ITEM 1. BUSINESS
Overview
Juniata Valley Financial Corp. (the “Company” or “Juniata”) is a Pennsylvania corporation formed in 1983 as a result of a plan of merger and reorganization of The Juniata Valley Bank (the “Bank”). The plan received regulatory approval on June 7, 1983, and Juniata, a one-bank holding company, registered under the Bank Holding Company Act of 1956. The Bank is the oldest independent commercial bank in Juniata and Mifflin Counties, having originated under a state bank charter in 1867. The Company has one reportable segment, consisting of the Bank, as described in Note 2 of The Notes to Consolidated Financial Statements.
Nature of Operations
Juniata operates primarily in central and northern Pennsylvania with the purpose of delivering financial services within its local markets. The Company provides retail and commercial banking services through 16 offices in the following locations: five community offices in Juniata County; five community offices and a financial services office in Mifflin County; two community offices in McKean County; one community office in each of Potter, Perry and Huntingdon Counties; and a loan production office in Centre County.
The Company offers a full range of consumer and commercial banking services. Consumer banking services include: online banking; mobile banking; telephone banking; automated teller machines; personal checking accounts; checking overdraft privileges; money market deposit accounts; savings accounts; debit cards; certificates of deposit; individual retirement accounts; secured lines of credit; construction and mortgage loans; and safe deposit boxes. Commercial banking services include low and high-volume business checking accounts; online account management services; remote deposit capability; ACH origination; payroll direct deposit; commercial lines of credit; commercial letters of credit; mobile deposit for small business customers; and commercial term and demand loans.
The Bank also provides comprehensive trust, asset management and estate services, and the Company has a contractual arrangement with a broker-dealer to offer a full range of financial services, including annuities, mutual funds, stock and bond brokerage services and long-term care insurance, to the Bank’s customers. Management believes the Bank has a relatively stable deposit base with no major seasonal depositor or group of depositors. Most of the Company’s commercial customers are small and mid-sized businesses in central and northern Pennsylvania.
Juniata’s loan underwriting policies are updated periodically and are presented for approval to the Board of Directors of the Bank. The purpose of the policies is to grant loans on a sound and collectible basis, to invest available funds in a safe, profitable manner, to serve the credit needs of the communities in Juniata’s primary market area and to ensure that all loan applicants receive fair and equal treatment in the lending process. It is the intent of the underwriting policies to seek to minimize loan losses by requiring careful investigation of the credit history of each applicant, verifying the source of repayment and the ability of the applicant to repay, securing those loans for which collateral is deemed to be required, exercising care in the documentation of the application, review, approval and origination process and administering a comprehensive loan collection program.
The major types of investments held by Juniata consist of obligations and securities issued by U.S. government agencies or corporations, obligations of state and local political subdivisions, mortgage-backed securities, subordinated debt and common stock. Juniata’s investment policy directs that investments be managed in a way that provides necessary funding for the Company’s liquidity needs and adequate collateral to pledge for public funds held, and as directed by the Asset Liability Committee, manages interest rate risk. The investment policy specifies the types of investments permitted to be owned, addresses credit quality of investments and includes limitations by investment types and issuer.
The Company’s primary source of funds is deposits, consisting of transaction type accounts, such as demand deposits and savings accounts, and time deposits, such as certificates of deposit. The majority of deposits are held by customers residing or located in Juniata’s market area. No material portion of the deposits has been obtained from a single or small group of customers, and the Company believes that the loss of any customer’s deposits or a small group of customers’ deposits would not have a material adverse effect on the Company.
Other sources of funds used by the Company include retail repurchase agreements, borrowings from the Federal Home Loan Bank of Pittsburgh, Federal Reserve Bank Paycheck Protection Program Liquidity Facility (“PPPLF”) advances and lines of credit established with various correspondent banks for overnight funding.
Competition
The Bank’s service area is characterized by a high level of competition for banking and financial services among commercial banks, varying in size from local community banks to regional and national banks, credit unions, savings and loan associations, and non-bank financial institutions, including fintech-based loan and deposit providers, located inside and outside the Bank’s market area. The Bank actively competes with dozens of such banks and institutions for local consumer and commercial deposit accounts, loans and other types of banking business. Many competitors have substantially greater financial resources and larger branch systems than those of the Bank.
In commercial transactions, the Company believes that the Bank’s legal lending limit to a single borrower (approximately $10,007,000 as of December 31, 2020) enables it to compete effectively for the business of small and mid-sized businesses. However, this legal lending limit is considerably lower than that of various competing institutions, and thus, may act as a constraint on the Bank’s effectiveness in competing for larger financings.
In consumer transactions, the Bank believes it can compete on a substantially equal basis with larger financial institutions because it offers competitive interest rates on deposit products and on loans.
In competing with other banks and financial institutions, the Bank seeks to provide personalized services through management’s knowledge and awareness of its service areas, customers and borrowers. In management’s opinion, larger institutions often do not provide comparable attention to the retail depositors and the relatively small commercial borrowers that comprise the Bank’s primary customer base.
Other competitors, including credit unions, consumer finance companies, fintech-based loan and deposit providers, insurance companies and money market mutual funds, compete with many of the lending and deposit services offered by the Bank. The Bank also competes with insurance companies, investment counseling firms, mutual funds and other business firms and individuals in corporate and trust investment management services.
Supervision and Regulation
General
The Company operates in a highly regulated industry and, thus, may be affected by changes in state and federal regulations and legislation. As a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”), the Company is subject to supervision and examination by the Board of Governors of the Federal Reserve System (“FRB”) and is required to file periodic reports and information regarding its business operations and those of the Bank with the FRB. In addition, under the Pennsylvania Banking Code of 1965, the Pennsylvania Department of Banking and Securities has the authority to examine the books, records and affairs of the Company and to require any documentation deemed necessary to ensure compliance with the Pennsylvania Banking Code.
The Bank Holding Company Act requires the Company to obtain FRB approval before: acquiring more than a five percent ownership interest in any class of the voting securities of any bank; acquiring all or substantially all the assets of a bank; or merging or consolidating with another bank holding company. In addition, the Bank Holding Company Act prohibits a bank holding company from acquiring the assets, or more than five percent of the voting securities, of a bank located in another state, unless such acquisition is specifically authorized by the statutes of the state in which the bank is located.
The Company is generally prohibited under the Bank Holding Company Act from engaging in, or acquiring, direct or indirect ownership or control of more than five percent of the voting shares of any company engaged in nonbanking activities unless the FRB, by order or regulation, has found such activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In making such determination, the FRB considers whether the performance of these activities by a bank holding company can reasonably be expected to produce benefits to the public that outweigh the possible adverse effects.
A satisfactory safety and soundness rating, particularly with regard to capital adequacy, and a satisfactory Community Reinvestment Act rating are generally prerequisites to obtaining federal regulatory approval to make acquisitions and open branch offices. As of December 31, 2020, the Bank was rated “satisfactory” under the Community Reinvestment Act and was a “well capitalized” bank. An institution’s Community Reinvestment Act rating is considered in determining whether to grant approvals relating to charters, branches and other deposit facilities, relocations, mergers, consolidations and acquisitions. Less than satisfactory performance may be the basis for denying an application.
There are various legal restrictions on the extent to which the Company and its non-bank subsidiaries can borrow or otherwise obtain credit from the Bank. In general, these restrictions require that any such extensions of credit must be secured by designated amounts of specified collateral and are limited, as to any one of the Company or such non-bank subsidiaries, to ten percent of the lending bank’s capital stock and surplus and, as to the Company and all such non-bank subsidiaries in the aggregate, to 20 percent of the Bank’s capital stock and surplus. Further, the Company and the Bank are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.
As a bank chartered under the laws of Pennsylvania, the Bank is subject to the regulations and supervision of the Federal Deposit Insurance Corporation (“FDIC”) and the Pennsylvania Department of Banking and Securities. These government agencies conduct regular safety and soundness and compliance reviews that have resulted in satisfactory evaluations to date. Some of the aspects of the lending and deposit business of the Bank that are regulated by these agencies include personal lending, mortgage lending and reserve requirements.
The operations of the Bank are also subject to numerous federal, state and local laws and regulations which set forth specific restrictions and procedural requirements with respect to interest rates on loans, the extension of credit, credit practices, the disclosure of credit terms and discrimination in credit transactions. The Bank also is subject to certain limitations on the amount of cash dividends that it can pay to the Company. See Note 14 of The Notes to Consolidated Financial Statements.
Under FRB policy, the Company is expected to act as a source of financial strength to the Bank, and to commit resources to support the Bank in circumstances where it might not be in a financial position to support itself. Consistent with the “source of strength” policy for subsidiary banks, the FRB has stated that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of cash dividends unless its net income available to common stockholders has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears to be consistent with the Company’s capital needs, asset quality and overall financial condition.
As a public company, the Company is subject to the Securities and Exchange Commission’s (“SEC”) rules and regulations relating to periodic reporting, proxy solicitation and insider trading.
On March 12, 2020, the SEC adopted amendments to the “accelerated filer” and “large accelerated filer” definitions pursuant to Rule 12b-2 under the Securities Exchange Act of 1934 in order to resolve an overlap that existed between the definitions related to accelerated filers and “smaller reporting companies,” with the focus to reduce disclosure and reporting obligations for lower-revenue smaller reporting companies. The final amendments were effective on, and apply to an annual report filing due on or after, April 27, 2020. The most notable impact of these amendments is that a smaller reporting company with less than $100 million in revenue that previously met the definition of an accelerated filer or large accelerated filer will not be required to obtain an attestation of their internal control over financial reporting as required under Section 404(b) of the Sarbanes-Oxley Act and will not be required to comply with the shorter SEC filing deadlines that apply to accelerated filers. Juniata qualifies as a smaller reporting company as of December 31, 2020 and is not required to obtain such an attestation and may comply with the shorter SEC filing deadlines.
FDIC Insurance
The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of federally insured banks and savings institutions and safeguards the safety and soundness of the banking and savings industries. The FDIC administers the Deposit Insurance Fund (“DIF”). The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) permanently raised the standard maximum deposit insurance coverage amount to $250,000 and made the increase retroactive to January 1, 2008. The FDIC deposit insurance coverage limit applies per depositor, per
insured depository institution for each account ownership category. The FDIC has been given greater latitude in setting the assessment rates for insured depository institutions which could be used to impose minimum assessments.
The FDIC is authorized to set the reserve ratios for the DIF annually at between 1.15% and 1.5% of estimated insured deposits. FDIC assessment rates currently range from 12 to 50 basis points. Institutions in the lowest risk category, Risk Category I, pay between 12 and 14 basis points. Initial base assessment rates range between 12 and 45 basis points (12 - 16 basis points for Category I). The initial base rates for risk categories II, III and IV were 20, 30 and 45 basis points, respectively. For institutions in any risk category, assessment rates rose above initial rates for institutions relying significantly on secured liabilities (repurchase agreements, Federal Home Loan Bank advances, secured Federal Funds purchased and other secured borrowings). Assessment rates increased for institutions with a ratio of secured liabilities to domestic deposits of greater than 15%, with a maximum of 50% above the rate before such adjustment.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd Frank Act”) revised the statutory authorities governing the FDIC’s management of the DIF. Key requirements from the Dodd-Frank Act have resulted in the FDIC’s adoption of amendments that: (1) redefined the assessment base used to calculate deposit insurance assessments to “average consolidated total assets minus average tangible equity”; (2) raised the DIF’s minimum reserve ratio to 1.35 percent and removed the upper limit on the reserve ratio; (3) revised adjustments to the assessment rates by eliminating one adjustment and adding another; and (4) revised the deposit insurance assessment rate schedules due to changes to the assessment base. Revised rate schedules and other revisions to the deposit insurance assessment rules became effective April 1, 2011. Though deposit insurance assessments maintain a risk-based approach, the FDIC’s changes effective April 1, 2011, impose a more extensive risk-based assessment system on large insured depository, institutions with at least $10 billion in total assets since they are more complex in nature and could pose greater risk. Due to the changes to the assessment base and assessment rates, as well as the DIF restoration time frame, the impact on the Company’s deposit insurance assessments resulted in lower premiums since 2011 and will likely continue in future years. In 2019, the Bank was allocated $160,000 in a small bank assessment credits and was permitted to use $102,000 during the year ended December 31, 2019. The Bank used the remaining $58,000 in credits in 2020.
Under the Dodd-Frank Act, the FDIC may terminate the insurance of an institution’s deposits upon finding that the institution has engaged in unsafe and unsound practices, is in an unsafe and unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. The Company does not know of any practice, condition or violation that might lead to termination of its deposit insurance.
In addition, all FDIC-insured institutions were required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, an agency of the Federal government established to finance resolutions of insolvent thrifts. These assessments ceased in 2019 as the Financing Corporation bonds fully matured.
Community Reinvestment Act
Under the Community Reinvestment Act, the Bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate-income neighborhoods. However, the Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its community. The Community Reinvestment Act also requires:
●the applicable regulatory agency to assess an institution’s record of meeting the credit needs of its community;
●public disclosure of an institution’s CRA rating; and
●that the applicable regulatory agency provides a written evaluation of an institution’s CRA performance utilizing a four-tiered descriptive rating system.
Capital Regulation
The Bank is subject to risk-based capital standards by which banks are evaluated in terms of capital adequacy. These regulatory capital requirements are administered by the federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators. Management believes, as of December 31, 2020, the Bank meets all capital adequacy requirements to which it is subject.
Prompt corrective action regulations provide five classifications: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end 2020 and 2019, the Bank was well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s capital category.
The United States is a member of the Basel Committee on Banking Supervision (the “Basel Committee”) that provides a forum for regular international cooperation on banking supervisory matters. The Basel Committee develops guidelines and supervisory standards and is best known for its international standards on capital adequacy. In December 2010, the Basel Committee released its final framework for strengthening international capital and liquidity regulation, officially identified by the Basel Committee as “Basel III”, which set capital standards that the Bank would otherwise be required to comply, if not for the federal banking agencies joint final rule in 2019 that provides an optional, simplified measure of capital adequacy, the community bank leverage ratio framework (“CBLR framework”), for qualifying community banking organizations, consistent with Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Economic Growth Act”). The final CBLR framework rule became effective on January 1, 2020 and the Bank elected to comply with the CBLR framework in 2020. In April 2020, the federal banking agencies issued an interim final rule that makes temporary change to the CBLR framework, pursuant to Section 4012 of the CARES Act, and a second interim final rule that provides a graduated increase in the community bank leverage ratio requirement after the expiration of the temporary changes implemented pursuant to Section 4012 of the CARES Act.
The community bank leverage ratio removes the requirement for qualifying banking organizations to calculate and report risk-based capital, but rather only requires compliance with a Tier 1 to average assets (“leverage”) ratio. Qualifying banking organizations that elect to use the CBLR framework and that maintain a leverage ratio of greater than required minimums will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the agencies’ capital rules (generally applicable rule) and, if applicable, will be considered to have met the well-capitalized ratio requirements for purposes of Section 38 of the Federal Deposit Insurance Act. Under the interim final rules, the community bank leverage ratio minimum requirement is 8.0% as of December 31, 2020, 8.5% for calendar year 2021, and 9.0% for calendar year 2022 and beyond. The interim rule allows for a two-quarter grace period to correct a ratio that falls below the required amount, provided the Bank maintains a leverage ratio of 7.0% as of December 31, 2020, 7.5% for calendar year 2021, and 8.0% for calendar year 2022 and beyond.
Under the final rule, an eligible banking organization can opt out of the CBLR framework and revert back to the risk-weighting framework without restriction. As of December 31, 2020, the Bank was a qualifying community banking organization as defined by the federal banking agencies and elected to measure capital adequacy under the CBLR framework. However, in the event an organization fails to meet the CBLR framework requirements, it will become subject to the Basel III capital requirements, described below.
The Bank is subject to risk-based and leverage capital standards. The risk-based capital standards relate a banking organization’s capital to the risk profile of its assets and require it to maintain Tier 1 capital of at least 4% of total risk-adjusted assets, and total capital, including Tier 1 capital, equal to at least 8% of total risk-adjusted assets. Tier 1 capital includes common stockholders’ equity and qualifying perpetual preferred stock together with related surpluses and retained earnings. The remaining portion of this capital standard, known as Tier 2 capital, may be comprised of limited life preferred stock, qualifying subordinated debt instruments and the reserves for possible loan losses.
Additionally, banking organizations must maintain a minimum leverage ratio of 3%, measured as the ratio of Tier 1 capital to adjusted average assets. This 3% leverage ratio is a minimum for the most highly rated banking organizations without any supervisory, financial or operational weaknesses or deficiencies. Other banking organizations are expected to maintain leverage capital ratios that are 100 to 200 basis points above such minimum, depending upon their financial condition.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (the "1991 Act"), a bank holding company is required to guarantee that any "undercapitalized" (as such term is defined in the statute) insured depository institution subsidiary will comply with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards as of the time the institution failed to comply with such capital restoration plan.
Federal banking agencies have broad powers to take corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are “well capitalized,” “adequately capitalized,” “undercapitalized”, “significantly undercapitalized,” or “critically undercapitalized.” As of December 31, 2020, the Bank was a “well-capitalized” bank, as defined by the FDIC.
The FDIC has issued a rule that sets the capital level for each of the five capital categories by which banks are evaluated. A bank is deemed to be “well capitalized” if the bank has a total risk-based capital ratio of 10% or greater, has a Tier 1 risk-based capital ratio of 6% or greater, has a leverage ratio of 5% or greater, and is not subject to any order or final capital directive by the FDIC to meet and maintain a specific capital level for any capital measure. A bank may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it received an unsatisfactory safety and soundness examination rating.
All of the bank regulatory agencies have issued rules that amend their capital guidelines for interest rate risk and require such agencies to consider in their evaluation of a bank’s capital adequacy the exposure of a bank’s capital and economic value to changes in interest rates. These rules do not establish an explicit supervisory threshold. The agencies intend, at a subsequent date, to incorporate explicit minimum requirements for interest rate risk into their risk-based capital standards and have proposed a supervisory model to be used together with bank internal models to gather data and hopefully propose at a later date, explicit minimum requirements.
The Basel III rules, among other things, narrow the definition of regulatory capital. Basel III requires bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. Specifically, Basel III requires financial institutions to maintain: (a) a minimum ratio of common equity tier 1 capital (CET1) to risk-weighted assets of at least 4.5%; (b) a minimum ratio of tier 1 capital to risk-weighted assets of at least 6.0%; (c) a minimum ratio of total (that is, tier 1 plus tier 2) capital to risk-weighted assets of at least 8.0%; and (d) a minimum leverage ratio of 3.0%, calculated as the ratio of tier 1 capital balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter). In addition, the rules also limit a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” of 2.5% above each of the foregoing capital requirements stated in (a) - (c). Basel III also provides for a “countercyclical capital buffer,” an additional capital requirement that generally is imposed when national regulators determine that excess aggregate credit growth has become associated with a buildup of systemic risk, in order to absorb losses during periods of economic stress. Banking institutions that maintain insufficient capital to comply with the capital conservation buffer face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.
Additionally, the Basel III framework requires banks and bank holding companies to measure their liquidity against specific liquidity tests, including a liquidity coverage ratio (“LCR”) designed to ensure that the banking entity maintains a level of unencumbered high-quality liquid assets greater than or equal to the entity’s expected net cash outflow for a 30-day time horizon under an acute liquidity stress scenario, and a net stable funding ratio (“NSFR”) designed to promote more medium and long-term funding based on the liquidity characteristics of the assets and activities of banking entities over a one-year time horizon. In September 2014, the federal regulatory agencies finalized rules implementing the LCR for U.S. financial institutions that are “internationally active banking organizations” and those generally with more than $250 billion in total consolidated assets. The FRB separately adopted a less stringent, modified LCR requirement for bank holding companies that have more than $50 billion in total consolidated assets. Because of the Company’s size, neither the LCR Rule nor any additional proposed rules under the Basel III liquidity framework are applicable to it.
The final rules apply to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more, and top-tier savings and loan holding companies (“banking organizations”).
Gramm-Leach-Bliley Act
On November 12, 1999, the Gramm-Leach-Bliley Act (“GLB”) became law. GLB permits commercial banks to affiliate with investment banks. It also permits bank holding companies which elect financial holding company status to engage in any type of financial activity, including securities, insurance, merchant banking/equity investment and other activities that are financial in nature. The Company has not elected financial holding company status. The merchant banking provisions of GLB allow a bank holding company to make a controlling investment in any kind of company, financial or commercial. GLB allows a bank to engage in virtually every type of activity currently recognized as financial or incidental or complementary to a financial activity. A commercial bank that wishes to engage in these activities is required to be well capitalized, well managed and to have a satisfactory or better Community Reinvestment Act rating. GLB also allows subsidiaries of banks to engage in a broad range of financial activities that are not permitted for banks themselves. Although the Company and the Bank have not commenced these types of activities to date, GLB enables them to evaluate new financial activities that would complement the products already offered to enhance non-interest income.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 implemented a broad range of corporate governance, accounting and reporting measures for companies, like Juniata, that have securities registered under the Securities Exchange Act of 1934. Specifically, the Sarbanes-Oxley Act and the various regulations promulgated under the Act, established, among other things: (i) requirements for audit committees, including independence, expertise, and responsibilities; (ii) additional responsibilities relating to financial statements for the Chief Executive Officer and Chief Financial Officer of reporting companies; (iii) standards for auditors and regulation of audits, including independence provisions that restrict non-audit services that accountants may provide to their audit clients; (iv) increased disclosure and reporting obligations for reporting companies and their directors and executive officers, including accelerated reporting of stock transactions and a prohibition on trading during pension blackout periods; and (v) a range of civil and criminal penalties for fraud and other violations of the securities laws. In addition, Sarbanes-Oxley required stock exchanges, such as NASDAQ, to institute additional requirements relating to corporate governance in their listing rules.
Section 404(b) of the Sarbanes-Oxley Act requires the Company to include in its Annual Report on Form 10-K a report by management on the adequacy of the Company’s internal control over financial reporting. Management’s internal control report must, among other things, set forth management’s assessment of the effectiveness of the Company’s internal control over financial reporting.
Due to the SEC’s recently adopted amendments to the “accelerated filer” and “large accelerated filer” definitions pursuant to Rule 12b-2 under the Securities Exchange Act of 1934, smaller reporting companies, such as Juniata, with less than $100 million in revenue that previously met the definition of an accelerated filer or large accelerated filer will not be required to obtain an attestation of their internal control over financial reporting as required under Section 404(b) of the Sarbanes-Oxley Act; thus no such attestation is included in this Annual Report on Form 10-K.
Financial Privacy
Federal banking regulators have adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. The privacy provisions of the GLB Act affect the Company by limiting how consumer information is transmitted and conveyed to outside vendors.
Anti-Money Laundering Initiatives and the USA Patriot Act
A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. U.S. federal laws and regulations, including the USA Patriot Act of 2001 (“USA Patriot Act”) imposes significant compliance and due diligence obligations, creates criminal and financial liability for non-compliance and expands the extra-territorial jurisdiction of the U.S. The United States Department of the Treasury has issued several regulations that apply various requirements of the USA Patriot Act to financial institutions. These regulations require financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Failure of a financial
institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all the relevant laws or regulations, could have serious legal and reputational consequences for the institution.
On January 1, 2021, the National Defense Authorization Act ("NDAA") was signed into law, which enacted significant changes to existing U.S. anti-money laundering (“AML”) laws. The NDAA includes: (i) significant changes to the collection of beneficial ownership and the establishment of a beneficial ownership registry, which requires certain corporate entities to report beneficial ownership information to the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”); (ii) enhanced whistleblower provisions, which provide that one or more whistleblowers who voluntarily provide original information leading to the successful enforcement of violations of the Bank Secrecy Act or other AML-related laws under certain circumstances will receive a percentage of the monetary sanctions collected and will receive increased protections; (iii) increased penalties for violations of the BSA; (iv) improvements to existing information sharing provisions that permit financial institutions to share information relating to suspicious activity for the purpose of combating illicit finance risks; and (v) expanded duties and powers of FinCEN. Many of the new provisions, including those with respect to beneficial ownership, require the Department of Treasury and FinCEN to promulgate rules.
Office of Foreign Assets Control Regulation
The U.S. has instituted economic sanctions which restrict transactions with designated foreign countries, nationals and others. These are typically known as the “OFAC rules” because they are administered by the Office of Foreign Assets Control of the U.S. Department of the Treasury (“OFAC”). The OFAC-administered sanctions target countries in various ways. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country, and prohibitions on “U.S. persons” engaging in financial transactions which relate to investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences for the institution. As U.S. financial institutions, the Company and the Bank are required to comply with the OFAC rules.
Consumer Protection Statutes and Regulations
The Company is subject to many federal consumer protection statutes and regulations, including the Truth in Lending Act, Truth in Savings Act, Equal Credit Opportunity Act, Fair Housing Act, Real Estate Settlement Procedures Act and Home Mortgage Disclosure Act. Among other things, these acts:
●require banks to disclose credit terms in meaningful and consistent ways;
●prohibit discrimination against an applicant in any consumer or business credit transaction;
●prohibit discrimination in housing-related lending activities;
●require banks to collect and report applicant and borrower data regarding loans for home purchases or improvement projects;
●require lenders to provide borrowers with information regarding the nature and cost of real estate settlements;
●prohibit certain lending practices and limit escrow account amounts with respect to real estate transactions; and
●prescribe possible penalties for violations of the requirements of consumer protection statutes and regulations.
On November 17, 2009, the FRB published a final rule amending Regulation E, which implements the Electronic Funds Transfer Act. The final rule limits the ability of a financial institution to assess an overdraft fee for paying automated teller machine transactions and one-time debit card transactions that overdraw a customer’s account, unless the customer affirmatively consents, or opts in, to the institution’s payment of overdrafts for these transactions.
Dodd-Frank Act
The Dodd-Frank Act resulted in significant financial regulatory reform. The Dodd-Frank Act also changed the responsibilities of the current federal banking regulators. Among other things, the Dodd-Frank Act created the Financial Oversight Council, with oversight authority for monitoring and regulating systemic risk, and the Consumer Financial Protection Bureau (“CFPB”), which has broad regulatory and enforcement powers over consumer financial products and
services. Effective July 21, 2011, the CFPB became responsible for administering and enforcing numerous federal consumer financial laws enumerated in the Dodd-Frank Act. The Dodd Frank Act also provided that, for banks with total assets of more than $10 billion, the CFPB would have exclusive or primary authority to examine those banks for, and enforce compliance with, the federal consumer financial laws. Although not subject to examination by the CFPB, the Company remains subject to the review and supervision of other applicable regulatory authorities, and such authorities may enforce compliance with regulations issued by the CFPB.
The scope of the Dodd-Frank Act impacts many aspects of the financial services industry, and it requires the development and adoption of numerous regulations, some of which have not yet been issued. The effects of the Dodd-Frank Act on the financial services industry will depend, in large part, upon the extent to which regulators exercise the authority granted to them under the Dodd-Frank Act and the approaches taken in implementing those regulations. Additional uncertainty regarding the effects of the Dodd-Frank Act exists due to court decisions and the potential for additional legislative changes to the Dodd-Frank Act.
The Dodd-Frank Act’s provisions that have received the most public attention have generally been those which apply only to larger institutions with total consolidated assets of $50 billion or more. However, the Dodd-Frank Act contains numerous other provisions that affect all bank holding companies, including the Company.
The following is a list of significant provisions of the Dodd-Frank Act, and, if applicable, the resulting regulatory rules adopted, that apply (or will apply), most directly to the Company and its subsidiary:
●Federal deposit insurance - On April 1, 2011, the FDIC’s revised deposit insurance assessment base changed from total domestic deposits to average total assets, minus average tangible equity.
●Debit card interchange fees - In June 2011, the FRB adopted regulations, which became effective on October 1, 2011, setting maximum permissible interchange fees issuers can receive or charge on electronic debit card transaction fees and network exclusivity arrangements.
●Interest on demand deposits - Beginning in July 2011, depository institutions were no longer prohibited from paying interest on business transaction and other accounts.
