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Positioned For Success
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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
2014 Annual Report
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2014 ANNUAL REPORT
C O N T E N T S
1
Chairman’s Message
9
Financial Information
11
Bank Local
12
Commercial Banking
14
Retail Banking
16
Retail Lending
17
Community Responsibility
18
Executive Leadership & Directors
F I R S T N A T I O N A L C O M M U N I T Y B A N K
Our Mission: Simply a better bank.TM
FNCB-AR14-pages1-10.pdf 1 4/13/2015 5:54:06 PM
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FIRST NATIONAL COMMUNITY BANCORP
T o O ur S hareholders, Customers &
Friends:
W e are pleased to report that 2
W e are pleased to report that 2
0 14 was a very productive and successful y ear for FN CB
0 14 was a very productive and successful y ear for FN CB
characteriz ed b
: our b est financial results since 2
; a considerab
le strengthening of our
capital position; continued and significant ongoing improvement to asset q uality metrics;
further strengthening of our corporate governance; resolution of certain litigation and
regulatory matters and completion of a sale transaction, which helped to focus our retail
b anking footprint in traditional areas of competitive strength.
In addition, on March 26, 2015 we announced that our wholly-owned subsidiary, First National
Community Bank (the “Bank”) was fully and completely released from the Consent Order entered
into with the Office of the Comptroller of the Currency ("OCC") in September 2010. The termination
of the Consent Order signifies that the OCC had determined that the Bank had met all of the
requirements of the Consent Order, and is a positive milestone that represents our team’s
successful efforts to improve our compliance-related infrastructure, as well as strengthen our
balance sheet and improve our financial performance.
S olid Performance
Our 2014 net income increased by $7.0 million, or 110.3%, to $13.4 million, or $0.81 per basic and
diluted share, compared to $6.4 million, or $0.39 per basic and diluted share, for 2013. The strong
earnings performance was due largely to higher net interest income and non-interest income, coupled
with lower non-interest expense. Return on average assets and return on average shareholders’ equity,
two important indicators of bank financial performance, equaled 1.38% and 29.50%, respectively, for
2014 compared to 0.67% and 18.65%, respectively, for 2013. Despite a challenging and competitive
market, our net interest income grew $0.7 million, or 2.9%. Our improved net interest income reflected a
14 basis point reduction in our funding costs, coupled with increased interest and dividend income from
the securities portfolio. Non-interest income grew $5.6 million, or 60.7%, due largely to higher net gains
on the sale of securities, favorable legal settlements and a net gain from the divestiture of our retail
banking operations in Monroe County. In addition, an improved risk profile, the resolution of outstanding
litigation and the recognition of operating efficiencies resulted in a $1.4 million, or 3.9%, decrease in
non-interest expense.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 1
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A S tronger Financial Position
Strengthening our capital position remained an important objective for 2014. Our strong net income
generation during the year enabled the Bank to add significantly to the capital levels that existed at the
end of 2013 and improve shareholder value as evidenced by a $1.01 per share, or 54.2%, increase in our
tangible book value to $3.10 per share at December 31, 2014 compared to $2.09 per share at the close
of 2013. At December 31, 2014, the Bank’s tier I leverage ratio was 9.78% and total risk-based capital
ratio was 15.42%; the highest capital levels recorded since December 31, 2008. Even with the stronger
capital position, we remain firmly committed to building and maintaining a strong capital base to support
future growth. Our total shareholders’ equity increased 53.1%,
or $17.8 million, in 2014 also reflecting our net income during
the year, as well as $4.2 million in other comprehensive income
related entirely to appreciation of available-for-sale securities.
We continued to focus on organic loan generation in 2014,
while concurrently implementing balance sheet management
strategies aimed at reducing risk and maintaining an
asset/liability position that is poised to perform better when
interest rates begin to rise. Loans grew $26.1 million, or 4.1%,
to $669.5 million at December 31, 2014 from $643.4 million at
Jim Bone, Executive Vice President & CFO,
Amy Kelley, Assistant Controller.
December 31, 2013. This approach yielded solid growth in both our commercial and retail lending
products in 2014. Commercial real estate loans grew $15.0 million, or 6.8%, and commercial and
industrial loans increased by $5.1 million, or 4.0%, both resulting from the development of expanded
business relationships with new and existing customers. Residential mortgage loans grew $7.9 million,
or 6.9%, to $122.8 million at December 31, 2014. We continued to retain residential mortgage loans with
original maturity terms of 15 years or less consistent with our asset/liability management strategy. We also
experienced gains in our indirect automobile lending, a niche platform for us, which was the primary
driver in consumer loan growth of $3.5 million, or 2.9%, in 2014.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 2
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During a financial climate of uncertainty and increased regulatory
scrutiny , FN CB has risen to the challenge and delivered unparalleled
results...no easy task.
Our experienced Board and Senior Management team have developed the strategic vision and
objectives necessary to position the Bank for 2015 and beyond. A solid foundation for the success
of our organization and employees.
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FN CB S EN
IO
LEADER
S HIP T EAM
From left to right front row: Gerard A. Champi, COO; Steven R. Tokach, President & CEO; James M. Bone, Jr., CPA, EVP & CFO;
Joseph J. Earyes, CPA, First SVP & Chief Retail Banking & Operations Officer; Brian C. Mahlstedt, First SVP & Chief Lending Officer;
Cathy J. Conrad, SVP & Credit Administration Officer; Mary G. Cummings, SVP & General Counsel; Back row: Mary Ann Gardner,
CRCM, SVP & Compliance Officer; Lisa L. Kinney, SVP & Retail Lending Officer; Donald H. Ryan, SVP & Human Resources Officer;
Ronald S. Honick, CPA, CIA, SVP & Audit Manager
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 3
R
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We believe a critical element of our success in 2014 was the disciplined management and strategic
repositioning of our balance sheet. During 2014, we began repositioning our investment portfolio by
selling a majority of tax-exempt obligations
and replacing them with taxable obligations
of U.S. government and government-
sponsored agencies, in order to be able to
utilize significant Federal income tax net
operating loss carryforwards available to
us. This repositioning created taxable
interest revenue and reduced credit and
concentration risk associated with these
municipal obligations, as well as mitigating
interest rate risk by shortening the duration
of our investment portfolio. In addition, we
Steven Tokach, President & CEO and Jerry Champi, COO
were able to benefit from market interest rate fluctuations to record a net gain on the sale of investment
securities that totaled $6.6 million, which in turn aided our capital growth. Our total assets at December
31, 2014 were $970.0 million, a decrease of $33.8 million, or 3.4%, from the 2013 year end and a
reflection of the balance sheet repositioning described above.
Another element of our asset/liability management
strategy in 2014 focused on reducing funding costs
whenever possible. This was achieved largely by
allowing $47.8 million in maturing certificates of
deposit that were generated through a national listing
service to mature and be replaced by lower-costing
core-customer deposits and advances through the
FHLB of Pittsburgh. Total deposits decreased $89.4
W e b elieve a critical element
of our success in 2
0 14 was
the disciplined management
and strategic repositioning of
our b alance sheet.
million, or 10.1%, to $795.3 million at December 31, 2014 from $884.7 million at the end of 2013. Non-
interest-bearing deposits decreased $33.5 million, or 21.3%, which resulted primarily from balance
fluctuations of several large commercial relationships. Interest-bearing deposits declined $55.9 million,
or 7.7%, largely due to the planned CD runoff. This strategy enabled us to reduce our cost of funds 14
basis points to 0.80% in 2014 from 0.94% in 2013.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 4
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Improved Asset Q uality
One of the most important and most impressive accomplishments realized in recent years has been the
substantial improvement in the Bank’s asset quality metrics. Our persistent focus on resolving problem
credits and disciplined approach to credit risk management led to further improvement in our asset
quality metrics and delinquency rates in 2014. Total non-performing loans decreased $0.9 million, or
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Cathy Conrad, SVP & Credit Administration Officer and
Stephanie Westington, CPA, SVP & Controller
13.4%, to $5.5 million, while the percentage of non-
performing loans to gross loans improved 17 basis
points to 0.82%. This compares favorably to the average
for all FDIC-insured commercial banks with total assets
between $500 million and $1.0 billion. For this peer
group, the ratio of non-performing loans to gross loans
was 1.06% at December 31, 2014. In addition, total loan
delinquencies improved to 1.21% of gross loans at the
close of 2014, compared to 1.54% at the end of 2013
and the average of 1.73% for the peer group at Decem-
ber 31, 2014.
The Bank was awarded a substantial settlement of $5.8
million in the second quarter of 2014, resulting from
judgments filed pursuant to a large commercial credit relationship. The settlement represented full
recovery of previously charged-off loans, satisfaction of all past due interest and late charges and
reimbursement of all legal fees and other-related expenses associated with this credit relationship.
Receipt of this settlement was the primary factor leading to a $5.9 million release of loan and lease loss
reserves, as well as having a favorable impact on both our non-interest income and non-interest expense
levels for the year.
Despite recording a credit for loan and lease losses for the year, we remained well reserved for potential
losses at December 31, 2014. Our allowance for loan and lease losses equaled $11.5 million, or 1.72%
of gross loans outstanding at December 31, 2014, compared with an average of 1.44% for peer banks at
the end of 2014.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 5
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O vercoming Hurdles and Creating Efficiencies
At the beginning of 2015, the Company was able to successfully resolve two matters with regulatory
agencies that have consumed a considerable amount of time and effort. Both matters were related
to circumstances and allegations that dated back several years. The first matter was an agreement
dated January 28, 2015 with the U.S. Securities and Exchange Commission (“SEC”) related to
disclosure, financial reporting and the restatement of our financial statements for the year ended
December 31, 2009 and the quarters ended March 31, 2010 and June 30, 2010, which we have
since appropriately addressed and filed. On February 27, 2015, we reached a comprehensive
settlement with both the OCC and FinCEN to resolve certain Bank Secrecy Act (“BSA”) allegations
based on events that transpired years ago. It is our belief that the Bank’s current BSA/Anti-Money
Laundering program meets all industry expectations. We also believe that the negotiated settlement
agreed to, provided a superior outcome for our shareholders, when compared to enduring
additional years of contested litigation and legal expenses that would result from challenging the
allegations. The resolution of the SEC matter and the OCC and FinCEN matter resulted in an
aggregate accrual of $1.7 million for civil money penalties in 2014.
While we realize we still have work to do in reaching our efficiency goals, the settlement of these
regulatory matters was an important step in reducing future legal and professional expenses, in
addition to freeing up management resources. Through the continued resolution of outstanding
litigation we were able to reduce legal expenses $0.7 million or 27.7% in 2014. Furthermore, our
improved risk profile and cost reduction initiatives have helped us make meaningful strides in
improving our operational efficiency and decreasing our non-interest expense by $1.4 million,
or 3.9%, in 2014.
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FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 6
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Leadership and Governance
During 2014, we took steps to add strength and depth to our Board of Directors through the
appointment of two prominent Northeastern Pennsylvania businessmen, William G. Bracey and
Keith W. Eckel, to our corporate governance team. Both Mr. Bracey and Mr. Eckel bring with them
proven leadership qualities along with extensive business and entrepreneurial acumen. Also, Louis A.
DeNaples, Sr., was re-elected at the 2014 annual shareholders’ meeting and returned to full director
status. We are pleased to be able to welcome Mr. Bracey and Mr. Eckel and welcome back Mr.
DeNaples to our board. We would like to thank all of our directors for their strong leadership and
continued commitment to sound governance of our organization.
It is also with great sadness that we acknowledge the August 22, 2014 passing of a long-time director,
customer and friend, Joseph J. Gentile. Mr. Gentile dedicated over 23 years of service to the Bank as
a director. His strong business background, understanding of the local business environment and
involvement within the community made him an asset to our organization; he is greatly missed.
M oving Forward
As we move ahead into 2015, we look forward to continuing to build on the initiatives put in place in 2014
and implement additional strategies focused on growing our core deposits, increasing net interest
income, generating additional non-interest revenue streams and further reducing non-interest expenses
in order to continue to create long-lasting value for customers and shareholders.
On February 17, 2015, our common stock began trading on the OTCQX Marketplace under its same
ticker symbol, “FNCB.” Launched in the spring of 2014, OTCQX for Banks is an expansion of the OTCQX
Marketplace which was designed to increase the visibility of well-managed, strongly-capitalized commu-
nity banks in the public markets. We are excited to be trading on a platform that was designed by OTC
Markets Group specifically for our industry, and which attracted 34 U.S. community banks to join the
OTCQX marketplace in 2014. We believe trading on OTCQX will improve the quality and availability of
information available for the investment community, and should make our shares more widely accessible
to investors, as well as increase the liquidity of our common stock over time.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 7
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In the fall of 2015, we anticipate transitioning to
a new core bank operating system. The conver-
sion to a more robust system that will provide us
with new technologies to improve day-to-day
operations and reporting capabilities, as well as
provide us with the ability to offer delivery
system enhancements and greater service to
our customers.
A foremost concern of management and the
board of directors has been the ability of the
Company to provide our shareholders with a
Dominick L. DeN aples
Chairman of the Board
S teven R
. T okach
President and CEO
tangible return on their investment. With the Bank’s release from the OCC Consent Order and being in full
compliance with all mandatory minimum capital requirements, the return to normal regulatory status is on
the horizon.
We would like to thank all the members of our team for their hard work and dedication to making FNCB
Simply a Better Bank! We would also like to thank you, our shareholders, for your continued confidence
and steadfast loyalty to our Company!
Yours truly,
Dominick L. DeN aples
Chairman of the Board
S teven R
President and Chief Executive Officer
. T okach
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 8
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FIN AN CIAL IN FO
M AT
IO
FIN AN CIAL CO
N DIT
IO
(dollars in thousands)
T otal loans
T otal deposits
0 14
0 13
0 12
0 11
0 10
9 ,4
3 ,3
7 ,7
9 ,5
2 1
7 ,9
0 14
0 13
0 12
0 11
0 10
5 ,3
4 ,6
4 ,6 13
7 ,13
2 ,4
S ecurities portfolio composition
Obligations of U.S Gov’ t Agencies
Obligations of State &
Political Subdivision
Residential CMOs*
Commercial CMOs*
Residential mortgage-backed securities*
Corporate debt securities
Negotiable cerificates of deposit
Eq uity Securities
3 1
$ 2
$ 2
$ 2
9 ,2
4 ,5
6 ,2
$ 6 1,2
4 ,0
$ 7
$ 4
$ 2 ,2
$ 9
2 18 ,9
*Issued by U.S. government/government-sponsored agencies
0 14
1.0
0 .19
3 .8
0 .4
13 .3
11.19
11.9
7 .9
FIN AN CIAL PER FO
M AN CE
(dollars in thousands)
—
0 ,3
$ 8
2 1
$ 3 ,2
$ 3 1,5
$ 8
9 ,6
$ 4
—
$ 9
5 1
6 ,17
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N et income
0 14
0 13
0 12
0 11
0 10
0 13
0 .2
3 .4
0 .4
8 .9
15 .3
1.5
$ 13 ,4
$ 6 ,3
2
($ 13 ,7 11)
($ 3
($
3 1,7
5 )
0 )
N on- interest income
N on- interest ex pense
$ 14 ,9
0 14
0 13
0 12
0 11
0 10
$
9 ,2
4 ,2
3
$ 12 ,9
$ 1,2
2
0 14
0 13
0 12
0 11
0 10
3 ,5
4 ,9
4 1,7
4 1,3
4 1,5
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 9
2
2
2
2
$
8
8
9
8
$
8
5
$
9
5
6
$
9
8
3
6
2
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2
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7
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3
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6
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$
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6
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7
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0
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3
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$
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0
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3
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0
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$
8
7
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0
9
5
6
9
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%
%
2
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6
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4
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2
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3
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0
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3
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%
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%
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%
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FIN AN CIAL IN FO
M AT
IO
AS
S ET
Q
U ALIT
N onperforming loans
as a percentage of total loans
0 .8
0 .9
1.6
0 14
0 13
0 12
0 11
0 10
2 .9
3 .7
T otal delinq uent loans
as a percentage of total loans
1.2 1%
1.5
2 .13
0 14
0 13
0 12
0 11
0 10
4 .0
4 .4
Allowance for loan and lease losses
as a percentage of total loans
Allowance for loan and lease losses
as a percentage of nonperforming loans
0 14
0 13
0 12
0 11
0 10
1.7
2 .18
3 .10
3 .0
2 .9
IT
CAPIT AL PO
T ier 1 leverage ratio (Bank)
(Tier 1 capital/average assets)
IO
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8 .6
2 19 .8
19
0 .9
0 13
0 12
0 11
0 10
10
4 .6
9 .5
T otal risk-
(Total risk-based capital/risk-weighted assets)
b ased capital ratio (Bank)
0 14
0 13
0 12
0 11
0 10
9 .7
8 .3
7 .2
7 .2
6 .0
0 14
0 13
0 12
0 11
0 10
15 .4
13 .4
11.7
11.7
9 .8
Book value per share
(Total capital/shares of common stock outstanding)
0 14
0 13
0 12
0 11
0 10
3 .12
2 .0
2 .2
2 .4
$ 1.9
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 10
2
2
2
2
2
2
2
2
2
2
2
2
2
2
%
2
2
2
2
2
$
4
2
$
$
4
$
3
5
2
2
2
2
2
2
2
2
2
4
%
%
3
%
3
%
2
2
2
2
2
2
Y
S
N
R
N
2
%
9
%
2
%
3
%
4
%
7
%
2
%
0
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7
8
%
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2
0
2
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2
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%
7
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8
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3
%
9
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3
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3
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2
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8
%
0
%
0
%
6
%
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BANK LOCAL, IT’S GOOD FOR
YOU AND THE COMMUNITY.
Three key elements comprise the FNCB ‘Bank
Local’ philosophy: offer products and services
that compare or surpass big banks; provide
customers with simply better service; and
Lastly, the FNCB ‘Bank Local’ initiative represents
Lastly, the FNCB ‘Bank Local’ initiative represents
thoroughly demonstrate a commitment to com-
our larger commitment to the towns, organizations
munity responsibility.
Product for product, service for service — FNCB
stands equally among its largest competitiors
with offerings to fulfill customers needs at any life
and small businesses in the areas we serve.
Committed to charitable giving and social responsi-
bility, we understand our role as a true community
bank, based locally, for more than a century.
stage. Driven by the same safe, secure technol-
Research suggests that by diverting even a small
ogy to satisfy the most discerning user, custom-
percentage of all banking away from big banks to
ers enjoy the freedom to bank how and when
support local banks, the community will be
they want— online, mobile or in-branch while
impacted in incremental economic activity, as well
enjoying benefits such as: cashback rewards,
as, create additional jobs each year. Because FNCB
nationwide ATM fee reimbursements, free mobile
keeps money local, it helps to fund area businesses
apps, bill pay and money management tools.
and non-profits thereby creating a cyclical environ-
As important is the intent to provide our custom-
ers with a simply better experience. As a result,
ment that positively impacts the businesses and
communities where we live and work.
we have implemented new policies, restructured
Overall, the FNCB Bank Local advantage partners
fees, consolidated products and measured
with customers, businesses and communities to
customer service satisfaction scores. We
provide the best products and services, the best
continue to identify ways to improve and enhance
customer experience and seeks to do so in a way
the customer experience and have outlined
that fulfills the social responsibility of being a true,
objectives that will continue into 2015.
local community bank.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 11
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COMMERCIAL BANKING
We offer experienced business solutions
and innovative ideas that drive results and
allow our customers to grow their busi-
ness, which in turn, grows our community.
That’s the FNCB Bank Local advantage.
Education Holdings 1, Inc. (Penn Foster)
Penn Foster, a long-standing educational institu-
tion in the local market, approached FNCB to
restructure their current financial position to
maintain viability and continued prosperity within
the community.
Accommodating a time-sensitive issue, FNCB
was able to provide a $ 6.0 million commercial
mortgage loan. As a result, Penn Foster was able
to achieve their financial goals by taking advan-
tage of the borrowing capacity supported by
their Scranton facility. The new commercial loan
will fund ongoing improvements in the company’s
operations including the key student support and
technology functions performed by the
company’s over 450 Scranton employees.
Since the restructure, the school has been able to
focus on expansion of current curriculums that
target larger segments of the public. Their
revenues trend upward while the school contin-
ues to post positive growth.
Joseph A. Castrogiovanni, SVP & Regional Commercial Lending
Manager; Amy L. Branning, Banking Officer & Relationship
Manager I; Brian C. Mahlstedt, First SVP & Chief Lending Officer
A Distinct Benefit of the
Bank Local Advantage
is Partnering with
Companies that Foster Goals
for the Greater Good
“Penn Foster is one example of an
online school that charges students
less than the average cost of
credits among U.S. News-ranked
schools, a move made possible in
part by trimming faculty costs. CEO
Frank Britt says, “...this allows the
school to deliver a high-touch
experience” and spend only 7
percent of its budget on faculty
costs, as opposed to around 70 to
80 percent, as most colleges do. It
also allows the school to charge
students less – Penn Foster
charges $79 per credit, Britt says.”
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 12
FNCB-AR14-pages11-20.pdf 13 4/13/2015 6:21:59 PM
Marywood University
Learning Commons
INNOVATIVE IDEAS DRIVEN
BY EXPERIENCE
M ary wood U niversity
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FNCB, partnered with multiple participating banks, loaned a total of $20.0 million to the University for the
construction of a new 72,000 square foot, technologically advanced learning facility that is currently
underway. The total project cost is estimated at $37.0 million. The Marywood University Learning Commons
will change minds about what a library is, how it works, and
what it’s supposed to do. The new home of Marywood's
Center for Communication Arts and an Entrepreneur Launch
Pad, the new facility will not merely be a repository for
information, it will be a place of intellectual exchange and
inspirational spaces where people can collaborate and
create knowledge using the latest technology.
Our
Commercial Banking
Commitment
ilimian, LLC
A prospective buyer of a local adhesive and chemicals
company approached FNCB seeking financing for the
acquisition. The prospective buyer worked with a similar
company in Connecticut and learned of the local sale.
With the buyer’s extensive knowledge of the industry,
FNCB, in conjunction with the U.S. Small Business Adminis-
tration, was able to approve $1.3 million in financing
allowing for the purchase of the assets and the local plant.
Consequently, all 20-25 jobs were retained with the added
intent of future expansion. The facility transition was
seamless with revenue and profits surpassing original
projections.
As a local b ank, we understand
the needs of our customers and
the communities we serve and
are committed to:
• offering business solutions that
are designed to partner with
customers helping ensure their
ongoing success.
• attentive, responsive service
that continues whenever our
customers need us.
• providing the experience and
command of industry necessary
to offer solid solutions matched
with technology and innovation to
fuel customers’ progress.
• reinvestment in community with
a deep understanding that strong,
vibrant communities are the
keystone of success.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 13
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FNCB-AR14-pages11-20.pdf 14 4/13/2015 6:21:59 PM
RETAIL BANKING
An enhanced customer service experience,
a suite of premiere technology offerings
and the Bank Local Advantage have
combined to offer customers simply better
banking that is unsurpassed.
R ET AIL BAN
IN G HIGHLIGHT
• FNCB embarked on an initiative to create a sales culture that
puts greater focus on building strong relationships with current
and future customers. This holistic approach to business
development begins with determining needs, communicating
solutions and becoming a trusted advisor.
• In conjunction with the shift to a sales culture, Branch Manag-
ers and CSRs participated in several training sessions focused
on enhancing customer service and the sales experience.
• A number of personal and business deposit products were
combined into simpler, easier-to-understand product offerings
that are better aligned with customer lifestyles.
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98%
FN CB R ET AIL BAN
S CO
S AT
PR
R ED A 9
IO
IS FACT
CU
R AT
IDIN G R ES PO
IV E S ER
T EN
AT
IN G
M ER
IN G FO
IV E,
ICE
• A new checking account targeted to students 14-25 years of
CU
M ER
age was launched in March. The account, which features no
monthly maintenance fees, nationwide ATM refunds, mobile
banking, remote deposit capture and budgeting tools — is
ideal for students on-the-go.
FN CB
O BILE
IDER
M
IN G T
CO
N LIN E &
BAN
BE FAV
IT ES
EAS E O F U
IN
AN D S ECU
IT
S E
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 14
K
S
K
8
%
S
T
O
N
R
O
V
N
S
T
V
S
T
O
S
N
S
O
K
O
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FNCB-AR14-pages11-20.pdf 15 4/13/2015 6:22:01 PM
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CUSTOMER PROTECTION AND
EASE OF PRODUCT SELECTION
WERE TOP OF MIND IN 2014
R ET AIL BAN
IN G HIGHLIGHT
(cont’ d)
O BILE BAN
IN G APPS
• With an eye on identity protection, FNCB
partnered with NXG Strategies to launch Fraud-
Defender, offering customers a fully managed
identity monitoring and protection service.
• A successful conversion of FNCB debit cards
from the Visa® to MasterCard® brand was
completed in October.
• Salesforce, a customer relationship management
(CRM) tool, was implemented at the branch level
giving staff and management an improved way to
manage customer relationships and the data and
information associated with them.
• Several new marketing initiatives were launched
to help grow deposits including offering a $100
bonus for new checking accounts with direct
deposit, an escalator CD offering and direct mail
campaigns targeting specific markets.
FIRST NATIONAL COMMUNITY BANK
FIRST NATIONAL COMMUNITY BANK
Available on the
App Store
Pictured above (left to right): Paul Dunda, SVP & Applica-
tions Services Manager; Rick Drust, VP & Retail Banking
Services Manager; Joe Earyes, First SVP & Chief Retail
Banking & Operations Officer; Tom Lunney, VP & Property
Manager; Phil Ogren, VP & Technology Services Officer;
Donna Czerw, SVP & Retail Banking Operations Manager
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 15
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FNCB-AR14-pages11-20.pdf 16 4/13/2015 6:22:02 PM
RETAIL LENDING
In addition to one of the most
successful Indirect Lending
platforms, FNCB is also committed
to a customer-centric mortgage
process designed for satisfaction
and overall heightened customer
experience. Our efforts are
reflected in overwhelming
customer satisfaction rates,
three years running.
Lisa Kinney, SVP & Retail Lending Officer, Ashley M. Tomko, AVP & Consumer &
Processing Supervisor/Compliance Liaison
CUSTOMER SERVICE COMMITMENT
ENHANCES RETAIL LENDING
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96%
O ver 9
customer
satisfaction rate
for straightforward,
on- time closings
93%
O ver 9
customer
satisfaction rate
for courteous
professional service
92%
customer
satisfaction rate
of the on- going
communication
throughout the
mortgage process
Our Indirect Lending platform is by far one of the most
successful programs among our competition. By
proactively and effectively serving our automotive
dealer partnerships, we further supplement the Bank
Local philosophy while maintaining the highest
customer satisfaction levels.
We survey all mortgage customers to assess our
services in an effort to better our offerings. According
to customers, the majority of which are extremely
satisified by the overall mortgage process, we also
earned high ratings for on-time closings, professional
service and on-going communication throughout the
loan process.
Our customer-focused approach continued throughout
the year with technology improvements including
simplified on-line applications and the utilization of
DecisionPro to automate and improve efficiencies
within the Indirect Lending Origination Platform central
repository.
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 16
6
%
3
%
9
2
%
FNCB-AR14-pages11-20.pdf 17 4/13/2015 6:22:03 PM
COMMUNITY
RESPONSIBILITY
UPDATE
We understand and support our
responsibility to the community. As
a true community bank, we are
dedicated to the communities we
serve through our volunteerism
and community giving programs.
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Don Ryan, SVP & Human Resources Officer, and Joan Dwyer, VP & Organizational
Development & Staffing Officer
The essence of community responsibility is our guiding force
and we have, therefore, taken great measures to uphold our
responsibility by supporting those organizations that best
maintain the needs of the community. An added goal includes
a concentrated focus on Community Reinvestment Act (CRA)
qualifying initaitives.
In 2014, we contributed over $250,000 to over 130 organizations
and services throughout Lackawanna, Luzerne & Wayne
Counties. However, we understood charitable contributions
weren’t enough and have since established Community Caring
initiatives that include a bank-sponsored program that
encourages and compensates employees for volunteer efforts.
Last year, employees volunteered 540 hours in more than 25
local agencies. Each year the program gains increased
momentum with an overall goal of full employee participation.
Other efforts throughout the year included: food drives,
house-builds, dress-down days, pledges, and special
collections to help specific causes and non-profit organizations.
$80,000
$181,000
540 Hrs
In 2
0 14 , FN CB
donated to over 13
local organiz ations
W as contrib uted to
PA Educational T ax
Credit (EIT C) for
scholarships, etc.
N early one- third
of FN CB employ ees
volunteered 5
0 hours
in 2
5 local
agencies
S upporting organiz ations that
work closest in meeting
the needs of the community .
American Red Cross
ARC of NEPA
American Cancer Society
American Heart Association
Big Brothers Big Sisters
Boys and Girls Clubs
Catherine McAuley Center
Catholic Social Services
Center for Comprehensive Cancer Care
Children’s Advocacy Center
Commission on Economic Opportunity
Deutsch Institute
EOTC
Friends of the Poor
Habitat for Humanity
Head Start
Janet Weiss Children’s Hospital
Junior Achievement
Little Sisters of the Poor
Make a Wish Foundation
Maternal & Family Health Services
Meals on Wheels of NEPA
Muscular Dystrophy Association
PA Association for the Blind
Ronald McDonald House
Ruth’s Place: House of Hope
Saint Francis of Assisi Soup Kitchen
Saint Joseph’s Center
Saint Vincent DePaul’s Soup Kitchen
Telespond Senior Services, Inc.
The Salvation Army
United Way
Voluntary Action Center
Women’s Resource Center
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 17
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4
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First N ational Community Bancorp, Inc. | O
fficers &
Directors
O FFICER
DIR ECT
Dominick L. DeN aples
Chairman of the Board
Secretary
ichael J . Cestone, J r.
illiam G. Bracey
Dr. Louis A. DeN aples, J r.
. T okach
S teven R
President and
Chief Executive Officer
. Bone, J r., CPA
J ames M
Executive Vice President
Chief Financial Officer
ichael J . Cestone, J r.
K eith W
. Eckel
J oseph Coccia
T homas J . M elone, CPA
Dominick L. DeN aples
J ohn P. M oses, Esq uire
Louis A. DeN aples
S teven R
. T okach
First N ational Community Bank | Directors
Dominick L. DeN aples
Chairman of the Board
. T okach
S teven R
President and
Chief Executive Officer
ichael J . Cestone, J r.
Secretary
illiam G. Bracey
J oseph Coccia
Louis A. DeN aples
Dr. Louis A. DeN aples, J r.
