Separation Agreement and Release with the former Chief Financial Officer upon his
resignation, which became effective August 31, 2012. Pursuant to the Separation Agreement, the Company agreed to pay his salary and
health insurance benefits through March 1, 2013. Salary and benefits expense of $91 thousand under this agreement were recognized in
2012.
46
In October 2012, the Company implemented a reduction in force, which eliminated nine positions, and a voluntary separation program
in an effort to better align the number of employees with the reduced asset size of the bank and transaction volumes. The voluntary
separation program was offered to full-time employees who have at least ten years of service and who have attained the age of 60 years
old by December 31, 2012. As of December 31, 2012, there were a total of 11 employees who had accepted the separation offer.
Employees affected by the reduction in force and employees opting for the voluntary separation program received separation packages
that included separation pay and medical benefit assistance for a period of time depending on their years of service. The Company
recognized $275 thousand in salaries and benefits expense in 2012 upon implementation of these programs. As of December 31, 2012,
the Company had 298 full-time equivalent employees on staff as compared to 336 on December 31, 2011.
Provision for Income Taxes
The Company did not record a provision or benefit for income taxes for the years ended December 31, 2013, 2012 and 2011. In 2013,
the Company recorded a $347 thousand reduction to the deferred tax valuation allowance, decreasing the valuation allowance to $34.1
million at December 31, 2013 from $34.5 million at December 31, 2012. In future periods, the Company anticipates that it will have a
minimal tax provision or benefit until such time as it is able to reverse the deferred tax asset valuation allowance.
In 2012, the Company recorded a $6.7 million valuation charge against its deferred tax assets, increasing the valuation allowance to
$34.5 million at December 31, 2012 from $27.8 million at December 31, 2011.
The Company calculates its current and deferred tax provision based on estimates and assumptions that could differ from actual results
reflected in income tax returns filed during the subsequent year. Any adjustments required based on filed returns are recorded when
identified in the subsequent year.
FINANCIAL CONDITION
Total assets increased $35.5 million, or 3.7%, to $1.0 billion, at December 31, 2013, as compared to $968.3 million at December 31,
2012. The increase in the balance sheet was driven by increases in net loans of $50.5 million, or 8.7%, and investment securities of
$18.5 million, or 10.0%. The growth in earning assets was funded primarily by deposit growth of $30.1 million, or 3.5%, an $8.5 million
increase in FHLB borrowings, and an $11.7 million decrease in cash and cash equivalents.
Total shareholders’ equity decreased $3.3 million to $33.6 million at December 31, 2013 from $36.9 million at the end of 2012. Net
income of $6.4 million was more than entirely offset by a $9.8 million reduction in accumulated other comprehensive income, which
resulted entirely from a decrease in the fair value of the Company’s available-for-sale securities portfolio. The decrease in fair value of
the available-for-sale portfolio was due entirely to fluctuations in market interest rates. The Company did not pay any dividends in 2013
or 2012. The Company suspended paying dividends in 2010 to conserve capital and comply with regulatory requirements.
Securities
The Company’s investment securities portfolio provides a source of liquidity needed to meet expected loan demand and provides a
source of interest income to increase our profitability. Additionally, the Company utilizes the investment securities portfolio to meet
pledging requirements to secure public deposits and for other purposes. Investment securities are classified as held-to-maturity and
carried at amortized cost when the Company has the positive intent and ability to hold them to maturity. Securities not classified as
held-to-maturity are classified as available-for-sale and are carried at fair value, with unrealized holding gains and losses reported as a
component of shareholders’ equity in accumulated other comprehensive income, net of tax. The Company determines the appropriate
classification of investment securities at the time of purchase. The decision to purchase or sell investment securities is based upon the
current assessment of long- and short-term economic and financial conditions, including the interest rate environment and other
statement of financial condition components. Investment securities with limited marketability and/or restrictions, such as Federal Home
Loan Bank and Federal Reserve Bank stocks, are carried at cost. Federal Reserve Bank stock is included in other assets.
At December 31, 2013, the Company’s investment portfolio was comprised principally of obligations of U.S. government-sponsored
agencies, including residential mortgage-backed securities and collateralized mortgage obligations (“CMOs”) and taxable and tax-
exempt obligations of states and political subdivisions. Except for obligations of U.S. Government-sponsored agencies, there were two
security issuers, St. Clair County, IL School District and the Commonwealth of Massachusetts, whose aggregate carrying values
exceeded 10.0% of Shareholders’ equity as of December 31, 2013. The aggregate carrying values of the securities of these issuers were
$4.1 million and $3.8 million, respectively.
The following table sets forth the carrying value of available-for-sale securities, which are carried at fair value, and held-to-maturity
securities, which are carried at amortized cost, at the dates indicated:
47
(in thousands)
Available-for-sale
Obligations of U.S. government agencies
Obligations of state and political subdivisions
Government-sponsored agency:
Collateralized mortgage obligations
Residential mortgage-backed securities
Private label collateralized mortgage obligations
Pooled trust preferred senior class
Pooled trust preferred mezzanine class
Corporate debt securities
Equity securities
Total securities available-for-sale
Held-to-maturity
Obligations of state and political subdivisions
2013
December 31,
2012
2011
-
$
78,054
$
1,891
103,501
$
8,048
96,161
34,799
89,656
-
-
-
407
951
203,867
$
9,103
69,456
-
-
-
410
1,000
185,361
$
8,468
31,393
36,256
1,604
2,197
342
1,006
185,475
$
$
2,308
$
2,198
$
2,094
The Company’s investment strategy in 2013 involved reducing potential credit risk within the securities portfolio. In carrying out this
strategy, management sought to shift the composition of the portfolio from predominantly obligations of state and political subdivisions,
which potentially have a higher degree of associated credit risk, to obligations of U.S. government-sponsored agencies. At December
31, 2013, obligations of states and political subdivision comprised 38.3% of total available-for-sale securities, compared to 55.8% at
December 31, 2012, while obligations of U.S. government-sponsored agencies, including collateralized mortgage obligations and
residential mortgage-backed securities comprised 61.0% of available-for-sale securities at December 31, 2013 compared to 42.4% at
year-end 2012.
During the year ended December 31, 2013, the Company sold 77 securities, including 68 of its obligations of state and political
subdivisions, 7 residential mortgage-backed securities, 1 CMO and 1 U.S. government agency security, with an aggregate carrying value
of $50.9 million. Net gains of $2.9 million were realized upon the sales and are included in non-interest income. Securities purchased
during the year ended December 31, 2013 included 9 CMOs totaling $32.8 million, 10 residential mortgage-backed securities totaling
$56.2 million and 11 obligations of states and political subdivisions totaling $10.4 million. All sales and purchases were executed as part
of the Company’s investment strategy described above and in anticipation of liquidity needs in response to increased loan demand and
cyclical deposit trends.
48
The following table sets forth the maturities of available-for-sale securities and held-to-maturity securities, based on carrying value at
December 31, 2013 and the weighted average yields of such securities calculated on the basis of the cost and effective yields weighted
for the scheduled maturity of each security.
Decmeber 31, 2013
(dollars in thousands)
Available-for-sale securities
Obligations of state and political subdivisions (1)
Yield
Government-sponsored agencies:
Collateralized mortgage obligations
Yield
Residential mortgage-backed securities:
Yield
Corporate debt securities
Yield
Equity securities (2)
Yield
Within
One Year
> 1 – 5
Years
6 - 10
Years
Over
10 Years
Collateralized
Mortgage
Obligations and
Mortgage-Backed
Securities (3)
No Fixed
Maturity
$
571
6.32%
$
-
$
21,274
4.45%
$
56,209
7.11%
$
-
$
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
407
0.93%
-
34,799
2.50%
89,656
1.59%
-
-
Total
$
78,054
6.38%
34,799
2.50%
89,656
1.59%
407
0.93%
951
3.32%
203,867
$
-
-
-
951
3.32%
951
$
Total available-for-sale securities
$
571
$
-
$
21,274
$
56,616
$
124,455
Weighted yield
6.32%
0.00%
4.45%
7.07%
1.84%
3.32%
3.58%
Held-to-maturity securities
Obligations of state and political subdivisions
Yield
Total held-to-maturity securities
Weighted yield
$
-
$
-
$
-
$
-
$
$
2,308
7.39%
2,308
$
-
$
-
$
-
$
-
$
-
$
-
$
$
2,308
7.39%
2,308
0.00%
0.00%
7.39%
0.00%
0.00%
0.00%
7.39%
(1) Yields on state and municipal securities have been adjusted to tax-equivalent yields using a 34.0% federal income tax rate.
(2) Yield represents actual return for the twelve months ended December 31, 2013.
(3) Collateralized mortgage obligations and residential mortgage-backed securities are not due at a single maturity date.
The majority of the Company’s securities portfolio is comprised of obligations of state and political subdivisions, residential mortgage-
backed securities, including home equity conversion mortgages, and collateralized mortgage obligations. The Company held 105
securities that were in an unrealized loss position at December 31, 2013, with 23 of those securities in an unrealized loss position for
more than 12 months. Substantially all of the unrealized losses relate to debt securities.
In determining whether unrealized losses are other-than-temporary, management considers the following factors:
• The causes of the decline in fair value, such as credit deterioration, interest rate fluctuations, or market volatility;
• The severity and duration of the decline;
• Whether or not the Company expects to receive all contractual cash flows;
• The Company’s ability and intent to hold the security to allow for recovery in fair value, as well as the likelihood of such a
recovery in the near term;
• The Company’s intent to sell the security, or if it is more likely than not that the Company will be required to sell the security,
before recovery of its amortized cost basis, less any current-period credit loss.
Management performed a review of the fair values of all securities as of December 31, 2013 and determined that movements in the fair
values of the securities were consistent with the change in market interest rates. As a result of its review and considering the attributes of
these debt securities, the Company concluded that the decreases in estimated fair value were temporary and OTTI did not exist at
December 31, 2013. To date, the Company has received all scheduled principal and interest payments and expects to fully collect all
future contractual principal and interest payments. The Company does not intend to sell the securities nor is it more likely than not that
the Company will be required to sell the securities.
Management does not believe that any individual unrealized loss at December 31, 2013 represents OTTI. The unrealized losses reported
for residential mortgage-backed securities and collateralized mortgage obligations relate entirely to securities issued by GNMA,
FHLMC and FNMA that are currently rated AAA by Moody’s Investor Services or Aaa by Standard & Poor’s and are guaranteed by the
U.S. government. The obligations of state and political subdivisions are comprised primarily of general-purpose debt obligations. The
majority of these obligations have a credit quality rating of A or better and are secured by the unlimited taxing power of the issuers. In
addition, the Company utilized a third party to perform an independent credit risk assessment of its state and political subdivision bonds
that were either non-rated or had a rating below A. There was one obligation of a state and political subdivision that had a rating below
A. According to the independent credit risk assessment, this bond, as well as the entire municipal portfolio, was considered investment
grade.
49
OTTI of Pooled Trust Preferred Collateralized Debt Obligations (“PreTSLs”):
At December 31, 2011, the Company held PreTSLs that were comprised of four securities collateralized by debt issued by bank holding
companies and insurance companies. The Company divested its holdings of PreTSLs during 2012 and held no such securities at
December 31, 2013 and 2012.
The table below provides a cumulative roll forward of credit losses recognized:
Rollforward of Cumulative Credit Loss
(in thousands)
Beginning Balance January 1
Credit losses on debt securities for which OTTI was not previously recognized
Additional credit losses on debt securities for which OTTI was previously recognized
Less: Sale of PLCMOs for which OTTI was previously recognized
Less: Sale of PreTSLs for which OTTI was previously recognized
Ending Balance, December 31
2013
$
-
-
-
-
-
$
-
2012
$
8,619
-
96
-
(8,715)
$
-
2011
$
22,598
-
798
-
(14,777)
8,619
$
Investments in FHLB and FRB stock, which have limited marketability, are carried at cost and totaled $3.5 million and $7.3 million at
December 31, 2013 and 2012, respectively. Management noted no indicators of impairment for the FHLB of Pittsburgh and the FRB
during 2012.
Loans
As previously mentioned, one of the key strategic initiatives in 2013 included growing the loan portfolio and enhancing interest income.
As part of this initiative, the Company hired a Chief Lending Officer with over 30 years of in-depth credit administration, commercial
lending and management experience with the primary objectives of leading the Bank’s commercial lending and business development
teams, as well as developing and managing business relationships with commercial customers.
During 2013, the Company experienced increased demand for its lending products, as new loan originations exceeded maturities and
payoffs. As a result, net loans increased $50.5 million, or 8.7%, to $629.9 million and represented 62.7% of total assets at December 31,
2013, from $579.4 million, or 59.8% of total assets, at December 31, 2012. Historically, commercial lending activities have represented
a significant portion of the Company’s loan portfolio. This includes commercial and industrial loans, commercial real estate loans and
construction, land acquisition and development loans.
From a collateral standpoint, a majority of the Company’s loan portfolio consisted of loans secured by real estate. Real estate secured
loans, which include commercial real estate, construction, land acquisition and development, residential real estate loans and home
equity lines of credit (“HELOCs”), increased $9.1 million, or 2.4%, to $387.0 million at December 31, 2013 from $377.9 million at
December 31, 2012. Despite the increase, real estate secured loans as a percentage of total gross loans decreased to 60.2% at December
31, 2013 from 63.2% as of December 31, 2012.
Commercial and industrial loans increased $17.3 million, or 15.8%, during the year to $127.0 million at December 31, 2013 from $109.7
million at December 31, 2012. Commercial and industrial loans consist primarily of equipment loans, working capital financing,
revolving lines of credit and loans secured by cash and marketable securities. In the fourth quarter of 2013, the Company acquired the
floor plan financing for a large automobile dealership in its market area, which directly contributed to the increase in commercial and
industrial loans. Loans secured by commercial real estate decreased $3.1 million, or 1.4%, to $218.5 million at December 31, 2013 from
$221.6 million at December 31, 2012. Commercial real estate loans include long-term commercial mortgage financing and are primarily
secured by first or second lien mortgages. The decrease in commercial real estate loans resulted primarily from the payoff, at the end of
2013, of one $10.7 million loan that was secured by a shopping center. Construction, land acquisition and development loans decreased
$8.1 million, or 25.0%, during the year to $24.4 million at December 31, 2013 from $32.5 million at December 31, 2012. The Company
continues to monitor its exposure to this higher-risk portfolio segment.
Residential real estate loans totaled $114.9 million at December 31, 2013, an increase of $24.7 million, or 27.4%, from $90.2 million at
December 31, 2012. The components of residential real estate loans include fixed-rate and variable-rate mortgage loans. HELOCs are
not included in this category but are included in consumer loans. The Company primarily underwrites fixed-rate purchase and refinance
of residential mortgage loans for sale in the secondary market to reduce interest rate risk and provide funding for additional loans.
However, during the third quarter of 2012, the Company began holding 15- and 20-year mortgages in the loan portfolio rather than
selling these loans in order to provide additional interest income based on their underlying yields in comparison to those available in the
market place for similar instruments. Management extended this strategy to 30-year mortgages in the third quarter of 2013.
50
Consumer loans increased $8.8 million, or 8.1%, during the year to $118.6 million at December 31, 2013 from $109.8 million at
December 31, 2012. The increase in consumer loans was concentrated in the Company’s indirect lending division, as management
offered promotions and incentives to automobile dealer customers during 2013. In addition, indirect lending volume was favorably
impacted by the new floor plan relationship with an automobile dealership.
Loans to state and municipal governments increased $5.9 million, or 17.4%, to $39.9 million at December 31, 2013 from $34.0 million
at December 31, 2012. The increase was attributable to new originations.
The detail of the the loan portfolio at December 31, for each of the last five years are as follows:
Loan Portfolio Detail
(in thousands)
Residential real estate
Commercial real estate
Construction, land acquisition and development
Commercial and industrial
Consumer
State and political subdivisions
Total loans, gross
Unearned discount
Net deferred loan fees and costs
Allowance for loan and lease losses
December 31,
2013
2012
2011
2010
2009
$
114,925
$
90,228
$
80,056
$
87,925
$
98,517
218,524
24,382
127,021
118,645
39,875
643,372
(143)
668
221,591
32,502
109,693
109,783
33,978
597,775
(103)
260
256,508
33,450
174,233
111,778
23,496
679,521
(159)
516
256,327
77,395
197,697
110,853
27,739
757,936
(225)
677
321,326
98,383
219,889
164,670
36,780
939,565
(298)
707
(14,017)
(18,536)
(20,834)
(22,575)
(22,458)
Loans, net
$
629,880
$
579,396
$
659,044
$
735,813
$
917,516
The following schedule shows the maturity distribution and re-pricing information of the loan portfolio by major classification as of
December 31, 2013.
Loan Repricing Distribution
(in thousands)
Residential real estate
Commercial real estate
Construction, land acquisition and development
Commercial and industrial
Consumer
State and political subdivisions
Total
Loans with predetermined interest rates
Loans with floating rates
Total
December 31, 2013
Within One
Year
One to Five
Years
Over Five
Years
Total
$
$
$
$
15,764
21,357
4,932
70,609
32,978
1,356
146,996
10,001
31,510
11,140
30,497
57,157
10,505
150,810
89,160
165,657
8,310
25,915
28,510
28,014
345,566
$
$
$
$
114,925
218,524
24,382
127,021
118,645
39,875
643,372
$
91,506
59,304
150,810
$
$
$
138,331
207,235
345,566
$
$
240,127
403,245
643,372
$
10,290
136,706
146,996
$
51
At December 31, 2013, 2012 and 2011, the Bank’s loan portfolio was concentrated in loans in the following industries.
Loan Concentrations
(dollars in thousands)
Automobile dealers
Land subdivision
Physicians
Colleges and Universities
Solid waste landfills
Hotels
Office complexes/units
Shopping centers/complexes
Asset Quality
2013
December 31,
2012
2011
Amount
18,467
$
15,974
13,932
12,671
12,254
9,847
9,636
8,083
% of gross
loans
Amount
% of gross
loans
Amount
% of gross
loans
2.87%
2.48%
2.17%
1.97%
1.90%
1.53%
1.50%
1.26%
$
10,607
17,658
9,269
4,879
13,233
13,596
9,801
21,068
1.77%
2.95%
1.55%
0.82%
2.21%
2.27%
1.64%
3.52%
$
10,842
19,626
10,400
3,087
42,270
13,771
16,091
18,722
1.60%
2.89%
1.53%
0.45%
6.22%
2.03%
2.37%
2.76%
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of
unpaid principal, net of unearned interest, deferred loan fees and costs, and reduced by the ALLL. The ALLL is established through a
provision for loan and lease losses charged to earnings.
The Company has established and consistently applies loan policies and procedures designed to foster sound underwriting and credit
monitoring practices. The Company manages credit risk through the efforts of loan officers, the loan review function, and the Loan
Quality and the ALLL management committees, as well as oversight from the Board of Directors. The Company continually evaluates
its credit risk management practices to ensure it is reacting to problems in the loan portfolio in a timely manner, although, as is the case
with any financial institution, a certain degree of credit risk is dependent in part on local and general economic conditions that are
beyond the Company’s control.
Under the Company’s risk rating system, loans rated pass/watch, special mention, substandard, doubtful, or loss are reviewed regularly
as part of the Company’s risk management practices. The Company’s Loan Quality Committee, which consists of key members of
senior management and credit administration, meets monthly or more often as necessary to review individual problem credits and
workout strategies and provides monthly reports to the Board of Directors.
A loan is considered impaired when it is probable that the Bank will be unable to collect all amounts due (including principal and
interest) according to the contractual terms of the note and loan agreement. For purposes of the Company’s analysis, loans that are
modified under a troubled debt restructuring (“TDRs”), loans rated substandard and non-accrual, and loans that are identified as doubtful
or loss are considered impaired. Impaired loans are analyzed individually to determine the amount of impairment. The Company
utilizes the fair value of collateral method for collateral dependent loans. A loan is considered to be collateral dependent when
repayment of the loan is expected to be provided through the liquidation of the collateral held. For impaired loans that are secured by
real estate, external appraisals are obtained annually, or more frequently as warranted, to ascertain a fair value so that the impairment
analysis can be updated. Should a current appraisal not be available at the time of impairment analysis, other sources of valuation may
be used including, current letters of intent, broker price opinions or executed agreements of sale. For non-collateral dependent loans, the
Company measures impairment based on the present value of expected future cash flows, net of disposal costs, discounted at the loan’s
original effective interest rate.
Loans to borrowers that are experiencing financial difficulty that are modified and result in the Company granting concessions to the
borrower are classified as TDRs and are considered to be impaired. Such concessions generally involve an extension of a loan’s stated
maturity date, a reduction of the stated interest rate, payment modifications, capitalization of property taxes with respect to residential
mortgage loans or a combination of these modifications. Non-accrual TDRs are returned to accrual status if principal and interest
payments, under the modified terms, are brought current, are performing under the modified terms for six consecutive months, and
management believes that collection of the remaining interest and principal is probable.
Non-performing loans are monitored on an ongoing basis as part of the Company’s loan review process. Additionally, work-out efforts
continue and are actively monitored for non-performing loans and OREO through the Loan Quality Committee. A potential loss on a
non-performing asset is generally determined by comparing the outstanding loan balance to the fair market value, less cost to sell, of the
pledged collateral.
52
Loans are placed on non-accrual when a loan is specifically determined to be impaired or when management believes that the collection
of interest or principal is doubtful. This generally occurs when a default of interest or principal has existed for 90 days or more, unless
such loan is well secured and in the process of collection, or when management becomes aware of facts or circumstances that the loan
would default before 90 days. The Company determines delinquency status based on the number of days since the date of the borrower’s
last required contractual loan payment. When the interest accrual is discontinued, all unpaid interest income is reversed and charged
back against current earnings. Any subsequent cash payments received are applied, first to the outstanding loan amounts, then to the
recovery of any charged-off loan amounts, with any excess treated as a recovery of lost interest. A non-accrual loan is returned to
accrual status when the loan is current as to principal and interest payments, is performing according to contractual terms for six
consecutive months and future payments are reasonably assured.
Management actively manages impaired loans in an effort to reduce loan balances by working with customers to develop strategies to
resolve borrower difficulties, through sale or liquidation of collateral, foreclosure, and other appropriate means. Real estate values in the
Company’s market area have appeared to stabilize. However, a weakening of economic and employment conditions could result in real
estate devaluations, which could negatively impact asset quality and, accordingly, cause an increase in the provision for loan and lease
losses.
Under the fair value of collateral method, the impaired amount of the loan is deemed to be the difference between the loan amount and
the fair value of the collateral, less the estimated costs to sell. For the Company’s calculations for real estate secured loans, a factor of
10% is generally utilized to estimate costs to sell, which is based on typical cost factors, such as a 6% broker commission, 1% transfer
taxes, and 3% various other miscellaneous costs associated with the sales process. If the valuation indicates that the fair value has
deteriorated below the carrying value of the loan, either the entire loan is written off or the difference between the fair value and the
principal balance is charged off. For impaired loans for which the value of the collateral less costs to sell exceeds the loan value, the
impairment is considered to be zero.
The following schedule reflects non-performing loans (including non-performing TDRs), OREO and accruing TDRs as of December 31
for each of the last five years:
Non-performing Loans, OREO and Accruing TDRs
(dollars in thousands)
Non-accrual loans
2013
2012
2011
2010
2009
$
6,356
$
9,652
$
19,913
$
28,267
$
25,865
Loans past due 90 days or more and still accruing
19
57
5
99
117
Total non-performing loans
Other real estate owned
Total non-performing loans and OREO
6,375
4,246
9,709
3,983
19,918
6,958
28,366
9,633
25,982
11,184
$
10,621
$
13,692
$
26,876
$
37,999
$
37,166
December 31,
Accruing TDRs
$
3,995
$
7,517
$
5,680
$
2,513
$
10,743
Non-performing loans as a percentage of gross loans
0.99%
1.62%
2.93%
3.74%
2.77%
Management continued to effectively manage problem credits through heightened work-out efforts on nonperforming loans and
disposing of its holdings of foreclosed properties. As a result, the Company’s asset quality continued to improve in 2013. Total non-
performing loans and OREO decreased $3.1 million, or 22.4%, to $10.6 million at December 31, 2013 from $13.7 million at December
31, 2012. At December 31, 2013, the Company’s ratio of non-performing loans to total gross loans was 0.99% compared to 1.62%
reported at December 31, 2012. The Company’s ratio of non-performing loans and OREO as a percentage of shareholders’ equity
decreased to 31.6% at December 31, 2013, as compared to 37.1% at December 31, 2012, as management continued to reduce the
balance of non-accrual loans. Though non-performing loans as a percentage of shareholders’ equity decreased, the percentage remains
elevated and further deterioration in economic conditions could lead to additional increases in impaired loans.
53
The following table presents the changes in non-performing loans for the years ended December 31, 2013 and 2012:
Changes in Non-performing Loans
(in thousands)
Balance at beginning of period
Loans newly placed on non-accrual
Change in loans past due 90 days or more and still accruing
Loans transferred to OREO
Loans returned to performing status
Loans charged-off
Loan payments received
Loans sold
Balance at end of period
Year ended December 31,
2013
2012
$
9,709
$
19,918
2,465
(38)
(255)
(314)
(1,823)
(2,624)
(745)
11,061
53
(1,586)
(405)
(8,273)
(4,223)
(6,836)
$
6,375
$
9,709
One large commercial loan in the amount of $3.9 million comprised 61.9% of the $6.4 million in non-performing loans at December 31,
2013. A substantial portion of this loan, which is secured by commercial real estate, is guaranteed by a U.S. governmental agency.
In addition to the non-performing loans identified in the table above, the Bank had potential problem loans consisting of substandard and
accruing loans in the amount of $22.5 million at December 31, 2013. The volume of potential problem loans decreased $10.9 million, or
32.6%, from $33.4 million at December 31, 2012.
In the fourth quarter of 2013, the Company sold one commercial real estate loan and five one- to four-family residential mortgage loans
to a third party. The commercial real estate loan, which was an accruing TDR at the time of sale, had an outstanding recorded investment
of $2.8 million. The five residential mortgage loans with an aggregate recorded investment of $745 thousand, were non-performing
TDRs. The Company recognized a loss of $223 thousand upon the sale of these six loans, which is included in non-interest income in
2013. In the fourth quarter of 2012, the Company sold three non-performing loans totaling $6.8 million to a third party. No gain or loss
was recognized upon the sale in 2012.
The Company has historically participated in loans with other financial institutions, the majority of which have been loans originated by
financial institutions located in the Company’s general market area. For the past nine years, the Company has participated in seven (7)
commercial real estate loans with a financial institution that was headquartered in Minneapolis, Minnesota. The majority of these loans
were for out of market commercial real estate projects. Two (2) projects were located in Pennsylvania, one (1) project was located in
New York and the other four (4) projects were located in Florida. The Company’s original aggregate commitment for these various
loans totaled approximately $34.0 million. Two of these loans, one local Pennsylvania project and the New York project, were paid in
full prior to 2011. During 2011, the two Florida credits rated “substandard” were paid off and one of the Florida properties held in
OREO was sold. The outstanding balance of the two remaining loans, one Florida property held in OREO and the Pennsylvania credit
rated “special mention,” had an aggregate balance of $4.3 million at December 31, 2013. The Florida credit has been written down to
the current fair value of the property and the Pennsylvania credit is currently performing.
54
The following table outlines accruing loan delinquencies and non-accrual loans as a percentage of gross loans at December 31, 2013,
2012 and 2011:
Accruing Loan Delinquencies and Non-accrual Loans
Accruing:
30-59 days
60-89 days
90+ days
Non-accrual
Total Delinquencies
2013
December 31,
2012
2011
0.46%
0.09%
0.00%
0.99%
1.54%
0.44%
0.06%
0.01%
1.62%
2.13%
0.83%
0.27%
0.00%
2.93%
4.03%
Total delinquencies, as a percent of gross loans , continued to improve in 2013, primarily due to rigorous collection and work-out efforts
directed at non-performing loans and the sale of several non-performing loans. Delinquencies for accruing loans increased $0.5 million
from $3.1 million at December 31, 2012 to $3.6 million at December 31, 2013, primarily due to an increase in residential and
commercial real estate loans that were 30 – 89 days past due. In its evaluation of the ALLL, management considers a variety of
qualitative factors including changes in the volume and severity of delinquencies.
The Company continues to recognize some weakness in local real estate markets and the local economy in general. The unemployment
rate for the Scranton-Wilkes-Barre metropolitan area, the Company’s predominant market area, improved to a seasonally adjusted rate of
8.7% for December 2013 from 9.5% for December 2012. However, unemployment in the Company’s market is the highest compared to
Pennsylvania’s 14 metropolitan areas and lags far behind that of the entire Commonwealth at 6.8%. The Company tries to mitigate these
factors by emphasizing strict underwriting standards.