●Stress testing - In October 2012, the FRB issued final rules regarding company-run stress testing, which were amended by the Economic Growth Act. In accordance with these rules, a company whose assets exceed $10 billion is required to conduct an annual stress test in the manner specified, and using assumptions for baseline, adverse and severely adverse scenarios announced by the FRB. The stress test is designed to assess the potential impact of various scenarios on a company’s earnings, capital levels and capital ratios over at least a nine-quarter time horizon. If applicable, the Company’s board of directors and its senior management are required to consider the results of the stress test in the normal course of business, including as part of its capital planning process and the evaluation of the adequacy of its capital. The Economic Growth Act raised the asset threshold for the stress testing requirement to apply to companies with assets above $100 billion. While the Company believes that both the quality and magnitude of its capital base are sufficient to support its current operations given its risk profile, this requirement is not applicable to the Company because its assets are under $100 billion.
●Ability-to-pay rules and qualified mortgages - As required by the Dodd-Frank Act, the CFPB issued a series of final rules in January 2013 amending Regulation Z, implementing the Truth in Lending Act, by requiring mortgage lenders to make a reasonable and good faith determination, based on verified and documented information, that a consumer applying for a residential mortgage loan has a reasonable ability to repay the loan according to its terms. These final rules, most of which became effective January 10, 2014, prohibit creditors, such as the Company, from extending residential mortgage loans without regard for the consumer’s ability to repay and add restrictions and requirements to residential mortgage origination and servicing practices. In addition, these rules restrict the imposition of prepayment penalties and compensation practices relating to residential mortgage loan origination. Mortgage lenders are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the mortgage lender to consider eight underwriting factors when making the credit decision. Alternatively, the mortgage lender can originate "qualified mortgages," which are
entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a "qualified mortgage" is a residential mortgage loan that does not have certain high-risk features, such as negative amortization, interest-only payments, balloon payments, or a term exceeding 30 years. In addition, to be a qualified mortgage, the points and fees paid by a consumer cannot exceed 3% of the total loan amount, and the borrower’s total debt-to-income ratio must be no higher than 43% (subject to certain limited exceptions for loans eligible for purchase, guarantee or insurance by a government sponsored entity or a federal agency).
Compliance with these rules has increased Juniata’s overall regulatory compliance costs and required changes to the underwriting practices of the Company with respect to mortgage loans.
●Integrated disclosures under the Real Estate Settlement Procedures Act and the Truth in Lending Act - In December 2013, the CFPB issued final rules revising and integrating previously separate disclosures required under the Real Estate Settlement Procedures Act (“RESPA”) and the Truth in Lending Act (“TILA”) in connection with certain closed-end consumer mortgage loans. These final rules became effective August 1, 2015 and require lenders to provide a new Loan Estimate, combining content from the former Good Faith Estimate required under RESPA and the initial disclosures required under TILA not later than the third business day after submission of a loan application, and a new Closing Disclosure, combining content of the former HUD-1 Settlement Statement required under RESPA and the final disclosures required under TILA at least three days prior to the loan closing.
●Volcker Rule - As mandated by the Dodd-Frank Act, in December 2013, the OCC, FRB, FDIC, SEC and Commodity Futures Trading Commission issued a final rule (the "Final Rules") implementing certain prohibitions and restrictions on the ability of a banking entity and non-bank financial company supervised by the FRB to engage in proprietary trading and have certain ownership interests in, or relationships with, a "covered fund" (the so-called "Volcker Rule"). The Final Rules generally treat as a covered fund any entity that would be an investment company under the Investment Company Act of 1940 (the "1940 Act") but for the application of the exemptions from SEC registration set forth in Section 3(c)(1) (fewer than l00 beneficial owners) or Section 3(c)(7) (qualified purchasers) of the 1940 Act. The Final Rules also require regulated entities to establish an internal compliance program that is consistent with the extent to which it engages in activities covered by the Volcker Rule, which must include making regular reports about those activities to regulators. Although the Final Rules provide some tiering of compliance and reporting obligations based on size, the fundamental prohibitions of the Volcker Rule apply to banking entities of any size, including the Company.
While the Company does not engage in proprietary trading or in any other activities prohibited by the Final Rules, the Company will continue to evaluate whether any of its investments fall within the definition of a "covered fund" and would need to be disposed of by the extended deadline. However, based on the Company’s evaluation to date, it does not currently expect that the Final Rules will have a material effect on its business, financial condition or results of operations.
●Incentive compensation - As required by the Dodd-Frank Act, a joint interagency proposed regulation was issued in April 2011. The proposed rule would require the reporting of incentive-based compensation arrangements by a covered financial institution and prohibit incentive-based compensation arrangements at a covered financial institution that provides excessive compensation or that could expose the institution to inappropriate risks that could lead to material financial loss. The proposed rule, if adopted as currently proposed, could limit the way the Company structures incentive compensation for its executives.
National Monetary Policy
In addition to being affected by general economic conditions, the earnings and growth of the Bank and, therefore, the earnings and growth of the Company, are affected by the policies of regulatory authorities, including the FRB and the FDIC. An important function of the FRB is to regulate the money supply and credit conditions. Among the instruments used to implement these objectives are open market operations in U.S. government securities, setting the discount rate and changes in financial institution reserve requirements. These instruments are used in varying combinations to influence overall growth and distribution of credit, bank loans, investments and deposits, and their use may also affect interest rates charged on loans or paid on deposits.
The monetary policies and regulations of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon the future businesses, earnings and growth of the Company cannot be predicted with certainty.
Tax Cuts and Jobs Act
On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was signed into law. Among other changes, the TCJA significantly changed corporate income tax law by reducing the corporate income tax rate from 35% to 21%, allowing for immediate capital expensing of certain qualified property and eliminating the deductibility of DIF assessments. The tax laws were generally effective for the 2018 tax year; however, the Company recognized certain effects of the changes in 2017, which was when the new legislation was enacted.
Coronavirus Aid, Relief, and Economic Security Act
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law, temporarily suspending certain requirements under U.S. GAAP. The CARES Act permits the suspension of ASC 310-40 for loan modifications that are made by financial institutions in response to the COVID-19 pandemic if (1) the borrower was not more than 30 days past due as of December 31, 2019, and (2) the loan modification is made between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the end of the coronavirus emergency declaration. A loan modification accounted for in accordance with the CARES Act is not treated as a TDR for accounting or disclosure purposes. The Consolidated Appropriations Act, 2021 ("Appropriations Act") was signed into law on December 27, 2020 and extends this temporary relief until the earlier of 60 days after the termination date of the national emergency or January 1, 2022.
In response to the COVID-19 pandemic, the Company established a COVID-19 Modification Program on March 20, 2020 to offer payment relief to certain borrowers. Through this program, the Company has approved interest and/or principal payment deferrals on loans for individuals and businesses affected by the economic impacts of the COVID-19 pandemic.
On April 7, 2020, the banking agencies issued a statement, “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working With Customers Affected by the Coronavirus (Revised)” (“Interagency Statement”), to encourage banks to work prudently with borrowers and to describe the agencies’ interpretation of how accounting rules under ASC 310-40 apply to certain COVID-19-related modifications. The interagency statement interpreted, but did not suspend, ASC 310-40. It indicates that a lender can conclude that a borrower is not experiencing financial difficulty if either (1) short-term (i.e. six months) modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented, or (2) the modification or deferral program is mandated by the federal government or a state government. Accordingly, any loan modification made in response to the COVID-19 pandemic that meets either of these practical expedients would not be considered a TDR because the borrower is not experiencing financial difficulty.
On August 3, 2020, the Federal Financial Institutions Examination Council (“FFIEC”) issued the Joint Statement on Additional Loan Accommodations Related to COVID-19 to provide prudent risk management and consumer protection principles for financial institution to consider while working with borrowers as loans near the end of initial loan accommodation periods applicable during the pandemic. If a financial institution elects to account for a loan modification under Section 4013 of the CARES Act, an additional loan modification could also be eligible under Section 4013. If a financial institution does not elect to account for a loan modification under Section 4013, an additional modification should be viewed cumulatively in determining whether the additional modification is a TDR. If a loan modification was previously elected under the Interagency Statement, subsequent qualifying loan modifications may be accounted for under Section 4013 of the CARES Act.
As part of the CARES Act, and in recognition of the challenging circumstances faced by small businesses, Congress created the Paycheck Protection Program (“PPP”), in which the Company is a participating lender. PPP covered loans are fully guaranteed as to principal and accrued interest by the SBA, and therefore, require a zero percent risk weight for risk-based capital requirements. The SBA reimburses PPP lenders for any amount of a PPP covered loan that is forgiven. PPP lenders are not held liable for any representations made by PPP borrowers in connection with a borrower's request for PPP
covered loan forgiveness. As of December 31, 2020, Juniata funded 508 PPP loans through the SBA, for a total of $32,064,000. As of December 31, 2020, 47 loans, totaling $3,349,000, had been forgiven by the SBA.
To provide liquidity to small business lenders and the broader credit markets, and to help stabilize the financial system, on April 7, 2020, the Federal Reserve Banks extended credit to financial institutions under the Paycheck Protection Program Liquidity Facility (“PPPLF”). Under the PPPLF, each Federal Reserve Bank can extend non-recourse loans to institutions eligible to make PPP covered loans. Under the PPPLF, only PPP covered loans guaranteed by the SBA under the Paycheck Protection Program with respect to both principal and interest and that are originated by an eligible institution may be pledged as collateral to the Federal Reserve Banks. The Company received $31,298,000 in PPPLF advances with a two year term in June 2020. Since some PPP loans collateralizing the advances have been forgiven, the Company has begun repaying the advances, and as of December 31, 2020, $27,955,000 remained.
Employees
As of December 31, 2020, the Company had a total of 127 full-time and 40 part-time employees.
Additional Information
The Company files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). Our SEC filings are available on the SEC’s website (http://www.sec.gov).
The Company’s common stock is quoted under the symbol “JUVF” on the Pink Open Market, an electronic inter-dealer quotation and trading system available through, and governed by, the NASDAQ system. You may also read reports, proxy statements and other information we file at the offices of the National Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington, DC 20006.
The Company’s website is www.JVBonline.com. At that address, we make available, free of charge, the Company’s Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act (see “Investor Information” section of website), as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
In addition, we will provide, at no cost, paper or electronic copies of our reports and other filings made with the SEC (except for exhibits). Requests should be directed to JoAnn N. McMinn, Chief Financial Officer, Juniata Valley Financial Corp., P.O. Box 66, Mifflintown, PA 17059, (855) 582-5101.
The information on the websites listed above is not, and should not be deemed to be, part of this Annual Report on Form 10-K and is not incorporated by reference in this document.
ITEM 1A.
ITEM 1A. RISK FACTORS
An investment in the Company's common stock involves certain risks, including, among others, the risks described below. In addition to the other information contained in this report, you should carefully consider the following risk factors in analyzing whether to make or to continue an investment in the Company:
RISKS RELATED TO INTEREST RATES AND LIQUIDITY
Fluctuations in market interest rates, particularly in a continuing period of low market interest rates, and relative balances of rate-sensitive assets to rate-sensitive liabilities, can negatively impact net interest margin and net interest income.
The operations of financial institutions such as the Company are dependent to a large degree on net interest income, which is the difference between interest income from loans and investments and interest expense on deposits and borrowings.
An institution's net interest income is significantly affected by market rates of interest that, in turn, are affected by prevailing economic conditions, by the fiscal and monetary policies of the federal government and by the policies of
various regulatory agencies. The FRB regulates the national money supply to manage recessionary and inflationary pressures. In doing so, the FRB may use techniques such as engaging in open market transactions of U.S. Government securities, changing the discount rate and changing reserve requirements against bank deposits. The use of these techniques may also affect interest rates charged on loans and paid on deposits. The interest rate environment, which includes both the level of interest rates and the shape of the U.S. Treasury yield curve, has a significant impact on net interest income.
Low market interest rates have pressured the net interest margin in recent years. Interest-earning assets, such as loans and investments, have been originated, acquired or repriced at lower rates, reducing the average rate earned on those assets. While the average rate paid on interest-bearing liabilities, such as deposits and borrowings, has also declined, the decline has not always occurred at the same pace as the decline in the average rate earned on interest-earning assets, resulting in a narrowing of the net interest margin.
Competition sometimes requires the Company to lower rates charged on loans more than the decline in market rates would otherwise indicate. Competition may also require the Company to pay higher rates on deposits than market rates would otherwise indicate. Thus, although loan demand has improved in recent years, intense competition among lenders has continued to place downward pressure on loan yields, also narrowing the net interest margin. Further, due to historically low market interest rates, rates paid on deposits have tended to reach a natural floor below which it is difficult to further reduce such rates.
Like all financial institutions, the Company's consolidated statement of financial condition is affected by fluctuations in interest rates. Volatility in interest rates can also result in disintermediation, which is the flow of deposits away from financial institutions into direct investments, such as U.S. Government and corporate securities and other investment vehicles, including mutual funds, which, because of the absence of federal insurance premiums and reserve requirements, generally pay higher rates of return than bank deposit products. See "Item 7: Management's Discussion of Financial Condition and Results of Operations”.
See the section entitled “Interest Rate Risk” and “Table 5 - Maturity Distribution” in Management’s Discussion and Analysis of Financial Condition, for the maturity distribution and cumulative sensitivity ratio of the Company’s interest earning assets and interest bearing liabilities.
Capital and liquidity strategies, including the impact of the capital and liquidity requirements implemented by the Basel III standards, may require the Company to maintain higher levels of capital, which could restrict the amount of capital that the Company has available to deploy for income generating and other activities.
In July 2013, the FRB approved the final rules implementing the Basel III capital standards (the “Basel III Rules”) which substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions. See previous Capital Regulation discussion.
As of December 31, 2020, the Company believes it meets all capital adequacy requirements to which it is subject. However, the new rules, which began January 1, 2015 and fully phased in on January 1, 2019, effectively require financial institutions to maintain higher capital levels than was previously required. As a result, Juniata may have to maintain capital in the form of assets that contribute less income to Juniata and that are not available for deployment as loans or other interest-income generating assets, funding of capital projects or other growth initiatives.
Competition, including competition on rates of deposit and for loan growth, may negatively impact the Company’s net interest margin.
There is significant competition among banks in the market areas served by the Company. In addition, as a result of deregulation of the financial industry, the Bank also competes with other providers of financial services, such as savings and loan associations, credit unions, consumer finance companies, securities firms, insurance companies, the mutual funds industry, fintech-based loan and deposit providers, full service brokerage firms and discount brokerage firms, some of which are subject to less extensive regulations than the Company with respect to the products and services they provide. Some of the Company’s competitors have greater resources than the Company and, as a result, may have higher lending limits and may offer other services not offered by the Company. See "Item 1: Business - Competition." Competition may
adversely affect the rates the Company pays on deposits and charges on loans, thereby potentially adversely affecting the Company’s profitability. The Company’s profitability depends upon its continued ability to successfully compete in the markets it serves. Further, intense competition among lenders can contribute to downward pressure on loan yields.
Changes in interest rates or disruption in liquidity markets may adversely affect the Company’s sources of funding.
The Company must maintain enough sources of liquidity to meet the demands of its depositors and borrowers, support its operations and meet regulatory expectations. The Company’s liquidity practices emphasize core deposits and repayments and maturities of loans and investments as its primary sources of liquidity. These primary sources of liquidity can be supplemented by Federal Home Loan Bank (“FHLB”) advances, borrowings from the Federal Reserve Bank and lines of credit from correspondent banks. Lower-cost, core deposits may be adversely affected by changes in interest rates, and secondary sources of liquidity can be costlier to the Company than funding provided by deposit account balances having similar maturities. In addition, adverse changes in the Company’s results of operations or financial condition, regulatory actions involving the Company, or changes in regulatory, industry or market conditions could lead to increases in the cost of these secondary sources of liquidity, the inability to refinance or replace these secondary funding sources as they mature, or the withdrawal of unused borrowing capacity under these secondary funding sources.
While the Company attempts to manage its liquidity through various techniques, the assumptions and estimates used do not always accurately forecast the impact of changes in customer behavior. For example, the Company may face limitations on its ability to fund loan growth if customers move funds out of the Bank’s deposit accounts in response to increases in interest rates. In the years following the 2008 financial crisis, even as the general level of market interest rates remained low by historical standards, depositors frequently avoided higher-yielding and higher-risk alternative investments, in favor of the safety and liquidity of non-maturing deposit accounts. These circumstances contributed to significant growth in non-maturing deposit account balances at the Company, and at depository financial institutions generally. In a rising rate environment, customers may become more sensitive to interest rates when making deposit decisions and considering alternative opportunities. This increased sensitivity to interest rates could cause customers to move funds into higher-yielding deposit accounts offered by the Company’s bank subsidiary, require the Company’s bank subsidiary to offer higher interest rates on deposit accounts to retain customer deposits or cause customers to move funds into alternative investments or deposits of other banks or non-bank providers. Technology and other factors have also made it more convenient for customers to transfer low-cost deposits into higher-cost deposits or into alternative investments or deposits of other banks or non-bank providers. Such movement of customer deposits could increase the Company’s funding costs, reduce its net interest margin and/or create liquidity challenges.
Market conditions have been negatively impacted by disruptions in the liquidity markets in the past, and such disruptions or an adverse change in the Company's results of operations or financial condition could, in the future, have a negative impact on secondary sources of liquidity. If the Company is not able to continue to rely primarily on customer deposits to meet its liquidity and funding needs, continue to access secondary, non-deposit funding sources on favorable terms or otherwise fails to manage its liquidity effectively, the Company’s ability to continue to grow may be constrained, and the Company’s liquidity, operating margins, results of operations and financial condition may be materially adversely affected.
Regulators are increasingly emphasizing liquidity planning at both the bank and Company levels.
Due to regulatory limitations on the Corporation’s ability to rely on short-term borrowings, any significant movements of deposits away from traditional depository accounts which negatively impacts the Corporation’s loan-to-deposit ratio could restrict its ability to achieve growth in loans or require the Corporation to pay higher interest rates on deposit products in order to retain deposits to fund loans.
Liquidity must also be managed at the holding company level. Banking regulators scrutinize liquidity at the holding company level, in addition to consolidated and bank liquidity levels. For safety and soundness reasons, banking regulations limit the amount of cash that can be transferred from subsidiary banks to the parent company in the form of loans and dividends. Generally, these limitations are based on a subsidiary bank’s regulatory capital levels and net income. These factors have affected some institutions' ability to pay dividends and have required some institutions to establish borrowing facilities at the holding company level.
COMPLIANCE AND REGULATORY RISKS
The increasing time and expense associated with regulatory compliance and risk management could negatively impact our results of operations.
The time, expense and internal and external resources associated with regulatory compliance continue to increase. Thus, balancing the need to address regulatory changes and effectively managing growth in non-interest expenses has become more challenging than it has been in the past.
The Company and the Bank are extensively regulated under federal and state banking laws and regulations that are intended primarily for the protection of depositors, federal deposit insurance funds and the banking system. In general, these laws and regulations establish: the eligible business activities for the Company; certain acquisition and merger restrictions; limitations on intercompany transactions such as loans and dividends; capital adequacy requirements; requirements for anti-money laundering programs; consumer lending and other compliance requirements. While these statutes and regulations are generally designed to minimize potential loss to depositors and the FDIC insurance funds, they do not eliminate risk, and compliance with such statutes and regulations increases the Company’s expense, requires management’s attention and can be a disadvantage from a competitive standpoint with respect to non-regulated competitors and larger bank competitors.
Compliance with banking statutes and regulations is important to the Company's ability to engage in new activities and to consummate additional acquisitions. Bank regulators are scrutinizing banks through longer and more extensive bank examinations in both the safety and soundness and compliance areas. The results of such examinations could result in a delay in receiving required regulatory approvals for potential new activities and transactional matters. If the Company's compliance record would be determined to be unsatisfactory, such approvals may not be able to be obtained. Federal and state banking regulators also possess broad powers to take supervisory actions, as they deem appropriate. These supervisory actions may result in higher capital requirements, higher deposit insurance premiums and limitations on the Company's operations that could have a material adverse effect on its business and profitability.
In addition, the Company is subject to changes in federal and state tax laws as well as changes in banking and credit regulations, accounting principles, governmental economic and monetary policies and collection efforts by taxing authorities.
Financial reform legislation is likely to have a significant impact on the Company’s business and results of operations; however, until more implementing regulations are adopted, the extent to which the legislation will impact the Company is uncertain.
In July 2010, the President of the United States signed into law the Dodd-Frank Act. Among other things, the Dodd-Frank Act created the Financial Stability Oversight Council, with oversight authority for monitoring and regulating systemic risk, and the CFPB, which has broad regulatory and enforcement powers over consumer financial products and services. The Dodd-Frank Act also changed the responsibilities of the current federal banking regulators, imposed additional corporate governance and disclosure requirements in areas such as executive compensation and proxy access, and restricted private equity activities of banks.
The scope of the Dodd-Frank Act impacted many aspects of the financial services industry. However, its implementation requires the development and adoption of many regulations, some of which have not yet been proposed, adopted or fully implemented. The ultimate effect of the Dodd-Frank Act on the financial services industry will depend, in large part, upon the extent to which regulators exercise the authority granted to them under the Dodd-Frank Act and the approaches taken in implementing regulations. Additional uncertainty regarding the effect of the Dodd-Frank Act exists due to court decisions and the potential for additional legislative changes to the Dodd-Frank Act. The delay in the implementation of many of the regulations mandated by the Dodd-Frank Act has resulted in a lack of clear regulatory guidance to banks. The resulting uncertainty has caused banks to take a cautious approach to business initiatives and planning. The Company has been impacted, and will likely continue to be in the future, by the so-called Durbin Amendment to the Dodd-Frank Act, which reduced debit card interchange revenue of banks and revised deposit insurance assessments. It also is likely to be
impacted by the Dodd-Frank Act in the areas of corporate governance, capital requirements, risk management, stress testing and regulation under consumer protection laws.
Pursuant to the Dodd-Frank Act, the CFPB was given rulemaking authority over most providers of consumer financial services in the U.S., examination and enforcement authority over the consumer operations of large banks, as well as interpretive authority with respect to numerous existing consumer financial services regulations. The CFPB began exercising these oversight authorities over the largest banks during 2011.
In January 2013, the CFPB issued a series of final rules related to mortgage loan origination and mortgage loan servicing, most provisions of which became effective January 10, 2014. These rules prohibit creditors, such as the Bank, from extending residential mortgage loans without regard for the consumer's ability to repay, provide certain safe harbor protections for the origination of loans that meet the requirements for a "qualified mortgage," add restrictions and requirements to residential mortgage origination and servicing practices and restrict the imposition of prepayment penalties and compensation practices relating to residential mortgage loan origination. Compliance with these rules has increased the Company’s overall regulatory compliance costs and required the Bank to change its underwriting practices. Moreover, these rules may adversely affect the volume of mortgage loans that the Bank originates and may subject it to increased potential liability related to its residential loan origination activities. In December 2013, the CFPB issued final rules revising and integrating previously separate disclosures required under the Truth in Lending Act and RESPA in connection with closed-end consumer mortgages. These final rules became effective August 1, 2015, and compliance with these rules required the Corporation to adapt its systems and procedures to accommodate the use of new disclosure forms to be provided to closed-end consumer mortgage borrowers at the time of application and at the time of closing for those loans within the timeframes required under these new rules.
RISKS RELATED TO OPERATIONS
The outbreak of the COVID-19 pandemic has adversely affected, and may continue to adversely affect, the Company’s business, results of operations and financial conditions for an indefinite period.
Beginning in the first quarter of 2020, the COVID-19 pandemic has caused disruption in economic and social activity, both globally and in the United States. The spread of COVID-19, and the related government actions to mandate or encourage temporary closures of businesses, quarantines, social distancing and "stay at home" orders, have caused severe disruptions in the U.S. economy, which has and will likely continue to, in turn, disrupt the business, activities, and operations of the Company’s customers, as well as the Company’s own business and operations.
The national public health crisis arising from the COVID-19 pandemic (and public expectations about it), combined with certain pre-existing factors, including, but not limited to, international trade disputes, inflation risks, and oil price volatility, could further destabilize the financial markets and the economies of the geographic markets in which the Company operates. The resulting impacts of the pandemic on consumers, including the sudden, significant increase in the unemployment rate, is expected to cause changes in consumer and business spending, borrowing needs and saving habits, which will likely affect the demand for loans and other products and services the Company offers, as well as the creditworthiness of current and prospective borrowers. The significant decrease in commercial activity and disruptions in supply chains associated with the pandemic, both nationally and in the Company’s markets, may cause customers, vendors, and counterparties to be unable to meet existing payment or other obligations to the Company.
The Company’s business is dependent upon the willingness and ability of its customers to conduct banking and other financial transactions. The pandemic has limited, and may continue to limit, customer demand for many banking products and services. Many companies and residents in the Company’s market areas have been subject to mandatory "non-essential business" shutdowns and stay at home orders, as well as additional restrictions, which have reduced banking activity across the Company’s market areas. In response to these mandates, the Company has temporarily limited most locations to drive-up and ATM services, with lobby access available by appointment only, reduced hours of operation at some locations, temporarily closed some locations and encouraged the Company’s customers to use electronic banking platforms. The Company expects these measures to remain in place for an undetermined period of time. The Company has and may continue to offer payment deferrals, forbearances, fee waivers, and other forms of assistance to commercial, small business and consumer customers. In addition, the use of quarantines and social distancing methods to curtail the spread of COVID-
19 - whether mandated by governmental authorities or recommended as a public health practice - may adversely affect the Company’s operations as key personnel, employees and customers avoid physical interaction. The continued spread of COVID-19 (or an outbreak of a similar highly contagious disease) could also negatively impact the business and operations of third-party service providers who perform critical services for the Company’s business. It is not yet known what impact these operational changes may have on the Company’s financial performance.
There continue to be broad concerns related to the potential effects of the COVID-19 pandemic. Even after the initial government mandated stay at home orders expired, the aftereffects of the pandemic may continue to have an adverse effect on, among other things, (i) the Company’s ability to attract customer deposits, (ii) the ability of the Company’s borrowers to satisfy their obligations to us, (iii) the demand for the Company’s loans or the Company’s other products and services and/or (iv) unemployment rates, financial markets, real estate markets or economic growth.
The outbreak of COVID-19 has significantly affected the financial markets and has resulted in several responses by the U.S. government, including a reduction in interest rates by the FOMC. These reductions in interest rates, especially if prolonged, could adversely affect the Company’s net interest income, margins and profitability.
The COVID-19 pandemic and its impact on the economy heightens the risk associated with many of the risk factors described in the Company’s previous reports filed with the Securities and Exchange Commission, including those related to economic conditions in the Company’s markets areas, interest rates, loan losses, the Company’s reliance on its executives and third party service providers and impairments of goodwill and intangible assets. For example, borrower loan defaults that adversely affect the Company’s earnings correlate with deteriorating economic conditions, which, in turn, may impact borrowers’ creditworthiness. If the Company’s borrowers are unable to meet their payment obligations, the Company will be required to increase its allowance for loan losses through provisions for credit losses. In addition, loan programs adopted by the federal government, such as the Paycheck Protection Program and the Main Street Lending Program, while intended to lessen the impact of the pandemic on businesses, may result in a decreased demand for the Company’s loan products.
The impact of the pandemic on the Company’s financial results is evolving and uncertain. The decline in economic activity occurring due to the COVID-19 pandemic and the actions by the FOMC with respect to interest rates is likely to affect the Company’s net interest income, non-interest income and credit-related losses for an uncertain period. The Company believes that it may experience a material adverse effect in the Company’s business, results of operations and financial condition as a result of the COVID-19 pandemic for an indefinite period.
Cyber security incidents could disrupt business operations, result in the loss of critical and confidential information, and adversely impact our reputation and results of operations.