K eith W
. Eckel
T homas J . M elone, CPA
J ohn P. M oses, Esq uire
First N ational Community Bank | Bank O
fficers
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. T okach
S teven R
President and
Chief Executive Officer
Gerard A. Champi
Chief Operating Officer
J oseph A. Castrogiovanni
Senior Vice President
Regional Commercial Lending Manager
. Honick, CPA, CIA
R onald S
Senior Vice President
Audit Manager
Cathy J . Conrad
Senior Vice President
Credit Administration Officer
. Bone, J r., CPA
J ames M
Executive Vice President
Chief Financial Officer
. Cz erw
Donna M
Senior Vice President
Retail Banking Operations Manager
J oseph J . Eary es, CPA
First Senior Vice President
Chief Retail Banking & Operations Officer
M ary G. Cummings
Senior Vice President
General Counsel
Brian C. M ahlstedt
First Senior Vice President
Chief Lending Officer
. Dunda
Paul S
Senior Vice President
Applications Services Manager
. Barrett
Patrick J
Senior Vice President
Regional Commercial Lending Manager
M ary Ann Gardner, CR CM
Senior Vice President
Compliance Officer
Lisa L. K
inney
Senior Vice President
Retail Lending Officer
ichard F. Post, J r.
Senior Vice President
Asset Recovery Manager
y an
Donald H. R
Senior Vice President
Human Resources Officer
S tephanie A. W estington, CPA
Senior Vice President
Controller
y an J . Barhight
Vice President
Credit Analyst Supervisor
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 18
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First N ational Community Bank | Bank O
fficers (continued)
ichard D. Drust
Vice President
Retail Banking Sales Manager
Larae L. K rushinski
Assistant Vice President
Credit Administration Supervisor
lime
Christine E. K
Banking Officer
Credit Analyst III
. Dwy er
J oan M
Vice President
Organizational Development/Staffing Officer
ichard D. Padula
Assistant Vice President
Mortgage Origination Supervisor
N adine A. Limongelli
Banking Officer
Community Office Manager II
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Dawn D. Gronski
Vice President
Compensation/Benefits Officer
A. J effers
N ancy
Vice President
Relationship Manager III
M atthew D. K arotko
Vice President
Operations Officer
T homas C. Lunney
Vice President
Property Manager
M adoly n A. M acArthur
Vice President
Community Office Manager III
Philip E. O gren
Vice President
Technology Services Officer
. W eller
K aren M
Vice President
Retail Banking Manager
Angelo Amb rosecchia
Assistant Vice President
Small Business Officer II
. Anderson
R oger R
Assistant Vice President
SmalI Business Officer I
. Benkoski
Eliz ab eth M
Assistant Vice President
Retail Training Coordinator
Frank J . K ost
Assistant Vice President
Applications Services Analyst II
Eileen A. S ennett
Assistant Vice President
Loan Operations Manager
K eehna M urphy
Banking Officer
Credit Analyst III
J enny J . S evers
Assistant Vice President
Retail Lending Sales Coordinator
S ara L. M atusinski
Banking Officer
Customer Care Center Supervisor
Christopher P. K unz
Banking Officer
Telecommunications Manager
. J urgiewicz
W alter M
Banking Officer
System & Desktop Services Manager
iller
. M
M arcella K
Banking Officer
BSA Manager
K elly S ukel
Banking Officer
Indirect/Consumer Lending Manager
. Pritchard
Eileen M
Banking Officer
Commuinty Office Manager III
illiam A. M cGuigan, CPA
Assistant Auditor
Bernice A. S hipp
Assistant Vice President
Community Office Manager III
Lucy E. S
inger
Assistant Vice President
Community Office Manager III
Deb ra A. S kurkis
Assistant Vice President
Community Office Manager III
K aren M
. S mith
Assistant Vice President
Relationship Manager I
. T omko
Ashley M
Assistant Vice President
Consumer Processing Supervisor/
Compliance Liaison
Amy L. Branning
Banking Officer
Relationship Manager I
ichael S
. Cummings
Banking Officer
Marketing Specialist
Claire Guarneri
Banking Officer
Community Office Manager II
. K elley
Amy M
Banking Officer
Assistant Controller
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 19
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banking
wayne
Honesdale R
t. 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
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
lackawanna
Clarks
Green Dickson
City
Dunmore M AIN
S cranton
K ey ser V
W heeler
Ave.
illage
Back
M ountain
t. 3 15
Pittston
Ex eter
Plains
ingston
ilkes- Barre
Daleville
N anticoke
Hanover
T ownship
luzerne
Haz leton
Simply a better bank.TM
1-
- FN CB | fncb
.com | M emb er FDIC
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
FIRST NATIONAL COMMUNITY BANCORP., INC. and SUBSIDIARIES
2014 ANNUAL REPORT | 20
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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, 2014
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 $83,370,845 at June 30, 2014.
APPLICABLE ONLY TO CORPORATE REGISTRANTS
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 13, 2015.
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 2015 Annual Meeting of Shareholders.
Contents
PART I .....................................................................................................................................................................3
Item 1. Business ...................................................................................................................................................3
Item 1A. Risk Factors. .............................................................................................................………………….19
Item 1B. Unresolved Staff Comments. ................................................................................................................28
Item 2. Properties. ..............................................................................................................................................28
Item 3. Legal Proceedings. ................................................................................................................................30
Item 4. Mine Safety Disclosures. .......................................................................................................................32
PART II… ..............................................................................................................................................................32
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases
of Equity Securities. ..............................................................................................................................32
Item 6. Selected Financial Data .........................................................................................................................34
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations ...............35
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. .............................................................69
Item 8. Financial Statements and Supplementary Data. ....................................................................................71
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .............131
Item 9A. Controls and Procedures………………… ..........................................................................................132
Item 9B. Other Information ................................................................................................................................134
PART III .............................................................................................................................................................134
Item 10. Directors, Executive Officers and Corporate Governance. .................................................................134
Item 11. Executive Compensation. ....................................................................................................................134
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters. ...........................................................................................................................134
Item 13. Certain Relationships and Related Transactions, and Director Independence. ...................................134
Item 14. Principal Accounting Fees and Services. ............................................................................................134
PART IV .............................................................................................................................................................135
Item 15. Exhibits and Financial Statement Schedules .......................................................................................135
2
PART I
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.As of December 31, 2014, the Company had met all regulatory capital
requirements established by its regulators. 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 $13.4 million and $6.4 million in 2014 and 2013, respectively, and a net loss of $13.7 million in
2012. Total assets were $970.0 million, $1.0 billion and $968.3 million at December 31, 2014, 2013 and 2012, respectively.
The Bank
Established as a national banking association in 1910, as of December 31, 2014 the Bank operated 19 full-service branch offices within
three contiguous counties, Lackawanna, Luzerne and Wayne, its primary market area located in the Northeast section of the state.
Retail Banking
The Bank provides a wide variety of retail banking products and services to individuals and businesses, including Mobile Banking,
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 deposit checks, electronically from start to finish, from anywhere at any time.
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 and perform related account transfers through the use of a touch tone 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. In 2014,
the Bank, through a strategic partnership with an independent vendor, began offering an identity theft protection plan package to its
customers. Subscribers select which coverage package they desire by visiting the Bank’s secure website and choosing “Identity
Protection” from the Resources menu.
3
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 payments through ACH transactions, 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. At December 31, 2014, one- to four-family residential
mortgage loans totaled $122.8 million, or 18.4%, of the total loan portfolio. One- to four-family mortgage loans are originated
generally for sale in the secondary market. However, management may portfolio one- to four-family residential mortgage loans as
deemed necessary according to asset/liability management strategies. During the year ended December 31, 2014, the Bank sold $8.3
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, 2014, construction, land acquisition and development loans of $18.8 million represented 2.8% of the
total loan portfolio.
Commercial Real Estate Loans
At December 31, 2014, commercial real estate loans totaled $233.5 million, or 34.9%, of the 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, 2014, commercial and industrial loans totaled $132.1 million, or 19.7%, of the 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, 2014,
consumer loans totaled $122.1 million, or 18.2%, of the total loan portfolio.
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, 2014,
state and political subdivision loans totaled $40.2 million, or 6.0%, of the total loan portfolio.
For more information regarding the loan portfolio and lending policies, please refer to Note 2 “Summary of Significant Accounting
Policies” to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.
4
Wealth Management
The Company offers customers wealth management services through a third party provider. 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 number 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
The Company participates in a highly regulated industry and is 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 the Company
takes 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 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 had been required to submit written progress reports to the OCC on a monthly basis. Effective April 10, 2014, the written
progress report requirement was changed from monthly to quarterly as of quarter-end March 31, 2014. The Committee has submitted
each of the required progress reports with the OCC. The members of the Committee are John P. Moses, William G. Bracey, Joseph
Coccia, Keith W. Eckel 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:
5
(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;
The Bank developed a Strategic Plan that it believes complies with the Order requirements. The Strategic Plan for the three-year
period January 1, 2014 to December 31, 2016 was completed and submitted to the OCC for review in April 2014. The OCC issued a
written determination of supervisory non-objection to the Strategic Plan in June 2014. The Strategic Plan was adopted by the Board in
June 2014. The Strategic Plan for the three-year period January 1, 2015 to December 31, 2017 was approved by the Board in January
2015.The Company believes that the Bank continues to be in compliance with the Strategic Plan.
(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%. The Capital Plan for the three-year period
January 1, 2014 to December 31, 2016 was completed and forwarded to the OCC for review in April 2014. The OCC issued a written
determination of supervisory non-objection to the Capital Plan in June 2014. The Capital Plan was adopted by the Board in June
2014. The Capital Plan for the three-year period January 1, 2015 to December 31, 2017 was approved by the Board in January 2015.
The Company believes that the Bank continues to be in compliance with the Capital Plan.
(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 15.42% at December 31, 2014, which was above the 13.00% required by the Order. The
Bank’s leverage capital ratio was 9.78% at December 31, 2014, which was above the 9.00% required by the Order. The Bank’s total
risk-based capital increased 199 basis points, while the Bank’s leverage ratio increased 146 basis points at December 31, 2014
compared to December 31, 2013.
(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 unless the Bank receives a
determination of no supervisory objection from the OCC.
On September 8, 2014, the Company sent to the OCC a request for a determination of no supervisory objection for a $1.0 million
capital distribution from the Bank to the Company to cure the junior subordinated debentures interest deferral. The Company received
a determination of no supervisory objection from the OCC in November 2014. On December 8, 2014, the Bank made a distribution to
the Company in the amount of $1.0 million.
(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 has implemented those recommendations and believes it is in compliance with the requirements of
this provision. Louis A. DeNaples re-joined the Board in December 2013 and the Company’s Board of Directors in May 2014,
William G. Bracey was appointed to the Board and the Company’s Board of Directors in May 2014, and Keith W. Eckel was
appointed to the Board and the Company’s Board of Directors in September 2014. One of the directors of the Bank and the Company,
Joseph J. Gentile, passed away in August 2014.
6
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 (the “Management Study”), on October 13, 2010. The Management Study was forwarded to
the OCC on October 29, 2010. The Board 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. The Board believes that it has prepared or caused 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.
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, 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, November 14, 2013 and November 26, 2014. The Board believes that is has adopted, implemented and
maintained compliance with a comprehensive Conflict of Interest Policy in accordance with the requirements of the provision.
(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 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 periodic Loan Policy revisions were approved by the Board from November
24, 2010 through November 2014 for purposes of continued compliance with this provision. The Board believes that it has taken
action to address the written credit policy requirements of the Order.
(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.
7
(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 substantial reduction in criticized assets.
In accordance with the requirements of the Order, since the date 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 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",
OCC Bulletin 2013-28, “Uniform Agreement on the Classification and Appraisal of Securities Held by Depository Institutions” and
FDIC 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 provisions:
(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;
8
The Company has taken, and continues to take, steps the Board of Directors 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. 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. On September 8, 2014, the Company sent a request to the Reserve Bank to approve a dividend
from the Bank in the amount of $1.0 million. The dividend was to be used to cure the interest deferral on the junior subordinated
debentures. The Company received written non-objection to allow the $1.0 million dividend payment from the Bank and cure of the
interest deferral on the junior subordinated debentures in the amount of $921 thousand. The $1.0 million dividend payment from the
Bank to the Company and the interest deferral payment on the junior subordinated debentures was completed in December 2014. The
Company made a subsequent request for and has received approval from the Reserve Bank to permit payment of the quarterly interest
payment on the junior subordinated debentures due March 15, 2015. The Company intends to pay the quarterly interest payment on
March 15, 2015.
(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 junior subordinated debentures 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 junior
subordinated debentures without the written approval of the Reserve Bank and Director. Previously, the Company has not made any
payments of interest, principal or other amounts on either of the Company’s debentures since the effective date of the Agreement.
On September 8, 2014, the Company sent to the Reserve Bank requests for approval for the Company to receive a $1.0 million capital
distribution from the Bank, and to make a distribution on the junior subordinated debentures to cure the interest deferral. The
Company received approval from the Reserve Bank in November 2014 to cure and pay the interest deferral. On December 15, 2014,
the Company paid all deferred and currently payable accrued interest totaling $921 thousand. On February 20, 2015, the Company
received approval from the Reserve Bank to pay the regular quarterly interest payment on March 15, 2015.
(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 by the Bank from the Federal Home Loan Bank (“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;
9
The Company has developed a Capital Plan that it believes is acceptable and maintains sufficient capital at the Company on a
consolidated basis. The annual update and revision to the Capital Plan for the three-year period January 1, 2014 to December 31, 2016
was completed in conjunction with the annual budget and strategic planning initiatives and provided to the Reserve Bank in April
2014. The Company notified the Reserve Bank that the OCC issued a written determination of supervisory non-objection to the
Capital Plan in June 2014, and that the Bank’s Board of Directors adopted the plan in June 2014. The annual update and revision to
the Capital Plan for the three-year period January 1, 2015 to December 31, 2017 was completed in conjunction with the annual budget
and strategic planning initiatives. Both plans and the annual budget were approved by the Board of Directors in January 2015 and will
be provided to the Reserve Bank during its next regulatory review of the Company.
The Bank’s total risk-based capital ratio was 15.42% at December 31, 2014, which was above the 13.00% minimum required by the
Order. The Bank’s leverage ratio was 9.78% at December 31, 2014, which was also above the 9.00% required by the Order.
(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, timely 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. At the request of the Reserve Bank, the Company provided the Reserve Bank with an
updated cash flow projection for 2014-2016 in August of 2013. The cash flow projection for 2015 was delivered to the Federal
Reserve Bank in December 2014.
(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 under Section 18(k) of the FDI Act and Part
359 of the FDIC’s regulations. The Company has not made any such indemnification or severance payments since the effective date
of the Agreement without obtaining prior regulatory non-objection 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 of directors 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, 2014, the Company and the Bank are restricted from paying any dividends, without regulatory approval.
10
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 each year ended December 31, 2014 and 2013, the Company incurred approximately $0.4 million 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
noteholders and shareholders. 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 2014 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. 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 2015.
The Company
The Company is a bank holding company registered with, and subject to regulation by, the Reserve Bank and the Board of Governors
of the Federal Reserve System (“FRB”). The Bank Holding Company Act of 1956, as amended (the “BHCA”), and other federal laws
subject bank holding companies 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 is not 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
11
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, borrowings, 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 Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) permits 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 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 believes it has developed and
implemented 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
12
business loans and consumer loans. Residential first mortgage loans on one- tofour-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.
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, 2014 and 2013 was 15.42% and 13.43%, respectively. The Tier
I capital to risk-weighted assets ratio at December 31, 2014 and 2013 was 14.16% and 12.17%, respectively. The Tier I capital to
average assets ratio at December 31, 2014 and 2013 was 9.78% and 8.32%, respectively. Under the Order, the Bank was required to
achieve a total capital ratio of 13.00% and a Tier I capital to average assets ratio of 9.00% by November 30, 2010. As of
December 31, 2014, the Bank met both the 13.00% minimum requirement for the total risk-based capital ratio and the 9.00%
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, 2014 and 2013 was 13.67% and 11.58%, respectively. The Tier I
capital to risk-weighted assets at December 31, 2014 and 2013 was 8.76% and 6.88%, respectively. The Tier I capital to average
assets at December 31, 2014 and 2013 was 6.05% and 4.71%, 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 4.50%, plus a “capital conservation buffer” of 2.50 %; (ii) a minimum ratio of Tier 1 capital to risk-
weighted assets of at least 6.00%, plus the capital conservation buffer, or 8.50%; (iii) a minimum ratio of Total (Tier 1 plus Tier 2) capital
to risk-weighted assets of at least 8.00% plus the capital conservation buffer, or 10.50%; and (iv) as a newly adopted international
standard, a minimum leverage ratio of 3.00%, 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
13
buffer in the range of 0.00% to 2.50% 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 10.00% of CET1 or all such
categories in the aggregate exceed 15.00% 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 4.00% 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 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 Rule also integrates the new capital requirements into the prompt corrective action provisions under
Section 38 of the FDIA.
In general, the Basel III Rule became 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 reserves 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 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 8.0%
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 6.0% 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 4.5%
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 4.0% 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
14
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 FDIAct 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.
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.
15
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
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
N/A
N/A
N/A
N/A
Less than 2.0%
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.
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 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 has required 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 have been given significant discretion in drafting these rules and regulations, As portions of the
statute continues to be subject to intensive rulemaking and public comment, which has not yet been completed with respect to the
application of certain key aspects of the law, the impact of certain portions of the Dodd-Frank Act may not be known for some time.
To date, the following provisions of the Dodd-Frank Act 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;
16
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
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.
A focus of the CFPB’s rulemaking efforts has been 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 2015, the Bank expects the CFPB to refine 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
17
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.
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.
Effective February 18, 2014 and for the remainder of the year ended December 31, 2014, the Bank was considered risk category II for
deposit insurance assessments and paid an annual assessment rate of 0.0014 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, 2014, the Company and the Bank employed 258 persons, including 39 part-time employees.
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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 website 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. 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 risk factors discussed below, which could materially affect the Company’s business, operating results or financial condition,
should be considered in addition to the other information about the Company presented in this Annual Report on Form 10-K.
However, the risk factors described below are not meant to be all inclusive. Additional risks and uncertainties not currently known or
that the Company currently deems to be insignificant may also materially adversely affect the business, operating results or financial
condition of the Company.
Risks Related to the Company and Its Business
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 to this 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 economic environment, including uncertain national and local conditions. Additionally,
concerns from some of the countries in the European Union, Asia and elsewhere have also strained the financial markets both abroad
and domestically. 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 in the past, 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;
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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;
the continuation of low market interest rates, may further pressure our interest margins as interest-earning assets, such as
loans and investments, are reinvested or reprice 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 is subject to lending risk.
As of December 31, 2014, approximately 37.7% 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 $5.5 million, or 0.8% of total gross loans, as of December 31, 2014, and $6.4 million, or 1.0% of total gross
loans, as of December 31, 2013. 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.
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, 2014, $405.0 million, or 60.5%, 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, $18.8 million, or 2.8%, were construction, land acquisition and development loans. Construction, land
acquisition and development loans have the highest risk of uncollectability. An additional $132.1 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.
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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 $42.6 million as of December 31,
2014. At December 31, 2014, there were no 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, 2014, the ALLL totaled $11.5 million, representing 1.7% 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.
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.
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The Company held approximately $2.8 million in capital stock of the Federal Home Loan of Pittsburgh (“FHLB”) as of December 31,
2014. 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. Although
the Company succeeded 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, 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.
The Company’s assets at December 31, 2014 included a substantial deferred tax asset. The Company may not be able to realize the
full amount of this asset.
The Company recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and
the tax bases of assets and liabilities. The net deferred tax asset was approximately $29.8 million, and $35.7 million at December 31,
22
2014 and 2013, respectively. The decrease in the deferred tax asset resulted primarily from changes in unrealized gains and losses on
available-for-sale securities, decreases in accrued interest payable and the allowance for loan and lease losses, as well as a reduction in
the deferred tax benefit related to net operating loss carryforwards.
The Company evaluates the carrying amount of its deferred tax assets on a quarterly basis, or more frequently, if necessary, in
accordance with guidance set forth in ASC Topic 740 “Income Taxes,” and applies the criteria in the guidance to determine whether it
is more likely than not that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight
of available evidence. If management determines based on available evidence, both positive and negative, that it is more likely than
not that some portion or all of the deferred tax asset will not be realized in future periods, a valuation allowance is calculated and
recorded. These determinations are inherently subjective and depend upon management’s estimates and judgments used in their
evaluation of both positive and negative evidence.
In evaluating available evidence, management considers, among other factors, historical financial performance, expectation of future
earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with
operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of termporary
differences. In assessing the need for a valuation allowance, management carefully weighed both positive and negative evidence
currently available. The weight given to the potential effect of positive and negative evidence must be commensurate with the extent
to which it can objectively verified. In particular, additional scrutiny must be given to deferred tax assets of an entity that has incurred
taxable losses during the three most recent years because it is significant negative evidence that is objective and verifiable and
therefore difficult to overcome. While, the Company generated table income in 2014, it recorded taxable losses in 2013 and 2012.
When determining the need for a valuation allowance, the Company assessed the possible sources of taxable income available
under tax law to realize a tax benefit for deductible temporary differences and carryforwards as defined in ASC Topic 740. While the
Company has shown substantial book net income in 2013 and 2014, these amount have been the result of significant non-recurring or
non-taxable transactions, such as the credit for loan and lease losses, legal settlements and gains on the sales of securities. The
Company utilizes a three-year rolling measurement of results when assessing whether it is in a cumulative loss position. Until such
time when the Company’s cumulative results are positive, it does not believe there is sufficient positive evidence to overcome the
negative evidence presented.The Company will exclude future taxable income as a factor until it can show consistent and sustainable
profitability. Based on the analysis of available positive and negative evidence, management determined that the established valuation
allowance equal to 100.0% of net deferred tax assets, excluding deferred tax assets or liabilities related to unrealized holding gains and
losses on available-for-sale securities, should be maintained.
The release of this valuation allowance could have a positive impact on future earnings. However, there can be no assurance as to
when the Company could be in a position to recapture the benefits of its deferred tax asset or to what extent. For further information
on the analysis of our deferred tax assets, please refer to the sections entitled “Critical Accounting Policies” and “Provision for
Income Taxes” of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 to this
Annual Report on Form 10-K.
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.
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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 the Company to make substantial capital expenditures to modify or adapt existing
products and services or develop new products and services. The Company 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, the Company 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.
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.
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. The financial liability or reputational
damage that may result from litigation or any other legal 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.
24
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.
The Company believes 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 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’s disclosure controls and procedures and internal controls over financial reporting may not achieve their intended
objectives.
The Company maintains disclosure controls and procedures designed to ensure the timely filing of reports as specified in the rules and
forms of the Securities and Exchange Commission. The Company also maintains a system of internal control over financial reporting.
These controls may not achieve their intended objectives. Control processes that involve human diligence and compliance, such as its
disclosure controls and procedures and internal controls over financial reporting, are subject to lapses in judgment and breakdowns
resulting from human failures. Controls can also be circumvented by collusion or improper management override. Because of such
limitations, there are risks that material misstatements due to error or fraud may not be prevented or detected and that information may
not be reported on a timely basis. If the Company’s controls are not effective, it could have a material adverse effect on its financial
condition, results of operations, and market for its common stock, and could subject the Company to additional regulatory scrutiny.
Risks Related to the Company’s Common Stock
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, 2014, an
average of 1,840 shares traded on a daily basis. There can be no assurance that an active and liquid market for the Company’s
25
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.
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 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.
Risks Related to Government Regulation and Accounting Pronouncements
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 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 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
26
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 to this 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
became 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 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.
The Company is 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.
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, but not limited to, 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.
On August 8, 2011, the Company announced that it had received document subpoenas from the SEC. The information requested
generally related 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. On January 28, 2015, the Company and
the SEC entered into a settlement agreement resolving these issues related to disclosure and financial reporting and the restatements of
the Company’s financial statements for the year ended December 31, 2009 and the quarters ended March 31, 2010 and June 30, 2010.
As part of this settlement agreement, on January 30, 2015 the Company paid a civil money penalty of $175 thousand to the SEC. The
Company accrued for the $175 thousand civil money penalty, which is included in non-interest expense for the year ended December
31, 2014.
On January 22, 2014, the Bank was advised by the Department of Treasury’s Financial Crimes Enforcement Network (“FinCEN”) that
FinCEN was investigating the Bank for alleged violations of the Bank Secrecy Act (“BSA”). On May 28, 2014 the Bank was advised
by the Office of the Comptroller of the Currency (“OCC”) that the OCC was investigating allegations that the Bank failed to file
timely Suspicious Activity Reports. On November 18, 2014 both FinCEN and OCC advised the Bank that they intended on assessing
civil money penalties against the Bank. Subsequent to November 18, 2014, the Bank had been negotiating with both regulatory
agencies about the alleged BSA violations. On February 27, 2015, the Bank reached a comprehensive settlement with FinCEN and
OCC to resolve the BSA allegations. In order to settle the matter, the Bank consented to an aggregate civil money penalty assessment
of $1.5 million which has been accrued and is included in non-interest expense for the year ended December 31, 2014.
27
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.
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 and Wayne counties. At December 31, 2014, aggregate net
book value of premises and equipment was $11.0 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.
On January 24, 2014, the Bank sold certain assets and liabilities of the its Marshalls Creek and Stroudsburg branches, both of which
are located in Monroe County, Pennsylvania to ESSA. The transaction 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 subsequently transferred into other real estate
owned.
28
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
1919 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
29
15
330-352 West Broad Street
Hazleton, PA
Own
Hazleton Branch
16
3 Old Boston Road
Pittston, PA
17
1001 Main Street
Honesdale, PA
Lease
Route 315 Branch
Own
Honesdale Branch
18
1127 Texas Palmyra Highway
Honesdale, PA
Lease
Honesdale Route 6 Branch
19
200 South Blakely Street
Dunmore, PA
20
107-109 South Blakely Street
Lease
Administrative Center
Dunmore, PA
Own
Parking Lot
21
114-116 South Blakely Street
Dunmore, PA
Own
Parking Lot
22
1708 Tripp Avenue
Dunmore, PA
23
119-123 South Blakely Street
Own
Parking Lot
Dunmore, PA
Own
Parking Lot
24
Main Street
Taylor, PA
25
1219 Wheeler Avenue
Dunmore, PA
26
785 Keystone Industrial Park Road
Throop, PA
Own
Land
Lease
Lease
Wheeler Ave. Branch
Bank Offices
27
100 Commerce Boulevard
Lease
Commercial Lending Office
Wilkes-Barre, PA
28
124 South Blakely Street
Own
Vacant Building for future Bank use
Dunmore, PA
Item 3. Legal Proceedings.
On August 8, 2011, the Company announced that it had received document subpoenas from the SEC. The information requested
generally related 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. On January 28, 2015, the Company and
the SEC entered into a settlement agreement resolving these issues related to disclosure and financial reporting and the restatements of
30
the Company’s financial statements for the year ended December 31, 2009 and the quarters ended March 31, 2010 and June 30, 2010.
As part of this settlement agreement, on January 30, 2015 the Company paid a civil money penalty of $175 thousand to the SEC. The
Company accrued for the $175 thousand civil money penalty, which is included in non-interest expense for the year ended December
31, 2014.
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 was made to
the Company on March 28, 2014. The Individual Defendants reserved their rights to indemnification under the Company’s Articles of
Incorporation and Bylaws, 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 accordance, the Company has recorded a liability for this
indemnification in other liabilities. In addition, in conjunction with the Settlement, the Company accrued $2.5 million related to fees
and costs of the plaintiff’s attorneys, which was included in non-interest expense in the consolidated statements of operations for the
year ended December 31, 2013. On April 1, 2014, the Company paid the $2.5 million related to fees and costs of the plaintiff’s
attorneys and partial indemnification of the Individual Defendants in the amount of $2.5 million, and, as such, as of December 31,
2014, $2.5 million remains accrued in other liabilities related to the potential indemnification of the Individual Defendants. The
Company settled any and all claims it had or may have had against Demetrius & Company, LLC, John Demetrius and Robert L. Rossi
& Company in connection with the Shareholder Derivative Suit.
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 for the losses and expenses already incurred by the Company and the Bank. The Company and the other
defendants are defending the claims and have opposed F&D’s requested relief by way of counterclaims, breaches of contract and bad
faith claims against F&D for the failure to fulfill its obligations to the Company and the Bank under the insurance policy. At this time,
the matter is in the discovery 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 the 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 similarly 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 the discovery stage. At this time the
Company cannot reasonably determine the outcome or potential range of loss.
On January 22, 2014, the Bank was advised by FinCEN that it was investigating the Bank for alleged violations of the BSA. On May
28, 2014, the Bank was advised by the OCC that it was investigating allegations that the Bank failed to file timely Suspicious Activity
Reports. On November 18, 2014, both FinCEN and OCC advised the Bank that they intended on assessing civil money penalties
against the Bank. Subsequent to November 18, 2014, the Bank had been negotiating with both regulatory agencies about the alleged
BSA violations. On February 27, 2015, the Bank reached a comprehensive settlement with FinCEN and OCC to resolve the BSA
allegations. In order to settle the matter, the Bank consented to an aggregate civil money penalty assessment of $1.5 million which
has been accrued and is included in non-interest expense for the year ended December 31, 2014.
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.
31
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
Effective February 17, 2015, the Company’s common shares are quoted on the OTCQX Marketplace operated by the OTC Markets
Group, Inc. under the sysmbol “FNCB.” Previous to this date, the Company’s common shares were quoted on the OTCQB Venture
Marketplace operated by the OTC Markets Group, Inc. 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.
Quarter
First
Second
Third
Fourth
Quarter
First
Second
Third
Fourth
Holders
Market Price
High
Low
2014
Dividends Paid
Per Share
2014
$ 9.90
6.85
6.85
6.65
$ 5.91
5.15
5.75
5.60
2013
$ 4.49
4.20
4.35
8.98
$ 2.83
3.41
3.85
3.90
$
$
2013
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
As of February 28, 2015 there were approximately 1,859 holders of record of the Company’s common shares. Because many of the
Company’s shares are held by brokers and other institutions on behalf of shareholders, the Company is unable to estimate the total
number of shareholders represented by these record holders.
Dividends
As of February 26, 2010, as a result of the Order and Agreement, the Company has suspended paying dividends 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” to 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, 2009. 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.
32
First National Community Bancorp, Inc.
Total Return Performance
First National Community Bancorp, Inc.
NASDAQ Composite
SNL Bank $500M-$1B
250
200
150
100
50
l
e
u
a
V
x
e
d
n
I
0
12/31/09
12/31/10
12/31/11
12/31/12
12/31/13
12/31/14
Index
First National Community Bancorp, Inc.
