FNCB BANCORP, INC. This Quarterly Report on Form 10-Q should be read in conjunction with the more detailed and comprehensive disclosures included in the Annual Report on Form 10-K for the year endedDecember 31, 2020 forFNCB Bancorp, Inc. In addition, please read this section in conjunction with the consolidated financial statements and notes to consolidated financial statements contained elsewhere herein.FNCB Bancorp, Inc. and its subsidiaries ("FNCB") are in the business of providing customary retail and commercial banking services to individuals, businesses and local governments and municipalities through its wholly-owned subsidiary,FNCB Bank , at its 17 full-service branch offices within its primary market area,Northeastern Pennsylvania .
FORWARD-LOOKING STATEMENTS AND OTHER INFORMATION
FNCB may from time to time make written or oral "forward-looking statements," including statements contained in our filings with theSecurities and Exchange Commission ("SEC"), in our reports to shareholders, and in our other communications, which are made in good faith by us pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with respect to FNCB's beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond our control). The words "may," "could," "should," "will," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan," "project," "future" and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause FNCB's financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the effect of the novel Coronavirus Disease 2019 ("COVID-19") pandemic on FNCB and its customers, theCommonwealth of Pennsylvania andthe United States , related to the economy and overall financial stability; government and regulatory responses to the COVID-19 pandemic; government intervention in theU.S. financial system including the effects of recent legislative, tax, accounting and regulatory actions and reforms, including, but not limited to, the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") and the Tax Cuts and Jobs Act; political instability; the ability of FNCB to manage credit risk; weakness in the economic environment, in general, and within FNCB's market area; the deterioration of one or a few of the commercial real estate loans with relatively large balances contained in FNCB's loan portfolio; greater risk of loan defaults and losses from concentration of loans held by FNCB, including those to insiders and related parties; if FNCB's portfolio of loans to small and mid-sized community-based businesses increases its credit risk; if FNCB's ALLL is not sufficient to absorb actual losses or if increases to the ALLL were required; FNCB is subject to interest-rate risk and any changes in interest rates could negatively impact net interest income or the fair value of FNCB's financial assets; if management concludes that the decline in value of any of FNCB's investment securities is other-than-temporary could result in FNCB recording an impairment loss; if FNCB's risk management framework is ineffective in mitigating risks or losses to FNCB; if FNCB is unable to successfully compete with others for business; a loss of depositor confidence resulting from changes in either FNCB's financial condition or in the general banking industry; if FNCB is unable to retain or grow its core deposit base; inability or insufficient dividends from its subsidiary,FNCB Bank ; if FNCB loses access to wholesale funding sources; interruptions or security breaches of FNCB's information systems; any systems failures or interruptions in information technology and telecommunications systems of third parties on which FNCB depends; security breaches; if FNCB's information technology is unable to keep pace with growth or industry developments or if technological developments result in higher costs or less advantageous pricing; the loss of management and other key personnel; dependence on the use of data and modeling in both its management's decision-making generally and in meeting regulatory expectations in particular; additional risk arising from new lines of business, products, product enhancements or services offered by FNCB; inaccuracy of appraisals and other valuation techniques FNCB uses in evaluating and monitoring loans secured by real property and other real estate owned; unsoundness of other financial institutions; damage to FNCB's reputation; defending litigation and other actions; dependence on the accuracy and completeness of information about customers and counterparties; risks arising from future expansion or acquisition activity; environmental risks and associated costs on its foreclosed real estate assets; any remediation ordered, or adverse actions taken, by federal and state regulators, including requiring FNCB to act as a source of financial and managerial strength for theFNCB Bank in times of stress; costs arising from extensive government regulation, supervision and possible regulatory enforcement actions; new or changed legislation or regulation and regulatory initiatives; noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations; failure to comply with numerous "fair and responsible banking" laws; any violation of laws regarding privacy, information security and protection of personal information or another incident involving personal, confidential or proprietary information of individuals; any rulemaking changes implemented by theConsumer Financial Protection Bureau ; non-compliance with the Paycheck Protection rules and regulations; inability to attract and retain its highest performing employees due to potential limitations on incentive compensation contained in proposed federal agency rulemaking; any future increases inFNCB Bank's FDIC deposit insurance premiums and assessments; and the success of FNCB at managing the risks involved in the foregoing and other risks and uncertainties, including those detailed in FNCB's filings with theSEC . FNCB cautions that the foregoing list of important factors is not all inclusive. Readers are also cautioned not to place undue reliance on any forward-looking statements, which reflect management's analysis only as of the date of this report, even if subsequently made available by FNCB on its website or otherwise. FNCB does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of FNCB to reflect events or circumstances occurring after the date of this report. Readers should carefully review the risk factors described in the documents that FNCB periodically files with theSEC , including its Annual Report on Form 10-K for the year endedDecember 31, 2020 .
Any references to FNCB's website, www.fncb.com or any variation thereof, shall not incorporate the contents of such website into this Report.
CRITICAL ACCOUNTING POLICIES
In preparing the consolidated financial statements, management has made
estimates, judgments and assumptions that affect the reported amounts of assets
and liabilities as of the date of the consolidated statements of condition and
results of operations for the periods indicated. Actual results could differ
significantly from those estimates.
FNCB's accounting policies are fundamental to understanding management's
discussion and analysis of its financial condition and results of operations.
Management has identified the policies on the determination of the allowance for
loan and lease losses ("ALLL"), securities' valuation and impairment evaluation,
the valuation of other real estate owned ("OREO") and income taxes to be
critical, as management is required to make subjective and/or complex judgments
about matters that are inherently uncertain and could be most subject to
revision as new information becomes available.
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The judgments used by management in applying the critical accounting policies discussed below may be affected by changes and/or deterioration in the economic environment, which may impact future financial results. Specifically, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the ALLL in future periods, and the inability to collect on outstanding loans could result in increased loan losses. In addition, the valuation of certain securities in FNCB's investment portfolio could be negatively impacted by illiquidity or dislocation in marketplaces resulting in significantly depressed market prices thus leading to impairment losses.