The Company’s computer systems, software and networks are regularly subject to cyber attacks, which may result in unauthorized access; mishandling or misuse of information; loss or destruction of data (including confidential customer information); account takeovers; unavailability of service; computer viruses or other malicious code; disruption or degradation of service; denial of service; and other events. Cyber threats may arise from human error, fraud or malice on the part of employees or third parties, including third party vendors, or may result from accidental technological failure. In addition, the parties intent on penetrating our systems may also attempt to fraudulently induce employees, customers, third parties or other users of our systems to disclose sensitive information in order to gain access to the Company’s data or that of the Company’s customers.
The use of quarantines and social distancing restrictions to reduce the spread of COVID-19 may present additional cyber security risks to the Company. A number of the Company’s employees have transitioned to working remotely as a result of the COVID-19 pandemic, which increases cyber security risks.
Cyber security incidents, depending on their nature and scope, could potentially result in the misappropriation, destruction, corruption or unavailability of critical data and confidential or proprietary information (the Company’s own or that of third parties) and the disruption of business operations. The potential consequences of a material cyber security incident include reputational damage, litigation with third parties, and increased cyber security protection and remediation costs, which in turn could adversely affect the Company’s competitiveness and results of operations. The Company carries insurance to
partially offset the risk of loss; however, there can be no assurance that the policy limits or policy exclusions would adequately protect the Company from a related loss.
Potential disruption or failure of network and information processing systems and those of third-party vendors may negatively impact our operations.
The Company's business activities are dependent on its ability to accurately and timely process, record and monitor many transactions. If any of its financial, accounting, network or other information processing systems fail or have other significant shortcomings, the Company could be materially adversely affected. The Company outsources some of it processing and other activities to third party vendors. Third parties with which the Company does business could be sources of operational risk to the Company, including the risk that the third parties' own network and information processing systems could fail. Any of these occurrences could materially diminish the Company's ability to operate one or more of the Company's businesses, or cause the Company to suffer financial loss, a disruption of its business, regulatory sanctions or damage to its reputation, any of which could materially adversely affect the Company.
The Company may be subject to disruptions or failures of the Company's financial, accounting, network and information processing systems arising from events that are wholly or partially beyond the Company's control, which may include, for example, computer viruses or electrical or telecommunications outages, denial of service attacks or hacking targeting the Company's or its vendors’ networks or information processing systems or websites, natural disasters, disease, pandemics or other damage to property or physical assets or terrorist acts. The Company has developed an emergency recovery program, which includes plans to maintain or resume operations in the event of an emergency and has contingency plans if operations or systems cannot be resumed or restored. The emergency recovery program is periodically reviewed and updated, and components of the emergency recovery program are periodically tested and validated. The Company also reviews and evaluates the emergency recovery programs of vendors which provide certain third-party systems that the Company considers critical. Nevertheless, there is no guarantee that these measures or any other measures can provide absolute security. In addition, because the methods used to cause cyber-attacks change frequently or, in some cases, are not recognized until launched, the Corporation may be unable to implement effective preventive measures or proactively address these attacks. Resulting disruptions or failures affecting any of the Company’s systems may give rise to interruption in service to customers, damage to the Company's reputation and loss or liability to the Company.
Failure by the Company to keep up with technological advancements in deployment of services and efficiency of operations may make it more vulnerable to competition.
The financial services industry is continually undergoing rapid technological change, with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Company’s operations. Many of the Company’s financial institution competitors have substantially greater resources to invest in technological improvements, and new payment services developed and offered by non-financial institution competitors pose an increasing threat to the traditional payment services offered by financial institutions. The Company may not be able to effectively implement new technology-driven products and services, be successful in marketing these products and services to its customers, or effectively deploy new technologies to improve the efficiency of its operations. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on the Company’s business, financial condition and results of operations.
Further, the costs of new technology, including personnel, can be high in both absolute and relative terms. There can be no assurance, given the fast pace of change and innovation, that the Company’s technology, either purchased or developed internally, will meet or continue to meet the needs of the Company and the needs of its customers.
ECONOMIC AND CREDIT RISKS
Participation in COVID-19 loan modifications, the PPP, or in other relief programs created in response to the COVID-19 pandemic, may expose the Company to credit losses as well as litigation and compliance risk.
To support our customers, businesses, and communities, the Company established a COVID-19 Modification Program on March 20, 2020 to offer payment relief to certain borrowers. Through this program, the Company approved interest and/or principal payment deferrals on loans for individuals and businesses affected by the economic impacts of the COVID-19 pandemic. The Company also participated in the PPP as a lender. The PPP commenced on April 3, 2020 and was available to qualified borrowers through August 8, 2020. The Company’s participation in COVID-19 loan modifications, the PPP, and in any other relief programs now or in the future, including those under the CARES Act, exposes the Company to certain credit, compliance, and other risks.
Participation in COVID-19 loan modifications could expose the Company to elevated future credit losses if customers are not able to fulfill the terms of their commitments. Additionally, among other regulatory requirements, PPP loans are subject to forbearance of loan payments for a six-month period to the extent that loans are not eligible for forgiveness. If PPP borrowers fail to qualify for loan forgiveness, including by failing to use the funds appropriately to qualify for forgiveness under the program, the Company has a greater risk of holding these loans at unfavorable interest rates. In addition, because of the short period between the passing of the CARES Act and the implementation of the PPP, there is ambiguity in the laws, rules, and guidance regarding the operation of the PPP, which exposes us to risks relating to noncompliance with the PPP. There is risk the SBA or another governmental entity could conclude there is a deficiency in the way the Company originated, funded, or serviced PPP loans, which may or may not be related to the ambiguity in the CARES Act or the rules and guidance promulgated by the SBA and the U.S. Treasury regarding the operation of the PPP. In the event of such deficiency, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already made payment under the guaranty, seek recovery of any loss related to the deficiency from the Company.
Difficult economic conditions and real estate markets, including protracted periods of low-growth and sluggish loan demand, can negatively impact the Company’s income, and result in higher charge-offs as borrowers’ ability to repay is negatively impacted by those conditions.
Lending money is an essential part of the banking business, and the revenues derived from lending activities are the most significant segment of the Company’s income statement. Extended periods of sluggish loan demand can materially affect the composition of the Company’s consolidated statement of financial condition, reducing the ratio of loans to deposits and the Company’s profitability. Adverse changes in the economy and real estate markets and the duration of economic downturns can negatively affect the solvency of businesses and consumers. Borrowers’ inability to repay loans causes increases in non-performing assets, which may result in elevated collection and carrying costs related to such non-performing assets and increases in loan charge-offs, significantly impacting the loan loss provision charged to earnings to fund the allowance for loan losses. The risk of non-payment is affected by credit risks of the borrower, changes in economic and industry conditions, the duration of the loan and, in the case of a collateralized loan, uncertainties as to the future value of the collateral supporting the loan. Historically, commercial loans have presented a greater risk of non-payment than consumer loans. The application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on these loans.
The Company has established an allowance for loan losses that management believes to be adequate to offset probable losses on the Company’s existing loans. However, there is no precise method of estimating loan losses. The Company determines the appropriate level of the allowance for credit losses based on many quantitative and qualitative factors, including, but not limited to the size and composition of the loan portfolio; changes in risk ratings; changes in collateral values; delinquency levels; historical losses; and economic conditions. In addition, as the Company’s loan portfolio grows, it will generally be necessary to increase the allowance for credit losses through additional provisions, which will impact the Company’s operating results. If the Company’s assumptions and judgments regarding such matters prove to be inaccurate, its allowance for credit losses might not be sufficient, and additional provisions for credit losses might need to be made. Depending on the amount of such provisions for credit losses, the adverse impact on the Company’s earnings could be material. Also, there can be no assurance that any future declines in real estate market conditions, general
economic conditions or changes in regulatory policies will not require the Company to increase its allowance for loan losses, through additional loan loss provisions, which could reduce earnings.
Investment securities losses, including other-than-temporary declines in the value of available for sale securities, may result in charges to earnings that could negatively impact our results of operations.
Price fluctuations in securities markets, as well as other market events, could have an impact on the Company’s results of operations. As described below, the Company’s holding of certain securities and the revenues the Company earns from its trust and investment management services business are particularly sensitive to those events:
●Equity investments:
As of December 31, 2020, the Company’s equity investments were comprised primarily of publicly traded financial institutions. The value of the securities in the Company’s equity portfolio may be affected by several factors. General economic conditions and uncertainty surrounding the financial institution sector impacts the value of these securities. Equity investments are stated at fair value with realized and unrealized gains and losses reported in net income. General declines in bank stock values, as well as deterioration in the performance of specific banks, are reflected on the Consolidated Statements of Income.
●Municipal securities:
As of December 31, 2020, the Company had approximately $8.0 million of municipal securities issued by various municipalities in its investment portfolio. Uncertainty with respect to the financial viability of municipal insurers places greater emphasis on the underlying strength of issuers. Increasing pressure on local tax revenues of issuers due to adverse economic conditions could also have a negative impact on the underlying credit quality of issuers.
●Investment management and trust services revenue:
The Company’s investment management and trust services revenue is also impacted by fluctuations in the securities markets. A portion of this revenue is based on the value of the underlying investment portfolios. If the values of those investment portfolios decrease, whether due to factors influencing U.S. securities markets in general or otherwise, the Company’s revenue could be negatively impacted. In addition, the Company’s ability to sell its brokerage services is dependent, in part, upon consumers’ level of confidence in securities markets.
RISKS RELATED TO INVESTMENT IN THE COMPANY’S STOCK
The Corporation is a holding company and relies on dividends from its subsidiaries for substantially all its revenue and its ability to make dividends, distributions and other payments.
The Company is a separate and distinct legal entity from the Bank and depends on the payment of dividends from the Bank for substantially all its revenues. As a result, the Company's ability to make dividend payments on its common stock depends primarily on certain federal and state regulatory considerations and the receipt of dividends and other distributions from its subsidiaries. There are various regulatory and prudential supervisory restrictions, which may change from time to time, that impact the ability of the Bank to pay dividends or make other payments to the Company. There can be no assurance that the Bank will be able to pay dividends at past levels, or at all, in the future. If the Company does not receive enough cash dividends or is unable to borrow from the Bank, then the Company may not have enough funds to pay dividends to its shareholders, repurchase its common stock or service its debt obligations.
"Anti-takeover" provisions may keep shareholders from receiving a premium for their shares.
The Articles of Incorporation of the Company presently contain certain provisions, such as staggered Board of Directors terms and super majority voting requirements for transactions not approved by the Company’s Board of Directors, which may be deemed to be "anti-takeover" in nature in that such provisions may deter, discourage or make more difficult the assumption of control of the Company by another Company or person through a tender offer, merger, proxy contest or similar transaction or series of transactions. In addition, provisions of Pennsylvania and applicable federal banking laws could similarly make it more difficult for a third party to acquire control of the Company. The overall effects of the "anti-takeover” provisions may be to discourage, make costlier or more difficult, or prevent a future takeover offer, thereby preventing shareholders from receiving a premium for their securities in a takeover offer. These provisions may also increase the possibility that a future bidder for control of the Company will be required to act through arms-length negotiation with the Company’s Board of Directors. Copies of the Articles of Incorporation of the Company are on file with the Securities and Exchange Commission and the Pennsylvania Secretary of State.
If the Company fails to maintain an effective system of internal controls, it may not be able to accurately report its financial results or prevent fraud. As a result, current and potential shareholders could lose confidence in the Company’s financial reporting, which could harm its business and the trading price of its common stock.
The Company has established a process to document and evaluate its internal controls over financial reporting to satisfy the requirements of Section 404(b) of the Sarbanes-Oxley Act of 2002 and related regulations, which require annual management assessments of the effectiveness of the Company’s internal controls over financial reporting. In this regard, management has dedicated internal resources, engaged outside consultants and adopted a detailed work plan to (i) assess and document the adequacy of internal controls over financial reporting, (ii) take steps to improve control processes, where appropriate, (iii) validate through testing that controls are functioning as documented and (iv) maintain a continuous reporting and improvement process for internal control over financial reporting.
The Company’s efforts to comply with Section 404(b) of the Sarbanes-Oxley Act of 2002 and the related regulations regarding the Company’s assessment of its internal controls over financial reporting are likely to continue to result in increased expenses. The Company’s management and audit committee have given the Company’s compliance with Section 404(b) a high priority. The Company cannot be certain that these measures will ensure that the Company implements and maintains adequate controls over its financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm the Company’s operating results or cause the Company to fail to meet its reporting obligations. If the Company fails to correct any issues in the design or operating effectiveness of internal controls over financial reporting or fails to prevent fraud, current and potential shareholders could lose confidence in the Company’s financial reporting, which could harm its business and the trading price of its common stock.
The Company may not be able to attract and retain skilled people.
The Company’s success depends, in large part, on its ability to attract and retain skilled people. Competition for talented personnel can be intense, and the Company may not be able to hire sufficiently skilled people or to 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 because of their skills, knowledge of the Company's operations and markets, industry experience, and the difficulty of promptly finding qualified replacement personnel.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
The physical properties of the Company are all owned or leased by the Bank.
The Bank owns and operates, for banking purposes, the buildings located at:
One South Main Street, Mifflintown, Pennsylvania (branch office)
218 Bridge Street, Mifflintown, Pennsylvania (corporate headquarters)
4068 William Penn Highway, Mifflintown, Pennsylvania (branch office)
1762 Butcher Shop Road, Mifflintown, Pennsylvania (operations center and Trust offices)
301 Market Street, Port Royal, Pennsylvania (branch office)
30580 Rt. 35, McAlisterville, Pennsylvania (branch office)
Four North Market Street, Millerstown, Pennsylvania (branch office)
17428 Tuscarora Creek Road, Blairs Mills, Pennsylvania (branch office)
One East Market Street, Lewistown, Pennsylvania (branch office)
20 Prince Street, Reedsville, Pennsylvania (branch office)
100 West Water Street, Lewistown, Pennsylvania (branch office)
320 South Logan Boulevard, Burnham, Pennsylvania (branch office)
571 Main Street, Richfield, Pennsylvania (branch office)
64 Main Street, Port Allegany, Pennsylvania (branch office)
118 East Second Street, Coudersport, Pennsylvania (branch office)
104 N Front Street, Liverpool, Pennsylvania (branch office)
The Bank leases four offices:
Branch Offices
Wal-Mart Supercenter, Route 522 South, Lewistown, Pennsylvania (lease expires January 2022)
52 West Mill Street, Port Allegany, Pennsylvania (lease expires June 2028)
Financial Services Office
129 South Main Street, Suite 600, Lewistown, Pennsylvania (lease expires October 2029)
Loan Production Office
1366 South Atherton Street, State College, Pennsylvania (lease expires December 2021)
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The nature of the Company’s and Bank’s business, at times, generates litigation involving matters arising in the ordinary course of business. However, in the opinion of management, there are no proceedings pending to which the Company or the Bank is a party or to which its property is subject, which, if adversely determined, would be material in relation to their financial condition. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Company by government authorities or others.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information:
The common stock of Juniata Valley Financial Corp. is quoted under the symbol “JUVF” on the Pink Open Market, an electronic inter-dealer quotation and trading system available through, and governed by, the NASDAQ system.
Transfer Agent:
Computershare Investor Services, P.O. Box 50500, Louisville, KY 40233-5000. Phone: (800) 368-5948. Website: www.computershare.com/investor.
Holders:
As of March 15, 2021, there were 1,725 registered holders of the Company’s outstanding common stock.
For information concerning the Company’s Equity Compensation Plans, see “Item 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”.
Dividends:
Cash dividends of $0.88 were declared in 2020 and 2019. As stated in Note 14 - Stockholders’ Equity and Regulatory Matters, in The Notes to Consolidated Financial Statements, the Company is subject to regulatory capital requirements that limit the amount of capital available for dividends. While the Company expects to continue its policy of regular dividend payments, no assurance of future dividend payments can be given. Future dividend payments will depend upon the Company’s financial condition, earnings, capital and regulatory requirements, prospects, business conditions and other factors deemed relevant by the Board of Directors.
Annual Meeting:
The Annual Meeting of Shareholders of Juniata Valley Financial Corp., which will be virtual, will be held at 10:30 a.m., on Tuesday, May 18, 2021, at www.meetingcenter.io/294116171 using password JUVF2021.
Recent Sales of Unregistered Securities:
None.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers:
The Company periodically repurchases shares of its common stock under the share repurchase program approved by the Board of Directors. In December of 2016, the Board of Directors authorized the repurchase of an additional 200,000 shares of its common stock through its share repurchase program. The program will remain authorized until all approved shares are repurchased, unless terminated by the Board of Directors. There were 4,400 shares purchased under the program during the fourth quarter of 2020, and 59,989 shares remain available to purchase under the program.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Not applicable.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE-YEAR FINANCIAL SUMMARY
(Dollars in thousands, except share and per share data)
FORWARD-LOOKING STATEMENTS
The information contained in this Annual Report on Form 10-K contains forward-looking statements (as such term is defined in the Securities Exchange Act of 1934 and the regulations thereunder) including statements which are not historical facts or that reflect trends or management’s intentions, plans, beliefs, expectations or opinions. Such forward-looking statements are subject to risks and uncertainties and may be affected by various factors which may cause actual results to differ materially from those in the forward-looking statements including, without limitation:
●the scope and duration of the COVID-19 pandemic, actions taken by governmental authorities in response to the pandemic and the direct and indirect impacts of the pandemic on the Company, its customers and third parties;
●the impact of adverse changes in the economy and real estate markets, including protracted periods of low-growth and sluggish loan demand;
●the effect of market interest rates and uncertainties, and relative balances of rate-sensitive assets to rate-sensitive liabilities, on net interest margin and net interest income;
●the effect of competition on rates of deposit and loan growth and net interest margin;
●increases in non-performing assets, which may result in increases in the allowance for credit losses, loan charge-offs and elevated collection and carrying costs related to such non-performing assets;
●other income growth, including the impact of regulatory changes which have reduced debit card interchange revenue;
●investment securities gains and losses, including other than temporary declines in the value of securities which may result in charges to earnings;
●the effects of changes in the applicable federal income tax rate;
●the level of other expenses, including salaries and employee benefit expenses;
●the impact of increased regulatory scrutiny of the banking industry;
●the impact of governmental monetary and fiscal policies, as well as legislative and regulatory changes;
●the results of regulatory examination and supervision processes;
●the failure of assumptions underlying the establishment of reserves for loan and lease losses, and estimates of collateral values and various financial assets and liabilities;
●the increasing time and expense associated with regulatory compliance and risk management;
●the ability to implement business strategies, including business acquisition activities and organic branch, product, and service expansion strategies;
●capital and liquidity strategies, including the impact of the capital and liquidity requirements modified by the Basel III standards;
●the effects of changes in accounting policies, standards, and interpretations on the presentation in the Company’s consolidated balance sheets and consolidated statements of income;
●the Company’s failure to identify and address cyber-security risks;
●the Company’s ability to keep pace with technological changes;
●the Company’s ability to attract and retain talented personnel;
●the Company’s reliance on its subsidiary for substantially all of its revenues and its ability to pay dividends;
●acts of war or terrorism;
●disruptions due to flooding, severe weather, or other natural disasters; and
●failure of third-party service providers to perform their contractual obligations.
OVERVIEW
This discussion relates to Juniata Valley Financial Corp. (“Company” or “Juniata”) and its wholly owned subsidiary, The Juniata Valley Bank (“Bank”). Juniata is a bank holding company that delivers financial services within its market, primarily central and northern Pennsylvania. The Bank provides retail and commercial banking, trust, estate, and wealth management services through 16 offices in Juniata, Mifflin, Perry, Huntingdon, McKean, Potter and Centre counties.
The overview is intended to provide a context for the following Management’s Discussion and Analysis of Financial Condition and Results of Operations. Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements, including the notes thereto, included in this Annual Report on Form 10-K. We have attempted to identify the most important matters on which our management
focuses in evaluating our financial condition and operating performance and the short-term and long-term opportunities, challenges and risks (including material trends and uncertainties) which we face. We also discuss the actions we are taking to address these opportunities, challenges and risks. The Overview is not intended as a summary of, or a substitute for review of, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
ECONOMIC AND INDUSTRY-WIDE FACTORS RELEVANT TO JUNIATA
As a financial services organization, Juniata’s core business is most influenced by the level of, and movement of, interest rates. Lending and investing are done daily, using funding from deposits and borrowings, resulting in net interest income, the most significant portion of operating results. Using asset/liability management tools, the Company continually evaluates the effects that possible changes in interest rates could have on operating results and balance sheet growth. Using this information, along with analysis of competitive factors, management designs and prices its products and services.
General economic conditions are relevant to Juniata’s business. In addition, economic factors impact customers’ needs for financing, thus affecting loan growth. Additionally, changes in the economy can directly impact the credit strength of existing and potential borrowers.
The ongoing nature of the COVID-19 pandemic is also relevant to Juniata’s business. The pandemic has affected, and will likely continue to affect, various aspects of Juniata’s operations and financial condition for an undetermined period.
FOCUS OF MANAGEMENT
The management of Juniata believes that it is important to know who and what we are to be successful. We must be aligned in our efforts to achieve goals. We have identified the four characteristics that define the Company and the personnel that support it. We are Committed, Capable, Caring and Connected. Management seeks to be the preeminent financial institution in its market area and measures its success by the five key elements described below.
SHAREHOLDER SATISFACTION
Above all else, management is committed to maximizing the value of our shareholders’ investment, through both stock value appreciation and dividend returns. Remaining connected to our communities will allow us to identify the financial needs of our market and to deliver those products and services capably. In doing so, we will seek to profitably grow the balance sheet and enhance earnings, while maintaining capital and liquidity levels that exceed all regulatory guidelines.
CUSTOMER RELATIONSHIPS
We are committed to maximizing customer satisfaction. We are sensitive to the expanding array of financial services and financial service providers available to our customers, both locally and globally. We are committed to fostering a complete customer relationship by helping clients identify their current and future financial needs and offering practical and affordable solutions to both. As our customers’ lifestyles change, the channels through which we deliver our services must change as well. One element of the Company’s strategic plan is to provide connection through every means available, wherever we are needed, whether through a stand-alone branch, in-store boutique, ATM or via online and mobile banking anywhere internet or cell phone signals can be received. In 2020, we continued to make advances in technological resources, placing data and information in the hands of our customers and employees because we are committed to optimizing the customer experience.
BALANCE SHEET GROWTH
We are capable of profitable balance sheet growth. Rapid growth should not be a substitute for careful fiscal and strategic management. It is our goal to continue quality growth despite intense competition by paying careful attention to the needs of our customers. We will continue to maintain high credit standards, knowing that lending under the right circumstances is the proper way to maintain soundness and profitability. We believe we consistently pay fair market rates on all deposits and have invested wisely and conservatively in compliance with self-imposed standards, minimizing risk of asset impairment. We aspire to increase our market share within the current communities that we serve, and to expand in contiguous areas through acquisition and investment. As part of our strategic plan for growth, we continue to actively seek opportunities for acquisitions of branches or stakes in other financial institutions, similar to those that have occurred in prior years, and most recently in April 2018 with the acquisition of the remaining shares of the Liverpool Community Bank (“LCB”).
OPERATING RESULTS
We are capable of producing profitability ratios that exceed those of many of our peers. Recognizing that net interest margins have narrowed for banks in general and that they may not return to the ranges experienced in the past, we also focus on the importance of providing fee-generating services in which customers find value. Offering a broad array of services prevents us from becoming too reliant on one form of revenue. It has also been our philosophy to spend conservatively and to implement operating efficiencies where possible to keep non-interest expense from escalating in areas that can be controlled.
CONNECTION TO THE COMMUNITY
We are active corporate citizens, connected to the communities we serve. Although the world of banking has transitioned to global availability through electronics, we believe that our community banking philosophy is not only still valid, but essential. Despite technological advances, banking is still a personal business, particularly in the rural areas we serve. We believe that our customers shop for services and value a relationship with an institution involved in the same community, with the same interests in its prosperity. We have a foundation and a history in each of the communities we serve. Management takes an active role in local business and industry development organizations to help attract and retain commerce in our market area. We provide businesses, large and small, with financial tools and financing needed to grow and prosper. And though these tools are electronically driven, they are custom-designed by relationship managers who take time to understand the need. We have always been committed to responsible lending practices. We invest locally by including local municipal bonds in our investment portfolio and participating in funding for such projects as low income and elderly housing. We support charitable programs that benefit the local communities, not only with monetary contributions, but also through the personal involvement of our caring employees. In 2020, we were privileged to support our local business clients with Paycheck Protection Loans, when they needed it most. And we maintained a physical presence at all service locations throughout the pandemic.
JUNIATA’S OPPORTUNITIES
SOUNDNESS AND STABILITY
Our financial condition is strong. We enjoy strong capital and liquidity ratios that significantly exceed regulatory guidelines. Our business model includes a plan for growth without sacrificing profitability or integrity. We believe an opportunity exists for banks such as ours to offer the trusted, personal service of a locally managed institution that has roots in the community reaching back over 150 years.
EXPANSION OF CUSTOMER BASE
Our strategic focus is based on leveraging our collective knowledge of the Company’s primary and contiguous markets to identify lending or fee-based opportunities consistent with our risk parameters and profitability targets. We continue to develop our sales team through mentoring and by making employee education paramount. We continually seek and implement back-room efficiencies. We recognize change is taking place in a world where convenience and mobility are priorities for consumers and businesses when choosing a financial institution with whom to do business. We offer full-featured secure mobile banking that includes remote check deposit for use on home computers and all mobile devices for consumers. For businesses, we provide options for cash management and remote deposit. We offer identity protection to the families of our customers, which we believe to be a true value-added service, with features that go far beyond traditional banking services, and sets us apart from other financial institutions in our market area. With the acquisition of First National Bank of Port Allegheny (“FNBPA”) in 2015, we expanded our market into the northern tier region of Pennsylvania and integrated the JVB brand there and have since expanded our footprint in Perry County, Pennsylvania, through the consummation of the acquisition of remaining shares of LCB in April 2018.
DELIVERY SYSTEM ENHANCEMENTS
We seek to continually enhance our customer delivery system, both through technology and physical facilities. We actively seek opportunities to expand our branch network through acquisitions. We believe that it is imperative that our customers have convenient and easy access to personal financial services that complement their lifestyle, whether it is through electronic or personal delivery. We achieved an early entry into the mobile banking arena and have since expanded online delivery, offering consumer remote deposit and Touch ID, and most recently online consumer loan and deposit accounting opening in 2020. Through the fully redesigned JVBonline.com website, we offer a suite of online services including the convenience of online loan applications for residential mortgages, home equity, vehicle and other personal loans. Online
and mobile banking features include full bill-pay and monetary transfers between internal and external accounts. Our ATM network is equipped with state-of-the art machines. Our Customer Care Center provides a dedicated service to address all customer inquiries and provides outreach through our social media sites. Our updated branch facilities feature a highly interactive and complete customer experience. In 2020, Juniata added online consumer deposit account opening capability to our product line and plans to expand the capability to business customers in 2021.
JUNIATA’S CHALLENGES
NET INTEREST MARGIN COMPRESSION
The low interest rate environment that has persisted in recent years has pressured the net interest margin for most banks, including Juniata. Loans have been originated, acquired or repriced at lower rates, reducing the average rate earned on those assets. While the average rate paid on interest-bearing liabilities, such as deposits and borrowings, has also declined, the decline has not always occurred at the same pace as the decline in the average rate earned on interest-earning assets, which can result in a narrowing of the net interest margin. We believe that increasing the net interest margin will continue to be a challenge until general market rates rise.
COMPETITION
Each year, competition becomes more intense and global in nature. To meet this challenge, we attempt to stay in close contact with our customers, monitoring their satisfaction with our services through surveys, personal visits and networking in the communities we serve. We strive to meet or exceed our customers’ expectations and deliver consistent high-quality service. We believe that our customers have become acutely aware of the value of local service, and we strive to maintain their confidence.
RATE ENVIRONMENT
We intend to continue making what we believe to be rational pricing decisions for loans, deposits and non-deposit products. This strategy can be difficult to maintain, as many of our peers appear to continue pricing for growth, rather than long-term profitability and stability. We believe that a strategy of “growth for the sake of growth” results in lower profitability, and such actions by large groups of banks have had an adverse impact on the entire financial services industry. We intend to maintain our core pricing principles, which we believe protect and preserve our future as a sound community financial services provider, proven by results.