At December 31, 2013, there were 21 properties in OREO with an aggregate balance of $4.2 million, compared to 24 properties with an
aggregate balance of $4.0 million at December 31, 2012. During the year ended December 31, 2013, five properties with an aggregate
carrying value of $255 thousand were foreclosed upon. In addition, three vacant lots, previously held in bank premises and equipment
for future expansion, were transferred to OREO for disposition. These three lots were written down to their appraised value less cost to
sell of $1.7 million. The Company recognized a valuation adjustment of $69 thousand at the time of transfer, which is included in non-
interest expense. In the fourth quarter, the Company entered into a sales agreement for one of the vacant lots, which is scheduled to close
by the end of the first quarter of 2014. Upon signing the agreement, the Company recorded an additional valuation adjustment of $78
thousand, which is included in non-interest expense. Valuation adjustments to the carrying value of OREO amounted to $223 thousand,
including the $147 thousand related to the vacant lots transferred to OREO from bank premises and equipment, in 2013.
During the year ended December 31, 2013, thirteen properties with an aggregate cost basis of $1.6 million were sold. The Company
realized net gains of $135 thousand on the sale of these properties, which is included in non-interest income. At December 31, 2013,
there was one property totaling $206 thousand, or 4.8% of OREO, that was located outside the Company’s general market area.
The Company actively markets OREO properties for sale through a variety of channels including internal marketing and the use of
outside brokers/realtors. The carrying value of OREO is generally calculated at an amount not greater than 90% of the most recent fair
market appraised value. A 10% factor is generally used to estimate costs to sell, which is based on typical cost factors, such as 6%
broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process. This fair value is
updated on an annual basis or more frequently if new valuation information is available. Further deterioration in the real estate market
could result in additional losses on these properties.
55
The following schedule presents the activity in OREO:
Changes in OREO
(in thousands)
Balance, beginning of year
Loans transferred to OREO
Bank premises transferred to OREO
Valuation adjustments
Carrying value of OREO sold
Balance, end of year
For the Years Ended December 31,
2013
2011
2012
$
$
$
3,983
255
1,819
(223)
(1,588)
4,246
6,958
1,586
-
(1,206)
(3,355)
3,983
9,633
3,995
-
(2,318)
(4,352)
6,958
$
$
$
The following schedule presents a distribution of OREO for the periods presented:
Distribution of OREO
(in thousands)
Land / lots
Commercial real estate
Residential real estate
Total other real estate owned
2013
2012
December 31,
2011
2010
2009
$
$
$
$
$
3,549
647
50
4,246
2,711
1,245
27
3,983
4,293
1,845
820
6,958
8,207
1,236
190
9,633
5,589
5,150
445
11,184
$
$
$
$
$
The expenses related to maintaining OREO, including the subsequent write-downs of the properties related to declines in value since
foreclosure amounted to $719 thousand, $2.0 million and $3.7 million for the years ended December 31, 2013, 2012, and 2011,
respectively.
Allowance for Loan and Lease Losses
The ALLL represents management’s estimate of probable loan losses inherent in the loan portfolio. The ALLL is analyzed in accordance
with GAAP and is maintained at a level that is based on management’s evaluation of the adequacy of the ALLL in relation to the risks
inherent in the loan portfolio.
As part of its evaluation, management considers qualitative and environmental factors, including, but not limited to:
• Changes in national, local, and business economic conditions and developments, including the condition of various market
segments;
• Changes in the nature and volume of the Company’s loan portfolio;
• Changes in the Company’s lending policies and procedures, including underwriting standards, collection, charge-off and recovery
practices and results;
• Changes in the experience, ability and depth of the Company’s management and staff;
• Changes in the quality of the Company’s loan review system and the degree of oversight by the Company’s Board of Directors;
• Changes in the trend of the volume and severity of past due and classified loans, including trends in the volume of non-accrual
loans, TDRs and other loan modifications;
• The existence and effect of any concentrations of credit and changes in the level of such concentrations;
• The effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the
Company’s current loan portfolio; and
• Analysis of its customers’ credit quality, including knowledge of their operating environment and financial condition.
Evaluations are intrinsically subjective, as the results are estimated based on management knowledge and experience and are subject to
interpretation and modification as information becomes available or as future events occur. Management monitors the loan portfolio on
an ongoing basis with emphasis on weakness in both the real estate market and the economy in general and its effect on repayment.
Adjustments to the ALLL are made based on management’s assessment of the factors noted above.
For purposes of its analysis, all loan relationships with an aggregate balance greater than $100 thousand that are rated substandard and
non-accrual, identified as doubtful or loss, and all TDRs are considered impaired and are analyzed individually to determine the amount
56
of impairment. Circumstances such as construction delays, declining real estate values, and the inability of the borrowers to make
scheduled payments have resulted in these loan relationships being classified as impaired. The Company utilizes the fair value of
collateral method for collateral-dependent loans and TDRs for which repayment depends on the sale of collateral. For non-collateral
dependent loans and TDRs, the Company measures impairment based on the present value of expected future cash flows discounted at
the loan’s original effective interest rate. With regard to collateral-dependent loans, appraisals are received at least annually to ensure
that impairment measurements reflect current market conditions. Should a current appraisal not be available at the time of impairment
analysis, other valuation sources including current letters of intent, broker price opinions or executed agreements of sale may be used.
Only downward adjustments are made based on these supporting values. Included in all impairment calculations is a cost to sell
adjustment of approximately 10%, which is based on typical cost factors, including a 6% broker commission, 1% transfer taxes and 3%
various other miscellaneous costs associated with the sales process. Sales costs are periodically revised based on actual experience. The
ALLL analysis is adjusted for subsequent events that may arise after the end of the reporting period but before the financial reports are
filed.
The Company’s ALLL consists of both specific and general components. At December 31, 2013, the ALLL that related to impaired
loans that are individually evaluated for impairment, the guidance for which is provided by ASC 310 “Impairment of a Loan” (“ASC
310”), was $310 thousand, or 2.2%, of the total ALLL. A general allocation of $13.7 million was calculated for loans analyzed
collectively under ASC 450 “Contingencies” (“ASC 450”), which represented 97.8% of the total ALLL of $14.0 million. The ratio of
the ALLL to total loans at December 31, 2013 and December 31, 2012 was 2.18% and 3.10%, respectively, based on total loans of
$643.4 million and $597.8 million, respectively. The decrease in the ALLL as a percentage of total loans reflects asset quality
improvements and lower levels of historical net charge-offs, coupled with increased loan demand.
The following table presents an allocation of the ALLL and percent of loans in each category as of December 31:
Allocation of the Allowance for Loan Losses
2013
2012
December 31,
2011
2010
2009
Percentage
of Loans in
Each
Category
to Total
Loans
17.86%
33.97%
3.79%
19.74%
18.44%
6.20%
100.00%
Percentage
of Loans in
Each
Category
to Total
Loans
15.09%
37.07%
5.44%
18.35%
18.37%
5.68%
100.00%
Percentage
of Loans in
Each
Category
to Total
Loans
11.78%
37.75%
4.92%
25.64%
16.45%
3.46%
100.00%
Allowance
1,823
$
11,151
2,590
3,292
1,526
452
20,834
$
Percentage
of Loans in
Each
Category
to Total
Loans
11.60%
33.82%
10.21%
26.08%
14.63%
3.66%
100.00%
Allowance
2,176
$
9,640
4,170
4,850
1,173
566
22,575
$
Allowance
1,764
$
8,062
2,162
4,167
1,708
673
18,536
$
Percentage
of Loans in
Each
Category
to Total
Loans
10.49%
34.20%
10.47%
23.40%
17.53%
3.91%
100.00%
Allowance
696
$
8,397
6,285
4,507
1,980
593
22,458
$
(dollars in thousands)
Residential real estate
Commercial real estate
Construction, land acquisition
and development
Commercial & industrial
Consumer
State & political
Total
Allowance
2,287
$
6,017
924
2,321
1,789
679
14,017
$
57
The following table presents a reconciliation of the ALLL and an illustration of charge-offs and recoveries by major loan category for
each of the last five years:
Reconciliation of the ALLL
(in thousands)
Balance, January 1,
Charge-offs:
Residential real estate
Commercial real estate
Construction, land acquisition
and development
Commercial & industrial
Consumer
State & political subdivision
Total charge-offs
Recoveries of charged-off loans:
Residential real estate
Commercial real estate
Construction, land acquisition
and development
Commercial & industrial
Consumer
State & political subdivision
Total recoveries
Net (recoveries) charge-offs
Provision (credit) for loan and lease losses
Balance, December 31
Ratios:
Net (recoveries) charge-offs as a
percentage of average loans
outstanding
Allowance for loan and lease losses
as a percentage of gross loans
outstanding at end of period
2013
Year Ended December 31,
2011
2012
2010
2009
$
18,536
$
20,834
$
22,575
$
22,458
$
8,254
664
65
179
341
655
-
1,904
343
879
683
3,298
258
3,389
673
-
8,301
35
1,035
1,273
2,395
1,857
416
739
-
6,680
57
93
221
5,049
12,893
6,883
736
-
25,782
32
152
307
24,980
-
2,247
483
-
28,017
-
33
130
1,853
450
-
3,655
(1,751)
(6,270)
14,017
$
265
265
338
-
1,938
6,363
4,065
18,536
$
2,188
1,852
226
-
4,416
2,264
523
20,834
$
303
151
220
-
858
24,924
25,041
22,575
$
-
22
77
-
132
27,885
42,089
22,458
$
(0.28)%
0.97%
0.31%
2.84%
2.87%
2.18%
3.10%
3.07%
2.98%
2.40%
The ALLL equaled $14.0 million at December 31, 2013, a decrease of $4.5 million from $18.5 million at December 31, 2012. The
Company posted net recoveries of $1.7 million in 2013. In addition, as a result of reductions in historical loss ratios and classified loans,
and recoveries of previously charged-off loans, the Company recorded a credit for loan and lease losses of $6.3 million for the year
ended December 31, 2013.
Funding Sources
The Company utilizes traditional deposit products, such as demand, savings, negotiable order of withdrawal (“NOW”), money market,
and time as its primary funding sources to support the earning asset base and future growth. Other sources, such as short- and long-term
FHLB advances, federal funds purchased, brokered time deposits, and certificates of deposit obtained through a listing service may be
utilized as necessary to support the asset growth and employ asset/liability management strategies. The average balance of interest-
bearing liabilities decreased by $56.4 million, or 6.9%, to $765.7 million during 2013 from $822.2 million during 2012. Interest-bearing
liabilities continued to reprice downward during the year, as evidenced by an 18 basis point decrease in the cost of funds to 0.94% in
2013 from 1.12% in 2012.
Deposits
Total deposits grew $30.1 million, or 3.5%, to $884.7 million at December 31, 2013 from $854.6 million at the end of 2012. Non-
interest-bearing demand deposits grew 19.8% and accounted for 86.7% of the deposit growth, while interest-bearing deposits increased
58
$4.0 million, or 0.6%. Interest-bearing deposits averaged $705.5 million in 2013, a decrease of $44.1 million, or 5.9%, compared to
$749.6 million in 2012. The decline was concentrated in time deposits. Specifically, average other time deposits with balances less than
$100 thousand decreased $34.9 million, or 18.2%, to $156.6 million in 2013 from $191.5 million in 2012, while average time deposits
over $100 thousand declined $9.6 million, or 5.7%, to $160.7 million in 2013 from $170.4 million in 2012. The rate paid on average
interest-bearing deposits decreased 13 basis points to 0.59% in 2013 from 0.72% in 2012. The decrease in the rate on interest-bearing
deposits was driven primarily by pricing decreases from time deposits, which are sensitive to interest rate changes. The Company
elected to allow higher cost time deposits to mature and chose to be more conservative in setting rates on new deposits and renewals.
The average rate paid on time deposits with balances less than $100 thousand decreased 18 basis points to 1.41%, while the rate paid on
time deposits over $100 thousand decreased 6 basis points to 0.81% during 2013. The decrease in average interest-bearing deposits was
partially offset by a $1.9 million increase in average non-interest-bearing demand deposits.
The average amount of, and the rate paid on, the major classifications of deposits is summarized for the periods indicated in the
following table:
Deposit Distribution
(dollars in thousands)
Inte re st-be aring de posits:
Demand
Savings
Time
Total interest-bearing deposits
2013
Ye ar Ende d De ce mbe r 31,
2012
2011
Amount
Rate
Amount
Rate
Amount
Rate
$
302,258
85,872
317,367
705,497
0.18%
0.10%
1.11%
0.59%
$
299,938
87,818
361,818
749,574
0.23%
0.18%
1.25%
0.72%
$
335,201
89,494
433,227
857,922
0.48%
0.32%
1.58%
1.02%
Non-interest-bearing deposits
130,186
128,254
107,763
Total deposits
$
835,683
$
877,828
$
965,685
The following table presents the maturity distribution of time deposits of $100,000 or more at December 31, 2013 and 2012:
Maturity Distribution of Time Deposits Greater Than $100,000
(in thous ands )
3 months or les s
Over 3 through 6 months
Over 6 though 12 months
Over 12 months
Total
Borrowings
December 31,
2013
2012
$
19,163
$
25,656
38,647
42,180
61,969
22,379
37,065
59,744
$
161,959
$
144,844
The following table presents the maximum amount of the Company's short-term borrowings that were outstanding at any month end
during the years ended December 31, 2013, 2012 and 2011:
Short-term Borrowings Outstanding
(in thousands)
Federal funds purchased
FHLB advances
FRB discount window borrowings
Total
For the Years Ended December 31,
2012
$
-
2013
-
$
-
-
$
-
-
$
-
2011
-
$
40,000
-
40,000
$
Short-term borrowings generally include Federal funds purchased and represent overnight borrowing transactions providing for short-
term funding requirements of the Company and mature within one business day of the transaction. The Company did not purchase any
short-term Federal funds during the years ended December 31, 2013, 2012 and 2011. Short-term borrowings also include borrowings
through the FRB discount window and are considered to be a contingency source of funding. Other than testing its availability for
contingency funding planning purposes, the Company did not borrow from the Federal Reserve discount window during the years ended
59
December 31, 2013, 2012 and 2011. At December 31, 2011, the Company did have an unused line of credit at the FHLB of
approximately $36.0 million. The Company did not have any outstanding short term borrowings at December 31, 2013, 2012, or 2011.
Long-term debt is comprised of FHLB advances, subordinated debentures and junior subordinated debentures. FHLB advances are
collateralized by the FHLB stock owned by the Company, certain mortgage-backed securities and a blanket lien on its residential and
commercial real estate mortgage loans. Average long-term debt decreased by $12.4 million, or 17.0%, to $60.2 million in 2013 from
$72.6 million in 2012 which was due to the maturity and repayments of several FHLB advances. The average rate paid for long term
debt in 2013 was 5.00%, a decrease of 28 basis points from 5.28% in 2012. The decrease in rate on the long-term debt was due
primarily to the maturity of higher-costing FHLB advances during 2013.
The Company had $25.0 million in unsecured, fixed-rate subordinated debentures at December 31, 2013 and 2012. The notes, which
bear interest at a rate of 9.0% per annum, will be payable to noteholders annually beginning on September 1, 2015, At December 31,
2013 and 2012, the Company had accrued and unpaid interest associated with these notes of $7.6 million and $5.3 million, respectively.
The average balance of junior subordinated debentures was $10.3 million for 2013 and 2012. The interest rate on these debentures,
resets quarterly at a spread of 1.67% above the current 3-month Libor rate. The average rate paid for junior subordinated debentures in
2013 was 1.97%, compared to 2.18% in 2012.
The maximum amount of total borrowings outstanding at any month end during the years ended December 31, 2013 and 2012 were
$79.8 million and $82.3 million, respectively. For further discussion of the Company’s borrowings, see Note 11-“Borrowed Funds” in
the Notes to the consolidated financial statements included in Item 8 hereof to this Annual Report on Form 10-K.
Liquidity
The term liquidity refers to the ability of the Company to generate sufficient amounts of cash to meet its cash flow needs. Liquidity is
required to fulfill the borrowing needs of the Company’s credit customers and the withdrawal and maturity requirements of its deposit
customers, as well as to meet other financial commitments. The Company’s liquidity position is impacted by several factors, which
include, among others, loan origination volumes, loan and investment maturity structure and cash flows, deposit demand and certificate
of deposit maturity structure and retention. Management monitors the Company’s liquidity position and fluctuations daily, so that the
Company can adapt accordingly to market influences and balance sheet trends. Management also forecasts liquidity needs and develops
strategies to ensure adequate liquidity at all times.
The Company’s statements of cash flows present the change in cash and cash equivalents from operating, investing and financing
activities. Cash and cash equivalents, which include cash and due from banks and interest-bearing deposits in other banks, are the
Company’s most liquid assets. At December 31, 2013, cash and cash equivalents totaled $103.6 million, a decrease of $11.7 million
compared to $115.3 million at December 31, 2012. Investing activities used $68.8 million in cash and cash equivalents in 2013. These
outflows were partially offset by net cash inflows from operating and financing activities of $18.4 million and $38.6 million,
respectively.
Investing activities primarily include transactions related to the Company’s lending activities and securities portfolio. The net cash flows
used in investing activities of $68.8 million were largely attributable to a net increase in loans to customers of $47.5 million. In addition,
the proceeds from sales, maturities, calls and principal payments of investment securities totaling $68.4 million, were more than entirely
offset by $99.4 million in purchases of investment securities. Also affecting investing activities were proceeds received from the sale of
classified loans, OREO and bank premises and equipment of $3.3 million, $1.7 million and $1.8 million, respectively.
The net cash and cash equivalents provided by operating activities of $18.4 million resulted primarily from the receipt of federal income
tax refunds in the amount of $11.6 million and proceeds received from the sale of loans held for sale, net of funds used to originate such
loans, of $1.2 million. In addition, net income of $6.4 million adjusted for the effects of noncash transaction such as depreciation, the
credit for loan and lease losses and net changes in other assets and liabilities also provided inflows of cash generated by operating
activities.
The $38.6 million in cash flows provided by financing activities primarily reflected a $30.1 million net increase in deposits. Proceeds
from FHLB advances of $32.3 million, partially offset by repayments of FHLB advances in the amount of $23.7 million also factored
into the net cash provided by financing activities.
Core deposits include non-interest-bearing and interest-bearing demand deposits, savings deposits and other time deposits, net of
brokered deposits and deposits generated through the Certificate of Deposit Account Registry Service (“CDARs”) and represent the
Company’s primary source of liquidity. Core deposits averaged $665.5 million in 2013, a decrease of $22.9 million, or 3.3%, compared
to $688.4 million in 2012. The decrease in core deposits resulted primarily from a $25.2 million, or 14.6%, decrease in net other time.
60
In addition to generating deposits, the Company has other potential sources of liquidity including the ability to borrow on credit lines
established at the FHLB and access to the FRB discount window. The Company had available borrowing capacity with the FHLB of
$75.9 million at December 31, 2013. In addition, the Company has the ability to solicit deposits, primarily certificates of deposit,
through QwikRate, a non-brokered marketplace for funding and investing. The Company had $87.0 million and $74.1 million in
certificates originated through QwikRate at December 31, 2013 and 2012, respectively.
Financial instruments whose contract amounts represent credit risk at December 31 are as follows:
(in thousands)
Commitments to extend credit ............................................................................
Standby letters of credit ......................................................................................
2013
$
155,701
25,321
$
2012
166,722
35,277
Capital
A strong capital base is essential to the continued growth and profitability of the Company and is therefore a management priority. The
Company’s principal capital planning goals are to provide an adequate return to shareholders while retaining a sufficient base from
which to provide for future growth, while at the same time complying with all regulatory standards. As more fully described in Note 17,
“Regulatory Matters” to the notes to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K,
regulatory authorities have prescribed specified minimum capital ratios as guidelines for determining capital adequacy to help assure the
safety and soundness of financial institutions.
61
The following schedules present information regarding the Company’s risk-based capital at December 31, 2013, 2012, and 2011 and
selected other capital ratios:
Capital Analysis
(in thousands)
Company
Tier I capital:
Total tier I capital
Tier II capital:
Subordinated notes
Allowable portion of allowance for loan losses
Total tier II capital
Total risk-based capital
Total risk-weighted assets
Bank
Tier I capital:
Total tier I capital
Tier II capital:
2013
De ce mbe r 31,
2012
2011
$
46,165
$
39,587
$
53,059
23,085
8,462
31,547
77,712
19,796
8,452
28,248
67,835
25,000
9,823
34,823
87,882
$
670,894
$
665,323
$
774,452
$
81,581
$
69,963
$
80,976
Allowable portion of allowance for loan losses
Total tier II capital
Total risk-based capital
Total risk-weighted assets
8,456
8,456
90,037
8,447
8,447
78,410
9,819
9,819
90,795
$
670,416
$
664,914
$
774,097
62
Actual
For Capital
Adequacy Purposes
To Be Well
Capitalized
Under Prompt
Corrective
Action Provision
Amount
Ratio
Amount
Ratio
Amount
Ratio
$
77,712
$
90,037
11.58%
13.43%
$
>53,672
$
>53,633
>8.00%
>8.00%
N/A
N/A
$
>67,042
>10.00%
$
46,165
$
81,581
6.88%
12.17%
$
>26,836
$
>26,817
>4.00%
>4.00%
N/A
$
>40,225
N/A
>6.00%
$
46,165
$
81,581
4.71%
8.32%
$
>39,230
$
>39,230
>4.00%
>4.00%
N/A
$
>49,038
N/A
>5.00%
Actual
For Capital
Adequacy Purposes
To Be Well
Capitalized
Under Prompt
Corrective
Action Provision
Amount
Ratio
Amount
Ratio
Amount
Ratio
$
67,835
$
78,410
10.20%
11.79%
$
>53,226
$
>53,193
>8.00%
>8.00%
N/A
N/A
$
>66,491
>10.00%
$
39,587
$
69,963
5.95%
10.52%
$
>26,613
$
>26,597
>4.00%
>4.00%
N/A
$
>39,895
N/A
>6.00%
$
39,587
$
69,963
4.07%
7.20%
$
>38,879
$
>38,865
>4.00%
>4.00%
N/A
$
>48,581
N/A
>5.00%
(dollars in thousands)
December 31, 2013
Total capital
(to risk-weighted assets)
Company
Bank
Tier I capital
(to risk-weighted assets)
Company
Bank
Tier I capital
(to average assets)
Company
Bank
(dollars in thousands)
December 31, 2012
Total capital
(to risk-weighted assets)
Company
Bank
Tier I capital
(to risk-weighted assets)
Company
Bank
Tier I capital
(to average assets)
Company
Bank
In 2013, the Company’s total regulatory capital increased $9.9 million, primarily as a result of net income of $6.4 million. Also affecting
total regulatory capital was an increase in the allowable portion of subordinated notes of $3.3 million. As of December 31, 2013, there
were 33,528,431 common shares available for future sale or share dividends. The number of shareholders of record at December 31,
2013 was 2,187. Quarterly market highs and lows, dividends paid and known market makers are highlighted in Part I, Item 5 of this
report. Refer to Note 17, “Regulatory Matters,” to the Notes to consolidated financial statements included in Item 8 of this Annual
Report on Form 10-K for further discussion of our capital requirements and dividend limitations. As a result of the Order, the Bank is
required to achieve a total risk-based capital ratio of 13% and Tier I capital to average assets ratio of 9% by November 30, 2010. As of
December 31, 2013, the Bank had achieved the 13.0% minimum requirement for the total risk-based capital ratio but did not meet the
9.0% minimum requirement for the Tier 1 leverage ratio. Furthermore, pursuant to the Order and the Agreement, the Bank and the
Company continue to be prohibited from declaring or paying any dividends without prior regulatory approval.
Additionally, the Company has available 20,000,000 authorized shares of preferred stock. There were no preferred shares issued and
outstanding at December 31, 2013 and 2012.
63
During 1999, the Company implemented a Dividend Reinvestment Plan (“DRIP”) which permits participants to automatically reinvest
cash dividends on all of their shares and to make voluntary cash contributions under terms of the plan. Under the DRIP, participants
purchase, at a 10% discount to the 10-day trading average, common shares that are either newly-issued by the Company or acquired by
the plan administrator in the open market or privately.
The Company’s operation of the DRIP Plan was suspended in 2011. New capital generated from shares issued under the DRIP totaled
$29 thousand during the year ended December 31, 2011. There was no new capital issued under the DRIP in 2013 and 2012.
The Board of Directors (the “Board”) on February 26, 2010 voted to suspend payment of the Company’s quarterly dividend indefinitely
in an effort to conserve capital. The Board recognizes the importance of preserving cash and, given the challenging economic conditions
that continue to impact the health and stability of many businesses within the region we serve, believes dividends should not be paid
from current and anticipated earnings to prudently fund operations. Additionally, as a result of the Order and the Agreement, the
Company is prohibited from paying dividends without the prior approval of the OCC and the Reserve Bank.
Off-Balance Sheet Arrangements
In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with GAAP, are not
recorded in our consolidated financial statements, or are recorded in amounts that differ from the notional amounts. These transactions
involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions may be used for general corporate
purposes or for customer needs. Corporate purpose transactions would be used to help manage credit, interest rate and liquidity risk or to
optimize capital. Customer transactions are used to manage customers' requests for funding.
For the year ended December 31, 2013, the Company did not engage in any off-balance sheet transactions that would have or would be
reasonably likely to have a material effect on its consolidated financial condition. For a further discussion of the Company’s off-balance
sheet arrangements, refer to Note 15, “Commitments, Contingencies, and Concentrations” to the notes to the consolidated financial
statements included in Item 8 hereof to this Annual Report on Form 10-K.
Contractual Obligations
The following table details the Company’s contractual obligations and commercial commitments as of December 31, 2013. Payments
due by period in the following table are based on final maturity dates without consideration of early redemption.
Contraction Obligations and Commercial Commitments
(in thousands)
Total
Less Than
one Year
1-3 Years
3-5 Years
More Than 5
Years
Payments Due by Period
Federal Home Loan Bank advances
$ 27,123
$ 10,000
$ 5,000
$ 10,000
$ 2,123
Subordinated debentures
Junior subordinated debt
Operating lease obligations
Total contractual cash obligations
25,000
-
10,000
10,000
5,000
10,310
-
-
-
10,310
2,140
$ 64,573
658
$ 10,658
618
$ 15,618
415
$ 20,415
449
$ 17,882
(in thousands)
Amount of Commitment Expirations by Period
Total
Amounts
Commited
Less Than
one Year
1-3 Years
3-5 Years
More Than 5
Years
Commitments to extend credit
$
155,701
$
135,399
$
5,025
$
2,871
$
12,406
Standby letters of credit
25,321
18,640
6,531
-
150
Total
$
181,022
$
154,039
$
11,556
$
2,871
$
12,556
The Company's Finance unit proactively monitors the level of unused commitments against the Company’s available sources of liquidity
from its investment portfolio, from deposit gathering activities as well as available unused borrowing capacity from the FHLB and the
Federal Reserve. The Finance unit reports the results of its liquidity monitoring regularly to the Company’s Asset/Liability Committee,
the Rate and Liquidity Committee, the Senior Management Committee and the Board of Directors.
64
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Sensitivity
Market risk is the risk to earnings and/or financial position resulting from adverse changes in market rates or prices, such as interest
rates, foreign exchange rates or equity prices. The Company’s exposure to market risk is primarily interest rate risk associated with our
lending, investing and deposit gathering activities, all of which are other than trading. Changes in interest rates affect earnings by
changing net interest income and the level of other interest-sensitive income and operating expenses. In addition, variations in interest
rates affect the underlying economic value of our assets, liabilities and off-balance sheet items.
Asset and Liability Management
The Company manages these objectives through its Asset and Liability Management Committee (“ALCO”) and its Rate and Liquidity
and Investment Committees, which consist of the members of senior management and certain members of the finance department.
Members of the committees meet regularly to develop balance sheet strategies affecting the future level of net interest income, liquidity
and capital. The major objectives of ALCO are to:
• Manage exposure to changes in the interest rate environment by limiting the changes in net interest margin to an acceptable
level within a reasonable range of interest rates;
• Ensure adequate liquidity and funding;
• Maintain a strong capital base; and
• Maximize net interest income opportunities.
ALCO monitors the Company’s exposure to changes in net interest income over both a one-year planning horizon and a longer-term
strategic horizon. ALCO uses net interest income simulations and economic value of equity (“EVE”) simulations as the primary tools in
measuring and managing the Company’s position and considers balance sheet forecasts, the Company’s liquidity position, the economic
environment, anticipated direction of interest rates and the Company’s earnings sensitivity to changes in these rates in its modeling. In
addition, ALCO has established policy tolerance limits for acceptable negative changes in net interest income. Furthermore, as part of its
ongoing monitoring, ALCO has been enhanced to require periodic back testing of modeling results, which involves after-the-fact
comparisons of projections with the Company’s actual performance to measure the validity of assumptions used in the modeling
techniques.