NASDAQ Composite
SNL Bank $500M-$1B
12/31/09
100.00
100.00
100.00
12/31/10
50.08
118.15
109.16
12/31/11
41.60
117.22
96.03
12/31/12
50.42
138.02
123.12
12/31/13
144.76
193.47
159.65
12/31/14
99.83
222.16
175.15
Period Ending
(*)
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 October 29, 2014, the Board of Directors adopted the 2014 Employee Stock Grant Plan (the “2014 Stock Grant Plan”) under
which shares of common stock not to exceed 13,500 were authorized to be granted to employees. On December 1, 2014, the
Company granted 50 shares of the Company’s common stock to each active full and part time employee. There were 12,850 shares
issued under this grant at a cost of $6.02 per share. The total cost of these grants, which was included in salary expense in the
Consolidated Statements of Operations, amounted to $77 thousand for the year ended December 31, 2014. 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 transaction, and no proceeds were received by the Company for this stock grant. There have been no sales of
unregistered securities during 2014.
33
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 thousands, except per share data)
2014
2013
2012
2011
2010
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 (credit) provision for loan and lease loss
(Credit) provision for loan and lease losses
Non-interest income
Non-interest expenses
Income (loss) before income taxes
Provision for income taxes
Net income (loss)
Earnings (loss) 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
$
970,029
$
1,003,808
$
968,274
$
1,102,639
$
1,167,298
218,989
-
658,747
795,336
96,504
51,398
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
$
32,673
$
32,953
$
37,027
$
42,936
$
55,471
6,147
26,526
(5,869)
14,920
33,569
13,746
326
13,420
0.81
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)
$
-
$
-
$
-
$
-
$
-
3.12
6.05%
13.67%
4.66%
5.27%
1.38%
29.50%
3.08%
30.30%
1.72%
0.82%
208.62%
(0.51%)
2.04
4.71%
11.58%
3.60%
3.30%
0.67%
18.65%
3.21%
20.79%
2.18%
0.99%
219.87%
(0.28%)
***
***
2.24
4.07%
10.20%
3.97%
3.75%
(1.35%)
(34.09%)
3.26%
9.71%
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%
*** Ratio is not meaningful for 2014 or 2013.
(1) Average balances were calculated using average daily balances. Average balances for loans include non-accrual loans.
(2) Tax-equivalent adjustments were calculated using the prevailing statutory rate of 34.0 percent.
34
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 and Risk Factors detailed
in Item 1A of Part I to this Annual Report on Form 10-K.
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 Securities and Exchange Commission (“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 technology 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. Management has identified the policies on the determination of the allowance for loan and lease losses
(“ALLL”), securities’ valuation and impairment evaluation, and the valuation of other real estate owned (“OREO”) and income taxes
to be critical, as management is required to make subjective and/or complex judgments about matters that are inherently uncertain and
could be most subject to revision as new information becomes available.
The judgments used by management in applying the critical accounting policies discussed below may be affected by 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
35
securities in the 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” to this Annual Report on Form 10-K for additional information
about the ALLL.
Securities Valuation
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 6-
“Securities” and Note 7-“Fair Value Measurements” of the notes to consolidated financial statements included in Item 8 – “Financial
Statements and Supplementary Data” to this Annual Report on Form 10-K 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. The Company did not recognize OTTI charges on
investment securities for years ended December 31, 2014 and 2013 within the consolidated statements of operations. The Company
recognized $96 thousand of OTTI for the year ended December 31, 2012.
See Note 2-“Summary of Significant Accounting Policies” and Note 4-“Securities” of the notes to consolidated financial statements
included in Item 8-“Financial Statements and Supplementary Data” to this Annual Report on Form 10-K for additional information
about valuation of securities.
36
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 are transferred to
OREO at fair value less estimated selling costs with any related write-down included in non-interest expense unless conditions warrant
an adjustment to value, as determined by management. 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, including alternative minimum tax, currently
payable or receivable and the change in deferred tax assets and liabilities. Deferred income taxes reflect the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for financial and tax reporting purposes. Management
conducts quarterly assessments of all available positive and negative evidence to determine the amount of deferred tax assets that will
more likely than not be realized. The Company establishes a valuation allowance for deferred tax assets and records a charge to
income if management determines, based on available evidence at the time the determination is made, that it is more likely than not
that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, management
considers past operating results, estimates of future taxable income based on approved business plans, future capital requirements and
ongoing tax planning strategies. This evaluation process involves significant management judgment about assumptions that are subject
to change from period to period depending on the related circumstances. The recognition of deferred tax assets requires management
to make significant assumptions and judgments about future earnings, the periods in which items will impact taxable income, future
corporate tax rates, and the application of inherently complex tax laws. The use of different estimates can result in changes in the
amounts of deferred tax items recognized, which can result in equity and earnings volatility because such changes are reported in
current period earnings. On December 31, 2010, the Company established a valuation allowance equal to 100 percent of its net
deferred tax asset, excluding deferred tax assets and liabilities related to unrealized holding gains and losses on available-for-sale
securities, and has maintained such an allowance through December 31, 2014.
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, 2014 and
2013, the Company determined that it did not have any uncertain tax positions or tax strategies and that no liability was required to be
recorded.
See Note 2-“Summary of Significant Accounting Policies” and Note 13-“Income Taxes” of the notes to consolidated financial
statements included in Item 8-“Financial Statements and Supplementary Data” to this Annual Report on Form 10-K for additional
information about the accounting for income taxes.
New Authoritative Accounting Guidance
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. The Company adopted ASU 2013-11 on January 1, 2014. The adoption of this new guidance did
not have an effect on the operating results or financial position of the Company.
37
Accounting Guidance to be Adopted in Future Periods
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 will not have a material effect on the
operating results or financial position of the Company.
ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360): “Reporting
Discontinued Operations and Disclosures of Disposals of Components of an Entity,” changes the criteria for reporting a discontinued
operation. Under the new guidance, a disposal of a component of an entity or group of components of an entity is required to be
reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on the entity’s
operations and financial results. This new guidance reduces complexity by removing the complex and extensive implementation
guidance and illustrations that are necessary to apply the current definition of a discontinued operation. The new guidance also
requires expanded disclosures about discontinued operations that will provide users with more information about the assets, liabilities,
revenues and expenses of a discontinued operation and will require pre-tax income attributable to a disposal of a significant part of an
organization that does not qualify for discontinued operations reporting, which will provide users with information about the ongoing
trends in a reporting organization’s results from continuing operations. A public company or not-for-profit organization that has
issued or is a conduit bond obligor for securities that are traded, listed, or quoted on an exchange or an over-the-counter market is
required to apply the new guidance prospectively to all disposals (or classifications as held for sale) of components of an organization
and all business or nonprofit activities that, on acquisition, are classified as held for sale that occur within annual periods beginning on
or after December 15, 2014, and interim periods within those years. The adoption of this guidance on January 1, 2015 will not have a
material effect on the operating results or financial position of the Company.
ASU 2014-09, Revenue from Contracts with Customers (Topic 606): Section A, “Summary and Amendments That Create Revenue
from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs-Contract with Customers (Subtopic 340-40);”
Section B, “Conforming Amendments to Other Topics and Subtopics in the Codification and Status Tables;” and Section C,
“Background Information and Basis for Conclusions,” provides a robust framework for addressing revenue recognition issues, and
upon its effective date, replaces almost all existing revenue recognition guidance, including industry specific guidance, in current
GAAP. The core principle of ASU 2014-09 is for companies to recognize revenue to depict the transfer of goods or services to
customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or
services. ASU 2014-09 will also result in enhanced interim and annual disclosures, both qualitative and quantitative, about revenue in
order to help financial statement users understand the nature, amount, timing and uncertainty of revenue and related cash flows. ASU
2014-09 is effective in annual reporting periods beginning after December 15, 2016 and the interim periods within that year for public
business entities, not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed or quoted on
an exchange or over-the-counter market and employee benefit plans that file or furnish financial statements to the SEC. Accordingly,
the Company will adopt this guidance on January 1, 2017 and is currently evaluating the effect this guidance may have on its
operating results or financial position.
ASU 2014-11, Transfers and Servicing (Topic 860): “Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures,”
changes the accounting for repurchase-to-maturity transactions and repurchase financing arrangements by aligning the accounting for
these transactions with the accounting for other typical repurchase agreements. Going forward, these transactions would all be
accounted for as secured borrowings. The new guidance eliminates sale accounting for repurchase-to-maturity transactions and
supersedes the guidance under which a transfer of a financial assets and a contemporaneous repurchase financing could be accounted
for on a combined basis as a forward arrangement, which has resulted in outcomes referred to as off-balance sheet accounting. ASU
2014-11 also requires a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains
substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction, and
requires expanded disclosure about the nature of the collateral pledged in repurchase agreements and similar transactions accounted
for as secured borrowings. Accounting changes in ASU 2014-11 are effective for public companies for interim and annual periods
beginning after December 15, 2014. In addition, the disclosure for certain transactions accounted for as a sale is effective for the first
interim or annual period beginning on or after December 15, 2014, and the disclosure for transactions accounted for as secured
borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after
March 15, 2015. The adoption of this guidance on the appropriate effective dates is not expected to have a material effect on the
operating results or financial position of the Company.
38
ASU 2014-12, Compensation – Stock Compensation (Topic 718): “Accounting for Share-Based Payments When the Terms of an
Award Provide that a Performance Target Could be Achieved after the Requisite Service Period,” requires a performance target that
affects vesting and that can be achieved after the requisite service period to be treated as a performance condition. To account for such
awards, an entity should apply existing guidance as it relates to awards with performance conditions that affect vesting. As such, the
performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be
recognized in the period in which it becomes probable that the performance target will be achieved and should represent compensation
cost attributable to the period(s) for which the requisite service already has been rendered. If the performance target becomes probable
of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized
prospectively over the remaining requisite service periods. The total amount of compensation cost should reflect the number of awards
that are expected to vest and should be adjusted to reflect those awards that ultimately vest. ASU 2014-12 is effective for annual
periods and interim periods within those annual periods beginning after December 15, 2015. The adoption of this guidance on January
1, 2016 is not expected to have a material effect on the operating results or financial position of the Company.
ASU 2014-14, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): “Classification of Certain Government-
Guaranteed Mortgage Loans Upon Foreclosure,” requires that a mortgage loan be derecognized and that a separate other receivable be
recognized upon foreclosure if the following conditions are met: (1) the loan has a government guarantee that is not separable from the
loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and
make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (3) at the time of foreclosure, any
amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other
receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the
guarantor. ASU 2014-14 is effective for public companies for interim and annual periods beginning after December 15, 2014. For all
other entities, the new standard is effective for annual periods ending after December 15, 2015 and interim periods beginning after
December 15, 2015. The adoption of this guidance on January 1, 2015 will not have a material effect on the operating results or
financial position of the Company.
ASU 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40): “Disclosure of Uncertainties about an
Entity’s Ability to Continue as a Going Concern,” defines management’s responsibility to evaluate whether there is substantial doubt
about an entity’s ability to continue as a going concern and provide guidance for related footnote disclosures. ASU 2014-15 requires
an entity’s management to assess the entity’s ability to continue as a going concern by incorporating and expanding upon certain
principles that are currently in U.S. auditing standards. Specifically ASU 2014-15: (1) provides a definition of the term substantial
doubt; (2) requires an evaluation as to whether there are conditions or events, considered in the aggregate, that raise substantial doubt
about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued (or within one
year after the date that the financial statements are available to be issued when applicable); (3) provides principles for considering the
mitigating effect of management’s plans; (4) requires certain disclosures when substantial doubt is alleviated; and (5) require an
express statement and other disclosures when substantial doubt is not alleviated. ASU 2014-15 is effective for annual periods ending
after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. The adoption of this
guidance on December 31, 2016 is not expected to have a material effect on the operating results or financial position of the Company.
ASU 2015-01, Income Statement – Extraordinary and Unusual Items (Subtopic 225-20): “Simplifying Income Statement Presentation
by Eliminating the Concept of Extraordinary Items,” will alleviate uncertainty for preparers, auditors and regulators because auditors
and regulators will no longer be required to evaluate whether a preparer presented an unusual and/or infrequent item appropriately.
Although ASU 2015-01 eliminates the concept of extraordinary items, the presentation and disclosure guidance for items that are
unusual in nature or infrequent in occurrence has been retained and has been expanded to include items that are both unusual in nature
or infrequent in occurrence. The nature and financial effects of each event or transaction is required to be presented as a separate
component of income from continuing operations or, alternatively, in the notes to the financial statements. ASU 2015-01 is effective
for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption of this guidance is
permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The adoption of this guidance on
January 1, 2016 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 this Management’s Discussion and Analysis in its entirety.
Results of Operations
The year ended December 31, 2014 proved to be a successful year for the Company, as evidenced by a 110.3% improvement in
earnings year over year. The strong earnings performance reflected continued improvement in asset quality, effective management of
operating costs and improved net interest income levels, and was the cornerstone in rebuilding the Company’s and the Bank’s capital
39
position. As a result the Bank reached a major milestone in 2014, by attaining full compliance with the regulatory capital levels and
ratios required under its Consent Order as mandated by the Office of the Comptroller of the Currency (“OCC”).
Net income increased $7.0 million, or 110.3%, and equaled $13.4 million, or $0.81 per diluted common share, in 2014, compared to
net income of $6.4 million, or $0.39 per diluted common share, in 2013. This was the most profitable year for the Company since
2008. The $7.0 million earnings improvement for the year ended December 31, 2014, as compared to the year ended December 31,
2013, was largely due to a $5.6 million increase in non-interest income, which resulted primarily from increases in gains on the sale of
available-for-sale securities of $3.8 million and favorable legal settlements of $1.8 million. Also favorably affecting the Company’s
earnings performance was a $0.7 million, or 2.9%, increase in net interest income and a decrease in non-interest expense of $1.4
million, or 3.9%. Partially offsetting these positive factors was a $326 thousand provision for incomes taxes recorded by the Company
for alternative minimum tax. Return on average assets and return on average equity were 1.38% and 29.50%, respectively, in 2014
compared to 0.67% and 18.65%, respectively, in 2013. The Company did not pay any dividends during the years ended December 31,
2014 and 2013.
Management’s Focus in 2014
In 2014, management continued to build on the initiatives started in the previous year which focused on core banking operations
including generating net interest income and non-interest income, controlling operating costs and positioning the Company for
sustainable growth over the long term. These initiatives, which are discussed in further detail in this MD & A, involved, but are not
limited to, the following:
Completion of the sale of the Marshalls Creek and Stroudsburg branches to ESSA Bank and Trust (“ESSA”). In the third
quarter of 2013, the Bank had entered into a Branch Purchase and Deposit/Loan Assumption Agreement (the “Branch
Purchase Agreement”) with ESSA. As part of the Branch Purchase Agreement, which was completed in the first quarter of
2014, ESSA acquired certain assets and liabilities of the Marshalls Creek and Stroudsburg branches, both located in Monroe
County, Pennsylvania. Pursuant to this transaction, the Bank sold deposits of $8.8 million, the real and personal property of
the Marshalls Creek branch totaling $2.5 million and loans of $1.1 million. The Bank realized a net gain on the branch
divestitures of $607 thousand, which is included in non-interest income in the Consolidated Statements of Operations for the
year ended December 31, 2014.
Continued effective resolution of problem credits and management of OREO properties. The Company’s asset quality
continued to improve in 2014 as evidenced by a 26.8% decrease in non-performing assets. Non-performing loans decreased
13.4% to $5.5 million, or 0.82% of gross loans, at December 31, 2014, compared to $6.4 million, or 0.99% of gross loans at
the close of 2013.
During the second quarter of 2014, the Company received a substantial legal settlement in the amount of $5.8 million
resulting from judgments filed by the Company pursuant to a large credit relationship. Of the total amount received, $3.6
million represented full recovery of previously charged-off loans, which was the primary factor leading to a credit for loan
and lease losses of $5.9 million in 2014, the second consecutive year the Company was able to release some of its loan and
lease loss reserves. The remainder of the settlement represented satisfaction of all past due interest and late charges and
reimbursement of all legal fees and other related expenses associated with these credits incurred and paid by the Company.
The Company posted net recoveries of $3.4 million in 2014 due primarily to the legal settlement mentioned above, compared
to net recoveries of $1.8 million in 2013. The Company uses national peer group data, data for all bank holding companies
with total assets between $500 million and $1.0 billion, as a benchmark in evaluating its asset quality metrics. The
Company’s ratio of non-performing assets, as a percentage of total loans and other real estate owned, equaled 1.16% at
December 31, 2014, a significant improvement from 1.64% at December 31, 2013 and well below the national peer group
average of 1.87%. Despite the release of reserves for two consecutive years, the Company’s reserve levels exceeded those of
the national peer group. The Company’s ratio of the allowance for loan and lease losses to total loans and leases equaled
1.72% at December 31, 2014, compared to 1.48% for the national peer group.
Repositioning of the investment securities portfolio in order to reduce potential credit, concentration and interest rate risk, as
well as maximize taxable interest revenue generation under the Company’s current tax position. The Company currently has
significant net operating loss (“NOL”) carryovers, which it uses to offset any taxable income. In addition, the Company has
established a full valuation allowance for its deferred tax assets. Because of this tax position, the Company does not benefit
from holding tax-exempt obligations of state and political subdivisions. Accordingly, management continued repositioning
the investment portfolio in 2014 by selling the majority of the Company’s tax-exempt obligations of states and political
subdivisions and replacing them with taxable obligations of U.S. government and government-sponsored agencies including,
collateralized mortgage obligations, residential mortgage-backed securities and single-maturity bonds. In addition, the
40
Company was able to benefit from a decrease in Treasury yields and record a net gain on the sale of investment securities of
$6.6 million.
Effective management of funding costs through the strategic use of lower-costing borrowings through the Federal Home
Loan Bank of Pittsburgh (“FHLB”) to replace maturing, higher-costing certificates of deposit generated through a national
deposit listing service. This transitioning from certificates of deposit to FHLB advances was the primary factor leading to a
$1.0 million decrease in interest expense and a 14 basis point reduction in the Company’s cost of funds.
Implementation of several intitiatives designed to improve the generation of non-interest revenue streams. The Company
completed a deposit service charge study and began implementing recommended changes to its service charge structure in
2014. In addition, in the fourth quarter of 2014 the Company transitioned its interchange transaction processor from VISA to
Mastercard. Although the effects of these initiatives in 2014 were minimal, management anticipates increases in non-interest
income in 2015 from a full-year of additional revenue generated from these enhancements.
Improved Risk Profile and Successful Resolution of Legal Matters
In addition to the above initiatives, non-interest expense levels were positively affected by the Company’s and the Bank’s improved
risk profile. During the first quarter, the Company was notified by the Federal Deposit Insurance Corporation (“FDIC”) that effective
February 18, 2014, its risk category forFDIC insurance assessments improved to risk category II from risk category III. In addition,
because of this improvement in risk category, the surcharge associated with its assessment from the Office of the Comptroller of the
Currency (“OCC”) decreased from 100.0% of the total OCC assessment to a 50.0% surcharge. Overall, the risk category improvement
equated to a $0.7 million, or 28.4% decrease in regulatory assessments expense included in non-interest expense. The Company also
experienced a $0.2 million, or 19.3%, reduction in insurance expense because of its improved risk profile.
Furthermore, at the beginning of 2015, the Company was able to successfully resolve two matters with regulatory agencies that have
consumed a considerable amount of time, effort and resources. Both matters were related to circumstances and allegations that dated
back several years. The first matter was an agreement dated January 28, 2015 between the Company and the U.S. Securities and
Exchange Commission (“SEC”) related to disclosure, financial reporting 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, which have since been appropriately
addressed by the Company. As part of the agreement, the Company agreed to a civil money penalty of $175,000, which was accrued
for and included in non-interest expense in the consolidated statements of operations in 2014.
On February 27, 2015, the Bank reached a comprehensive settlement with both the OCC and the Financial Crimes Enforcement
Network to resolve certain Bank Secrecy Act (“BSA”) allegations based on events that transpired years ago. Management believes
that the Bank’s current BSA/Anti-money laundering program meets all industry expectations. Management also believes that settling
this matter was in the best interest of the Bank and the Company’s shareholders, as opposed to enduring additional years of contested
litigation that would result from challenging the allegations. As part of this agreement, the Bank consented to an aggregate civil
money penalty of $1.5 million, which was accrued for and included in non-interest expense in the consolidated statements of
operations in 2014.
Balance Sheet Profile
Total assets decreased $33.8 million, or 3.4%, to $970.0 million at December 31, 2014 from $1.0 billion at December 31, 2013. The
contraction in the balance sheet resulted primarily from an $89.4 million, or 10.1%, decrease in total deposits. The Company
experienced strong demand for its lending products, which resulted in a $28.9 million, or 4.6%, increase in loans, net of unearned
income, net deferred loan costs and the allowance for loan and lease losses. In addition, securities available for sale increased $15.1
million, or 7.4%. Theses outflows were the primary factors leading to the $67.9 million, or 65.6%, decline in cash and cash
equivalents to $35.7 million at December 31, 2014, from $103.6 million at the end of 2013. Due to favorable rates as compared to
other funding sources, the Company utilized FHLB borrowings as an additional source of liquidity. As a result, total borrowed funds
increased $34.1 million, or 54.6%, to $96.5 million at December 31, 2014 from $62.4 million at December 31, 2013.
Total shareholders’ equity improved $17.8 million or 53.1% to $51.4 million at December 31, 2014 from $33.6 million at the end of
2013. Net income of $13.4 million, coupled with $4.2 million in other comprehensive income related entirely to appreciation of the
Company’s available-for-sale securities, accounted for the majority of the capital improvement. The total risk-based capital ratios for
the Company and the Bank were 13.67% and 15.42%, respectively, at December 31, 2014, compared to 11.58% and 13.43%,
respectively, at December 31, 2013. Similarly, Tier I capital to average assets ratio improved for the Company and Bank to 6.05% and
9.78%, respectively, at December 31, 2014, from 4.71% and 8.32%, respectively, at December 31, 2013. The Bank’s total capital ratio
of 15.42% and Tier I leverage ratio of 9.78% both exceeded the minimum ratios of 13.00% and 9.00% mandated by the OCC under
the Consent Order.
41
Looking Ahead to 2015
For 2015, management will continue to build on the initiatives put in place in 2014 and implement additional strategies focused on
growing core deposits. In addition, the Company began the implementation process of converting its core banking system to a more
robust system that will allow the Company to capitalize on new technology through increased efficiency and delivery system
enhancements for customers. Furthermore, with the full compliance with all mandatory minimum capital requirements under the OCC
Consent Order, the Company anticipates completing the journey to normal regulatory status in the near future.
Summary of Performance
Net Interest Income
2014 compared to 2013
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. Comparing the years ended December 31, 2014 and 2013, tax-
equivalent net interest income was stable, decreasing only $26 thousand, or 0.09%. The tax-equivalent net interest margin, a key
measurement used in the banking industry to measure income from earning assets relative to the cost to fund those assets, is
calculated by dividing tax-equivalent net interest income by average interest-earning assets. The Company’s tax-equivalent net interest
margin contracted 13 basis points to 3.08% in 2014 from 3.21% in 2013. 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 2.95% in 2014, a
decrease of 14 basis points compared to 3.09% in 2013. The Company’s net interest margin and rate spread were impacted by several
strategic tax planning and ALCO initiatives in 2014, as well as an ongoing challenging rate environment and competitive pressures
that continued to impact loan pricing.
The Company currently has significant net operating loss (“NOL”) carryovers, which it uses to offset any taxable income. In addition,
the Company has established a full valuation allowance for its deferred tax assets. Because of this tax position, the Company does not
benefit from holding tax-exempt obligations of state and political subdivisions. In addition, management also sought to reduce the
amount of potential credit and concentration risk within the portfolio, as well as manage interest rate risk by shortening the duration of
the portfolio. Accordingly, management continued repositioning the investment portfolio in 2014 by selling the majority of the
Company’s tax-exempt obligations of state and political subdivisions and replacing them with taxable obligations of U.S. government
and government-sponsored agencies including collateralized mortgage obligations (“CMOs”), residential mortgage-backed securities
and single-maturity bonds. The effect of this repositioning was the primary factor leading to a $534 thousand, or 7.1%, decrease in
tax-equivalent interest income genereated from the investment portfolio.
Despite increased demand for the Company’s loan products, competition within its market area for loans escalated, which along with
the already challenging rate environment, forced loan yields down. In addition, one of the Company’s niche markets is indirect auto
lending. Demand for these loans increased in 2014 due to several promotions directed at the Company’s automobile dealer customers.
However, rates offered on consumer automobile loans are generally lower than those offered on other types of loan products offered to
commercial customers.
Tax-equivalent interest income decreased $1.1 million, or 3.0%, to $34.3 million in 2014 from $35.4 million in 2013. The
repositioning of the investment portfolio accounted for $534 thousand, or 50.6%, of the overall decrease in tax-equivalent interest
income. In addition, the tax-equivalent yield on the loan portfolio decreased 27 basis points from 4.37% in 2013 to 4.10% in 2014,
which resulted in a corresponding decrease in tax-equivalent interest income of $1.8 million. Specifically, the yield on taxable loans
decreased 27 basis points, while the yield on tax-exempt loans fell 37 basis points, and accounted for corresponding decreases in
interest income of $1.6 million and $147 thousand, respectively. Partially offsetting this decrease due to loan yields was a $29.9
million, or 4.7%, increase in average total loans to $666.3 million in 2014 from $636.5 million in 2013. The growth in average loans
resulted in an increase in tax-equivalent interest income of $1.3 million.
However, the effects of the securities portfolio repositioning and declining loan yields was almost entirely mitigated by a $1.0 million,
or 14.3%, reduction in interest expense, which resulted primarily from the planned replacement of maturing certificates of deposit
with lower-costing advances from the FHLB. Overall, the Company’s cost of funds decreased 14 basis points to 0.80% in 2014 from
0.94% in 2013. The decrease in funding costs resulted in a $1.8 million decrease in interest expense. Partially offsetting the reduction
in interest expense due to changes in rates was a $5.8 million, or 0.8%, increase in average interest-bearing liabilities to $771.5 million
in 2014 from $765.7 million in 2013.
42
Total average time deposits decreased $49.0 million, or 15.4%. Of the total decrease in average time deposits, $25.1 million, or
51.2%, resulted from a decrease in average time deposits generated through QwickRate®, a national deposit listing service. In
addition, the cost of time deposits decreased 12 basis points to 0.99% in 2014 from 1.11% in 2013, as these rate-sensitive deposits
continued to runoff at maturing rates that were higher than current rates. The decrease in volume and cost of time deposits resulted in a
combined decrease in interest expense of $0.8 million. Average borrowed funds increased $33.5 million, or 55.5%, to $93.7 million in
2014 from $60.2 million in 2013. The increase in borrowed funds was entirely attributable to an increase in advances through the
FHLB of Pittsburgh and resulted in additional interest expense of $1.3 million. However, this was more than entirely offset by a 183
basis point reduction in the cost of borrowed funds, which resulted in a corresponding decrease in interest expense of $1.3 million.
Changes in the volumes and rates paid for borrowed funds resulted in a combined net decrease in interest expense of $45 thousand.
Interest-bearing demand deposits and savings deposits averaged $18.5 million and $2.8 million higher in 2014 as compared to 2013,
respectively, while the cost of interest-bearing demand deposits and savings accounts each decreased 4 basis points. The changes in
volumes and rates for interest-bearing demand deposits and savings accounts netted a combined decrease in interest expense of $139
thousand.
2013 compared to 2012
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 4 basis points to 3.21% in 2013 from 3.25% 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 3.08% in 2013, a decrease of 4 basis points compared to 3.12% 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 22 basis points to 4.02% in 2013 from 4.24% in 2012, which resulted from a 27 basis point decrease in the tax-
equivalent yield on the loan portfolio and a 79 basis point reduction in the tax-equivalent yield on total securities. The 22 basis point
decline in the tax-equivalent yield on earning assets caused a $2.9 million decrease in tax-equivalent interest income, which was
partially offset by a decrease in interest expense of $822 thousand, resulting from an 18 basis point decline in the cost of average
interest-bearing liabilities. Also negatively impacting net interest income was a $61.4 million decrease in average earning assets,
which was partially offset by lower volume of average interest-bearing liabilities as compared to the previous year.
43
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 $1.4 million and $410 thousand, respectively. The tax-equivalent
yield on the investment portfolio decreased 79 basis points to 3.69% in 2013 from 4.48% in 2012 and resulted in a corresponding
decrease in interest income of $1.1 million. Specifically, the yield on taxable and tax-free investments decreased 78 basis points and
11 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 $542 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 $143 thousand
decrease in interest expense.
As previously mentioned, average earning assets decreased $61.4 million, or 6.5%, from $940.4 million in 2012 to $879.0 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 $202.4 million, a decrease of $5.4 million in 2013
compared to 2012. The average balance of tax-free securities decreased $12.6 million, or 15.1%, while average taxable securities
increased $7.2 million, or 5.8%, 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 $1.5 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 $1.4 million, which almost entirely offset
the negative impact from the decreases in volumes of average earning assets.
Non-accrual loans
The interest income that would have been earned on non-accrual and restructured loans outstanding at December 31, 2014, 2013 and
2012 in accordance with their original terms approximated $406 thousand, $572 thousand and $1.4 million, respectively. Interest
income on impaired loans of $235 thousand, $366 thousand, and $376 thousand was recognized based on payments received in 2014,
2013 and 2012.
44
The following table reflects the components of net interest income for each of the three years ended December 31, 2014, 2013 and 2012:
Year ended December 31,
Year ended December 31,
Year ended December 31,
Average
Balance
2014
Interest
Yield/
Cost
Average
Balance
2013
Interest
Yield/
Cos t
Average
Balance
2012
Interes t
Yield/
Cost
$
625,969
$
25,316
1,989
27,305
4,090
2,853
6,943
71
34,319
40,370
666,339
179,903
40,277
220,180
28,729
915,248
73,713
(13,094)
4.04%
4.93%
4.10%
2.27%
7.08%
3.15%
0.25%
3.75%
$
597,776
$
25,744
2,050
27,794
2,406
5,071
7,477
103
35,374
38,694
636,470
131,478
70,938
202,416
40,067
878,953
89,749
(18,613)
4.31%
5.30%
4.37%
1.83%
7.15%
3.69%
0.26%
4.02%
$
619,151
$
28,153
2,174
30,327
3,248
6,062
9,310
190
39,827
33,863
653,014
124,253
83,553
207,806
79,571
940,391
92,341
(20,526)
$
975,867
$
950,089
$
1,012,206
(dollars in thousands)
ASSETS
Earning ass ets (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 ass ets
Non-earning assets
Allowance for loan and lease losses
Total assets
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing liabilities
Interes t-bearing demand deposits
$
320,780
$
453
Savings depos its
Time deposits over $100,000
Other time deposits
Total interest-bearing deposits
Borrowed funds and other interest-bearing liabilities
Total interest-bearing liabilities
Demand depos its
Other liabilities
Shareholders' equity
88,678
135,871
132,489
677,818
93,694
771,512
134,132
24,724
45,499
Total liabilities and shareholders ' equity
$
975,867
Net interest income/interest rate apread (6)
Tax equivalent adjustment
Net interest income as reported
Net interest margin (7)
57
1,048
1,622
3,180
2,967
6,147
28,172
(1,646)
$
26,526
$
302,258
$
559
85,872
160,728
156,639
705,497
60,240
765,737
130,186
19,946
34,220
$
950,089
90
1,301
2,214
4,164
3,012
7,176
28,198
(2,421)
$
25,777
0.14%
0.06%
0.77%
1.22%
0.47%
3.17%
0.80%
2.95%
3.08%
0.18%
0.10%
0.81%
1.41%
0.59%
5.00%
0.94%
3.08%
3.21%
$
299,938
$
699
87,818
170,356
191,462
749,574
72,593
822,167
128,254
21,568
40,217
1,012,206
161
1,476
3,048
5,384
3,834
9,218
30,609
(2,800)
$
27,809
Interest income is presented on a tax-equivalent basis using a 34% rate.