REGULATIONS
The Company is subject to banking regulation, as well as regulation by the Securities and Exchange Commission (“SEC”) and, as such, must comply with many laws, including the USA Patriot Act, the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) and the Dodd-Frank Wall Street Reform and Consumer Protection Act. Management has established a Disclosure Committee for Financial Reporting, an internal group at Juniata that seeks to ensure that current and potential investors in the Company receive full and complete information concerning our financial condition. Juniata has incurred direct and indirect costs associated with compliance with the SEC’s filing and reporting requirements imposed on public companies by the Sarbanes-Oxley Act, as well as adherence to new and existing banking regulations and stronger corporate governance requirements. Regulatory burdens continue to increase as evidenced by the provisions in the Dodd-Frank Act that impact the Company in the areas of corporate governance, capital requirements and restrictions on fees that may be charged to consumers.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Company’s consolidated financial statements are prepared based upon the application of accounting principles generally accepted in the United States of America (“GAAP”), the most significant of which are described in Note 2 of The Notes to Consolidated Financial Statements - Summary of Significant Accounting Policies. Certain of these policies, particularly with respect to allowance for loan losses and the investment portfolio, require numerous estimates and economic assumptions, based upon information available as of the date of the consolidated financial statements. As such, over time, they may prove inaccurate or vary and may significantly affect the Company’s reported results and financial position in future periods.
The accounting policy for establishing the allowance for loan losses relies to a greater extent on the use of estimates than other areas and, as such, has a greater possibility of producing results that could be different from those currently reported. Changes in underlying factors, assumptions or estimates in the allowance for loan losses could have a material impact on the Company’s future financial condition and results of operations. The allowance for loan losses is maintained at a level believed adequate by management to absorb probable losses in the loan portfolio. Management’s determination of the adequacy of the allowance for loan losses is based upon an evaluation of individual credits in the loan portfolio, historical loan loss experience, current economic conditions and other relevant factors. This determination is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.
RESULTS OF OPERATIONS
2020 and 2019 FINANCIAL PERFORMANCE OVERVIEW
The comparability of the results of operations for the years ended December 31, 2020 and December 31, 2019 was impacted by the following events discussed in more detail below: (i) the COVID-19 pandemic in 2020; and (ii) termination of The Juniata Valley Bank Retirement Plan (“JVB Plan”) in 2019. Juniata’s management believes it is meaningful to present a performance comparison that segregates the financial impact of the afore-mentioned items, in providing an analysis of comparative results. The following discussion includes both GAAP measures, as well as non-GAAP financial measures that are reconciled to GAAP financial measures in the supplemental tables presented below. The non-GAAP measures are referred to as “adjusted” results.
The year 2020 was challenging, primarily due to the COVID-19 pandemic. Several initiatives were implemented to address the impact of the COVID-19 pandemic on Juniata, its customers, employees and markets. Juniata remained responsive to the needs of loan customers for short-term payment relief as a result of the pandemic, as well as participated in the Paycheck Protection Program (“PPP”) through the Small Business Administration (“SBA”). While asset quality measures remained strong throughout 2020, the effects of the economic downturn resulted in increased provisioning for loan losses. Juniata increased its provision for loan losses by $1,294,000, from a credit of $573,000 recorded in 2019 to a provision expense of $721,000 recorded in 2020.
In 2020, Juniata executed a strategy to create a more efficient balance sheet, producing securities gains of $549,000 which were used to offset a one-time $524,000 prepayment penalty on the extinguishment of $10,000,000 in long-term debt. The total net gain on the sales and calls of securities recorded in 2020 was $855,000 compared to a $43,000 net loss on the sales and calls of securities in 2019.
In 2019, Juniata satisfied all obligations of the JVB Plan, recording pre-tax pension settlement charges of $1,221,000 during the year while no comparable charges were recorded in 2020. The pre-tax charges represent the acceleration of pension expenses that would otherwise have impacted Juniata’s future earnings.
Net income for Juniata in 2020 was $5,602,000, compared to net income of $5,835,000 for 2019. Earnings per share on a fully diluted basis decreased from $1.14 in 2019 to $1.10 in 2020. When adjusted for the impact of the tax-effected events mentioned above, adjusted net income was $5,911,000 for the year ended December 31, 2020, a decrease of 7.4% over adjusted net income of $6,381,000 for the year ended December 31, 2019. Adjusted earnings per share decreased by 7.2% from $1.25 in 2019 to $1.16 in 2020. For 2020, return on average assets (“ROA”) and return on average equity (“ROE”) were 0.76% and 7.37%, respectively. When adjusted for the impact of the items mentioned above, return on average assets was 0.80% in 2020 compared to 0.99% in 2019, while return on average equity was 7.78% in 2020 compared to 9.01% in 2019.
The net interest margin, on a fully tax-equivalent basis, decreased from 3.57% in 2019 to 3.00% in 2020. The yield on earning assets decreased 76 basis points to 3.55%, while the cost of funds decreased 26 basis points, to 0.80%, in 2020 compared to 2019.
Comparative disclosures illustrating the reconciliation of the non-GAAP financial measures discussed above to GAAP financial measures for the most recent two years are on the following page.
Juniata strives to attain consistently satisfactory earnings levels each year by protecting the core (repeatable) earnings base through conservative growth strategies that seek to minimize stockholder and balance-sheet risk, while serving its rural Pennsylvania customer base. This approach has helped achieve solid performances year after year. The Company considers the return on assets ratio to be a key indicator of its success and constantly scrutinizes the broad categories of the income statement that impact this profitability indicator.
Summarized below are the components of net income and the contribution of each to ROA for 2020 and 2019.
NET INTEREST INCOME
Net interest income is the amount by which interest income on earning assets exceeds interest expense on interest bearing liabilities. Net interest income is the most significant component of revenue, comprising approximately 82% of total revenues (the total of net interest income and non-interest income, exclusive of gains on sales and calls of securities) for 2020. Interest spread measures the absolute difference between average rates earned and average rates paid. Because some interest earning assets are tax-exempt, an adjustment is made for analytical purposes to present all assets on a fully tax-equivalent basis. Net interest margin is the percentage of net return on average earning assets, on a fully tax-equivalent basis, and provides a measure of comparability of a financial institution’s performance.
Both net interest income and net interest margin are impacted by interest rate changes, changes in the relationships between various rates and changes in the composition of the average balance sheet. Additionally, product pricing, product mix and customer preferences dictate the composition of the balance sheet and the resulting net interest income. Table 1 shows average asset and liability balances, average interest rates and interest income and expense for the years 2020, 2019 and 2018. Table 2 further shows changes attributable to the volume and rate components of net interest income.
TABLE 1
AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS
Notes:
(1)Average balances were calculated using a daily average.
(2)Includes interest-bearing demand and money market accounts.
(3)Net margin on interest earning assets is net interest income divided by average interest earning assets.
(4)Interest on obligations of states and municipalities is not subject to federal income tax. In order to make the net yield comparable on a fully taxable basis, a tax equivalent adjustment is applied against the tax-exempt income utilizing a federal tax rate of 21%.
TABLE 2
RATE/VOLUME ANALYSIS OF NET INTEREST INCOME
Notes:
(5)Non-accruing loans are included in the above table until they are charged off.
(6)The change in interest due to rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
(7)Includes net unrealized gains (losses) on securities available for sale: $4,298,000 in 2020, ($486,000) in 2019 and ($4,687,000) in 2018.
(8)Interest income includes loan fees of $463,000, $70,000 and $95,000 in 2020, 2019 and 2018, respectively.
On average, total loans outstanding increased $4,931,000, or 1.2%, in 2020 compared to 2019. Average loans in 2020 included average PPP loan balances of $21,421,000. Average total loans outstanding decreased by 0.3%, to $408,320,000, in 2019 when compared to 2018. Average yields on loans decreased by 50 basis points in 2020 compared to 2019, which was 26 basis points greater than 2018. As shown in Table 2, Rate - Volume Analysis of Net Interest Income, the decrease in yield in 2020 lowered interest income on loans by approximately $2,160,000, while the increase in volume raised interest income by $349,000 compared to 2019, resulting in a net decline in interest recorded on loans of $1,811,000. During 2019, the increase in yield raised interest income on loans by approximately $1,111,000, while the decline in volume decreased interest income by $111,000 compared to 2018, resulting in a net increase in interest recorded on loans of $1,000,000. Contributing 5 basis points to the increase in loan yields in 2019 was the collection of a substantial amount of previously unaccrued interest on a loan charged off in 2012. The prime rate declined 150 basis points in 2020, ending at 3.25%, which impacted the yield on loans. During 2019, the prime rate declined 75 basis points during 2019, ending at 4.75%.
During 2020, cash flows from maturities, sales and repayments of investment securities were reinvested into the securities portfolio, as were the additional funds from the growth in interest bearing liabilities and non-interest bearing demand
deposits. As a result, average balances of investment securities increased by $81,246,000, or 46.2%, during 2020 compared to 2019. This increase in volume accounted for a $1,982,000 increase in interest income compared to 2019, while the 49 basis point decline in the overall yield of the investment portfolio between 2020 and 2019 decreased net interest income by $1,289,000, resulting in an aggregate increase in interest recorded on investment securities of $693,000 in 2020 compared to 2019.
During 2019, cash flows from maturities, sales and repayments of investment securities were reinvested into the securities portfolio, as were the additional funds from the growth in interest bearing liabilities. As a result, average balances of investment securities increased by $24,420,000, or 16.1%, during 2019 compared to 2018. This increase in volume accounted for a $610,000 increase in interest income compared to 2018. The 15 basis point improvement in the overall yield of the investment portfolio between 2019 and 2018 increased net interest income by $219,000, resulting in an aggregate increase in interest recorded on investment securities of $829,000 in 2019 compared to 2018.
In total, yield on earning assets in 2020 was 3.55% compared to 4.31% in 2019 and 4.18% in 2018. On a fully tax equivalent basis, the yield on earning assets decreased 78 basis points to 3.59% in 2020, from 4.37% in 2019, which was an increase of 13 basis points from 4.25% in 2018.
Average interest bearing liabilities increased by $60,400,000, or 13.6%, in 2020 compared to 2019, which increased $17,755,000 compared to 2018. Within the categories of interest bearing liabilities, deposits increased on average by $26,744,000 in 2020 compared to 2019, primarily due to government payments and decreased spending during the pandemic. Average borrowings increased by $33,656,000 in 2020 compared to 2019, mainly due to a $13,497,000 increase in short-term borrowings from a cash flow hedge using three month FHLB advances, as well as the addition of $17,561,000 in FRB advances from the Company’s participation in the PPPLF. During 2019, average deposits increased by $8,810,000 and average borrowings increased by $8,945,000 compared to 2018. Changes in the volume and rate of other interest-bearing liabilities, in aggregate, decreased interest expense by $671,000 in 2020 compared to 2019, while the aggregate changes in volume and rate in 2019 increased interest expense by $1,073,000 compared to 2018. The percentage of average interest earning assets funded by average non-interest bearing demand deposits was approximately 22.7% in 2020, compared to 21.4% in 2019 and 23.1% in 2018. The total cost to fund earning assets (computed by dividing the total interest expense by the total average earning assets) in 2020 was 0.59%, compared to 0.79% in 2019 and 0.64% in 2018. This decrease in 2020 was primarily due to the 150 basis point decline in the federal funds target range during the year caused by the COVID-19 pandemic.
Net interest income was $20,246,000 for 2020, a decrease of $660,000 when compared to 2019. An increase in volume contributed $1,437,000, which was offset by a decline of $2,097,000 due to rate, resulting in a decrease in net interest income in 2020 compared to 2019.
PROVISION FOR LOAN LOSSES
Juniata’s provision for loan losses is determined as a result of an analysis of the adequacy level of the allowance for loan losses. In order to closely reflect the potential losses within the current loan portfolio based upon current information known, the Company carries no unallocated allowance. Using the process of analysis described in “Application of Critical Accounting Policies” earlier in this discussion, the Company determined that a provision of $721,000 was appropriate for 2020, an increase of $1,294,000, compared to 2019. The increased provision was primarily due to the additional probability of losses inherent in the loan portfolio, particularly in segments most affected by the economic conditions resulting from the COVID-19 pandemic, such as hospitality and restaurants. Additional consideration was also included for estimated elevated losses within the COVID-19 deferral loan pool. In addition to the provision expense of $721,000 in 2020, the allowance for loan losses was further funded by net recoveries of previously charged off loans totaling $412,000. A credit of $573,000 was recorded to the loan loss provision during the year ended December 31, 2019 primarily due to net recoveries of $500,000 on previously charged off loans. as well as a general improvement in credit quality factors, such as delinquency trends and classified loan balances. The discussion included in the Loans and Allowance for Loan Losses in the section below titled “Financial Condition” explains the information and analysis used to arrive at the provision for 2020.
NON-INTEREST INCOME
The Company remains committed to providing comprehensive services and products to meet the current and future financial needs of its customers. Juniata believes its responsiveness to customers’ needs surpasses that of many of its competitors and measures its success by the customer acceptance of fee-based services. The Company continually explores avenues to enhance product offerings in areas beneficial to its customers, such as adding new features and services for its electronic banking clientele. Fraud protection services are made available to all consumer depositors. We offer a variety of options for financing to home-buyers that includes a mortgage referral program, providing significant fee income. Juniata also provides alternative investment opportunities through an arrangement with a broker dealer that integrates the delivery of non-traditional products with Juniata’s Trust and Wealth Management Division. This arrangement enables Juniata to meet the investment needs of a varied customer base and to better identify its clients’ needs for traditional trust services.
Non-interest income was $5,320,000 in 2020 compared to $4,749,000 in 2019. Most significantly impacting the comparative year-end periods was an $855,000 net gain on the sales and calls of securities recorded in 2020 compared to a $43,000 net loss on the sales and calls of securities in 2019. The recorded net gain in 2020 was due in part to the execution of a balance sheet strategy in the second quarter of 2020 that produced securities gains of $549,000 which offset a $524,000 prepayment penalty on the extinguishment of long-term debt, as well as to the restructuring of the debt securities portfolio in the third quarter to reduce Juniata’s overall premium exposure resulting in a net gain of $283,000 on the sales of securities.
Fee-generated non-interest revenues consist of customer service fees derived from deposit accounts, trust relationships and sales of non-deposit products. In 2020, revenues from these services totaled $2,090,000, representing a decrease of $293,000, or 12.3%, from 2019 revenues, due to a decline in customer service fees. Customer service fees decreased by $341,000, or 19.9%, due to a decline in overdraft fee income caused by decreased consumer spending and stimulus fund deposits associated with the pandemic. Fees from estate settlements increased by $15,000, while non-estate trust fees declined by $1,000 in 2020 compared to 2019. Variance in fees from estate settlements occurs because estate settlements occur sporadically and are not necessarily consistent year to year. Non-estate fees are repeatable revenues that generally increase and decrease in relation to movements in interest rates as market values of trust assets under management increase or decrease and as new relationships are established. Commissions from sales of non-deposit products increased in 2020, in comparison to 2019, by $34,000, or 12.5%, as sales increased.
Fees generated by debit card activity increased by $116,000, or 8.6%, in 2020 compared to the prior year due to increased debit card usage.
Earnings on bank-owned life insurance and annuities declined by $26,000 in 2020 compared to 2019 caused by a decline in earnings resulting from the lower rate environment.
Other non-interest-related fees derived from loan activity decreased by $35,000 when comparing 2020 to 2019, due to declines in revenues generated from title insurance fees and the loan referral program.
The change in value of equity securities declined $79,000 in 2020 compared to 2019 resulting from declines in bank stock market values.
As a percentage of average assets, non-interest income (excluding securities gains/losses on sales or calls of securities and change in value of equity securities) was 0.61% and 0.74% in 2020 and 2019, respectively.
NON-INTEREST EXPENSE
Management strives to control non-interest expense where possible in order to improve operating results. Non-interest expense was $19,293,000 in 2020 compared to $20,407,000 in 2019, a decrease of 5.5%. Most significantly impacting the comparative year-end periods was a $1,263,000 decline in employee benefits expense due to recording $1,221,000 in pre-tax pension settlement charges in 2019 due to settling the remaining obligations associated with the final liquidation of the JVB Plan, while no comparable expenses were recorded in 2020.
Also contributing to the decline in non-interest expense in 2020 compared to 2019 was a $413,000 decrease in employee compensation expense due to furloughed staff necessitated by temporary branch closures resulting from Pennsylvania’s mandates during the COVID-19 pandemic.
Professional fees decreased by $246,000, or 25.6%, during 2020 compared to 2019 predominantly due to fees paid to the Company’s former audit firm during the transition to the newly engaged firm during 2019, while no comparable expenses were incurred in 2020. Occupancy expense also declined in 2020 compared to 2019 due to a decline in maintenance expense.
Partially offsetting these declines was a $524,000 prepayment penalty on the prepayment of $10,000,000 in FHLB long-term debt as part of a balance sheet management strategy to create a more efficient balance sheet. Data processing expense increased by $180,000 in 2020 compared to 2019 due to an increase in core processing expense, as well as the addition of expenses associated with a new online account opening platform. FDIC insurance premiums increased by $124,000 due to an increase in the assessment based upon the growth in assets, as well as lower small bank assessment credits being applied in 2020 compared to 2019. Additionally, a net gain on sales of other real estate owned of $208,000 was realized in 2019, while no such activity was recorded in 2020.
As a percentage of average assets, non-interest expense was 2.61% in 2020 as compared to 3.15% in 2019. Excluding the prepayment penalty on long-term debt, non-interest expense as a percentage of average assets was 2.54% in 2020. Excluding defined benefit settlement costs in 2019, non-interest expense as a percentage of average assets was 2.96% in 2019.
INCOME TAXES
Income tax for 2020 amounted to a benefit of $50,000 versus a benefit of $14,000 in 2019. Both periods included the effect of a tax credit of $902,000. The tax credit was available to the Company as a result of an equity investment in two low-income housing projects.
Exclusive of the tax credit, the Company recorded income tax expense of $852,000 in 2020, compared to $888,000 in 2019. The tax expense for 2020 included a $57,000 benefit resulting from a provision in the CARES Act, which allowed the carryback of net operating losses from the acquired Liverpool Community Bank to a year in which the statutory tax rate was higher. Juniata’s effective tax rate in 2020 was (0.9)% versus (0.2)% in 2019. See Note 13 of The Notes to Consolidated Financial Statements for further information on income taxes.
.
FINANCIAL CONDITION
BALANCE SHEET SUMMARY
Juniata functions as a financial intermediary and, as such, its financial condition can be best analyzed in terms of changes in its uses and sources of funds and can also be analyzed in terms of changes in daily average balances. The table below sets forth average daily balances for the last two years and the dollar change and percentage change for the past year.
TABLE 3
CHANGES IN USES AND SOURCES OF FUNDS
Overall, total average assets increased by $92,829,000, or 14.3%, for the year 2020 compared to 2019. The increase in 2020 was primarily due to an increase in deposits, as well as short-term debt and FRB advances, which were used to fund loans and the purchases of taxable securities during the year. The ratio of average earning assets to total average assets increased from 91.9% in 2019 to 92.3% in 2020. The ratio of average interest-bearing liabilities to total average assets decreased in 2020 to 68.0% from 68.5% in 2019. Although Juniata’s investment in low income elderly housing projects and its bank owned life insurance and annuities are not classified as interest-earning assets, income is derived directly from those assets. These instruments have represented 2.7% and 3.1% of total average assets in 2020 and 2019, respectively. A
more detailed discussion of the Company’s earning assets and interest bearing liabilities will follow in the Sections titled “Loans”, “Investments” and “Deposits”.
LOANS
Loans outstanding at the end of each year consisted of the following:
From year-end 2019 to year-end 2020, total loans outstanding increased by $22,071,000, primarily due to PPP loans, which are included in the commercial, financial and agricultural class. The following table summarizes how the ending balances changed annually in each of the last two years.
The loan portfolio was comprised of approximately 34.9% consumer loans (real estate - mortgage and personal loans) and 65.1% commercial loans (commercial, financial and agricultural, real estate - commercial and construction, and obligations of states and political subdivisions) on December 31, 2020 compared to 39.8% consumer loans and 60.2% commercial loans on December 31, 2019. Management believes that diversification in the loan portfolio is important, and management performs a loan concentration analysis on a quarterly basis. The highest loan concentration by activity type in 2020 was real estate - commercial loans secured by income-producing property, with debt service on this category of loans being reliant upon the cash flow generated by the property. In the aggregate, loans in this category had outstanding balances of $106,220,000 at December 31, 2020, or 140.80% of the Bank’s capital. Components of this concentration group with balances considered for general reserve purposes are as follows:
Given the reserves allocated to this sector over the past several years and the continuing softness in the market, management continues to assess a concentration risk factor to this group of loans when analyzing the adequacy of the allowance for loan losses. See Note 6 of The Notes to Consolidated Financial Statements.
During 2020, the growth in commercial, financial and agricultural loans, as well as real estate - construction loans and obligations of states and political subdivisions, was partially offset by a decline in the other loan categories. The overall increase in total loans was largely due to Juniata’s participation in the PPP, as well as the growth in real estate - construction loans. In 2019, there was growth in commercial, financial and agricultural loans, as well as real estate - construction loans, which was offset by a decline is all other loan categories. The decrease was largely due to a few unanticipated real estate - commercial and obligations of states and political subdivision loan payoffs, as well as the competitive lending environment. Juniata is willing, able and continues to lend to qualifying businesses and individuals. Our business model closely aligns lenders and community office managers’ efforts to effectively develop referrals and existing customer relationships. Continued emphasis is placed on responsiveness and personal attention given to customers, which we believe differentiates the Bank from its competition. Nearly all commercial loans are either variable or adjustable rate loans, while non-mortgage consumer loans generally have fixed rates for the duration of the loan.
Juniata strives to offer fair, competitive rates and to provide optimal service to attract loan growth and will continue to place emphasis on attracting the entire customer relationship of our borrowers.
The loan portfolio carries the potential risk of past due, non-performing or, ultimately, charged-off loans. The Bank attempts to manage this risk through credit approval standards and aggressive monitoring and collection efforts. Where prudent, the Bank secures commercial loans with collateral consisting of real and/or tangible personal property. The Company maintains a dedicated credit administration division, in response to the need for heightened credit review, both in the loan origination process and in the ongoing risk assessment process. Juniata’s lending strategy and credit standards stress quality growth, diversified by product. A standardized credit policy is in place throughout the Company, and the credit committee of the Board of Directors reviews and approves all loan requests for amounts that exceed management’s approval levels. The Company makes credit judgments based on a customer’s existing debt obligations, collateral, ability to pay and general economic trends. See Note 2 of The Notes to Consolidated Financial Statements.
The allowance for loan losses is set at an amount calculated to provide for probable losses on existing loans. A quarterly provision or credit is charged to earnings to maintain the allowance at adequate levels. Charge-offs and recoveries are recorded as adjustments to the allowance. The allowance for loan losses on December 31, 2020 was 0.97% of total loans, net of unearned interest, compared to 0.74% of total loans, net of unearned interest, at the end of 2019.
Loans that Juniata acquired through mergers and acquisitions, such as those acquired from Liverpool in 2018 and FNBPA in 2015 are recorded at fair value with no carryover of the related allowance for loan losses. Acquired loans subsequently deemed to be impaired are included in the allowance for loan losses as impaired loans. Through loan amortization and other scheduled payments, the excluded balances become a smaller percentage of total outstanding loans over time, contributing to the increase in the allowance as a percentage of total loans. The allowance increased $1,133,000 when compared to December 31, 2019, due to an increase in the qualitative risk factors for all loan segments in the loan portfolio as of December 31, 2020 resulting from the change in the economic environment caused by the COVID-19 pandemic, compared to recording a credit of $573,000 to the loan loss provision in 2019. Net recoveries for 2020 were 0.10% of average loans outstanding compared to net recoveries of 0.12% in 2019.
During 2020, Juniata approved interest and/or principal payment deferrals on 227 loans, excluding TDRs, totaling $77,088,000, for individuals and businesses affected by the economic impacts of COVID-19 as permitted by Section 4013 of the CARES Act. As of December 31, 2020, four loans totaling $5,052,000 remained in deferment; however, future deferments could still occur. None of the borrowers approved for these designated deferrals were delinquent as of March 20, 2020, the date on which the Company’s COVID-19 Modification Program went into effect, and the loan modifications are not considered to be troubled-debt restructures under Section 4013.
At December 31, 2020, non-performing loans (as defined in Table 4 below), as a percentage of the allowance for loan losses, were 10.8% as compared to 74.4% at December 31, 2019. Non-performing loans were 0.11% of loans as of December 31, 2020, and 0.55% of loans as of December 31, 2019. The decrease in nonperforming loans in 2020 compared to 2019 was predominantly due to a $1,397,000 decline in non-accrual loans in 2020 primarily due to two relationships totaling $1,231,000 returned to accruing status. All non-performing loans were collateralized with real estate at December 31, 2020.
TABLE 4
NON-PERFORMING LOANS
Loans on which the accrual of interest has been discontinued are designated as non-accrual loans. Accrual of interest on loans is generally discontinued when the contractual payment of principal or interest has become 90 days past due or reasonable doubt exists as to the full, timely collection of principal or interest. However, it is the Company’s policy to continue to accrue interest on loans over 90 days past due if (1) they are guaranteed or well secured and (2) there is an effective means of timely collection in process. When a loan is placed on non-accrual status, all unpaid interest credited to income in the current year is reversed against current period income, and unpaid interest accrued in prior years is charged against the allowance for loan losses. Interest received on non-accrual loans generally is either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. Generally, accruals are resumed on loans only when the obligation is brought fully current with respect to interest and principal, has performed in accordance with the contractual terms for a reasonable period and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The Company’s non-accrual and charge-off policies are the same, regardless of loan type. During 2020, gross interest income that would have been recorded if loans on non-accrual status had been current was $97,000, of which $82,000 was collected and included in net income.
ALLOWANCE FOR LOAN LOSSES
The amount of allowance for loan losses is determined through a critical quantitative and qualitative analysis performed by management that includes significant assumptions and estimates. It is maintained at a level deemed adequate to absorb probable estimated losses within the loan portfolio and supported by detailed documentation. To assess potential credit weaknesses, it is important to analyze observable trends that may be occurring.
Management systematically monitors the loan portfolio and the adequacy of the allowance for loan losses on a quarterly basis to provide for probable losses inherent in the portfolio. The Bank’s methodology for maintaining the allowance is highly structured and contains two components: 1) specific allowances allocated to loans evaluated for impairment under the Financial Accounting Standards Board’s Accounting Standards Codification ("FASB ASC") Section 310-10-35; and 2) allowances calculated for pools of loans evaluated for impairment under FASB ASC Subtopic 450-20 (Contingencies).
Component for impaired loans:
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all the circumstances surrounding the loans and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.
The estimated fair values of substantially all the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral. For commercial loans secured with real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the current appraisal and the condition of the property. Appraised values may be discounted to arrive at the estimated selling price of the collateral, which is considered the estimated fair value. The discounts also include the estimated costs to sell the property. For commercial loans secured by non-real estate collateral, estimated fair values are determined based on the borrower’s financial statements, inventory reports, aging accounts receivable, equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. For such loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The Company generally does not separately identify individual consumer segment loans for impairment analysis unless such loans are subject to a restructuring agreement.
Loans whose terms are modified are classified as troubled debt restructurings if the Company grants borrower’s concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a below-market interest rate based on the loan’s risk characteristics or an extension of a loan’s stated maturity date. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for a sustained period after modification. Loans classified as troubled debt restructurings are designated as impaired.
As of December 31, 2020, 27 loans, with aggregate outstanding balances of $4,227,000, were evaluated for impairment. A collateral analysis was performed on each of these 27 loans to establish a portion of the reserve needed to carry impaired loans at no higher than fair value. As a result of this analysis, one loan for $78,000 was determined to have insufficient collateral, and therefore, a $2,000 specific reserve was established. Loans acquired with credit impairment are considered impaired loans but are not included with this component for consideration in the allowance. They were carried at fair value of $962,000 as of December 31, 2020.