Allowance for Loan and Lease Losses
Management evaluates the credit quality of FNCB's loan portfolio on an ongoing basis and performs a formal review of the adequacy of the ALLL on a quarterly basis. The ALLL is established through a provision for loan losses charged to earnings and is maintained at a level management considers adequate to absorb estimated probable losses inherent in the loan portfolio as of the evaluation date. Loans, or portions of loans, determined by management to be uncollectible are charged off against the ALLL, while recoveries of amounts previously charged off are credited to the ALLL. Determining the amount of the ALLL is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, qualitative factors, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. Banking regulators, as an integral part of their examination of FNCB, also review the ALLL, and may require, based on their judgments about information available to them at the time of their examination, that certain loan balances be charged off or require that adjustments be made to the ALLL. Additionally, the ALLL is determined, in part, by the composition and size of the loan portfolio. The ALLL consists of two components, a specific component and a general component. The specific component relates to loans that are classified as impaired. For such loans, an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans and is based on historical loss experience adjusted by qualitative factors. The general reserve component of the ALLL is based on pools of unimpaired loans segregated by loan segment and risk rating categories of "Pass," "Special Mention" or "Substandard and Accruing." Historical loss factors and various qualitative factors are applied based on the risk profile in each risk rating category to determine the appropriate reserve related to those loans. Substandard loans on non-accrual status above the$100 thousand loan relationship threshold and all loans considered troubled debt restructurings ("TDRs") are classified as impaired.
See Note 4, "Loans/Subsequent Event" of the notes to consolidated financial statements included in Item 1 hereof for additional information about the ALLL.
Securities Valuation and Evaluation for Impairment
Management utilizes various inputs to determine the fair value of its investment
portfolio. To the extent they exist, unadjusted quoted market prices in active
markets (Level 1) or quoted prices for similar assets or models using inputs
that are observable, either directly or indirectly (Level 2) are utilized to
determine the fair value of each investment in the portfolio. In the absence of
observable inputs or if markets are illiquid, valuation techniques are used to
determine fair value of any investments that require inputs that are both
unobservable and significant to the fair value measurement (Level 3). For Level
3 inputs, valuation techniques are based on various assumptions, including, but
not limited to, cash flows, discount rates, adjustments for nonperformance and
liquidity, and liquidation values. A significant degree of judgment is involved
in valuing investments using Level 3 inputs. The use of different assumptions
could have a positive or negative effect on FNCB's financial condition or
results of operations. See Note 3, "Securities" and Note 10, "Fair Value
Measurements" of the notes to consolidated financial statements included in Item
1 hereof for additional information about FNCB's securities valuation
techniques.
On a quarterly basis, management evaluates individual investment securities in
an unrealized loss position for other than temporary impairment ("OTTI"). The
evaluation for OTTI requires the use of various assumptions, including but not
limited to, the length of time an investment's fair value is less than book
value, the severity of the investment's decline, any credit deterioration of the
issuer, whether management intends to sell the security, and whether it is
more-likely-than-not that FNCB will be required to sell the security prior to
recovery of its amortized cost basis. Debt investment securities deemed to have
OTTI are written down by the impairment related to the estimated credit loss,
and the non-credit related impairment loss is recognized in other comprehensive
income. FNCB did not recognize any OTTI charges on investment securities for
the three months ended March 31, 2021 and 2020 within the consolidated
statements of income.
Refer to Note 3, "Securities," of the notes to consolidated financial statements included in Item 1 hereof for additional information about valuation of securities.
Other Real Estate Owned
OREO consists of property acquired by foreclosure, abandonment or conveyance of
deed in-lieu of foreclosure of a loan, and bank premises that are no longer used
for operation or for future expansion. OREO is held for sale and is initially
recorded at fair value less estimated costs to sell at the date of acquisition
or transfer, which establishes a new cost basis. Upon acquisition of the
property through foreclosure or deed-in-lieu of foreclosure, any adjustment to
fair value less estimated selling costs is recorded to the ALLL. The
determination is made on an individual asset basis. Bank premises no longer used
for operations or future expansion are transferred to OREO at fair value less
estimated selling costs with any related write-down included in non-interest
expense. Subsequent to acquisition, valuations are periodically performed and
the assets are carried at the lower of cost or fair value less estimated cost to
sell. Fair value is determined through external appraisals, current letters of
intent, broker price opinions or executed agreements of sale, unless management
determines that conditions exist that warrant an adjustment to the value. Costs
relating to the development and improvement of the OREO properties may be
capitalized; holding period costs and any subsequent changes to the valuation
allowance are charged to expense as incurred.
Income Taxes
The objectives of accounting for income taxes are to recognize the amount of
taxes payable or refundable for the current year and deferred tax liabilities
and assets for the future tax consequences of events that have been recognized
in an entity's financial statements or tax returns. Judgment is required in
assessing the future tax consequences of events that have been recognized in
FNCB's consolidated financial statements or tax returns. Fluctuations in the
actual outcome of these future tax consequences could impact our consolidated
financial condition or results of operations.
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FNCB records an income tax provision or benefit based on the amount of tax currently payable or receivable and the change in deferred tax assets and liabilities. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial and tax reporting purposes. Management conducts quarterly assessments of all available positive and negative evidence to determine the amount of deferred tax assets that will more likely than not be realized. FNCB establishes a valuation allowance for deferred tax assets and records a charge to income if management determines, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, management considers past operating results, estimates of future taxable income based on approved business plans, future capital requirements and ongoing tax planning strategies. This evaluation process involves significant management judgment about assumptions that are subject to change from period to period depending on the related circumstances. The recognition of deferred tax assets requires management to make significant assumptions and judgments about future earnings, the periods in which items will impact taxable income, future corporate tax rates, and the application of inherently complex tax laws. The use of different estimates can result in changes in the amounts of deferred tax items recognized, which may result in equity and earnings volatility because such changes are reported in current period earnings. In connection with determining the income tax provision or benefit, management considers maintaining liabilities for uncertain tax positions and tax strategies that it believes contain an element of uncertainty. Periodically, management evaluates each of FNCB's tax positions and strategies to determine whether a liability for uncertain tax benefits is required. As ofMarch 31, 2021 andDecember 31, 2020 , management determined that FNCB did not have any uncertain tax positions or tax strategies and that no liability was required to be recorded.
Refer to Note 5, "Income Taxes," of the notes to consolidated financial statements included in Item 1 hereof for additional information about income taxes.