(1)
(2) Loans are stated net of unearned income.
(3) Non-accrual 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 are bas ed 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 average interest-bearing liabilities
and is presented on a tax-equivalent bas is.
(7) Net interest income as a percentage of total average interest earning as sets.
4.55%
6.42%
4.64%
2.61%
7.26%
4.48%
0.24%
4.24%
0.23%
0.18%
0.87%
1.59%
0.72%
5.28%
1.12%
3.12%
3.25%
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%.
45
The following table summarizes the effect that changes in volumes of earning assets and interest-bearing liabilities and the interest
rates earned and paid on these assets and liabilities have on net interest income comparing years ended December 31, 2014 and 2013.
The net change or mix component attributable to the combined impact of rate and volume changes has been allocated proportionately
to the change due to volume and the change due to rate.
(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
Net Interest Income
Provision for Loan and Lease Losses
For the Year Ended December 31,
2014 vs. 2013
December 31,
2013 vs. 2012
Increase (Decrease) due to change in
Increase (Decrease) due to change in
Volume
Rate
Total
Volume
Rate
Total
$
1,182
$
(1,610)
$
(428)
$
(992)
$
(1,417)
$
(2,409)
86
1,268
1,016
(2,211)
(1,195)
(30)
43
33
3
(208)
(366)
(538)
1,303
765
(147)
(1,757)
668
(7)
661
(2)
(1,098)
(139)
(36)
(45)
(226)
(446)
(1,348)
(1,794)
(61)
(489)
1,684
(2,218)
(534)
(32)
(1,055)
(106)
(33)
(253)
(592)
(984)
(45)
286
(706)
180
(928)
(748)
(88)
(410)
(1,827)
(1,022)
(63)
(1,085)
1
(1,542)
(2,911)
5
(4)
(86)
(593)
(678)
(679)
(145)
(67)
(89)
(241)
(542)
(143)
(685)
(124)
(2,533)
(842)
(991)
(1,833)
(87)
(4,453)
(140)
(71)
(175)
(834)
(1,220)
(822)
(2,042)
$
(722)
$
696
$
(26)
$
(185)
$
(2,226)
$
(2,411)
(1,029)
(1,357)
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.
2014 compared to 2013
The Company recorded a credit for loan and lease losses of $5.9 million in 2014, compared to a credit of $6.3 million in 2013.
During 2014, the Bank received a substantial legal settlement in the amount of $5.8 million resulting from judgments filed by the
Bank pursuant to a large credit relationship. Of the total amount received, $3.6 million represented full recovery of previously
charged-off loans, which was the primary factor leading to the credit for loan and lease losses. The remainder of the settlement
represented satisfaction of all past due interest and late charges and reimbursement of all legal fees and other related expenses
associated with these credits distributed as follow: 1) $1.8 million included in non-interest income for amounts recovered that were
incurred in prior years; and 2) $0.4 million included as a credit to non-interest expense for amounts recovered that were incurred and
paid in 2014.
In addition to this settlement, continued improvement in the Company’s asset quality metrics also factored into the release of reserves
in 2014. Non-performing loans decreased $0.9 million, or 13.4%, to $5.5 million at December 31, 2014 from $6.4 million at
December 31, 2013. The Company recorded net recoveries of $3.4 million for the year ended December 31, 2014, compared to $1.7
million for the same period of 2013. 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.
46
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 34.3%, 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-Interest Income:
The following table lists the components of non-interest income for the years ended December 31, 2014, 2013 and 2012:
Non-Interest Income
2014
$
2013
$
2012
$
(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 mortgage loans held for sale
Net loss on the sale of classified loans
Net loss on the sale of education loans
Net gain on the sale of other real estate owned
Gain on the sale of bank premises and equipment and other assets
Gain on branch divestiture
Loan-related fees
Income from bank-owned life insurance
Legal settlements
Other
Total non-interest income
2014 compared to 2013
2,975
6,640
-
292
-
(13)
209
-
607
440
650
2,127
993
14,920
2,945
2,887
-
362
(223)
-
135
579
-
423
706
288
1,181
9,283
2,985
(1,712)
(96)
859
-
-
305
-
-
514
692
-
736
4,283
$
$
$
Non-interest income totaled $14.9 million in 2014, an increase of $5.6 million, or 60.7%, from $9.3 million in 2013. The increase in
the Company’s non-interest income was due largely to an increase in net gains on the sale of investment securities, monies received
from a legal settlement and a $0.6 million net gain recorded on the divestiture of the Company’s Monroe County branch offices. Net
gains on the sale of investment securities increased $3.7 million, or 130.0%, to $6.6 million in 2014 from $2.9 million in 2013.
As previously mentioned, the Bank received a substantial legal settlement in the amount of $5.8 million resulting from judgments filed
by the Bank pursuant to a large credit relationship, which was the primary factor leading to the increase in the credit for loan and lease
losses. A portion of the settlement totaling $1.8 million represented satisfaction of all past due interest and late charges and
reimbursement of all legal fees and other related expenses associated with these credits incurred and paid by the Bank. Any expenses
incurred in 2014 were credited to the appropriate non-interest expense account in 2014. The amount of settlement related to expenses
incurred in previous years is included under legal settlments in non-interest income.
The Company’s non-interest income was also impacted by increases in net gains on the sale of OREO properties, deposit service
charges and loan related fees, along with decreases in net gains on the sale of mortgage loans held for sale, income from bank-owned
life insurance and other income, and a $13 thousand net loss on the sale of the Company’s student loan portfolio. In addition, in 2013
the Company sold its administrative facility located in Luzerne County. This property had a net book value of $1.2 million at the time
of sale and the Company recorded a gain on the sale of $579 thousand in 2013.
The sale of OREO properties in 2014 generated a net gain of $209 thousand, which was an increase of $74 thousand, or 54.8%,
compared to a net gain of $135 thousand in 2013. Service charges on deposit accounts increased $30 thousand, or 1.0%, comparing
the years ended December 31, 2014 and 2013. The Company completed a deposit service charge study and began implementing
recommended changes to its service charge structure in 2014. In addition, in the fourth quarter of 2014 the Company transitioned its
interchange transaction processor from VISA to Mastercard. Management anticipates an increase in non-interest income in 2015
related to these changes. Loan-related fees increased $17 thousand, or 4.0%, to $440 thousand in 2014 from $423 thousand in 2013,
which was due primarily to additional fees from issuing letters of credit.
47
During 2014, the Company continued to hold 15- and 20-year mortgages in its portfolio rather than selling these loans on the
secondary market as part of its asset/liability management strategy. In addition, the volume of mortgages originated was negatively
impacted by new and more stringent regulations, which became effective at the beginning of 2014. Moreover, the volume of
mortgage loans refinanced slowed considerably as mortgage rates have remained stable for a considerable time. As a result, net gains
recorded on the sale of mortgage loans in 2014 decreased $70 thousand, or 19.3%, to $292 thousand in 2014 from $362 thousand in
2013. Comparing the years ended December 31, 2014 and 2013, income from bank-owned life insurance decreased $56 thousand, or
$7.9%, while other income decreased $188 thousand, or 15.9%. A 12.2% decline in revenue generated from wealth management
services was the primary factor leading to the decrease in other income.
2013 compared to 2012
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, a legal settlement of $288 thousand and an increase in other non-interest income of $445
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 $445 thousand, or 60.1%, increase primarily resulted from 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.
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.
Non-Interest Expense
The following table lists the major components of non-interest expense for the years ended December 31, 2014, 2013 and 2012:
Non-Interest Expense
(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 losses
Other operating expenses
Total non-interest expense
48
2014
2013
2012
$
$
$
13,111
2,088
1,471
470
2,088
1,801
522
2,569
(94)
1,799
1,567
951
90
-
2,279
2,857
33,569
13,218
2,215
1,468
523
2,066
2,515
800
719
(246)
2,488
1,674
1,179
482
2,500
123
3,224
34,948
14,702
2,225
1,723
614
2,141
2,721
882
2,027
358
4,233
4,385
896
765
446
170
3,450
41,738
$
$
$
2014 compared to 2013
The Company experienced a $1.4 million, or 3.9%, decrease in non-interest expense to $33.6 million in 2014 from $34.9 million in
2013. Non-interest expense was primarily impacted by reductions in regulatory assessments, legal expense, loan collection expense,
insurance expense, bank shares tax and other operating expenses, partially offset by valuation adjustments to properties held in other
real estate owned and other losses, which were primarily related to penalties assessed by certain regulatory agencies. Non-interest
expense also benefitted from decreases in salaries and employee benefits and occupancy costs.
During the first quarter of 2014, the Company was notified by the Federal Deposit Insurance Corporation (“FDIC”) that its risk
category for FDIC assessments had improved from a risk category III to a risk category II based upon the Company’s most recent
regulatory examination. Due to the change in risk categories, the Company’s initial base assessment rate for deposit insurance
decreased from 0.23 basis points to 0.14 basis points. The new assessment rate became effective on February 18, 2014. The changes in
assessment rates resulted in a $714 thousand, or 28.4%, decrease in regulatory assessments expense included in non-interest expense.
As a result of the resolution of certain long-standing litigation, legal expense declined $689 thousand, or 27.7% to $1.8 million in
2014 from $2.5 million in 2013. Despite the decrease, the Company’s legal expense remains elevated. The Company anticipates a
continued decline in future legal expenses as outstanding litigation continues to be resolved. Decreases in non-performing loans,
coupled with reimbursement of certain expenses related to the settlement of judgments filed against parties to a large credit
relationship, the Company’s loan collection expenses decreased $392 thousand, or 81.3%. During the second quarter of 2014, the
Company’s professional liability, fidelity bond and errors and omissions insurance policies were renewed at lower rates for the
upcoming insurance period. As a result, the Company experienced a $228 thousand, or 19.3% decrease in insurance expense
comparing 2014 and 2013. Effective January 1, 2014, the Commonwealth of Pennsylvania enacted a reduction in the bank shares tax
rate, which resulted in a decrease in bank shares tax expense of $278 thousand, or 34.8%. The $367 thousand, or 11.4%, decrease in
other operating expenses resulted primarily from a 41.8% decrease in telecommunication cost associated with enhancements made by
the Company to its network.
Expenses associated with other real estate owned increased $1.9 million, or 257.3%, to $2.6 million from $0.7 million for the same
period of 2013. The Company recorded valuation adjustments to the cost basis of several OREO properties totaling $2.2 million. The
valuation adjustments reflected the continued decline in real estate values for properties located in Monroe County, Pennsylvania. In
addition, the Company adjusted the cost basis of four OREO properties to liquidation value, as these properties were approaching the
five-year regulatory holding period threshold.
Included in other losses were penalites assessed by regulatory agencies regarding two separate settlements. The Company recorded a
penalty in the amount of $175 thousand related to a settlement agreement it reached with the SEC. In addition, the Bank recorded a
penalty assessment in the amount of $1.5 million related to a joint settlement agreement it reached with the OCC and FinCEN. These
two penalties accounted for approximately 73.5% of other losses recorded in 2014. The remaining amount in other losses in 2014
related to charges incurred on the abandonment of software and losses sustained in several branch robberies, fraudulent debit card
transactions and wire transfers.
Salaries and employee benefits expense decreased $107 thousand, or 0.8%, to $13.1 million in 2014 from $13.2 million in 2013.
Total salary expense decreased $209 thousand, or 1.9%, due to a decline in the number of full-time equivalent employees, partially
offset by increases in stock-based compensation and employee incentive compensation. At December 31, 2014, the number of full-
time equivalent employees was 237 as compared to 260 at December 31, 2013. Payroll taxes and employee benefits increased $102
thousand, or 4.9%, which was due primarily to an increase in health care costs.
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 2014 and 2013, 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 $134 thousand and $129 thousand in 2014 and 2013,
respectively.
Pursuant to the 2014 Employee Stock Grant Plan and the 2013 Employee Stock Grant Plan, the Board of Directors granted 50 shares
of the Company’s common stock in both 2014 and 2013, respectively to each active full and part time employee. There were 12,850
shares at a cost per share of $6.02 granted under the 2014 Stock Grant Plan and 14,400 shares at a cost per share of $4.26 granted
under the 2013 Stock Grant Plan. The total costs of these grants was $77 thousand and $61 thousand, respectively, for the years ended
December 31, 2014 and 2013, which were included in salaries and employee benefits expense.
49
Occupancy costs decreased $127 thousand, or 5.7%, to $2.1 million in 2014 from $2.2 million in 2013. The decrease in occupancy
costs reflected decreases in real estate taxes, utility costs and depreciation, which resulted primarily from the divestitures of the
Monroe County branches.
2013 compared to 2012
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 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.
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.
Provision for Income Taxes
The Company recorded income tax expense of $326 thousand in 2014, which was related entirely to alternative minimum tax. The
Company did not record a provision or benefit for income taxes for the years ended December 31, 2013 and 2012. In 2014, the
Company recorded a $3.8 million reduction to the deferred tax valuation allowance, decreasing the valuation allowance to $30.3
million at December 31, 2014 from $34.1 million at December 31, 2013. 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.
50
The Company evaluates the carrying amount of its deferred tax assets on a quarterly basis, or more frequently, if necessary, in
accordance with guidance set forth in ASC Topic 740 “Income Taxes,” and applies the criteria in the guidance to determine whether it
is more likely than not that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight
of available evidence. If management determines based on available evidence, both positive and negative, that it is more likely than
not that some portion or all of the deferred tax asset will not be realized in future periods, a valuation allowance is calculated and
recorded. These determinations are inherently subjective and depend upon management’s estimates and judgments used in their
evaluation of both positive and negative evidence.
In evaluating available evidence, management considers, among other factors, historical financial performance, expectation of future
earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with
operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of termporary
differences. In assessing the need for a valuation allowance, management carefully weighed both positive and negative evidence
currently available. The weight given to the potential effect of positive and negative evidence must be commensurate with the extent
to which it can be objectively verified. In particular, additional scrutiny must be given to deferred tax assets of an entity that has
incurred taxable losses during the three most recent years because it is significant negative evidence that is objective and verifiable
and therefore difficult to overcome. While the Company generated taxable income in 2014, it recorded taxable losses in 2013 and
2012.
When determining the need for a valuation allowance, the Company assessed the possible sources of taxable income available
under tax law to realize a tax benefit for deductible temporary differences and carryforwards as defined in ASC Topic 740. While the
Company has shown substantial book net income in 2013 and 2014, these amounts have been the result of significant non-recurring or
non-taxable transactions, such as the credit for loan and lease losses, legal settlements and gains on the sales of securities. The
Company utilizes a three-year rolling measurement of results when assessing whether it is in a cumulative loss position. Until such
time when the Company’s cumulative results are positive, it does not believe there is sufficient positive evidence to overcome the
negative evidence presented.The Company will exclude future taxable income as a factor until it can show consistent and sustainable
profitability. Based on the analysis of available positive and negative evidence, management determined that the established valuation
allowance equal to 100.0% of net deferred tax assets, excluding deferred tax assets or liabilities related to unrealized holding gains and
losses on available-for-sale securities, should be maintained.
The Company recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and
the tax bases of assets and liabilities. The net deferred tax asset, not including unrealized holding gains and losses on available-for-sale
securities, approximated $30.3 million,and $34.1 million at December 31, 2014 and 2013, respectively. Accordingly, the Company
recorded a valuation allowance for the entire balance of the net deferred tax assets at December 31, 2014 and 2013. The deferred tax
asset will continue to be analyzed on a quarterly basis for changes affecting realizability.
In 2014, management assessed and implemented tax planning strategies available to the Company in order to generate taxable income,
prevent a net operating loss or tax credit carryforward from expiring unused and promote the realization of existing deferred tax
assets. Theses strategies included the repositioning of the securities portfolio from tax-exempt to taxable investments through the sale
of available-for-sale investment securities with fair values greater than book values and the redeployment of cash and cash equivalents
into higher yielding investment options.
Sustained profitability is a driving factor used to determine when projections of future taxable income become more reliable and can
again be used to assess the ability to fully realize the deferred tax asset. When the determination is made to include projections of future
taxable income as a factor, the valuation allowance will be reduced accordingly resulting in a corresponding increase in net income.
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 decreased $33.8 million, or 3.4%, to $970.0 million, at December 31, 2014, as compared to $1.0 billion at December 31,
2013. The balance sheet contraction resulted primarily from an $89.4 million, or 10.1%, decrease in total deposits. The Company
experienced strong loan demand, which resulted in a $28.9 million, or 4.6%, increase in loans, net of unearned income, net deferred
costs and the allowance for loan and lease losses. Available-for-sale investment securities increased $15.1 million, or 7.4%. These
outflows were the primary factors leading to the $67.9 million, or 65.56%, decline in cash and cash equivalents to $35.7 million at
December 31, 2014 from $103.6 million at the end of 2013. Due to favorable rates as compared to other funding sources, the
Company utilized borrowings through the FHLB of Pittsburgh as an additional source of liquidity. As a result, total borrowed funds
increased $34.1 million, or 54.6%, to $96.5 million at December 31, 2014 from $62.4 million at December 31, 2013.
51
The Company’s capital position strengthened as evidenced by an increase in total shareholders’ equity of $17.8 million, or 53.1% .
Net income of $13.4 million, coupled with a $4.2 million increase in accumulated other comprehensive income due to appreciation in
the fair value of the Company’s available-for-sale securities portfolio, accounted for the majority of the capital improvement. The
Company did not pay any dividends in 2014 or 2013. The Company suspended paying dividends in 2010 to comply with regulatory
requirements and conserve capital.
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 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 (loss), 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 asset/liability management strategies. Securities with limited marketability and/or restrictions, such as FHLB of Pittsburgh and
FRB stocks, are carried at cost. FRB stock is included in other assets.
At December 31, 2014, the Company’s investment portfolio was comprised principally of securities issued by U.S. government or
U.S. government-sponsored agencies, which include residential mortgage-backed securities, residential and commercial CMOs and
single-maturity bonds. Except for U.S. government and government-sponsored agencies, there were no securities of any individual
issuer that exceeded 10.0% of shareholders’ equity as of December 31, 2014.
The following table presents 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 December 31, 2014, 2013 and 2012:
(in thousands)
Available-for-sale
Obligations of U.S. government agencies
Obligations of state and political subdivisions
U.S. government/government-sponsored agencies:
Collateralized mortgage obligations - residential
Collateralized mortgage obligations - commercial
Residential mortgage-backed securities
Corporate debt securities
Negotiable certificates of deposit
Equity securities
Total securities available-for-sale
Held-to-maturity
Obligations of state and political subdivisions
2014
December 31,
2013
2012
$
29,276
24,509
-
$
78,054
$
1,891
103,501
26,231
61,256
74,098
420
2,232
967
218,989
$
3,221
31,578
89,656
407
-
951
203,867
$
9,103
-
69,456
410
-
1,000
185,361
$
$
-
$
2,308
$
2,198
Management monitors the Company’s investment portfolio regularly and adjusts the investment strategy to reflect changes in liquidity
needs, asset/liability strategy and tax planning requirements. Management actions for the year ended December 31, 2014 reflected the
Company’s current investment strategy designed to reduce potential credit and concentration risk within the balance sheet, manage
interest rate risk by shortening the duration of the portfolio, and reduce tax-free holdings as required under tax planning initiatives. The
Company currently has $52.7 million in net operating loss (“NOL”) carryovers, which it uses to offset any taxable income. In addition,
the Company has established a full valuation allowance for its deferred tax assets. Because of this tax position, the Company does not
benefit from holding tax-exempt obligations of state and political subdivisions. Accordingly, current tax planning initiatives focus on
generating sustained taxable income to be able to reduce NOL carryovers and begin reversing the deferred tax asset valuation allowance.
As part of this strategy in 2014, the Company sold 110 of its available-for-sale securities including 94 tax-exempt and 5 taxable
obligations of state and political subdivisions, 7 residential mortgage-backed securities, 3 U.S. government agency bonds, and 1
commercial CMO. The securities sold had an aggregate amortized cost of $105.0 million. Gross proceeds received totaled $111.2
million, with net gains of $6.3 million realized upon the sales and included in non-interest income.
52
During the year ended ended December 31, 2014, the Company sold its entire holdings of held-to-maturity securities comprised of
four zero-coupon obligations of state and political subdivisions with an aggregate amortized cost of $2.3 million. Gross proceeds
received from the sale of held-to-maturity securities were $2.7 million, with net gains of $0.4 million realized upon the sale. These
securities were sold as part of management’s strategy to reduce the amount of potential credit and concentration risk in the investment
portfolio. Since the securities were sold for for reasons other than those permitted under GAAP, the Company is not permitted to
classify securities as held-to-maturity for a period of two years from the date of the sales.
Securities purchased during the year ended December 31, 2014 totaled $123.4 million, including $18.3 million in home equity
conversion mortgages of a U.S. government agency, $45.4 million of single-maturity bonds of U.S. government-sponsored agencies,
$24.8 million in residential CMOs of U.S. government-sponsored agencies, $32.7 million in commercial CMOs of U.S. government-
sponsored agencies and $2.2 million in negotiable certificates of deposit.
At December 31, 2014, obligations of states and political subdivisions comprised only 11.2% of the available-for-sale securities
portfolio, a significant reduction compared to 38.3% at December 31, 2013. In addition, management was able to reduce the amount
of potential interest rate risk in the available-for-sale portfolio as evidenced by a decrease in the weighted average duration of the
available-for-sale portfolio to 4.97 years at December 31, 2014 from 6.15 years at the close of 2013.
The following table presents the maturities of available-for-sale securities, based on carrying value at December 31, 2014, 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. The yields on obligations of states and political subdivisions are presented on a tax-equivalent basis using an
effective tax rate of 34.0%. Because residential and commercial collateralized mortgage obligations and residential mortgage-backed
securities are not due at a single maturity date, they are not included in the maturity categories in the following summary.
December 31, 2014
Within
One Year
> 1 – 5
Years
6 - 10
Years
Over
10 Years
Collateralized
Mortgage
Obligations and
Mortgage-Backed
Securities
No Fixed
Maturity
$
-
$
-
$
-
$
-
$
-
-
-
-
-
-
-
-
$
-
0.00%
$
-
-
-
-
-
2,232
1.97%
-
2,232
1.97%
$
29,276
2.00%
7,061
3.59%
-
-
-
-
-
-
17,448
7.27%
-
-
-
420
0.85%
-
-
-
26,231
2.31%
61,256
2.34%
74,098
2.07%
-
-
-
$
36,337
2.31%
$
17,868
7.12%
$
161,585
2.21%
967
3.50%
967
3.50%
$
$
-
-
-
-
-
-
Total
$
29,276
2.00%
24,509
6.21%
26,231
2.31%
61,256
2.34%
74,098
2.07%
420
0.85%
2,232
1.97%
967
3.50%
218,989
2.63%
(dollars in thousands)
Available-for-sale securities
Obligations of U.S. government agencies
Yield
Obligations of state and political subdivisions
Yield
U.S. government/government-sponsored agencies:
Collateralized mortgage obligations - residential
Yield
Collateralized mortgage obligations - commercial
Yield
Residential mortgage-backed securities
Yield
Corporate debt securities
Yield
Negotiable certificates of deposit
Yield
Equity securities
Yield
Total available-for-sale securities
Weighted yield
OTTI Evaluation
Management evaluates individual securities in an unrealized loss position quarterly for OTTI. As part of its evaluation, management
considers, among other things, the length of time a security’s fair value is less than amortized cost, the severity of decline, any credit
deterioration of the issuer, whether or not 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.
As previously mentioned, securities issued by U.S. government or U.S. government-sponsored agencies, including single-maturity
bonds, residential mortgage-backed securities, and residential and commercial CMOs, comprise the majority of the Company’s
securities portfolio. Management performed a review of the fair values of all securities in an unrealized loss position as of December
31, 2014 and determined that movements in the fair values of the securities were consistent with the change in market interest rates. At
December 31, 2014, the Company held 25 securities that were in an unrealized loss position, with 12 of those securities in an
unrealized loss position for more than 12 months. All but one of the securities in an unrealized loss position at December 31, 2014
were debt securities. Additionally, management considers the severity of each security’s unrealized loss position, placing greater
emphasis on any security with a unrealized loss greater than 5.0% of its amortized cost. At December 31, 2014, there was one
security, a corporate debt security, with an unrealized loss greater than 5.0% of its amortized cost. The security, a floating rate bond of
53
JP Morgan Chase, had an unrealized loss of $80 thousand, or 16.0%, of its amortized cost at December 31, 2014. This bond was
originally issued by Chase Manhattan Bank. JP Morgan Chase, surviving after the merger, is one of the largest banks in the world with
a legacy dating back to 1799. JP Morgan Chase was considered well capitalized under regulatory capital guidelines at December 31,
2014.
The remaining 24 securities in an unrealized position at December 31, 2014 included 22 securities issued by a U.S. government or
government-sponsored agency, one obligation of a state and political subdivision and one equity security. The obligations of the U.S.
government or government-sponsored agencies are securities issued by GNMA, FHLMC, FNMA and the Federal Farm Credit Bank
that are currently rated Aaa by Moody’s Investor Services or AA+ by Standard & Poor’s (“S&P”) and are guaranteed by the U.S.
government.The one state and political subdivision obligation in an unrealized loss position at December 31, 2014 was a general-
purpose debt obligation, which has an S&P credit rating of A+, is secured by the unlimited taxing power of the issuer and carries a
secondary level of credit enhancement. The one equity security in an unrealized loss position at December 31, 2014, which was a
mutual fund investment that qualifies the Company for credit under the Community Reinvestment Act. The mutual fund is comprised
of one- to four-family residential mortgage-backed securities collateralized by properties within the Company’s geographical market.
In aggregate, unrealized losses totaled $768 thousand, which represented only 0.4%, of the total amortized cost of investment
securities at December 31, 2014.
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 prior to recovery of their amortized cost. Based on the result of its review and considering the
attributes of these debt and equity securities, management concluded that the individual unrealized losses were temporary and OTTI
did not exist at December 31, 2014. For more information regarding the Company’s evaluation of securities for OTTI, see Note 4-
“Securities” of the notes to consolidated financial statements included in Item 8 – “Financial Statement and Supplementary Data to
this Annual Report on Form 10-K.
Investments in FHLB and Federal Reserve Bank (“FRB”) stock, which have limited marketability, are carried at cost and totaled $4.2
million and $3.5 million at December 31, 2014 and 2013, respectively. FRB stock of $1.3 million is included in Other Assets at
December 31, 2014 and 2013. Management noted no indicators of impairment for the FHLB of Pittsburgh and FRB of Philadelphia at
December 31, 2014.
Loans
During 2014, the Company experienced increased demand for its lending products, as new loan originations exceeded maturities and
payoffs. As a result, loans, net of unearned income, net deferred loan costs and the allowance for loan losses increased $28.9 million,
or 4.6%, to $658.7 million and represented 67.9% of total assets at December 31, 2014, from $629.9 million, or 62.7% of total assets,
at December 31, 2013. 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 consists of loans secured by real estate. Real estate secured
loans, which include commercial real estate, construction, land acquisition and development, residential real estate loans and home
equity lines of credit (“HELOCs”), increased $18.0 million, or 4.7%, to $405.0 million at December 31, 2014 from $387.0 million at
December 31, 2013. Real estate secured loans represented 60.5% of total gross loans at December 31, 2014 and 60.2% at December
31, 2013.
Commercial and industrial loans increased $5.1 million, or 4.0%, during the year to $132.1 million at December 31, 2014 from $127.0
million at December 31, 2013. Commercial and industrial loans consist primarily of equipment loans, working capital financing,
automobile floor plans, revolving lines of credit and loans secured by cash and marketable securities. Loans secured by commercial
real estate increased $15.0 million, or 6.8%, to $233.5 million at December 31, 2014 from $218.5 million at December 31, 2013.
Commercial real estate loans include long-term commercial mortgage financing and are primarily secured by first or second lien
mortgages. Construction, land acquisition and development loans decreased $5.5 million, or 22.8%, during the year to $18.8 million at
December 31, 2014, from $24.4 million at December 31, 2013. The Company continues to monitor its exposure to this higher-risk
portfolio segment.
Residential real estate loans totaled $122.8 million at December 31, 2014, an increase of $7.9 million, or 6.9%, from $114.9 million at
December 31, 2013. 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, as part of the Bank’s current asset/liability management strategy, fixed-rate residential mortgage loans with maturity
terms of 15 years or less that are eligible for sale on the secondary market are being retained in the portfolio. Beginning January 2015,
54
based on current liquidity levels and asset/liability strategy, the Company will begin retaining up to $10.0 million of fixed-rate
residential mortgages regardless of maturity term. In addition, in January 2015, management began a campaign to promote the
Company’s “WOW” residential mortgage product. This product is a non-saleable mortgage with maturity terms of 7.5, 10 and 14.5
years that offers customers an attractive interest rate, low closing cost and quicker close.
Consumer loans increased $3.5 million, or 2.9%, to $122.1 million at December 31, 2014, from $118.6 million at December 31, 2013.
The increase was concentrated in the Company’s portfolio of indirect automobile loans. During the first quarter of 2014, the Company
sold its education loan portfolio to a third party. This portfolio had a recorded investment of $2.6 million at the time of sale and the
Company realized a loss of $13 thousand upon the sale, which is included in non-interest income in the consolidated statements of
operations for the year ended December 31, 2014. This portfolio was sold due to the low outstanding loan balance as related to the
current servicing costs which reduced the yield on the portfolio to an unacceptable level.
Loans to state and municipal governments increased $0.3 million, or 0.8%, to $40.2 million at December 31, 2014 from $39.9 million
at December 31, 2013.