Earnings at risk and economic value at risk simulations
Earnings at Risk
Earnings-at-risk simulation measures the change in net interest income and net income under various interest rate scenarios. Specifically,
given the current market rates, ALCO looks at “earnings at risk” to determine anticipated changes in net interest income from a base
case scenario with scenarios of + 200/-100 basis points changes to interest rates. The simulation takes into consideration that not all
assets and liabilities re-price equally and simultaneously with market rates (i.e., savings rate).
Economic Value at Risk
While earnings-at-risk simulation measures the short-term risk in the balance sheet, economic value (or portfolio equity) at risk measures
the long-term risk by finding the net present value of the future cash flows from the Company’s existing assets and liabilities. ALCO
examines this ratio regularly, and given the current rate environment, has utilized rate shocks of +200/- 100 basis points for simulation
purposes. Management recognizes that, in some instances, this ratio may contradict the “earnings at risk” ratio.
While ALCO regularly performs a wide variety simulations under various strategic balance sheet and treasury yield curve scenarios, the
following results reflect the Company’s sensitivity over the subsequent twelve months based on the following assumptions:
• Asset and liability levels using December 31, 2013 as a starting point;
• Cash flows are based on contractual maturity and amortization schedules with applicable prepayments derived from internal
historical data and external sources; and
• Cash flows are reinvested into similar instruments so as to keep interest-earning asset and interest-bearing liability levels
constant
65
The following table illustrates the simulated impact of a 200 basis point upward and a 100 basis point downward movement in interest
rates on net interest income and the change in economic value. The impact of the rate movements were developed by simulating the
effect of rates changing over a twelve-month period from the December 31, 2013 levels.
Earnings at risk:
Percent change in net interest income
Economic value at risk:
Percent change in economic value of equity
RATES + 200
RATES – 100
POLICY LIMITS
3.9%
2.7%
(1.4)%
-20.0%/-10.0%
(6.9)%
-20.0%/-10.0%
Under the model, the Company’s net interest income is expected to increase 3.9%, while the Company’s economic value of equity is
expected to increase 2.7%, under a 200 basis point upward movement in interest rates. The anticipated increase in net interest income
reflects the composition of the Company’s loan portfolio, which is comprised of a significant balance of variable-rate loans, which will
reprice immediately or in the near term. In comparison, results for a similar model at December 31, 2012 simulated a 5.3% increase in
net interest income under a 200 basis point upward movement in interest rates.
This analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results.
These simulations are based on numerous assumptions: the nature and timing of interest rate levels, prepayments on loans and securities,
deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacements of asset and liability cash flows, and other
factors. While assumptions reflect current economic and local market conditions, the Company cannot make any assurances as to the
predictive nature of these assumption, including changes in interest rates, customer preferences, competition and liquidity needs, or what
actions ALCO might take in responding to these changes.
66
Item 8. Financial Statements and Supplementary Data.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
First National Community Bancorp, Inc. and Subsidiaries
We have audited the accompanying consolidated statements of financial condition of First National Community
Bancorp, Inc. and Subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated
statements of operations, comprehensive (loss) income, changes in shareholdersʼ equity, and cash flows for each of the
three years in the period ended December 31, 2013. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
financial position of First National Community Bancorp, Inc. and Subsidiaries as of December 31, 2013 and 2012, and
the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013,
in conformity with U.S. generally accepted accounting principles.
As explained in Note 17, the Companyʼs subsidiary bank (the “Bank”) is under a Consent Order from the Office of the
Comptroller of the Currency whereby the Bank is required to achieve and maintain certain minimum regulatory capital
ratios.
/s/ McGladrey LLP
New Haven, Connecticut
March 24, 2014
67
FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except share data)
Assets
Cash and cash equivalents:
Cash and due from banks
Interest-bearing deposits in other banks
Total cash and cash equivalents
Securities available for sale at fair value
Securities held to maturity at amortized cost (fair value $2,424 and $2,483)
Stock in Federal Home Loan Bank of Pittsburgh, at cost
Loans held for sale
Loans, net of allowance for loan and lease losses of $14,017 and $18,536
Bank premises and equipment, net
Accrued interest receivable
Refundable federal income taxes
Intangible assets
Bank-owned life insurance
Other real estate owned
Other assets
Total Assets
Liabilities
Deposits
Demand (non-interest-bearing)
Interest-bearing
Total deposits
Borrowed funds
Federal Home Loan Bank of Pittsburgh advances
Subordinated debentures
Junior subordinated debentures
Total borrowed funds
Accrued interest payable
Other liabilities
Total liabilities
Shareholders' Equity
Preferred Shares ($1.25 par)
Authorized: 20,000,000 shares at December 31, 2013 and 2012
Issued and outstanding: 0 shares at December 31, 2013 and 2012
Common Shares ($1.25 par)
Authorized: 50,000,000 shares at December 31, 2013 and 2012
Issued and outstanding: 16,471,569 at December 31, 2013 and 16,457,169 shares at December 31, 2012
Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive (loss) income
Total shareholders' equity
Total Liabilities and Shareholders’ Equity
December 31,
2013
2012
$
19,295
$
21,710
84,261
103,556
203,867
2,308
2,146
820
629,880
15,363
2,191
45
467
28,167
4,246
10,752
93,561
115,271
185,361
2,198
5,957
1,615
579,396
18,937
2,199
11,637
632
27,461
3,983
13,627
$
1,003,808
$
968,274
$
157,550
$
131,476
727,148
884,698
27,123
25,000
10,310
62,433
8,732
14,367
723,137
854,613
18,593
25,000
10,310
53,903
6,427
16,406
970,230
931,349
-
-
20,589
61,627
(45,546)
(3,092)
33,578
20,571
61,584
(51,928)
6,698
36,925
$
1,003,808
$
968,274
The accompanying notes to consolidated financial statements are an integral part of these statements.
68
FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thous ands , except s hare data)
Interes t income
Interes t and fees on loans
Interes t and dividends on s ecurities
U.S. government agencies
State and political s ubdivis ions , tax-free
State and political s ubdivis ions , taxable
Other s ecurities
Total interes t and dividends on s ecurities
Interes t on interes t-bearing depos its and federal funds s old
Total interes t income
Interes t expens e
Interes t on depos its
Interes t on borrowed funds
Interes t on Federal Home Loan Bank of Pitts burgh advances
Interes t on s ubordinated debentures
Interes t on junior s ubordinated debentures
Total interes t on borrowed funds
Total interes t expens e
Net interes t income before (credit) provis ion for loan and leas e los s es
(Credit) provis ion for loan and leas e los s es
Net interes t income after (credit) provis ion for loan and leas e los s es
Non-interes t income
Depos it s ervice charges
Net gain (los s ) on the s ale of s ecurities
Gros s other-than-temporary-impairment (los s es ) gains
Portion of gain recognized in OCI before taxes
Other-than-temporary-impairment los s es recognized in earnings
Net gain on the s ale of loans held for s ale
Net los s on the s ale of clas s ified loans
Net gain on the s ale of other real es tate owned
Gain on the s ale of bank premis es and equipment and other as s ets
Loan-related fees
Income from bank-owned life ins urance
Other
Total non-interes t income
Non-interes t expens e
Salaries and employee benefits
Occupancy expens e
Equipment expens e
Advertis ing expens e
Data proces s ing expens e
Regulatory as s es sments
Bank s hares tax
Expens e of other real es tate owned
(Credit) provis ion for off-balance s heet commitments
Legal expens e
Profes s ional fees
Ins urance expens es
Loan collection expens es
Legal s ettlements
Other operating expens es
Total non-interes t expens e
Income (los s ) before income taxes
Provis ion for income taxes
Net income (los s )
Earnings (los s ) per s hare
Bas ic
Diluted
For the Year Ended December 31,
2013
2012
2011
$
27,097
$
29,588
$
34,467
1,859
3,277
463
154
5,753
103
32,953
4,164
527
2,281
204
3,012
7,176
25,777
(6,270)
32,047
2,945
2,887
-
-
-
362
(223)
135
579
423
706
1,469
9,283
13,218
2,215
1,468
523
2,066
2,515
800
719
(246)
2,488
1,674
1,179
482
2,500
3,347
34,948
6,382
-
1,352
3,931
482
1,484
7,249
190
37,027
5,384
1,322
2,288
224
3,834
9,218
27,809
4,065
23,744
2,985
(1,712)
(96)
-
(96)
859
-
305
-
514
692
736
4,283
14,702
2,225
1,723
614
2,141
2,721
882
2,027
358
4,233
4,385
896
765
446
3,620
41,738
(13,711)
-
2,852
5,093
112
234
8,291
178
42,936
8,759
2,621
2,281
206
5,108
13,867
29,069
523
28,546
3,105
5,114
751
(1,549)
(798)
755
-
2,528
20
673
787
765
12,949
14,117
2,508
1,654
629
2,036
3,159
1,103
3,720
(423)
2,716
5,413
685
780
-
3,733
41,830
(335)
-
$
6,382
$
(13,711)
$
(335)
$
0.39
$
0.39
$
(0.83)
$
(0.02)
$
(0.83)
$
(0.02)
Cas h Dividends Declared Per Common Share
$
-
$
-
$
-
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Bas ic
Diluted
16,458,353
16,458,353
16,442,160
16,442,160
16,439,508
16,439,508
The accompanying notes to cons olidated financial s tatements are an integral part of thes e s tatements .
69
FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(in thousands)
Net income (loss)
Other comprehensive (loss) income:
Unrealized (losses) gains on securities available for sale
Taxes
Net of tax amount
Noncredit-related gains on OTTI securities not expected to be sold
Taxes
Net of tax amount
Reclassification adjustment for (gains) losses included in net income (loss)
Taxes
Net of tax amount
For the Year Ended December 31,
2013
2012
2011
$
6,382
$
(13,711)
$
(335)
(11,946)
4,061
(7,885)
-
-
-
(2,887)
982
(1,905)
14,351
(4,880)
9,471
-
-
-
1,808
(614)
1,194
15,050
(5,117)
9,933
1,655
(563)
1,092
(4,316)
1,467
(2,849)
Total other comprehensive (loss) income
(9,790)
10,665
8,176
Comprehensive (loss) income
$
(3,408)
$
(3,046)
$
7,841
The accompanying notes to consolidated financial statements are an integral part of these statements.
70
FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2013, 2012 and 2011
(in thousands, except share data)
Balances, December 31, 2010
Net loss for the year
Other comprehensive income, net of tax of $4,213
Proceeds from issuance of common shares through dividend
reinvestment plan
Balances, December 31, 2011
Net loss for the year
Other comprehensive income, net of tax of $5,494
Stock-based compensation
Balances, December 31, 2012
Net income for the year
Other comprehensive loss, net of tax of $5,044
Stock-based compensation
Balances, December 31, 2013
Number
of Common
Shares
Common
Stock
Additional
Paid-in
Capital
Accumulated
Other
Total
Accumulated
Comprehensive
Shareholders'
Deficit
(Loss) Income
Equity
16,433,020
$
20,541
$
61,539
$
(37,882)
$
(12,143)
$
32,055
-
-
9,099
16,442,119
-
-
15,050
-
-
11
20,552
-
-
19
-
-
18
61,557
-
-
27
(335)
-
-
(38,217)
(13,711)
-
16,457,169
$
20,571
$
61,584
$
(51,928)
-
-
14,400
-
-
18
-
-
43
16,471,569
$
20,589
$
61,627
6,382
-
-
8,176
-
(3,967)
-
10,665
$
-
6,698
-
(9,790)
(335)
8,176
29
39,925
(13,711)
10,665
46
$
36,925
6,382
(9,790)
61
$
33,578
-
(45,546)
$
$
-
(3,092)
The accompanying notes to consolidated financial statements are an integral part of these statements.
71
FIRST NATIONAL COMMUNITY BANCORP, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Operating activities:
Net income (loss)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Investment securities amortization (accretion), net
Equity in trust
Depreciation and amortization
(Credit) provision for loan and lease losses
Valuation adjustment for off-balance sheet commitments
Stock-based compensation expense
(Gain) loss on the sale of securities
Other-than-temporary-impairment loss
Gain on the sale of loans held for sale
Loss on the sale of classified loans
Gain on the sale of bank premises and equipment and other assets
Loss on the disposition of bank premises and equipment and other assets
Net gain on the sale of other real estate owned
Valuation adjustment for other real estate owned
Income from bank-owned life insurance
Proceeds from the sale of loans held for sale
Funds used to originate loans held for sale
Decrease in interest receivable
Decrease (increase) in refundable federal income taxes
Decrease (increase) in prepaid expenses and other assets
Increase in interest payable
Increase in accrued expenses and other liabilities
Total adjustments
Net cash provided by (used in) operating activities
Cash flows from investing activities:
For the Year Ended December 31,
2013
2012
2011
$ 6,382
$ (13,711)
$ (335)
487
(1,628)
(1,293)
(6)
(7)
(4)
1,265
1,249
1,338
(6,270)
4,065
523
(246)
358
(423)
61
46
-
(2,887)
1,712
(5,114)
-
96
798
(362)
(859)
(755)
223
-
-
(579)
-
(20)
-
142
-
(135)
223
(305)
1,206
(2,528)
2,318
(706)
(692)
(787)
12,944
27,017
28,573
(11,787)
(27,679)
(26,638)
8
353
567
11,592
(25)
797
4,209
(4,520)
4,170
2,305
2,126
1,538
1,713
12
569
12,052
2,667
3,629
18,434
(11,044)
3,294
Maturities, calls and principal payments of investment securities available for sale
14,596
33,170
29,449
Proceeds from the sale of securities available for sale
Purchases of securities available for sale
Purchase of Federal Reserve Bank Stock
Payment of liability for securities purchased not settled
Redemption of the stock of the Federal Home Loan Bank of Pittsburgh
Net (increase) decrease in loans to customers
Proceeds from the sale of classified loans
Proceeds from the sale of other real estate owned
Purchases of bank premises and equipment
Proceeds from the sale of bank premises and equipment
Net cash (used in) provided by investing activities
Cash flows from financing activities:
Net increase (decrease) in deposits
Proceeds from Federal Home Loan Bank of Pittsburgh advances
Repayment of Federal Home Loan Bank of Pittsburgh advances
Repayment of other borrowed funds
Proceeds from issuance of common shares, net of share issuance costs
Net cash provided by (used in) financing activities
Net (decrease) increase in cash and cash equivalents
Cash & cash equivalents at beginning of year
Cash & cash equivalents at end of year
Supplemental cash flow information
Cash paid (received) during the period for:
Interest
Income taxes
Other transactions:
Securities purchased, not settled
Principal balance of loans transferred to other real estate owned
Transfer of loans held for sale to loans
Transfer from loans held for sale to other assets
Transfer of bank premises and equipment to other real estate owned
Deferred gain on sale of other real estate owned
53,787
46,099
122,640
(99,432)
(63,279)
(63,409)
-
(90)
-
-
(5,120)
-
3,811
2,442
1,912
(47,490)
67,743
73,540
3,275
6,836
-
1,668
3,660
6,880
(810)
(1,601)
(893)
1,831
-
32
(68,764)
89,860
170,151
30,085
32,250
(102,523)
-
(25,300)
60,000
(23,720)
(29,668)
(113,626)
-
-
(407)
-
-
29
38,615
(132,191)
(79,304)
(11,715)
(53,375)
94,141
115,271
168,646
74,505
$ 103,556
$ 115,271
$ 168,646
$ 4,871
$ 7,092
$ 12,329
(11,592)
-
-
255
-
1,586
-
-
-
-
1,819
-
(800)
5,120
3,995
(1,289)
698
-
55
-
-
The accompanying notes to the consolidated financial statements are an integral part of these statements.
72
Notes to Consolidated Financial Statements
Note 1. Organization
First National Community Bancorp, Inc., is a registered bank holding company under the Bank Holding Company Act of 1956. It was
incorporated under the laws of the Commonwealth of Pennsylvania in 1997. It is the parent company of First National Community
Bank (the “Bank”) and the Bank’s wholly owned subsidiaries FNCB Realty Company, Inc., FNCB Realty Company I, LLC, and FNCB
Realty Company II, LLC. Unless the context otherwise requires, the term “Company” is used to refer to First National Community
Bancorp, Inc., and its subsidiaries. In certain circumstances, however, the term “Company” refers to First National Community
Bancorp, Inc., itself.
The Bank provides customary retail services to individuals and businesses through its twenty-one banking locations located in
northeastern Pennsylvania.
FNCB Realty Company, Inc., FNCB Realty Company I, LLC, and FNCB Realty Company II, LLC were formed to hold real estate
and/or operate businesses acquired in exchange for debt settlement or foreclosure.
During December 2006 the Bank created First National Community Statutory Trust I (“Issuing Trust”) which is wholly owned by the
Company. The Issuing Trust was formed to provide an additional funding source for the Company through the issuance of pooled trust
preferred securities. The Company has adopted Accounting Standards Codification 810-10, Consolidation, for the issuing trust.
Accordingly, this trust has not been consolidated with the accounts of the Company, because the Company is not the primary beneficiary
of the trust.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements of the Company include the accounts of First National Community Bancorp, Inc., the Bank, and
the Bank’s wholly-owned subsidiaries. All inter-company transactions and balances have been eliminated. The accounting and reporting
policies of the Company conform to accounting principles general accepted in the United States of America (“GAAP”) and general
practices within the financial services industry.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from these
estimates. Material estimates that are particularly susceptible to change are the allowance for loan and lease losses, investment security
valuations, the evaluation of investment securities and other real estate owned for impairment, and the evaluation of deferred income
taxes.
Cash Equivalents
For purposes of reporting cash flows, cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally,
federal funds are purchased and sold for one day periods.
Securities
The Company classifies investment securities as either held-to-maturity or available-for-sale at the time of purchase. Investment
securities that are classified as held-to-maturity are carried at amortized cost when management has the positive intent and ability to hold
them to maturity. Investment securities that are classified as available-for-sale are carried at fair value with unrealized gains and losses
recognized as a component of shareholders’ equity in accumulated other comprehensive income. Gains and losses on sales of
investment securities are recognized using the specific identification method on a trade date basis. Interest income on investments
includes amortization of premiums and accretion of discounts. Realized gains and losses are derived based on the amortized cost of the
security sold.
Quarterly, the Company evaluates its investment securities classified as held-to-maturity or available-for-sale for other-than-temporary
impairment (“OTTI”). Unrealized losses on securities are considered to be other-than-temporarily impaired when the Company believes
the security’s impairment is due to factors that could include the issuer’s inability to pay interest or dividends, the issuer’s potential for
default, and/or other factors. Based on current authoritative guidance, when a held-to-maturity or available-for-sale debt security is
73
assessed for OTTI, the Company must first consider (a) whether management intends to sell the security and (b) whether it is more
likely than not that the Company will be required to sell the security prior to recovery of its amortized cost basis. If one of these
circumstances applies to a security, an OTTI loss is recognized in the statement of operations equal to the full amount of the decline in
fair value below amortized cost. If neither of these circumstances applies to a security, but the Company does not expect to recover the
entire amortized cost basis, an OTTI loss has occurred that must be separated into two categories: (a) the amount related to credit loss
and (b) the amount related to other factors (such as market risk). In assessing the level of OTTI attributable to credit loss, the Company
compares the present value of cash flows expected to be collected with the amortized cost basis of the security. The portion of the total
OTTI related to credit loss is identified as the amount of principal cash flows not expected to be received over the remaining term of the
security as estimated based on cash flow projections discounted at the applicable original yield of the security, and is recognized in
earnings, while the amount related to other factors is recognized in other comprehensive income. The total OTTI loss is presented in the
statement of operations less the portion recognized in other comprehensive income. When a debt security becomes other-than-
temporarily impaired, its amortized cost basis is reduced to reflect the portion of the total impairment related to credit loss.
For equity securities, the entire decline in the value that is considered other-than-temporary is recognized in earnings.
Investments in the Federal Reserve Bank and Federal Home Loan Bank stock have limited marketability, are carried at cost and are
evaluated for impairment based on the Company’s determination of the ultimate recoverability of the par value of the stock. The
investment in the Federal Reserve Bank stock is included in other assets.
Loans and Loan Fees
Loans receivable, other than loans held for sale, are stated at the principal outstanding, net of unamortized loan fees and costs, partial
charge-offs and the allowance for loan and lease losses. Interest income on all loans is recognized using the effective interest method.
Loan origination and commitment fees, as well as certain direct loan origination costs, are deferred and the net amount is amortized as
an adjustment of the related loan’s yield. The Bank is generally amortizing these amounts over the life of the related loans except for
residential mortgage loans, where the timing and amount of prepayments can be reasonably estimated. For these mortgage loans, the net
deferred fees or costs are amortized over an estimated average life of five years. Amortization of deferred loan fees or costs is
discontinued when a loan is placed on non-accrual status.
Loans are placed on non-accrual status when a loan is specifically determined to be impaired or when management believes that the
collection of interest or principal is doubtful. This is generally when a default of interest or principal has existed for 90 days or more,
unless the loan is fully secured and in the process of collection, or when management becomes aware of facts or circumstances that the
loan would default before 90 days. The Company determines delinquency status based on the number of days since the date of the
borrower’s last required contractual loan payment. When the interest accrual is discontinued, the balance of any previously accrued but
unpaid interest is reversed and charged against interest income. Any cash payments subsequently received are applied, first to the
outstanding loan amounts, then to the recovery of any charged-off loan amounts. Any excess amount is treated as a recovery of lost
interest. A non-accrual loan is returned to accrual status when the loan is current as to principal and interest payments, is performing
according to contractual terms for six consecutive months and future payments are reasonably assured.
In underwriting a loan secured by real property (unless exempt based on legal requirements), the Company requires an appraisal of the
property by an independent licensed appraiser approved by the Bank’s Board of Directors. The appraisal is either reviewed internally or
by an independent third party hired by the Bank. Generally, management obtains updated appraisals when a loan is deemed impaired.
These appraisals may be more limited than those prepared for the underwriting of a new loan.
Troubled Debt Restructurings
A troubled debt restructuring (“TDR”) is a loan for which the Company, for legal or economic reasons related to a debtor’s financial
difficulties, has granted a concession to the debtor that it otherwise would not have considered. Such concessions granted generally
involve a reduction of the stated interest rate, an extension of a loan’s maturity date, or payment modifications. A non-accrual TDR is
returned to accrual status if principal and interest payments under the modified terms are brought current, is performing under the
modified terms for six consecutive months and future payments are reasonably assured.
Loan Impairment
A loan is considered impaired when it is probable that the Bank will be unable to collect all amounts due (including principal and
interest) according to the contractual terms of the note and loan agreement. For purposes of the Company’s analysis, TDRs, loans rated
substandard and on non-accrual status, and loans that are identified as doubtful or loss, are considered impaired. Impaired loans are
analyzed individually for impairment. The Company generally utilizes the fair value of collateral method for collateral dependent loans.
A loan is considered to be collateral dependent when repayment of the loan is expected to be provided through the liquidation of the
collateral held. For impaired loans that are secured by real estate, external appraisals are obtained annually, or more frequently as
warranted, to ascertain a fair value so that the impairment analysis can be updated. Should a current appraisal not be available at the
74
time of impairment analysis, other sources of valuation such as current letters of intent, broker price opinions or executed agreements of
sale may be used. For non-collateral dependent impaired loans and TDRs, the Company measures impairment based on the present
value of expected future cash flows, discounted at the loan’s original effective interest rate.
Generally all loans with balances of $100 thousand or less are considered within homogeneous pools and are not individually evaluated
for impairment. However, individual loans with balances of $100 thousand or less are individually evaluated for impairment if that loan
is part of a larger impaired loan relationship or the loan is considered a TDR.
Impaired loans or portions thereof are charged-off upon determination that all or a portion of the loan balance is uncollectible and
exceeds the fair value of the collateral. A loan is considered uncollectible when the borrower is delinquent with respect to principal or
interest repayment and it is unlikely that the borrower will have the ability to pay the debt in a timely manner, collateral value is
insufficient to cover the outstanding indebtedness and the guarantors (if applicable) do not provide adequate support for the loan.
Allowance for Loan and Lease Losses
Management continually evaluates the credit quality of the Company’s loan portfolio, and performs a formal review of the adequacy of
the allowance for loan and lease losses (“ALLL”) on a quarterly basis. Management establishes the ALLL through provisions for loan
losses charged to earnings and maintains the ALLL at a level it considers adequate to absorb probable losses inherent in the loan
portfolio as of the evaluation date. Loans, or portions of loans, determined by management to be uncollectable are charged off against
the ALLL, while recoveries of amounts previously charged off are credited to the ALLL.
Determining the amount of the ALLL is considered a critical accounting estimate because it requires significant judgment and the use of
estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous
loans based on historical loss experience and qualitative factors, and consideration of current economic trends and conditions, all of
which may be susceptible to significant change. Various banking regulators, as an integral part of their examinations of the Company,
also review the ALLL. Such regulators may require, based on their judgments about information available to them at the time of their
examination, that certain loan balances be charged off or require that adjustments be made to the ALLL. Additionally, the ALLL is
determined, in part, by the composition and size of the loan portfolio.
The ALLL consists of two components, a specific component and a general component. The specific component relates to loans that are
classified as impaired. For such loans an allowance is established when the discounted cash flows, collateral value or observable market
price of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans and is based on
historical loss experience adjusted by qualitative factors. The general reserve component of the ALLL is based on pools of unimpaired
loans segregated by loan segment and risk rating categories of “Pass”, “Special Mention” or “Substandard and Accruing.” Historical loss
factors and various qualitative factors are applied based on the risk profile in each risk rating category to determine the appropriate
reserve related to those loans. As previously mentioned, substandard loans on nonaccrual status are included in impaired loans.
When establishing the ALLL, management categorizes loans into segments generally based on the nature of the collateral and basis of
repayment. These risk characteristics of the Company’s loan segments are as follows:
Construction, Land Acquisition and Development loans - These loans consist of loans secured by real estate, with the purpose of
constructing one- to four-family homes, residential developments and various commercial properties including, shopping centers, office
complexes and single-purpose, owner-occupied structures. Additionally, loans in this category include loans for land acquisition,
secured by raw land. The Bank’s construction program offers either short-term, interest-only loans that require the borrower to pay
interest only during the construction phase with a balloon payment of the principal outstanding at the end of the construction period or
interest only during construction with a conversion to amortizing principal and interest when the construction is complete. Loans for
undeveloped real estate are subject to a loan-to-value ratio not to exceed 65%. Construction loans are treated similarly to the developed
real estate loans and are generally subject to an 80% loan to value ratio based upon an “as-completed” appraised value. Construction
loans generally yield a higher interest rate than other mortgage loans but also carry more risk.
Commercial Real Estate Loans - These loans represent the largest portion of the Bank’s total loan portfolio and loans in this portfolio
generally carry larger loan balances. The commercial real estate mortgage loan portfolio is secured by a broad range of real estate,
including but not limited to, office complexes, shopping centers, hotels, warehouses, gas stations/ convenience markets, residential care
facilities, nursing care facilities, restaurants and multifamily housing. The Bank’s commercial real estate portfolio consists of owner-
occupied properties and non-owner-occupied properties and includes the personal guarantees of the principals when deemed necessary.
The Bank offers various rates and terms for commercial mortgage loans secured by real estate. The interest rates associated with these
types of loans are primarily priced as adjustable-rate loans with re-pricing dates extending three through seven years or floating-rate
loans that adjust to a spread over the National Prime Rate (“NPR”) index. Loan pricing for most floating-rate commercial mortgage
loans generally has a minimum interest rate. The terms for commercial real estate loans typically do not exceed 20 years. Commercial
75
real estate mortgage loans are originated under a comprehensive lending policy. In particular, these types of loans are subject to specific
loan-to-value guidelines prior to the time of closing. The policy limits for developed real estate loans are subject to a maximum loan-to-
value ratio of 80%. Commercial mortgage loans must also meet specific criteria that include the capacity, capital, credit worthiness and
cash flow of the borrower and the project being financed. Potential borrower(s) and guarantor(s) are required to provide the Bank with
historical and current financial data. As part of the underwriting process for commercial real estate loans, the Bank performs a review of
the cash flow analysis of the borrower(s), guarantor(s) and the project. The Bank also considers the borrower’s expertise, credit history,
net worth and the value of the underlying property. The Bank generally requires that borrowers for loans secured by real estate maintain
a debt service coverage ratio of at least 1.20 times.
Commercial and Industrial Loans - The Bank offers commercial loans to individuals and businesses located in its primary market area.
The commercial loan portfolio includes lines of credit, dealer floor plan lines, equipment loans, vehicle loans, improvement loans and
term loans. These loans are primarily secured by vehicles, machinery and equipment, inventory, accounts receivable, marketable
securities, deposit accounts and real estate as secondary collateral . The Bank offers various rates and terms for commercial loans.