New Authoritative Accounting Guidance and Accounting Guidance to be Adopted in Future Periods
Refer to Note 2, "New Authoritative Accounting Guidance," of the notes to consolidated financial statements included in Item 1 hereof for information about new authoritative accounting guidance adopted by FNCB during the three months endedMarch 31, 2021 , as well as new accounting guidance issued, but not previously reported, that will be adopted by FNCB in future periods.
Impact of the COVID-19 pandemic
During the first quarter of 2021, effects from the COVID-19 pandemic continue to impact national, regional and local economies. However, as restrictions are slowly lifted, the Unites States economy has begun to recover and with the availability and distribution of vaccines, continued improvement in economic activity is anticipated for the remainder of 2021. In earlyApril 2021 , the Governor ofPennsylvania reduced some of the restrictions on certain businesses, primarily restaurants and hospitality-related businesses. However, working remotely is strongly encouraged and businesses with in-person operations are subject toCDC andCommonwealth of Pennsylvania guidance. FNCB branches are open, and while fully operational, are still operating under the pandemic preparedness plan. FNCB continues to followCDC and Commonwealth guidance and take additional precautions to ensure the safety of its customers and its employees. Additionally, FNCB has worked with local health care providers to secure and offer vaccinations to all eligible employees. While positive developments have occurred, management is keenly aware that FNCB's business and consumer customers may continue to experience varying degrees of financial distress. Uncertainty regarding the pandemic still exists. Should the number of cases rise, or new COVID-19 variant infections increase, additional economic restrictions could be mandated again. Commercial activity has improved, but has not returned pre-pandemic levels, which may impede loan growth and could result in a deterioration in asset quality. Additionally, FNCB's commercial customer base includes businesses in industries such as hotel/lodging, restaurants, hospitality, and retail and commercial real estate, all of which have been significantly and adversely impacted by the COVID-19 pandemic. Management continues to closely monitor customers within these industries as the economic recovery unfolds. OnDecember 27, 2020 , another COVID-19 relief bill was signed into law that extended and modified several provisions of the PPP. This included an additional allocation of$284 billion in funding. The SBA reactivated the PPP onJanuary 11, 2021 , and onJanuary 19, 2021 , FNCB began originating additional PPP loans through the PPP. The SBA will continue to accept new applications throughMay 31, 2021 . In the three months endedMarch 31, 2021 , FNCB had generated and received SBA approval and funding for 540 PPP loans totaling$59.0 million and received$2.8 million in related deferred loan origination fees associated with this funding. During the three months endedMarch 31, 2021 , FNCB received forgiveness for PPP loans totaling$30.2 million originated in 2020 under the first round of funding, with$1.3 million in PPP loan origination fees, net of loan origination costs, recognized into interest income upon forgiveness. PPP loans outstanding atMarch 31, 2021 were$107.4 million . FNCB expects to apply and receive forgiveness for the majority of these loans by the end of 2021. Management expects the COVID-19 pandemic, as well as certain provisions of legislative and regulatory relief efforts, to continue to impact FNCB's operations. The full impact is unknown, continues to evolve and will be contingent upon the speed and extent of recovery. At this time, management cannot determine or estimate the full magnitude of the impact and cannot provide any assurances as to how the crisis may ultimately affect FNCB's results of operations or financial position. The FNCB team will continue to work diligently to address any issues related to the COVID-19 pandemic in a safe and sound manner as they arise. Management believes that FNCB's balance sheet and capital position are strong and will allow FNCB to withstand the challenges that may be presented. 27
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Table of Contents Executive Summary
The following overview should be read in conjunction with this MD&A in its entirety.
FNCB recorded consolidated net income of$5.8 million , or$0.29 per basic and diluted common share, for the three months endedMarch 31, 2021 , an increase of$3.7 million , or 182.7%, compared to$2.1 million , or$0.10 per basic and diluted common share, for the three months endedMarch 31, 2020 . The increase in first quarter 2021 earnings over the same quarter of 2020 was primarily due to a$2.2 million , or 24.2% increase in net interest income, which reflected lower funding costs, higher volumes of earning assets and the recognition of$1.3 million in net loan origination fees on forgiven PPP loans, partially offset by reductions in earning asset yields. Also favorably impacting net income in the first quarter of 2021, were an increase in non-interest income, coupled with a reduction in the provision for loan and lease losses. Partially offsetting these positive factors comparing the year-to-date periods was an increase in income tax expense, due to higher levels of pre-tax net income in 2021. For the three months endedMarch 31, 2021 and 2020, the annualized return on average assets and return on average equity was 1.61% and 15.27%, respectively, and 0.69% and 6.06%, respectively, for the same period of 2020. FNCB declared and paid dividends to holders of common stock of$0.060 per share for the three months endedMarch 31, 2021 , a 9.1% increase compared to$0.055 per share for the same quarter of 2020. Total assets increased$34.4 million , or 2.3%, to$1.500 billion atMarch 31, 2021 from$1.466 billion atDecember 31, 2020 . The change in total assets primarily reflected increases in net loans and available-for-sale debt securities, which were partially offset by a decrease in cash and cash equivalents. Net loans increased$30.7 million , or 3.5%, to$919.9 million atMarch 31, 2021 from$889.2 million atDecember 31, 2020 . Also contributing to the balance sheet expansion was a$57.4 million , or 16.4%, increase in available-for-sale debt securities to$407.4 million atMarch 31, 2021 from$350.0 million atDecember 31, 2020 . Cash and cash equivalents decreased$57.3 million , or 36.7%, to$98.5 million atMarch 31, 2021 from$155.8 million atDecember 31, 2020 . Total deposits increased$35.4 million , or 2.7%, to$1.323 billion atMarch 31, 2021 from$1.287 billion atDecember 31, 2020 . Total borrowed funds remained constant at$10.3 million atMarch 31, 2021 andDecember 31, 2020 . Total shareholders' equity decreased$930 thousand , or 0.6%, to$154.9 million atMarch 31, 2021 from$155.9 million atDecember 31, 2020 . Contributing to the decrease in capital was a$5.6 million decrease in accumulated other comprehensive income related primarily to the depreciation in the fair value of FNCB's available-for-sale debt securities, net of deferred taxes. Also contributing to the decrease in capital were dividends declared and paid of$1.2 million for the three months endedMarch 31, 2021 . These reductions to capital were partially offset by net income for the three months endedMarch 31, 2021 of$5.8 million .FNCB Bank's total risk-based capital and Tier 1 leverage ratios improved to 16.26% and 9.88% atMarch 31, 2021 , respectively, compared to 15.79% and 9.57% atDecember 31, 2020 , respectively. 28