The following table summarizes loans receivable, net by category at December 31, 2014, for each of the last five years:
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,
2014
2013
2012
2011
2010
$
122,832
$
114,925
$
90,228
$
80,056
$
87,925
233,473
18,835
132,057
122,092
40,205
669,494
(98)
871
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
(11,520)
(14,017)
(18,536)
(20,834)
(22,575)
Loans, net
$
658,747
$
629,880
$
579,396
$
659,044
$
735,813
The following schedule shows the maturity distribution and re-pricing information of the loan portfolio by major classification as of
December 31, 2014.
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, 2014
Within One
Year
One to Five
Years
Over Five
Years
Total
$
$
$
$
2,494
16,992
9,632
73,593
31,561
575
134,847
6,885
37,655
2,037
31,980
64,695
3,903
147,155
113,453
178,826
7,166
26,484
25,836
35,727
387,492
122,832
233,473
18,835
132,057
122,092
40,205
669,494
$
$
$
$
$
$
145,309
242,183
387,492
$
$
111,849
35,306
147,155
$
4,948
129,899
134,847
$
55
$
$
262,106
407,388
669,494
At December 31, 2014, 2013 and 2012, the Bank’s loan portfolio was concentrated in loans in the following industries.
Loan Concentrations
(dollars in thousands)
Retail space/shopping centers
Automobile dealers
Office complexes/units
Colleges and Universities
Land subdivision
Physicians
1-4 family residential investment properties
2014
December 31,
2013
2012
Amount
$
33,140
24,194
17,249
16,680
15,220
13,636
12,764
% of gross
loans
4.95%
3.61%
2.58%
2.49%
2.27%
2.04%
1.91%
Amount
$
23,472
18,467
17,924
12,671
15,974
13,932
18,839
% of gross
loans
Amount
% of gross
loans
3.65%
2.87%
2.79%
1.97%
2.48%
2.17%
2.93%
$
29,740
10,607
15,962
4,879
17,658
7,140
9,269
4.98%
1.77%
2.67%
0.82%
2.95%
1.19%
1.55%
Asset Quality
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount
of unpaid principal, net of unearned interest, deferred loan fees and costs, and reduced by the ALLL. The ALLL is established through
a provision for loan and lease losses charged to earnings.
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 that are 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, finance 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 Company 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”), loan relationships with an aggregate outstanding balance greater than $100
thousand rated substandard and non-accrual, and loans that are identified as doubtful or loss are considered impaired. Impaired loans
are analyzed individually to determine the amount of impairment. 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 any deferred fees and costs, discounted at the loan’s original effective
interest rate.
Loans to borrowers that are experiencing financial difficulty that are modified and result in the 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 of the
pledged collateral, less cost to sell.
56
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. In addition, employment conditions within the Company’s market area have
shown substantial improvement. The unemployment rate for the Scranton/Wilkes-Barre Pennsylvania metropolitan area decreased to
5.9% for December 2014 from 8.4% for December 2013. However, any weakening of economic and employment conditions could
result in real estate devaluations and increases in loan delinquency rates, which could negatively impact asset quality and, accordingly,
result in 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, 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
2014
2013
2012
2011
2010
$
5,522
$
6,356
$
9,652
$
19,913
$
28,267
Loans past due 90 days or more and still accruing
-
19
57
5
99
Total non-performing loans
Other real estate owned
Total non-performing loans and OREO
5,522
2,255
6,375
4,246
9,709
3,983
19,918
6,958
28,366
9,633
$
7,777
$
10,621
$
13,692
$
26,876
$
37,999
December 31,
Accruing TDRs
$
5,282
$
3,995
$
7,517
$
5,680
$
2,513
Non-performing loans as a percentage of gross loans
0.82%
0.99%
1.62%
2.93%
3.74%
Management continues to manage problem credits through heightened work-out efforts on non-performing loans and aggressively
disposing of its holdings of foreclosed properties. The Company experienced significant further improvement in its asset quality
during 2014. Total non-performing loans and OREO decreased $2.8 million, or 26.8%, to $7.8 million at December 31, 2014 from
$10.6 million at December 31, 2013. The Company’s ratio of non-performing loans to total gross loans improved to 0.82% at
December 31, 2014 from 0.99% at December 31, 2013, as management continued to reduce the balance of non-accrual loans. The
Company’s ratio of non-performing loans and OREO as a percentage of shareholders’ equity decreased to 15.1% at December 31,
2014 from 31.6% at December 31, 2013. Despite the decrease, the percentage remains elevated. Management monitors nonaccrual
loans, delinquency trends and economic conditions within the Company’s market area on an on-going basis in order to proactively
address any potential collection-related issues.
TDRs at December 31, 2014 and 2013 were $9.0 million and $8.1 million, respectively. Accruing and non-accruing TDRs were $5.3
million and $3.7 million, respectively at December 31, 2014 and $4.0 million and $4.1 million, respectively at December 31, 2013.
There were 18 loans modified as TDRs during the year ended ended December 31, 2014, with an aggregate post-modification
outstanding balance of $1.3 million. In addition, two TDRs with an aggregate outstanding balance of $0.1 million that were on non-
accrual status at December 31, 2013 were transferred to accruing status during the year ended December 31, 2014. New modifications
during the year ended December 31, 2014 included 12 residential real estate loans, 4 commercial real estate loans and 2 consumer
57
loans. The terms of such modifications included one or a combination of the following: extension of term, capitalization of real estate
taxes or principal forbearance.
The average balance of impaired loans was $9.5 million and $13.1 million for the years ended December 31, 2014 and 2013,
respectively. The Company recognized $235 thousand and $366 thousand of interest income on impaired loans for the years ended
December 31, 2014 and 2013, respectively.
The following table presents the changes in non-performing loans for the years ended December 31, 2014 and 2013:
Changes in Non-performing Loans
(in thousands)
Balance, January 1
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, December 31
Year ended December 31,
2014
2013
$
6,375
$
9,709
2,348
(19)
(13)
(222)
(1,289)
(1,658)
-
2,465
(38)
(255)
(314)
(1,823)
(2,624)
(745)
$
5,522
$
6,375
The additional interest income that would have been earned on non-accrual and restructured loans for the years ended December 31,
2014 and 2013 had the loans been performing in accordance with their original terms approximated $406 thousand and $572 thousand,
respectively.
One large commercial loan in the amount of $3.6 million comprised 65.5% of the $5.5 million in non-performing loans at December
31, 2014. 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 $21.3 million at December 31, 2014. The volume of potential problem loans decreased $1.2
million, or 5.3%, from $22.5 million at December 31, 2013.
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 was included in non-
interest income in 2013. The Company did not sell any such loans in 2014.
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 ten 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. At December 31, 2014, there was one remaining loan under this relationship, a
Pennsylvania credit, with an outstanding balance of $4.0 million at December 31, 2014. This loan has a credit rating of “pass-watch”
and was performing in accordance with the terms of the loan agreement at December 31, 2014.
58
The following table outlines accruing loan delinquencies and non-accrual loans as a percentage of gross loans at December 31, 2014,
2013 and 2012:
Accruing:
30-59 days
60-89 days
90+ days
Non-accrual
Total delinquencies
2014
De ce mbe r 31,
2013
2012
0.30%
0.09%
0.00%
0.82%
1.21%
0.46%
0.09%
0.00%
0.99%
1.54%
0.44%
0.06%
0.01%
1.62%
2.13%
Total delinquencies, as a percent of gross loans, continued to improve in 2014, primarily due to rigorous collection and work-out
efforts directed at non-performing loans. Delinquencies for accruing loans decreased $1.0 million to $2.6 million at December 31,
2014 from $3.6 million at December 31, 2013, primarily due to an decrease 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 the local real estate and job markets and the local economy in general. As
previously mentioned, the unemployment rate for the Scranton-Wilkes-Barre metropolitan area, the Company’s predominant market
area, improved to a seasonally adjusted rate of 5.9% for December 2014 from 8.4% for December 2013. However, unemployment in
the Company’s market continues to be the highest compared to Pennsylvania’s 14 metropolitan areas and lags far behind the
unemployment rate of 4.8% for the entire Commonwealth. The Company tries to mitigate these factors by emphasizing strict
underwriting standards.
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 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 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
59
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, 2014, 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 $384 thousand, or 3.3%, of the total ALLL. A general allocation of $11.1 million was calculated for loans analyzed
collectively under ASC 450 “Contingencies” (“ASC 450”), which represented 96.7% of the total ALLL of $11.5 million. The ratio of
the ALLL to total loans at December 31, 2014 and December 31, 2013 was 1.72% and 2.18%, respectively, based on total loans of
$669.5 million and $643.4 million, respectively. The decrease in the ALLL as a percentage of total loans reflects asset quality
improvements and lower levels of net charge-offs as compared to previous periods, coupled with increased loan demand.
At December 31, 2014, based on its evaluation of the ALLL, management established an unallocated reserve of $45 thousand. As part
of its evaluation, management applies loss rates to each loan segment. The loss rates are based on actual historical loss experience for
the respective loan segment. The Company has experienced net recoveries related to its construction, land acquisition and
development segment of the loan portfolio for the majority of the quarters in the twelve-quarter lookback period, which resulted in an
overall negative historical loss factor for this segment. Management decided to reverse the negative provision created by the negative
historical loss factor and establish an unallocated reserve. Management will continue to monitor the unallocated balance for propriety
as part of its quarterly evaluation of the ALLL.
The ALLL equaled $11.5 million at December 31, 2014, a decrease of $2.5 million from $14.0 million at December 31, 2013. The
Company recorded net recoveries of $3.4 million in 2014. 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 $5.9 million for the
year ended December 31, 2014.
The following table presents an allocation of the ALLL and percent of loans in each category for each of the last five years:
Allocation of the Allowance for Loan Losses
2014
2013
December 31,
2012
2011
2010
Percentage
of Loans in
Each
Category
to Total
Loans
18.35%
34.87%
2.81%
19.72%
18.24%
6.01%
0.00%
100.00%
Allowance
1,772
$
4,663
665
2,104
1,673
598
45
11,520
$
Percentage
of Loans in
Each
Category
to Total
Loans
17.86%
33.97%
3.79%
19.74%
18.44%
6.20%
0.00%
100.00%
Percentage
of Loans in
Each
Category
to Total
Loans
15.09%
37.07%
5.44%
18.35%
18.37%
5.68%
0.00%
100.00%
Allowance
1,764
$
8,062
2,162
4,167
1,708
673
-
18,536
$
Percentage
of Loans in
Each
Category
to Total
Loans
11.78%
37.75%
4.92%
25.64%
16.45%
3.46%
0.00%
100.00%
Allowance
1,823
$
11,151
2,590
3,292
1,526
452
-
20,834
$
Allowance
2,287
$
6,017
924
2,321
1,789
679
-
14,017
$
Percentage
of Loans in
Each
Category
to Total
Loans
11.60%
33.82%
10.21%
26.08%
14.63%
3.66%
0.00%
100.00%
Allowance
2,176
$
9,640
4,170
4,850
1,173
566
-
22,575
$
(dollars in thousands)
Residential real estate
Commercial real estate
Construction, land acquisition
and development
Commercial and industrial
Consumer
State and political subdivisions
Unallocated
Total
Total loans
60
The following table presents an analysis of the ALLL category for each of the last five years:
Reconciliation of the ALLL
(in thousands)
Balance, January 1,
Charge-offs:
Analysis of the Allowance for Loan and Lease Losses
2014
For the Year Ended December 31,
2013
2012
2011
2010
$
14,017
$
18,536
$
20,834
$
22,575
$
22,458
Residential real estate
Commercial real estate
Construction, land acquisition and development
Commercial and industrial
Consumer
State and political subdivision
Total charge-offs
Recoveries of charged-off loans:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Commercial and industrial
Consumer
State and political subdivision
Total recoveries
Net (recoveries) charge-offs
(Credit) provision for loan and lease losses
Balance, December 31
Ratios:
Net (recoveries) charge-offs as a percentage
of average loans
Allowance for loan and lease losses as a
percent of gross loans outstanding at period end
Other Real Estate Owned
204
-
45
217
922
-
1,388
90
362
3,538
262
508
-
4,760
(3,372)
(5,869)
11,520
$
664
65
179
341
655
-
1,904
343
879
130
1,853
450
-
3,655
(1,751)
(6,270)
14,017
$
683
3,298
258
3,389
673
-
8,301
35
1,035
265
265
338
-
1,938
6,363
4,065
18,536
$
1,273
2,395
1,857
416
739
-
6,680
57
93
2,188
1,852
226
-
4,416
2,264
523
20,834
$
221
5,049
12,893
6,883
736
-
25,782
32
152
303
151
220
-
858
24,924
25,041
22,575
$
(0.51)%
(0.28)%
0.97%
0.31%
2.84%
1.72%
2.18%
3.10%
3.07%
2.98%
At December 31, 2014, there were 15 properties in OREO with an aggregate balance of $2.3 million, compared to 21 properties with
an aggregate balance of $4.2 million at December 31, 2013. During the year ended December 31, 2014, one property with a carrying
value of $13 thousand was foreclosed upon. During 2014, there were eight sales and two partial sales of properties with an aggregate
carrying value of $1.6 million. The Company realized net gains on the sale of these properties of $209 thousand, which is included in
non-interest income.
Due to a change in strategic purpose, the Company transferred the real property of the former Stroudsburg office from bank premises
and equipment to OREO for disposition during the year ended December 31, 2014. The deposits and loans of this branch were sold to
ESSA as part of the Branch Purchase Agreement. The Company retained this facility and was initially planning to use it for other
bank-related purposes. This property with a carrying value of $1.7 million was written down to its appraised value less cost to sell of
$0.8 million at the time of transfer. A valuation adjustment of $0.9 million, included in non-interest expense, was recorded at the time
of transfer.
In the third quarter of 2013, the Company transferred three vacant lots from bank premises and equipment that were previously held
for future expansion to OREO. One of the properties was subsequently sold during the year ended December 31, 2014. There was no
gain or loss realized upon the sale. The Company had one of the properties located in Monroe County, Pennsylvania re-appraised
during the third quarter of 2014 due to continued decline in real estate values, which resulted in a valuation adjustment of $0.3 million
and is included in non-interest expense for the year ended December 31, 2014.
In addition, there were four properties that have been held in OREO for a significant amount of time and were approaching the
regulatory holding period threshold of five years. In an effort to aggressively dispose of these properties, management requested
independent appraisals using a liquidation value basis for each of the properties. Accordingly, the Company incurred valuation
adjustments to these four properties totaling $0.7 million for the year ended December 31, 2014. One of the properties was
subsequently sold in 2014, while two of the properties went under contract. The Company requested a one-year extension with the
61
OCC for the fourth property. Total valuation adjustments to the carrying value of OREO included in non-interest expense for the year
ended December 31, 2014 amounted to $2.2 million.
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.
The following table presents the activity in OREO:
(in thousands)
Balance, Janauary 1
Property foreclosures
Bank premises transferred to OREO
Valuation adjustments
Carrying value of OREO sold
Balance, December 31
For the Years Ended December 31,
2014
2012
2013
$
$
$
4,246
13
1,749
(2,200)
(1,553)
2,255
3,983
255
1,819
(223)
(1,588)
4,246
6,958
1,586
-
(1,206)
(3,355)
3,983
$
$
$
The following table presents a distribution of OREO at December 31 for the past five years:
(in thousands)
Land / lots
Commercial real estate
Residential real estate
Total other real estate owned
2014
2013
December 31,
2012
2011
2010
$
$
$
$
$
1,287
941
27
2,255
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
$
$
$
$
$
The expenses related to maintaining OREO, including the subsequent write-downs of the properties related to declines in value since
foreclosure, net of any income received, amounted to $2.6 million, $719 thousand, and $2.0 million for the years ended December 31,
2014, 2013, and 2012, respectively.
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 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. Average interest-bearing liabilities increased by $5.8 million, or 0.8%, to
$771.5 million during 2014 from $765.7 million during 2013. Interest-bearing liabilities continued to reprice downward during the
year, as evidenced by a 14 basis point decrease in the cost of funds to 0.80% in 2014 from 0.94% in 2013.
Deposits
Total deposits decreased $89.4 million, or 10.1%, to $795.3 million at December 31, 2014 from $884.7 million at the end of 2013.
Non-interest-bearing demand deposits decreased $33.5 million, or 21.3%, while interest-bearing deposits decreased $55.9 million, or
7.7%. The decrease in demand deposits was largely attributable to a $32.2 million decline in non-interest-bearing business checking
accounts, which resulted primarily from balance fluctuations of several large commercial relationships. The decrease in interest-
bearing deposits was primarily due to the expected runoff of $47.8 million in certificates of deposits that were generated through
QwickRate®, a national listing service. As part of the Company’s asset/liability management strategy, management focused on
replacing these higher-costing, national listing service deposits as they matured with lower-costing core-customer deposits and
advances through the FHLB of Pittsburgh.
Despite the decrease comparing period-end balances, non-interest-bearing demand deposits averaged $3.9 million, or 3.0%, higher in
2014 as compared to 2013. Interest-bearing deposits averaged $677.8 million in 2014, a decrease of $27.7 million, or 3.9%, compared
to $705.5 million in 2013. The decline was concentrated in time deposits, as average other time deposits with balances less than $100
62
thousand decreased $24.1 million, or 15.4%, to $132.5 million in 2014 from $156.6 million in 2013, while average time deposits over
$100 thousand declined $24.9 million, or 15.5%, to $135.9 million in 2014 from $160.7 million in 2013. Average interest-bearing
demand and savings deposits grew $18.5 million and $2.8 million, respectively, comparing 2014 and 2013. The Company was
successful in continuing to reduce its funding costs as evidenced by a 12 basis point decrease in the rate paid on average interest-
bearing deposits to 0.47% in 2014 from 0.59% in 2013. The decrease was driven primarily by pricing decreases from time deposits,
which are sensitive to interest rate changes. The Company elected to allow higher-costing 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 19 basis points to 1.22%, while the rate paid on time deposits over $100 thousand decreased 4 basis points to
0.77% during 2014.
Management recognizes the importance of deposit growth as the Company’s primary funding source for its loan products and has
implemented several strategies and promotions focused on growing commercial and consumer demand deposit balances. One such
promotion offers customers a one-time $100 dollar cash bonus for opening a new checking account and meeting certain deposit
requirements. As of December 31, 2014, 194 new checking accounts with a combined balance of $0.4 million were opened under this
promotion. In addition, the Company currently offers a special escalator certificate of deposit with maturity terms of 12, 24 and 30
months. The escalator feature of the certificate allows customers a one-time option to increase the interest rate during the term should
the Company increase the rate on a similar certificate offered. As of December 31, 2014, the Company generated $3.1 million in new
escalator certificates.
The average amount of, and the rate paid on, the major classifications of deposits is summarized for the periods indicated in the
following table:
De posit Distribution
(dollars in thousands)
Inte re st-be aring de posits:
Demand
Savings
Time
Total interest-bearing deposits
2014
For the Ye ar Ende d De cembe r 31,
2013
2012
Amount
Rate
Amount
Rate
Amount
Rate
$
320,780
88,678
268,360
677,818
0.14%
0.06%
0.99%
0.47%
$
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%
Non-interest-bearing deposits
134,132
130,186
128,254
Total deposits
$
811,950
$
835,683
$
877,828
The following table presents the maturity distribution of time deposits of $100,000 or more at December 31, 2014 and 2013:
Maturity Dis tribution of Time Depos its 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,
2014
2013
$
30,040
$
19,163
27,919
32,052
22,033
38,647
42,180
61,969
$
112,044
$
161,959
Short-term borrowings generally represent overnight borrowing transactions through the FHLB providing for short-term funding
requirements of the Company and mature within one business day of the transaction. The Company does not currently utilize short-
term federal funds sold products as a funding alternative. Accordingly, the Company did not purchase any short-term Federal funds
during the years ended December 31, 2014, 2013 and 2012. 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 December 31, 2014, 2013
and 2012. The Company did not have any outstanding short term borrowings at December 31, 2014, 2013, or 2012.
63
Long-term debt is comprised of FHLB advances, subordinated debentures and junior subordinated debentures and totaled $96.5
million at December 31, 2014, an increase of $34.1 million, or 54.6%, from $62.4 million at December 31, 2013. The increase was
related entirely to an increase in advances through the FHLB of Pittsburgh. FHLB advances are collateralized under a blanket pledge
agreement. Previously, only the Company’s commercial real estate loans, one- to four-family mortgage loans, or mortgage-backed
securities were allowed as collateral under this blanket pledge agreement. During the first quarter of 2014, the FHLB notified the
Company that commercial and industrial loans that were previously restricted were now acceptable collateral under the agreement. In
addition, the Company is required to purchase FHLB stock based upon the amount of advances outstanding. Due to the increase in
FHLB advances, the FHLB stock required to be held by the Company increased to $2.8 million at December 31, 2014 from $2.1
million at December 31, 2013. At December 31, 2014, the Company had $200.2 million of credit with the FHLB available for
borrowing purposes.
Average long-term debt increased $33.5 million, or 55.5%, to $93.7 million in 2014 from $60.2 million in 2014. The average rate paid
for long-term debt in 2014 decreased 183 basis points to 3.17% from 5.00% in 2013. The decrease in rate on the long-term debt was
due primarily to the maturity of higher-costing FHLB advances during 2014. In addition, of the $34.1 million increase in FHLB
borrowings, $17.9 million was funded through the FHLB’s “Community Lending Program,” which offers match funding for loans
originated for qualified community and economic development projects at very competitive rates that are typically 15 to 25 basis
points below the FHLB’s regular published rates. The $17.9 million in advances under this program had a weighted-average cost of
0.26% and maturity terms of one and two years.
The Company had $25.0 million in unsecured, fixed-rate subordinated debentures at December 31, 2014 and 2013. The notes, which
bear interest at a rate of 9.0% per annum, will be payable to noteholders annually beginning on September 1, 2015. The Company also
had $10.3 million of junior subordinated debentures at December 31, 2014 and 2013. 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 2014
was 1.93%, compared to 1.97% in 2013.
Under the November 24, 2010 Written Agreement (the “Agreement”) with the Federal Reserve Bank of Philadelphia (the “Reserve
Bank”), the Company and its non-bank subsidiary may not make any payment of interest, principal or other amounts on the
Company’s subordinated debentures or junior subordinated debentures without the prior written approval of the Reserve Bank and the
Director. Accordingly, the Company was deferring interest payments on the Company’s Debentures since the last interest payment
due on September 14, 2010. During 2014, the Company requested and received non-objection from the Reserve Bank to make a
distribution on the junior subordinated debentures to cure the interest deferral on December 15, 2014. On December 15, 2014, the
Company paid all deferred and currently payable accrued interest totaling $921 thousand. At December 31, 2014 and 2013, accrued
and unpaid interest associated with the Debentures amounted to $9 thousand and $695 thousand, respectively. The Company
continued to defer interest payments on the subordinated debentures in 2014. The last payment made on these instruments was the
payment due on September 1, 2010. The accrued and unpaid interest associated with the subordinated debentures amounted to $9.9
million and $7.6 million at December 31, 2014 and 2013, respectively. For more information refer to Note 17, “Regulatory Matters”
to these consolidated financial statements.
The maximum amount of total borrowings outstanding at any month end during the years ended December 31, 2014 and 2013 were
$122.7 million and $79.8 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. The Company has liquidity and contingent funding policies in place that are
designed with controls in place to provide advanced detection of potentially significant funding shortfalls, establish methods for
assessing and monitoring risk levels, and institute prompt responses that may alleviate a potential liquidity crisis. Management
monitors 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, performs stress tests on its liquidity levels 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 due from banks and interest-bearing deposits in other banks are the Company’s most liquid assets. At December
31, 2014, cash and cash equivalents totaled $35.7 million, a decrease of $67.9 million from $103.6 million at December 31, 2013.
Cash outlays for investing and financing activities used $21.5 million and $54.9 million, respectively, of cash and cash equivalents
during the year ended December 31, 2014. These outflows were partially offset by net cash provided by operating activities of $8.5
64
million. The $21.5 million in cash used in investing activities resulted primarily from a net increase in loans to customers of $25.3
million. In addition, purchases of available-for-sale securities, net of proceeds received from sales, maturities, calls and principal
reductions from securities, and FHLB of Pittsburgh stock used $3.8 million and $0.7 million in cash and cash equivalents,
respectively. These outflows were partially offset by proceeds received from the sale of OREO, education loan portfolio and bank
premises and equipment of $1.7 million, $2.5 million and $2.5 million, respectively. The $54.9 million used in financing activities
resulted from an $88.9 million net decrease in deposits, partially offset by proceeds from FHLB advances, net of repayments, of $34.1
million.
Despite the decrease in cash and cash equivalents, management believes that the Company’s liquidity position is sufficient to meet its
cash flow needs as of December 31, 2014. The decrease in total deposits anticipated deposit trends of certain large commercial
customers and the runoff of certificates of deposit with above market interest rates. As previously mentioned, the majority of this
runoff was concentrated in certificates of deposit obtained through a national listing service. Management, in accordance with the
Company’s current asset/liability strategy, decided to replace these certificates with short-term, lower-costing advances from the
FHLB of Pittsburgh. Advances from the FHLB of Pittsburgh totaled $194.2 million for the year ended December 31, 2014. The
Company made repayments of advances to the FHLB of Pittsburgh amounting to $160.2 million during the year ended December 31,
2014.
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. Despite the decrease in total average deposits, average core deposits increased $6.0 million to
$671.5 million in 2014 compared to $665.5 million in 2013. The increase in average core deposits resulted from increases in interest-
bearing and non-interest-bearing demand deposits and savings deposits, partially offset by a reduction in retail time deposits. 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
$200.2 million at December 31, 2014. In addition, the Company has the ability to solicit deposits, primarily certificates of deposit,
through QwickRate®, a non-brokered marketplace for funding and investing. The Company had $39.2 million and $87.0 million in
certificates originated through QwickRate® at December 31, 2014 and 2013, 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
Capital
December 31,
2014
2013
$ 181,446
$ 155,701
21,364
25,321
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.
65
The following schedules present information regarding the Company’s risk-based capital at December 31, 2014, 2013, and 2012 and
selected other capital ratios:
(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
Capital Analysis
2014
De ce mber 31,
2013
2012
$
59,930
$
46,165
$
39,587
25,000
8,591
33,591
23,085
8,462
31,547
19,796
8,452
28,248
$
93,521
$
77,712
$
67,835
Total risk-weighted assets
$
683,956
$
670,894
$
665,323
Total average assets (for Tier I leverage ratio)
$
990,346
$
980,754
$
971,978
Bank
Tier I capital:
Total tier I capital
Tier II capital:
$
96,816
$
81,581
$
69,963
Allowable portion of allowance for loan losses
Total tier II capital
Total risk-based capital
8,587
8,587
8,456
8,456
8,447
8,447
$
105,403
$
90,037
$
78,410
Total risk-weighted assets
$
683,576
$
670,416
$
664,914
Total average assets (for Tier I leverage ratio)
$
990,407
$
980,747
$
971,620
66
Actual
For Capital
Adequacy Purposes
To Be Well
Capitalized
Under Prompt
Corrective
Action Provision
(dollars in thousands)
December 31, 2014
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
Amount
Ratio
Amount
Ratio
Amount
Ratio
$
$
93,521
105,403
$
$
59,930
96,816
$
$
59,930
96,816
13.67%
15.42%
8.76%
14.16%
6.05%
9.78%
$
$
>54,717
>54,686
$
$
>27,358
>27,343
$
$
>39,614
>39,616
>8.00%
>8.00%
>4.00%
>4.00%
>4.00%
>4.00%
N/A
>68,358
$
N/A
>41,015
$
N/A
>49,520
$
N/A
>10.00%
N/A
>6.00%
N/A
>5.00%
Actual
For Capital
Adequacy Purposes
To Be Well
Capitalized
Under Prompt
Corrective
Action Provision
(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
Amount
Ratio
Amount
Ratio
Amount
Ratio
$
$
77,712
90,037
$
$
46,165
81,581
$
$
46,165
81,581
11.58%
13.43%
6.88%
12.17%
4.71%
8.32%
$ >53,672
$ >53,633
$ >26,836
$ >26,817
$ >39,230
$ >39,230
>8.00%
>8.00%
>4.00%
>4.00%
>4.00%
>4.00%
N/A
$ >67,042
N/A
$ >40,225
N/A
$ >49,038
N/A
>10.00%
N/A
>6.00%
N/A
>5.00%
In 2014, the Company’s total regulatory capital increased $15.8 million, primarily as a result of net income of $13.4 million. Also
affecting total regulatory capital was an increase in the allowable portion of subordinated notes of $1.9 million. As of December 31, 2014,
there were 33,515,581 common shares available for future sale or share dividends. The number of shareholders of record at December 31,
2014 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 13.00% and Tier I capital to average assets ratio of 9.00% by November 30, 2010.
As of December 31, 2014, the Bank had achieved both ratios. 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.
As previously mentioned, on September 8, 2014, the Company requested for approval to receive a $1.0 million capital distribution from
the Bank, and to make a distribution on the junior subordinated debentures to cure the interest deferral. The Company received approval
from the Reserve Bank in November 2014 and on December 15, 2014, the Company paid all deferred and currently payable accrued
interest totaling $921 thousand. The Company subsequently requested and received approval from the Reserve Bank to pay the first
quarter 2015 interest payment. The Company intends to pay this interest payment of $50 thousand, which is due on March 15, 2015.
Additionally, the Company has available 20,000,000 authorized shares of preferred stock. There were no preferred shares issued and
outstanding at December 31, 2014 and 2013.
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.
Accordingly, there was no new capital issued under the DRIP in 2014 and 2013.
The Board of Directors (the “Board”) on February 26, 2010 voted to suspend payment of the Company’s quarterly dividend in an
effort to conserve capital. 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.
67
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, 2014, 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.
The following table details the Company’s commercial commitments summarized by expiration at December 31, 2014.
(in thousands)
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
$
181,446
$
146,903
$
9,606
$
3,583
$
21,354
Standby letters of credit
21,364
21,205
55
-
104
Total
$
202,810
$
168,108
$
9,661
$
3,583
$
21,458
In order to provide for probable losses inherent in these instruments, the Company recorded reserves for unfunded commitments of
$416 thousand and $511 thousand at December 31, 2014 and 2013, respectively, which were included in other liabilities on the
consolidated statements of financial condition.
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.
Contractual Obligations
The following table details the Company’s contractual obligations as of December 31, 2014. Payments due by period in the following
table are based on final maturity dates without consideration of early redemption.