These loans also normally require the personal guarantee of the principals where deemed necessary. Most lines of credit are primarily
issued for one year time periods and are renewable annually thereafter at the discretion of the Bank. Most other commercial loans range
in terms from one to seven years. The interest rates associated with these types of loans are primarily underwritten as fixed-rate loans
based upon the term of the loan or floating-rate loans that adjust to a spread over the NPR index. Loan pricing for most floating-rate
commercial loans generally have a minimum interest rate floor. The interest rate for most lines of credit is issued on a floating-rate
basis. Finally, loans secured by deposit accounts are primarily underwritten at a spread over the interest rate of the deposit instrument
used as collateral for the loan.
State and Political Subdivision Loans - The Bank originates general obligation notes and tax anticipation loans to state and political
subdivisions, which are primarily municipalities in the Bank’s market area.
Residential Real Estate Loans - The Bank offers fixed- and variable-rate one- to four-family residential loans. Residential first lien
mortgages are generally subject to an 80% loan to value ratio based on the appraised value of the property. The Bank will generally
require the mortgagee to purchase Private Mortgage Insurance (“PMI”) if the amount of the loan exceeds the 80% loan to value ratio.
The interest rates for the variable rate loans are adjusted to a percentage above the one year treasury rate. The Bank may sell loans and
retain servicing when warranted by market conditions. The Bank also offers a rate lock to customers that allow the borrowers to lock in
their interest rates at the time of application as well as at time of commitment. Residential mortgage loans are generally smaller in size
and are considered homogeneous as they exhibit similar characteristics.
Consumer Loans - Include both secured and unsecured installment loans, personal lines of credit and overdraft protection loans. The
Bank is also in the business of underwriting indirect auto loans which are originated through various auto dealers in northeastern
Pennsylvania and dealer floor plan loans. The Bank offers home equity loans and home equity lines of credit (“HELOCs”) with a
maximum combined loan-to-value ratio of 90% based on the appraised value of the property. Home equity loans have fixed rates of
interest and carry terms up to 15 years. HELOCs have adjustable interest rates and are based upon the prime interest rate. Consumer
loans are generally smaller in size and exhibit homogeneous characteristics.
Liability for Off-Balance-Sheet Credit-Related Financial Instruments
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing need
of its customers. These financial instruments include commitments to extend credit, unused portions of lines of credit, including
revolving HELOCs, and letters of credit. The Company’s exposure to credit loss in the event of nonperformance by the other party to the
financial instrument is represented by the contractual notional amount of these instruments. The Company uses the same credit policies
in making these commitments as it does for on-balance sheet instruments. In order to provide for probable losses inherent in these
instruments, the Company records a reserve for unfunded commitments, included in other liabilities on the consolidated balance sheet,
with the offsetting expense recorded in other operating expenses in the consolidated statements of operations.
Mortgage Banking Activities
Mortgage loans originated by the Bank and intended for sale are carried at the lower of aggregate cost or fair value determined on an
individual loan basis. Net unrealized losses are recorded as a valuation allowance and charged to earnings. Gains and losses on sales of
mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold and include the value
assigned to the rights to service the loan. Net gains on the sale of residential mortgage loans for the years ended December 31, 2013,
2012 and 2011 were $362 thousand, $859 thousand and $755 thousand, respectively. Loans held for sale are generally sold with loan
servicing rights retained by the Company. At December 31, 2013 and 2012, loans held for sale amounted to $820 thousand and $1.6
million, respectively.
76
Servicing
Servicing assets are reported in other assets and amortized in proportion to and over the period during which estimated servicing income
will be received. Servicing loans for others consists of collecting mortgage payments, maintaining escrow accounts, disbursing
payments to investors, and processing foreclosures. Loan servicing income is recorded when earned and represents servicing fees from
investors and certain charges collected from borrowers, such as late payment fees. The Company has fiduciary responsibility for related
escrow and custodial funds.
Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets.
Generally, purchased servicing rights are capitalized at the cost to acquire the rights. For sales of mortgage loans originated by the
Bank, a portion of the cost of originating the loan is allocated to the servicing retained right based on fair value. Fair value is based on
market prices for comparable mortgage servicing contracts, when available, or alternately, is based on a valuation model that calculates
the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants
would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation
rate, ancillary income, prepayment speeds and default rates and losses. Capitalized servicing rights are amortized into interest income in
proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.
Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is
determined by stratifying rights into tranches based on predominant risk characteristics, such as interest rate, loan type and investor type.
Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized
amount for the tranche. If the Bank later determines that all or a portion of the impairment no longer exists for a particular tranche, a
reduction of the allowance may be recorded as an increase to income. Servicing fee income is recorded for fees earned for servicing
loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income
when earned.
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 ( put presumptively beyond the reach of the
transferor and its creditors) even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain
it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the transferor does not maintain effective
control over the transferred assets through either (a) an agreement that both entitles and obligates the transferor to repurchase or redeem
the assets before maturity or (b) the ability to unilaterally cause the holder to return specific assets, other than through a cleanup call.
Other Real Estate Owned
Other real estate owned (“OREO”) consists of property acquired by foreclosure, abandonment or conveyance of deed in-lieu of
foreclosure of a loan, and bank premises that are no longer used for operations or for future expansion. OREO is held for sale and is
initially recorded at fair value less costs to sell at the date of acquisition or transfer, which establishes a new cost basis. Upon acquisition
of a property through foreclosure or deed in-lieu of foreclosure, any write-down to fair value less estimated selling costs is charged to the
ALLL. The determination is made on an individual asset basis. Bank premises no longer used for operations or future expansion is
transferred to OREO at fair value less estimated selling costs with any related write-down included in non-interest expense. Subsequent
to acquisition or transfer, valuations of properties are periodically performed by management and the assets are carried at the lower of
cost basis or fair value less estimated cost to sell. Fair value is determined through external appraisals, current letters of intent, broker
price opinions or executed agreements of sale. Costs relating to the development and improvement of the OREO properties may be
capitalized, while holding period costs are charged to expense as incurred.
Bank Premises and Equipment
Land is stated at cost. Bank premises, equipment and leasehold improvements are stated at cost less accumulated depreciation. Costs for
routine maintenance and repair are expensed as incurred, while significant expenditures for improvements are capitalized. Depreciation
expense is computed generally using the straight-line method over the following ranges of estimated useful lives, or in the case of
leasehold improvements, to the expected terms of the leases, if shorter.
Buildings and improvements ...........................................................
Furniture, fixtures and equipment ...................................................
Leasehold improvements.................................................................
10 to 40 years
3 to 15 years
2 to 39 years
77
Intangible Assets
Intangible assets consist entirely of a core deposit intangible which arose in connection with the acquisition of the Bank’s Honesdale
branch. The core deposit intangible is amortized over an estimated useful life of 10 years.
Long-lived Assets
Intangible assets and bank premises and equipment are reviewed by management at least annually for potential impairment and
whenever events or circumstances indicate that carrying amounts may not be recoverable.
Income Taxes
The Bank recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets
are reduced by a valuation allowance when, in the opinion of management, it is more-likely-than-not that all or some portion of the
deferred tax assets will not be realized.
The Company files a consolidated Federal income tax return. Under tax sharing agreements, each subsidiary provides for and settles
income taxes with the Company as if it would have filed on a separate return basis.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities,
while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately
sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available
evidence, management believes it is more-likely-than-not that the position will be sustained upon examination, including the resolution
of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet
the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being
realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that
exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits along with any associated
interest and penalties that would be payable to the taxing authorities upon examination. The Company determined that it had no
liabilities for uncertain tax positions at December 31, 2013 and 2012.
Interest and penalties related to income taxes, if any, are presented within non-interest expense.
Earnings per Share
Earnings per share is calculated on the basis of the weighted-average number of common shares outstanding during the year. Basic
earnings per share excludes dilution and is computed by dividing net income available to common shareholders by the weighted-average
common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if
outstanding stock options were exercised and converted into common stock. The dilutive effect of stock options is calculated using the
treasury stock method.
Stock-Based Compensation
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. All options are
charged against income at their fair value. The entire expense of the award is recognized over the vesting period. Shares of stock granted
are recorded at the fair value of the shares at the grant date, over the vesting period.
78
Bank-Owned Life Insurance
Bank-owned life insurance (“BOLI”) represents the cash surrender value of life insurance policies on certain current and former
directors and officers of the Company. The Company purchased the insurance as a future source of funding for the Company’s
liabilities, including the payment of employee benefits such as health care. BOLI is carried in the consolidated statements of financial
condition at its cash surrender value. Increases in the cash value of the policies, as well as proceeds received, are recorded in non-interest
income, and are not subject to income taxes. Under some of these policies, the beneficiaries receive a portion of the death benefit. The
net present value of the future death benefits scheduled to be paid to the beneficiaries was $94 thousand and $99 thousand at December
31, 2013 and 2012, respectively, and is reflected in “Other Liabilities” on the consolidated statements of financial condition.
Fair Value Measurement
The Company uses fair value measurements to record fair value adjustments to certain financial assets and liabilities and to determine
fair value disclosures. Available-for-sale securities are recorded at fair value on a recurring basis. Additionally, from time to time, the
Company may be required to recognize adjustments to other assets at fair value on a nonrecurring basis, such as impaired loans, other
securities, and OREO.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in
an orderly transaction between market participants at the measurement date. An orderly transaction is a transaction that assumes
exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for
transactions involving such assets or liabilities: it is not a forced transaction.
Accounting standards define fair value, establish a framework for measuring fair value, establish a three-level hierarchy for disclosure of
fair value measurement and provide disclosure requirements about fair value measurements. The valuation hierarchy is based upon the
transparency of inputs to the valuation of an asset or liability as of the measurement date.
The three levels of the fair value hierarchy are:
•
•
•
Level 1 valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets.
Level 2 valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for
identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant
assumptions are observable in the market or can be corroborated by market data.
Level 3 valuation is derived from other valuation methodologies including discounted cash flow models and similar techniques that
use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that
market participants would use in determining fair value.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income (loss). Although
certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate
component of the shareholders’ equity section of the statement of financial condition, such items, along with a net income (loss), are
components of comprehensive income (loss).
New Authoritative Accounting Guidance
Accounting Standards Update (“ASU”) No. 2011-11, Balance Sheet (Topic 210): “Disclosures about Offsetting Assets and Liabilities”
requires enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting
arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s
recognized assets and recognized liabilities within the scope of this update. The amendments require enhanced disclosures by requiring
improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either ASC
210-20-45 or ASC 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether
they are offset in accordance with either ASC 210-20-45 or ASC 815-10-45. The Company adopted ASU No. 2011-11 on January 1,
2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company.
ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350): “Testing Indefinite-Lived Intangible Assets for Impairment” simplifies
the guidance for testing the decline in realizable value (impairment) of indefinite-lived intangible assets other than goodwill. ASU No.
2012-02 allows an entity the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative
impairment test. An organization electing to perform a qualitative assessment is no longer required to calculate the fair value of an
79
indefinite-lived intangible asset unless the organization determines, based on a qualitative assessment, that it is “more likely than not”
that the asset is impaired. The Company adopted ASU 2012-02 on January 1, 2013. The adoption of this new guidance did not have an
effect on the operating results or financial position of the Company.
ASU No. 2013-01, Balance Sheet (Topic 210): “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” clarifies the
scope of transactions that are subject to the disclosures about offsetting, specifically that ordinary trade receivables and receivables are
not in the scope of ASU No. 2011-11. This update applies only to derivatives, repurchase agreements and reverse purchase agreements,
and securities borrowing and securities lending transactions that are offset in accordance with specific criteria contained in FASB
Accounting Standards Codification or subject to a master netting arrangement or similar agreement. The Company adopted ASU 2013-
01 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the
Company.
ASU No. 2013-02, Comprehensive Income (Topic 220): “Reporting of Amounts Reclassified Out of Accumulated Other
Comprehensive Income” improves the transparency of reporting these reclassifications. The new amendments require an organization to:
present either on the face of the statement where income is presented or in the notes to the financial statements the effects on the line
items of net income of significant amounts reclassified out of accumulated other comprehensive income; or cross reference to other
disclosures currently required under GAAP for other reclassification items to be reclassified directly to income in their entirety in the
same reporting period. The amendments apply to all public and private companies that report other comprehensive income. The
Company adopted ASU 2013-02 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results
or financial position of the Company; however, see Note 20 to the consolidated financial statements for additional disclosures related to
the adoption of ASU No. 2013-02.
Accounting Guidance to be Adopted in Future Periods
ASU 2013-11, Income Taxes (Topic 740): “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a
Similar Tax Loss, or a Tax Credit Carryforward Exists,” requires an unrecognized tax benefit, or a portion of an unrecognized tax
benefit, be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax
loss, or a tax credit carryforward. If a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at
the reporting date, the unrecognized tax benefit should be presented in the financial statements as a liability and not combined with
deferred tax assets. This guidance is effective prospectively for fiscal years, and interim periods within those years beginning after
December 15, 2014, with early adoption permitted. The Company is evaluating the effect the adoption of ASU 2013-11 on January 1,
2015 may have on the operating results or financial position of the Company.
ASU 2014-04, Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40): “Reclassification of Residential Real Estate
Collateralized Consumer Mortgage Loans upon Foreclosure,” clarifies that an in substance repossession or foreclosure occurs, and a
creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan,
upon either (a) the creditor obtaining legal title to residential real estate property upon completion of a foreclosure or (b) the borrower
conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of
foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both the
amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans
collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable
jurisdiction. This guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15,
2014, with early adoption permitted. The adoption of this guidance on January 1, 2015 is not expected to have a material effect on the
operating results or financial position of the Company.
Reclassification of Prior Year Financial Statements
Certain reclassifications have been made to the prior year’s consolidated financial statements to conform to the current year’s
presentation. Such reclassifications had no impact on the Company’s results of operations.
Note 3. RESTRICTED CASH BALANCES
The Bank is required to maintain certain average reserve balances as established by the Federal Reserve Bank. The amount of those
reserve balances for the reserve computation period which included December 31, 2013 and 2012 was $1.4 million for both years, which
was satisfied through the restriction of vault cash and deposits maintained at the Federal Reserve Bank.
In addition, the Bank maintains compensating balances at correspondent banks, most of which are not required, but are used to offset
specific charges for services. At December 31, 2013 and 2012, the amount of these balances was $379 thousand and $378 thousand,
respectively.
80
Note 4. SECURITIES
Securities have been classified as available-for-sale or held-to-maturity in the consolidated financial statements according to
management’s intent. The following tables present the amortized cost, gross unrealized gains and losses, and the fair value of the
Company’s available-for-sale and held-to-maturity securities at and December 31, 2013 and 2012:
(in thousands)
Available-for-sale:
Obligations of state and political subdivisions
Government-sponsored agency:
Collateralized mortgage obligations
Residential mortgage-backed securities
Corporate debt securities
Equity securities
Total available-for-sale securities
Held-to-maturity:
Obligations of state and political subdivisions
(in thousands)
Available-for-sale:
Obligations of U.S. government agencies
Obligations of state and political subdivisions
Government-sponsored agency:
Collateralized mortgage obligations
Residential mortgage-backed securities
Corporate debt securities
Equity securities
Total available-for-sale securities
Held-to-maturity:
Obligations of state and political subdivisions
December 31, 2013
Gross
Unrealized
Holding
Gains
Gross
Unrealized
Holding
Losses
Fair
Value
Amortized
Cost
$
79,488
$
1,422
$
2,856
$
78,054
35,906
91,648
500
1,010
208,552
$
46
98
-
-
1,566
$
1,153
2,090
93
59
6,251
$
34,799
89,656
407
951
203,867
$
$
2,308
$
116
$
-
$
2,424
December 31, 2012
Gross
Unrealized
Holding
Gains
Gross
Unrealized
Holding
Losses
Fair
Value
Amortized
Cost
$
1,821
95,312
$
70
8,922
-
$
733
$
1,891
103,501
8,805
67,765
500
1,010
175,213
$
311
1,920
-
-
11,223
$
13
229
90
10
1,075
$
9,103
69,456
410
1,000
185,361
$
$
2,198
$
285
$
-
$
2,483
At December 31, 2013 and 2012, securities with a carrying amount of $204.2 million and $185.0 million, respectively, were pledged as
collateral to secure public deposits and for other purposes.
The following table shows the approximate fair value of the Company’s debt securities at December 31, 2013 using contractual
maturities. Expected maturities will differ from contractual maturity because issuers may have the right to call or prepay obligations
with or without call or prepayment penalties. Because collateralized mortgage obligations and mortgage-backed securities are not due at
a single maturity date, they are not included in the maturity categories in the following maturity summary.
81
(in thousands)
Amounts maturing in:
One year or less
One year through five years
After five years through ten years
After ten years
Collateralized mortgage obligations
Residential mortgage-backed securities
Total
December 31, 2013
Available-for-Sale
Held-to-Maturity
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
$
$
595
-
21,195
58,198
35,906
91,648
207,542
571
-
21,274
56,616
34,799
89,656
202,916
$
-
-
2,308
-
-
-
2,308
$
$
-
-
2,424
-
-
-
2,424
$
$
$
Gross proceeds from the sale of securities for the years ended December 31, 2013, 2012, and 2011 were $53.8 million, $46.1 million,
and $122.6 million, respectively, with the gross realized gains being $3.3 million, $1.4 million, $5.1 million, respectively, and gross
realized losses being $408 thousand, $3.1 million, and $2 thousand, respectively.
The following tables indicate the length of time that individual securities held-to-maturity and available-for-sale have been in a
continuous unrealized loss position at December 31, 2013 and 2012:
(in thousands)
Obligations of state and political subdivisions
Government-sponsored agency:
Collateralized mortgage obligations
Residential mortgage-backed securities
Corporate debt securities
Equity securities
Total
Less than 12 Months
Gross
Unrealized
Losses
Fair
Value
December 31, 2013
12 Months or Greater
Gross
Unrealized
Losses
Fair
Value
Total
Fair
Value
$
33,835
$
1,837
$
4,756
$
1,019
$
38,591
31,683
79,046
-
-
144,564
$
1,139
1,961
-
-
4,937
$
833
7,506
407
941
14,443
$
14
129
93
59
1,314
$
32,516
86,552
407
941
159,007
$
Gross
Unrealized
Losses
$
2,856
1,153
2,090
93
59
6,251
$
(in thousands)
Obligations of state and political subdivisions
Government-sponsored agency:
Collateralized mortgage obligations
Residential mortgage-backed securities
Corporate debt securities
Equity securities
Total
Less than 12 Months
Gross
Unrealized
Losses
$
Fair
Value
8,649
398
$
December 31, 2012
12 Months or Greater
Gross
Unrealized
Losses
$
Fair
Value
4,139
335
$
1,485
12,899
-
990
24,023
$
13
229
-
10
650
$
2
-
410
-
4,551
$
-
-
90
-
$
425
Total
Fair
Value
$
12,788
1,487
12,899
410
990
28,574
$
Gross
Unrealized
Losses
$
733
13
229
90
10
1,075
$
The majority of the Company’s securities portfolio is comprised of obligations of states and political subdivisions, residential mortgage-
backed securities, including home equity conversion mortgages, and collateralized mortgage obligations. The Company held 105
securities that were in an unrealized loss position at December 31, 2013, with 23 of those securities in an unrealized loss position for
more than 12 months. Substantially all of the unrealized losses relate to debt securities.
In determining whether unrealized losses are other-than-temporary, management considers the following factors:
• The causes of the decline in fair value, such as credit deterioration, interest rate fluctuations, or market volatility;
• The severity and duration of the decline;
• Whether or not the Company expects to receive all contractual cash flows;
82
• The Company’s ability and intent to hold the security to allow for recovery in fair value, as well as the likelihood of such a
recovery in the near term;
• The Company’s intent to sell the security, or if it is more likely than not that the Company will be required to sell the security,
before recovery of its amortized cost basis, less any current-period credit loss.
Management performed a review of the fair values of all securities as of December 31, 2013 and determined that movements in the fair
values of the securities were consistent with the change in market interest rates. As a result of its review and considering the attributes of
these debt securities, the Company concluded that the decreases in estimated fair value were temporary and OTTI did not exist at
December 31, 2013. To date, the Company has received all scheduled principal and interest payments and expects to fully collect all
future contractual principal and interest payments. The Company does not intend to sell the securities nor is it more likely than not that
the Company will be required to sell the securities.
Management does not believe that any individual unrealized loss at December 31, 2013 represents OTTI. The unrealized losses reported
for residential mortgage-backed securities and collateralized mortgage obligations relate entirely to securities issued by GNMA,
FHLMC and FNMA that are currently rated AAA by Moody’s Investor Services or Aaa by Standard & Poor’s and are guaranteed by the
U.S. government. The obligations of states and political subdivisions are comprised primarily of general-purpose debt obligations. The
majority of these obligations have a credit quality rating of A or better and are secured by the unlimited taxing power of the issuers. In
addition, the Company utilized a third party to perform an independent credit analysis of its state and political subdivision bonds that
were either non-rated or had a rating below A. There was one obligation of a state and political subdivision that had a rating below A.
According to the independent credit analysis, this bond was considered investment grade.
OTTI of Pooled Trust Preferred Collateralized Debt Obligations (“PreTSLs”):
At December 31, 2011, the Company held PreTSLs that were comprised of four securities collateralized by debt issued by bank holding
companies and insurance companies. The Company divested its holdings of PreTSLs during 2012 and held no such securities at
December 31, 2013 and 2012.
The table below provides a cumulative roll forward of OTTI credit losses recognized:
(in thousands)
Beginning Balance, January 1
Credit losses on debt securities for which OT T I was not previously recognized
Additional credit losses on debt securities for which OT T I was previously recognized
Less: Sale of Private Label CMOs for which OT T I was previously recognized
Less: Sale of PreT SLs for which OT T I was previously recognized
Ending Balance, December 31
2013
-
$
-
-
-
-
$
-
2012
$
8,619
-
96
-
(8,715)
$
-
$
2011
22,598
-
798
-
(14,777)
8,619
$
Investments in FHLB of Pittsburgh and FRB stock, which have limited marketability, are carried at cost and totaled $3.5 million and
$7.3 million at December 31, 2013 and 2012, respectively. Management noted no indicators of impairment for the FHLB of Pittsburgh
and the FRB of Philadelphia during 2013.
83
Note 5. LOANS
Loans receivable, net, consists of the following at December 31, 2013 and 2012:
(in thous ands )
Res idential real es tate
Commercial real es tate
Cons truction, land acquis ition and development
Commercial and indus trial
Cons umer
State and political s ubdivis ions
Total loans , gros s
Unearned income
Net deferred loan fees and cos ts
Allowance for loan and leas e los s es
Loans , net
December 31,
2013
$ 114,925
2012
$ 90,228
218,524
24,382
127,021
118,645
39,875
643,372
(143)
668
221,591
32,502
109,693
109,783
33,978
597,775
(103)
260
(14,017)
$ 629,880
(18,536)
$ 579,396
The Company has granted loans, letters of credit and lines of credit to certain executive officers and directors of the Company as well as
to certain related parties of executive officers and directors. These loans, letters of credit and lines of credit were made on substantially
the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons
and, when made, did not involve more than normal risk of collectability. Refer to Note 14 to these consolidated financial statements for
more information about related party transactions.
For information about credit concentrations within the Company’s loan portfolio, refer to Note 15 to these consolidated statements.
The Company originates one- to four-family mortgage loans for sale in the secondary market. During the years ended December 31,
2013, 2012 and 2011, the Company sold $12.6 million, $26.2 million and $28.1 million of one- to four-family mortgages, respectively.
The Company retains servicing rights on these mortgages.
The Company had $820 thousand and $1.6 million in loans held-for-sale at December 31, 2013 and 2012, respectively. All loans held
for sale are one- to four-family residential mortgage loans.
The Company sold one performing classified commercial real estate loan and five non-performing classified one- to four-family
residential mortgage loans during the year ended December 31, 2013. The loans had an aggregate recorded investment of $3.5 million at
the time of sale, after charge-offs recorded. There was a loss of $223 thousand recognized upon the sale of these loans which was
included in non-interest income in 2013. The Company sold three non-performing commercial real estate loans during the year ended
December 31, 2012. The three loans had an aggregate recorded investment of $6.8 million at the time of sale, after charge-offs recorded.
No gain or loss was recognized upon the sale of these loans in 2012.
The Company does not have any lending programs commonly referred to as subprime lending. Subprime lending generally targets
borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, and
bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios.
The Company provides for loan losses based on the consistent application of its documented ALLL methodology. Loan losses are
charged to the ALLL and recoveries are credited to it. Additions to the ALLL are provided by charges against income based on various
factors which, in management’s judgment, deserve current recognition of estimated probable losses. Loan losses are charged-off in the
period the loans, or portion thereof, are deemed uncollectible. Generally, the Company will record a loan charge-off (including a partial
charge-off) to reduce a loan to the estimated recoverable amount based on the methodology detailed below. The Company regularly
reviews the loan portfolio and makes adjustments for loan losses in order to maintain the ALLL in accordance with GAAP. The ALLL
consists primarily of the following two components:
(1)
Specific allowances are established for impaired loans, which are defined by the Company as all loan relationships with an
aggregate outstanding balance greater than $100 thousand that are rated substandard and on non-accrual status, rated doubtful or
loss, and all TDRs. The amount of impairment provided for as an allowance is represented by the deficiency, if any, between the
carrying value of the loan and either (a) the present value of expected future cash flows discounted at the loan’s effective interest
rate, (b) the loan’s observable market price, or (c) the fair value of the underlying collateral, less estimated costs to sell, for
84
collateral dependent loans. Impaired loans that have no impairment losses are not considered for general valuation allowances
described below. If the Company determines that collection of the impairment amount is remote, the Company will record a
charge-off.
(2)
General allowances are established for loan losses on a portfolio basis for loans that do not meet the definition of impaired. The
Company divides its portfolio into loan segments, with loans exhibiting similar characteristics. Loans rated special mention or
substandard and accruing which are embedded in these loan segments are then separated from these loan segments. These loans
are then subject to an analysis placing increased emphasis on the credit risk associated with these types of loans. The Company
applies an estimated loss rate to each loan group. The loss rates applied are based on the Company’s own historical loss
experience based on the loss rate for each segment of loans with similar risk characteristics in its portfolio. In addition
management evaluates and applies certain qualitative or environmental factors that are likely to cause estimated credit losses
associated with the Company’s existing portfolio that may differ from historical experience, which are discussed below. This
evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon
changes in economic and real estate market conditions. Actual loan losses may be significantly more than the ALLL that is
established, which could have a material negative effect on the Company’s operating results or financial condition.
Management makes adjustments for loan losses based on its evaluation of several qualitative and environmental factors, including but
not limited to:
•
•
•
•
•
•
•
•
•
Changes in national, local, and business economic conditions and developments, including the condition of various market
segments;
Changes in the nature and volume of the Company’s loan portfolio;
Changes in the Company’s lending policies and procedures, including underwriting standards, collection, charge-off and
recovery practices and results;
Changes in the experience, ability and depth of the Company’s lending management and staff;
Changes in the quality of the Company's loan review system and the degree of oversight by the Company’s Board of Directors;
Changes in the trend of the volume and severity of past due and classified loans, including trends in the volume of non-accrual
loans, TDRs and other loan modifications;
The existence and effect of any concentrations of credit and changes in the level of such concentrations;
The effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses
in the Company's current loan portfolio; and
Analysis of our customers’ credit quality, including knowledge of their operating environment and financial condition.
Management evaluates the ALLL based on the combined total of the specific and general components. Generally, when the loan
portfolio increases, absent other factors, the ALLL methodology results in a higher dollar amount of estimated probable losses.
Conversely, when the loan portfolio decreases, absent other factors, the ALLL methodology results in a lower dollar amount of
estimated probable losses.
Each quarter, management evaluates the ALLL and adjusts the ALLL as appropriate through a provision for loan losses. While the
Company uses the best information available to make evaluations, future adjustments to the ALLL may be necessary if conditions differ
substantially from the information used in making the evaluations. In addition, as an integral part of its examination process, the Office
of the Comptroller of the Currency (“OCC”) periodically reviews the Company’s ALLL. The OCC may require the Company to adjust
the ALLL based on its analysis of information available to it at the time of its examination.
In the fourth quarter of 2012, the Company changed its loan segment structure to combine the indirect auto loans and
installment/HELOC loans, which were previously considered separate classes of consumer loans. Management determined that both
loan classes exhibited similar risk characteristics and therefore did not need to be separately evaluated in the ALLL calculation. In
addition, the Company no longer segregates solid waste landfill loans from other commercial and industrial loans. During 2012, a
significant amount of the solid waste landfill loans were paid off. The remaining balance of these loans was not material to warrant
evaluation as a separate class at December 31, 2013 and 2012.