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Table of Contents Summary of Performance Net Interest Income Net interest income, defined as the difference between (i) interest income, interest and fees on interest-earning assets, and (ii) interest expense, interest paid on deposits and borrowed funds, is the primary source of earnings for commercial banks. As such, it is the primary determinant of profitability for FNCB. Net interest income is impacted by variations in the volume, rate and composition of earnings assets and interest-bearing liabilities, changes in general market rates and the level of non-performing assets. Interest income is presented on a fully tax-equivalent basis using the corporate statutory tax rate of 21.0% in 2021 and 2020. In response to the significant disruption and uncertainty in the economic environment brought on by COVID-19, theFederal Open Market Committee ("FOMC") lowered the federal funds target rate 150 basis points in two emergency actions inMarch 2020 . As a result, the target range for federal funds fell from 1.50%-1.75% atDecember 31, 2020 to 0.00%-0.25% atMarch 31, 2020 and has remained at that level throughMarch 31, 2021 . TheFOMC actions, along with decreases in general market interest rates, has resulted in decreases in both the tax-equivalent yield on earning-assets and the rate paid on interest-bearing liabilities comparing the three months endedMarch 31, 2021 and 2020. Additionally, net interest income, earning-asset yields and the net interest margin were impacted by the origination, funding and forgiveness of PPP loans. Net interest income on a tax-equivalent basis increased$2.3 million , or 24.9%, to$11.6 million for the three months endedMarch 31, 2021 from$9.3 million for the comparable period of 2020. The improvement in tax-equivalent net interest income for the first quarter of 2021 primarily reflected an increase in tax-equivalent interest income of$1.2 million or 10.6%, to$12.5 million from$11.3 million for the same quarter of 2020, coupled with a decrease in interest expense of$1.1 million , or 57.0%, to$846 thousand from$2.0 million comparing the first quarters of 2021 and 2020. The tax-equivalent net interest margin, a key measurement used in the banking industry to measure income from earning assets relative to the cost to fund those assets, is calculated by dividing tax-equivalent net interest income by average interest-earning assets. FNCB's tax-equivalent net interest margin improved 24 basis points to 3.59% for the first quarter of 2021 from 3.35% for the same quarter of 2020. The margin improvement was primarily impacted by activity related to PPP loans, coupled with a decrease of 55 basis points in the cost of funds. Additionally, rate spread, the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities shown on a fully tax-equivalent basis, improved 34 basis points to 3.51% for the three months endedMarch 31, 2021 from 3.17% for the same period of 2020. Comparing the three months endedMarch 31, 2021 tax-equivalent interest income increased$1.2 million , to$12.5 million compared to$11.3 million for the same quarter in 2020. This included an increase of$945 thousand in interest income due to a$87.0 million , or 10.4%, increase in average total loan balances. Partially offsetting the volume increase was a 14-basis point reduction in the tax-equivalent yield on average loan balances that reduced tax-equivalent interest income by$315 thousand . Included in tax-equivalent interest income on loans for the three months endedMarch 31, 2021 was$1.5 million earned on PPP loans, including the recognition of$1.2 million in net deferred loan origination fees. PPP loans, net of deferred origination fees, averaged$94.8 million for the first quarter of 2021. There was no activity related to PPP loans in the first quarter of 2020. In addition, total average securities increased$90.6 million , or 33.4%, to$362.0 million from$271.4 million in the same quarter of 2020, contributing$891 thousand to tax-equivalent interest income, which was slightly offset by the$307 thousand decline in tax-equivalent interest income due to the 10 basis-point reduction in the tax-equivalent yield on the securities portfolio. The 57.0% decrease in interest expense was primarily due to a 55-basis point reduction in the cost of funds to 0.34% for the three months endedMarch 31, 2021 from 0.89% for the same three months of 2020. Specifically, the average rate paid for interest-bearing deposits decreased 49 basis points to 0.32% for the first quarter of 2021 from 0.81% for the same period of 2020, resulting in a decrease to interest expense of$1.2 million . The average rates paid for interest-bearing demand and time deposits, which reflected the reduction in market interest rates, decreased 48 basis points and 58 basis points, respectively, comparing the three months endedMarch 31, 2021 and 2020. The decrease in interest expense due to changes in deposit rates was coupled with a$51.5 million , or 83.3% decrease in average borrowed funds comparing the three months endedMarch 31, 2021 to the same period of 2020, which resulted in a$241 thousand decrease in interest expense. FNCB experienced strong deposit growth due to additional fiscal stimulus in the first quarter of 2021. Changing customer deposit preferences due to the reduction in economic activity and uncertainty related to the COVID-19 pandemic also contributed to the deposit growth, as well as factoring into deposit migration from time deposits into non-maturity deposits. Specifically, average interest-bearing deposits increased$177.9 million , or 21.7%, to$999.1 million from$821.2 million comparing the first quarters of 2021 and 2020, respectively. Average interest-bearing demand deposits increased$167.0 million , or 31.6%, to$695.8 million for the first quarter of 2021 compared to$528.8 million for the same quarter of 2020, while average savings deposits increased$20.4 million , or 21.7%, to$114.3 million from$94.0 million comparing the first quarters of 2021 and 2020, respectively. Conversely, average time deposits decreased$9.5 million to$188.9 million for the three months endedMarch 31, 2021 from$198.4 million for the same three months of 2020. The strong growth in deposit volumes resulted in a combined net increase to interest expense of$330 thousand . FNCB used the excess liquidity from deposit growth to reduce its reliance on and repay higher-costing borrowed funds. As a result, average borrowed funds decreased$51.5 million , or 83.3%, to$10.3 million from$61.8 million comparing the first quarters of 2021 and 2020, which resulted in a decrease to interest expense of$241 thousand . 29