(in thousands)
Contractual Obligations and Commercial Commitments
Total
Less Than
one Year
1-3 Years
3-5 Years
More Than 5
Years
Payments Due by Period
Federal Home Loan Bank advances
$ 61,194
$ 29,000
$ 20,435
$ 11,759
$ -
Subordinated debentures
Junior subordinated debt
Operating lease obligations
Total contractual cash obligations
25,000
5,000
10,000
10,000
-
10,310
-
-
-
10,310
2,141
$ 98,645
658
$ 34,658
703
$ 31,138
393
$ 22,152
387
$ 10,697
68
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Risk
Interest Rate Sensitivity
Market risk is the risk to earnings and/or financial position resulting from adverse changes in market rates or prices, such as interest
rates, foreign exchange rates or equity prices. 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 certain 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 of 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, 2014 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.
69
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, 2014 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
0.9%
(0.4)%
(10.0)%/(5.0)%
(6.8)%
(7.5)% (20.0)%/(10.0)%
Under the model, the Company’s net interest income is expected to increase 0.9%, while the Company’s economic value of equity is
expected to decrease 6.8%, 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 re-price immediately or in the near term. In comparison, results for a similar model for the year ended December 31, 2013
simulated a 3.9% 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 assumptions, including changes in interest rates, customer preferences, competition and liquidity
needs, or what actions ALCO might take in responding to these changes.
As previously mentioned, as part of its 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. As part of its quarterly review, management compared tax-equivalent net interest
income recorded for the three months ended December 31, 2014 with tax-equivelent net interest income that was projected for the
same three-month period. The variance between actual and projected tax-equivalent net interest income for the three-month period
ended December 31, 2014 was $71 thousand or 0.98%. Although the variance was deemed immaterial, ALCO performs a rate/volume
analysis between actual and projected results in order to continue to improve the accuracy of its simulation models.
70
Item 8. Financial Statements and Supplementary Data.
Report of Independent Registered Public Accounting Firm
Stockholders and Board of Directors of
First National Community Bancorp, Inc. and Subsidiaries
We have audited the accompanying consolidated statement of financial condition of First National Community
Bancorp, Inc. and Subsidiaries (the “Company”) as of December 31, 2014 and the related consolidated
statements of operations, comprehensive income (loss), changes in shareholders’ equity, and cash flows for
the year then ended. 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 audit.
We conducted our audit 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 audit provides a reasonable basis
for our opinion.
the consolidated
in all
In our opinion,
material respects, the financial position of First National Community Bancorp, Inc. and Subsidiaries as of
December 31, 2014, and the results of their operations and their cash flows for the year then ended in
conformity with accounting principles generally accepted in the United States of America.
financial statements
to above present
referred
fairly,
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), the Company’s internal control over financial reporting as of December 31, 2014, based on
criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), and our report dated March 13, 2015 expressed an
unqualified opinion.
/s/ Baker Tilly Virchow Krause, LLP
Wilkes-Barre, Pennsylvania
March 13, 2015
71
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 statement of financial condition of First National Community
Bancorp, Inc. and Subsidiaries (the “Company”) as of December 31, 2013, and the related consolidated statements of
operations, comprehensive loss, changes in shareholders’ equity, and cash flows for each of the two 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 the
results of their operations and their cash flows for each of the two years in the period ended December 31, 2013, in
conformity with U.S. generally accepted accounting principles.
As explained in Note 17, the Company’s 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
72
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 $0 and $2,424)
Stock in Federal Home Loan Bank of Pittsburgh, at cost
Loans held for sale
Loans, net of allowance for loan and lease losses of $11,520 and $14,017
Bank premises and equipment, net
Accrued interest receivable
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, 2014 and December 31, 2013
Issued and outstanding: 0 shares at December 31, 2014 and December 31, 2013
Common shares ($1.25 par)
Authorized: 50,000,000 shares at December 31, 2014 and December 31, 2013
Issued and outstanding: 16,484,419 shares at December 31, 2014 and 16,471,569 shares at December 31, 2013
Additional paid-in capital
Accumulated deficit
Accumulated other comprehensive income (loss)
Total shareholders' equity
Total liabilities and shareholders’ equity
December 31,
2014
December 31,
2013
$
$
22,657
13,010
35,667
218,989
-
2,803
603
658,747
11,003
2,075
302
28,817
2,255
8,768
970,029
19,295
84,261
103,556
203,867
2,308
2,146
820
629,880
15,363
2,191
467
28,167
4,246
10,797
1,003,808
$
$
$
124,064
671,272
795,336
$
157,550
727,148
884,698
61,194
25,000
10,310
96,504
10,262
16,529
918,631
27,123
25,000
10,310
62,433
8,732
14,367
970,230
-
-
20,605
61,781
(32,126)
1,138
51,398
970,029
$
20,589
61,627
(45,546)
(3,092)
33,578
1,003,808
$
The accompanying notes to consolidated financial statements are an integral part of these statements.
73
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 in other banks
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 los s on the s ale of education 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
Gain on branch dives titures
Loan-related fees
Income from bank-owned life ins urance
Legal s ettlements
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 los s es
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,
2014
2013
2012
$
26,629
$
27,097
$
29,588
3,494
1,883
324
272
5,973
71
32,673
3,180
450
2,281
236
2,967
6,147
26,526
(5,869)
32,395
2,975
6,640
-
-
-
292
-
(13)
209
-
607
440
650
2,127
993
14,920
13,111
2,088
1,471
470
2,088
1,801
522
2,569
(94)
1,799
1,567
951
90
-
2,279
2,857
33,569
13,746
326
1,859
3,347
393
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
288
1,181
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
123
3,224
34,948
6,382
-
1,352
4,001
412
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
170
3,450
41,738
(13,711)
-
$
13,420
$
6,382
$
(13,711)
$
0.81
$
0.81
$
0.39
$
0.39
$
(0.83)
$
(0.83)
Cas h Dividends Declared Per Common S hare
$
-
$
-
$
-
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Bas ic
Diluted
16,472,660
16,472,871
16,458,353
16,458,353
16,442,160
16,442,160
The accompanying notes to cons olidated financial s tatements are an integral part of thes e s tatements .
74
FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
Net income (loss)
Other comprehensive income (loss):
Unrealized gains (losses) on securities available for sale
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,
2014
2013
2012
$
13,420
$
6,382
$
(13,711)
12,682
(4,312)
8,370
(6,272)
2,132
(4,140)
(11,946)
4,061
(7,885)
(2,887)
982
(1,905)
14,351
(4,880)
9,471
1,808
(614)
1,194
Total other comprehensive income (loss)
4,230
(9,790)
10,665
Comprehensive income (loss)
$
17,650
$
(3,408)
$
(3,046)
The accompanying notes to consolidated financial statements are an integral part of these statements.
75
FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 2014, 2013 and 2012
(in thousands, except share data)
Balances, December 31, 2011
Net loss for the year
Stock-based compensation
Other comprehensive income, net of tax of $5,494
Balances, December 31, 2012
Net income for the year
Stock-based compensation
Other comprehensive loss, net of tax of $5,043
Balances, December 31, 2013
Net income for the year
Stock-based compensation
Restricted stock awards
Other comprehensive income, net of tax of $2,180
Balances, December 31, 2014
Number
of Common
Shares
Common
Stock
Additional
Paid-in
Capital
Accumulated
Other
Total
Accumulated
Comprehensive
Shareholders'
Deficit
(Loss) Income
Equity
16,442,119
$
20,552
$
61,557
$
(38,217)
$
(3,967)
$
39,925
-
15,050
-
-
19
-
-
27
-
(13,711)
0
-
-
-
10,665
(13,711)
46
10,665
16,457,169
$
20,571
$
61,584
$
(51,928)
$
6,698
$
36,925
-
14,400
-
-
18
-
-
43
-
6,382
-
-
-
-
(9,790)
6,382
61
(9,790)
16,471,569
$
20,589
$
61,627
$
(45,546)
$
(3,092)
$
33,578
-
12,850
-
-
-
16
-
-
-
61
93
-
13,420
-
-
-
-
-
-
4,230
13,420
77
93
4,230
16,484,419
$
20,605
$
61,781
$
(32,126)
$
1,138
$
51,398
The accompanying notes to consolidated financial statements are an integral part of these statements.
76
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:
For the Year Ended December 31,
2014
2013
2012
$ 13,420
$ 6,382
$ (13,711)
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 available-for-sale securities
Gain on the sale of held-to-maturity securities
Other-than-temporary-impairment loss
Gain on the sale of loans held for sale
Loss on the sale of classified loans
Loss on the sale of education loans
Gain on branch divestitures
Loss (gain) 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:
Maturities, calls and principal payments of investment securities available for sale
Proceeds from the sale of securities available for sale
Proceeds from the sale of held-to-maturity securities
Purchases of securities available for sale
Purchase of Federal Reserve Bank Stock
Payment of liability for securities purchased not settled
(Purchase) 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 education 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 (decrease) increase in deposits
Proceeds from Federal Home Loan Bank of Pittsburgh advances
Repayment of Federal Home Loan Bank of Pittsburgh advances
Net cash (used in) provided by financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental cash flow information
Cash paid (received) during the period for:
Interest
Income taxes
Other transactions:
Principal balance of loans transferred to other real estate owned
Transfer of bank premises and equipment to other real estate owned
Change in deferred gain on sale of other real estate owned
1,356
(6)
1,470
(5,869)
(94)
170
(6,272)
(368)
-
(292)
-
13
(607)
232
(209)
2,200
(650)
8,555
(8,046)
116
-
169
1,530
1,694
(4,908)
8,512
487
(6)
(1,628)
(7)
1,265
1,249
(6,270)
4,065
(246)
358
61
46
(2,887)
1,712
-
-
(362)
223
-
-
(579)
(135)
223
(706)
-
96
(859)
-
-
-
142
(305)
1,206
(692)
12,944
27,017
(11,787)
(27,679)
8
353
11,592
(25)
4,209
2,305
1,713
12,052
18,434
(4,520)
2,126
12
2,667
(11,044)
8,331
14,596
33,170
111,243
53,787
46,099
2,686
-
-
(123,380)
(99,432)
(63,279)
-
-
(90)
-
-
(5,120)
(657)
3,811
2,442
(25,321)
(47,490)
67,743
-
3,275
6,836
2,537
-
-
1,737
1,668
3,660
(1,217)
(810)
(1,601)
2,505
1,831
-
(21,536)
(68,764)
89,860
(88,936)
194,235
30,085
32,250
(102,523)
-
(160,164)
(23,720)
(29,668)
(54,865)
38,615
(132,191)
(67,889)
(11,715)
(53,375)
103,556
115,271
168,646
$ 35,667
$ 103,556
$ 115,271
$ 4,617
$ 4,871
$ 7,092
308
(11,592)
-
13
255
1,586
1,749
1,819
-
26
55
-
The accompanying notes to the consolidated financial statements are an integral part of these statements.
77
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 nineteen 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.
On a quarterly basis, the Company evaluates each of its investment securities classified as held-to-maturity or available-for-sale for
other-than-temporary impairment (“OTTI”). An individual security is considered impaired when its current fair value is less than its
amortized cost basis. As part of the OTTI evaluation, management considers the following factors in determining whether the
security’s impairment is other than temporary:
78
The length of time and extent of the impairment;
The causes of the decline in fair value, such as credit deterioration, interest rate fluctuations, or market volatility;
Adverse industry or geographic conditons;
Historical implied volatility;
Payment structure of the security and whether or not Company expects to receive all contractual cash flows;
Failure of the issuer to make contractual interest or principal payments in the past;
Changes in the security’s rating; and
Recoveries or additional declines in the security’s fair value subsequent to the balance sheet date
Based on current authoritative guidance, when a held-to-maturity or available-for-sale debt security is 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 Company evaluates whether or not the unrealized loss is expected to recovered based on evidence to support
a realizable value equal to or greater than the amortized cost basis. If it is probable that the amortized cost basis will not be recovered,
taking into consideration the estimated recovery period and ability of the Company to hold the security until recovery, the entire
difference between the security’s cost basis and its fair value is recognized in earnings at the balance sheet date.
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.
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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 Company 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 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 and lease 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 three components, a specific component, a general component, and an unallocated 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, loans relationships with an
aggregate balance greater than $100 thousand that are rated substandard and on nonaccrual status are included in impaired loans. An
unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The
unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the
methodologies for estimating specific and general losses in the portfolio.
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:
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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 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.
81
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,
2014, 2013 and 2012 were $292 thousand, $362 thousand and $859 thousand, respectively. Loans held for sale are generally sold
with loan servicing rights retained by the Company. At December 31, 2014 and 2013, loans held for sale amounted to $603 thousand
and $820 thousand, respectively.
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 of 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
82
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
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 Company 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, 2014 and 2013.
Interest and penalties related to income taxes, if any, are presented within non-interest expense.
83
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.
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 $97 thousand and $94 thousand
at December 31, 2014 and 2013, 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.
84
Comprehensive Income (Loss)
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
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. The Company adopted ASU 2013-11 on January 1, 2014. The adoption of this new guidance did
not have an effect on the operating results or financial position of the Company.
Accounting Guidance to be Adopted in Future Periods
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.
ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360): “Reporting
Discontinued Operations and Disclosures of Disposals of Components of an Entity,” changes the criteria for reporting a discontinued
operation. Under the new guidance, a disposal of a component of an entity or group of components of an entity is required to be
reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on the entity’s
operations and financial results. This new guidance reduces complexity by removing the complex and extensive implementation
guidance and illustrations that are necessary to apply the current definition of a discontinued operation. The new guidance also
requires expanded disclosures about discontinued operations that will provide users with more information about the assets, liabilities,
revenues and expenses of a discontinued operation and will require pre-tax income attributable to a disposal of a significant part of an
organization that does not qualify for discontinued operations reporting, which will provide users with information about the ongoing
trends in a reporting organization’s results from continuing operations. A public company or not-for-profit organization that has
issued or is a conduit bond obligor for securities that are traded, listed, or quoted on an exchange or an over-the-counter market is
required to apply the new guidance prospectively to all disposals (or classifications as held for sale) of components of an organization
and all business or nonprofit activities that, on acquisition, are classified as held for sale that occur within annual periods beginning on
or after December 15, 2014, and interim periods within those years. 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.
ASU 2014-09, Revenue from Contracts with Customers (Topic 606): Section A, “Summary and Amendments That Create Revenue
from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs-Contract with Customers (Subtopic 340-40);”
Section B, “Conforming Amendments to Other Topics and Subtopics in the Codification and Status Tables;” and Section C,
“Background Information and Basis for Conclusions,” provides a robust framework for addressing revenue recognition issues, and
upon its effective date, replaces almost all existing revenue recognition guidance, including industry specific guidance, in current
GAAP. The core principle of ASU 2014-09 is for companies to recognize revenue to depict the transfer of goods or services to
customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or
services. ASU 2014-09 will also result in enhanced interim and annual disclosures, both qualitative and quantitative, about revenue in
order to help financial statement users understand the nature, amount, timing and uncertainty of revenue and related cash flows. ASU
2014-09 is effective in annual reporting periods beginning after December 15, 2016 and the interim periods within that year for public
business entities, not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed or quoted on
an exchange or over-the-counter market and employee benefit plans that file or furnish financial statements to the SEC. Accordingly,
85
the Company will adopt this guidance on January 1, 2017 and is currently evaluating the effect this guidance may have on its
operating results or financial position.
ASU 2014-11, Transfers and Servicing (Topic 860): “Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures,”
changes the accounting for repurchase-to-maturity transactions and repurchase financing arrangements by aligning the accounting for
these transactions with the accounting for other typical repurchase agreements. Going forward, these transactions would all be
accounted for as secured borrowings. The new guidance eliminates sale accounting for repurchase-to-maturity transactions and
supersedes the guidance under which a transfer of a financial assets and a contemporaneous repurchase financing could be accounted
for on a combined basis as a forward arrangement, which has resulted in outcomes referred to as off-balance sheet accounting. ASU
2014-11 also requires a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains
substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction, and
requires expanded disclosure about the nature of the collateral pledged in repurchase agreements and similar transactions accounted
for as secured borrowings. Accounting changes in ASU 2014-11 are effective for public companies for interim and annual periods
beginning after December 15, 2014. In addition, the disclosure for certain transactions accounted for as a sale is effective for the first
interim or annual period beginning on or after December 15, 2014, and the disclosure for transactions accounted for as secured
borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after
March 15, 2015. The adoption of this guidance on the appropriate effective dates is not expected to have a material effect on the
operating results or financial position of the Company.
ASU 2014-12, Compensation – Stock Compensation (Topic 718): “Accounting for Share-Based Payments When the Terms of an
Award Provide that a Performance Target Could be Achieved after the Requisite Service Period,” requires a performance target that
affects vesting and that can be achieved after the requisite service period to be treated as a performance condition. To account for such
awards, an entity should apply existing guidance as it relates to awards with performance conditions that affect vesting. As such, the
performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be
recognized in the period in which it becomes probable that the performance target will be achieved and should represent compensation
cost attributable to the period(s) for which the requisite service already has been rendered. If the performance target becomes probable
of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized
prospectively over the remaining requisite service periods. The total amount of compensation cost should reflect the number of awards
that are expected to vest and should be adjusted to reflect those awards that ultimately vest. ASU 2014-12 is effective for annual
periods and interim periods within those annual periods beginning after December 15, 2015. The adoption of this guidance on January
1, 2016 is not expected to have a material effect on the operating results or financial position of the Company.
ASU 2014-14, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): “Classification of Certain Government-
Guaranteed Mortgage Loans Upon Foreclosure,” requires that a mortgage loan be derecognized and that a separate other receivable be
recognized upon foreclosure if the following conditions are met: (1) the loan has a government guarantee that is not separable from the
loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and
make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (3) at the time of foreclosure, any
amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other
receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the
guarantor. ASU 2014-14 is effective for public companies for interim and annual periods beginning after December 15, 2014. For all
other entities, the new standard is effective for annual periods ending after December 15, 2015 and interim periods beginning after
December 15, 2015. 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.
ASU 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40): “Disclosure of Uncertainties about an
Entity’s Ability to Continue as a Going Concern,” defines management’s responsibility to evaluate whether there is substantial doubt
about an entity’s ability to continue as a going concern and provide guidance for related footnote disclosures. ASU 2014-15 requires
an entity’s management to assess the entity’s ability to continue as a going concern by incorporating and expanding upon certain
principles that are currently in U.S. auditing standards. Specifically ASU 2014-15: (1) provides a definition of the term substantial
doubt; (2) requires an evaluation as to whether there are conditions or events, considered in the aggregate, that raise substantial doubt
about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued (or within one
year after the date that the financial statements are available to be issued when applicable); (3) provides principles for considering the
mitigating effect of management’s plans; (4) requires certain disclosures when substantial doubt is alleviated; and (5) require an
express statement and other disclosures when substantial doubt is not alleviated. ASU 2014-15 is effective for annual periods ending
after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. The adoption of this
guidance on December 31, 2016 is not expected to have a material effect on the operating results or financial position of the Company.
ASU 2015-01, Income Statement – Extraordinary and Unusual Items (Subtopic 225-20): “Simplifying Income Statement Presentation
by Eliminating the Concept of Extraordinary Items,” will alleviate uncertainty for preparers, auditors and regulators because auditors
and regulators will no longer be required to evaluate whether a preparer presented an unusual and/or infrequent item appropriately.
86
Although ASU 2015-01 eliminates the concept of extraordinary items, the presentation and disclosure guidance for items that are
unusual in nature or infrequent in occurrence has been retained and has been expanded to include items that are both unusual in nature
or infrequent in occurrence. The nature and financial effects of each event or transaction is required to be presented as a separate
component of income from continuing operations or, alternatively, in the notes to the financial statements. ASU 2015-01 is effective
for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption of this guidance is
permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The adoption of this guidance on
January 1, 2016 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, 2014 and 2013 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, 2014 and 2013, the amount of these balances was $306 thousand and $379 thousand,
respectively.
87
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 December 31, 2014 and 2013:
(in thousands)
Available-for-sale:
Obligations of U.S. government agencies
Obligations of state and political subdivisions
U.S. government/government-sponsored agencies:
Collateralized mortgage obligations - residential
Collateralized mortgage obligations - commercial
Residential mortgage-backed securities
Corporate debt securities
Negotiable certificates of deposit
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
U.S. government/government-sponsored agencies:
Collateralized mortgage obligations - residential
Collateralized mortgage obligations - commercial
Residential mortgage-backed securities
Corporate debt securities
Negotiable certificates of deposit
Equity securities
Total available-for-sale securities
Held-to-maturity:
Obligations of state and political subdivisions
December 31, 2014
Gross
Unrealized
Holding
Gains
Gross
Unrealized
Holding
Losses
Fair
Value
Amortized
Cost
$
29,246
23,132
$
77
1,380
$
47
3
$
29,276
24,509
26,129
61,017
73,998
500
2,232
1,010
217,264
$
103
492
441
-
-
-
2,493
$
1
253
341
80
-
43
768
$
26,231
61,256
74,098
420
2,232
967
218,989
$
$
-
$
-
$
-
$
-
December 31, 2013
Gross
Unrealized
Holding
Gains
Gross
Unrealized
Holding
Losses
Fair
Value
Amortized
Cost
$
-
79,488
-
$
1,422
-
$
2,856
$
-
78,054
3,190
32,716
91,648
500
-
1,010
208,552
$
46
-
98
-
-
-
1,566
$
15
1,138
2,090
93
-
59
6,251
$
3,221
31,578
89,656
407
-
951
203,867
$
$
2,308
$
116
$
-
$
2,424
Except for U.S. government and government-sponsored agencies, there were no securities of any individual issuer that exceeded
10.0% of shareholders’ equity at December 31, 2014. There were two security issuers, St. Clair County, IL School District and the
Commonwealth of Massachusetts, whose aggregate carrying values of $4.1 million and $3.8 million, respectively, exceeded 10.0% of
shareholders’ equity at December 31, 2013.
88
The following table presents the amortized cost and approximate fair value of the Company’s available-for-sale debt securities at
December 31, 2014 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
residential mortgage-backed securities are not due at a single maturity date, they are not included in the maturity categories in the
following maturity summary.
(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, 2014
Available-for-Sale
Amortized
Cost
Fair
Value
$
-
2,232
36,049
16,829
87,146
73,998
216,254
$
-
$
2,232
36,337
17,868
87,487
74,098
218,022
$
The following table presents the gross proceeds received and gross realized gains and losses on sales of available-for-sale and held-to-
maturity securities for each of the three years ended December 31, 2014, 2013 and 2012.
(in thousands)
Available-for-sale:
Gross proceeds received
Gross realized gains
Gross realized losses
Held-to-maturity:
Gross proceeds received
Gross realized gains
Gross realized losses
Year Ended December 31,
2014
2013
2012
$
111,243
$
53,787
$
46,099
6,272
-
3,295
(408)
1,353
(3,065)
$
2,686
$
-
$
-
368
-
-
-
-
-
The Company sold its entire portfolio of held-to-maturity securities consisting of four obligations of states and political subdivisions
with an aggregate amortized cost of $2.3 million during the year ended December 31, 2014. The four securities were tax-exempt, zero-
coupon bonds of California municipalities. These securities were sold as part of management’s strategy to reduce the amount of
potential credit and concentration risk in the investment portfolio. Since the securities were sold for for reasons other than those
permitted under GAAP, the Company is not permitted to classify securities as held-to-maturity for a period of two years from the date
of the sales.
89
The following tables present the number of, fair value and gross unrealized losses of available-for-sale securities with unrealized
losses at December 31, 2014 and 2013, aggregated by investment category and length of time the securities have been in an unrealized
loss position.
(dollars in thousands)
Obligantions of U.S. government agencies
Obligations of state and policitical subdivisions
U.S. government/government-sponsored agencies:
Collateralized mortgage obligations - residential
Collateralized mortgage obligations - commercial
Residential mortgage-backed securities
Corporate debt securities
Negotiable certificates of deposit
Equity securities
Total
Less than 12 Months
December 31, 2014
12 Months or Greater
Number
of
Securities
Fair
Value
Gross
Number
Unrealized
of
Losses
Securities
Fair
Value
Gross
Number
Unrealized
of
Losses
Securities
2
-
1
7
3
-
-
-
$
9,513
$
47
-
653
32,513
16,659
-
-
-
-
-
1
105
56
-
-
-
-
1
-
3
6
1
-
1
$
-
$
-
254
-
8,693
37,619
420
-
957
3
-
148
285
80
-
43
2
1
1
10
9
1
-
1
Total
Fair
Value
Gross
Unrealized
Losses
$
9,513
$
47
254
653
41,206
54,278
420
-
957
3
1
253
341
80
-
43
13
$
59,338
$
209
12
$
47,943
$
559
25
$
107,281
$
768
(dollars in thousands)
Obligations of U.S. government agencies
Obligations of state and policitical subdivisions
U.S. government/government-sponsored agencies:
Collateralized mortgage obligations - residential
Collateralized mortgage obligations - commercial
Residential mortgage-backed securities
Corporate debt securities
Negotiable certificates of deposit
Equity Securities
Total
Less than 12 Months
December 31, 2013
12 Months or Greater
Number
of
Securities
Fair
Value
Gross
Number
Unrealized
of
Losses
Securities
Fair
Value
Gross
Number
Unrealized
of
Losses
Securities
-
58
2
9
13
-
-
-
$
-
$
-
33,835
1,837
105
31,578
79,046
-
-
-
1
1,138
1,961
-
-
-
-
18
1
-
2
1
-
1
$
-
$
-
4,756
1,019
833
-
7,506
407
-
941
14
-
129
93
-
59
-
76
3
9
15
1
-
1
Total
Fair
Value
Gross
Unrealized
Losses
$
-
$
-
38,591
2,856
938
31,578
86,552
407
-
941
15
1,138
2,090
93
-
59
82
$
144,564
$
4,937
23
$
14,443
$
1,314
105
$
159,007
$
6,251
Management evaluates individual securities in an unrealized loss position quarterly for OTTI. As part of its evaluation, management
considers, among other things, the length of time a security’s fair value is less than amortized cost, the severity of decline, any credit
deterioration of the issuer, whether or not 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.
As previously mentioned, securities issued by U.S. government or U.S. government-sponsored agencies, including single-maturity
bonds, residential mortgage-backed securities, and residential and commercial CMOs, comprise the majority of the Company’s
securities portfolio. Management performed a review of the fair values of all securities in an unrealized loss position as of December 31,
2014 and determined that movements in the fair values of the securities were consistent with the change in market interest rates. At
December 31, 2014, the Company held 25 securities that were in an unrealized loss position, with 12 of those securities in an unrealized
loss position for more than 12 months. All but one of the securities in an unrealized loss position at December 31, 2014 were debt
securities. Additionally, management considers the severity of each security’s unrealized loss position, placing greater emphasis on any
security with a unrealized loss greater than 5.0% of its amortized cost. At December 31, 2014, there was one security, a corporate debt
security, with an unrealized loss greater than 5.0% of its amortized cost. The security, a floating rate bond of JP Morgan Chase, had an
unrealized loss of $80 thousand, or 16.0%, of its amortized cost at December 31, 2014. This bond was originally issued by Chase
Manhattan Bank. JP Morgan Chase, surviving after the merger, is one of the largest banks in the world with a legacy dating back to
1799. JP Morgan Chase was considered well capitalized under regulatory capital guidelines at December 31, 2014.
The remaining 24 securities in an unrealized position at December 31, 2014 included 22 securities issued by a U.S. government or
government-sponsored agency, one obligation of a state and political subdivision and one equity security. The obligations of the U.S.
government or government-sponsored agencies are securities issued by GNMA, FHLMC, FNMA and the Federal Farm Credit Bank
that are currently rated Aaa by Moody’s Investor Services or AA+ by Standard & Poor’s (“S&P”) and are guaranteed by the U.S.
90
government.The one state and political subdivision obligation in an unrealized loss position at December 31, 2014 was a general-
purpose debt obligation, which has an S&P credit rating of A+, is secured by the unlimited taxing power of the issuer and carries a
secondary level of credit enhancement. The one equity security in an unrealized loss position at December 31, 2014, which was a
mutual fund investment that qualifies the Company for credit under the Community Reinvestment Act. The mutual fund is comprised
of one- to four-family residential mortgage-backed securities collateralized by properties within the Company’s geographical market.
In aggregate, unrealized losses totaled $768 thousand, which represented only 0.4%, of the total amortized cost of investment
securities at December 31, 2014.
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 prior to recovery of their amortized cost. Based on the result of its review and considering the
attributes of these debt and equity securities, management concluded that the individual unrealized losses were temporary and OTTI
did not exist at December 31, 2014. For more information regarding the Company’s evaluation of securities for OTTI, see Note 4-
“Securities” of the notes to consolidated financial statements included in Item 8 – “Financial Statement and Supplementary Data to
this Annual Report on Form 10-K.
Investments in FHLB of Pittsburgh and FRB stock, which have limited marketability, are carried at cost and totaled $4.2 million and
$3.5 million at December 31, 2014 and 2013, respectively. Management noted no indicators of impairment for the FHLB of
Pittsburgh and the FRB of Philadelphia during 2014.
Note 5. LOANS
The following table summarizes loans receivable, net by category at December 31, 2014 and 2013:
(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,
2014
$ 122,832
2013
$ 114,925
233,473
18,835
132,057
122,092
40,205
669,494
(98)
871
218,524
24,382
127,021
118,645
39,875
643,372
(143)
668
(11,520)
$ 658,747
(14,017)
$ 629,880
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. For more information about related party
transactions, refer to Note 14 to these consolidated financial statements.
For information about credit concentrations within the Company’s loan portfolio, refer to Note 15 to these consolidated financial
statements.
The Company originates one- to four-family mortgage loans for sale in the secondary market. During the years ended December 31,
2014, 2013 and 2012, the Company sold $8.3 million, $12.6 million and $26.2 million of one- to four-family mortgages, respectively.
The Company retains servicing rights on these mortgages.
The Company had $603 thousand and $820 thousand in loans held-for-sale at December 31, 2014 and 2013, respectively. All loans
held for sale are one- to four-family residential mortgage loans.
The Company sold all of its education loans, which are categorized as consumer loans, to a third party during the year ended
December 31, 2014. The education loans had a recorded investment of $2.6 million at the time of sale. The Company recognized a
loss of $13 thousand upon the sale of these loans which is included in non-interest income for the year ended December 31, 2014.
91
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 did not sell any performing or non-performing classified loans in 2014.
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 portions 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 its 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 troubled debt restructured loans (“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 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 for 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
specific loans. The Company applies an estimated loss rate to each loan segment. 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 to 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, troubled debt restructurings 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 customers’ credit quality, including knowledge of their operating environment and financial condition.
Management evaluates the ALLL based on the combined total of the impaired 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.
92
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
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.