The following tables present activity in the ALLL, by loan category, the amount of gross loans receivable that are evaluated individually
and collectively for impairment, and the related portion of the ALLL that is allocated to each loan portfolio segment for the years ended
December 31, 2013, 2012 and 2011:
85
Allowance for Loan and Lease Losses by Loan Category
December 31, 2013
Real Estate
Residential
Real Estate
Commercial
Real Estate
Construction,
Land
Acquisition and
Development
Commercial
and Industrial
Consumer
State and
Political
Subdivisions
Total
$
$
$
$
$
$
$
1,764
(664)
343
844
2,287
8,062
(65)
879
(2,859)
6,017
2,162
(179)
130
(1,189)
924
4,167
(341)
1,853
(3,358)
2,321
1,708
(655)
450
286
1,789
673
-
-
6
679
18,536
(1,904)
3,655
(6,270)
14,017
$
$
$
$
$
$
$
$
12
$
296
$
1
$
-
$
1
$
-
$
310
$
2,275
$
5,721
$
923
$
2,321
$
1,788
$
679
$
13,707
(in thousands)
Allowance for loan losses:
Beginning balance, January 1, 2013
Charge-offs
Recoveries
Provisions (credits)
Ending balance, December 31, 2013
Ending balance, December 31, 2013:
Individually evaluated for impairment
Ending balance, December 31, 2013:
Collectively evaluated for impairment
Loans receivable:
Ending balance, December 31, 2013
$
114,925
$
218,524
$
24,382
$
127,021
$
118,645
$
39,875
$
643,372
Ending balance, December 31, 2013:
Individually evaluated for impairment
Ending balance, December 31, 2013:
Collectively evaluated for impairment
$
1,985
$
6,626
$
306
$
-
$
316
$
-
$
9,233
$
112,940
$
211,898
$
24,076
$
127,021
$
118,329
$
39,875
$
634,139
Allowance for Loan and Lease Losses by Loan Category
December 31, 2012
Real Estate
Residential
Real Estate
Commercial
Real Estate
Construction,
Land
Acquisition and
Development
Commercial
and Industrial
Consumer
State and
Political
Subdivisions
Total
$
$
$
$
$
$
$
1,823
(683)
35
589
1,764
11,151
(3,298)
1,035
(826)
8,062
2,590
(258)
265
(435)
2,162
3,292
(3,389)
265
3,999
4,167
1,526
(673)
338
517
1,708
452
-
-
221
673
20,834
(8,301)
1,938
4,065
18,536
$
$
$
$
$
$
$
$
40
$
268
$
2
$
-
$
-
$
-
$
310
$
1,724
$
7,794
$
2,160
$
4,167
$
1,708
$
673
$
18,226
(in thousands)
Allowance for loan losses:
Beginning balance, January 1, 2012
Charge-offs
Recoveries
Provisions (credits)
Ending balance, December 31, 2012
Ending balance, December 31, 2012:
Individually evaluated for impairment
Ending balance, December 31, 2012:
Collectively evaluated for impairment
Loans receivable:
Ending balance, December 31, 2012
$
90,228
$
221,591
$
32,502
$
109,693
$
109,783
$
33,978
$
597,775
Ending balance, December 31, 2012:
Individually evaluated for impairment
Ending balance, December 31, 2012:
Collectively evaluated for impairment
$
2,773
$
11,459
$
993
$
-
$
-
$
-
$
15,225
$
87,455
$
210,132
$
31,509
$
109,693
$
109,783
$
33,978
$
582,550
86
Allowance for Loan and Lease Losses by Loan Category
December 31, 2011
Real Estate
Commercial and Industrial
Consumer
Residential
Real Estate
Commercial
Real Estate
Construction,
Land
Acquisition and
Development
Solid Waste
Landfills
Commercial
and
Industrial
Indirect
Auto
Installment/
HELOC
State and
Political
Subdivisions
Total
$
$
$
$
$
$
$
$
$
2,176
(1,273)
57
863
1,823
9,640
(2,395)
93
3,813
11,151
4,170
(1,857)
2,188
(1,911)
2,590
11
-
-
5
16
4,839
(416)
1,852
(2,999)
3,276
597
(530)
219
516
802
576
(209)
7
350
724
566
-
-
(114)
452
22,575
(6,680)
4,416
523
20,834
$
$
$
$
$
$
$
$
$
$
65
$
545
$
91
$
-
$
-
$
-
$
-
$
-
$
701
$
1,758
$
10,606
$
2,499
$
16
$
3,276
$
802
$
724
$
452
$
20,133
(in thousands)
Allowance for loan losses:
Beginning balance, January 1, 2011
Charge-offs
Recoveries
Provisions (credits)
Ending balance, December 31, 2011
Ending balance, December 31, 2011:
Individually evaluated for impairment
Ending balance, December 31, 2011:
Collectively evaluated for impairment
Loans receivable:
Ending balance, December 31, 2011
$
80,056
$
256,508
$
33,450
$
42,270
$
131,963
$
63,722
$
48,056
-
23,496
$
$
679,521
Ending balance, December 31, 2011:
Individually evaluated for impairment
Ending balance, December 31, 2011:
Collectively evaluated for impairment
$
3,615
13,012
2,979
-
4,066
-
31
-
$
23,703
$
76,441
$
243,496
$
30,471
$
42,270
$
127,897
$
63,722
$
48,025
$
23,496
$
655,818
Credit Quality Indicators – Commercial Loans
The Company continuously monitors the credit quality of its commercial loans. Credit quality is monitored by reviewing certain credit
quality indicators. Management has determined that its credit risk ratings are the key credit quality indicator that best assist management
in monitoring the credit quality of the Company’s loan receivables.
The Bank’s commercial loan classification and credit grading processes are part of the lending, underwriting, and credit administration
functions to ensure an ongoing assessment of credit quality. Accurate and timely loan classification and credit grading is a critical
component of loan portfolio management. Loan officers are required to review their loan portfolio risk ratings regularly for accuracy.
The loan review function uses the same risk rating system in the loan review process. This allows an independent third party to assess
the quality of the portfolio and compare the accuracy of ratings with the loan officer’s and management’s assessment.
A formal loan classification and credit grading system reflects the risk of default and credit losses. A written description of the risk
ratings is maintained that includes a discussion of the factors used to assign appropriate classifications of credit grades to loans. The
process identifies groups of loans that warrant the special attention of management. The risk grade groupings provide a mechanism to
identify risk within the loan portfolio and provide management and the Board with periodic reports by risk category. The credit risk
ratings play an important role in the establishment and evaluation of the provision for loan and lease losses and the ALLL. After
determining the historical loss factor which is adjusted for qualitative and environmental factors for each portfolio segment, the portfolio
segment balances that have been collectively evaluated for impairment are multiplied by the general reserve loss factor for the respective
portfolio segments in order to determine the general reserve. Loans that have an internal credit rating of special mention or substandard
follow the same process; however, the qualitative and environmental factors are further adjusted for the increased risk.
The Company utilizes a loan rating system that assigns a degree of risk to commercial loans based on relevant information about the
ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation,
public information and current economic trends, among other factors. Management analyzes these non-homogeneous loans individually
by grading the loans as to credit risk and probability of collection for each type of loan. Commercial loans include commercial indirect
auto loans which are not individually risk rated, and Construction, Land Acquisition and Development Loans include residential
construction loans which are also not individually risk rated. These loans are monitored on a pool basis due to their homogeneous nature
as described in “Credit Quality Indicators – Other Loans” below. The Company risk rates certain residential real estate loans and
consumer loans that are part of a larger commercial relationship using its credit grading system. These loans are described in
“Commercial Credit Quality Indicators.” The grading system contains the following basic risk categories:
1. Minimal Risk
2. Above Average Credit Quality
3. Average Risk
4. Acceptable Risk
5. Pass - Watch
6. Special Mention
87
7. Substandard - Accruing
8. Substandard - Non-Accrual
9. Doubtful
10. Loss
This analysis is performed on a quarterly basis using the following definitions for risk ratings:
Pass - Assets rated 1 through 5 are considered pass ratings. These assets show no current or potential problems and are considered fully
collectible. All such loans are considered collectively for ALLL calculation purposes. However, accruing TDRs that have been
performing for an extended period of time, do not represent a higher risk of loss, and have been upgraded to a pass rating are evaluated
individually for impairment.
Special Mention – Assets classified as special mention assets do not currently expose the Company to a sufficient degree of risk to
warrant an adverse classification but do possess credit deficiencies or potential weaknesses deserving close attention. Special Mention
assets have a potential weakness or pose an unwarranted financial risk which, if not corrected, could weaken the asset and increase risk
in the future.
Substandard - Assets classified as substandard have well defined weaknesses based on objective evidence, and are characterized by the
distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful - Assets classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic
that the weaknesses present make collection or liquidation in full highly questionable and improbable based on current circumstances.
Loss - Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets is not
warranted.
The following tables present the recorded investment in loans receivable by the aforementioned class of loan and credit quality
indicator at December 31, 2013 and 2012:
Commercial Credit Quality Indicators
December 31, 2013
Real Estate
Residential Real
Estate
Commercial Real
Estate
Construction,
Land Acquisition
and Development
Commercial and
Industrial
Consumer
State and
Political
Subdivisions
Total
$
$
$
$
$
19,050
869
1,347
-
-
21,266
$
191,601
12,568
14,355
-
-
$
218,524
13,781
1,361
6,168
-
-
21,310
$
113,048
3,777
4,525
-
-
$
121,350
$
$
$
$
$
Commercial Credit Quality Indicators
December 31, 2012
Real Estate
Residential Real
Estate
Commercial Real
Estate
Construction,
Land Acquisition
and Development
Commercial and
Industrial
Consumer
State and
Political
Subdivisions
Total
$
$
$
$
$
$
$
17,138
564
2,309
-
-
20,011
189,903
8,587
23,101
-
-
221,591
23,052
57
7,395
-
-
30,504
93,484
7,437
3,395
-
-
104,316
$
$
$
$
$
$
$
39,151
-
724
-
-
39,875
28,204
849
4,925
-
-
33,978
379,177
18,575
27,276
-
-
425,028
355,105
17,494
41,268
-
-
413,867
2,546
-
157
-
-
2,703
3,324
-
143
-
-
3,467
(in thousands)
Internal risk rating
Pass
Special mention
Substandard
Doubtful
Loss
Total
(in thousands)
Internal risk rating
Pass
Special mention
Substandard
Doubtful
Loss
Total
Credit Quality Indicators – Other Loans
Certain residential real estate loans, consumer loans, and commercial indirect auto loans are monitored on a pool basis due to their
homogeneous nature. Loans that are delinquent 90 days or more are placed on non-accrual status. The Company utilizes accruing versus
non-accruing status as the credit quality indicator for these loan pools. The following tables present the recorded investment in
88
residential real estate loans, consumer loans and commercial indirect auto loans based on payment activity at December 31, 2013 and
2012:
Other Loans Credit Quality Indicators
December 31, 2013
Accruing
Loans
$
Non-accruing
Loans
$
Total
$
(in thousands)
Residential real estate
Construction, land acquisition and development - residential
Commercial - indirect auto
Consumer
Total
$
$
$
Other Loans Credit Quality Indicators
December 31, 2012
Accruing
Loans
$
Non-accruing
Loans
$
Total
$
92,181
3,072
5,671
115,809
216,733
68,446
1,998
5,377
106,272
182,093
1,478
-
-
133
1,611
1,771
-
-
44
1,815
93,659
3,072
5,671
115,942
218,344
70,217
1,998
5,377
106,316
183,908
(in thousands)
Residential real estate
Construction, land acquisition and development - residential
Commercial - indirect auto
Consumer
Total
$
$
$
Included in loans receivable are loans for which the accrual of interest income has been discontinued due to deterioration in the financial
condition of the borrowers. The recorded investment of these non-accrual loans was $6.4 million and $9.7 million at December 31, 2013
and 2012, respectively. Generally, loans are placed on non-accruing status when they become 90 days or more delinquent, and remain
on non-accrual status until they are brought current, have six months of performance under the loan terms, and factors indicating
reasonable doubt about the timely collection of payments no longer exists. Therefore, loans may be current in accordance with their loan
terms, or may be less than 90 days delinquent and still be on a non-accruing status. Loans past due 90 days or more and still accruing
interest were $19 thousand and $57 thousand at December 31, 2013 and 2012, respectively, and consisted of loans that are well secured
and in the process of renewal.
89
The following tables set forth the detail, and delinquency status, of past due and non-accrual loans at December 31, 2013 and 2012:
(in thousands)
Performing (accruing) loans:
Real estate:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Total real estate
Commercial and industrial
Consumer
State and political subdivisions
Total peforming (accruing) loans
Non-accrual loans:
Real estate:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Total real estate
Commercial and industrial
Consumer
State and political subdivisions
Total non-accrual loans
Total loans receivable
Performing and Non-Performing Loan Delinquency Status
0-29 Days
Past Due
30-59 Days
Past Due
December 31, 2013
Delinquency Status
60-89 Days
Past Due
>/= 90 Days
Past Due
Total
$
112,519
213,660
24,259
350,438
$
571
629
78
1,278
$
116
-
-
116
-
$
-
-
-
$
113,206
214,289
24,337
351,832
126,441
116,710
39,875
633,464
570
4,183
-
4,753
181
14
-
4,948
232
1,420
-
2,930
73
52
-
125
-
31
-
156
125
362
-
603
51
-
45
96
23
16
-
135
19
-
-
19
1,025
-
-
1,025
-
92
-
1,117
126,817
118,492
39,875
637,016
1,719
4,235
45
5,999
204
153
-
6,356
$
638,412
$
3,086
$
738
$
1,136
$
643,372
90
(in thousands)
Performing (accruing) loans:
Real estate:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Total real estate
Commercial and industrial
Consumer
State and political subdivisions
Total peforming (accruing) loans
Non-accrual loans:
Real estate:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Total real estate
Commercial and industrial
Consumer
State and political subdivisions
Total non-accrual loans
Total loans receivable
Performing and Non-Performing Loan Delinquency Status
0-29 Days
Past Due
30-59 Days
Past Due
December 31, 2012
Delinquency Status
60-89 Days
Past Due
>/= 90 Days
Past Due
Total
$
86,301
216,100
31,899
334,300
$
422
194
29
645
$
31
-
-
31
$
30
-
-
30
$
86,784
216,294
31,928
335,006
108,932
107,821
33,978
585,031
953
250
446
1,649
61
2
-
1,712
517
1,489
-
2,651
105
121
-
226
30
-
-
256
20
333
-
384
230
4,352
-
4,582
11
2
-
4,595
27
-
-
57
2,156
574
128
2,858
95
136
-
3,089
109,496
109,643
33,978
588,123
3,444
5,297
574
9,315
197
140
-
9,652
$
586,743
$
2,907
$
4,979
$
3,146
$
597,775
91
Impaired Loans
The following tables present a distribution of the recorded investment, unpaid principal balance and related allowance for the
Company’s impaired loans, which have been analyzed for impairment under ASC 310, at December 31, 2013 and 2012. Non-accrual
loans other than TDRs, with balances less than the $100 thousand loan relationship threshold are not evaluated individually for
impairment and are accordingly not included in the following tables. However, these loans are evaluated collectively for impairment as
homogenous pools in the general allowance under ASC Topic 450. Total non-accrual loans, other than TDRs, with balances less than the
$100 thousand loan relationship threshold that were evaluated under ASC Topic 450 amounted to $1.1 million and $1.9 million at
December 31, 2013 and 2012, respectively.
(in thousands)
With no allowance recorded:
Real estate:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Total real estate loans
Commercial and industrial
Consumer
State and political subdivisions
Total impaired loans with no related allowance recorded
With a related allowance recorded:
Real estate:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Total real estate loans
Commercial and industrial
Consumer
State and political subdivisions
Total impaired loans with a related allowance recorded
Total of impaired loans
Real estate:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Total real estate loans
Commercial and industrial
Consumer
State and political subdivisions
Total impaired loans
December 31, 2013
Recorded
Investment
Unpaid Principal
Balance
Related
Allowance
$
1,043
4,060
-
5,103
$
1,125
4,435
-
5,560
$
-
-
-
-
-
-
-
5,103
-
942
2,566
306
3,814
-
316
-
4,130
1,985
6,626
306
8,917
-
316
-
-
-
-
5,560
946
2,566
306
3,818
-
316
-
4,134
2,071
7,001
306
9,378
-
316
-
-
-
-
-
12
296
1
309
-
1
-
310
12
296
1
309
-
1
-
$
9,233
$
9,694
$
310
92
(in thousands)
With no allowance recorded:
Real estate:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Total real estate loans
Commercial and industrial
Consumer
State and political subdivisions
Total impaired loans with no related allowance recorded
With a related allowance recorded:
Real estate:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Total real estate loans
Commercial and industrial
Consumer
State and political subdivisions
Total impaired loans with a related allowance recorded
Total of impaired loans
Real estate:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Total real estate loans
Commercial and industrial
Consumer
State and political subdivisions
Total impaired loans
December 31, 2012
Recorded
Investment
Unpaid Principal
Balance
Related
Allowance
$
1,275
389
709
2,373
$
1,378
665
804
2,847
-
$
-
-
-
-
-
-
2,373
1,498
11,070
284
12,852
-
-
-
12,852
2,773
11,459
993
15,225
-
-
-
-
-
2,847
-
-
-
-
1,512
11,070
284
12,866
40
268
2
310
-
-
-
12,866
2,890
11,735
1,089
15,714
-
-
-
-
-
310
40
268
2
310
-
-
$
-
15,225
$
-
15,714
$
-
310
The total recorded investment in impaired loans, which consists of non-accrual loans with an aggregate loan relationship greater than
$100,000 and TDRs, amounted to $9.2 million and $15.2 million at December 31, 2013 and 2012, respectively. The related allowance
on impaired loans was $0.3 million as of both December 31, 2013 and 2012.
93
The following table presents the average balance and the interest income recognized on impaired loans for the years ended December 31,
2013, 2012, and 2011:
(in thous ands )
Real estate:
Res idential real estate
Commercial real es tate
Construction, land acquisition and development
Total real estate
Commercial and indus trial
Consumer
State and political s ubdivis ions
2013
2012
2011
Average
Balance
Interes t
Income (1)
Average
Balance
Interes t
Income (1)
Average
Balance
Interes t
Income (1)
Year Ended December 31,
$
2,301
$
22
$
3,882
$
11
$
2,834
$
7
10,004
761
13,066
-
79
-
313
28
363
-
-
3
14,196
2,340
20,418
2,521
232
157
328
37
376
-
-
-
12,827
6,445
22,106
4,971
58
-
184
38
229
9
-
-
Total impaired loans
$
13,145
$
366
$
23,328
$
376
$
27,135
$
238
(1) Interest income repres ents income recognized on performing TDRs .
Included in total impaired loans are accruing TDRs of $4.0 million and $7.5 million as of December 31, 2013 and 2012, respectively.
The Bank was not committed to lend additional funds to loans classified as a TDR as of December 31, 2013.
The additional interest income that would have been earned on non-accrual and restructured loans for the years ended December 31,
2013, 2012, and 2011 had these loans performed in accordance with their original terms approximated $572 thousand, $1.4 million, and
$2.2 million, respectively.
Troubled Debt Restructured Loans
TDRs at December 31, 2013 and 2012 were $8.1 million and $8.9 million, respectively. Accruing and non-accruing TDRs were $4.0
million and $4.1 million, respectively at December 31, 2013 and $7.5 million and $1.4 million, respectively at December 31, 2012.
Approximately $301 thousand and $257 thousand in specific reserves have been established for these loans as of December 31, 2013
and 2012, respectively.
The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the
loan, an extension of the maturity date, or a permanent reduction of the recorded investment in the loan.
The following tables show the pre- and post- modification recorded investment in loans modified as TDRs during the years ended
December 31, 2013 and 2012:
(dollars in thousands)
Troubled debt restructuring:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Commercial and industrial
Consumer
Total new troubled debt restructuring
Year Ended December 31, 2013
Year Ended December 31, 2012
Pre-
Modification
Outstanding
Recorded
Investments
Post-
Modification
Outstanding
Recorded
Investments
Number of
Contracts
Pre-
Modification
Outstanding
Recorded
Investments
Post-
Modification
Outstanding
Recorded
Investments
Number of
Contracts
16
2
-
-
2
20
$
827
4,561
-
-
318
5,706
$ 947
4,561
-
-
318
5,826
1
3
1
-
5
$
624
2,428
39
-
$ 624
2,428
39
-
3,091
3,091
One of the loans modified as a TDR during the year ended December 31, 2013 is supported by a 90.0% guarantee by the Small Business
Administration. The unguaranteed portion of this loan was $395 thousand and the restruction had no effect on the ALLL at December
31, 2013. The remaining TDRs described above increased the allowance for loan losses by $6 thousand and $224 thousand through
allocation of a specific reserve for the years ended December 31, 2013 and 2012, respectively. There were no charge-offs that resulted
from the TDRs described above during the year ended December 31, 2013 or 2012.
94
The following table shows the types of modifications made during the years ended December 31, 2013 and 2012:
(in thousands)
Type of modification:
Extension of term
Extension of term and capitalization of taxes
Principal forebearance
Capitalization of taxes
Total modifications
(in thousands)
Type of modification:
Extension of term
Extension of term and rate concession
Total modifications
Residential
Real Estate
Commercial
Real Estate
$
41
860
-
46
947
$
-
-
4,561
-
4,561
$
$
Residential
Real Estate
Commercial
Real Estate
Year Ended December 31, 2013
Construction,
Land Acquisition
and
Development
$
-
-
-
-
$
-
Commercial
and
Industrial
$
-
-
-
-
$
-
Year Ended December 31, 2012
Construction,
Land Acquisition
and
Development
Commercial
and
Industrial
Consumer
Total
$
$
318
-
-
-
318
359
860
4,561
46
5,826
$
$
Consumer
Total
$
$
$
624
-
624
432
1,996
2,428
$
$
$
39
-
39
-
$
-
$
-
-
$
-
$
-
$
$
1,095
1,996
3,091
The following table summarizes TDRs which have re-defaulted (defined as past due 90 days) during the years ended December 31, 2013
and 2012 that were restructured within the twelve months prior to such re-default:
(dollars in thousands)
Residential real estate
Commercial real estate
Construction, land acquisition and development
Commercial and industrial
Total
Note 6. OTHER REAL ESTATE OWNED
Year Ended December 31, 2013
Year Ended December 31, 2012
Number of
Contracts
Recorded
Investment
Number of
Contracts
Recorded
Investment
$
$
1
-
-
-
1
27
-
-
-
27
2
-
1
-
3
196
-
408
-
604
$
$
The following schedule presents the composition of OREO at December 31, 2013 and 2012:
(in thous ands )
Land / lots
Commercial real es tate
Res idential real es tate
Total other real es tate owned
December 31,
2013
2012
$
$
3,549
647
50
4,246
2,711
1,245
27
3,983
$
$
The following table presents the activity in OREO for the years ended December 31, 2013, 2012 and 2011:
(in thousands)
Balance, beginning of year
Loans transferred to OREO
Bank premises transferred to OREO
Valuation adjustments
Carrying value of OREO sold
Balance, end of year
For the Years Ended December 31,
2013
2012
2011
$
3,983
$
6,958
$
9,633
255
1,819
(223)
(1,588)
1,586
-
(1,206)
(3,355)
3,995
-
(2,318)
(4,352)
$
4,246
$
3,983
$
6,958
During 2013, the Company transferred three vacant lots with an aggregate carrying value of $1.8 million to OREO from bank premises
and equipment that were previously held for future expansion and are now being held for sale. The three lots were written down to fair
95
value less cost to sell of $1.7 million. The Company recognized a valuation adjustment of $69 thousand at the time of transfer, which is
included in non-interest expense.
The following table presents the components of net expense of OREO for the years ended December 31, 2013, 2012 and 2011:
For the Years Ended December 31,
$
$
$
(in thousands)
Insurance
Legal fees
Maintenance
(Income) losses from the operation of foreclosed properties
Professional Fees
Real estate taxes
Utilities
Impairment charges
Other
Total
2013
147
131
82
(27)
35
122
6
223
-
719
2012
65
66
147
24
211
287
21
1,206
-
2,027
$
$
$
2011
58
235
63
22
250
724
48
2,318
2
3,720
Note 7. BANK PREMISES AND EQUIPMENT
The following table summarizes bank premises and equipment at December 31, 2013 and 2012:
(in thousands)
Land
Buildings and improvements
Furniture, fixtures and equipment
Leasehold improvements
Total
Accumulated depreciation
Net
December 31,
2013
2012
$
4,191
$
6,779
10,126
12,575
4,953
31,845
(16,482)
10,612
12,106
4,689
34,186
(15,249)
$
15,363
$
18,937
Depreciation and amortization expense amounted to $1.3 million, $1.4 million and $1.3 million for the years ended December 31, 2013,
2012, and 2011, respectively.
On December 31, 2013, the Company sold one of its administrative facilities located in Luzerne County, PA, with a carrying value of
$1.2 million for $1.8 million. The Company recognized a gain of $579 thousand on the sale which is included in non-interest income.
Note 8. SERVICING
The Company originates one-to-four-family residential loans that it sells in the secondary market. Servicing of these loans is retained by
the Company. The Company also performs servicing for a pool of automobile loans sold in 2010. Loans serviced for others are not
included in the accompanying consolidated statements of financial condition, but the related servicing income and expenses are
recognized in the consolidated statements of operations. The unpaid balances of mortgage and other loans serviced for others were
$130.5 million, $154.5 million and $180.0 million at December 31, 2013, 2012, and 2011, respectively.
The one- to four-family residential mortgage real estate loans were underwritten to Freddie Mac guidelines and were subsequently
assigned and delivered to Freddie Mac. At December 31, 2013, substantially all of the loans serviced for others were performing in
accordance with their contractual terms.
96
The following table summarizes the activity pertaining to mortgage servicing rights for the years ended December 31, 2013 and 2012:
(in thousands)
Balance, beginning of year
Mortgage servicing rights capitalized
Amortization
Balance, end of year
For the Year Ended December 31,
2013
2012
$
675
$
777
119
(265)
220
(322)
$
529
$
675
The fair value of all servicing assets was $990 thousand and $884 thousand at December 31, 2013 and 2012, respectively. Fair value has
been determined using discount rates ranging from 2.75% to 8.31% and prepayment speeds ranging from 108% to 550% PSA,
depending upon the stratification of the specific right. Based upon this fair value, management has determined that no valuation
allowance associated with these mortgage servicing rights is necessary at December 31, 2013 and 2012.
Note 9. INTANGIBLE ASSETS
Intangible assets consist entirely of a core deposit premium acquired in connection with the purchase of the Honesdale branch in
2006. The core deposit intangible is being amortized, using the straight-line method over the useful life of 10 years. Management
reviews the core deposit intangible at least annually for potential impairment. Management’s evaluation at December 31, 2013 and 2012
indicated that there was no impairment to the core deposit intangible.
The following table summarizes core deposit intangible assets at December 31, 2013 and 2012:
(in thous ands )
Gros s carrying amount
Accumulated amortization
Net carrying amount
December 31,
2013
2012
$
1,650
$
1,650
(1,183)
(1,018)
$
467
$
632
Amortization expense on core deposit intangible assets totaled $165 thousand in 2013, $165 thousand in 2012 and $166 thousand in
2011. Amortization expense on core deposit intangible assets with finite useful lives is expected to total $165 thousand for each of the
years 2014 and 2015, and $137 thousand for 2016.
Note 10. DEPOSITS
The following table summarizes deposits at December 31, 2013 and 2012:
(in thous ands )
Demand (non-interes t bearing)
Interes t-bearing:
Interes t-bearing demand
Savings
Time ($100,000 and over)
Other time
Total interes t-bearing
Total depos its
December 31,
2013
2012
$
157,550
$
131,476
334,742
87,806
161,959
142,641
727,148
321,863
83,101
144,844
173,329
723,137
$
884,698
$
854,613
The Company had brokered deposits, which are classified as other time deposits in the above table, of $5.0 million and $15.7 million, at
December 31, 2013 and 2012, respectively.
97
The following table summarizes scheduled maturities of time deposits, including certificates of deposit and individual retirement
accounts, at December 31, 2013:
(in thousands)
2014
2015
2016
2017
2018
2019 and thereafter
Total
Time Deposits
$100,000
and Over
Other
Time Deposits
Total
$
99,990
$
76,997
$
176,987
48,950
9,970
1,123
1,760
166
36,483
16,491
5,923
6,211
536
85,433
26,461
7,046
7,971
702
$
161,959
$
142,641
$
304,600
Investment securities with a carrying value of $204.2 million and $185.0 million at December 31, 2013 and 2012, respectively, were
pledged to collateralize certain municipal deposits.
Note 11. BORROWED FUNDS
The following table summarizes the components of borrowed funds at December 31, 2013 and 2012:
(in thousands)
FHLB advances
Subordinated debentures
Junior subordinated debentures
Total
December 31,
2013
2012
$
27,123
$
18,593
25,000
10,310
25,000
10,310
$
62,433
$
53,903
The Company also utilizes short-term Federal funds purchased which represent overnight borrowings providing for the short-term
funding requirements of the Bank and generally mature within one business day of the transaction. The Company did not purchase any
short-term Federal funds during the years ended December 31, 2013. Federal Reserve Discount Window borrowings also represent
overnight funding to meet the short-term liquidity requirements of the Bank and are fully collateralized with investment securities.