Component for pooled loan contingencies:
A contingency is an existing condition, or set of circumstances, involving uncertainty as to possible gain or loss to the Company that will ultimately be resolved when one or more future events occur or fail to occur. These conditions may be considered in relation to individual loans or in relation to groups of similar types of loans. If the conditions are met, a provision is made even though the loans that are uncollectible may not be identifiable.
In accordance with FASB ASC Subtopic 450-20, when measuring estimated credit losses, these loans are grouped into homogenous pools with similar characteristics and evaluated collectively considering both quantitative measures, such as historical loss, and qualitative measures, in the form of environmental adjustments.
These pools are established by general loan type, or "class" as follows:
●Commercial, financial and agricultural
●Real estate - commercial
●Real estate - construction
●Real estate - mortgage
●Obligations of states and political subdivisions
●Personal
Some portfolio segments are further disaggregated and evaluated collectively for impairment based on "class segments," which are largely based on the type of collateral underlying each loan. For commercial, financial and agricultural loans, class segments include commercial loans secured by other-than real estate collateral. Real estate - commercial class segments include loans secured by farmland, multi-family properties, owner-occupied non-farm, non-residential properties and other nonfarm non-residential properties. Real estate - construction loan class segments include loans secured by commercial real estate, loans to commercial borrowers secured by residential real estate and loans to individuals secured by residential real estate. Real estate - mortgage includes loans secured by first and junior liens on residential real estate.
Obligations of states and political subdivision loan class segment primarily includes tax-anticipation notes to local municipalities and other tax-exempt organizations. Personal loan class segments include direct consumer installment loans, indirect automobile loans and other revolving and unsecured loans to individuals.
Quantitative factor determination:
An average annual loss rate is calculated for each pool through an analysis of historical losses over a five-year look-back period. Using data for each loan, a loss emergence period is determined within each segmented class pool. The loss emergence period reflects the approximate length of time from the point when a loss is incurred (the loss trigger event) to the point of loss confirmation (the date of eventual charge-off). The loss emergence period is applied to the average annual loss to produce the quantitative factor for each pooled class segment.
Qualitative factor determination:
Historical loss rates computed in the quantitative component reflects an estimate of the level of incurred losses in the portfolio based on historical experience. Management considers that the current conditions may deviate from those that prevailed over the historical look-back period. Thus, the quantitative rates are an imperfect estimate, necessitating an evaluation of qualitative considerations, i.e. environmental factors, to incorporate these risks.
Management considered qualitative, environmental risk factors including:
●National, regional and local economic and business conditions, and developments that affect the collectability of the portfolio, including the condition of various market segments;
●Changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified loans;
●Changes in the nature and volume of the portfolio and terms of loans;
●Changes in the experience, ability and depth of lending and credit management and other relevant staff;
●Existence and effect of any concentrations of credit and changes in the level of such concentrations;
●Changes in the quality of the loan review system;
●Changes in lending policies and procedures including changes in underwriting standards and collection, charge-off and recovery practices;
●Changes in the value of underlying collateral for collateral-dependent loans; and
●Effect of external influences, including competition, legal and regulatory requirements.
Within each loan segment, an analysis was performed over a ten-year look-back period to discover peak historical losses, and with this data, management established ranges of risk from minimal to very high, for each risk factor, to produce a supportable anchor for risk assignment. Based on the framework for risk factor evaluation and range of adjustments established through the anchoring process, a risk assessment and corresponding adjustment was assigned for each portfolio segment as of December 31, 2020. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation.
The combination of quantitative and qualitative factors was applied to year-end balances in each pooled segment to establish the overall allowance.
A summary of activity in the allowance for loan loss for the last five years is shown below. The Company recorded net recoveries of $412,000 in 2020. Based on the analysis described above, the provision for loan loss in 2020 was 226% higher than in 2019. With the provision exceeding net recoveries, the loan loss allowance increased by 38.3% over the December 31, 2019 allowance. Management’s analysis indicated that the loan loss allowance of $4,094,000 at December 31, 2020 was adequate.
The following tables show how the allowance for loan losses is allocated among the various types of outstanding loans and the percent of loans by type to total loans.
INVESTMENTS
Total investments, defined to include all interest earning assets except loans (i.e. debt securities available for sale at fair value), equity securities, federal funds sold, interest bearing deposits, restricted investment in bank stock and other interest-earning assets), totaled $321,417,000 on December 31, 2020, representing an increase of $103,853,000, or 47.7%, compared to year-end 2019. The increase in 2020 was mainly the result of an overall increase in available funds from deposits due primarily to government stimulus payments and less consumer spending during the pandemic, as well as funds made available from increased FHLB borrowings which were invested in the securities portfolio.
The following table summarizes how the ending balances changed annually in each of the last two years.
The investment area is managed according to internally established guidelines and quality standards. Juniata segregates its investment securities portfolio into two classifications: those held to maturity and those available for sale. Juniata classifies all new marketable investment securities as available for sale, and currently holds no securities in the held to maturity or trading classifications. At December 31, 2020, the market value of the entire securities portfolio was greater than amortized cost by $4,508,000 as compared to December 31, 2019, when the market value was less than amortized cost by $647,000. The weighted average life of the investment portfolio was 4.8 years on December 31, 2020 and 3.8 years on December 31, 2019. The weighted average maturity has remained short to achieve a desired level of liquidity. Table 5, “Maturity Distribution”, in this Management’s Discussion and Analysis of Financial Condition shows the remaining maturity or earliest possible repricing for investment securities.
The following table sets forth the maturities of securities and the weighted average yields of such securities by contractual maturities or call dates. Yields on obligations of states and public subdivisions are presented on a tax-equivalent basis.
BANK OWNED LIFE INSURANCE AND ANNUITIES
The Company periodically insures the lives of certain bank officers to provide split-dollar life insurance benefits to some key officers and to offset the cost of providing post-retirement benefits through non-qualified plans. Some annuities are also owned to provide cash streams that match certain post-retirement liabilities. See Note 7 of The Notes to Consolidated Financial Statements. The following table summarizes how the cash surrender values of these instruments changed annually in each of the last two years.
GOODWILL AND INTANGIBLE ASSETS
Branch Acquisition
On September 8, 2006, the Company acquired a branch office in Richfield, PA. Goodwill recorded on that acquisition was $2,046,000 and is measured annually for impairment.
FNBPA Acquisition
On November 30, 2015, the Company completed its acquisition of FNBPA and, as of December 31, 2020 and 2019, goodwill related to the FNBPA acquisition was $3,402,000. In addition, a core deposit intangible in the amount of $303,000 was recorded and is being amortized over a ten-year period using a sum of the year’s digits basis. Core deposit
intangible amortization expense recorded in 2020 was $33,000 and, for the succeeding five years beginning 2021, is estimated to be $27,000, $22,000, $16,000, $10,000 and $5,000 per year, respectively. The core deposit intangible will be fully amortized in 2025. Core deposit and other intangible assets, net of amortization, was $80,000 as of December 31, 2020 and $113,000 as of December 31, 2019.
LCB Acquisition
On April 30, 2018, Juniata completed the acquisition of LCB and, as a result, recorded goodwill of $3,599,000 as of December 31, 2020 and 2019. In addition, a core deposit intangible of $289,000 was recorded and will be amortized over a ten-year period using a sum of the years’ digits basis. Core deposit intangible expense recorded in 2020 was $44,000, and for the succeeding five years beginning 2021, is estimated to be $39,000, $33,000, $28,000, $23,000 and $17,000 per year, respectively, and $21,000 in total for years after 2025. Core deposit intangible, net of amortization, was $161,000 as of December 31, 2020 and $205,000 as of December 31, 2019.
Mortgage Servicing Rights
Due to a strategic shift in focus to a new mortgage product, which is increasing fees derived from loan activity, the Company did not originate and sell residential mortgage loans to the secondary market in 2020 or 2019; however, the Company retained the servicing rights on loans originated and sold in prior years. The mortgage servicing rights are valued based on the present value of estimated future cash flows on pools of mortgages stratified by rate and maturity date. The computed value is carried as an intangible asset. As of December 31, 2020 and December 31, 2019, the fair value of mortgage servicing rights was $158,000 and $180,000, respectively.
DEFERRED TAXES
The Company accounts for income taxes under the asset/liability method. Deferred tax assets and liabilities are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carryforwards, if applicable. A valuation allowance is established against deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. Management established a valuation allowance of $34,000 in 2019 for a capital loss carryforward for which the tax benefit is not likely to be realized and continues to carry that allowance as of December 31, 2020. As of December 31, 2020, the Company recorded a net deferred tax liability of $66,000, which was carried as a non-interest bearing liability. As of December 31, 2019, the Company recorded a net deferred tax asset of $589,000, which was carried as a non-interest earning asset. See Note 13 of The Notes to Consolidated Financial Statements.
OTHER NON-INTEREST EARNING ASSETS
The following table summarizes the components of the non-interest earning asset category, and how the ending balances changed annually over the last two years.
DEPOSITS
As of December 31, 2020, total deposits were $622,866,000, an increase of $90,929,000 as compared to the previous year end, due primarily to government stimulus payments and less consumer spending during the pandemic. The following table summarizes how the ending balances changed annually over the last two years.
The following table shows the comparison of average core deposits and average time deposits as a percentage of total deposits for the last two years.
Average deposits increased $54,257,000, or 10.3%, to $582,884,000 in 2020. Core transaction accounts increased by 13.5% in 2020. The largest dollar increase in 2020 compared the previous year was $27,513,000 in non-interest demand accounts, while the largest percentage increase of 23.2% was in time deposit accounts $100,000 and greater. In addition to deposit products, Juniata provides alternatives to customers through the sale of wealth management (non-deposit) products.
The consumer continues to have a need for transaction accounts, and the Bank is continuing to focus on that need to build deposit relationships. Products are geared toward low-cost convenience and ease for the customer. The Company’s strategy is to aggressively seek to grow customer relationships by staying in touch with customers’ changing needs and new methods of connectivity, in an effort to increase deposit (and loan) market share. The Bank offers identity protection services as an option for all consumer demand depositors. We believe this product to be a valuable and essential tool necessary to combat the upsurge in fraud and identity theft. This product is a unique benefit to our customers as there are no other banks in our immediate market that offer a similar service.
The Bank competes in the marketplace with many sources that offer products that directly compete with traditional banking products. In keeping with our desire to provide our customers with a full array of financial services, we supplement the services traditionally offered by our Trust Department by staffing our community offices with wealth management consultants that are licensed and trained to sell variable and fixed rate annuities, mutual funds, stock brokerage services and long-term care insurance. Although the sale of these products can reduce the Bank’s deposit levels, these products
offer solutions for our customers that traditional bank products cannot and allow us to service our customer base more completely. Fee income from the sale of non-deposit products (primarily annuities and mutual funds) was $306,000 and $272,000 in 2020 and 2019, respectively, representing approximately 5.8% and 5.7%, respectively, of total non-interest income.
OTHER INTEREST BEARING LIABILITIES
Juniata funds its needs primarily with local deposits and when necessary, relies on external funding sources for additional funding. External funding sources include credit facilities at correspondent banks and the Federal Home Loan Bank of Pittsburgh. Juniata’s average balances for all borrowings increased by $33,656,000 in 2020 compared to 2019 due to a three-year cash flow hedge on $20,000,000 in three-month advances from the FHLB, as well as the addition of FRB advances from the participation in the Federal Reserve Bank’s PPPLF.
PENSION PLAN
The Company’s noncontributory pension plan, the JVB Plan, covered substantially all its employees employed prior to December 31, 2007. As of January 1, 2008, the JVB Plan was amended to close the plan to new entrants. All active participants as of December 31, 2007 became 100% vested in their accrued benefit and, if they remained eligible, continued to accrue benefits until December 31, 2012. The benefits were based on years of service and the employee’s compensation. Effective December 31, 2012, the JVB Plan was amended to cease future service accruals after that date (i.e., it was frozen).
The JVB Plan was amended in 2016 to provide pension benefits to all former FNBPA employees that were previously participants in the former Retirement Plan for the First National Bank of Port Allegany (“FNB Plan”), as of November 30, 2015, at the same level of benefit provided in the FNB Plan. Effective December 31, 2016, the FNB Plan was merged into the JVB Plan, which was amended to provide the same benefits to the class of participants previously included in the FNB Plan.
Juniata’s Board of Directors resolved to terminate the JVB Plan, effective November 30, 2018. JVB Plan participants elected preferences for receiving their vested benefit in the form of either lump sum payments or annuities. Juniata incurred a pre-tax charge of $1,221,000. As of December 31, 2019, all obligations were satisfied and The JVB Plan was liquidated. Please refer to Note 19 of The Notes to Consolidated Financial Statements.
STOCKHOLDERS’ EQUITY
Total stockholders’ equity increased by $2,890,000, or 3.9%, in 2020 compared to 2019. The Company was well-capitalized and had the capacity to maintain its typical dividend level in 2020. The Company’s net income exceeded dividends paid by $1,137,000. The adjustment to accumulated other comprehensive income (“AOCI”) to record the change in fair value of debt securities and cash flow hedges increased equity by $3,007,000. Stock based compensation expense recorded pursuant to the Company’s Long-Term Incentive Plan added $128,000 to stockholders’ equity in 2020, while payments for exercised stock options increased shareholders’ equity by $70,000. Treasury stock purchases during the year ended December 31, 2020 decreased stockholders’ equity by $1,452,000, as did the unrealized loss on cash flow hedge.
The following table summarizes how the components of equity changed annually in the last two years.
Average stockholders’ equity in 2020 was $76,056,000, an increase of 7.5% from $70,771,000 in 2019, and was $62,689,000 in 2018. At December 31, 2020, Juniata held 125,838 shares of stock in treasury versus 42,020 at December 31, 2019. Return on average equity decreased to 7.37% in 2020 from 8.24% in 2019 partially due to the growth in average equity resulting primarily from the increase in AOCI, as well as lower income in 2020 compared to 2019. See the discussion in the 2020 Financial Overview section.
The Company periodically repurchases shares of its common stock under the share repurchase program approved by the Board of Directors. In December of 2016, the Board of Directors authorized the repurchase of an additional 200,000 shares of its common stock through its share repurchase program. The program will remain authorized until all approved shares are repurchased, unless terminated by the Board of Directors. Repurchases have typically been accomplished through open market transactions and have complied with all regulatory restrictions on the timing and amount of such repurchases. Shares repurchased have been added to treasury stock and accounted for at cost. These shares may be reissued for stock option exercises, employee stock purchase plan purchases, restricted stock awards, to fulfill dividend reinvestment program needs and to supply shares needed as consideration in an acquisition. During 2020 and 2019, 87,712 and 21,508 shares, respectively, were repurchased in conjunction with this program. There were also 565 and 800 restricted share awards forfeited in 2020 and 2019, respectively. Treasury shares of 4,459 and 22,489 were also redeemed for stock option exercises and employee stock purchase plan purchases in 2020 and 2019, respectively. Shares remaining authorized for repurchase in the program were 59,989 as of December 31, 2020.
Juniata declared dividends of $0.88 per common share in both 2020 and 2019 (See Note 14 of The Notes to Consolidated Financial Statements regarding restrictions on dividends from the Bank to the Company). The dividend payout ratio was 79.71% and 76.93% in 2020 and 2019, respectively. The dividend payout ratio in 2020 was greater than 2019 due to lower net income in 2020 compared to 2019. In January 2021, the Board of Directors declared a dividend of $0.22 per share to stockholders of record on February 15, 2021, payable on March 1, 2021.
Juniata’s book value per share at December 31, 2020 was $15.23 as compared to $14.45 at December 31, 2019. Juniata’s average equity to assets ratio for 2020 and 2019 was 10.28% and 10.93%, respectively. Refer also to the Capital Risk section in the Asset / Liability management discussion that follows.
ASSET / LIABILITY MANAGEMENT OBJECTIVES
Management believes that optimal performance is achieved by maintaining overall risks at a low level. Therefore, the objective of asset/liability management is to control risk and produce consistent, high quality earnings independent of changing interest rates. The Company has identified five major risk areas discussed below:
●Liquidity Risk
●Capital Risk
●Interest Rate Risk
●Investment Portfolio Risk
●Economic Risk
Liquidity Risk
Through liquidity risk management, we seek to maintain our ability to readily meet commitments to fund loans, purchase assets and other securities and repay deposits and other liabilities. Liquidity management also includes the ability to manage unplanned changes in funding sources and recognize and address changes in market conditions that affect the quality of liquid assets. Juniata has developed a methodology for assessing its liquidity risk through an analysis of its primary and total liquidity sources. Juniata relies on three main types of liquidity sources: (1) asset liquidity, (2) liability liquidity and (3) off-balance sheet liquidity.
Asset liquidity refers to assets that we are quickly able to convert into cash, consisting of cash, federal funds sold and securities. Short-term liquid assets generally consist of federal funds sold and securities maturing over the next twelve months. The quality of our short-term liquidity is very good; as federal funds are unimpaired by market risk and as bonds approach maturity, their value moves closer to par value. Liquid assets tend to reduce earnings when there is not an immediate use for such funds, since normally these assets generate income at a lower rate than loans or other longer-term investments.
Liability liquidity refers to funding obtained through deposits. The largest challenge associated with liability liquidity is cost. Juniata’s ability to attract deposits depends primarily on several factors, including sales effort, competitive interest rates and other conditions that help maintain consumer confidence in the stability of the financial institution. Large certificates of deposit, public funds and brokered deposits are all acceptable means of generating and providing funding. If the cost is favorable or fits the overall cost structure of the Bank, then these sources have many benefits. They are readily available, come in large block size, have investor-defined maturities and are generally low maintenance.
Off-balance sheet liquidity is closely tied to liability liquidity. Sources of off-balance sheet liquidity include Federal Home Loan Bank borrowings, repurchase agreements and federal funds lines with correspondent banks. These sources provide immediate liquidity to the Bank. They are available to be deployed when a need arises. These instruments also come in large block sizes, have investor-defined maturities and generally require low maintenance.
“Available liquidity” encompasses all three sources of liquidity when determining liquidity adequacy. It results from the Bank’s access to short-term funding sources for immediate needs and long-term funding sources when the need is determined to be permanent. Management uses both on-balance sheet liquidity and off-balance sheet liquidity to manage its liquidity position. The Company’s liquidity strategy seeks to maintain an adequate volume of high-quality liquid instruments to facilitate customer liquidity demands. Management also maintains sufficient capital, which provides access to the liability and off-balance sheet sides of the balance sheet for funding. An active knowledge of debt funding sources is important to liquidity adequacy.
Contingency funding management involves maintaining contingent sources of immediate liquidity. Management believes that it must consider an array of available sources in terms of volume, maturity, cash flows and pricing. To meet demands in the normal course of business or for contingency, secondary sources of funding such as public funds deposits, collateralized loans, sales of investment securities or sales of loan receivables are considered.
It is the Company’s policy to maintain both a primary liquidity ratio and a total liquidity ratio greater than 10% of total assets. The primary liquidity ratio equals liquid assets divided by total assets, where liquid assets equal the sum of cash and due from banks, federal funds sold, interest-bearing deposits with other banks and available for sale securities. Total
liquidity is comprised of all components noted in primary liquidity plus securities classified as held-to-maturity, if any. If either of these liquidity ratios falls below 10%, it is the Company’s policy to increase liquidity in a timely manner to achieve the required ratio.
It is the Company’s policy to maintain available liquidity greater than 10% of total assets and contingency liquidity greater than 7.5% of total assets.
Juniata is a member of the FHLB of Pittsburgh, which provides short-term liquidity and a source for long-term borrowings. The Bank uses this vehicle to satisfy temporary funding needs throughout the year. Additionally, in 2020, the Company executed a three-year cash flow hedge on $20,000,000 in rolling three-month advances from the FHLB. The Company had short-term borrowings of $20,000,000 on December 31, 2020 and $9,700,000 on December 31, 2019.
The Bank’s maximum borrowing capacity with the FHLB was $166,178,000 at December 31, 2020. In order to borrow additional amounts, the FHLB would require the Bank to purchase additional FHLB Stock. The FHLB is a source of both short-term and long-term funding. The Bank must maintain sufficient qualifying collateral to secure all outstanding advances.
Juniata needs to have liquid resources available to fulfill contractual obligations that require future cash payments.
Capital Risk
The Company maintains sufficient core capital to protect depositors and shareholders and to take advantage of business opportunities while ensuring that it has resources to absorb the risks inherent in the business. Federal banking regulators have established capital adequacy requirements for banks and bank holding companies based on risk factors, which require more capital backing for assets with higher potential credit risk than assets with lower credit risk.
The Bank is subject to risk-based capital standards by which banks are evaluated in terms of capital adequacy. These regulatory capital requirements are administered by the federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital and classification are also subject to qualitative judgments by the regulators. Management believes as of December 31, 2020, the Bank meets all capital adequacy requirements to which it is subject.
Prompt corrective action regulations provide five classifications: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end 2020 and 2019, the most recent regulatory notifications categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.
In 2019, the federal banking agencies jointly issued a final rule that provides for an optional, simplified measure of capital adequacy, the community bank leverage ratio framework (“CBLR framework”), for qualifying community banking organizations, consistent with Section 201 of the Economic Growth Act. The final rule became effective on January 1, 2020 and was elected by the Bank in 2020. In April 2020, the federal banking agencies issued an interim final rule that makes temporary change to the CBLR framework, pursuant to section 4012 of the CARES Act, and a second interim final rule that provides a graduated increase in the community bank leverage ratio requirement after the expiration of the temporary changes implemented pursuant to section 4012 of the CARES Act.
The community bank leverage ratio removes the requirement for qualifying banking organizations to calculate and report risk-based capital, but rather only requires compliance with a Tier 1 to average assets (“leverage”) ratio. Qualifying banking organizations that elect to use the CBLR framework and that maintain a leverage ratio of greater than required minimums will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the
agencies’ capital rules (generally applicable rule) and, if applicable, will be considered to have met the well-capitalized ratio requirements for purposes of Section 38 of the Federal Deposit Insurance Act. Under the interim final rules, the community bank leverage ratio minimum requirement is 8.0% as of December 31, 2020, 8.5% for calendar year 2021, and 9.0% for calendar year 2022 and beyond. The interim rule allows for a two-quarter grace period to correct a ratio that falls below the required amount, provided the Bank maintains a leverage ratio of 7.0% as of December 31, 2020, 7.5% for calendar year 2021, and 8.0% for calendar year 2022 and beyond.
Under the final rule, an eligible banking organization can opt out of the CBLR framework and revert back to the risk-weighting framework without restriction. As of December 31, 2020, the Bank was a qualifying community banking organization as defined by the federal banking agencies and elected to measure capital adequacy under the CBLR framework. See Note 14 of Notes to the Consolidated Financial Statements.
Interest Rate Risk
Table 5, presented below, illustrates the maturity distribution of the Company’s interest-sensitive assets and liabilities as of December 31, 2020. Earliest re-pricing opportunities for variable and adjustable rate products and scheduled maturities for fixed rate products have been placed in the appropriate column to compute the cumulative sensitivity ratio (ratio of interest-earning assets to interest-bearing liabilities). Securities with call features are treated as though the call date is the maturity date. Through one year, the cumulative sensitivity ratio is 0.30, indicating a liability-sensitive balance sheet, when measured on a static basis.
TABLE 5
MATURITY DISTRIBUTION
As of December 31, 2020
Remaining Maturity / Earliest Possible Repricing
Investment Portfolio Risk
Management considers its investment portfolio risk as the amount of appreciation or depreciation the investment portfolio will sustain when interest rates change. The securities portfolio will decline in value when interest rates rise and increase in value when interest rates decline. Securities with long maturities, excessive optionality (as a result of call features) and unusual indexes tend to produce the most market risk during interest rate movements. Rate shocks of minus 100 and plus 100, 200, 300 and 400 basis points were applied to the securities portfolio to determine how Tier 1 capital would be affected if the securities portfolio had to be liquidated and all gains and losses were recognized. The test revealed that, as of December 31, 2020, capital levels would remain adequate under these scenarios.
Economic Risk
Economic risk is the risk that the long-term or underlying value of the Company will change if interest rates change. Economic value of equity (“EVE”) represents the change in the value of the balance sheet without regard to business continuity. Rate shocks are applied to all financial assets and liabilities, using parallel and non-parallel rate shifts of 100
to 400 basis points to estimate the change in EVE under the various hypothetical scenarios. As of December 31, 2020, in a rising rate environment, the modeling results indicate that the Company’s liabilities would increase in value slightly more than assets would lose value. A non-parallel 200 basis point increase shock in rates produced an estimated 6.1% increase in EVE, indicating a stable value well within Juniata’s policy guidelines.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has numerous off-balance sheet loan obligations that exist to meet the financing needs of its customers. These financial instruments include commitments to extend credit, unused lines of credit and letters of credit. Because many commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These instruments involve, to varying degrees, elements of credit and interest rate risk that are not recognized in the consolidated financial statements. The Company does not expect that these commitments will have an adverse effect on its liquidity position.
Exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and financial guarantees written is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making these commitments as it does for on-balance sheet instruments.
The Company had outstanding loan origination commitments aggregating $81,997,000 and $97,037,000 on December 31, 2020 and 2019, respectively. In addition, the Company had $13,092,000 and $13,448,000 outstanding in unused lines of credit commitments extended to its customers on December 31, 2020 and 2019, respectively. The increase was mainly due to the acquisition of Liverpool’s consumer lines of credit.
Letters of credit are instruments issued by the Company that guarantee payment by the Bank to the beneficiary in the event of default by the Company’s customer in the non-performance of an obligation or service. Most letters of credit are extended for a one-year period. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds collateral supporting those commitments for which collateral is deemed necessary. The amount of the liability as of December 31, 2020 and 2019 for guarantees under letters of credit issued is not material.
The maximum undiscounted exposure related to these guarantees on December 31, 2020 was $4,006,000, and the approximate value of underlying collateral upon liquidation that would be expected to cover this maximum potential exposure was $32,906,000.
In 2017, the Company executed renewal agreements for technology outsourcing services through two outside service bureaus. Both agreements provide for termination fees if the Company cancels the services prior to the end of the 7-year commitment period that runs through May 31, 2024. At December 31, 2020, potential termination fees were estimated to be approximately $2,053,000 and $981,000 on the two contracts. The potential termination fees decrease by approximately 15% in each succeeding year through 2024. Since the Company does not expect to terminate these services with either vendor prior to the end of the commitment periods, no liability has been recorded as of December 31, 2020.
EFFECTS OF INFLATION
The performance of a bank is affected more by changes in interest rates than by inflation; therefore, the effect of inflation is normally not as significant to the Company as it is to other businesses and industries. During periods of high inflation, the money supply usually increases, and banks normally experience above average growth in assets, loans and deposits. A bank’s operating expenses may increase during inflationary times as the price of goods and services increase.
A bank’s performance is also affected during recessionary periods. In times of recession, a bank usually experiences a tightening on its earning assets and on its profits. A recession is usually an indicator of higher unemployment rates, which could mean an increase in the number of nonperforming loans because of continued layoffs and other deterioration of consumers’ financial condition.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following audited financial statements are set forth in this Annual Report on Form 10-K on the following pages:
REPORT ON MANAGEMENT’S ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
CONSOLIDATED STATEMETNS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT ON MANAGEMENT’S ASSESSMENT OF INTERNAL
CONTROL OVER FINANCIAL REPORTING
Management is responsible for the preparation, integrity and fair presentation of the consolidated financial statements included in this Annual Report on Form 10-K. The consolidated financial statements and notes included in this annual report have been prepared in conformity with accounting principles generally accepted in the United States of America, and as such, include some amounts that are based on management’s best estimates and judgments.
The Company’s management is responsible for establishing and maintaining effective internal control over financial reporting. The system of internal control over financial reporting, as it relates to the financial statements, is evaluated for effectiveness by management and tested for reliability through a program of internal audits and management testing and review. Actions are taken to correct potential deficiencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only a reasonable assurance with respect to financial statement preparation.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013).