At December 31, 2014, management, based on its evaluation of the ALLL, established an unallocated reserve of $45 thousand. As
previously mentioned, as part of its evaluation, management applies loss rates to each loan segment which are based on historical loss
experience for that segment. The Company has experienced net recoveries related to its construction, land acquisition and
development segment of the loan portfolio for the majority of the quarters over the previous three years, which resulted an overall
negative historical loss factor, and consequently a negative provision of $45 thousand for this particular loan segment at December
31, 2014. Based on the higher risk characteristics inherent in this segment of the portfolio, management reversed the negative
provision and established the unallocated reserve.
The following table summarizes the activity in the ALLL by loan category for the years ended December 31, 2014, 2013 and 2012:
Allowance for Loan and Lease Losses by Loan Category
December 31, 2014
Real Estate
Residential
Real Estate
Commercial
Real Estate
Construction,
Land
Acquisition and
Development
Commercial
and Industrial
Consumer
State and
Political
Subdivisions
Unallocated
Total
$
$
$
$
$
$
$
2,287
(204)
90
(401)
1,772
6,017
-
362
(1,716)
4,663
924
(45)
3,538
(3,752)
665
2,321
(217)
262
(262)
2,104
1,789
(922)
508
298
1,673
679
-
-
(81)
598
-
$
-
-
45
45
$
14,017
(1,388)
4,760
(5,869)
11,520
$
$
$
$
$
$
$
$
51
$
331
$
1
$
-
$
1
$
-
$
-
$
384
$
1,721
$
4,332
$
664
$
2,104
$
1,672
$
598
$
45
$
11,136
(in thousands)
Allowance for loan losses:
Beginning balance, January 1, 2014
Charge-offs
Recoveries
Provisions (credits)
Ending balance, December 31, 2014
Ending balance, December 31, 2014:
Individually evaluated for impairment
Ending balance, December 31, 2014:
Collectively evaluated for impairment
Loans receivable:
Ending balance, December 31, 2014
$
122,832
$
233,473
$
18,835
$
132,057
$
122,092
$
40,205
$
-
$
669,494
Ending balance, December 31, 2014:
Individually evaluated for impairment
Ending balance, December 31, 2014:
Collectively evaluated for impairment
$
2,487
$
6,660
$
256
$
32
$
361
$
-
$
-
$
9,796
$
120,345
$
226,813
$
18,579
$
132,025
$
121,731
$
40,205
$
-
$
659,698
93
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
Credit Quality Indicators – Commercial Loans
Management continuously monitors the credit quality of the Company’s commercial loans by regularly reviewing certain credit
quality indicators. Management utilizes credit risk ratings as the key credit quality indicator for evaluating 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. Quarterly, the Company engages an independent
94
third party to assess the quality of the loan portfolio and evaluate 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 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 as described in
“Credit Quality Indicators – Commercial Loans.” 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
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 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 loan category and credit quality indicator at December 31,
2014 and 2013:
95
Commercial Credit Quality Indicators
December 31, 2014
Real Estate
Residential Real
Estate
Commercial Real
Estate
Construction,
Land Acquisition
and Development
Commercial and
Industrial
Consumer
State and
Political
Subdivisions
Total
$
$
$
$
$
19,892
451
1,077
-
-
21,420
$
204,252
13,217
16,004
-
-
$
233,473
10,910
1,423
5,566
-
-
17,899
$
122,261
1,962
2,397
-
-
$
126,620
38,685
925
595
-
-
40,205
399,414
17,978
25,764
-
-
443,156
$
$
$
$
$
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
39,151
-
724
-
-
39,875
379,177
18,575
27,276
-
-
425,028
$
$
$
$
$
3,414
-
125
-
-
3,539
2,546
-
157
-
-
2,703
(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 unless collection of the loan is in
process and reasonably assured. 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 residential real estate loans, residential construction, land
acquisition and development loans, commercial indirect auto loans, and consumer loans based on payment activity at December 31,
2014 and 2013:
Other Loans Credit Quality Indicators
December 31, 2014
(in thousands)
Residential real estate
Construction, land acquisition and development - residential
Commercial - indirect auto
Consumer
Total
Accruing
Loans
$
100,576
936
5,437
118,377
225,326
Non-accruing
Loans
$
836
-
-
176
1,012
$
$
$
Total
$
101,412
936
5,437
118,553
226,338
Other Loans Credit Quality Indicators
December 31, 2013
(in thousands)
Residential real estate
Construction, land acquisition and development - residential
Commercial - indirect auto
Consumer
Total
96
Accruing
Loans
$
Non-accruing
Loans
$
Total
$
92,181
3,072
5,671
115,809
216,733
1,478
-
-
133
1,611
93,659
3,072
5,671
115,942
218,344
$
$
$
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 $5.5 million and $6.4 million at
December 31, 2014 and 2013, 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. There were no loans
past due 90 days or more and still accruing at December 31, 2014. Loans past due 90 days or more and still accruing interest were $19
thousand at December 31, 2013 and consisted of loans that are well secured and in the process of renewal.
The following tables present the delinquency status of past due and non-accrual loans by loan category at December 31, 2014 and 2013:
(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 performing (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
0-29 Days
Past Due
30-59 Days
Past Due
December 31, 2014
Delinquency Status
60-89 Days
Past Due
>/= 90 Days
Past Due
Total
$
121,407
229,207
18,740
369,354
$
420
136
-
556
-
$
-
95
95
-
$
-
-
-
$
121,827
229,343
18,835
370,005
131,621
120,204
40,205
661,384
495
288
-
783
55
42
-
880
90
1,334
-
1,980
99
3,628
-
3,727
-
-
-
3,727
135
378
-
608
17
19
-
36
52
58
-
146
-
-
-
-
394
195
-
589
104
76
-
769
131,846
121,916
40,205
663,972
1,005
4,130
-
5,135
211
176
-
5,522
$
662,264
$
5,707
$
754
$
769
$
669,494
97
(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
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
98
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, 2014 and 2013. 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 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 $1.0 million and $1.1 million at
December 31, 2014 and 2013, 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, 2014
Recorded
Investment
Unpaid Principal
Balance
Related
Allowance
$
385
4,401
68
4,854
$
410
5,024
68
5,502
-
$
-
-
-
32
-
-
4,886
-
2,102
2,259
188
4,549
-
361
-
4,910
2,487
6,660
256
9,403
32
361
-
59
-
-
5,561
2,137
2,259
188
4,584
-
361
-
4,945
2,547
7,283
256
10,086
59
361
-
-
-
-
-
51
331
1
383
-
1
-
384
51
331
1
383
-
1
-
$
9,796
$
10,506
$
384
99
(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
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 $9.8 million and $9.2 million at December 31, 2014 and 2013, respectively. The related allowance
on impaired loans was $0.4 million and $0.3 million at December 31, 2014 and 2013, respectively.
100
The following table presents the average balance and the interest income recognized on impaired loans for the years ended December
31, 2014, 2013, and 2012:
(in thous ands )
Real es tate:
Res idential real es tate
Commercial real es tate
Cons truction, land acquisition and development
Total real es tate
Commercial and indus trial
Consumer
State and political s ubdivisions
2014
2013
Average
Balance
Interest
Income (1)
Average
Balance
Interes t
Income (1)
2012
Average
Balance
Interes t
Income (1)
Year Ended December 31,
$
2,226
$
91
$
2,301
$
22
$
3,882
$
11
6,616
284
9,126
76
343
-
118
15
224
-
11
-
10,004
761
13,066
-
79
-
313
28
363
-
-
3
14,196
2,340
20,418
2,521
232
157
328
37
376
-
-
-
Total impaired loans
$
9,545
$
235
$
13,145
$
366
$
23,328
$
376
(1) Interes t income repres ents income recognized on performing TDRs .
Included in total impaired loans are accruing TDRs of $5.3 million and $4.0 million as of December 31, 2014 and 2013, respectively.
The Bank was not committed to lend additional funds to any loan classified as a TDR as of December 31, 2014.
The additional interest income that would have been earned on non-accrual and restructured loans for the years ended December 31,
2014, 2013, and 2012 had these loans performed in accordance with their original terms approximated $406 thousand, $572 thousand,
and $1.4 million, respectively.
Troubled Debt Restructured Loans
TDRs at December 31, 2014 and 2013 were $9.0 million and $8.1 million, respectively. Accruing and non-accruing TDRs were $5.3
million and $3.7 million, respectively at December 31, 2014 and $4.0 million and $4.1 million, respectively at December 31, 2013.
Approximately $346 thousand and $301 thousand in specific reserves have been established for TDRs as of December 31, 2014 and
2013, 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, capitalization of real estate taxes, 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, 2014 and 2013:
(in thousands)
Troubled debt restructurings:
Residential real estate
Commercial real estate
Construction, land acquisition and development
Commercial and industrial
Consumer
For the Year Ended December 31, 2014
For the Year Ended December 31, 2013
Pre-Modification
Post-Modification
Pre-Modification
Post-Modification
Number
of
Contracts
Outstanding
Recorded
Investments
Outstanding
Recorded
Investments
Number
of
Contracts
Outstanding
Recorded
Investments
Outstanding
Recorded
Investments
12
$
780
$ 862
16
$
827
$ 947
4
-
-
2
238
-
-
182
238
-
-
187
2
-
-
2
4,561
-
-
318
4,561
-
-
318
Total new troubled debt restructurings
18
$
1,200
$
1,287
20
$
5,706
$
5,826
The TDRs described above increased the allowance for loan losses by $4 thousand and $6 thousand through allocation of a specific
reserve for the years ended December 31, 2014 and 2013, respectively. There were no charge-offs that resulted from the TDRs
described above during the year ended December 31, 2014 or 2013.
101
The following table shows the types of modifications made during the years ended December 31, 2014 and 2013:
(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 capitalization of taxes
Principal forebearance
Capitalization of taxes
Total modifications
$
$
$
$
Residential
Real Estate
Commercial
Real Estate
$
$
263
339
225
35
862
238
-
-
-
238
Residential
Real Estate
Commercial
Real Estate
$
41
860
-
46
947
$
-
-
4,561
-
4,561
$
$
Year Ended December 31, 2014
Construction,
Land Acquisition
and
Development
-
$
-
-
-
$
-
Commercial
and
Industrial
-
$
-
-
-
$
-
Year Ended December 31, 2013
Construction,
Land Acquisition
and
Development
$
-
-
-
-
$
-
Commercial
and
Industrial
$
-
-
-
-
$
-
Consumer
Total
$
$
135
52
-
-
187
318
-
-
-
318
636
391
225
35
1,287
359
860
4,561
46
5,826
Consumer
Total
$
$
$
$
The following table summarizes TDRs which have re-defaulted (defined as past due 90 days) during the years ended December 31,
2014 and 2013 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
Consumer
Total
For the Year Ended December 31, 2014
Number of
Contracts
Recorded
Investment
For the Year Ended December 31, 2013
Number of
Contracts
Recorded
Investment
-
-
-
-
-
-
-
$
-
-
-
-
$
-
1
-
-
-
-
1
$
$
27
-
-
-
-
27
Note 6. OTHER REAL ESTATE OWNED
The following table presents the composition of OREO at December 31, 2014 and 2013:
December 31,
2014
2013
$
$
1,287
941
27
2,255
3,549
647
50
4,246
$
$
(in thous ands )
Land / lots
Commercial real es tate
Res idential real es tate
Total other real es tate owned
102
The following table presents the activity in OREO for the years ended December 31, 2014, 2013 and 2012:
(in thousands)
Balance, beginning of year
Property foreclosures
Bank premises transferred to OREO
Valuation adjustments
Carrying value of OREO sold
Balance, end of year
For the Years Ended December 31,
2014
2013
2012
$
4,246
$
3,983
$
6,958
13
1,749
(2,200)
(1,553)
255
1,819
(223)
(1,588)
1,586
-
(1,206)
(3,355)
$
2,255
$
4,246
$
3,983
Due to a change in strategic purpose, the Company transferred the Stroudsburg office from bank premises and equipment to OREO for
disposition during the year ended December 31, 2014. The deposits and loans of this branch were sold to ESSA Bank and Trust
pursuant to a Branch Purchase and Deposit/Loan Assumption Agreement. The Company retained this facility and was initially
planning to use it for other bank-related purposes. This property with a carrying value of $1.7 million was written down to its
appraised value less cost to sell of $0.8 million at the time of transfer. A valuation adjustment of $0.9 million, included in non-interest
expense, was recorded at the time of transfer.
During 2013, the Company transferred three vacant lots from bank premises and equipment that were previously held for future
expansion to OREO. One of the properties was subsequently sold during the year ended ended December 31, 2014. There was no
gain or loss realized upon the sale. The Company had one of the properties located in Monroe County, Pennsylvania re-appraised in
2014 due to continued decline in real estate values, which resulted in a valuation adjustment of $0.3 million and is included in non-
interest expense for the year ended December 31, 2014.
In addition, four properties that have been held in OREO for a significant amount of time are approaching the regulatory holding
period threshold of five years. In an effort to aggressively dispose of these properties, management requested independent appraisals
using a liquidation value basis for each of the properties. Accordingly, the Company incurred valuation adjustments to these four
properties totaling $0.7 million for the year ended December 31, 2014. In aggregate, valuation adjustments to the carrying value of
OREO included in non-interest expense totaled $2.2 million for the year ended December 31, 2014.
The following table presents the components of net expense of OREO for the years ended December 31, 2014, 2013 and 2012:
For the Years Ended December 31,
$
$
$
2014
96
55
17
85
144
8
14
2,200
2,619
(50)
2,569
2013
147
131
37
35
122
6
45
223
746
(27)
719
2012
65
66
7
211
287
21
140
1,206
2,003
24
2,027
$
$
$
(in thousands)
Insurance
Legal fees
Maintenance
Professional fees
Real estate taxes
Utilities
Other
Valuation adjustments
Total expense
(Income) losses from the operation of foreclosed properties
Net expense of OREO
103
Note 7. BANK PREMISES AND EQUIPMENT
The following table summarizes bank premises and equipment at December 31, 2014 and 2013:
(in thousands)
Land
Buildings and improvements
Furniture, fixtures and equipment
Leasehold improvements
Total
Accumulated depreciation
Net
December 31,
2014
2013
$
2,711
$
4,191
7,187
11,638
4,985
26,521
(15,518)
10,126
12,575
4,953
31,845
(16,482)
$
11,003
$
15,363
Depreciation and amortization expense amounted to $1.3 million for each of the years ended December 31, 2014 and 2013, and $1.4
million for the year ended December 31, 2012.
On January 24, 2014, the Company sold the premises and certain equipment of its Marshalls Creek, Monroe County branch as part of
the Branch Purchase Agreement with ESSA Bank and Trust. The property sold had a net book value of $2.3 million, and the Company
realized a gain on the sale of the property of $181 thousand, which is included in the $607 thousand gain on branch divestiture in non-
interest income for the year ended December 31, 2014.
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
for the year ended December 31, 2013.
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
$122.2 million, $130.5 million and $154.5 million at December 31, 2014, 2013, and 2012, 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, 2014, substantially all of the loans serviced for others were performing in
accordance with their contractual terms.
The following table summarizes the activity pertaining to mortgage servicing rights for the years ended December 31, 2014, 2013 and
2012. Mortgage servicing rights are included in other assets in the consolidated statements of financial condition.
(in thousands)
For the Year Ended December 31,
2014
2013
2012
Balance, beginning of year
$
529
$
675
$
777
Mortgage servicing rights capitalized
Amortization
Balance, end of year
77
(273)
119
(265)
220
(322)
$
333
$
529
$
675
The fair value of all servicing assets was $898 thousand and $990 thousand at December 31, 2014 and 2013, respectively. Fair value
has been determined using discount rates ranging from 2.75% to 8.32% and prepayment speeds ranging from 105% to 490% 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, 2014 and 2013.
104
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, 2014 and
2013 indicated that there was no impairment to the core deposit intangible.
The following table summarizes core deposit intangible assets at December 31, 2014 and 2013:
(in thous ands )
Gros s carrying amount
Accumulated amortization
Net carrying amount
December 31,
2014
2013
$
1,650
$
1,650
(1,348)
(1,183)
$
302
$
467
Amortization expense on core deposit intangible assets totaled $165 thousand in each of the three years ended 2014, 2013 and 2012.
Amortization expense on core deposit intangible assets with finite useful lives is expected to total $165 thousand for 2015, and $137
thousand for 2016.
Note 10. DEPOSITS
The following table summarizes deposits at December 31, 2014 and 2013:
(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,
2014
2013
$
124,064
$
157,550
345,679
89,489
112,044
124,060
671,272
334,742
87,806
161,959
142,641
727,148
$
795,336
$
884,698
The Company had brokered deposits, which are classified as other time deposits in the above table, of $4.5 million and $5.0 million, at
December 31, 2014 and 2013, respectively.
105
The following table summarizes scheduled maturities of time deposits, including certificates of deposit and individual retirement
accounts, at December 31, 2014:
(in thousands)
2015
2016
2017
2018
2019
2020 and thereafter
Total
Time Deposits
$100,000
and Over
$
90,011
16,229
2,932
1,684
1,021
167
112,044
$
Other
Time Deposits
$
78,474
24,401
11,149
6,061
3,742
233
124,060
$
Total
168,485
40,630
14,081
7,745
4,763
400
236,104
$
$
Investment securities with a carrying value of $217.6 million and $204.4 million at December 31, 2014 and 2013, respectively, were
pledged to collateralize certain municipal deposits.
Note 11. BORROWED FUNDS
The following table summarizes the components of borrowed funds at December 31, 2014 and 2013:
(in thousands)
FHLB advances
Subordinated debentures
Junior subordinated debentures
Total
December 31,
2014
2013
$
61,194
$
27,123
25,000
10,310
25,000
10,310
$
96,504
$
62,433
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, 2014. 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, 2014.
The following table presents borrowed funds by their maturity dates at December 31, 2014:
(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, 2014
Amount
Weighted
Average
Interest Rate
$
34,000
15,435
15,000
10,000
11,759
10,310
96,504
$
1.58%
3.28%
3.59%
5.02%
5.21%
1.91%
3.00%
The FHLB of Pittsburgh borrowings of $61.2 million are all fixed-rate advances having maturities of one year or more, and are
collateralized under a blanket pledge agreement. Previously, only the Company’s commercial real estate loans, one- to four-family
mortgage loans, or mortgage-backed securities were allowed as collateral under the blanket pledge agreement. During the first quarter
106
of 2014 the FHLB notified the Company that previously restricted commercial and industrial loans were now acceptable collateral
under the blanket pledge agreement. Loans of $378.9 million and $160.5 million, at December 31, 2014 and 2013, respectively, were
pledged to collateralize FHLB advances under this agreement. In addition, the Company is required to purchase FHLB stock based
upon the amount of advances outstanding. The Company was in compliance with this requirement, having a stock investment in
FHLB of Pittsburgh of $2.8 million at December 31, 2014.
The maximum amount of borrowings outstanding at any month end during the years ended December 31, 2014 and 2013 was $122.7
million and $79.8 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 1.93% in 2014, 1.97% in 2013, and 2.18% in 2012. 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.
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, 2014 and 2013 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, 2014 and 2013.
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, 2014 and 2013.
Pursuant to the November 24, 2010 Written Agreement (the “Agreement”) with the Federal Reserve Bank of Philadelphia (the
“Reserve Bank”), the Company and its non-bank subsidiary may not make any payment of interest, principal or other amounts on the
Company’s subordinated debentures or junior subordinated debentures without the prior written approval of the Reserve Bank and the
Director. The Company was deferring interest payments on the Company’s Debentures since the last interest payment due on
September 14, 2010. During 2014, the Company requested and received non-objection from the Reserve Bank to make a distribution
on the Debentures to cure the interest deferral on December 15, 2014. On December 15, 2014, the Company paid all deferred and
currently payable accrued interest totaling $884 thousand. At December 31, 2014 and 2013, accrued and unpaid interest associated
with the Debentures amounted to $9 thousand and $695 thousand, respectively. The Company continued to defer interest payments
on the Company’s Notes in 2014. The last payment made on the Notes was the payment due on September 1, 2010. The accrued and
unpaid interest associated with the Notes amounted to $9.9 million and $7.6 million at December 31, 2014 and 2013, respectively. For
more information refer to Note 17, “Regulatory Matters” to these consolidated financial statements.
Note 12. BENEFIT PLANS
The Bank has a defined contribution profit sharing plan (“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
107
years of credited service. On February 25, 2015, the Board of Directors approved a change in the vesting schedule of discretionary
contributions made by the Company under the Profit Sharing Plan, including the 401(k) feature. The change in the vesting schedule,
which was retroactively effective January 1, 2015, provides that Company contributions will vest 25.0% each year of credited service,
with employee participants being 100.0% vested after four years of credited service.
There were no discretionary annual contributions made to the profit sharing plan in 2014, 2013 and 2012. Discretionary matching
contributions under the 401(k) feature of the plan totaled $134 thousand, $129 thousand, and $41 thousand in 2014, 2013 and 2012,
respectively.
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 $7.2 million at
December 31, 2014 and $7.3 million at December 31, 2013.
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, 2014, 2013 and
2012:
(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
Regulatory penalties
Other items, net
Provision for income taxes
For the Year Ended December 31,
2014
$ 4,674
2013
$ 2,170
2012
$ (4,662)
(1,087)
(1,574)
(1,824)
21
37
65
(221)
(240)
(235)
(3,799)
(347)
6,637
570
-
-
168
(46)
19
$
326
$
-
$
-
108
The following table summarizes the components of the net deferred tax asset included in other assets at December 31, 2014 and 2013:
(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
Charitable contribution carryover
Accrued rent expense
Accrued vacation
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,
2014
2013
$
4,073
$
4,954
2,467
-
486
1,360
157
439
2,457
403
182
58
884
19
17,919
30,904
(425)
(586)
(63)
(80)
(1,154)
29,750
(30,336)
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)
$
(586)
$
1,592
As of December 31, 2014, the Company had $52.7 million of net operating loss carryovers resulting in deferred tax assets of $17.9
million. Beginning in 2031, these net operating loss carryovers will expire if not utilized. As of December 31, 2014, the Company
also had $1.2 million of charitable contribution carryovers resulting in gross deferred tax assets of $403 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 $2.5 million as of December 31, 2014 that have an indefinite life.
The Company evaluates the carrying amount of its deferred tax assets on a quarterly basis, or more frequently, if necessary, in
accordance with guidance set forth in ASC Topic 740 “Income Taxes,” and applies the criteria in the guidance to determine whether it
is more likely than not that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight
of available evidence. If management determines based on available evidence, both positive and negative, that it is more likely than
not that some portion or all of the deferred tax asset will not be realized in future periods, a valuation allowance is calculated and
recorded. These determinations are inherently subjective and depend upon management’s estimates and judgments used in their
evaluation of both positive and negative evidence.
In evaluating available evidence, management considers, among other factors, historical financial performance, expectation of future
earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with
operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of termporary
differences. In assessing the need for a valuation allowance, management carefully weighed both positive and negative evidence
currently available. The weight given to the potential effect of positive and negative evidence must be commensurate with the extent
to which it can objectively verified. In particular, additional scrutiny must be given to deferred tax assets of an entity that has incurred
109
taxable losses during the three most recent years because it is significant negative evidence that is objective and verifiable and
therefore difficult to overcome. While, the Company generated table income in 2014, it recorded taxable losses in 2013 and 2012.
When determining the need for a valuation allowance, the Company assessed the possible sources of taxable income available
under tax law to realize a tax benefit for deductible temporary differences and carryforwards as defined in ASC Topic 740. While the
Company has shown substantial book net income in 2013 and 2014, these amount have been the result of significant non-recurring or
non-taxable transactions, such as the credit for loan and lease losses, legal settlements and gains on the sales of securities. The
Company utilizes a three-year rolling measurement of results when assessing whether it is in a cumulative loss position. Until such
time when the Company’s cumulative results are positive, it does not believe there is sufficient positive evidence to overcome the
negative evidence presented.The Company will exclude future taxable income as a factor until it can show consistent and sustainable
profitability. Based on the analysis of available positive and negative evidence, management determined that the established valuation
allowance equal to 100.0% of net deferred tax assets, excluding deferred tax assets or liabilities related to unrealized holding gains and
losses on available-for-sale securities, should be maintained.
For the year ended December 31, 2014, the Company recorded income tax expense of $326 thousand, which was entirely related to
alternative minimum tax. There was no income tax expense recorded during the years ended December 31, 2013 and 2012.
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, 2014 and 2013:
(in thousands)
Balance January 1,
Additions, new loans and advances
Repayments
Other (1)
Balance December 31,
For the Year Ended December 31,
2014
2013
$
32,506
$
33,296
82,236
(72,748)
(248)
50,260
(50,794)
(256)
$
41,746
$
32,506
(1) Other represents loans to related parties that ceased being related parties during the year
At December 31, 2014, there were no loans made to directors, executive officers and their related parties that 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 $11.7 million at December 31, 2014. The Company also sold a participation interest in this line to the same director in
the amount of $5.2 million, of which $4.7 million is outstanding. The Bank receives a 25 basis point annual servicing fee from this
director on the participation balance. At December 31, 2013, the aggregate amount outstanding under the line was $8.5 million and
the participation interest sold under this line was $3.4 million.
Deposits from directors, executive officers and their related parties held by the Bank at December 31, 2014 and 2013 amounted to
$77.4 million and $115.5 million, respectively. Interest paid on the deposits amounted to $97 thousand, $80 thousand, and $139
thousand for the years ended December 31, 2014, 2013 and 2012, respectively.
In the course of its operations, the Company acquires goods and services from and transacts business with various companies affiliated
with 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 to related parties for these services of $2.7 million, $2.6 million, and $1.6 million
in 2014, 2013, and 2012, respectively.
Subordinated notes held by officers and directors and/or their related parties totaled $9.0 million and $10.0 million at December 31,
2014 and 2013, respectively. During the third quarter of 2014, one of the Company’s directors, Joseph J. Gentile, passed away and is
no longer considered a related party. Mr. Gentile had held $1.0 million in the Company’s subordinated notes. There were no interest
110
payments made to directors and/or their related parties in 2014, 2013 and 2012. Interest accrued and unpaid on the notes to related
parties totaled $3.6 million and $3.0 million at December 31, 2014 and 2013, 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, 2014, 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, 2014 are as follows:
Minimum Future Lease Payments
December 31, 2014
(in thousands)
Facilities
Equipment
Total
2015
2016
2017
2018
2019
2020 and thereafter
Total
$
606
$
52
$
658
337
299
228
111
383
36
31
27
27
4
373
330
255
138
387
$
1,964
$
177
$
2,141
Total rental expense under leases amounted to $660 thousand, $692 thousand and $734 thousand in 2014, 2013 and 2012,
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, 2014 and 2013 are as follows:
(in thous ands )
December 31,
2014
2013
Commitments to extend credit
$ 181,446
$ 155,701
Standby letters of credit
21,364
25,321
In order to provide for probable losses inherent in these instruments, the Company recorded reserves for unfunded commitments of
$416 thousand and $511 thousand at December 31, 2014 and 2013, respectively, which were included in other liabilities on the
consolidated balance sheets.
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.
111
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, 2014, the Company serviced payments on $8.7 million of first lien residential loan principal under these terms for the
FHLB. At December 31, 2014, the maximum obligation for such guarantees by the Company would be approximately $1.0 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. There were no due from bank accounts in
excess of the $250 thousand limit covered by the Federal Deposit Insurance Corporation (“FDIC”) at December 31, 2014. At
December 31, 2013, there were no due from bank accounts in excess of the $250 thousand FDIC limit, except for the Bank’s account
at the FHLB with a balance of $298 thousand.
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 $252.3 million, or 37.7% of gross loans at December 31, 2014. 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, 2014, the Company had commercial real estate and construction, land acquisition and development loans and
loan commitments totaling $28.7 million, or 4.3%, of gross loans to customers outside of it primary market area.
At December 31, 2014 and 2013, the Bank’s loan portfolio was concentrated in loans in the following industries.
(in thousands)
Retail space/shopping centers
Automobile dealers
Office complexes/units
Colleges and Universities
Land subdivision
Physicians
1-4 family residential investment properties
Litigation
December 31, 2014
December 31, 2013
Amount
$
33,140
24,194
17,249
16,680
15,220
13,636
12,764
% of
Gross Loans
4.95%
3.61%
2.58%
2.49%
2.27%
2.04%
1.91%
Amount
$
23,472
18,467
17,924
12,671
15,974
13,932
18,839
% of
Gross Loans
3.65%
2.87%
2.79%
1.97%
2.48%
2.17%
2.93%
On August 8, 2011, the Company announced that it had received document subpoenas from the SEC. The information requested
generally related 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. On January 28, 2015, the Company and
the SEC entered into a settlement agreement resolving these issues related to disclosure and financial reporting and the restatements of
the Company’s financial statements for the year ended December 31, 2009 and the quarters ended March 31, 2010 and June 30, 2010.
As part of this settlement agreement, on January 30, 2015 the Company paid a civil money penalty of $175 thousand to the SEC. The
Company accrued for the $175 thousand civil money penalty in its 2014 results of operations.
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
112
or liability, agreed to settle the derivative litigation for $5.0 million. The $5.0 million Settlement payment was made to the Company
on March 28, 2014. The Individual Defendants reserved their rights to indemnification under the Company’s Articles of Incorporation
and Bylaws, 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 accordance, the Company has recorded a liability for this indemnification in
other liabilities. In addition, in conjunction with the Settlement, the Company accrued $2.5 million related to fees and costs of the
plaintiff’s attorneys, which was included in non-interest expense in the consolidated statements of operations for the year ended
December 31, 2013. On April 1, 2014, the Company paid the $2.5 million related to fees and costs of the plaintiff’s attorneys and
partial indemnification of the Individual Defendants in the amount of $2.5 million, and as such, as of December 31, 2014 $2.5 million
remains accrued in other liabilities related to the potential indemnification of the Individual Defendants. The Company settled any and
all claims it had or may have had against Demetrius & Company, LLC, John Demetrius and Robert L. Rossi & Company in
connection with the Shareholder Derivative Suit.
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 for the losses and expenses already incurred by the Company and the Bank. The Company and the other
defendants are defending the claims and have opposed F&D’s requested relief by way of counterclaims, breaches of contract and bad
faith claims against F&D for its failure to fulfill its obligations to the Company and the Bank under the insurance policy. At this time,
the matter is in the discovery 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 the 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 similarly 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 the 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.
On January 22, 2014, the Bank was advised by the Department of Treasury’s Financial Crimes Enforcement Network (“FinCEN”) that
FinCEN was investigating the Bank for alleged violations of the Bank Secrecy Act (“BSA”). On May 28, 2014 the Bank was advised
by the Office of the Comptroller of the Currency (“OCC”) that the OCC was investigating allegations that the Bank failed to file
timely SARS. On November 18, 2014 both FinCEN and OCC advised the Bank that they intended on assessing civil money penalties
against the Bank. Subsequent to November 18, 2014, the Bank had been negotiating with both regulatory agencies about the alleged
BSA violations. On February 27, 2015, the Bank reached a comprehensive settlement with FinCEN and OCC to resolve the BSA
allegations. In order to settle the matter, the Bank consented to an aggregate civil money penalty assessment of $1.5 million which
has been accrued and is included in non-interest expense for the year ended December 31, 2014.