Other than testing its availability for contingency funding planning purposes, the Company did not borrow from the Federal Reserve
Discount Window during the year ended December 31, 2013.
The following table presents borrowed funds by their maturity dates at December 31, 2013:
(in thousands)
Within one year
After one year but within two years
After two years but within three years
After three years but within four years
After four years but within five years
After five years
Total
December 31, 2013
Amount
Weighted
Average
Interest Rate
$
10,000
10,000
5,000
10,000
10,000
17,433
62,433
$
1.92%
4.76%
9.00%
4.92%
5.02%
4.19%
4.55%
The FHLB of Pittsburgh borrowings of $27.1 million are all fixed-rate advances having maturities of 90 days or more, and are
collateralized either under a blanket pledge agreement for commercial real estate loans, one- to four-family mortgage loans, or
mortgage-backed securities. In addition, the Company is required to purchase FHLB stock based upon the amount of advances
98
outstanding. The Company was in compliance with this requirement, having a stock investment in FHLB of Pittsburgh of $2.1 million
at December 31, 2013. Loans of $160.5 million and $118.9 million, at December 31, 2013 and 2012, respectively, were pledged to
collateralize FHLB advances.
The maximum amount of borrowings outstanding at any month end during the years ended December 31, 2013 and 2012 was $79.8
million and $82.3 million, respectively.
On December 14, 2006, First National Community Statutory Trust I (the “Trust”), a trust formed under Delaware law that is an
unconsolidated subsidiary of the Company, issued $10.0 million of trust preferred securities (the “Trust Securities”) at a variable interest
rate of 7.02%, with a scheduled maturity of December 15, 2036. The Company owns all of the ownership interest in the Trust. The
proceeds from the issue were invested in $10.3 million, 7.02% Junior Subordinated Debentures (the “Debentures”) issued by the
Company. The interest rate on the Trust Securities and the Debentures resets quarterly at a spread of 1.67% above the current 3-month
Libor rate. The average interest rate paid on the Debentures was 1.97% in 2013, 2.18% in 2012, and 2.00% in 2011. The Debentures
are unsecured and rank subordinate and junior in right to all indebtedness, liabilities and obligations of the Company. The Debentures
represent the sole assets of the Trust. Interest on the Trust Securities is deferrable until a period of twenty consecutive quarters has
elapsed. The Company had the option, subject to required regulatory approval of the Federal Reserve, to prepay the trust securities
beginning December 15, 2011. The Company has, under the terms of the Debentures and the related Indenture, as well as the other
operative corporate documents, agreed to irrevocably and unconditionally guarantee the Trust’s obligations under the Debentures. At
December 31, 2013 and 2012, accrued and unpaid interest associated with the Debentures amounted to $695 thousand and $491
thousand, respectively.
The Company has reflected this investment on a deconsolidated basis. As a result, the Debentures totaling $10.3 million, have been
reflected in Borrowed Funds in the consolidated statements of financial condition at December 31, 2013 and 2012 under the caption
“Junior Subordinated Debentures”. The Company records interest expense on the Debentures in its consolidated statement of
operations. The Company also records its common stock investment issued by First National Community Statutory Trust I in “Other
Assets” in its consolidated statements of financial condition at December 31, 2013 and 2012.
On September 1, 2009, the Company offered only to accredited investors up to $25.0 million principal amount of unsecured
Subordinated Notes Due September 1, 2019 at a fixed interest rate of 9% per annum (the “Notes”) in denominations of $100 thousand
and integral multiples of $100 thousand in excess thereof. The Notes mature on September 1, 2019. For the first five years from
issuance, the Company will pay interest only on the Notes. Commencing September 1, 2015, the Company is required to pay both
interest and a portion of the principal calculated to return the entire principal amount of the Notes at maturity subject to deferral.
Payments of interest are payable to registered holders of the Notes (the “Noteholders”) quarterly on the first of every third month,
subject to deferral. Payments of principal will be payable to the Noteholders annually beginning on September 1, 2015. The principal
balance outstanding for these notes was $25.0 million at both December 31, 2013 and 2012. At December 31, 2013 and 2012, accrued
and unpaid interest associated with the Notes amounted to $7.6 million and $5.3 million, respectively.
Pursuant to the November 24, 2010 Written Agreement (the “Agreement”) with the Federal Reserve Bank of Philadelphia (the “Reserve
Bank”), the Company and its nonbank subsidiary may not make any payment of interest, principal or other amounts on the Company’s
subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director. For more
information refer to Note 17, “Regulatory Matters” to these consolidated financial statements.
The Company is currently deferring interest payments on the Company’s Debentures and Notes. The last payment made on the
Debentures was the payment due on September 14, 2010 and the last payment made on the Notes was the payment due on September 1,
2010.
Note 12. BENEFIT PLANS
The Bank has a defined contribution profit sharing plan which covers all eligible employees. The Bank’s contribution to the plan is
determined at management’s discretion at the end of each year and funded. On April 25, 2012, the Board of Directors ratified an
amendment to the defined contribution profit sharing plan to include the provisions under section 401(k) of the Internal Revenue Code
(“401(k) ”). The 401(k) feature of the plan, which became effective on September 1, 2012, permits employees to make voluntary salary
deferrals, either pre-tax or Roth, up to the dollar limit prescribed by law. The Company may make discretionary matching contributions
equal to a uniform percentage of employee salary deferrals. Company discretionary matching contributions are determined each year by
management. Since September 1, 2012, the Company has been matching 50.0% of employee salary deferrals up to 4.0% for each
employee. Company matching contributions to the 401(k) Plan are funded bi-weekly and are included in salaries and employee benefits
expense. Employee salary deferrals vest immediately, while Company discretionary contributions begin vesting 20.0% each year after
two years of credited service. Employee participants are 100.0% vested after six years of credited service.
99
There were no discretionary annual contributions made to the profit sharing plan in 2013, 2012 and 2011. Discretionary matching
contributions under the 401(k) feature of the plan totaled $129 thousand and $41 thousand in 2013 and 2012, respectively. There were
no discretionary matching contributions made under the 401(k) feature of the plan in 2011.
The Bank has an unfunded non-qualified deferred compensation plan covering all eligible Bank officers and directors as defined by the
plan. This plan permits eligible participants to elect to defer a portion of their compensation. Elective deferred compensation and
accrued earnings, included in other liabilities in the accompanying statements of financial condition, aggregated $7.3 million at both
December 31, 2013 and 2012. The Bank had not funded the deferred compensation plan as of December 31, 2013 or 2012.
Note 13. INCOME TAXES
The following table presents a reconciliation between the effective income tax expense (benefit) and the income tax expense (benefit)
that would have been provided at the federal statutory tax rate of 34.0% for each of the years ended December 31, 2013, 2012 and 2011:
(in thousands)
Provision (benefit) at statutory tax rates
Add (deduct):
Tax effects of non-taxable income
Non-deductible interest expense
Bank-owned life insurance
Change in valuation allowance
Other items, net
Provision for income taxes
Year Ended December 31,
2013
$ 2,170
2012
$ (4,662)
2011
$ (114)
(1,574)
(1,824)
(2,288)
37
65
98
(240)
(235)
(268)
(347)
6,637
2,568
(46)
19
4
$
-
$
-
$
-
100
The following table summarizes the components of the net deferred tax asset included in other assets at December 31, 2013, and the net
deferred tax liability included in other liabilities at December 31, 2012:
(in thousands)
Allowance for loan and lease losses
Deferred compensation
Unrealized holding losses on securities available-for-sale
Other real estate owned valuation
Deferred intangible assets
Employee benefits
Accrued interest
AMT tax credits
Fixed asset valuation
Charitable contribution carryover
Accrued rent expense
Accrued vacation
Accrued real estate taxes
Accrued legal settlement costs
Deferred income
Net operating loss carryover
Gross deferred tax assets
Deferred loan origination fees
Unrealized holding gains on securities available-for-sale
Prepaid expenses
Depreciation
Gross deferred tax liabilities
Net deferred asset before valuation allowance
Valuation allowance
Net deferred tax assets (liabilities)
December 31,
2013
2012
$
4,954
$
6,603
2,468
1,592
513
1,504
91
2,824
2,278
-
399
204
56
-
850
33
18,616
36,382
(338)
-
(56)
(261)
(655)
35,727
(34,135)
2,517
-
932
1,602
41
1,441
2,215
407
312
213
51
14
-
-
18,422
34,770
(34)
(3,451)
-
(254)
(3,739)
31,031
(34,482)
$
1,592
$
(3,451)
As of December 31, 2013 and 2012, the Company has established a valuation allowance of $34.1 million and $34.5 million,
respectively, related to net deferred tax assets that would be realizable based only on future taxable income. At December 31, 2013, no
valuation allowance was recorded for the deferred tax asset related to the unrealized holding losses on securities available-for-sale
because the Company had the intent and ability to hold these securities until recovery of the unrealized losses, which may be at maturity.
The Company will continue to monitor its deferred tax position and may make changes to the valuation allowance recorded as
circumstances change.
As of December 31, 2013, the Company had $54.8 million of net operating loss carryovers resulting in deferred tax assets of $18.6
million. Beginning in 2031, these net operating loss carryovers will expire if not utilized. As of December 31, 2013, the Company also
had $1.2 million of charitable contribution carryovers resulting in gross deferred tax assets of $399 thousand. These charitable
contribution carryovers will expire after December 31, 2015 if not utilized. In addition, the Company had alternative minimum tax
credit carryovers of $2.3 million as of December 31, 2013 that have an indefinite life.
The Company records interest and penalties on potential income tax deficiencies as part of non-interest expense. In May 2012, the
Company was contacted by the Internal Revenue Service (IRS) for examination of its 2010 and 2009 income tax returns. At December
31, 2012 and 2011, the Company had recognized $11.6 million of refundable federal income taxes associated with its net operating
losses incurred in 2010 and 2009. The IRS concluded its examination of the 2010 and 2009 income tax returns in 2013 and the Company
received the entire $11.6 million of refundable federal income taxes.
101
Note 14. RELATED PARTY TRANSACTIONS
The Company and the Bank have engaged in and intend to continue to engage in banking and financial transactions in the conduct of its
business with directors and the executive officers of the Company and the Bank and their related parties.
The Bank has granted loans, letters of credit and lines of credit to directors, executive officers and their related parties. The following
table summarizes the changes in the total amounts of such outstanding loans, advances under lines of credit as well as repayments during
the years ended December 31, 2013 and 2012:
(in thousands)
Balance January 1,
New loans and advances
Repayments
Other (1)
Balance December 31,
Year Ended December 31,
2013
2012
$
33,296
$
87,442
50,260
(50,794)
(256)
64,509
(118,655)
-
$
32,506
$
33,296
(1) Other represents loans to related parties that ceased being related parties during the year
At December 31, 2013, loans in the amount of $90 thousand made to directors, executive officers and their related parties were not
performing in accordance with the terms of the loan agreements.
Included in related party loans is a commercial line of credit with a company owned by a director with a total aggregate balance
outstanding of $8.5 million at December 31, 2013. The Company also sold a participation interest in this line to the same director in the
amount of $5.2 million, of which $3.4 million is outstanding. The Bank receives a 25 basis point annual servicing fee from this director
on the participation balance. At December 31, 2012, the aggregate amount outstanding under the line was $8.0 million and the
participation interest sold under this line was $3.2 million.
Deposits from directors, executive officers and their related parties held by the Bank at December 31, 2013 and 2012 amounted to
$115.5 million and $66.7 million, respectively. Interest paid on the deposits amounted to $80 thousand, $139 thousand, and $446
thousand for the years ended December 31, 2013, 2012, and 2011, respectively.
In the course of its operations, the Company acquires goods and services from and transacts business with various companies of related
parties. The Company believes these transactions were made on the same terms as those for comparable transactions with unrelated
parties. The Company recorded payments for these services of $2.6 million, $1.6 million, and $1.8 million in 2013, 2012, and 2011,
respectively.
Subordinated notes held by officers and directors and/or their related parties totaled $10.0 million at December 31, 2013 and 2012. There
were no interest payments made to directors and/or their related parties in 2013, 2012 and 2011. Interest accrued and unpaid on the notes
totaled $3.0 million and $2.1 million at December 31, 2013 and 2012, respectively.
During the year ended December 31, 2012, the Company sold an OREO property to a related party for $202 thousand, with a gain of
$41 thousand recognized on the sale.
Note 15. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS
Leases
At December 31, 2013, the Company was obligated under certain non-cancelable leases with initial or remaining terms of one year or
more. Minimum future obligations under non-cancelable leases in effect at December 31, 2013 are as follows:
102
Minimum Future Lease Payments
December 31, 2013
(in thousands)
Facilities
Equipment
Total
2014
2015
2016
2017
2018
2019 and thereafter
Total
$
604
$
54
$
658
316
281
243
172
449
21
-
-
-
-
337
281
243
172
449
$
2,065
$
75
$
2,140
Total rental expense under leases amounted to $692 thousand, $734 thousand and $725 thousand in 2013, 2012 and 2011, respectively.
Financial Instruments with off-balance sheet commitments
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs
of its customers. These financial instruments include commitments to extend credit and standby letters of credit that involve varying
degrees of credit, interest rate or liquidity risk in excess of the amount recognized in the balance sheet. The Company’s exposure to
credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of
credit is represented by the contractual amount of those instruments.
Financial instruments whose contract amounts represent credit risk at December 31 are as follows:
(in thous ands )
December 31,
2013
2012
Commitments to extend credit
$ 155,701
$ 166,722
Standby letters of credit
25,321
35,277
Commitments to extend credit are agreements to lend to customers in accordance with contractual provisions. These commitments
usually are for specific periods or contain termination clauses and may require the payment of a fee. The total amounts of unused
commitments do not necessarily represent future cash requirements, in that commitments often expire without being drawn upon.
Letters of credit and financial guarantees are agreements whereby the Company guarantees the performance of a customer to a third
party. Collateral may be required to support letters of credit in accordance with management’s evaluation of the creditworthiness of
each customer. The credit exposure assumed in issuing letters of credit is essentially equal to that in other lending activities.
Federal Home Loan Bank — Mortgage Partnership Finance Program
Under a secondary market loan servicing program with the FHLB, the Company, in exchange for a monthly fee, provides a credit
enhancement guarantee to the FHLB for foreclosure losses in excess of 1% of original loan principal sold to the FHLB. At
December 31, 2013, the Company serviced payments on $10.6 million of first lien residential loan principal under these terms for the
FHLB. At December 31, 2013, the maximum obligation for such guarantees by the Company would be approximately $1.5 million if
total foreclosure losses on the entire pool of loans exceed approximately $77 thousand. Management believes the likelihood of a
reimbursement for loss payable to the FHLB beyond the monthly credit enhancement fee is remote.
Concentrations of Credit Risk
Cash Concentrations: The Bank maintains cash balances at several correspondent banks. Except for the account with the FHLB, there
were no due from bank accounts in excess of the $250 thousand limit covered by the Federal Deposit Insurance Corporation as of
103
December 31, 2013 and 2012. The balance in the Bank’s account at the FHLB was $298 thousand and $304 thousand at December 31,
2013 and 2012, respectively.
Loan Concentrations: The Company attempts to limit its exposure to concentrations of credit risk by diversifying its loan portfolio and
closely monitoring any concentrations of credit risk. The commercial real estate and construction, land acquisition and development
portfolios comprise $242.9 million, or 37.8% of gross loans at December 31, 2013. Geographic concentrations exist because the
Company provides its services in its primary market area of Northeastern Pennsylvania and conducts limited activities outside of that
area. At December 31, 2013, the Company had commercial real estate and construction, land acquisition and development loans and
loan commitments totaling $38.9 million, or 6.1%, of gross loans to customers outside of it primary market area.
At December 31, 2013 and 2012, the Bank’s loan portfolio was concentrated in loans in the following industries.
(dollars in thousands)
Automobile dealers
Land subdivision
Physicians
Colleges and universities
Solid waste landfills
Hotels
Office complexes/units
Shopping centers/complexes
Litigation
December 31, 2013
December 31, 2012
Amount
$
18,467
15,974
13,932
12,671
12,254
9,847
9,636
8,083
% of gross
loans
2.87%
2.48%
2.17%
1.97%
1.90%
1.53%
1.50%
1.26%
Amount
$
10,607
17,658
9,269
4,879
13,233
13,596
9,801
21,068
% of gross
loans
1.77%
2.95%
1.55%
0.82%
2.21%
2.27%
1.64%
3.52%
On May 24, 2012, a putative shareholder by the name of Lori Gray filed a complaint in the Court of Common Pleas in Lackawanna
County against certain present and former directors of the Company (including all of the current directors except Steven R. Tokach and
Thomas J. Melone) and Demetrius & Company, LLC (“Demetrius”) alleging, inter alia, breach of fiduciary duty, abuse of control,
corporate waste, unjust enrichment and, in the case of Demetrius, professional negligence, negligent misrepresentation, breach of
contract and aiding and abetting breach of fiduciary duty. The Company was named as a nominal defendant. The Board had appointed
a special committee in January 2012 to investigate the matters raised in the Gray complaint. The special committee retained independent
counsel to assist with its investigation. Following the investigation, the special committee found that the Board had not breached its
fiduciary duty to shareholders. Subsequently, the parties commenced settlement discussions and on December 18, 2013, the Court
entered an Order Granting Preliminary Approval of Proposed Settlement subject to notice to shareholders. On February 4, 2014, the
Court issued a Final Order and Judgment for the matter granting approval of a Stipulation of Settlement (the “Settlement”) and
dismissing all claims against the Company and its directors. As part of the Settlement, there was no admission of liability by the Board.
Pursuant to the Settlement, the Board, without admitting any fault, wrongdoing or liability, agreed to settle the derivative litigation for
$5 million, which is expected to be paid to the Company by the individual defendants in the first half of 2014. The directors have
reserved their rights to indemnification under the Company’s Articles of Incorporation and By-laws, resolutions adopted by the Board,
the Pennsylvania Business Corporation Law and any and all rights they have against the Company’s and the Bank’s insurance carriers.
The Company expects to indemnify the directors upon their request for indemnification. In addition, in conjunction with the Settlement,
the Company accrued $2.5 million related to fees and costs of the plaintiff’s attorneys, which has been included in non-interest expense
for the year ended December 31, 2013.
On September 5, 2012, Fidelity and Deposit Company of Maryland (“F&D”) filed an action against the Company and its subsidiary,
First National Community Bank, as well as several current and former officers and directors of the Company, in the United States
District Court for the Middle District of Pennsylvania. F&D has asserted a claim for the rescission of a directors’ and officers’ insurance
policy and a bond that it had issued to the Company. On November 9, 2012, the Company and the Bank answered the claim and asserted
counterclaims. The Company and the other defendants are defending the claims. At this time, the matter is in a preliminary stage and the
Company cannot reasonably determine the outcome or potential range of loss in connection with this matter.
On August 13, 2013, Steven Antonik, individually, as Administrator of the Estate of Linda Kluska, William R. Howells, and Louise A.
Howells, on behalf of themselves and others similarly situated, filed a consumer protection class action against the Company and Bank
in the Lackawanna County Court of Common Pleas, seeking equitable, injunction and monetary relief to address an alleged pattern and
practice of wrong doing by the Bank relating to the repossession and sale of the Plaintiffs’ and class members’ financed motor
104
vehicles. This matter is in its early discovery stage. At this time the Company cannot reasonably determine the outcome or potential
range of loss.
On September 17, 2013, Charles Saxe, III individually and on behalf of all others similarity situated filed a consumer class action against
the Bank in the Lackawanna County Court of Common Pleas alleging violations of the Pennsylvania Uniform Commercial Code in
connection with the repossession and resale of financed vehicles. This matter is in its early discovery stage. At this time the Company
cannot reasonably determine the outcome or potential range of loss.
The Company has been subject to tax audits and is also a party to routine litigation involving various aspects of its business, such as
claims to enforce liens, condemnation proceedings on properties in which the Company holds security interests, claims involving the
making and servicing of real property loans and other issues incident to its business, none of which is expected to have a material
adverse impact on the consolidated financial condition, results of operations or liquidity of the Company.
Note 16. STOCK COMPENSATION PLANS
On August 30, 2000, the Company’s Board adopted an Employee Stock Incentive Plan (the “Stock Incentive Plan”) in which options
may be granted to key officers and other employees of the Company. The aggregate number of shares which may be issued upon
exercise of the options under the plan cannot exceed 1,100,000 shares. Options and rights granted under the Stock Incentive Plan
become exercisable six months after the date the options are awarded and expire ten years after the award date. Upon exercise, the
shares are issued from the Company’s authorized but unissued stock. The Stock Incentive Plan expired on August 30, 2010 and therefore
no further grants will be made under this plan.
The Board also adopted on August 30, 2000, the 2000 Independent Directors Stock Option Plan (the “Directors’ Stock Plan”) for
directors who are not officers or employees of the Company. The aggregate number of shares issuable under the Directors’ Stock Plan
cannot exceed 550,000 shares and are exercisable six months from the date the awards are granted and expire three years after the award
date. Upon exercise, the shares are issued from the Company’s authorized but unissued shares. The Directors’ Stock Plan expired on
August 30, 2010 and therefore no further grants will be made under this plan.
No compensation expense related to options under either the Stock Incentive Plan or the Directors’ Stock Plan was required to be
recorded in each of the years ended December 31, 2013, 2012, and 2011.
A summary of the status of the Company’s stock option plans is presented below:
2013
2012
2011
Outstanding at the beginning of the year
Granted
Exercised
Forfeited
Outstanding at the end of the year
Options exercisable at year end
Weighted average fair value of options granted
during the year
Stock-based compensation expense
Shares
129,170
-
-
(46,572)
82,598
82,598
Weighted
Average
Exercise
Price
$
14.26
-
-
11.22
15.98
15.98
$
$
-
$
$
-
Shares
188,193
-
-
(59,023)
129,170
129,170
Weighted
Average
Exercise
Price
12.62
-
-
9.03
14.26
14.26
$
$
$
-
$
-
Shares
222,616
-
-
(34,423)
188,193
188,193
Weighted
Average
Exercise
Price
12.58
-
-
12.37
12.62
12.62
$
$
$
-
$
-
At December 31, 2013, 2012 and 2011 the exercisable options had no total intrinsic value and there was no unrecognized compensation
expense.
105
Information pertaining to options outstanding at December 31, 2013 is as follows:
Options Outstanding
Options Excercisable
Weighted
Average
Weighted
Remaining
Number
Contractual
Average
Exercise
Number
Weighted
Average
Exercise
Range of Exercise Price
Outstanding
Life
Price
Exercisable
Price
$10.81 - $23.13
82,598
3.5
$
15.98
82,598
$
15.98
On November 28, 2012, the Board of Directors adopted the 2012 Employee Stock Grant Plan (the “2012 Stock Grant Plan”) under
which shares of common stock not to exceed 16,000 were authorized to be granted to employees. On December 17, 2012, the Company
granted 50 shares of the Company’s common stock to each active full and part time employee. There were 15,050 shares granted under
the 2012 Stock Grant Plan at a cost of $3.05 per share.
On November 27, 2013, the Board of Directors adopted the 2013 Employee Stock Grant Plan (the “2013 Stock Grant Plan”) under
which shares of common stock not to exceed 15,000 were authorized to be granted to employees. On December 2, 2013, the Company
granted 50 shares of the Company’s common stock to each active full and part time employee. There were 14,400 shares granted under
the 2013 Stock Grant Plan at a cost of $4.26 per share. The total cost of these grants, which was included in salary expense in the
Consolidated Statements of Operations, amounted to $61 thousand and $46 thousand for the years ended December 31, 2013 and 2012,
respectively. No additional shares were granted under either plan.
On January 24, 2013, the Board of Directors initially approved the design of a new Long-Term Incentive Compensation Plan (“LTIP”).
Upon the recommendation of the Compensation Committee, the final LTIP was formally adopted by the Board of Directors on October
23, 2013 and was ratified at the 2013 Annual Shareholders Meeting on December 23, 2013. The LTIP is designed to reward executives
and key employees for their contributions to the long-term success of the Company, primarily as measured by the increase in the
Company’s stock price. The LTIP provides the Board with the authority to offer several different types of long-term incentives,
including Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Units and Performance
Shares. No awards were granted under the LTIP as of December 31, 2013. The Board made initial awards in 2014 under the terms of
the LTIP.
Note 17. REGULATORY MATTERS
The Bank is under a Consent Order (the “Order”) from the Office of the Comptroller of the Currency (“OCC”) dated September 1, 2010.
The Company is also subject to a Written Agreement (the “Agreement”) with the Federal Reserve Bank of Philadelphia (the “Reserve
Bank”) dated November 24, 2010.
OCC Consent Order. The Bank, pursuant to a Stipulation and Consent to the Issuance of a Consent Order dated September 1, 2010,
without admitting or denying any wrongdoing, consented and agreed to the issuance of the Order by the OCC, the Bank’s primary
regulator. The Order requires the Bank to undertake certain actions within designated timeframes, and to operate in compliance with the
provisions thereof during its term. The Order is based on the results of an examination of the Bank as of March 31, 2009. Since the
examination, management has engaged in ongoing discussions with the OCC and has taken steps to improve the condition, policies and
procedures of the Bank. Compliance with the Order is monitored by a committee (the “Committee”) of at least three directors, none of
whom is an employee or controlling shareholder of the Bank or its affiliates or a family member of any such person. The Committee is
required to submit written progress reports to the OCC on a monthly basis. The Committee has submitted each of the required monthly
progress reports with the OCC. The members of the Committee are John P. Moses, Joseph Coccia, Joseph J. Gentile and Thomas J.
Melone. The material provisions of the Order are set forth below with a description of the status of the Bank’s effort to comply with
such provisions:
(i) By October 31, 2010, the Board of Directors of the Bank (the “Board”) was required to adopt and implement a three-year strategic
plan (a “Strategic Plan”) which must be submitted to the OCC for review and prior determination of no supervisory objection; the
Strategic Plan must establish objectives for the Bank’s overall risk profile, earnings performance, growth, balance sheet mix, off-balance
sheet activities, liability structure, capital adequacy, reduction in the volume of nonperforming assets, product line development, and
market segments that the Bank intends to promote or develop, and is to include strategies to achieve those objectives; if the Strategic
Plan involves the sale or merger of the Bank, it must address the timeline and steps to be followed to provide for a definitive agreement
within 90 days after the receipt of a determination of no supervisory objection;
106
The Bank has developed a Strategic Plan that it believes complies with the Order requirements. A three-year Strategic Plan for the
period January 1, 2011 to December 31, 2013 was prepared and submitted to the OCC for review. On an annual basis, the Bank
prepares an updated and revised Strategic Plan. Strategic Plans for the periods January 1, 2012 to December 31, 2014 and January 1,
2013 to December 31, 2015 were submitted to the OCC for review. The Strategic Plan for the periods January 1, 2014 to December 31,
2016 is in process, and the Bank expects to submit it to the OCC for review in the near term.
(ii) by October 31, 2010, the Board was required to adopt and implement a three year capital plan (a “Capital Plan”), which must be
submitted to the OCC for review and prior determination of no supervisory objection;
The Bank has developed a Capital Plan that it believes complies with the Order requirements to ensure that the Bank’s leverage ratio
equals or exceeds 9% and the Bank’s total risk-based capital ratio equals or exceeds 13%. This Capital Plan for the period January 1,
2011 through December 31, 2013 and its annual update and revisions for 2012 and 2013 were submitted to the OCC for review. The
annual update and revision to the Capital Plan is in process in conjunction with the annual budget and strategic planning initiatives.
Management expects to forward the 2014-2016 Capital Plan to the OCC for review in the near term.
(iii) by November 30, 2010, the Bank was required to achieve and thereafter maintain a total risk-based capital equal to at least 13% of
risk-weighted assets and a Tier 1 capital equal to at least 9% of adjusted total assets;
The Bank’s total risk-based capital ratio was 13.43% at December 31, 2013, which was above the 13% required by the Order. The
Bank’s leverage capital ratio was 8.32% at December 31, 2013, which was below the 9% required by the Order. The Bank’s total risk-
based capital increased 164 basis points, while the Bank’s leverage ratio increased 112 basis points at December 31, 2013 compared to
December 31, 2012. The Bank continues to execute its Capital Plan and has engaged an outside financial advisory firm to assist the
Bank in taking appropriate actions to achieve and maintain compliance with the capital requirements of the Order. Appropriate actions
or combinations of actions may include capital accretion through current earnings, raising additional capital, reducing the Bank’s assets
through sales of branch offices, loans or other real estate owned, or pursuing other strategic transactions.
(iv) the Bank may not pay any dividend or capital distribution unless it is in compliance with the higher capital requirements required by
the Order, the Capital Plan, applicable legal requirements and, then only after receiving a determination of no supervisory objection from
the OCC;
The Board has acknowledged the prohibition on payment of dividends or any other capital distributions without the prior written consent
of the OCC. The Bank has not paid any dividends or capital distributions since the effective date of the Order.