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Net interest income depends upon the relative amount of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them. The following tables present certain information about FNCB's consolidated statements of financial condition and consolidated statements of income for the three-month period endedMarch 31, 2021 and 2020, and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are calculated by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are derived from average daily balances. The yields include amortization of fees which are considered adjustments to yields. Three Months Ended March 31, 2021 March 31, 2020 Average Yield/ Average Yield/ (dollars in thousands) Balance Interest Cost Balance Interest Cost Assets Earning assets (2)(3) Loans-taxable (4)$ 873,544 $ 9,401 4.30 %$ 780,855 $ 8,693 4.45 % Loans-tax free (4) 46,897 487 4.15 % 52,615 565 4.30 % Total loans (1)(2) 920,441 9,888 4.30 % 833,470 9,258 4.44 % Securities-taxable 286,128 1,968 2.75 % 236,697 1,927 2.92 % Securities-tax free 75,876 615 3.24 % 7,698 72 3.74 % Total securities (1)(5) 362,004 2,583 2.85 % 271,395 1,999 2.95 % Interest-bearing deposits in other banks and federal funds sold (8) 13,490 3 0.09 % 7,230 21 1.16 % Total earning assets (8) 1,295,935 12,474 3.85 % 1,112,095 11,278 4.06 % Non-earning assets (8) 187,490
100,520
Allowance for loan and lease losses (12,189 ) (8,967 ) Total assets$ 1,471,236 $ 1,203,648 Liabilities and Shareholders' Equity Interest-bearing liabilities Interest-bearing demand deposits$ 695,794 380 0.22 %$ 528,802 930 0.70 % Savings deposits 114,349 20 0.07 % 93,989 28 0.12 % Time deposits 188,942 398 0.84 % 198,425 702 1.42 % Total interest-bearing deposits 999,085 798 0.32 % 821,216 1,660 0.81 % Borrowed funds and other interest-bearing liabilities 10,310 48 1.86 % 61,843 307 1.99 % Total interest-bearing liabilities 1,009,395 846 0.34 % 883,059 1,967 0.89 % Demand deposits 294,525 172,132 Other liabilities 12,413 11,636 Shareholders' equity 154,903 136,821 Total liabilities and shareholder's equity$ 1,471,236 $ 1,203,648 Net interest income/interest rate spread (6) (8) 11,628 3.51 % 9,311 3.17 % Tax equivalent adjustment (231 ) (134 ) Net interest income as reported$ 11,397 $ 9,177 Net interest margin (7) (8) 3.59 % 3.35 %
(1) Interest income is presented on a tax equivalent basis using a 21% rate.
(2) Loans are stated net of unearned income.
(3) Non-accrual loans are included in loans within earning assets.
(4) Loan fees included in interest income are not significant.
(5) The yields for securities that are classified as available for sale is based
on the average historical amortized cost.
(6) Interest rate spread represents the difference between the average yield on
interest earning assets and the cost of interest-bearing liabilities and is
presented on a tax equivalent basis.
(7) Net interest income as a percentage of total average interest earning
assets.
(8) Reflects revisions to average balances for the three months ended
2020 to reclassify certain average deposits in other banks from non-interest
deposits in other banks to non-earning assets in the amount of
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Table of Contents
Rate Volume Analysis
The most significant impact on net income between periods is derived from the
interaction of changes in the volume and rates earned or paid on
interest-earning assets and interest-bearing liabilities. The volume of earning
assets, specifically loans and investments, compared to the volume of
interest-bearing liabilities represented by deposits and borrowings, combined
with the spread, produces the changes in net interest income between periods.
Components of interest income and interest expense are presented on a
tax-equivalent basis using the corporate federal income tax rate of 21%.
The following table summarizes the effect that changes in volumes of earning
assets and interest-bearing liabilities and the interest rates earned and paid
on these assets and liabilities have on net interest income. The net change or
mix component attributable to the combined impact of rate and volume changes has
been allocated proportionately to the change due to volume and the change due to
rate.
Three Months Ended March 31,
2021 vs. 2020
Increase (Decrease)
Due to Due to Total
(in thousands) Volume Rate Change
Interest income:
Loans - taxable $ 1,005 $ (297 ) $ 708
Loans - tax free (60 ) (18 ) (78 )
Total loans 945 (315 ) 630
Securities - taxable 170 (129 ) 41
Securities - tax free 721 (178 ) 543
Total securities 891 (307 ) 584
Interest-bearing deposits in other banks and
federal funds sold 10 (28 ) (18 )
Total interest income 1,846 (650 ) 1,196
Interest expense:
Interest-bearing demand deposits 357 (907 ) (550 )
Savings deposits 5 (13 ) (8 )
Time deposits (32 ) (272 ) (304 )
Total interest-bearing deposits 330 (1,192 ) (862 )
Borrowed funds and other interest-bearing
liabilities (241 ) (18 ) (259 )
Total interest expense 89 (1,210 ) (1,121 )
Net interest income $ 1,757 $ 560 $ 2,317 Provision for Loan and Lease Losses