Based on our assessment, management concluded that as of December 31, 2020, the Company’s internal control over financial reporting was effective and met the criteria of the Internal Control-Integrated Framework (2013).
Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Marcie A. Barber
JoAnn N. McMinn
President and Chief Executive Officer
Chief Financial Officer
Crowe LLP
Independent Member Crowe Global
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and the Board of Directors of Juniata Valley Financial Corp.
Mifflintown, Pennsylvania
Opinions on the Financial Statements
We have audited the accompanying consolidated statement of financial condition of Juniata Valley Financial Corp. (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for the years then ended and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinions
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Loan Losses - Adjustments for qualitative factors
As more fully described in Note 2 to the consolidated financial statements, the Company estimates and records an allowance for loan losses collectively evaluated for impairment by developing a loss rate based on quantitative and qualitative factors. Quantitative factors are based on historical loss rates using historical data for each loan pool. Qualitative factors are used to adjust historical loss rates considering relevant risk factors. The risk factors considered include national, regional and local economic and business conditions, and developments that affect the collectability of the portfolio, including the condition of various market segments, changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified loans , changes in the nature and volume of portfolio, changes in lending and credit management team, existence and effect of any concentrations, changes in quality of the loan review system, changes in lending policies and procedures, changes in the value of underlying collateral-dependent loans, and the effect of external influences including competition, legal, and regulatory requirements.
The principal considerations for our determination that auditing the qualitative adjustments to the quantitative factor is a critical audit matter is the high degree of judgment involved in the assessment of the risk of loss associated with each risk factor. Our audit procedures included substantive testing related to the adjustments for these risk factors. Procedures included, among others:
●Substantively testing management’s process, including evaluating their judgments and assumptions, for developing the qualitative factors, which included:
oEvaluation of the completeness and accuracy of data inputs used as a basis for the factors underlying the qualitative allowance.
oEvaluation of the relevance and reliability of the selected data inputs.
oEvaluation of the reasonableness of management’s judgments related to the qualitative and quantitative assessment of the data used in the determination of the factors underlying the qualitative allowance and the resulting allocation to the allowance.
oAnalytically evaluating the qualitative factors year over year for directional consistency, testing for reasonableness, and obtaining evidence for significant changes.
oTesting the mathematical accuracy of the allowance calculation, including the calculation of the qualitative allowance. The test of the calculation of the qualitative allowance including testing the accuracy of the allocation of the underlying factors.
/s/ Crowe LLP
We have served as the Company’s auditor since 2019.
Cleveland, Ohio
March 15, 2021
JUNIATA VALLEY FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
See The Notes to Consolidated Financial Statements
JUNIATA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
See The Notes to Consolidated Financial Statements
JUNIATA VALLEY FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(1)Amounts are included in gain (loss) on sales and calls of securities on the Consolidated Statements of Income as a separate element within total non-interest income.
(2)Amounts are included in the computation of net periodic benefit cost and are included in employee benefits expense on the Consolidated Statements of Income as a separate element within total non-interest expense.
(3)Amounts are included in interest expense on short-term borrowings and repurchase agreements on the consolidated statements of income.
(4)Income tax amounts are included in the income tax (benefit) provision on the Consolidated Statements of Income.
See The Notes to Consolidated Financial Statements
JUNIATA VALLEY FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
See The Notes to Consolidated Financial Statements
JUNIATA VALLEY FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
See The Notes to Consolidated Financial Statements
JUNIATA VALLEY FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2020 and 2019
1. NATURE OF OPERATIONS
Juniata Valley Financial Corp. (“Juniata” or the “Company”) is a bank holding company operating in central and northern Pennsylvania for the purpose of delivering financial services within its local market. Through its wholly-owned banking subsidiary, The Juniata Valley Bank (the “Bank”), Juniata provides retail and commercial banking and other financial services through 16 branch locations located in Juniata, Mifflin, Perry, McKean, Potter and Huntingdon Counties. Additionally, in Mifflin, Juniata and Centre Counties, the Company maintains three offices for loan production, trust services and wealth management sales. Each of the Company’s lines of business are part of the same reporting segment, whose operating results are regularly reviewed and managed by a centralized executive management group. As a result, the Company has only one reportable segment for financial reporting purposes. The Bank provides a full range of banking services, including online and mobile banking, an automatic teller machine network, checking accounts, identity protection products for consumers, savings accounts, money market accounts, fixed rate certificates of deposit, club accounts, secured and unsecured commercial and consumer loans, construction and mortgage loans, online account opening, safe deposit facilities and credit loans with overdraft checking protection. The Bank also provides a variety of trust services. The Company has a contractual arrangement with a broker-dealer to allow the offering of annuities, mutual funds, stock and bond brokerage services and long-term care insurance to its local market. The Bank operates under a state bank charter and is subject to regulation by the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation. Juniata is subject to regulation by the Board of Governors of the Federal Reserve Bank and the Pennsylvania Department of Banking and Securities.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting policies of Juniata Valley Financial Corp. and its wholly owned subsidiary conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general financial services industry practices. A summary of the more significant accounting policies applied in the preparation of the accompanying consolidated financial statements follows.
Principles of Consolidation
The consolidated financial statements include the accounts of Juniata Valley Financial Corp. and its wholly owned subsidiary, The Juniata Valley Bank. All significant intercompany transactions and balances have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Significant Group Concentrations of Credit Risk
Most of the Company’s activities are with customers located within Juniata’s footprint in central and northern Pennsylvania. Note 5 discusses the types of securities in which the Company invests. Note 6 discusses the types of lending in which the Company engages.
As of December 31, 2020, credit exposure to lessors of non-residential buildings and dwellings represented 44% of capital, credit exposure to residential buildings and dwellings represented 39% of capital, credit exposure to hotels and motels represented 31% of capital, and credit exposure to continuing care retirement communities represented 27% of capital. Otherwise, there were no concentrations of credit to any industry equaling more than 15% of total capital. The Bank’s business activities are geographically concentrated in the counties of Juniata, Mifflin, Perry, Huntingdon, Centre, Franklin, McKean, Potter and Snyder, Pennsylvania. The Bank has a diversified loan portfolio; however, a substantial portion of its debtors’ ability to honor their obligations is dependent upon the economy in central and northern Pennsylvania.
Revenue Recognition
The Company generally acts in a principal capacity, on its own behalf, in most contracts with customers. In such transactions, revenue and related costs to provide these services are recognized on a gross basis in the financial statements. In some cases, the Company acts in an agent capacity, deriving revenue through assisting other entities in transactions with its customers. In such transactions, revenue and the related costs to provide the services are recognized on a net basis in the financial statements. These transactions primarily relate to non-deposit product commissions and fees derived from customer’s use of various interchange and ATM/debit card networks.
All the Company’s revenue from contracts with customers in the scope of ASC Topic 606, Revenue from Contracts with Customers, are recognized within non-interest income on the consolidated statements of income. Revenue streams not within the scope of ASC 606 included in non-interest income on the consolidated statements of income include earnings on bank-owned life insurance and annuities, income from unconsolidated subsidiary, fees derived from loan activity, mortgage banking income, gain/loss on sales and calls of securities, and the change in value of equity securities. Refer to Note 18 for a description of the Company’s sources of revenue accounted for under ASC 606.
Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest bearing demand deposits with banks and federal funds sold. Generally, federal funds are sold for one-day periods.
Interest Bearing Time Deposits with Banks
Interest-bearing time deposits with banks consist of certificates of deposits in other banks with original maturities of greater than 90 days. These time deposits all have maturities within five years.
Securities
Debt securities classified as available for sale are stated at fair value, with the unrealized gains and losses, net of tax, reported as a component of other comprehensive income. Securities classified as available for sale are those securities that the Company intends to hold for an indefinite period but not necessarily to maturity. Interest and dividends are recognized as income when earned. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method. The Company had no securities classified as held to maturity at December 31, 2020 and 2019.
Management evaluates debt securities for other-than-temporary impairment (“OTTI”) on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For debt securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a debt security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: (1) OTTI related to credit loss, which must be recognized in the income statement and (2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.
All the Company’ equity securities are within the scope of ASC 321, Investments - Equity Securities, while debt securities are under ASC 320, Investments - Debt Securities. ASC 321 requires all equity securities within its scope to be measured at fair value with changes in fair value recognized in net income.
Restricted Investment in Bank Stock
The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. The Bank also owns restricted stock investments in the Atlantic Community Bankers Bank (“ACBB”). Both the FHLB and ACBB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Loans
Loans that the Company has the intent and ability to hold for the foreseeable future or until maturity are stated at the outstanding unpaid principal balances, net of any deferred fees or costs and the allowance for loan losses. Interest income on all loans, other than non-accrual loans, is accrued over the term of the loans based on the amount of principal outstanding.
The loan portfolio includes the following classes: (1) commercial, financial and agricultural, (2) real estate - commercial, (3) real estate - construction, (4) real estate - mortgage, (5) obligations of states and political subdivisions, and (6) personal loans.
Interest income on consumer, mortgage and commercial loans is discontinued and loans are placed on non-accrual status at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Loans are charged off to the extent principal or interest is deemed uncollectible. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on non-accrual or charged off at an earlier date if collection of principal or interest is considered doubtful. Non-accrual loans and loans past due 90 days still on accrual include both homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Under the cost-recovery method, interest income is not recognized until the loan principal balance is reduced to zero. Under the cash-basis method, interest income is recorded when the payment is received in cash. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current, the loan has performed in accordance with the contractual terms for a reasonable period and future payments are reasonably assured.
Loan Origination Fees and Costs
Loan origination fees and related direct origination costs for a given loan are deferred and amortized over the life of the loan on a level-yield basis as an adjustment to interest income over the contractual life of the loan. As of December 31, 2020, the amount of net unamortized origination fees carried as an adjustment to outstanding loan balances was $298,000. As of December 31, 2019, the amount of net unamortized origination costs carried as an adjustment to outstanding loan balances was $70,000.
Acquired Loans
Loans that Juniata acquires through business combinations are recorded at fair value with no carryover of the related allowance for loan losses. Some of these loans have shown evidence of credit deterioration since origination. These purchased credit impaired (“PCI”) loans are recorded at the amount paid, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, losses are recognized by an increase in the allowance for loan losses.
Such purchased credit impaired loans are accounted for individually or aggregated into pools of loans based on common risk characteristics, such as credit score, loan type, and date of origination. Juniata estimates the amount and timing of expected cash flows for each loan or pool, and the expected cash flows in excess of the amount paid is recorded as interest income over the remaining life of the loan or pool (accretable yield). The excess of the loan’s or pool’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference).
Over the life of the loan or pool, expected cash flows continue to be estimated. If the present value of expected cash flows is less than the carrying amount, a loss is recorded as a provision for loan losses. If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.
PCI loans that met the criteria for impairment or non-accrual of interest prior to the acquisition may be considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if Juniata expects to fully collect the new carrying value (i.e. fair value) of the loans. As such, Juniata may no longer consider the loan to be non-accrual or nonperforming and may accrue interest on these loans, including the impact of any accretable discount. In addition, charge-offs on such loans would be first applied to the nonaccretable difference portion of the fair value adjustment.
Loans acquired through business combinations that do not meet the specific criteria of ASC 310-30, but for which a discount is attributable at least in part to credit quality, are also accounted for in accordance with this guidance. As a result, related discounts are recognized subsequently through accretion based on the contractual cash flows of the acquired loans.
Allowance for Loan Losses
The allowance for loan losses (“allowance”) represents management’s estimate of losses inherent in the loan portfolio as of the consolidated statement of financial condition date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the loan balance is uncollectible. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, as well as other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgement, should be charged off.
For financial reporting purposes, the provision for loan losses charged to current operating income is based on management’s estimates, and actual losses may vary from estimates. These estimates are reviewed and adjusted at least quarterly and are reported in earnings in the periods in which they become known.
Loans included in any class are considered for charge-off when:
●principal or interest has been in default for 120 days or more and for which no payment has been received during the previous four months;
●all collateral securing the loan has been liquidated and a deficiency balance remains;
●a bankruptcy notice is received for an unsecured loan;
●a confirming loss event has occurred; or
●the loan is deemed to be uncollectible for any other reason.
There are two components of the allowance: (1) specific allowances allocated to loans evaluated for impairment under ASC Section 310-10-35; and (2) allowances calculated for pools of loans evaluated collectively for impairment under ASC Subtopic 450-20, Contingencies.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings (“TDRs”) and classified as impaired.
Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all the circumstances surrounding the loans and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. If a loan is impaired, a portion of the allowance
is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.
Impairment for substantially all the Company’s impaired loans is measured based on the estimated fair value of the loan’s collateral. For real estate - commercial loans, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the current appraisal and the condition of the property. Appraised values may be discounted to arrive at the estimated selling price of the collateral, which is considered the estimated fair value. The discounts also include the estimated costs to sell the property. For commercial, financial and agricultural, and obligations of states and political subdivision loans, estimated fair values are determined based on the borrower’s financial statements, inventory reports, aging accounts receivable, equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. For such loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The Company generally does not separately identify individual consumer segment loans for impairment analysis unless such loans are subject to a restructuring agreement.
Troubled debt restructurings are individually evaluated for impairment and included in the separately identified impairment disclosures. Loans whose terms are modified are classified as troubled debt restructurings if the Company grants borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a below-market interest rate based on the loan’s risk characteristics, an extension of a loan’s stated maturity date or a significant delay in payment. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for a sustained period after modification. For TDRs that subsequently default, the Company determines the amount of the allowance on that loan in accordance with the accounting policy for the allowance for loan losses on loans individually identified as impaired. The Company incorporates recent historical experience related to TDRs, including the performance of TDRs that subsequently default, into the calculation of the allowance by loan portfolio class.
The general component of the allowance covers loans that are collectively evaluated for impairment. In accordance with ASC Subtopic 450-20, when measuring estimated credit losses, these loans are grouped into homogenous pools with similar characteristics and evaluated collectively considering both quantitative measures, such as historical loss, and qualitative measures, in the form of environmental adjustments.
Quantitative factor determination:
An average annual loss rate is calculated for each pool through an analysis of historical losses over a five-year look-back period. Using data for each loan, a loss emergence period is determined within each class pool. The loss emergence period reflects the approximate length of time from the point when a loss is incurred (the loss trigger event) to the point of loss confirmation (the date of eventual charge-off). The loss emergence period is applied to the average annual loss to produce the quantitative factor for each pooled class.
Qualitative factor determination:
Historical loss rates computed in the quantitative component reflects an estimate of the level of incurred losses in the portfolio based on historical experience. Management considers that the current conditions may deviate from those that prevailed over the historical look-back period. Thus, the quantitative rates are an imperfect estimate, necessitating an evaluation of qualitative considerations (i.e. environmental factors) to incorporate these risks.
Management considered qualitative, environmental risk factors including:
●National, regional and local economic and business conditions, and developments that affect the collectability of the portfolio, including the condition of various market segments;
●Changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified loans;
●Changes in the nature and volume of the portfolio and terms of loans;
●Changes in the experience, ability and depth of lending and credit management and other relevant staff;
●Existence and effect of any concentrations of credit and changes in the level of such concentrations;
●Changes in the quality of the loan review system;
●Changes in lending policies and procedures including changes in underwriting standards and collection, charge-off and recovery practices;
●Changes in the value of underlying collateral for collateral-dependent loans; and
●Effect of external influences, including competition, legal and regulatory requirements.
Within each loan class, an analysis was performed over a ten-year look-back period to discover peak historical losses, and with this data, management established ranges of risk from minimal to very high, for each risk factor, to produce a supportable anchor for risk assignment. Based on the framework for risk factor evaluation and range of adjustments established through the anchoring process, a risk assessment and corresponding adjustment was assigned for each class as of December 31, 2020. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation.
The combination of quantitative and qualitative factors was applied to year-end balances in each class to establish the overall allowance.
Reserve for Unfunded Lending Commitments
The reserve for unfunded lending commitments represents management’s estimate of probable incurred losses inherent in its unfunded lending commitments and is recorded in other liabilities on the consolidated statement of financial condition, when necessary. The amount of the reserve for unfunded lending commitments is not material to the consolidated financial statements.
Loans Held for Sale and Mortgage Servicing Rights
The Company has originated residential mortgage loans with the intent to sell. These individual loans were normally sold to the buyer immediately. The Company maintains servicing rights on these loans.
When mortgage loans are sold with servicing retained, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. Under the fair value measurement method, the Company measures servicing rights at fair value at each reporting date and reports changes in fair value of servicing assets in earnings in the period in which the changes occur, which are included with mortgage banking income on the income statement. The fair values of servicing rights are subject to fluctuations because of changes in estimated and actual prepayment speeds and default rates and losses. The carrying amount of mortgage servicing rights was $158,000 and $180,000 at December 31, 2020 and 2019, respectively.
Servicing fee income, which is reported on the income statement as mortgage banking 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. Servicing fees totaled $76,000 and $88,000 for the years ended December 31, 2020 and 2019, respectively. Late fees and ancillary fees related to loan servicing are not material.
Commercial, Financial and Agricultural Lending
The Company originates commercial, financial and agricultural loans primarily to businesses located in its primary market area and surrounding areas. These loans are used for various business purposes, which include short-term loans and lines of credit to finance machinery and equipment purchases, inventory and accounts receivable. Generally, the maximum term for loans extended on machinery and equipment is shorter and does not exceed the projected useful life of such machinery and equipment. Most business lines of credit are written with a five year maturity, subject to an annual review.
Commercial, financial and agricultural loans are generally secured with short-term assets; however, in many cases, additional collateral, such as real estate, is provided as additional security for the loan. Loan-to-value maximum values have been established by the Company and are specific to the type of collateral. Collateral values may be determined using invoices, inventory reports, accounts receivable aging reports, collateral appraisals, etc.
In underwriting commercial, financial and agricultural loans, an analysis of the borrower’s capacity to repay the loan, the adequacy of the borrower’s capital and collateral, as well as an evaluation of conditions affecting the borrower, is performed. Analysis of the borrower’s past, present and future cash flows is also an important aspect of the Company’s analysis.
Concentration analysis assists in identifying industry specific risk inherent in commercial, financial and agricultural lending. Mitigants include the identification of secondary and tertiary sources of repayment and appropriate increases in oversight.
Commercial, financial and agricultural loans generally present a higher level of risk than certain other types of loans, particularly during slow economic conditions.
Real Estate - Commercial Lending
The Company engages in real estate - commercial lending in its primary market area and surrounding areas. The Company’s real estate - commercial portfolio is secured primarily by residential housing, commercial buildings, raw land and hotels. Generally, real estate - commercial loans have terms that do not exceed 20 years, have loan-to-value ratios of up to 80% of the appraised value of the property and are typically secured by personal guarantees of the borrowers.
As economic conditions deteriorate, the Company reduces its exposure in real estate loans with higher risk characteristics. In underwriting these loans, the Company performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the property securing the loan. Appraisals on properties securing real estate - commercial loans originated by the Company are performed by independent appraisers.
Real estate - commercial loans generally present a higher level of risk than certain other types of loans, particularly during slow economic conditions.
Real Estate - Construction Lending
The Company engages in real estate - construction lending in its primary market area and surrounding areas. The Company’s real estate - construction lending consists of commercial and residential site development loans, as well as commercial building construction and residential housing construction loans.
The Company’s commercial real estate - construction loans are generally secured with the subject property, and advances are made in conformity with a pre-determined draw schedule supported by independent inspections. Terms of construction loans depend on the specifics of the project, such as estimated absorption rates, estimated time to complete, etc.
In underwriting commercial real estate - construction loans, the Company performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, the reliability and predictability of the cash flow generated by the project using feasibility studies, market data, etc. Appraisals on properties securing real estate - commercial loans originated by the Company are performed by independent appraisers.
Real estate - construction loans generally present a higher level of risk than certain other types of loans, particularly during slow economic conditions. The difficulty of estimating total construction costs adds to the risk as well.
Real Estate - Mortgage Lending
The Company’s real estate - mortgage portfolio is comprised of one-to-four family residential mortgages and commercial loans secured by one-to-four family properties. One-to-four family residential mortgage loan originations, including home equity installment and home equity lines of credit loans, are generated by the Company’s marketing efforts, its present customers, walk-in customers and referrals. These loans originate primarily within the Company’s market area or with customers primarily from the market area.
The Company offers fixed-rate and adjustable rate real estate - mortgage loans with terms up to a maximum of 25 years for both permanent structures and those under construction. The Company’s one-to-four family residential mortgage originations are secured primarily by properties located in its primary market area and surrounding areas. Most of the
Company’s residential real estate - mortgage loans originate with a loan-to-value of 80% or less. Home equity installment loans are secured by the borrower’s primary residence with a maximum loan-to-value of 80% and a maximum term of 15 years. Home equity lines of credit are secured by the borrower’s primary residence with a maximum loan-to-value of 90% and a maximum term of 20 years.
In underwriting one-to-four family residential real estate - mortgage loans, the Company evaluates the borrower’s ability to make monthly payments, the borrower’s repayment history and the value of the property securing the loan. The ability to repay is determined by the borrower’s employment history, current financial conditions, and credit background. The analysis is based primarily on the customer’s ability to repay and secondarily on the collateral or security. Most properties securing real estate - mortgage loans made by the Company are appraised by independent fee appraisers. The Company generally requires real estate - mortgage loan borrowers to obtain an attorney’s title opinion or title insurance, and fire and property insurance (including flood insurance, if necessary) in an amount not less than the amount of the loan. The Company does not engage in sub-prime residential real estate - mortgage originations.
Residential real estate - mortgage loans and home equity loans generally present a lower level of risk than certain other types of consumer loans because they are secured by the borrower’s primary residence. Risk is increased when the Company is in a subordinate position for the loan collateral.
Obligations of States and Political Subdivisions
The Company lends to local municipalities and other tax-exempt organizations. These loans are primarily tax-anticipation notes and, as such, carry little risk. Historically, the Company has never had a loss on any loan of this type.
Personal Lending
The Company offers a variety of secured and unsecured personal loans, including vehicle loans, mobile home loans and loans secured by savings deposits as well as other types of personal loans.
Personal loan terms vary according to the type and value of collateral and creditworthiness of the borrower. In underwriting personal loans, a thorough analysis of the borrower’s willingness and financial ability to repay the loan as agreed is performed. The ability to repay is determined by the borrower’s employment history, current financial conditions and credit background.
Personal loans may entail greater credit risk than do residential mortgage loans, particularly in the case of personal loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles or recreational equipment. In such cases, any repossessed collateral for a defaulted personal loan may not provide an adequate source of repayment of the outstanding loan balance because of the greater likelihood of damage, loss or depreciation. In addition, personal loan collections are dependent on the borrower’s continuing financial stability and, thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.
Other Real Estate Owned
Assets acquired in settlement of mortgage loan indebtedness are recorded as other real estate owned (“OREO”) at fair value less estimated costs to sell, establishing a new cost basis. Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the property to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. If fair value declines after foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.
Goodwill and Other Intangibles
Goodwill arises from business combinations and is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interest in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized but tested for impairment at least annually or more frequently if events and circumstances exists that indicate that a goodwill impairment test should be performed.
Juniata has selected November 30 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet.
Other intangible assets consist of core deposit intangible assets arising from whole bank acquisitions and are amortized on an accelerated method over their estimated useful lives.
There were no impairment losses recognized because of periodic impairment testing in the years ended December 31, 2020 and 2019.
Derivatives
At the inception of a derivative contract, the Company designates the derivative as one of three types based on the Company’s intentions and belief as to likely effectiveness as a hedge. These three types are (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“Fair value hedge”), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation (“Stand-alone derivative”). For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized in current earnings as fair values change. For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. Change in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as non-interest income.
Net cash settlements on derivative that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Net cash settlements on derivatives that do not qualify for hedge accounting are reported in non-interest income. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.
The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.
When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as non-interest income. When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.
The Company is exposed to losses if a counterparty fails to make its payments under a contract in which the Company is in the net receiving position. The Company anticipates that the counterparties will be able to fully satisfy their obligations under the agreements. All the contracts to which the Company is a party settle monthly or quarterly. In addition, the Company obtains collateral above certain thresholds of the fair value of its hedges for each counterparty based upon their credit standing and the Company has netting agreements with the dealers with which it does business.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed principally using the straight-line method over the estimated useful lives of the related assets, which range from 3 to 10 years for furniture and equipment and 25 to 40 years for buildings. Expenditures for maintenance and repairs are charged against income as
incurred. Costs of major additions and improvements are capitalized. Amortization of leasehold improvements is computed on a straight-line basis over the shorter of the assets’ useful life or the related lease term.
Trust Assets and Revenues
Assets held in a fiduciary capacity are not assets of the Bank or the Bank’s Trust Department and are, therefore, not included in the consolidated financial statements. Trust revenues are recorded on the accrual basis as the related obligations are satisfied.
Bank Owned Life Insurance, Annuities and Split-dollar Arrangements
The Company has purchased life insurance policies on certain key executives. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
Juniata has promised a continuation of life insurance coverage to certain persons post-retirement. The estimated present value of future benefits to be paid was $1,146,000 and $1,117,000 as of December 31, 2020 and 2019, respectively, and is included in other liabilities. Related expenses for 2020 and 2019 were $29,000 and $36,000.
Investments in Low-income Housing Partnerships
Juniata has invested as a limited partner in two partnerships that provide low-income housing in Lewistown, Pennsylvania. The carrying value of the investment in the limited partnerships was $3,105,000 at December 31, 2020 and $3,904,000 at December 31, 2019. The decline in carrying value in 2020 was the result of amortization since the project is fully funded as the final remaining draw occurred in 2019.
Income Taxes
The Company accounts for income taxes in accordance with income tax accounting guidance ASC Topic 740, Income Taxes.
Current income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are reduced by a valuation allowance if, based on the weight of the evidence available, it is more likely than not that some, or all, of a deferred tax asset will not be realized.
The Company recognizes a benefit for uncertain tax positions if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term “more likely than not” means a likelihood of more than 50 percent; the terms “examined” and “upon examination” also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management’s judgment. The Company recognizes interest and penalties on income taxes, if any, as a component of income tax expense.
Advertising
The Company follows the policy of charging costs of advertising to expense as incurred. Advertising expenses were $270,000 and $312,000 in 2020 and 2019, respectively, and included in other non-interest expense.
Off-balance Sheet Financial Instruments
In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit. Such financial instruments are recorded on the consolidated statement of financial condition when they are funded.
Transfer of Financial Assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Earnings Per Common Share
Basic earnings per common share is net income divided by weighted average number of common shares outstanding during the period. All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities for this calculation. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes changes in unrealized gains and losses on securities available for sale and unrealized gains and losses on cash flow hedges arising during the period, as well as reclassification adjustments for realized gains and losses on securities available for sale and cash flow hedges included in net income.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable, and an amount or range of loss can be reasonably estimated. Management believes that there are no such matters that will have a material effect on the financial statements.
Dividend Restrictions
Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Company or by the Company to shareholders.
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate footnote. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates.
Stock-based Compensation
The Company sponsors a stock compensation plan for certain key officers which allows, among other stock-based compensation methods, for stock options and restricted stock awards. Prior to 2016, stock options were used exclusively for long-term compensation. Beginning in 2016, restricted shares awards have been used. Compensation expense for stock options granted and restricted stock awarded is measured using the fair value of the award on the grant date and is recognized over the vesting period. The stock-based compensation expense amounts for stock options were derived based on the fair value of options using the Black-Scholes option-pricing model.
Segment Reporting
Management does not separately allocate expenses, including the cost of funding loan demand, between the commercial, retail and trust operations of the Company. As such, discrete financial information is not available, and segment reporting would not be meaningful.
Reclassifications
Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior year net income or shareholders’ equity.
Risk and Uncertainties
On March 11, 2020, the World Health Organization announced that the COVID-19 outbreak was deemed a pandemic, and on March 13, 2020, the President declared the ongoing COVID-19 pandemic of sufficient magnitude to warrant an emergency declaration. The extent to which the coronavirus may impact business activity or investment results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus and the actions required to contain the coronavirus or teat its impact, among others. The economic effects of the COVID-19 pandemic may negatively impact significant estimates and the assumptions underlying those estimates; particularly susceptible to material change is the determination of the allowance for loan losses.