(v) by November 15, 2010, the Committee must have reviewed the Board and the Board’s committee structure; by November 30, 2010,
the Board was required to prepare or cause to be prepared an assessment of the capabilities of the Bank’s executive officers to perform
their past and current duties, including those required to respond to the most recent examination report, and to perform annual
performance appraisals of each officer;
The Committee completed its review of the Board and the Board committee structure on November 10, 2010 by reviewing the Board
Structure Study report completed by an independent consultant engaged by the Committee. The report was forwarded to the OCC on
November 24, 2010. The Company is in the process of implementing those recommendations.
The Board completed its assessment of the capabilities of the Bank’s executive officers upon receipt of a Management Study, completed
by an independent consultant (“Management Study”), on October 13, 2010. The Management Study was forwarded to the OCC on
October 29, 2010. The Board of Directors completed a successful search for President and Chief Executive Officer in December 2011.
Since the effective date of the Order, other changes have been made to the executive management team related to the size and
complexity of the organization.
Annual performance appraisals are prepared for each officer based on established and timely management goals to confirm that each
officer is performing the duties outlined in his or her job description.
(vi) by October 31, 2010, the Board was required to adopt, implement and thereafter ensure compliance with a comprehensive Conflict
of Interest Policy applicable to the Bank’s and the Company’s directors, executive officers, principal shareholders and their affiliates and
such person’s immediate family members and their related interests, employees, and by November 30, 2010, was required to review
existing relationships with such persons to identify those, if any, not in compliance with the policy; and review all subsequent proposed
transactions with such persons or modifications of transactions;
The Bank’s Conflict of Interest Policy has been revised to provide comprehensive guidance and a review was conducted of existing
relationships to ensure compliance with the Conflict of Interest Policy. The revised policy was approved by the Board on September 29,
107
2010 and forwarded to the OCC on October 7, 2010. Additional revisions were approved by the Board on April 29, 2011, October 24,
2012, May 22, 2013 and November 14, 2013.
(vii) by October 31, 2010, the Board was required to develop, implement and ensure adherence to policies and procedures for Bank
Secrecy Act (“BSA”) compliance; and account opening and monitoring procedures compliance;
The Board believes it has developed and implemented a written program of policies and procedures to provide for compliance with the
requirements of the BSA as well as compliance with account opening and monitoring procedures.
(viii) by October 31, 2010, the Board was required to ensure the BSA audit function is supported by an adequately staffed department or
third party firm; to adopt, implement and ensure compliance with an independent BSA audit; and to assess the capabilities of the BSA
officer and supporting staff to perform present and anticipated duties;
The Board believes that the Bank’s BSA audit function is adequately staffed; and the BSA Officer and staff have been assessed to
determine their ability to implement and maintain compliance with the BSA policies and programs detailed above.
(ix) by October 31, 2010, the Board was required to adopt, implement and ensure adherence to a written credit policy (the “Loan
Policy”), including specified features, to improve the Bank’s loan portfolio management;
The Bank’s written Loan Policy has been revised to improve guidance and control over the Bank’s lending functions. The revised
policy was approved by the Board on October 27, 2010. Additional revisions were approved by the Board on November 24, 2010, July
27, 2011, October 27, 2011, March 28, 2012, June 27, 2012, October 11, 2012 and July 24, 2013.
(x) the Board was required to take certain actions to resolve certain credit and collateral exceptions;
The Board believes that it has taken action to appropriately address the credit and collateral exceptions concerns detailed in the Order.
(xi) by October 31, 2010, the Board was required to establish an effective, independent and ongoing loan review system to review, at
least quarterly, the Bank’s loan and lease portfolios to assure the timely identification and categorization of problem credits; by
October 31, 2010, to adopt and adhere to a program for the maintenance of an adequate ALLL, and to review the adequacy of the Bank’s
ALLL at least quarterly;
The Board has established an independent and ongoing loan review program on a quarterly basis that it believes provides for the timely
identification and categorization of problem credits.
The ALLL policy and methodologies have been reviewed and revised to determine the appropriate level of the ALLL, including
documenting the analysis in accordance with GAAP and other applicable regulatory guidelines. The revised policy was approved by the
Board on October 27, 2010 and is updated on an annual basis. The Board reviews the ALLL methodology analysis on a quarterly basis
as part of the financial reporting process.
(xii) by October 31, 2010, the Board was required to adopt and the Bank implement and adhere to a program to protect the Bank’s
interest in criticized assets; and the Bank may only extend additional credit (including renewals) to a borrower whose loans are criticized
under specified circumstances;
The Board committed to a program to reduce the Bank’s risk exposure to criticized assets by implementing a detailed monthly reporting
and monitoring process. The Board believes that this program has resulted in a reduction in criticized assets.
In accordance with the requirements of the Order, the Bank has not extended any additional credit to, or for the benefit of, any borrower
who has a loan or other extension of credit that either has been charged off or criticized without the prior approval of the Bank’s Board,
or loan committee under specified circumstances, since the date of the Order.
(xiii) by October 31, 2010, the Board was required to adopt and ensure adherence to action plans for each piece of other real estate
owned;
The Board committed to action plans for each piece of other real estate owned centered around a robust reporting and monitoring
process. The Board believes that this program has resulted in a substantial reduction in other real estate owned balances.
(xiv) by November 30, 2010, the Board was required to develop, implement and ensure adherence to a policy for effective monitoring
and management of concentrations of credit;
108
The Board believes it developed and implemented a written concentration management program consistent with OCC Bulletin 2006-46
on November 24, 2010. This program was forwarded to the OCC on November 30, 2010. Loan concentration analysis reports are
prepared and reviewed quarterly by the Board as part of the Bank’s loan portfolio management practices.
(xv) by October 31, 2010, the Board was required to revise and implement the Bank’s Other than Temporary Impairment Policy;
The Board believes that the Other Than Temporary Impairment Policy has been reviewed and revised so that the quarterly OTTI
analysis process identifies and measures OTTI in accordance with GAAP and supervisory guidance, including Financial Accounting
Standards Board Accounting Standards Codification 320-10-35 (Recognition and Presentation of Other-than-Temporary Impairments),
OCC Bulletin 2009-11 dated April 17, 2009, "Other-than-Temporary Impairment Accounting" and OCC Call Report Instructions.
(xvi) by October 31, 2010, the Board was required to take action to maintain adequate sources of stable funding and liquidity and a
contingency funding plan; by October 31, 2010, the Board was required to adopt, implement and ensure compliance with an
independent, internal audit program;
The Board believes that it has taken action to maintain adequate sources of stable funding and liquidity and developed an appropriate
contingency funding plan for the Bank. A Liquidity Funding policy that addresses liquidity needs, funding sources and contingency
funding was approved by the Board on November 24, 2010 and has been implemented and is reviewed and updated annually.
Additional policies related to liquidity, funding and contingency funding have since been created and are updated annually since the
Order was executed.
The Board believes that it has taken appropriate steps to adopt, implement and comply with an independent adequately staffed internal
audit program.
(xvii) take actions to correct cited violations of law; and adopt procedures to prevent future violations and address compliance
management.
The Board and management believe that they have taken appropriate action to correct cited violations and adopted procedures designed
to prevent future violations and address compliance management.
Federal Reserve Agreement. On November 24, 2010, the Company entered into the Agreement with the Reserve Bank. The Agreement
requires the Company to undertake certain actions within designated timeframes, and to operate in compliance with the provisions
thereof during its term. The material provisions of the Agreement are set forth below with a description of the status of the Company’s
efforts to comply with such provision:
(i) the Company’s Board was required to take appropriate steps to fully utilize the Company’s financial and managerial resources to
serve as a source of strength to the Bank, including taking steps to ensure that the Bank complies with its Consent Order entered into
with the OCC;
The Company has taken, and continues to take, steps the Board believes are appropriate to use the Company’s financial and managerial
resources to serve as a source of strength to the Bank. The steps the Bank has taken to comply with the Order are discussed above.
(ii) the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the
Division of Banking Supervision and Regulation (the “Director”) of the Federal Reserve Board;
The Company has acknowledged the prohibition on payment of dividends without the prior written consent of the Reserve Bank and
Director of the Division of Banking Supervision and Regulation. The Company has not paid any dividends since the effective date of
the Agreement.
(iii) the Company may not take dividends or other payments representing a reduction of the Bank’s capital without the prior written
approval of the Reserve Bank;
The Company has acknowledged the prohibition on taking dividends or any other capital distributions from the Bank without the prior
written consent of the Reserve Bank. The Bank has not paid and the Company has not received any dividends or capital distributions
from the Bank since the effective date of the Agreement.
(iv) the Company and its nonbank subsidiary may not make any payment of interest, principal or other amounts on the Company’s
subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director;
109
The Company has acknowledged the prohibition on any payment related to the Company’s subordinated debentures and trust preferred
securities without the written approval of the Reserve Bank and Director. The Company has not made any payments of interest, principal
or other amounts on the Company’s subordinated debentures or trust preferred securities since the effective date of the Agreement.
(v) the Company may not make any payment of interest, principal or other amounts on debt owed to insiders of the Company without
the prior written approval of the Reserve Bank and Director;
The Company has acknowledged the prohibition on any payment related to the debt owed to insiders of the Company without the
written approval of the Reserve Bank and Director. The Company has not made any payments related to debt owed to insiders since the
effective date of the Agreement.
(vi) the Company and its nonbank subsidiary may not incur, increase or guarantee any debt without the prior written approval of the
Reserve Bank;
The Company has acknowledged the prohibition on incurring, increasing or guaranteeing any debt without the written approval of the
Reserve Bank other than permitted borrowings from the FHLB. The Company has not incurred, increased or guaranteed any debt since
the effective date of the Agreement.
(vii) the Company may not purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank;
The Company has acknowledged the prohibition on purchasing or redeeming any shares of its stock without the written approval of the
Reserve Bank, other than permitted borrowings from the FHLB. The Company has not purchased or redeemed any shares of its stock
since the effective date of the Agreement.
(viii) the Company was required to submit to the Reserve Bank, by January 23, 2011, an acceptable written plan to maintain sufficient
capital at the Company on a consolidated basis. Thereafter, the Company must notify the Reserve Bank within 45 days of the end of any
quarter in which the Company’s capital ratios fall below the approved capital plan’s minimum ratios, and submit an acceptable written
plan to increase the Company’s capital ratios above the capital plan’s minimums;
The Company has developed a Capital Plan that it believes is acceptable and maintains sufficient capital at the Company on a
consolidated basis. The Capital Plan was submitted to the Reserve Bank on January 11, 2011. The Capital Plan has since been updated
at least annually and forwarded to the Reserve Bank. The annual update and revision to the Capital Plan is in process in conjunction with
the annual budget and strategic planning initiatives.
The Bank’s total risk-based capital ratio was 13.43% at December 31, 2013, which was above the 13% minimum required by the Order.
Given the inability to achieve the minimum leverage ratio as stated in the capital requirements of the Order at the Bank level, the
Company continues to update the Reserve Bank on a quarterly basis of its plans to increase its capital ratios above the Capital Plan
minimums.
(ix) the Company was required to immediately take all actions necessary to ensure that: (1) each regulatory report accurately reflects the
Company’s condition on the date for which it is filed and all material transactions between the Company and its subsidiaries; (2) each
such report is prepared in accordance with its instructions; and (3) all records indicating how the report was prepared are maintained for
supervisory review;
The Company believes that it has taken actions to ensure that all required regulatory reports are filed to accurately reflect its financial
condition on the date filed, are prepared in accordance with instructions and that records detailing how the reports were filed are
maintained and available for supervisory review.
(x) the Company was required to submit to the Reserve Bank, by January 23, 2011, acceptable written procedures to strengthen and
maintain internal controls to ensure all required regulatory reports and notices filed with the Board of Governors are accurate and filed in
accordance with the instructions for preparation;
The Company believes that it has designed effective written procedures and strengthened internal controls so that all required Board of
Governors reports and notices filed are accurate and in accordance with instructions. The written procedures were provided to the
Reserve Bank on January 21, 2011.
110
(xi) the Company was required to submit to the Reserve Bank, by January 8, 2011, a cash flow projection for 2011, reflecting the
Company’s planned sources and uses of cash, and submit a cash flow projection for each subsequent calendar year at least one month
prior to the beginning of such year;
The Company created a cash flow projection for 2011 and submitted it to the Reserve Bank on January 7, 2011 in accordance with
requirements of the Agreement. Similar projections for 2012, 2013, and 2014 were provided to the Reserve Bank within the time
requirements prescribed in the Agreement.
(xii) the Company must comply with: (1) the notice provisions of Section 32 of the FDI Act and Subpart H of Regulation Y in
appointing any new director or senior executive officer or changing the duties of any senior executive officer; and (2) the restrictions on
indemnification and severance payments of Section 18(k) of the FDI Act and Part 359 of the FDIC’s regulations;
The Company has acknowledged the notice requirements on the appointment of any new director or senior executive officer. The
Company has filed the appropriate notice for each new director or senior executive officer since the date of the Agreement.
The Company acknowledges the restriction on indemnification and severance payments. The Company has not made any such
indemnification or severance payments since the effective date of the Agreement without obtaining prior regulatory non-objections from
the OCC and regulatory concurrence from the FDIC as required by Part 359.
(xiii) the Board must submit written progress reports within 30 days of the end of each calendar quarter.
The Company’s Board has filed each of the required written progress reports with the Reserve Bank since the Agreement was executed.
Banking regulations also limit the amount of dividends that may be paid without prior approval of the Bank’s regulatory agency. At
December 31, 2013, the Company and the Bank are restricted from paying any dividends, without regulatory approval.
The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if
undertaken, could have a direct material adverse effect on the Company’s financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, specific capital guidelines that involve quantitative measures of assets, liabilities,
and certain off-balance sheet items as calculated under regulatory accounting practices must be met. Capital amounts and classification
are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
In July 2013, the Federal Reserve, the OCC and the FDIC approved the final Basel III capital framework for U.S. banking organizations
(the “Regulatory Capital Rules”) implementing regulatory capital reforms and changes required by the Dodd-Frank Act.
The Regulatory Capital Rules are effective on January 1, 2014; however, the mandatory compliance date for the Company and the Bank
as “standardized approach” banking organizations begins on January 1, 2015 and is subject to transitional provisions extending to
January 1, 2019. The Regulatory Capital Rules include new risk-based capital and leverage ratios and refine the definition of what
constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to the Company
and the Bank under the Regulatory Capital Rules will be:
•
•
•
•
a new common equity Tier 1 capital ratio of 4.5%;
a Tier 1 capital ratio of 6% (increased from 4%);
a total capital ratio of 8% (unchanged from current rules); and
a Tier 1 leverage ratio of 4% for all institutions.
The Regulatory Capital Rules also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum capital
requirements, which must consist entirely of common equity Tier 1 capital and result in the following minimum ratios:
•
•
•
a common equity Tier 1 capital ratio of 7.0%;
a Tier 1 capital ratio of 8.5%; and
a total capital ratio of 10.5%.
The new capital conservation buffer requirement will be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will
increase by that amount each year until fully implemented in January 2019. An institution will be subject to limitations on paying
dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These
limitations will establish a maximum percentage of eligible retained income that could be utilized for such actions.
111
The Regulatory Capital Rules also implement revisions and clarifications consistent with Basel III regarding the various components of
Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that will no longer qualify as Tier 1
capital, some of which will be phased out over time.
The Regulatory Capital Rules also revise the prompt corrective action framework, which is designed to place restrictions on insured
depository institutions, including the Bank, if their capital levels begin to show signs of weakness. These revisions will take effect
January 1, 2015. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer,
insured depository institutions will be required to meet the following increased capital level requirements in order to qualify as “well
capitalized:”
•
•
•
•
a new common equity Tier 1 risk-based capital ratio of 6.5%;
a Tier 1 risk-based capital ratio of 8% (increased from 6%);
a total risk-based capital ratio of 10% (unchanged from current rules); and
a Tier 1 leverage ratio of 5% (increased from 4%).
The Regulatory Capital Rules set forth certain changes for the calculation of risk-weighted assets, which we will be required to utilize
beginning January 1, 2015. The provisions applicable to banking organizations under the “standardized approach” include changes with
respect to risk weights for commercial real estate loans, past due exposures and conversion factors for commitments with an original
maturity of one year or less.
Current quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts
and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and
of Tier I capital (as defined) to average assets (as defined).
In accordance with the Order, the Bank is required to achieve and thereafter maintain a total risk-based capital equal to at least 13% of
risk-weighted assets and a Tier 1 capital equal to at least 9% of adjusted total assets. As of December 31, 2013, the Bank met the 13.0%
minimum requirement for the total-risk based capital ratio but did not meet the 9.0% minimum requirement for the Tier 1 leverage ratio.
The minimum capital requirements under the Order take precedence over the standard regulatory capital adequacy definitions described
in the tables below.
The Company’s and the Bank’s actual capital positions and ratios as of December 31, 2013, 2012 and 2011 are presented in the
following table:
(in thousands)
Company
Tier I capital:
Total tier I capital
Tier II capital:
Subordinated notes
Allowable portion of allowance for loan losses
Total tier II capital
Total risk-based capital
Total risk-weighted assets
Bank
Tier I capital:
Total tier I capital
Tier II capital:
2013
De ce mbe r 31,
2012
2011
$
46,165
$
39,587
$
53,059
23,085
8,462
31,547
77,712
19,796
8,452
28,248
67,835
25,000
9,823
34,823
87,882
$
670,894
$
665,323
$
774,452
$
81,581
$
69,963
$
80,976
Allowable portion of allowance for loan losses
Total tier II capital
Total risk-based capital
Total risk-weighted assets
8,456
8,456
90,037
8,447
8,447
78,410
9,819
9,819
90,795
$
670,416
$
664,914
$
774,097
112
The following schedules present information regarding the Company’s risk-based capital at December 31, 2013 and 2012, and selected
other capital ratios:
Actual
For Capital
Adequacy Purposes
To Be Well
Capitalized
Under Prompt
Corrective
Action Provision
Amount
Ratio
Amount
Ratio
Amount
Ratio
$
77,712
$
90,037
11.58%
13.43%
$
>53,672
$
>53,633
>8.00%
>8.00%
N/A
$
>67,042
N/A
>10.00%
$
46,165
$
81,581
6.88%
12.17%
$
>26,836
$
>26,817
>4.00%
>4.00%
N/A
$
>40,225
N/A
>6.00%
$
46,165
$
81,581
4.71%
8.32%
$
>39,230
$
>39,230
>4.00%
>4.00%
N/A
$
>49,038
N/A
>5.00%
Actual
For Capital
Adequacy Purposes
To Be Well
Capitalized
Under Prompt
Corrective
Action Provision
Amount
Ratio
Amount
Ratio
Amount
Ratio
$
67,835
$
78,410
10.20%
11.79%
$
>53,226
$
>53,193
>8.00%
>8.00%
N/A
$
>66,491
N/A
>10.00%
$
39,587
$
69,963
5.95%
10.52%
$
>26,613
$
>26,597
>4.00%
>4.00%
N/A
$
>39,895
N/A
>6.00%
$
39,587
$
69,963
4.07%
7.20%
$
>38,879
$
>38,865
>4.00%
>4.00%
N/A
$
>48,581
N/A
>5.00%
(dollars in thousands)
December 31, 2013
Total capital
(to risk-weighted assets)
Company
Bank
Tier I capital
(to risk-weighted assets)
Company
Bank
Tier I capital
(to average assets)
Company
Bank
(dollars in thousands)
December 31, 2012
Total capital
(to risk-weighted assets)
Company
Bank
Tier I capital
(to risk-weighted assets)
Company
Bank
Tier I capital
(to average assets)
Company
Bank
Note 18. FAIR VALUE MEASUREMENTS
In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches. Accounting
standards established a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the
use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market
participants would use in pricing the asset or liability, which are developed based on market data obtained from sources independent of
the Company. Unobservable inputs reflects the Company’s assumptions about the assumptions the market participants would use in
pricing an asset or liability, which are developed based on the best information available in the circumstances.
The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities
(Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). A financial asset or liability’s level within
the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is
broken down into three levels based on the reliability of inputs as follows:
113
• Level 1 valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets;
Level 2 valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for
•
identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant
assumptions are observable in the market or can be corroborated by market data; and
• Level 3 valuation is derived from other valuation methodologies including discounted cash flow models and similar techniques that
use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market
participants would use in determining fair value.
A description of the valuation methodologies used for assets recorded at fair value, and for estimating fair value for financial instruments
not recorded at fair value, is set forth below.
Cash, Short-term Investments, Accrued Interest Receivable and Accrued Interest Payable
For these short-term instruments, the carrying amount is a reasonable estimate of fair value.
Securities
The estimated fair values of available-for-sale equity securities are determined by obtaining quoted prices on nationally recognized
exchanges (Level 1 inputs). The estimated fair values for the Company’s investments in obligations of U.S. government agencies,
obligations of state and political subdivisions, government sponsored agency collateralized mortgage obligations, government sponsored
agency residential mortgage-backed securities, and corporate debt securities are obtained by the Company from a nationally-recognized
pricing service. This pricing service develops estimated fair values by analyzing like securities and applying available market
information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing (Level 2
inputs), to prepare valuations. Matrix pricing is a mathematical technique widely used in the industry to value debt securities without
relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark
quoted securities. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the
U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the
bond’s terms and conditions, among other things and are based on market data obtained from sources independent from the Company.
The Level 2 investments in the Company’s portfolio are priced using those inputs that, based on the analysis prepared by the pricing
service, reflect the assumptions that market participants would use to price the assets. The Company has determined that the Level 2
designation is appropriate for these securities because, as with most fixed-income securities, those in the Company’s portfolio are not
exchange-traded, and such non-exchange-traded fixed income securities are typically priced by correlation to observed market data. The
Company has reviewed the pricing service’s methodology to confirm its understanding that such methodology results in a valuation
based on quoted market prices for similar instruments traded in active markets, quoted markets for identical or similar instruments traded
in markets that are not active and model-based valuation techniques for which the significant assumptions can be corroborated by market
data as appropriate to a Level 2 designation.
For those securities for which the inputs used by an independent pricing service were derived from unobservable market information, the
Company evaluated the appropriateness and quality of each price. The Company reviewed the volume and level of activity for all
classes of securities and attempted to identify transactions which may not be orderly or reflective of a significant level of activity and
volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing
service may be adjusted, as necessary, to estimate fair value (fair values based on Level 3 inputs). If applicable, the adjustment to fair
value was derived based on present value cash flow model projections prepared by the Company or obtained from third party providers
utilizing assumptions similar to those incorporated by market participants. The estimated fair value of the PreTSLs and Private Label
Collateralized Mortgage Obligations in the Company’s securities portfolio during 2012 and 2011, prior to being sold in 2012, were
obtained from third-party service providers that prepared the valuation using a discounted cash flow approach with inputs derived from
unobservable market information (Level 3 inputs).
The Company owned one security issued by a state and political subdivision having an amortized cost of $595 thousand that was valued
using Level 3 inputs at December 31, 2013 and two such securities having an amortized cost of $1.8 million at December 31, 2012.
These securities had credit ratings that were either withdrawn or downgraded by nationally recognized credit rating agencies, and as a
result the market for these securities was inactive at December 31, 2013 and 2012. These securities were historically priced using Level
2 inputs. The credit ratings withdrawal and downgrade have resulted in a decline in the level of significant other observable inputs for
these investment securities at the measurement dates. Broker pricing and bid/ask spreads are very limited for these securities. At
December 31, 2013 and 2012, the Company valued one security based on similar nonrated Pennsylvania Sewer bonds adjusted for
coupon and maturity. For the other security at December 31, 2012, the Company obtained a bid indication from a third-party municipal
trading desk to determine the fair value of this security.
114
Loans
Except for collateral dependent impaired loans, fair values of loans are estimated by discounting the projected future cash flows using
market discount rates that reflect the credit, liquidity, and interest rate risk inherent in the loan. Projected future cash flows are
calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. The estimated fair value of
collateral dependent impaired loans is based on the appraised loan value or other reasonable offers less estimated costs to sell. The
Company does not record loans at fair value on a recurring basis. However from time to time, a loan is considered impaired and an
allowance for credit losses is established. The specific reserves for collateral dependent impaired loans are based on the fair value of the
collateral less estimated costs to sell. The fair value of the collateral is generally based on appraisals. In some cases, adjustments are
made to the appraised values due to various factors including age of the appraisal, age of comparables included in the appraisal, and
known changes in the market and in the collateral. When significant adjustments are based on unobservable inputs, the resulting fair
value measurement is categorized as a Level 3 measurement. See also, Note 2 “Summary of Significant Accounting Policies-Loan
Impairment” and Note 5-“Loans.”
Loans Held For Sale
Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.
Mortgage Servicing Rights
The fair value of mortgage servicing rights is estimated using a discounted cash flow model that applies current estimated prepayments
derived from the mortgage-backed securities market and utilizes a current market discount rate for observable credit spreads. The Bank
does not record mortgage servicing rights at fair value on a recurring basis.
Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) Stock
Ownership in equity securities of FHLB of Pittsburgh and the FRB is restricted and there is no established market for their resale. The
carrying amount is a reasonable estimate of fair value.
Deposits
The fair value of demand deposits, savings deposits, and certain money market deposits is the amount payable on demand at the
reporting date. The fair value of fixed-maturity certificates of deposit is estimated based on discounted cash flows using the rates
currently offered for deposits of similar remaining maturities.
Borrowed funds
The Bank uses discounted cash flows using rates currently available for debt with similar terms and remaining maturities are used to
estimate fair value.
Commitments to extend credit and standby letters of credit
The fair value of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For
fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.
The fair value of off-balance sheet commitments is insignificant and therefore not included in the table for non-recurring assets and
liabilities.
115
Assets Measured at Fair Value on a Recurring Basis
The following tables detail the financial asset amounts that are carried at fair value and measured at fair value on a recurring basis at
December 31, 2013 and 2012, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine the
fair value:
(in thousands)
Available-for-sale securities:
Fair value measurements at December 31, 2013
Significant
Quoted prices
other
Significant
in active markets
observable
unobservable
for identical
Fair value
assets (Level 1)
inputs
(Level 2)
inputs
(Level 3)
Obligations of state and political subdivisions
$
78,054
$
-
$
77,483
$
571
Government-sponsored agency:
Collateralized mortgage obligations
Residential mortgage-backed securities
Corporate debt securities
Equity securities
34,799
89,656
407
951
-
-
-
951
34,799
89,656
407
-
-
-
-
-
Total securities available-for-sale
$
203,867
$
951
$
202,345
$
571
(in thousands)
Available-for-sale securities:
Obligations of U.S. government agencies
Obligations of state and political subdivisions
Government-sponsored agency:
Collateralized mortgage obligations
Residential mortgage-backed securities
Corporate debt securities
Equity securities
Total securities available-for-sale
Fair value measurements at December 31, 2012
Significant
Quoted prices
other
Significant
in active markets
observable
unobservable
for identical
Fair value
assets (Level 1)
inputs
(Level 2)
inputs
(Level 3)
$
1,891
$
-
$
1,891
$
-
103,501
9,103
69,456
410
1,000
-
-
-
-
1,000
101,762
1,739
9,103
69,456
410
-
-
-
-
-
$
185,361
$
1,000
$
182,622
$
1,739
116
The table below presents reconciliation and statement of operations classifications of gains and losses for all assets measured at fair
value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2013 and 2012:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(in thousands)
Balance at December 31, 2011
Amortization
Accretion
Purchases
Paydowns
Sales and calls
Total gains or losses (realized/unrealized):
Included in earnings
Included in other comprehensive income
Balance at December 31, 2012
Amortization
Accretion
Purchases
Paydowns
Sales and calls
Total gains or losses (realized/unrealized):
Included in earnings
Included in other comprehensive income
Balance at December 30, 2013
PreTSLs
$
3,801
-
-
-
(172)
(3,629)
-
-
-
$
-
-
-
-
-
-
-
$
-
State and
Political
Subdivisions
$
2,811
-
-
-
(550)
(585)
$
-
63
1,739
-
-
-
(570)
(622)
Private Label
CMOs
$
36,256
(395)
101
14,691
(13,478)
(37,175)
-
-
-
$
-
-
-
-
-
Total
$
42,868
(395)
101
14,691
(14,200)
(41,389)
$
-
63
1,739
-
-
-
(570)
(622)
2
22
571
$
-
-
$
-
2
22
571
$
Assets Measured at Fair Value on a Non-Recurring Basis
Assets measured at fair value on a non-recurring basis are summarized below:
Fair value measurements at December 31, 2013
Significant
Significant
Quoted prices
other
other
in active markets
observable
unobservable
for identical
inputs
inputs
(in thousands)
Collateral-dependent impaired loans
Other real estate owned
Fair value (1)
$ 5,229
assets (Level 1)
$ -
(Level 2)
$ -
(Level 3)
$ 5,229
$ 3,931
$ -
$ -
$ 3,931
Fair value measurements at December 31, 2012
Significant
Significant
Quoted prices
other
other
in active markets
observable
unobservable
for identical
inputs
inputs
(in thousands)
Collateral-dependent impaired loans
Other real estate owned
Fair value (1)
$ 7,816
assets (Level 1)
$ -
(Level 2)
$ -
(Level 3)
$ 7,816
$ 2,455
$ -
$ -
$ 2,455
1) Represents carrying value and related write-downs for which adjustments are based on appraised value. Management makes adjustments to the appraised values as
necessary to consider declines in real estate values since the time of the appraisal. Such adjustments are based on management’s knowledge of the local real estate
markets.