Note 16. STOCK COMPENSATION PLANS
On August 30, 2000, the Company’s Board adopted the 2000 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.
Therefore, no further grants will be made under the 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
113
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, therefore, no further grants will be made under the 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, 2014, 2013, and 2012.
A summary of the status of the Company’s stock option plans is presented below:
2014
2013
2012
For the Years Ended December 31,
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
82,598
-
-
(18,119)
64,479
64,479
Weighted
Average
Exercise
Price
$
15.98
-
-
16.37
15.87
15.87
$
$
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
$
$
$
-
$
-
At December 31, 2014, 2013 and 2012 the exercisable options had no total intrinsic value and there was no unrecognized
compensation expense.
Information pertaining to options outstanding at December 31, 2014 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
64,479
2.9
$
15.87
64,479
$
15.87
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 fair value 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 fair value of $4.26 per share.
On October 29, 2014, the Board of Directors adopted a 2014 Employee Stock Grant Plan (the “2014 Stock Grant Plan”) under which
shares of common stock not to exceed 13,500 were authorized to be granted to employees. On December 1, 2014, the Company
granted 50 shares of the Company’s common stock to each active full and part time employee. There were 12,850 shares granted
under the 2014 Stock Grant Plan at a fair value of $6.02 per share.
The total cost of these grants, which was included in salary expense in the Consolidated Statements of Operations, amounted to $77
thousand, $61 thousand and $46 thousand for the years ended December 31, 2014, 2013 and 2012, respectively. No additional shares
were granted under these plans.
114
The Board of Directors, upon the recommendation of the Compensation Committee, formally adopted a Long-Term Incentive
Compensation Plan (“LTIP”) on October 23, 2013. The LTIP 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 authorizes up to 1,200,000 shares of common stock for
issuance and 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. The Board approved
initial awards under the terms of the LTIP, which were granted to executives and key employees on March 1, 2014. The initial grant
was comprised solely of 45,750 shares of restricted stock. At December 31, 2014, there were 1,154,250 shares of common stock
available for award under the LTIP. For the year ended December 31, 2014, stock-based compensation expense totaled $93 thousand
and was included in salaries and employee benefits expense in the Consolidated Statements of Operations. Total unrecognized
compensation expense related to unvested restricted stock awards at December 31, 2014 was $214 thousand. On March 1, 2015, an
additional 84,900 shares of restricted stock were awarded under the LTIP.
The following table summarizes the activity related to the Company’s unvested restricted stock awards during the year ended
December 31, 2014.
2014
Weighted-
Average
Grant Date
Fair Value
Res tricted
S hares
Unves ted unres tricted s tock awards at January 1,
-
$
-
Awards granted
Forfeitures
Ves tings
45,750
-
-
6.70
-
-
Unves ted unres tricted s tock awards at December 31,
45,750
$
6.70
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 had been required to submit written progress reports to the OCC on a monthly basis. Effective April 10, 2014, the written
progress report requirement was changed from monthly to quarterly as of quarter-end March 31, 2014. The Committee has submitted
each of the required progress reports with the OCC. The members of the Committee are John P. Moses, William G. Bracey, Joseph
Coccia, Keith W. Eckel 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;
The Bank developed a Strategic Plan that it believes complies with the Order requirements The Strategic Plan for the three-year period
January 1, 2014 to December 31, 2016 was completed and submitted to the OCC for review in April 2014. The OCC issued a written
determination of supervisory non-objection to the Strategic Plan in June 2014. The Strategic Plan was adopted by the Board in June
2014. The Strategic Plan for the three-year period January 1, 2015 to December 31, 2017 was approved by the Board in January 2015.
The Company believes that the Bank continues to be in compliance with the Strategic Plan.
115
(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%. The Capital Plan for the three-year period
January 1, 2014 to December 31, 2016 was completed and forwarded to the OCC for review in April 2014. The OCC issued a written
determination of supervisory non-objection to the Capital Plan in June 2014. The Capital Plan was adopted by the Board in June
2014. The Capital Plan for the three-year period January 1, 2015 to December 31, 2017 was approved by the Board in January 2015.
The Company believes that the Bank continues to be in compliance witht the Capital Plan.
(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 15.42% at December 31, 2014, which was above the 13.00% required by the Order. The
Bank’s leverage capital ratio was 9.78% at December 31, 2014, which was above the 9.00% required by the Order. The Bank’s total
risk-based capital increased 199 basis points, while the Bank’s leverage ratio increased 146 basis points at December 31, 2014
compared to December 31, 2013.
(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 unless the Bank receives a
determination of no supervisory objection from the OCC.
On September 8, 2014, the Company sent to the OCC a request for a determination of no supervisory objection for a $1.0 million
capital distribution from the Bank to the Company to both cure the junior subordinated debentures interest deferral. The Company
received a determination of no supervisory objection from the OCC in November 2014. On December 8, 2014, the Bank made a
distribution to the Company in the amount of $1.0 million.
(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 has implemented those recommendations and believes it is in compliance with the requirements of
this provision. Louis A. DeNaples re-joined the Board in December 2013 and the Company’s Board of Directors in May 2014,
William G. Bracey was appointed to the Board and the Company’s Board of Directors in May 2014, and Keith W. Eckel was
appointed to the Board and the Company’s Board of Directors in September 2014. One of the Bank’s and the Company’s directors,
Joseph J. Gentile, passed away in August 2014.
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 (the “Management Study”), on October 13, 2010. The Management Study was forwarded to
the OCC on October 29, 2010. The Board 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. The Board believes that it has prepared or caused 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.
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;
116
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, 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, November 14, 2013 and November 26, 2014. The Board believes that is has adopted, implemented and
maintained compliance with a comprehensive Conflict of Interest Policy in accordance with the requirements of the provision.
(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 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 periodic Loan Policy revisions were approved by the Board from November
24, 2010 through November 2014 for purposes of continued compliance with this provision. The Board believes that it has taken
action to address the written credit policy requirements of the Order.
(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 substantial reduction in criticized assets.
In accordance with the requirements of the Order, since the date 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;
117
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 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",
OCC Bulletin 2013-28, “Uniform Agreement on the Classification and Appraisal of Securities Held by Depository Institutions” and
FDIC 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 provisions:
(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 of Directors 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. 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;
118
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. On September 8, 2014, the Company sent a request to the Reserve Bank to approve a dividend
from the Bank in the amount of $1.0 million. The dividend was to be used to cure the interest deferral on the junior subordinated
debentures. The Company received written non-objection to allow the $1.0 million dividend payment from the Bank and cure of the
interest deferral on the junior subordinated debentures in the amount of $921 thousand. The $1.0 million dividend payment from the
Bank to the Company and the interest deferral payment on the junior subordinated debentures was completed in December 2014. The
Company made a subsequent request for and has received approval from the Reserve Bank in to permit payment of the quarterly
interest payment on the junior subordinated debentures due March 15, 2015, which remains pending.
(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 junior subordinated debentures 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 junior
subordinated debentures without the written approval of the Reserve Bank and Director. Previously, the Company has not made any
payments of interest, principal or other amounts on either of the Company’s debentures or junior subordinated debentures since the
effective date of the Agreement.
On September 8, 2014, the Company sent to the Reserve Bank requests for approval for the Company to receive a $1.0 million capital
distribution from the Bank, and to make a distribution on the junior subordinated debentures to cure the interest deferral. The
Company received approval from the Reserve Bank in November 2014 to cure and pay the interest deferral. On December 15, 2014,
the Company paid all deferred and currently payable accrued interest totaling $921 thousand. On February 2, 2015, the Company
received approval from the Reserve Bank to pay the regular quarterly interest payment due on March 15, 2015.
(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 by the Bank from the Federal Home Loan Bank (“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 annual update and revision to the Capital Plan for the three-year period January 1, 2014 to December 31, 2016
was completed in conjunction with the annual budget and strategic planning initiatives and provided to the Reserve Bank in April
2014. The Company notified the Reserve Bank that the OCC issued a written determination of supervisory non-objection to the
Capital Plan in June 2014, and that the Bank’s Board of Directors adopted the plan in June 2014. The annual update and revision to
the Capital Plan for the three-year period January 1, 2015 to December 31, 2017 was completed in conjunction with the annual budget
and strategic planning initiatives. Both plans and the annual budget were approved by the Board of Directors in January 2015 and will
be provided to the Reserve Bank during its next regulatory review of the Company.
The Bank’s total risk-based capital ratio was 15.42% at December 31, 2014, which was above the 13.00% minimum required by the
Order. The Bank’s leverage ratio was 9.78% at December 31, 2014, which was also above the 9.00% required by the Order.
119
(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, timely 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. At the request of the Reserve Bank, the Company provided the Reserve Bank with an
updated cash flow projection for 2014-2016 in August of 2013. The cash flow projection for 2015 was delivered to the Federal
Reserve Bank in December 2014.
(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 under Section 18(k) of the FDI Act and Part
359 of the FDIC’s regulations. The Company has not made any such indemnification or severance payments since the effective date
of the Agreement without obtaining prior regulatory non-objection 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 of directors 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, 2014, 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 began 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
120
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 4.50%;
a Tier 1 capital ratio of 6.00% (increased from 4.00%);
a total capital ratio of 8.00% (unchanged from current rules); and
a Tier 1 leverage ratio of 4.00% for all institutions.
The Regulatory Capital Rules also establish a “capital conservation buffer” of 2.50% 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 7.00%;
a Tier 1 capital ratio of 8.50%; and
a total capital ratio of 10.50%.
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.
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 took 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 6.50%;
a Tier 1 risk-based capital ratio of 8.00% (increased from 6.00%);
a total risk-based capital ratio of 10.00% (unchanged from current rules); and
a Tier 1 leverage ratio of 5.00%.
The Regulatory Capital Rules set forth certain changes for the calculation of risk-weighted assets, which are required to be utilized
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 ratio equal to at least
13.00% of risk-weighted assets and a Tier I capital ratio equal to at least 9.00% of adjusted total assets. As of December 31, 2014, the
Bank met both the 13.00% minimum requirement for the total-risk based capital ratio and the 9.00% minimum requirement for the
Tier I leverage ratio. The minimum capital requirements under the Order take precedence over the standard regulatory capital
adequacy definitions described in the tables below.
121
The Company’s and the Bank’s actual capital positions, risk-weighted assets and total average assets for the Tier I leverage ratio at
December 31, 2014, 2013 and 2012 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
2014
De ce mber 31,
2013
2012
$
59,930
$
46,165
$
39,587
25,000
8,591
33,591
23,085
8,462
31,547
19,796
8,452
28,248
$
93,521
$
77,712
$
67,835
Total risk-weighted assets
$
683,956
$
670,894
$
665,323
Total average assets (for Tier 1 leverage ratio)
$
990,346
$
980,754
$
971,978
Bank
Tier I capital:
Total tier I capital
Tier II capital:
$
96,816
$
81,581
$
69,963
Allowable portion of allowance for loan losses
Total tier II capital
Total risk-based capital
8,587
8,587
8,456
8,456
8,447
8,447
$
105,403
$
90,037
$
78,410
Total risk-weighted assets
$
683,576
$
670,416
$
664,914
Total average assets (for Tier 1 leverage ratio)
$
990,407
$
980,747
$
971,620
122
The following tables present information regarding the Company’s risk-based capital ratios at December 31, 2014 and 2013:
Actual
For Capital
Adequacy Purposes
To Be Well
Capitalized
Under Prompt
Corrective
Action Provision
(dollars in thousands)
December 31, 2014
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
Amount
Ratio
Amount
Ratio
Amount
Ratio
$
$
93,521
105,403
$
$
59,930
96,816
$
$
59,930
96,816
13.67%
15.42%
8.76%
14.16%
6.05%
9.78%
$
$
>54,717
>54,686
$
$
>27,358
>27,343
$
$
>39,614
>39,616
>8.00%
>8.00%
>4.00%
>4.00%
>4.00%
>4.00%
N/A
>68,358
$
N/A
>41,015
$
N/A
>49,520
$
N/A
>10.00%
N/A
>6.00%
N/A
>5.00%
Actual
For Capital
Adequacy Purposes
To Be Well
Capitalized
Under Prompt
Corrective
Action Provision
(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
Amount
Ratio
Amount
Ratio
Amount
Ratio
$
$
77,712
90,037
$
$
46,165
81,581
$
$
46,165
81,581
11.58%
13.43%
6.88%
12.17%
4.71%
8.32%
$ >53,672
$ >53,633
$ >26,836
$ >26,817
$ >39,230
$ >39,230
>8.00%
>8.00%
>4.00%
>4.00%
>4.00%
>4.00%
N/A
$ >67,042
N/A
$ >40,225
N/A
$ >49,038
N/A
>10.00%
N/A
>6.00%
N/A
>5.00%
Note 18. FAIR VALUE MEASUREMENTS
In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches.
Accounting standards establish 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:
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 of financial
instruments not recorded at fair value, is set forth below.
123
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 CMOs, 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 Company owned one security issued by a state and political subdivision, with an amortized cost of $595 thousand at December
31, 2013, that was valued using level 3 inputs. This security had a credit rating that was 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. This security was
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 this investment security at the measurement dates. Broker pricing and bid/ask spreads are very
limited for this security. At December 31, 2013, the Company obtained a bid indication from a third-party municipal trading desk to
determine the fair value of this security. This security was repaid in its entirety during 2014.
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.
Loans Held For Sale
Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.
124
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 Company does not record mortgage servicing rights at fair value on a recurring basis.
Restricted 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 FHLB
advance rates currently offered for similar remaining maturities.
Borrowed funds
The Company uses discounted cash flows using rates currently available for debt with similar terms and remaining maturities 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.
Assets Measured at Fair Value on a Recurring Basis
The following tables present financial assets that are measured at fair value on a recurring basis at December 31, 2014 and 2013, and
the fair value hierarchy of the respective valuation techniques utilized by the Company to determine the fair value:
(in thous ands )
Available-for-s ale s ecurities :
Obligations of U.S. government agencies
Obligations of s tate and political s ubdivis ions
U.S. government/government-s pons ored agencies :
Collateralized mortgage obligations - res idential
Collateralized mortgage obligations - commercial
Res idential mortgage-backed s ecurities
Corporate debt s ecurities
Negotiable certificates of depos it
Equity s ecurities
Total available-for-s ale s ecurities
Fair Value Meas urements at December 31, 2014
Quoted Prices
in Active Markets
for Identical As s ets
(Level 1)
Significant
Obs ervable
Inputs
(Level 2)
Significant
Unobs ervable
Inputs
(Level 3)
Fair Value
$
29,276
24,509
-
$
-
$
29,276
24,509
-
$
-
26,231
61,256
74,098
420
2,232
967
218,989
$
-
-
-
-
-
967
967
$
26,231
61,256
74,098
420
2,232
-
218,022
$
-
-
-
-
-
-
$
-
125
(in thous ands )
Available-for-sale s ecurities :
Obligations of U.S. government agencies
Obligations of s tate and political s ubdivis ions
U.S. government/government-s pons ored agency:
Collateralized mortgage obligations - res idential
Collateralized mortgage obligations - commercial
Res idential mortgage-backed s ecurities
Corporate debt s ecurities
Negotiable certificates of depos it
Equity s ecurities
Total available-for-s ale s ecurities
Fair Value Meas urements at December 31, 2013
Quoted Prices
in Active Markets
for Identical As sets
(Level 1)
Significant
Obs ervable
Inputs
(Level 2)
Significant
Unobs ervable
Inputs
(Level 3)
Fair Value
-
$
78,054
-
$
-
$
-
77,483
-
$
571
3,221
31,578
89,656
407
-
951
203,867
$
-
-
-
-
-
951
951
$
3,221
31,578
89,656
407
-
-
202,345
$
-
-
-
-
-
-
571
$
There were no transfers between levels within the fair value hierarchy during the years ended December 31, 2014 and 2013.
The following table presents a 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), which consisted entirely of obligations of states and
political subdivisions, for the years ended December 31, 2014 and 2013:
Fair Value Meas urements
Us ing Significant Unobs ervable Inputs (Level 3)
(in thous ands )
Balance, January 1
Amortization
Accretion
Principal payments received
Sales and calls
Total gains or los s es (realized/unrealized):
Included in earnings
Included in other comprehens ive income
Balance, December 31,
Assets Measured at Fair Value on a Non-Recurring Basis
For the Years Ended December 31,
2014
2013
$
571
-
-
(571)
-
$
1,739
-
-
(570)
(622)
-
-
$
-
$
2
22
571
Collateral-dependent impaired loans are classified as Level 3 assets and the estimated fair value of the collateral is based on the
appraised 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 the Company’s acquisition of the property.
Subsequent to the Company’s acquisition, the balance may be written down further. It is the Company’s policy to obtain certified
external appraisals of real estate collateral underlying impaired loans and OREO, and estimate fair value using those appraisals. Other
valuation sources may be used, including broker price opinions, letters of intent and executed sale agreements.
126
The following tables present assets that are measured at fair value on a non-recurring basis at December 31, 2014 and 2013, and the
fair value hierarchy of the respective valuation technique utilized by the Company to determine fair value:
(in thousands)
Collateral-dependent impaired loans
Other real estate owned
Fair value (1)
$ 5,380
Assets (Level 1)
$ -
(Level 2)
$ -
(Level 3)
$ 5,380
$ 2,087
$ -
$ -
$ 2,087
Fair value measurements at December 31, 2014
Quoted Prices
in Active Markets
for Identical
Significant
Observable
Inputs
Significant
Unobservable
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, 2013
Quoted Prices
in Active Markets
for Identical
Significant
Observable
Inputs
Significant
Unobservable
Inputs
(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.
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, 2014 and 2013:
(in thousands)
Financial assets
Fair Value
December 31, 2014
December 31, 2013
Measurement
Carrying Value
Fair Value
Carrying Value
Fair Value
Cash and short term investments
Level 1
$
35,667
$
35,667
$
103,556
$
103,556
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
See previous table
218,989
218,989
203,867
203,867
Level 2
Level 2
Level 2
Level 3
Level 2
Level 3
Level 2
Level 2
Level 2
-
4,154
603
658,747
2,075
333
795,336
96,504
10,262
-
4,154
603
659,231
2,075
898
779,986
100,020
10,262
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
127
Note 19. EARNINGS PER SHARE
For the Company, the numerator of both the basic and diluted earnings per common share is net income available to common
shareholders (which is equal to net income less dividends on preferred stock and related discount accretion). The weighted average
number of common shares outstanding used in the denominator for basic earnings per common share is increased to determine the
denominator used for diluted earnings per common share by the effect of potentially dilutive common share equivalents utilizing the
treasury stock method. For the Company, common share equivalents are outstanding stock options to purchase the Company’s
common shares and unvested restricted stock.
The following table shows the calculation of both basic and diluted earnings per common share for the years ended December 31,
2014, 2013 and 2012:
(in thousands, except share data)
Net income (loss)
For the Year Ended December 31,
2014
2013
2012
$
13,420
$
6,382
$
(13,711)
Basic weighted-average number of common shares outstanding
16,472,660
16,458,353
16,442,160
Plus: common share equivalents
211
-
-
Diluted weighted-average number of common shares outstanding
16,472,871
16,458,353
16,442,160
Income (loss) per common share:
Basic
Diluted
$
0.81
$
0.39
$
(0.83)
$
0.81
$
0.39
$
(0.83)
For the year ended December 31, 2014, common share equivalents in the table above are related entirely to the incremental shares of
unvested restricted stock. Stock options of 64,479 shares, 82,598 shares and 129,170 shares, respectively for the years ended
December 31, 2014, 2013 and 2012 were excluded from common share equivalents. The exercise prices of stock options exceeded the
average market price of the Company’s common shares during the periods presented. Similarly, the weighted-average stock price for
the Company’s common stock for the year ended December 31, 2014 exceeded the fair market value of the restricted stock at the date
of grant, therefore, inclusion of these common share equivalents would be anti-dilutive to the diluted earnings per common share
calculation.
128
Note 20. OTHER COMPREHENSIVE INCOME (LOSS)
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, 2014, 2013 and 2012:
(in thous ands)
Available-for-s ale securities :
For the year Ended December 31, 2014
Amount Reclass ified
from Accumulated
Affected Line Item
Other Comprehens ive
in the Consolidated
Income (Loss )
Statements of Operations
Reclas sification adjustment for net (gains ) loss es reclas sified into net income
$
(6,272)
Net gain on s ale of s ecurities
Taxes
Net of tax amount
2,132
Income taxes
$
(4,140)
(in thous ands)
Available-for-s ale securities :
For the year Ended December 31, 2013
Amount Reclass ified
from Accumulated
Affected Line Item
Other Comprehens ive
in the Consolidated
Income (Loss )
Statements of Operations
Reclas sification adjustment for net (gains ) loss es reclas sified into net income
$
(2,887)
Net gain on s ale of s ecurities
Taxes
Net of tax amount
982
Income taxes
$
(1,905)
(in thous ands)
Available-for-s ale securities :
For the year Ended December 31, 2012
Amount Reclass ified
from Accumulated
Affected Line Item
Other Comprehens ive
in the Consolidated
Income (Loss )
Statements of Operations
Reclas sification adjustment for net (gains ) loss es reclas sified into net income
$
1,808
Net los s on s ale of securities
Taxes
Net of tax amount
(614)
Income taxes
$
1,194
The following table summarizes the changes in accumulated other comprehensive income (loss), net of tax for the years ended
December 31, 2014, 2013 and 2012:
2014
For the Ye ar Ende d De ce mbe r 31,
2013
$
$
2012
$
(3,092)
8,370
(4,140)
4,230
1,138
6,698
(7,885)
(1,905)
(9,790)
(3,092)
(3,967)
9,471
1,194
10,665
6,698
$
$
$
(in thousands)
Balance, January 1,
Other comprehensive income (loss) before reclassifications
Amounts reclassified from accumulated other comprehensive income (loss)
Net other comprehensive income (loss) during the period
Balance, December 31,
129
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:
Subordinated debentures
Junior subordinated debentures
Accrued interest payable
Other liabilities
Total liabilities
Shareholders’ equity
December 31,
2014
2013
$
462
$
254
370
98,286
276
364
78,995
107
$
99,394
$
79,720
$
25,000
$
25,000
10,310
9,903
2,783
47,996
51,398
10,310
8,307
2,525
46,142
33,578
Total liabilities and shareholders’ equity
$
99,394
$
79,720
Condensed Statements of Operations
(in thousands)
Income:
Dividends from subsidiaries
Income from trust
Other income
Total income (loss)
Expense:
Interest on subordinated notes
Interest on junior subordinated debentures
Other operating expenses
Other losses
Total expenses
(Loss) income before income taxes
Provision (credit) for income taxes
(Loss) income before equity in undistributed net income (loss) of subsidiary
Equity in undistributed net income (loss) of subsidiary
For the Year Ended December 31,
2014
2013
2012
$
1,000
$
-
$
-
6
275
1,281
2,281
236
128
276
2,921
(1,640)
-
(1,640)
15,060
6
-
6
2,281
204
123
2,500
5,108
(5,102)
-
(5,102)
11,484
7
-
7
2,288
224
-
-
2,512
(2,505)
-
(2,505)
(11,206)
Net income (loss)
$
13,420
$
6,382
$
(13,711)
130
Condensed Statements of Cash Flows
(in thousands)
Cash flows from operating activities:
Net income (loss)
For the Year Ended
2014
2013
2012
$
13,420
$
6,382
$
(13,711)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Equity in undistributed (income) loss of subsidiary
Equity in trust
Increase in accrued interest payable
Increase in other liabilities
Net cash provided by (used in) operating activities
Increase (decrease) in cash
Cash at beginning of year
Cash at end of year
(15,060)
(6)
1,596
258
208
208
254
(11,484)
(6)
2,485
2,522
(101)
(101)
355
11,206
(7)
2,512
2
2
2
353
$
462
$
254
$
355
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 (loss)
Income (loss) per share:
Basic
Diluted
(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
2014
Quarter Ended
March 31,
June 30,
September 30, December 31,
$
8,124
$
8,218
$
8,312
$
8,019
1,573
6,551
(1,570)
8,121
3,453
7,991
3,583
70
1,550
6,668
(4,005)
10,673
4,962
8,965
6,670
90
1,501
6,811
(54)
6,865
4,442
7,783
3,524
166
1,523
6,496
(240)
6,736
2,063
8,830
(31)
-
$
3,513
$
6,580
$
3,358
$
(31)
$
0.21
$
0.40
$
0.20
$
-
$
0.21
$
0.40
$
0.20
$
-
2013
Quarter Ended
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
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
131
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, 2014.
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, 2014.
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 2014 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 the Company’s 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.
Effective November 2014 the Company implemented the newly issued framework established in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in May 2013 (the “2013
Framework”). Prior to November 2014, the Company conducted assessments of the effectiveness of the Company’s internal control
over financial reporting based on criteria established in Internal Control – Integrated Framework issued by COSO in 1992 (the “1992
Framework”). As part of the transition, management compared the Company’s internal controls implemented under the 1992
Framework to the newly issued 2013 Framework and determined that based on the Company’s business no material gaps existed in
internal control.
As of December 31, 2014, management of the Company conducted an assessment of the effectiveness of the Company’s internal
control over financial reporting based on criteria established in the 2013 Framework. 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, 2014.
/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
132
Report of Independent Registered Public Accounting Firm
Stockholders and Board of Directors of
First National Community Bancorp, Inc. and Subsidiaries
We have audited First National Community Bancorp, Inc. and Subsidiaries’ (the “Company”) internal control over
financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework
(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s
management is responsible for maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal
Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over
financial reporting based on our audit.
We conducted our audit 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 effective
internal control over financial reporting was maintained in all material respects. Our audit of internal control over
financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that
a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on
the assessed risk. Our audit also included performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded
as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with authorizations of management
and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the consolidated statement of financial condition of First National Community Bancorp, Inc. and Subsidiaries as
of December 31, 2014 and the related consolidated statements of operations, comprehensive income (loss), changes in
shareholders’ equity, and cash flows for the year then ended, and our report dated March 13, 2015 expressed an
unqualified opinion.
/s/ Baker Tilly Virchow Krause, LLP
Wilkes-Barre, Pennsylvania
March 13, 2015
133
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.
134
Item 15. Exhibits and Financial Statement Schedules
1.
Financial Statements
PART IV
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 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+
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-Q for the
quarter ended September 30, 2014, as filed on November 10, 2014, 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.
Amended and Restated Declaration of Trust by and among Wilmington Trust Company. First National
Community Bancorp, Inc. and with individuals as administrators, 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.
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.
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 10.6
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.
135
EXHIBIT 10.7
EXHIBIT 10.8
EXHIBIT 10.9+
EXHIBIT 10.10+
EXHIBIT 10.11+
EXHIBIT 10.12+
EXHIBIT 10.13+
EXHIBIT 10.14+
EXHIBIT 10.15+
EXHIBIT 21
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.
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.
2013 Employee Stock Grant Plan – filed as Exhibit 10.18 to the Company’s Form 10-K for the year
ended December 31, 2013, as filed on March 24, 2014, is hereby incorporated by reference.
2014 Employee Stock Grant Plan – filed as Exhibit 10.1 to the Company’s Form 10-Q for the quarter
ended September 30, 2014, as filed on November 10, 2014 is hereby incorporated by reference.
Form of Restricted 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.
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 Baker Tilly Virchow Krause, LLP
EXHIBIT 23.1*
Consent of McGladrey LLP.
EXHIBIT 31.1*
Certification of Chief Executive Officer
EXHIBIT 31.2*
Certification of Chief Financial Officer
EXHIBIT 32**
Section 1350 Certification — Chief Executive Officer and Chief Financial Officer
EXHIBIT 101.INS
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_____________________________
* Filed herewith
** Furnished herewith
+ Management contract, compensatory plan or arrangement
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:
136
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 13, 2015
Date
March 13, 2015
Date
/s/ Stephanie A. Westington March 13, 2015
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 13, 2015
Date
/s/ William G. Bracey
William G. Bracey
March 13, 2015
Date
/s/ Joseph Coccia
Joseph Coccia
March 13, 2015
Date
/s/ Keith W. Eckel
Keith W. Eckel
March 13, 2015
Date
/s/ Louis A. DeNaples
Louis A. DeNaples
March 13, 2015
Date
/s/ Louis A. DeNaples, Jr.
Louis A. DeNaples, Jr.
March 13, 2015
Date
/s/ Dominick L. DeNaples
Dominick L. DeNaples
March 13, 2015
Date
Th
/s/ Thomas J. Melone
Thomas J. Melone
March 13, 2015
Date
/s/ John P. Moses
John P. Moses
March 13, 2015
Date
/s/ Steven R. Tokach
Steven R. Tokach
March 13, 2015
Date
137
EXHIBIT 23
Consent of Independent Registered Public Accounting Firm
We hereby consent to the incorporation by reference in Registration Statement on Form S-8 (No. 333-193545) of First
National Community Bancorp, Inc. and Subsidiaries of our reports dated March 13, 2015, relating to the consolidated
financial statements and the effectiveness of First National Community Bancorp, Inc. and Subsidiaries’ internal control
over financial reporting, which appear in this Form 10-K.
/s/ Baker Tilly Virchow Krause, LLP
Wilkes-Barre, Pennsylvania
March 13, 2015
EXHIBIT 23.1
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, 2014.
/s/ McGladrey, LLP
New Haven, Connecticut
March 12, 2015
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 13, 2015
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 13, 2015
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
In connection with the Annual Report of First National Community Bancorp, Inc. (“the Company”) on Form 10-K for the year ended
December 31, 2014 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Steven R. Tokach,
President and Chief Executive Officer of the Company, and I, James M. Bone, Jr., Executive Vice President and Chief Financial
Officer of the Company, pursuant to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes –Oxley Act of 2002,
that to the best of our knowledge:
1.
78m or 78o (d)); and
the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C.
2.
operations of the Company for the year ended December 31, 2014.
the information contained in the Report fairly presents, in all material respects, the financial condition and results of
Date: March 13, 2015
Date: March 13, 2015
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.
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2014 ANNUAL REPORT
C O N T E N T S
1
Chairman’s Message
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Financial Information
11
Bank Local
12
Commercial Banking
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Retail Banking
16
Retail Lending
17
Community Responsibility
18
Executive Leadership & Directors
F I R S T N A T I O N A L C O M M U N I T Y B A N K
Our Mission: Simply a better bank.TM
FNCB-AR14cover1.pdf 1 4/14/2015 1:26:39 PM
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Positioned For Success
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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
2014 Annual Report