3. RECENT ACCOUNTING STANDARDS UPDATE (“ASU”)
New Accounting Standards Adopted in 2020:
ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities
Issued: August 2017
Summary: ASU 2017-12 simplifies the application of hedge accounting. More specifically, the amendments in this update better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. Furthermore, the amendments expand and refine hedge accounting for both nonfinancial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. Additionally, amendments in this update require an entity to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported. edge ineffectiveness is no longer separately measured and reported.
Effective Date: The ASU is effective for fiscal years beginning after December 15, 2018 and interim periods within those years. The Company adopted the ASU in April 2020 when it established its first derivative contracts.
Pending Accounting Standards:
ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
Issued: June 2016
Summary: ASU 2016-13 requires credit losses on most financial assets to be measured at amortized cost and certain other instruments to be measured using an expected credit loss model (referred to as the current expected credit loss (“CECL”) model). Under this model, entities will estimate credit losses over the entire contractual term of the instrument (considering estimated prepayments, but not expected extensions or modifications unless reasonable expectation of a troubled debt restructuring exists) from the date of initial recognition of that instrument.
The ASU also replaces the current accounting model for purchased credit impaired loans and debt securities. The allowance for credit losses for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (“PCD financial assets”), should be determined in a similar manner to other financial assets measured on an amortized cost basis. However, upon initial recognition, the allowance for credit losses is added to the purchase price (“gross up approach”) to determine the initial amortized cost basis. The subsequent accounting for PCD financial assets is the same expected loss model described above.
Further, the ASU made certain targeted amendments to the existing impairment model for available for sale (“AFS”) debt securities. For an AFS debt security for which there is neither the intent nor a more-likely-than-not requirement to sell, an entity will record credit losses as an allowance rather than a write-down of the amortized cost basis.
Effective Date: On October 16, 2019, the FASB voted and approved to delay the effective date of this ASU for smaller reporting companies until fiscal years beginning after December 15, 2022. Since the Company is a smaller reporting company, the approved delay by the FASB is applicable. While the Company’s senior management is currently in the process of evaluating the impact of the amended guidance on its consolidated financial statements and disclosures, it expects the allowance for loan and lease losses (“ALLL”) to increase upon adoption given that the allowance will be required to cover the full remaining expected life of the portfolio, rather than the incurred loss under current U.S. GAAP. The extent of this increase is still being evaluated and will depend on economic conditions and the composition of the Company’s loan portfolio at the time of adoption. In preparation, the Company has taken steps to prepare for the implementation when it becomes effective by forming an internal taskforce, gathering pertinent data, participating in training courses, and partnering with a software provider that specializes in ALLL analysis, as well as assessing the sufficiency of data currently available through its core database.
ASU 2020-04, Reference Rate Report (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting
Issued: March 2020
Summary: ASU 2020-04 was issued to ease the potential burden in accounting for reference rate reform. The amendments in ASU 2020-04 are elective and apply to all entities that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued due to reference rate reform.
The new guidance provides the following optional expedients that reduce costs and complexity of accounting for reference rate reform:
●Simplify accounting analyses for contract modifications.
●Allow hedging relationships to continue without de-designation if there are qualifying change in the critical terms of an existing hedging relationship due to reference rate reform.
●Allow a change in the systematic and rational method used to recognize in earnings the components excluded from the assessment of hedge effectiveness.
●Allow a change in the designated benchmark interest rate to a different eligible benchmark interest rate in a fair value hedging relationship.
●Allow the shortcut method for a fair value hedging relationship to continue for the remainder of the hedging relationship.
●Simplify the assessment of hedge effectiveness and provide temporary optional expedients for cash flow hedging relationships affected by reference rate reform.
●Allow a one-time election to sell or transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform and are classified as held to maturity before January 1, 2020.
Effective Date: ASU 2020-04 is effective for all entities from the beginning of an interim period that includes the issuance date of the ASU. An entity may elect to apply the amendments prospectively through December 31, 2022. The adoption of this standard is not expected to have a material effect on the Company’s operating results or financial condition.
4. RESTRICTIONS ON CASH AND DUE FROM BANKS
The Bank is required to maintain cash reserve balances with the Federal Reserve Bank if vault cash is insufficient to cover the reserve requirement. As of December 31, 2020 and 2019, respectively, no reserves were required to be held at the Federal Reserve Bank.
5. SECURITIES
Equity Securities
Equity securities owned by the Company consist of common stock of various financial services providers (“Bank Stocks”). The Company had $1,091,000 in equity securities recorded at fair value as of December 31, 2020, and $1,144,000 in equity securities recorded at fair value as of December 31, 2019.
During the years ended December 31, 2020 and 2019, the Company recorded a net loss of $53,000 and a net gain of $26,000, respectively, on the consolidated statements of income because of the change in fair value of the Company’s equity securities.
Debt Securities Available for Sale
The Company’s investment portfolio includes primarily mortgage-backed securities issued by U.S. Government sponsored agencies backed by residential mortgages (approximately 85%), bonds issued by U.S. Government sponsored agencies (approximately 8%), corporate debt securities (approximately 4%) and municipalities (approximately 3%) as of December 31, 2020. Most of the municipal bonds are general obligation bonds with maturities or pre-refunding dates within 5 years.
The amortized cost and fair value of debt securities available for sale as of December 31, 2020 and 2019, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because the securities may be called or prepaid with or without prepayment penalties.
Certain obligations of the U.S. Government and state and political subdivisions are pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes as required or permitted by law. The carrying value of the pledged assets was $74,614,000 and $50,365,000 at December 31, 2020 and 2019, respectively.
In addition to cash received from the scheduled maturities of securities, some investment securities available for sale are sold at current market values through normal operations. Following is a summary of proceeds received from all investment securities transactions and the resulting realized gains and losses:
The following table shows gross unrealized losses and fair values of debt securities available for sale, aggregated by category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2020:
At December 31, 2020, three U.S. Government and agency securities, one corporate debt security and seven mortgage-backed securities had unrealized losses. None of these securities were in a continuous loss position for 12 months or more.
The mortgage-backed securities in the Company’s portfolio are government sponsored enterprise (“GSE”) pass-through instruments issued by the Federal National Mortgage Association (“FNMA”), which guarantees the timely payment of principal on these investments.
The unrealized losses noted above are considered temporary impairments. The decline in the values of the debt securities is due only to interest rate fluctuations, rather than erosion of issuer credit quality. As a result, the payment of contractual cash flows, including principal repayment, is not at risk. None of the debt securities are deemed to be other-than-temporarily impaired because the Company does not intend to sell the securities, does not believe it will be required to sell the securities before recovery and expects to recover the entire amortized cost basis.
The following table shows gross unrealized losses and fair values of securities available for sale, aggregated by category and length of time that individual securities had been in a continuous unrealized loss position, at December 31, 2019:
6. LOANS AND RELATED ALLOWANCE FOR LOAN LOSSES
Loan Portfolio Classification
The following table presents the loan portfolio by class at December 31, 2020 and 2019.
Paycheck Protection Program Loans
On March 27, 2020, the CARES Act was enacted, establishing the PPP which is administered and guaranteed by the SBA, and as such, the Company carries no allowance on these loans. The PPP is intended to provide economic relief to small businesses nationwide adversely impacted by COVID-19. The Company participated in the PPP, and during 2020, funded 508 PPP loans totaling $32,064,000. All the Company’s PPP loans are part of the commercial, financial and agricultural loan portfolio. At December 31, 2020, 47 PPP loans totaling $3,349,000, had been forgiven by the SBA. The outstanding balance of PPP loans as of December 31, 2020 was $28,715,000, with related unamortized net fees of $475,000.
The following tables summarize loans and the activity in the allowance for loan losses by loan class, segregated into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of and for the years ended December 31, 2020 and 2019:
The following tables summarize information regarding impaired loans by portfolio class as of December 31, 2020 and December 31, 2019:
The recorded investment in loans excludes accrued interest receivable and loan origination fees, net due to immateriality. For purposes of this disclosure, the unpaid principal balance is not reduced for partial charge-offs.
The following table presents non-accrual loans by classes of the loan portfolio as of December 31, 2020 and December 31, 2019:
Interest income not recorded based on the original contractual terms of the loans for non-accrual loans was $97,000 and $130,000 in 2020 and 2019, respectively. The decline in unrecorded interest income on non-accrual loans in 2020 compared to 2019 was due to the payoff of several non-accrual loans during the year ended December 31, 2020.
The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the past due status as of December 31, 2020 and December 31, 2019:
(1)These loans are guaranteed, or well secured, and there is an effective means of collection in process.
(2)Loans are considered past due when the borrower is in arrears on two or more monthly payments.
Troubled Debt Restructurings
As of December 31, 2020 and 2019, the Company had a recorded investment in troubled debt restructurings of $3,802,000 and $703,000, respectively. There were no specific reserves for those loans on December 31, 2020 and 2019. There were also no commitments to lend additional amounts to these customers as of December 31, 2020 and 2019.
The modification of the terms of the real estate - commercial loans performed during the year ended December 31, 2020 included declines in the stated rate of interest below the current market rate. The modification of the terms of the residential real estate - mortgage and real estate - commercial loans performed during the year ended December 31, 2019 included extensions to the maturity date of 1.2 and 5.5 years, respectively.
As of December 31, 2020, one accruing restructured loan for $33,000 was in default because it was delinquent in excess of 30 days with respect to the terms of the restructuring. There were no defaults of troubled debt restructurings within 12 months of restructure during 2020 or 2019.
The following tables summarize loans whose terms were modified, resulting in troubled debt restructurings during 2020 and 2019.
The troubled debt restructurings described above had no specific allowance for loan losses and resulted in no charge-offs during the year ending December 31, 2020.
The troubled debt restructurings described above had no specific allowance for loan losses and resulted in charge-offs of $16,000 during the year ending December 31, 2019.
The CARES Act permits financial institutions to exclude loan modifications to borrowers affected by the COVID-19 pandemic from TDR treatment if (1) the borrower was not more than 30 days past due as of December 31, 2019, and (2) the loan modification is made between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the end of the coronavirus emergency declaration. A loan modification accounted for in accordance with the CARES Act is not treated as a TDR for accounting or disclosure purposes. The Consolidated Appropriations Act, 2021 ("Appropriations Act") was signed into law on December 27, 2020 and extends this temporary relief until the earlier of 60 days after the termination date of the national emergency or January 1, 2022.
On April 7, 2020, the federal banking supervisory agencies issued a Revised Interagency Statement on Loan Modifications by Financial Institutions Working with Customers Affected by the Coronavirus (“Interagency Statement”). The interagency statement offers some practical expedients for evaluating whether loan modifications that occur in response to the COVID-19 pandemic are TDRs. A lender can conclude that a borrower is not experiencing financial difficulty if either (1) short-term (i.e. six months) modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented, or (2) the modification or deferral program is mandated by the federal government or a state government (e.g., a state program that requires all institutions within that state to suspend mortgage payments for a specified period). Accordingly, any loan modification made in response to the COVID-19 pandemic that meets either of these practical expedients would not be considered a TDR because the borrower is not experiencing financial difficulty.
On August 3, 2020, the Federal Financial Institutions Examination Council (“FFIEC”) issued the Joint Statement on Additional Loan Accommodations Related to COVID-19 to provide prudent risk management and consumer protection principles for financial institution to consider while working with borrowers as loans near the end of initial loan accommodation periods applicable during the pandemic. In determining whether to offer additional accommodations options to a borrower, it is generally appropriate for the financial institution to assess each loan based upon the fundamental risk characteristics affecting the collectability of that credit, including evaluating the borrower’s financial condition and repayment capacity, as well as assessing whether current conditions have affected collateral values or the strength of guarantees, if applicable. If a financial institution elects to account for a loan modification under Section 4013 of the CARES Act, an additional loan modification could also be eligible under Section 4013 if (1) related to the COVID event; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (a) 60 days after the date of termination of the National Emergency or (b) December 31, 2020. If a financial institution does not elect to account for a loan modification under Section 4013, an additional modification should be viewed cumulatively in determining whether the additional modification is a TDR. If a loan modification was previously elected under the Interagency Statement, subsequent qualifying loan modifications may be accounted for under Section 4013 of the CARES Act.
During 2020, Juniata approved interest and/or principal payment deferrals on 227 loans, excluding TDRs, totaling $77,088,000, for individuals and businesses affected by the economic impacts of COVID-19. As of December 31, 2020, four loans totaling $5,052,000 remained in deferment; however, future deferments could still occur. None of the borrowers approved for these designated deferrals were delinquent as of March 20, 2020, the date on which the Company’s COVID-19 Modification Program went into effect, and the loan modifications are not considered to be troubled-debt restructures under Section 4013.
Credit Quality Indicators
The Company categorizes loans into risk categories 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. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes loans to commercial customers with an aggregate loan exposure greater than $500,000 and for lines of credit in excess of $50,000. This analysis is performed on a continuing basis with all such loans reviewed annually. The Company uses the following definitions for risk ratings:
Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date. Loans in this category are reviewed no less than quarterly.
Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Loans in this category are reviewed no less than monthly.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, based on currently existing facts, conditions, and values, highly questionable and improbable. Loans in this category are reviewed no less than monthly.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered pass-rated loans.
The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company’s internal risk rating system as of December 31, 2020 and December 31, 2019. The increase in the special mention category at December 31, 2020 compared to December 31, 2019 was predominantly the result of downgrading participated hospitality and recreational facility relationships from pass to special mention in 2020 due to the pandemic.
7. BANK OWNED LIFE INSURANCE AND ANNUITIES
The Company holds bank-owned life insurance (“BOLI”) and deferred annuities with a combined cash value of $16,568,000 and $16,266,000 at December 31, 2020 and 2019, respectively. As annuitants retire, the deferred annuities may be converted to payout annuities to create payment streams that match certain post-retirement liabilities. The net increase in cash surrender value on the BOLI and annuities was $302,000 and $328,000 in 2020 and 2019, respectively; the net change resulting from premium payments and earnings recorded as non-interest income. The contracts are owned by the Bank in various insurance companies. The crediting rate on the policies varies annually based on the insurance companies’ investment portfolio returns in their general fund and market conditions. Changes in cash value of BOLI and annuities in 2020 and 2019 are shown below:
8. PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
Depreciation expense on premises and equipment charged to operations was $806,000 in 2020 and $801,000 in 2019.
The Company had no premises and equipment subject to lease agreements in which it acts as the lessor.
9. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
On September 8, 2006, the Company acquired a branch office in Richfield, PA. Goodwill associated with this transaction is carried at $2,046,000. On November 30, 2015, the Company acquired FNBPA and carries goodwill of $3,402,000 relating to the acquisition. On April 30, 2018, Juniata completed the acquisition of the remaining stock of LCB and, as a result, recorded goodwill of $3,599,000. Total goodwill at both December 31, 2020 and December 31, 2019 was $9,047,000.
Intangible Assets
On November 30, 2015, a core deposit intangible in the amount of $303,000 associated with the FNBPA acquisition was recorded. On April 30, 2018, a core deposit intangible of $289,000 associated with the LCB acquisition was recorded. Both core deposit intangibles are being amortized over a ten-year period using a sum of the years’ digits basis.
The following table shows the amortization schedule for each of the intangible assets recorded.
10. DEPOSITS
The aggregate amount of demand deposit overdrafts that were reclassified as loans was $50,000 at December 31, 2020, compared to $70,000 at December 31, 2019.
Deposits consist of the following:
Aggregate amount of scheduled maturities of time deposits as of December 31, 2020 include the following:
11. BORROWINGS
Short term borrowings, and the related maximum amounts outstanding at the end of any month in both of the years ended December 31, 2020 and 2019, are presented below.
The following table presents supplemental information related to short-term borrowings.
The Bank has repurchase agreements with some of its depositors, under which customers’ funds are invested daily into an interest bearing account. These funds are carried by the Company as short-term debt. It is the Company’s policy to completely collateralize repurchase agreements with U.S. Government securities. As of December 31, 2020, the securities that serve as collateral for securities sold under agreements to repurchase had a fair value of $8,870,000. The interest rate paid on these funds is variable and subject to change daily.
The Company began participating in the Federal Reserve Bank’s Paycheck Protection Program Liquidity Facility (“PPPLF”) in 2020 and received $31,298,000 in advances. As of December 31, 2020, $27,955,000 PPPLF advances were outstanding. The advances are collateralized by PPP loans granted by the Company. The maturity date of the PPPLF advance equals the maturity date of the underlying PPP loans pledged to secure the extension of credit, which is two years. The maturity date of the PPPLF’s extension of credit will be accelerated if an underlying PPP loan goes into default if the Company sells the PPP loan to the SBA to realize on the SBA guarantee. The maturity date of the PPPLF’s extension of credit also will be accelerated to the extent of any loan forgiveness reimbursement received by the Company from the SBA. The interest rate on the advances is fixed at 0.35%.
Long-term debt is comprised only of FHLB advances with an original maturity of one year or more. In 2020, Juniata executed a balance sheet strategy by repaying $10,000,000 in FHLB long-term advances, at a weighted average rate of 2.75%, to create a more efficient balance sheet. A prepayment penalty of $524,000 was incurred. Outstanding balances were $35,000,000 as of December 31, 2020 and $45,000,000 as of December 31, 2019.
The following table summarizes the scheduled maturities of long-term debt as of December 31, 2020.
The Bank must maintain sufficient qualifying collateral with the FHLB to secure borrowings. Therefore, a Master Collateral Agreement has been entered into which pledges all mortgage related assets as collateral for future borrowings. Mortgage related assets could include loans or investment securities. As of December 31, 2020, the amount of loans included in qualifying collateral was $229,357,000. As of December 31, 2019, the amount of loans included in qualifying collateral was $255,566,000. No investment securities were included in qualifying collateral as of December 31, 2020 or 2019.
The Bank’s maximum borrowing capacity with the FHLB was $166,178,000, with a balance of $55,830,000 outstanding as of December 31, 2020. The Bank’s maximum borrowing capacity with the FHLB was $183,790,000, with a balance of $55,604,000 outstanding as of December 31, 2019. To borrow additional amounts, the FHLB would require the Bank to purchase additional FHLB Stock. The FHLB is a source of both short-term and long-term funding. The Bank must maintain sufficient qualifying collateral to secure all outstanding advances. Qualifying collateral is defined by the FHLB and includes outstanding balances of the Company’s real estate loans, excluding loans with certain risk mitigants, including delinquencies and loans made to insiders, borrowers with low credit scores or loans with high loan-to-value ratios.
12. OPERATING LEASE OBLIGATIONS
A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period in exchange for consideration. On January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842), and all subsequent ASUs that modified Topic 842 using the optional transition method. The adoption of this standard resulted in the recording of a ROU asset and lease liability of $556,000 as of January 1, 2019 for the Company’s four operating lease obligations in which the Company is the lessee.
The Company elected the package of practical expedients, which removed the requirements to reassess whether any expired or existing contracts contain leases, reassess the lease classification for any expired or existing leases, and reassess the initial direct costs for any existing leases. The Company also elected two other practical expedients allowing the combination of lease and nonlease components by class of underlying asset and using hindsight in determining the lease terms since most of the leases have an extension option.
The four operating leases, one of which is with a related party, are comprised of real estate property for branch and office space with terms extending through 2029. Operating leases were previously not recognized on the Company’s consolidated statements of condition, but with the adoption of Topic 842, operating lease agreements are recognized on the consolidated statements of condition as a ROU asset and a corresponding lease liability. As of December 31, 2020, the Company had operating lease ROU assets totaling $379,000 included in other assets and operating lease liabilities totaling $388,000 included in other liabilities.
The calculated amount of the ROU assets and lease liabilities are impacted by the length of the lease term and the discount rate used to calculate the present value of the minimum lease payments. The Company’s lease agreements often include one or more options to renew at the Company’s discretion. If at lease inception, the Company considers the exercising of a renewal option to be reasonably certain, the Company will include the extended term in the calculation of the ROU asset and lease liability.
Topic 842 requires the use of the rate implicit in the lease as the discount rate if that rate is readily determinable. As this rate is rarely determinable, the Company utilized its incremental borrowing rate at lease inception, which is the rate the Company would have incurred to borrow on a collateralized basis over a similar term at an amount equal to the lease payments in a similar economic environment. Because the four operating leases existed prior to the adoption of Topic 842 on January 1, 2019, the incremental borrowing rate for the remaining lease term at January 1, 2019 was used.
As of December 31, 2020, the weighted-average remaining operating lease term was 7.1 years, and the weighted-average discount rate was 5.46%.
The Company elected, for the real estate class of underlying assets which is currently its only class, not to separate lease and nonlease components and to account for them as a single lease component. The Company has one operating lease agreement containing a monthly ATM surcharge, which is combined with the property rental payment because of electing the practical expedient. The Company’s total operating lease cost for the years ended December 31, 2020 and 2019 were $116,000 and $120,000, respectively. During the years ended December 31, 2020 and 2019, total operating lease payments made to a related party totaled $24,000 and $23,000, respectively.
The future minimum payments for operating leases with initial or remaining terms of one year or more as of December 31, 2020 were as follows:
13. INCOME TAXES
The components of income tax (benefit) expense for the two years ended December 31 were:
Federal credits are available for ten years for Juniata’s investment in two low income housing projects. Tax credits associated with phase I will continue through 2023, while phase II credits will run through 2027. The tax credits are included in the tax expense line item on the Consolidated Statements of Income. Amortization of the investments using the cost method is scheduled to occur over the same period as tax credits are earned. Juniata’s maximum exposure to loss is limited to the carrying value of the investment at year-end.
The total tax benefit during the year ended December 31, 2020 was $50,000 compared to a total tax benefit of $14,000 during the year ended December 31, 2019. In 2020, the Company was able to take advantage of a provision in the CARES Act, allowing the carryback of net operating losses (“NOLs”) from a prior period. Prior to the enactment of the CARES Act, Juniata had been carrying a deferred tax asset for an NOL that arose from a previous bank acquisition, which qualified for the new carryback rules and was able to carry back to years in which the statutory tax rate was 34%, as opposed to the current 21%. The reversal of a portion of the deferred tax asset carried for this NOL, at an amount in excess of its carrying amount, was recorded as a $57,000 credit to income tax expense during 2020.
A reconciliation of the statutory income tax (benefit) expense computed at 21% to the income tax expense included in the consolidated statements of income follows:
Deductible temporary differences and taxable temporary differences gave rise to a net deferred tax asset for the Company as of December 31, 2020 and 2019. The components giving rise to the net deferred tax asset are detailed below:
The Company has concluded that the deferred tax assets are realizable (on a more likely than not basis) through the combination of future reversals of existing taxable temporary differences, certain tax planning strategies and expected future taxable income.
It is the Company’s policy to recognize interest and penalties on unrecognized tax benefits in income tax expense in the Consolidated Statements of Income. No significant income tax uncertainties were identified because of the Company’s evaluation of its income tax position. Therefore, the Company recognized no adjustment for unrecognized income tax benefits for the years ended December 31, 2020 and 2019. The Company is no longer subject to examination by taxing authorities for years before 2017. Tax years 2017 through the present, with limited exception, remain open to examination.
14. STOCKHOLDERS’ EQUITY AND REGULATORY MATTERS
The Company is authorized to issue 500,000 shares of preferred stock with no par value. The Board has the ability to fix the voting, dividend, redemption and other rights of the preferred stock, which can be issued in one or more series. No shares of preferred stock have been issued.
The Company has a dividend reinvestment and stock purchase plan. Under this plan, additional shares of Juniata Valley Financial Corp. stock may be purchased at the prevailing market prices through reinvested dividends and voluntary cash payments, within limits. To the extent that shares are not available in the open market, the Company has reserved common stock to be issued under the plan. Any adjustment in capitalization of the Company will result in a proportionate adjustment to the reserved shares for this plan. At December 31, 2020, 141,887 shares were available for issuance under the Dividend Reinvestment Plan.
The Company periodically repurchases shares of its common stock under a share repurchase program approved by the Board of Directors. In December of 2016, the Board of Directors authorized the repurchase of an additional 200,000 shares of its common stock through its share repurchase program. The program will remain authorized until all approved shares are repurchased, unless terminated by the Board of Directors. Repurchases have typically been through open market transactions and have complied with all regulatory restrictions on the timing and amount of such repurchases. Shares repurchased have been added to treasury stock and accounted for at cost. These shares may be reissued for stock option exercises, stock awards, employee stock purchase plan purchases, to fulfill dividend reinvestment program needs and to supply shares needed for exchange in an acquisition. During 2020 and 2019, 87,712 and 21,508 shares, respectively, were repurchased in conjunction with this program. In 2020 and 2019, 565 and 800 issued shares, respectively, were transferred to treasury due to forfeitures of restricted stock awards. Remaining shares authorized in the program were 44,617 as of December 31, 2020.
The Bank is subject to risk-based capital standards by which banks are evaluated in terms of capital adequacy. These regulatory capital requirements are administered by the federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital and classification are also subject to qualitative judgments by the regulators. Management believes that, as of December 31, 2020, the Bank meets all capital adequacy requirements to which it is subject.
Prompt corrective action regulations provide five classifications: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end 2020 and 2019, the most recent regulatory notifications categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.
In 2019, the federal banking agencies jointly issued a final rule that provides for an optional, simplified measure of capital adequacy, the community bank leverage ratio framework (“CBLR framework”), for qualifying community banking organizations, consistent with Section 201 of the Economic Growth Act. The final rule became effective on January 1, 2020 and was elected by the Bank in 2020. In April 2020, the federal banking agencies issued an interim final rule that makes temporary change to the CBLR framework, pursuant to Section 4012 of the CARES Act, and a second interim final
rule that provides a graduated increase in the community bank leverage ratio requirement after the expiration of the temporary changes implemented pursuant to Section 4012 of the CARES Act.
The community bank leverage ratio removes the requirement for qualifying banking organizations to calculate and report risk-based capital, but rather only requires a minimum Tier 1 to average assets (“leverage”) ratio. Qualifying banking organizations that elect to use the CBLR framework and that maintain a leverage ratio of greater than required minimums will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the agencies’ capital rules (generally applicable rule) and, if applicable, will be considered to have met the well-capitalized ratio requirements for purposes of section 38 of the Federal Deposit Insurance Act. Under the interim final rules, the community bank leverage ratio minimum requirement is 8.0% as of December 31, 2020, 8.5% for calendar year 2021, and 9.0% for calendar year 2022 and beyond. The interim rule allows for a two-quarter grace period to correct a ratio that falls below the required amount, provided the Bank maintains a leverage ratio of 7.0% as of December 31, 2020, 7.5% for calendar year 2021, and 8.0% for calendar year 2022 and beyond.
Under the final rule, an eligible banking organization can opt out of the CBLR framework and revert back to the risk-weighting framework without restriction. As of December 31, 2020, the Bank was a qualifying community banking organization as defined by the federal banking agencies and elected to measure capital adequacy under the CBLR framework.
Actual and required capital amounts and ratios are presented below.
Certain regulatory restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans or advances. As of December 31, 2020, $35,775,000 of undistributed earnings of the Bank, included in the consolidated stockholders’ equity, was available for distribution to the Company as dividends without prior regulatory approval, subject to the regulatory capital requirements above.
15. EARNINGS PER SHARE
Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method. Restricted stock is participating, and therefore, is included in the basic EPS calculation. The following table sets forth the computation of basic and diluted earnings per share:
16. ACCUMULATED OTHER COMPREHENSIVE INCOME
The following tables show changes in accumulated other comprehensive income by component, net of tax, for the years ending December 31, 2020 and 2019:
The following table shows significant amounts reclassified out of each component of accumulated other comprehensive income for the year ending December 31, 2020:
The following table shows significant amounts reclassified out of each component of accumulated other comprehensive loss for the year ending December 31, 2019:
17. FAIR VALUE MEASUREMENT
Fair value measurement and disclosure guidance defines fair value as the price that would be received to sell an asset or transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. 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 and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact. Additional guidance is provided on determining when the volume and level of activity for the asset or liability has significantly decreased. The guidance also includes guidance on identifying circumstances when a transaction may not be considered orderly.