Collateral-dependent impaired loans are classified as Level 3 assets and the estimated fair value of the collateral is based on the
appraised loan value or other reasonable offers less estimated costs to sell. When the measure of the impaired loan is less than the
recorded investment in the loan, the impairment is recorded through a valuation allowance or is charged off. The amount shown is the
balance of impaired loans, net of any charge-offs and the related allowance for loan losses.
OREO properties are recorded at fair value less the estimated cost to sell at the date of acquisition. Subsequent to acquisition, the
balance might be written down further. It is the Company’s policy to obtain certified external appraisals of real estate collateral
117
underlying impaired loans, including OREO, and it estimates fair value using those appraisals. Other valuation sources may be used,
including broker price opinions, letters of intent and executed sale agreements.
The Company discloses fair value information about financial instruments, whether or not recognized in the Statement of Financial
Condition, for which it is practicable to estimate that value. The following estimated fair value amounts have been determined by the
Company using available market information and appropriate valuation methodologies. However, management judgment is required to
interpret data and develop fair value estimates. Accordingly, the estimates below are not necessarily indicative of the amounts the
Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may
have a material effect on the estimated fair value amounts.
The following table summarizes the estimated fair values of the Company’s financial instruments at December 31, 2013 and 2012:
(in thousands)
Financial assets
Fair Value
December 31, 2013
December 31, 2012
Measurement
Carrying Value
Fair Value
Carrying Value
Fair Value
Cash and short term investments
Level 1
$
103,556
$
103,556
$
115,271
$
115,271
Securities available for sale
Securities held to maturity
FHLB and FRB Stock
Loans held for sale
Loans, net
Accrued interest receivable
Mortgage servicing rights
Financial liabilities
Deposits
Borrowed funds
Accrued interest payable
Note 19. EARNINGS PER SHARE
See previous table
203,867
203,867
185,361
185,361
Level 2
Level 2
Level 2
Level 3
Level 2
Level 3
Level 2
Level 2
Level 2
2,308
3,496
820
629,880
2,191
529
884,698
62,433
8,732
2,424
3,496
820
632,536
2,191
990
887,056
65,642
8,732
2,198
7,308
1,615
579,396
2,199
675
854,613
53,903
6,427
2,483
7,308
1,615
592,504
2,199
884
858,970
59,021
6,427
The following table shows the calculation of both basic and diluted earnings per common share for the years ended December 31, 2013,
2012 and 2011:
(in thousands, except share data)
Net income (loss)
Year Ended December 31,
2013
2012
2011
$
6,382
$
(13,711)
$
(335)
Basic weighted-average number of common shares outstanding
16,458,353
16,442,160
16,439,508
Plus: common share equivalents
-
-
-
Diluted weighted-average number of common shares outstanding
16,458,353
16,442,160
16,439,508
Loss per common share:
Basic
Diluted
$
0.39
$
(0.83)
$
(0.02)
$
0.39
$
(0.83)
$
(0.02)
Common share equivalents, in the table above, exclude stock options with exercise prices that exceed the average market price of the
Company’s common shares during the periods presented. Inclusion of these stock options would be anti-dilutive to the diluted earnings
per common share calculation. Antidilutive stock options equaled 82,598 shares, 129,170 shares, and 188,193 shares for the years ended
December 31, 2013, 2012, and 2011, respectively.
118
Note 20. OTHER COMPREHENSIVE INCOME
The following tables summarize the reclassifications out of accumulated other comprehensive income (loss), which is comprised entirely
of unrealized gains and losses on available-for-sale securities, for each of the years ended December 31, 2013 and 2012:
(in thousands)
Income
Statements of Operations
2013
Amount Reclassified
from Accumulated
Other Comprehensive
Affected Line Item
in the Consolidated
Available-for-sale securities:
Reclassification adjustment for net (gains) losses reclassified
into net income
Taxes
Net of tax amount
$
(2,887)
Net gain on sale of securities
982
Income taxes
$
(1,905)
2012
Amount Reclassified
from Accumulated
Other Comprehensive
Affected Line Item
in the Consolidated
(in thousands)
Income
Statements of Operations
Available-for-sale securities:
Reclassification adjustment for net (gains) losses reclassified
into net income
Taxes
Net of tax amount
$
1,808
Net loss on sale of securities
(614)
Income taxes
$
1,194
2011
Amount Reclassified
from Accumulated
Other Comprehensive
Affected Line Item
in the Consolidated
(in thousands)
Income
Statements of Operations
Available-for-sale securities:
Reclassification adjustment for net (gains) losses reclassified
into net income
Taxes
Net of tax amount
$
(4,316)
Net gain on sale of securities
1,467
Income taxes
$
(2,849)
The following table summarizes the changes in accumulated other comprehensive (loss) income, net of tax:
Ye ar Ende d
De ce mbe r 31,
2012
2011
2013
$
$
$
6,698
(7,885)
-
(1,905)
(9,790)
(3,092)
(3,967)
9,471
-
1,194
10,665
6,698
(12,143)
9,933
1,092
(2,849)
8,176
(3,967)
$
$
$
(in thous ands )
Beginning balance
Other comprehensive (loss) income before reclassifications
Noncredit-related gains on OTTI securities not expected to be sold
Amounts reclassified from accumulated other comprehensive (loss) income
Net other comprehensive (loss) income during the period
Ending balance
119
Note 21. CONDENSED FINANCIAL INFORMATION — PARENT COMPANY ONLY
Condensed parent company only financial information is as follows:
Condensed Statements of Condition
(in thousands)
Assets
Cash
Investment in statutory trust
Investment in subsidiary (equity method)
Other assets
Total assets
Liabilities and Shareholders’ Equity
Junior subordinated debentures
Subordinated debentures
Accrued interest payable
Other liabilities
Shareholders’ equity
December 31,
2013
2012
$
254
$
355
364
78,995
107
358
77,301
46
$
79,720
$
78,060
$
10,310
$
10,310
25,000
8,307
2,525
33,578
25,000
5,822
3
36,925
Total liabilities and shareholders’ equity
$
79,720
$
78,060
Condensed Statements of Operations
(in thousands)
Income
Year Ended December 31,
2013
2012
2011
Equity in undistributed income (loss) of subsidiary
$
11,484
$
(11,206)
$
2,248
Equity in trust
Total income (loss)
Expense
Net income (loss)
6
11,490
5,108
7
(11,199)
2,512
4
2,252
2,587
$
6,382
$
(13,711)
$
(335)
120
Condensed Statements of Cash Flows
(in thousands)
Cash flows from operating activities:
Net income (loss)
Adjustments to reconcile net loss to net cash provided (used) by operating activities:
Equity in undistributed (income) loss of subsidiary
Equity in trust
Increase in accrued interest payable
Increase in other liabilities
Net cash (used in) provided by operating activities
Cash flows from investing activities:
Investment in capital of subsidiary
Net cash used in investing activities
Cash flows from financing activities:
Proceeds from issuance of common stock, net of stock issuance costs
Net cash provided by financing activities
(Decrease) increase in cash
Cash at beginning of year
Cash at end of year
For the Year Ended
2013
2012
2011
$
6,382
$
(13,711)
$
(335)
(11,484)
(6)
2,485
2,522
(101)
-
-
-
-
(101)
355
11,206
(7)
2,512
2
2
-
-
-
-
2
353
(2,248)
(4)
2,486
-
(101)
(3,000)
(3,000)
29
29
(3,072)
3,425
$
254
$
355
$
353
Note 22. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
(in thousands, except share data)
Interest income
Interest expense
Net interest income
Credit for loan and lease losses
Net interest income after credit for loan and lease losses
Non-interest income
Non-interest expense
Income before taxes
Provision for income taxes
Net income
Income per share:
Basic
Diluted
(in thousands, except share data)
Interest income
Interest expense
Net interest income
Provision (credit) for loan and lease losses
Net interest income after provision (credit) for loan and lease losses
Non-interest income
Non-interest expense
Loss before taxes
Provision for income taxes
Net loss
Loss per share:
Basic
Diluted
Quarter Ending
2013
March 31,
June 30,
September 30, December 31,
$
8,210
$
8,167
$
8,189
$
8,387
1,857
6,353
(1,224)
7,577
2,459
8,305
1,731
-
1,818
6,349
(2)
6,351
2,281
7,912
720
-
1,812
6,377
(1,159)
7,536
2,415
8,064
1,887
-
1,689
6,698
(3,885)
10,583
2,128
10,667
2,044
-
$
1,731
$
720
$
1,887
$
2,044
$
0.11
$
0.04
$
0.11
$
0.13
$
0.11
$
0.04
$
0.11
$
0.13
Quarter Ending
2012
March 31,
June 30,
September 30, December 31,
$
9,744
$
9,424
$
8,985
$
8,874
2,573
7,171
(136)
7,307
1,450
9,922
(1,165)
-
2,343
7,081
(280)
7,361
1,544
9,872
(967)
-
2,206
6,779
3,792
2,987
1,659
11,167
(6,521)
-
2,096
6,778
689
6,089
(370)
10,777
(5,058)
-
$
(1,165)
$
(967)
$
(6,521)
$
(5,058)
$
(0.07)
$
(0.06)
$
(0.40)
$
(0.30)
$
(0.07)
$
(0.06)
$
(0.40)
$
(0.30)
121
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
The Company’s management has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and
procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of
December 31, 2013.
Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded the Company’s disclosure
controls and procedures were effective as of December 31, 2013.
The Company continually seeks to improve the effectiveness and efficiency of its internal control over financial reporting, resulting in
frequent process refinement. There have been no changes to the Company’s internal control over financial reporting during the
Company’s fourth quarter of 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal
control over financial reporting.
As a result of a provision of the Dodd-Frank Act, which, among other things, permanently exempted non-accelerated filers such as the
Company, from complying with the requirements of Section 404(b) of Sarbanes-Oxley, which requires an issuer to include an attestation
report from an issuer’s independent registered public accounting firm on the issuer’s control over financial reporting, this Annual Report
on From 10-K does not include an attestation report of the Company’s registered public accounting firm regarding the Company’s
internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for First National
Community Bancorp, Inc. (the “Company”). 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 in the United States and is not intended to provide absolute assurance that a misstatement
of our financial statements would be prevented or detected.
Internal control over financial reporting includes those policies and procedures that pertain to the maintenance of records that in
reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; 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 only being made in accordance with authorizations of
management and directors of the Company; and 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.
Any control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives
of the control system are met. The design of a control system inherently has limitations and the benefits of controls must be weighed
against their costs. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the controls. Therefore, no assessment of a cost-effective system of internal controls can provide
absolute assurance that all control issues and instances of fraud, if any, will be detected.
As of December 31, 2013, management of the Company conducted an assessment of the effectiveness of the Company’s internal control
over financial reporting based on criteria established in Internal Control - Integrated Framework (the “Framework”) issued by the
Committee of Sponsoring Organizations of the Treadway Commission in 1992. Based on this evaluation under the criteria in the
Framework, management concluded that The Company’s system of internal control over financial reporting was effective as of
December 31, 2013.
/s/ Steven R. Tokach
Steven R. Tokach
President and Chief Executive Officer
/s/ James M. Bone, Jr., CPA
James M. Bone, Jr., CPA
Executive Vice President and
Chief Financial Officer
122
Item 9B. Other Information
None
Item 10. Directors, Executive Officers and Corporate Governance.
PART III
The information concerning the Directors and Executive Officers of the Company required by this Item 10 is incorporated herein by
reference to the sections entitled “Information as to Nominees, Directors and Executive Officers” in the Company’s Definitive Proxy
Statement for its 2014 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission on or about
April 18, 2014 (the “Proxy Statement”). Disclosure of compliance with Section 16(a) of the Securities Exchange Act of 1934, as
amended, by the Company’s Directors and Executive Officers is incorporated by reference to the section entitled “Section 16(a)
Beneficial Ownership Reporting Compliance” in the Proxy Statement. In addition, information concerning Audit Committee and Audit
Committee Financial Expert is included in the Proxy Statement under the caption “Audit Committee Report” and is incorporated herein
by reference.
The Company has adopted a Code of Business Conduct and Ethics (the “Code”) that applies to the Company’s directors and employees,
including the President and Principal Executive Officer (“PEO”), Principal Financial Officer (“PFO”) and Principal Accounting Officer
(“PAO”). The Code includes guidelines relating to compliance with laws, the ethical handling of actual or potential conflicts of interest,
the use of corporate opportunities, protection and use of the Company’s confidential information, accepting gifts and business courtesies,
accurate financial and regulatory reporting, and procedures for promoting compliance with, and reporting violations of, the Code. The
Code is available on the Company’s website at www.fncb.com/investorrelations/ under the heading “Governance Documents.” The
Company intends to post any amendments to the Code on its website and also to disclose any waivers (to the extent applicable to the
Company’s President, PEO, PFO or PAO) on a Form 8-K within the prescribed time period.
Item 11. Executive Compensation.
The information required by this Item 11 is incorporated herein by reference to the section entitled “Executive Compensation” in the
Company’s Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this Item 12 is incorporated herein by reference to the section entitled “Principal Beneficial Owners of the
Company’s Common Stock” in the Company’s Proxy Statement.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this Item 13 related to certain relationships and related transactions is incorporated herein by reference to
the section entitled “Certain Relationships and Related Transactions” in the Company’s Proxy Statement. The information required
under this Item 13 related to Director Independence is incorporated herein by reference to the section entitled “Corporate Governance”
in the Company’s Proxy Statement.
Item 14. Principal Accounting Fees and Services.
The information required by this Item 14 is incorporated herein by reference to the section entitled “Fees Paid to Independent Registered
Public Accounting Firm” in the Company’s Proxy Statement.
123
PART IV
Item 15. Exhibits and Financial Statement Schedules
1.
Financial Statements
The following financial statements are included by reference in Part II, Item 8 hereof:
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Financial Condition
Consolidated Statements of Operations
Consolidated Statements of Comprehensive (Loss) Income
Consolidated Statements of Changes in Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2.
Financial Statement Schedules
Financial Statement Schedules are omitted because the required information is either not applicable, not required or is shown in
the respective financial statements or in the notes thereto.
3.
The following exhibits are filed herewith or incorporated by reference.
EXHIBIT 2.1
EXHIBIT 3.1
EXHIBIT 3.2
EXHIBIT 4.1
EXHIBIT 4.2
EXHIBIT 10.1
EXHIBIT 10.2
EXHIBIT 10.3
EXHIBIT 10.4
EXHIBIT 10.5
Branch Purchase and Deposit/Loan Assumption Agreement – filed as Exhibit 2.1 to the Company’s
Current Report of Form 8-K on August 16, 2013, is hereby incorporated by reference.
Amended and Restated Articles of Incorporation dated May 19, 2010 — filed as Exhibit 3.1 to the
Company’s Current Report on Form 8-K on May 19, 2010, is hereby incorporated by reference.
Amended and Restated Bylaws - filed as Exhibit 3.2 to the Company’s Form 10-Q for the quarter
ended September 30, 2013, as filed on November 12, 2013, is hereby incorporated by reference
Form of Common Stock Certificate — filed as Exhibit 4.1 to the Company’s Form 10-K for the year
ended December 31, 2009, as filed on March 16, 2010, is hereby incorporated by reference.
Form of Subordinated Note — filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K dated
August 28, 2009, is hereby incorporated by reference.
Dividend Reinvestment Plan — filed as Exhibit 99.1 to the Company’s Amended Registration
Statement on Form S-3 as filed on July 16, 2009, is hereby incorporated by reference.
Amended and Restated Declaration of Trust by and among Wilmington Trust Company, First National
Community Bancorp, Inc., William Lance, Stephen J. Kavulich and Robert J. Mancuso dated as of
December 14, 2006, filed as Exhibit 10.1 to the Company’s 8-K on December 19, 2006 is hereby
incorporated by reference.
Guarantee Agreement by and between First National Community Bancorp, Inc. and Wilmington Trust
Company, dated as of December 14, 2006, filed as Exhibit 10.4 to the Company’s Current Report on
Form 8-K on December 19, 2006, SEC file number 333-24121, is hereby incorporated by reference.
Indenture by and between First National Community Bancorp, Inc. and Wilmington Trust Company,
dated as of December 14, 2006, filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K on
December 19, 2006, SEC file number 333-24121, is hereby incorporated by reference.
Treasury Tax and Loan Demand Note by and between First National Community Bank and the Federal
Reserve Bank of Philadelphia dated as of July 17, 1996, — filed as Exhibit 10.5 to the Company’s
Form 10-K/A as filed on December 2, 2011, is hereby incorporated by reference.
EXHIBIT 10.6
Credit Facility by and between First National Community Bancorp, Inc. and Federal Home Loan Bank
124
EXHIBIT 10.7+
EXHIBIT 10.8+
EXHIBIT 10.9+
of Pittsburgh, dated as of September 22, 1993, — filed as Exhibit 10.6 to the Company’s Form 10-K/A
as filed on December 2, 2011, is hereby incorporated by reference.
2000 Stock Incentive Plan-filed as Exhibit 10.2 to the Company’s Form 10-K for the year ended
December 31, 2004, SEC file number 333-24121, as filed on March 16, 2005, is hereby incorporated by
reference.
2000 Independent Directors Stock Option Plan — filed as Exhibit 10.3 to the Company’s Form 10-K for
the year ended December 31, 2004, SEC file number 333-24121, as filed on March 16, 2005, is hereby
incorporated by reference.
Directors’ and Officers’ Deferred Compensation Plan - filed as Exhibit 10.4 to the Company’s Form 10-
K for the year ended December 31, 2004, as filed on March 16, 2005, is hereby incorporated by
reference.
EXHIBIT 10.10+
Discretionary Cash Bonus Plan Description— filed as Exhibit 10.5 to the Company’s Form 10-K for the
year ended December 31, 2009, as filed on March 16, 2010, is hereby incorporated by reference.
EXHIBIT 10.11
EXHIBIT 10.12
EXHIBIT 10.13
EXHIBIT 10.14
EXHIBIT 10.15+
EXHIBIT 10.16+
EXHIBIT 10.17+
Consent Order - filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K on September 7,
2010 is hereby incorporated by reference.
Agreement with Federal Reserve Bank of Philadelphia — filed as Exhibit 10.1 to the Company’s
Current Report on Form 8-K on December 1, 2010.
Professional Services Agreement dated April 5, 2010 by and between the Company and Eugene T.
Subol — filed as Exhibit 99.1 to the Company’s Current Report on Form 8-K on April 5, 2010, is
hereby incorporated by reference.
Stipulation of Settlement dated November 27, 2013 – filed as Exhibit 10.1 to the Company’s Current
Report on Form 8-K on December 4, 2013, is hereby incorporated by reference.
2013 Long-Term Incentive Compensation Plan – filed as Exhibit 10.1 to the Company’s Current Report
on Form 8-K on December 27, 2013, is hereby incorporated by reference.
Executive Incentive Plan – filed as Exhibit 10.14 to the Company’s Form 10-K for the year ended
December 31, 2012, as filed on March 28, 2013, is hereby incorporated by reference.
2012 Employee Stock Grant Plan – filed as Exhibit 10.15 to the Company’s Form 10-K for the year
ended December 31, 2012, as filed on March 28, 2013, is hereby incorporated by reference.
EXHIBIT 10.18 +
*
2013 Employee Stock Grant Plan.
EXHIBIT 10.19+
EXHIBIT 10.20+
EXHIBIT 14
EXHIBIT 21
Form of Retricted Stock Award Agreement – filed as Exhibit 4.2 to the Company’s Form S-8 on
January 24, 2014 is hereby incorporated by reference.
Form of Stock Option Award Agreement – filed as Exhibit 4.3 to the Company’s Form S-8 on January
24, 2014 is hereby incorporated by reference.
Code of Business Conducts and Ethics – filed as Exhibit 14 to the Company’s Form 10-K as filed on
April 6, 2012 is hereby incorporated by reference.
Subsidiaries— filed as Exhibit 21 to the Company’s Form 10-K for the year ended December 31, 2009,
as filed on March 16, 2010, is hereby incorporated by reference.
EXHIBIT 23*
Consent of McGladrey LLP.
EXHIBIT 31.1*
Certification of Chief Executive Officer
EXHIBIT 31.2*
Certification of Chief Financial Officer
125
EXHIBIT 32**
Section 1350 Certification — Chief Executive Officer and Chief Financial Officer
EXHIBIT 101.INS
XBRL INSTANCE DOCUMENT
EXHIBIT 101.SCH
XBRL TAXONOMY EXTENSION SCHEMA
EXHIBIT 101.CAL
XBRL TAXONOMY EXTENSION CALCULATION LINKBASE
EXHIBIT 101.DEF
XBRL TAXONOMY EXTENSION DEFINITION LINKBASE
EXHIBIT 101.LAB
XBRL TAXONOMY EXTENSION LABEL LINKBASE
EXHIBIT 101.PRE
XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE
_____________________________
* Filed herewith
** Furnished herewith
+ Management contract, compensatory plan or arrangement
126
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:
Registrant: FIRST NATIONAL COMMUNITY BANCORP, INC.
/s/ Steven R. Tokach
Steven R. Tokach
President and Chief Executive Officer
/s/ James M. Bone, Jr.
James M. Bone, Jr., CPA
Executive Vice President and Chief Financial Officer
Principal Financial Officer
March 24, 2014
Date
March 24, 2014
Date
/s/ Stephanie A. Westington March 24, 2014
Stephanie A. Westington, CPA
Senior Vice President and Controller
Principal Accounting Officer
Date
Pursuant to the requirements of the Securities 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:
Directors:
/s/ Michael J. Cestone, Jr.
Michael J. Cestone, Jr.
March 24, 2014
Date
/s/ Joseph Coccia
Joseph Coccia
March 24, 2014
Date
/s/ Louis A. DeNaples, Jr.
Louis A. DeNaples, Jr.
March 24, 2014
Date
/s/ Dominick L. DeNaples
Dominick L. DeNaples
March 24, 2014
Date
/s/ Joseph J. Gentile
Joseph J. Gentile
March 24, 2014
Date
/s/ Thomas J. Melone
Thomas J. Melone
/s/ Steven R. Tokach
Steven R. Tokach
March 24, 2014
Date
March 24, 2014
Date
/s/ John P. Moses
John P. Moses
March 24, 2014
Date
127
EXHIBIT 10.18
Purpose:
November 27, 2013
First National Community Bancorp, Inc.
2013 Employee Stock Grant Plan
(cid:127) The purpose of the First National Community Bank (FNCB) 2013 Employee Stock Grant Plan (the Plan) is to provide
employees with a long term financial interest in FNCB’s future growth and profitability by providing them with company
ownership in the form of common stock.
Term:
(cid:127) The 2013 Employee Stock Grant Plan is intended to be a one-time program implemented in December, 2013.
Stock Subject to Plan:
(cid:127) The 2013 Employee Stock Grant Plan will utilize existing, authorized, but unissued FNCB common stock. The shares of
stock granted under this Plan will not exceed 15,000 shares.
Plan Approval and Administration:
(cid:127) The FNCB Board of Directors is responsible for authorizing this Plan. The Board of Directors authorized the implementation
of this Plan by Board resolution on November 27, 2013.
(cid:127) The Plan will be administered by Human Resources and Finance.
Awards:
(cid:127) All eligible employees will be granted fifty (50) shares of FNCB common stock.
(cid:127) Awards will be kept in book entry form using FNCB’s designated stock registration firm.
Plan Eligibility: To be eligible to participate in the Plan, an employee must be:
(cid:127) An active FNCB employee classified as Full Time or Part Time as of the date the program is announced to employees (the
“Effective Date”).
(cid:127) All executive officers who are actively employed on the Effective Date will be eligible to participate in the Plan.
Stock Restrictions:
(cid:127) Stock Grant recipients may not sell the shares granted under the Plan until after January 1, 2015. FNCB’s designated stock
registration firm will be responsible for administering the terms of this Plan provision.
Plan Participant Responsibilities:
(cid:127) Award recipients will be responsible for all costs and fees associated with the sale of their FNCB stock.
(cid:127) Award recipients will be responsible for all tax obligations arising from the stock grant and ownership of stock under this
Plan.
Transfer of Shares:
(cid:127) Except as noted below, shares may not be transferred or sold to another party prior to January 1, 2015.
(cid:127)
In the event of an employee’s death prior to the date that the one year prohibited sale restriction has been satisfied, the shares
will be transferred to the employee’s estate, for distribution pursuant to the employee’s will or applicable law. The shares
will then remain subject to the restriction on transfer.
EXHIBIT 23
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in Registration Statement (No. 333-193545) on Form S-8 of First National Community
Bancorp, Inc. and Subsidiaries of our report dated March 24, 2014, relating to our audit of the consolidated financial statements,
which appears in this Annual Report on Form 10-K of First National Community Bancorp, Inc. and Subsidiaries for the year ended
December 31, 2013.
/s/ McGladrey, LLP
New Haven, Connecticut
March 24, 2014
EXHIBIT 31.1
I, Steven R. Tokach, certify that:
CERTIFICATION
1.
I have reviewed this annual report on Form 10-K of First National Community Bancorp, Inc.;
2.
Based on my knowledge, this 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 report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
3.
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
4.
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 control 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 fiscal 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
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
5.
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 control 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 24, 2014
By:
/s/ Steven R. Tokach
Steven R. Tokach
President and Chief Executive Officer
EXHIBIT 31.2
I, James M. Bone, Jr., certify that:
CERTIFICATION
1.
I have reviewed this annual report on Form 10-K of First National Community Bancorp, Inc.;
2.
Based on my knowledge, this 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 report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
3.
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
4.
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 control 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 fiscal 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
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
5.
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 control 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 24, 2014
By:
/s/ James M. Bone, Jr.
James M. Bone, Jr., CPA
Executive Vice President and Chief Financial Officer
EXHIBIT 32
CERTIFICATION OF CEO AND CFO PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code), I,
Steven R. Tokach, Chief Executive Officer of First National Community Bancorp, Inc. (the “Company”) and I, James M. Bone, Jr.,
Chief Financial Officer of the Company, hereby certify that the Company’s Annual Report on Form 10-K for the period ended
December 31, 2013 (the “Report”):
1.
78o (d)); and
Fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or
2.
operations of the Company for the year ended December 31, 2013.
The information contained in the Report fairly presents, in all material respects, the financial condition and results of
Date: March 24, 2014
Date: March 24, 2014
By:
/s/ Steven R. Tokach
Steven R. Tokach
President and Chief Executive Officer
By:
/s/ James M. Bone, Jr.
James M. Bone, Jr., CPA
Executive Vice President and Chief Financial Officer
The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of
Chapter 63 of Title 18 of the United States Code) and is not being filed as part of the Report or as a separate disclosure document.
2013AR-33114-CoverArtwork.pdf 2 4/4/2014 9:40:48 AM
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Wealth Management Services
fncb.com/wealthmanagementservices | 570.348.4321
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We have earned our reputation as a leader by maintaining a high level of professional integrity
and building long-term relationships based on mutual respect and strict adherence to the
fundamental principles of needs-based investing.
At FNCB Wealth Management Services, we believe that:
You are entitled to consistent and objective investment
advice from knowledgeable Professionals.
Investment advice should be appropriate to your financial
circumstances and investment goals – based on your
personal risk tolerance.
You should conduct business with representatives whose
only motivation is serving your best interests.
INVEST Financial Corporation member FINRA/SIPC, a registered investment adviser, is not affiliated with
First National Community Bank or FNCB Wealth Management Services. INVEST and its affiliated insurance
agancies offer securities, advisory services, and certain Insurance products. Products are: Not FDIC
insured; Not deposits, obligations of, or guaranteed by any bank; Subject to investment risk, including
the possible loss of principal amount invested.
2013AR-33114-CoverArtwork.pdf 1 4/4/2014 9:40:46 AM
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FIRST NATIONAL COMMUNITY BANCORP, INC.
102 EAST DRINKER STREET, DUNMORE, PA 18512
1.877.879.3622 | fncb.com
Simply a better bank.TM
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2013
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annual
annual
FIRST NATIONAL COMMUNITY BANCORP, INC.report
report
report
FIRST NATIONAL COMMUNITY BANCORP, INC.
FIRST NATIONAL COMMUNITY BANCORP, INC.