The provision for loan and lease losses is an expense charged against net interest income to provide for probable losses attributable to uncollectible loans and is based on management's analysis of the adequacy of the ALLL. A release of reserves, resulting in a credit for loan and lease losses, reflects the reversal of amounts previously charged to the ALLL. Management closely monitors the loan portfolio and the adequacy of the ALLL by considering the underlying financial performance of the borrower, collateral values and associated credit risks. Future material adjustments may be necessary to the provision for loan and lease losses and the ALLL if economic conditions or loan performance differ substantially from the assumptions management considered in its evaluation of the ALLL. In 2020, management tried to address any potential adverse impact the COVID-19 pandemic had on economic conditions in its application of FNCB's methodology on the allowance for loan and lease losses by adjusting the qualitative factor associated with changes in national, local and business economic conditions and developments, which resulted in higher credit provisioning in 2020. Management made no adjustment to the qualitative factor associated with changes in national, local and business economic conditions and developments, as the economy appears to have begun to recover from the impacts of the COVID-19 pandemic in 2021. FNCB recorded a provision for loan and lease losses of$186 thousand for the three-month period endedMarch 31, 2021 compared to$1.2 million for the three months endedMarch 31, 2020 . The reduction in the provision for loan and lease losses was attributable to a reduction in loan volumes, excluding PPP loans. Non-interest Income Non-interest income increased$1.1 million or 63.8%, to$2.8 million for the three months endedMarch 31, 2021 from$1.7 million for the same three months of 2020. The increase resulted primarily from a gain of$422 thousand from a bank-owned life insurance death benefit claim that was recognized in the first quarter of 2021, coupled with increases in net gains on equity securities, and net gains on the sale of mortgage loans held for sale. Net gains on equity securities increased$350 thousand to$364 thousand for the first quarter of 2021 compared to$14 thousand for the same quarter of 2020. Net gains on the sale of mortgage loans were$224 thousand for the three months endedMarch 31, 2021 , a$128 thousand , or 133.3%, increase compared to$96 thousand in net gains realized for the same three-month period of 2020. Additionally FNCB experienced increases in net gains on available-for-sale debt securities, loan related fees and deposit service charges. Net gains on the sale of available-for-sale securities totaled$213 thousand for the first quarter of 2021, an increase of$64 thousand , or 43.0%, compared to$149 thousand for the same quarter of 2020. Additionally, loan-related fees increased$77 thousand , or 137.5%, to$133 thousand for the three months endedMarch 31, 2021 , compared to$56 thousand for the same period of 2020, while an increase in debit card usage contributed to the$49 thousand , or 5.9%, increase in deposit service charges to$874 thousand from$825 thousand comparing the three months endedMarch 31, 2021 and 2020, respectively. 31
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Table of Contents Non-interest Expense Non-interest expense was relatively constant at$7.2 million , decreasing by$34 thousand , or 0.5%, comparing the three months endedMarch 31, 2021 and 2020. The decrease primarily reflected reductions in salaries and benefits, advertising expenses and other operating expenses. Salaries and benefits decreased$193 thousand , or 4.9% to$3.7 million for the three months endedMarch 31, 2021 , from$3.9 million for the same period in 2020, due primarily to the deferral of payroll-related loan origination costs associated with PPP loans. Advertising expenses decreased$90 thousand , or 43.5%, to$117 thousand for the first quarter of 2021 from$207 thousand for the same quarter of 2020, as FNCB reduced its advertising during the pandemic. Other operating expenses decreased$97 thousand , or 11.1%, to$775 thousand from$872 thousand comparing the three months endedMarch 31, 2021 and 2020. This decrease reflected reductions in OREO-related expenses, coupled with reductions in office expense, auto expense and travel and entertainment expense due to travel restrictions and a large percentage of staff working remotely. These expense reductions were offset by increases in regulatory assessments of$129 thousand , or 218.6%, data processing of$94 thousand , or 13.0%, professional fees of$71 thousand , or 37.8%, and occupancy expense of$55 thousand , or 9.9%, comparing the three months endedMarch 31, 2021 and 2020. Regulatory assessments for the first quarter of 2020 were reduced by the remainder of theFDIC's small bank assessment credit. There were no such assessment credits in 2021. The increase in data processing expense reflected added costs associated with employees working remotely, coupled with additions to FNCB's digital banking services, while the increase in professional fees was primarily due to additional costs associated with FNCB's annual audit. The increase in FNCB's occupancy expense was largely due to higher snow removal costs. Provision for Income Taxes FNCB recorded income tax expense of$1.0 million for the three months endedMarch 31, 2021 , an increase of$529 thousand , or 117.0%, compared to income tax expense of$0.5 million for the same period of 2020. The increase in income tax expense primarily reflected an increase in pre-tax net income of$4.3 million , or 170.9%, when comparing the three months endedMarch 31, 2021 and 2020. Despite the increase in income tax expense, FNCB's effective tax rate decreased to 14.40% for the first quarter of 2021 compared to 17.97% for the same quarter of 2020, which was primarily caused by higher levels of tax-exempt income. FINANCIAL CONDITION Assets Total assets increased$34.4 million , or 2.3%, to$1.500 billion atMarch 31, 2021 from$1.466 billion atDecember 31, 2020 . The change in total assets primarily reflected increases in net loans and available-for-sale debt securities, which were partially offset by a decrease in cash and cash equivalents. Net loans increased$30.7 million , or 3.5%, to$919.9 million atMarch 31, 2021 from$889.2 million atDecember 31, 2020 , primarily due to the origination and funding of a second round of PPP loans, partially offset by first-round PPP loan forgiveness. Available-for-sale debt securities increased$57.4 million , or 16.4%, to$407.4 million atMarch 31, 2021 from$350.0 million atDecember 31, 2020 , which primarily reflected the deployment of excess liquidity into the investment portfolio. Conversely, cash and cash equivalents decreased$57.3 million , or 36.7%, to$98.5 million atMarch 31, 2021 from$155.8 million atDecember 31, 2020 . Total deposits increased$35.4 million , or 2.7%, to$1.323 billion atMarch 31, 2021 from$1.287 billion atDecember 31, 2020 . Specifically, non-interest bearing deposits increased$48.0 million , or 17.7%, due primarily to second round PPP loan funding and additional fiscal stimulus payments. Partially offsetting the increase in non-interest bearing deposits was a$12.7 million , or 1.2%, reduction in interest-bearing deposits reflecting the continued runoff and migration of certificates of deposit. Borrowed funds remained constant at$10.3 million atMarch 31, 2021 andDecember 31, 2020 , comprised entirely of$10.3 million in FNCB's junior subordinated debentures. 32