Fair value measurement and disclosure guidance provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed, and significant adjustments to the related prices may be necessary to estimate fair value in accordance with fair value measurement and disclosure guidance.
This guidance clarifies that, when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. The guidance provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.
The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, the guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.
Level 2 Inputs - Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 Inputs - Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
An asset’s or liability’s placement in the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
Equities Securities
The fair value of equity securities is based upon quoted prices in active markets and is reported using Level 1 inputs.
Debt Securities Available for Sale
For debt securities available for sale where quoted prices are not available, fair values are calculated based on market prices of similar securities and are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurement from an independent pricing service. 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 debt securities’ terms and conditions, among other things. For debt securities available for sale where quoted prices or market prices of similar securities are not available, fair values are calculated using other market indicators and are reported at fair value utilizing Level 3 inputs.
Derivatives
The fair values of derivatives are based on valuation models using observable market data as of the measurement date utilizing Level 2 inputs. The Company’s derivatives are comprised of interest rate swaps traded in an over-the-counter market where quoted market prices are not always available; therefore, the fair values are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of curves, prepayment rates and volatility factors used to value the position. Most market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.
Impaired Loans
Certain impaired loans are reported on a non-recurring basis at the fair value of the underlying collateral since repayment is expected solely from the collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included in the Level 3 fair value classification, based upon the lowest level of input that is significant to the fair value measurements.
Other Real Estate Owned
Certain assets included in other real estate owned are carried at fair value because of impairment and accordingly are measured on a non-recurring basis as they are carried at the lower of cost or fair value. These assets are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. Values are estimated using Level 3 inputs, based on appraisals that consider the sales prices of property in the proximate vicinity less estimated costs to sell.
Mortgage Servicing Rights
The fair value of servicing assets is based on the present value of estimated future cash flows on pools of mortgages stratified by rate and maturity date and are considered Level 3 inputs.
The following tables summarize financial assets and financial liabilities measured at fair value as of December 31, 2020 and December 31, 2019, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value.
Assets measured at fair value on a nonrecurring basis for which Level 3 inputs have been used to determine fair value are immaterial to the Company’s consolidated financial statements.
Fair Value of Financial Instruments
Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in sales transactions on the dates indicated. The estimated fair value amounts have been measured as of their respective year ends and have not been re-evaluated or updated for purposes of these consolidated financial statements after those respective dates. As such, the estimated fair values of these financial instruments after the respective reporting dates may be different from the amounts reported at each year end.
The information presented below should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is provided only for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful.
The carrying amounts and estimated fair values of the Company’s financial instruments are as follows:
The following tables present the carrying amount, fair value and placement in the fair value hierarchy of the Company’s financial instruments not previously disclosed as of December 31, 2020 and December 31, 2019. These tables exclude financial instruments for which the carrying amount approximates fair value.
18. REVENUE RECOGNITION
The Company adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606), as well as subsequent ASU’s that modified ASC 606, on January 1, 2018. The Company elected to apply the ASU and all related ASU’s using the modified retrospective approach applied to all contracts initiated on or after the effective date, and for contracts which have remaining obligations as of the effective date, while prior period results continue to be reported under legacy U.S. GAAP. Based on this assessment, the Company concluded that ASC 606 did not materially change the method by which the Company currently recognizes revenue for these revenue streams, which is by recognizing revenues as they are earned based upon contractual terms, as transactions occur, or as services are provided and collectability is reasonably assured.
The Company generally acts in a principal capacity, on its own behalf, in most contracts with customers. In such transactions, revenue and related costs to provide these services are recognized on a gross basis in the financial statements. In some cases, the Company acts in an agent capacity, deriving revenue through assisting other entities in transactions with its customers. In such transactions, revenue and the related costs to provide the services are recognized on a net basis in the financial statements. These transactions primarily relate to non-deposit product commissions and fees derived from customer’s use of various interchange and ATM/debit card networks.
All the Company’s revenue from contracts with customers in the scope of ASC 606 are recognized within non-interest income on the consolidated statements of income. Revenue streams not within the scope of ASC 606 included in non-interest income on the consolidated statements of income include earnings on bank-owned life insurance and annuities, income from unconsolidated subsidiary, fees derived from loan activity, mortgage banking income, gain/loss on sales and calls of securities, and the change in value of equity securities.
A description of the Company’s sources of revenue accounted for under ASC 606 are as follows:
Customer Service Fees - fees mainly represent fees from deposit customers for transaction based, account maintenance, and overdraft services. Transaction based fees include, but are not limited to, stop payment and overdraft fees. These fees are recognized at the time of the transaction when the performance obligation has been fulfilled. Account maintenance fees and account analysis fees are earned over the course of a month, representing the period of the performance obligation, and are recognized monthly.
Debit Card Fee Income - consists of interchange fees from cardholder transactions conducted through the card payment network. Cardholders use debit cards to conduct point-of-sale transactions that produce interchange fees. The Company acts in an agent capacity to offer processing services for debit cards to its customers. Fees are recognized with the processing of the transactions and netted against the related fees from such transactions.
Trust Fees - include asset management and estate fees. Asset management fees are generally based on a fee schedule, based upon the market value of the assets under management, and recognized monthly when the service obligation is completed. Trust fees recognized in 2020 and 2019 were $358,000 and $359,000, respectively. Fees for estate management services are based on a specified fee schedule and generally recognized as the following performance obligations are fulfilled: (i) 25% of total estate fee recognized when all estate assets are collected and debts paid, (ii) 50% of the total fee is recognized when the inheritance tax return is filed, and (iii) remaining 25% is recognized when the first and final account is confirmed, settling the estate. Estate fees recognized during 2020 and 2019 were $50,000 and $35,000, respectively.
Commissions From Sales Of Non-Deposit Products - include, but are not limited to, brokerage services, employer-based retirement solutions, individual retirement planning, insurance solutions, and fee-based investment advisory services. The Company acts in an agent capacity to offer these services to customers. Revenue is recognized, net of related fees, in the month in which the contract is fulfilled.
Other Non-Interest Income - includes certain revenue streams within the scope of ASC 606 comprised primarily of ATM surcharges, commissions on check orders, and wire transfer fees. ATM surcharges are the result of customers conducting ATM transactions that generate fee income. All these fees, as well as wire transfer fees, are transaction based and are recognized at the time of the transaction. In addition, the Company acts in an agent capacity to offer checks to its customers and recognizes commissions, net of related fees, when the contract is fulfilled.
Gains/Losses On Sales Of Other Real Estate Owned - are recognized when control of the property transfers to the buyer, which generally occurs when the deed is executed.
Contract Balances
A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due from the customer). The company’s non-interest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as asset management fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter longer-term revenue contracts with customers, and therefore, does not experience significant contract balances.
Contract Acquisition Costs
The Company expenses all contract acquisition costs as costs are incurred.
19. EMPLOYEE BENEFIT PLANS
Long-Term Incentive Plan
The Company maintains the 2016 Long-Term Incentive Plan (the “Plan”), that amended and restated the former 2011 Stock Option Plan (the “2011 Plan”). The Plan continues in effect for any outstanding awards under the 2011 Plan in accordance with the terms and conditions governing such awards immediately prior to the effective date of the Plan but expanded the types of awards authorized to include, among others, restricted stock. Under the provisions of the Plan, while active, awards may consist of grants of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock and performance shares to officers and key employees of the Company, as well as directors.
Compensation expense for stock options granted and restricted stock awarded is measured using the fair value of the award on the grant date and is recognized over the vesting period. The Company recognized $128,000 and $113,000 of expense for the years ended December 31, 2020 and 2019, respectively, for stock-based compensation.
The Plan is administered by a committee of the Board of Directors. The Committee determines, among other things, the recipients of stock compensation, the number of shares to be subject to each award, the option price, the duration of the option and the restricted period, as appropriate. A recipient of the restricted shares will forfeit those shares in their entirety if employment is terminated prior to the vesting date for reasons other than retirement, death or disability. Forfeited awards are returned to the pool of shares available for grant for future awards. The maximum number of shares of common stock that may be issued under the Plan is 300,000 shares, and 161,090 shares were available for grant as of December 31, 2020. Shares of common stock issued under the Plan may be treasury shares or authorized but unissued shares.
During 2020, a total of 9,530 restricted shares was awarded to certain officers and all directors. In 2019, a total of 7,500 shares of restricted stock was awarded to certain officers. Each of the awards vest after three-years, with no interim vesting.
The following table presents compensation expense and related tax benefits for restricted stock awards recognized on the consolidated statement of income.
At December 31, 2020, there was $178,000 of unrecognized compensation cost related to all non-vested restricted stock awards. This cost is expected to be recognized through February 2023.
The following table presents a summary of non-vested restricted shares activity for 2020.
No stock options were awarded in 2020. Options granted prior to 2020 vest over three to five years and are exercisable at the grant price, which is at least the fair market value of the stock on the grant date. The Plan provides that the option price per share is not to be less than the fair market value of the stock on the day the option was granted, but in no event less than the par value of such stock. Options granted under the Plan are exercisable no earlier than one year after the date of grant and expire ten years after the date of the grant. All options previously granted under the Plans are scheduled to expire through February 17, 2025.
Total options outstanding as of December 31, 2020 have exercise prices between $17.65 and $18.00, with a weighted average exercise price of $17.78 and a weighted average remaining contractual life of 2.78 years.
As of December 31, 2020, there was no unrecognized compensation cost related to options granted under the Plan.
Cash received from option exercises under the Plans for the year ended December 31, 2019 was $364,000. No options were exercised under the Plans for the year ended December 31, 2020.
A summary of the status of the outstanding stock options as of December 31, 2020 and 2019, and changes during the years ending on those dates is presented below:
Defined Benefit Retirement Plans
The Company sponsored defined benefit retirement plan, JVB Plan, which covered substantially all its employees employed prior to December 31, 2007 was amended, January 1, 2008 to close the plan to new entrants. All active participants as of December 31, 2007 became 100% vested in their accrued benefit and, if they remained eligible, continued to accrue benefits until December 31, 2012. The benefits were based on years of service and the employee’s compensation. Effective December 31, 2012, the JVB Plan was amended to cease future service accruals after that date (i.e., it was frozen).
As a result of the FNBPA acquisition, the Company assumed sponsorship of a second defined benefit retirement plan, the Retirement Plan for the First National Bank of Port Allegany (“FNB Plan”), as of November 30, 2015, which covered substantially all former FNBPA employees that were employed prior to September 30, 2008. The FNBPA Plan was amended as of December 31, 2015 to cease future service accruals to previously unfrozen participants and was considered “frozen”. Effective December 31, 2016, the FNB Plan was merged into the JVB Plan, which was amended to provide the same benefits to the class of participants previously included in the FNB Plan.
Juniata’s Board of Directors resolved to terminate the JVB Plan, effective November 30, 2018. JVB Plan participants elected preferences for receiving their vested benefit in the form of either lump sum payments or annuities. Juniata incurred a pre-tax charge of $1,221,000. As of December 31, 2019, all obligations were satisfied and The JVB Plan was liquidated. Excess funds of $431,000 were transferred to fund the Company’s 401(k) Safe Harbor Plan.
The measurement date for the JVB Plan is December 31. Information pertaining to the activity in the defined benefit plan was as follows:
Pension expense for the JVB Plan included the following components for the years ended December 31:
Defined Contribution Plan
The Company has a Defined Contribution Plan under which employees, through payroll deductions, are able to defer portions of their compensation. The Company makes an annual non-elective fully vested contribution equal to 3% of compensation to each eligible participant. For the year ended December 31, 2020, the contribution amount totaled $249,000, which was credited to employee’s accounts by January 31, 2021. This liability at December 31, 2019 totaled $250,000 and was credited to employee accounts by January 31, 2020. Expense incurred under this plan was $247,000 and $248,000 in 2020 and 2019, respectively. The Defined Contribution Plan also includes an employer matching contribution for employees that elect to defer compensation into this program. The matching contribution in 2020 and 2019 was $214,000 and $212,000, respectively.
Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan under which employees, through payroll deductions, are able to purchase shares of Company stock annually. The option price of the stock purchases is between 95% and 100% of the fair market value of the stock on the offering termination date as determined annually by the Board of Directors. The maximum number of shares which employees may purchase under the Plan is 250,000; however, the annual issuance of shares may not exceed 5,000 shares plus any unissued shares from prior offerings. There were 4,459 shares issued in 2020 and 1,880 shares issued in 2019 under this plan. As of December 31, 2020, there were 166,620 shares reserved for issuance under the Employee Stock Purchase Plan.
Supplemental Retirement Plans
The Company has non-qualified supplemental retirement plans for directors and key employees. At December 31, 2020 and 2019, the present value of the future liability associated with these plans was $135,000 and $166,000, respectively. For the years ended December 31, 2020 and 2019, $11,000 and $16,000, respectively, was charged to expense in connection with these plans. The Company offsets the cost of these plans through the purchase of bank-owned life insurance and annuities. See Note 7.
Deferred Compensation Plans
The Company has entered into deferred compensation agreements with certain directors to provide each director with an additional retirement benefit, or to provide their beneficiary with a benefit, in the event of pre-retirement death. At December 31, 2020 and 2019, the present value of the future liability was $1,584,000 and $1,603,000, respectively. For the years ended December 31, 2020 and 2019, $20,000 and $42,000, respectively, was charged to expense in connection with these plans. The Company offsets the cost of these plans through the purchase of bank-owned life insurance. See Note 7.
Salary Continuation Plans
The Company has non-qualified salary continuation plans for key employees. At December 31, 2020 and 2019, the present value of the future liability was $1,194,000 and $1,209,000, respectively. For the years ended December 31, 2020 and 2019, $94,000 and $57,000, respectively, was charged to expense in connection with these plans. The Company offsets the cost of these plans through the purchase of bank-owned life insurance. See Note 7.
20. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
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 may include commitments to extend credit and letters of credit. Because many commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These instruments involve, to varying degrees, elements of credit risk that are not recognized in the consolidated financial statements.
Exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making these commitments and conditional obligations as it does for on-balance sheet instruments. The Company controls the credit risk of its financial instruments through credit approvals, limits and monitoring procedures; however, it does not generally require collateral for such financial instruments since there is no principal credit risk.
A summary of the Company’s financial instrument commitments is as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since portions of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained by the Bank upon extension of credit is based on management’s credit evaluation of the counterparty. Collateral held varies but may include personal or commercial real estate, accounts receivable, inventory and equipment.
Outstanding letters of credit are instruments issued by the Bank that guarantee payment to the beneficiary by the Bank in the event of default by the Bank’s customer in the non-performance of an obligation or service. Most letters of credit are extended for one year periods. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds collateral supporting those commitments for which collateral is deemed necessary. The amount of the liability as of December 31, 2020 and 2019 for guarantees under letters of credit issued is not material.
The maximum undiscounted exposure related to these guarantees on December 31, 2020 was $3,906,000, and the approximate value of underlying collateral upon liquidation that would be expected to cover this maximum potential exposure was $32,906,000.
21. RELATED-PARTY TRANSACTIONS
The Bank has granted loans to certain of its executive officers, directors and their related interests. The aggregate dollar amount of these loans was $4,321,000 and $8,127,000 at December 31, 2020 and 2019, respectively. During 2020, $6,582,000 of new loans were added and repayments totaled $10,388,000. None of these loans were past due, in non-accrual status or restructured on December 31, 2020 or 2019.
Deposits and other funds from related parties held by Juniata amounted to $1,699,000 and $1,396,000 at December 31, 2020 and 2019, respectively.
22. DERIVATIVES
The Company began utilizing interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position in 2020. The notional amount of the interest rate swaps does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual interest rate swap agreements.
Interest rate swaps with a notional amount totaling $40,000,000 as of December 31, 2020, were designated as cash flow hedges on certain FHLB advances. Because the interest rate swap agreements did not commence until 2020, there was no notional value as of December 31, 2019. The interest rate swaps were determined to be fully effective during the period presented, and as such, no amount of ineffectiveness has been included in net income. The aggregate fair value of the swaps is recorded in either other assets or other liabilities on the Consolidated Statements of Condition with changes in fair value recorded in other comprehensive income. The Company expects the hedges to remain fully effective during the remaining terms of the swaps.
The Company presents derivative positions gross on the balance sheet. The following table reflects the derivatives recorded on the Consolidated Statements of Condition as of December 31, 2020.
The effect of cash flow hedge accounting, before income taxes, on accumulated other comprehensive income for the period ended December 31, 2020 is as follows:
The effect of cash flow hedge accounting on the Consolidated Statements of Income for the year ended December 31, 2020 was as follows:
Location and Amount of Gain or Loss Recognized in Income on Fair Value and Cash Flow Hedging Relationships
23. COMMITMENTS AND CONTINGENT LIABILITIES
In 2017, the Company executed renewal agreements for technology outsourcing services through two outside service bureaus. Both agreements provide for termination fees if the Company cancels the services prior to the end of the 7-year commitment period that runs through May 31, 2024. As of December 31, 2020, potential termination fees were estimated to be approximately $2,053,000 and $981,000 on the two contracts. The potential termination fees decrease by approximately 15% in each succeeding year through 2024. Since the Company does not expect to terminate these services with either vendor prior to the end of the commitment periods, no liability has been recorded as of December 31, 2020.
The Company, from time to time, may be a defendant in legal proceedings relating to the conduct of its banking business. Most of such legal proceedings are a normal part of the banking business and, in management’s opinion, the consolidated financial condition and results of operations of the Company would not be materially affected by the outcome of such legal proceedings.
Additionally, the Company has sold qualifying residential mortgage loans to the FHLB as part of its Mortgage Partnership Finance Program (“Program”). Under the terms of the Program, there is limited recourse back to the Company for loans that do not perform in accordance with the terms of the loan agreement. Each loan sold under the Program is “credit enhanced” such that the individual loan’s rating is raised to “BBB”, as determined by the FHLB. The Program can be terminated by either the FHLB or the Company, without cause, by giving notice to the other party. The FHLB has no obligation to commit to purchase any mortgage through, or from, the Company.
24. SUBSEQUENT EVENT
In January 2021, the Board of Directors declared a dividend of $0.22 per share to shareholders of record on February 15, 2021, payable on March 1, 2021.
25. JUNIATA VALLEY FINANCIAL CORP. (PARENT COMPANY ONLY) FINANCIAL INFORMATION
CONDENSED BALANCE SHEETS
(Dollars in thousands)
CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Dollars in thousands)
CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Attached as exhibits to this Form 10-K are certifications of the Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the Exchange Act). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications.
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
The Company’s management, with the participation of its CEO and CFO, conducted an evaluation, as of December 31, 2020, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)). Based on this evaluation, the Company’s CEO and CFO concluded that, as of the end of the period covered by this annual report, the Company’s disclosure controls and procedures were effective in reaching a reasonable level of assurance that management is timely alerted to material events relating to the company during the period when the Company’s periodic reports are being prepared.
Conclusion Regarding Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a - 15(f) promulgated under the Exchange Act. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the evaluation under the framework in Internal Control-Integrated Framework (2013), the Company’s management concluded that internal control over financial reporting was effective as of December 31, 2020.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for the preparation, integrity and fair presentation of the consolidated financial statements included in this Annual Report on Form 10-K. The consolidated financial statements and notes included in this annual report have been prepared in conformity with accounting principles generally accepted in the United States of America, and as such, include some amounts that are based on management’s best estimates and judgments.
The Company’s management is responsible for establishing and maintaining effective internal control over financial reporting. The system of internal control over financial reporting, as it relates to the financial statements, is evaluated for effectiveness by management and tested for reliability through a program of internal audits and management testing and review. Actions are taken to correct potential deficiencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only a reasonable assurance with respect to financial statement preparation.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013).
Based on our assessment, management concluded that as of December 31, 2020, the Company’s internal control over financial reporting was effective and met the criteria of the Internal Control-Integrated Framework (2013).
The independent registered public accounting firm that audited the consolidated financial statements included in the annual report has issued an attestation report on the Company’s internal control over financial reporting.
/s/ Marcie A. Barber
Marcie A. Barber, President and Chief Executive Officer
/s/ JoAnn N. McMinn
JoAnn N. McMinn, Chief Financial Officer
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Incorporated by reference herein is information appearing in the Proxy Statement for the Annual Meeting of Shareholders to be held on May 18, 2021 (the “Proxy Statement”) under the captions “Directors of the Company”, “Executive Officers of the Company”, “Corporate Governance and Board Matters” and “Section 16(a) Beneficial Ownership Reporting Compliance”. The Company has adopted a Code of Ethics that is applicable to the Company’s Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer and other designated senior officers, which can be found in the Investor Information - Governance Documents section of the Company’s website at www.JVBonline.com. The Company will file its Proxy Statement on or before April 6, 2021.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference herein is the information contained in the Proxy Statement under the captions “Director’s Compensation” and “Compensation Committee Interlocks and Insider Participation”.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Incorporated by reference herein is the information contained in the Proxy Statement under the caption “Stock Ownership by Management and Beneficial Owners”. Additionally, the following table contains information regarding equity compensation plans approved by shareholders, which include a stock option plan for the Company’s employees and an employee stock purchase plan. The Company has no equity compensation plans that were not approved by shareholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Incorporated by reference herein is the information contained in the Proxy Statement under the caption “Related Party Transactions” and “Corporate Governance and Board Matters”.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Incorporated by reference herein is information contained in the Proxy Statement under the caption “Independent Registered Public Accounting Firm”.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) The following consolidated financial statements of the Company are filed as part of this Form 10-K:
(i)Reports of Independent Registered Public Accounting Firm
(ii)Consolidated Statements of Financial Condition as of December 31, 2020 and December 31, 2019
(iii)Consolidated Statements of Income for the fiscal years ended December 31, 2020 and December 31, 2019
(iv)Consolidated Statements of Comprehensive Income for the fiscal years ended December 31, 2020 and December 31, 2019
(v)Consolidated Statements of Stockholders’ Equity for the fiscal years ended December 31, 2020 and December 31, 2019
(vi)Consolidated Statements of Cash Flows for the fiscal years ended December 31, 2020 and December 31, 2019
(vii)Notes to Consolidated Financial Statements
(a)(2) Financial Statements Schedules. All financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and have therefore been omitted.
(a)(3) Exhibits.
3.1
Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3(i) to the Company’s Form 8-K Current Report filed with the SEC on November 12, 2015)
3.2
Amended and Restated Bylaws (incorporated by reference to Exhibit 3.4 to the Company’s Current Report on Form 8-K filed with the SEC on February 27, 2019)
4.1
Description of Registrant’s Securities (incorporated by reference to the Company’s Form 8-A filed with the SEC on September 13, 2011)
10.1
Form of 1999 Directors Deferred Compensation Agreement (incorporated by reference to Exhibit 10.1 to the Company’s Annual Report on Form 10-K filed with the SEC on March 13, 2009)*
10.2
Form of Amendments to the 1999 Directors Deferred Compensation Agreement (incorporated by reference to Exhibit 10.7 to the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2011)*
10.3
Form of Director Supplemental Life Insurance/ Split Dollar Plan (incorporated by reference to Exhibit 10.1 to the Company’s Annual Report on Form 10-K filed with the SEC on March 13, 2009)*
10.4
Employee Annual Incentive Plan, (filed herewith)*■
10.5
Change of Control Severance Agreement with JoAnn N. McMinn (incorporated by reference to Exhibit 10 to the Company’s Quarterly Report on Form 10-Q filed with the SEC on November 8, 2005).*
10.6
Salary Continuation Agreement with JoAnn N. McMinn (incorporated by reference to Exhibit 10.17 to the Company’s Annual Report on Form 10-K filed with the SEC on March 14, 2008)*
10.7
Salary Continuation Agreement with Marcie A. Barber (incorporated by reference to Exhibit 10.17 to the Company’s Annual Report on Form 10-K filed with the SEC on March 14, 2008)*
10.8
Change of Control Severance Agreement with Marcie A. Barber (incorporated by reference to Exhibit 10.19 to the Company’s Current Report on Form 8-K filed with the SEC on May 27, 2008)*
10.9
Long Term Incentive Plan of Juniata Valley Financial Corp. (incorporated by reference to Exhibit 10.1 to the Company’s 2016 proxy statement filed with the SEC on April 8, 2016)*
10.10
Agreement and Plan of Merger, dated December 29, 2017 by and between Juniata Valley Financial Corp., The Juniata Valley Bank and Liverpool Community Bank (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on January 5, 2018)
21.1
Subsidiaries of Juniata Valley Financial Corp.
23.1
Consent of Crowe LLP
31.1
Rule 13a-4(d) Certification of Marcie A. Barber
31.2
Rule 13a-4(d) Certification of JoAnn N. McMinn
32.1
Section 1350 Certification of Marcie A. Barber
32.2
Section 1350 Certification of JoAnn N. McMinn
101.LAB
XBRL Taxonomy Extension Label Linkbase
101.PRE
XBRL Taxonomy Extension Presentation Linkbase
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema
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XBRL Taxonomy Extension Calculation Linkbase
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XBRL Taxonomy Extension Definition Linkbase
Cover Page Interactive Data File (embedded within the Inline XBRL document).
* Denotes a compensatory plan.
■ Denotes that portions of such Plan have been omitted pursuant to a request for confidential treatment and such confidential information has been filed separately with the Securities Exchange Commission.
(b) Exhibits. The exhibits required to be filed as part of this report are submitted as a separate section of this report.
(c) Financial Statements Schedules. None Required.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
JUNIATA VALLEY FINANCIAL CORP. (REGISTRANT)
Date: March 15, 2021
/s/ Marcie A. Barber
By: Marcie A. Barber
Director, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ Timothy I. Havice
March 15, 2021
Timothy I. Havice
Chairman
/s/ Philip E. Gingerich, Jr.
March 15, 2021
Philip E. Gingerich, Jr.
Vice Chairman
/s/ Marcie A. Barber
March 15, 2021
Marcie A. Barber
Director and Chief Executive Officer (Principal Executive Officer)
/s/ Martin L. Dreibelbis
March 15, 2021
Martin L. Dreibelbis
Director
/s/ Gary E. Kelsey
March 15, 2021
Gary E. Kelsey
Director
/s/ Michael A. Buffington
March 15, 2021
Michael A. Buffington
Director
/s/ Richard M. Scanlon
March 15, 2021
Richard M. Scanlon, DMD
Director
/s/ Bradley J. Wagner
March 15, 2021
Bradley J. Wagner
Director
/s/ JoAnn N. McMinn
March 15, 2021
JoAnn N. McMinn
Chief Financial Officer (Principal Accounting and Financial Officer)
JUNIATA VALLEY FINANCIAL CORP.
CORPORATE OFFICERS
Timothy I. Havice
Chairman
Philip E. Gingerich, Jr.
Vice Chairman
Marcie A. Barber
President and Chief Executive Officer
JoAnn N. McMinn
Executive Vice President, Secretary, Treasurer and Chief Financial Officer
JUNIATA VALLEY FINANCIAL CORP. AND THE JUNIATA VALLEY BANK
BOARD OF DIRECTORS
Marcie A. Barber
Timothy I. Havice, Chairman
President and Chief Executive Officer
Owner, T.I. Havice, Developer
Michael A. Buffington
Gary E. Kelsey
Founder and President of
Retired, Potter County, PA
Buffington Property Management, LLC
Register of Wills and Recorder of Deeds
and One-Stop Communications
Richard M. Scanlon, DMD
Martin L. Dreibelbis
Retired, Dentist and Dental Consultant to
Retired, Petroleum Consultant
Central PA Institute of Science and Technology
Philip E. Gingerich, Jr., Vice Chairman
Bradly J. Wagner
President, Central Insurers Group, Inc.
Chief Operating Officer and Vice President
of Manufacturing for Wenger Feeds, LLC
THE JUNIATA VALLEY BANK
BUSINESS DEVELOPMENT BOARD MEMBERS
Mark S. Elsesser
Donald R. Hartzler
Jeffrey C. Moyer
Craig M. Rupert
William J. Rupp, Jr.
Richard A. Smeltz
Corey P. Wray