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Table of Contents Cash and Cash Equivalents Cash and cash equivalents decreased$57.3 million , or 36.7%, to$98.5 million atMarch 31, 2021 from$155.8 million atDecember 31, 2020 . The decrease was primarily due to the utilization of funds to purchase available-for-sale debt securities. In addition, FNCB paid dividends of$0.06 per share for the three months endedMarch 31, 2021 , an increase of 9.1% compared to dividends of$0.055 per share paid for the same quarter of 2020. Securities FNCB's investment securities portfolio provides a source of liquidity needed to meet expected loan demand and interest income to increase profitability. Additionally, the investment securities portfolio is used to meet pledging requirements to secure public deposits and for other purposes. Debt securities are classified as either held-to-maturity or available-for-sale at the time of purchase based on management's intent. Held-to-maturity securities are carried at amortized cost, while available-for-sale securities are carried at fair value, with unrealized holding gains and losses reported as a component of shareholders' equity in accumulated other comprehensive income (loss), net of tax. AtMarch 31, 2021 andDecember 31, 2020 , all debt securities were classified as available-for-sale. Equity securities with readily determinable fair values are carried at fair value, with gains and losses due to fluctuations in market value included in the consolidated statements of income. Securities with limited marketability and/or restrictions, such as FHLB ofPittsburgh stock, are carried at cost. Management monitors the investment portfolio regularly. Decisions to purchase or sell investment securities are based upon management's current assessment of long- and short-term economic and financial conditions, including the interest rate environment and asset/liability management, liquidity and tax-planning strategies. AtMarch 31, 2021 , FNCB's investment portfolio was comprised principally of available-for-sale debt securities including, fixed-rate, taxable and tax-exempt obligations of state and political subdivisions, and fixed-rate and floating-rate securities issued byU.S. government orU.S. government-sponsored agencies, which include mortgage-backed securities and residential and commercial collateralized mortgage obligations ("CMOs"). FNCB also holds investments, to a lesser extent, in private CMOs, corporate debt securities asset-backed securities andU.S. Treasury securities. Additionally, FNCB holds equity investments in the common and preferred stock of certain publicly- and privately-traded bank holding companies. Except forU.S. government and government-sponsored agencies, there were no securities of any individual issuer that exceeded 10.0% of shareholders' equity atMarch 31, 2021 . The following table presents the carrying value of debt securities, all of which were classified as available-for-sale and carried at fair value atMarch 31, 2021 andDecember 31, 2020 :
Composition of
March 31, December 31,
(in thousands) 2021 2020
Available-for-sale debt securities:
U.S. Treasury securities $ 1,916 $ -
Obligations of state and political subdivisions 205,628
205,828
U.S. government/government-sponsored agencies: Collateralized mortgage obligations - residential 106,430
56,972
Collateralized mortgage obligations - commercial 3,803
3,904
Mortgage-backed securities 16,367
13,026
Private collateralized mortgage obligations 37,512 38,199 Corporate debt securities 26,272 24,580 Asset-backed securities 9,468 7,526 Total available-for-sale debt securities$ 407,396 $ 350,035 Activity related to available-for-sale debt securities within the investment portfolio during the first quarter of 2021 reflected an asset/liability strategy to deploy a portion of excess liquidity into the investment portfolio to enhance net interest income. As a result of the deployment, available-for-sale debt securities increased$57.4 million , or 16.4%, to$407.4 million atMarch 31, 2021 from$350.0 million atDecember 31, 2020 . Specifically, during the three months endedMarch 31, 2021 , FNCB purchased 31 available-for-sale debt securities including 15 agency CMOs, 4 tax-exempt obligations of state and political subdivisions, 4 taxable obligations of state and political subdivisions, 3 corporate debt securities, 3 private asset-backed securities, 1 private CMO and 1 U.S.Treasury security. The securities purchased had an aggregate principal balance of$73.6 million and a weighted-average yield of 1.10%. During the three months endedMarch 31, 2021 , FNCB sold 3 taxable obligations of state and political subdivisions with an aggregate amortized cost of$2.8 million with a weighted-average yield of 2.78%. FNCB received gross proceeds of$3.0 million and realized a net gain of$213 thousand upon the sales, which is included in non-interest income. The following table presents the maturities of available-for-sale debt securities, based on carrying value atMarch 31, 2021 and the weighted-average yields of such securities calculated on the basis of the amortized cost and effective yields weighted for the scheduled maturity of each security. The yields on tax-exempt obligations of state and political subdivisions are presented on a tax-equivalent basis using the federal corporate income tax rate of 21.0%. Because residential, commercial and private collateralized mortgage obligations, mortgage-backed securities and asset-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following summary. 33
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Maturity Distribution of
March 31, 2021
Collateralized
Mortgage
Obligations,
Mortgage-Backed
and Asset-Backed
(dollars in thousands) < 1 Year >1 - 5 Years 6 - 10 Years Over 10 Years Securities Total
Available-for-sale debt securities:
U.S. Treasury securities $ - $ - $ 1,916 $ - $ - $ 1,916
Yield 1.23 % 1.23 %
Obligations of state and political
subdivisions 4,696 66,570 18,290 116,072 - 205,628
Yield 2.42 % 2.97 % 2.88 % 2.83 % 2.87 %
U.S. government/government-sponsored
agencies:
Collateralized mortgage obligations -
residential - - - - 106,430 106,430
Yield 1.83 % 1.83 %
Collateralized mortgage obligations -
commercial - - - - 3,803 3,803
Yield 1.98 % 1.98 %
Mortgage-backed securities - - - - 16,367 16,367
Yield 2.63 % 2.63 %
Private collateralized mortgage
obligations - - - - 37,512 37,512
Yield 2.49 % 2.49 %
Corporate debt securities - 1,005 25,267 - - 26,272
Yield 6.50 % 5.04 % 5.10 %
Asset-backed securities - - - - 9,468 9,468
Yield 1.47 % 1.47 %
Total available-for-sale debt
securities $ 4,696 $ 67,575 $ 45,473 $ 116,072 $ 173,580 $ 407,396
Weighted average yield 2.42 % 3.02 % 4.01 % 2.83 % 2.03 % 2.65 %
OTTI Evaluation
There was no OTTI recognized during the three months ended March 31, 2021 or
2020. For additional information regarding management's evaluation of securities
for OTTI, see Note 3, "Securities" of the notes to consolidated financial
statements included in Item 1 hereof.
Restricted Securities The following table presents the investment in FNCB's restricted securities,
which have limited marketability and are carried at cost, at
March 31, December 31,
(in thousands) 2021 2020
Stock in
10 10
Total restricted securities, at cost$ 1,149 $ 1,745
Management noted no indicators of impairment for the
Equity Securities Included in equity securities with readily determinable fair values atMarch 31, 2021 andDecember 31, 2020 were investments in the common or preferred stock of publicly traded bank holding companies and an investment in a mutual fund comprised of 1-4 family residential mortgage-backed securities collateralized by properties within FNCB's market area. The cost basis and fair value of equity securities totaled$3.4 million and$4.3 million , respectively, atMarch 31, 2021 and$2.5 million and$3.0 million , respectively, atDecember 31, 2020 . During the first quarter of 2021, FNCB purchased investments in the common stock of two publicly-traded bank holding companies with an aggregate cost of$877 thousand . Equity securities with readily determinable fair values are reported at fair value with net unrealized gains and losses recognized in the consolidated statements of income. FNCB recognized net gains on equity securities included in non-interest income of$364 thousand for the three months endedMarch 31, 2021 and$14 thousand for the same three months of 2020. 34
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AtMarch 31, 2021 andDecember 31, 2020 , equity securities without readily determinable fair values consisted of a$500 thousand investment in a fixed-rate, non-cumulative perpetual preferred stock of a privately-held bank holding company, which is included in other assets in the consolidated statement of financial condition. The preferred stock pays quarterly dividends at an annual rate of 8.25%, which commenced onMarch 30, 2021 . The preferred stock of this bank holding company is not traded on any established market and is accounted for as an equity security without a determinable fair value. Under GAAP, an equity security without a readily determinable fair value shall be written down to its fair value if a qualitative assessment indicates that the investment is impaired, and the fair value of the investment is less than its carrying value. As part of its qualitative assessment, management engaged an independent third party to provide a valuation of this investment as ofMarch 31, 2021 , which indicated that the investment was not impaired. Management determined that no adjustment for impairment was required atMarch 31, 2021 . Loans Total loans, gross, increased$32.3 million , or 3.6%, to$935.6 million atMarch 31, 2021 from$903.3 million atDecember 31, 2020 , which was predominantly due to the origination and funding of the second round of PPP loans, net of forgiveness received on first round PPP loans that were originated in 2020. OnJanuary 19, 2021 , the SBA fully re-opened the loan portal and began accepting applications for a second round of PPP loans. During the first quarter of 2021, FNCB originated and received funding for 540 PPP loans totaling$59.0 million in funding. As ofMarch 31, 2021 , PPP loans outstanding were$107.4 million , an increase of$28.8 million from$78.6 million outstanding atDecember 31, 2020 . The SBA will cease to accept applications under the second round funding onMay 31, 2021 . FNCB received forgiveness on first round PPP loans of$30.2 million during the three months endedMarch 31, 2021 and expects to receive forgiveness for the majority of PPP loans outstanding by the end of 2021. Excluding PPP loans, FNCB experienced modest growth in commercial and residential real estate loans. The increases in these major loan categories were partially offset by a reductions in construction, land acquisition and development loans, state and political subdivision loans and consumer loans. From a collateral standpoint, a majority of FNCB's loan portfolio consists of loans secured by real estate. Real estate secured loans, which include commercial real estate, construction, land acquisition and development, residential real estate loans, increased$11.9 million , or 2.3%, to$541.9 million atMarch 31, 2021 from$530.0 million atDecember 31, 2020 . The increase was concentrated in commercial real estate. Real estate secured loans represented 57.9% and 58.7% of gross loans atMarch 31, 2021 andDecember 31, 2020 , respectively. Commercial real estate loans increased$12.7 million , or 4.6%, to$286.6 million atMarch 31, 2021 from$273.9 million atDecember 31, 2020 . Commercial real estate loans include long-term commercial mortgage financing and are primarily secured by first or second lien mortgages. Commercial and industrial loans, which consist primarily of equipment loans, working capital financing, revolving lines of credit and loans secured by cash and marketable securities and PPP loans,increased$25.8 million , or 10.8%, to$264.3 million atMarch 31, 2021 from$238.5 million atDecember 31, 2020 . Construction, land acquisition and development loans decreased$3.0 million , or 4.9%, to$56.8 million atMarch 31, 2021 from$59.8 million atDecember 31, 2020 . Residential real estate loans totaled$198.5 million atMarch 31, 2021 , an increase of$2.2 million , or 1.1%, from$196.3 million atDecember 31, 2020 . Residential real estate loans include fixed-rate and variable-rate, amortizing mortgage loans, home equity term loans and home equity lines of credit ("HELOCs"). FNCB primarily underwrites fixed-rate residential mortgage loans for sale in the secondary market to reduce interest rate risk and provide funding for additional loans. Additionally, FNCB offers its proprietary "WOW" mortgage product, which is a non-saleable mortgage with maturity terms of 7.5 to 19.5 years that provides customers with an attractive fixed interest rate, low closing costs and a guaranteed 30-day close. Consumer loans, which are primarily comprised of indirect automobile loans, decreased by$3.4 million , or 3.9%, to$82.5 million atMarch 31, 2021 from$85.9 million atDecember 31, 2020 . FNCB did not aggressively compete for indirect automobile loans in the first quarter of 2021. Loans to state and political subdivisions decreased$2.1 million , or 4.3%, to$46.9 million atMarch 31, 2021 from$49.0 million atDecember 31, 2020 .
The following table presents loans receivable, net by major category at
Loan Portfolio Detail
March 31, December 31,
(in thousands) 2021 2020
Residential real estate $ 198,519 $ 196,328
Commercial real estate 286,575 273,903
Construction, land acquisition and development 56,857 59,785
Commercial and industrial 264,267 238,435
Consumer 82,521 85,881
State and political subdivisions 46,891 49,009
Total loans, gross 935,630 903,341
Unearned income (116 ) (110 )
Net deferred loan costs (3,571 ) (2,129 )
Allowance for loan and lease losses (12,076 ) (11,950 )
Loans, net $ 919,867 $ 889,152
Under industry regulations, a concentration is considered to exist when there
are amounts loaned to a multiple number of borrowers engaged in similar
activities which would cause them to be similarly impacted by economic or other
conditions. Typically, industry guidelines require disclosure of concentrations
of loans exceeding 10.0% of total loans outstanding. FNCB had no such
concentrations at March 31, 2021 or December 31, 2020 . In addition to industry
guidelines, FNCB's internal policy considers a concentration to exist in its
loan portfolio if an aggregate loan balance outstanding to borrowers within a
specific industry exceeds 25.0% of capital. However, management regularly
reviews loans by all industry categories to determine if a potential
concentration exists.
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The following table presents industry concentrations within FNCB's loan
portfolio at
Loan Concentrations
March 31, 2021 December 31, 2020
(in thousands) Amount % of Gross Loans Amount % of Gross Loans
1-4 family residential
investment properties $ 64,938 6.94 % $ 58,114 6.43 %
Retail space/shopping centers 46,534 4.97 % 43,926 4.86 %
Modifications Related to COVID-19
In lateMarch 2020 , the federal banking regulators issued guidance encouraging banks to work prudently with and provide short-term payment accommodations to borrowers affected by COVID-19. Additionally, Section 4013 of the CARES Act addressed COVID-19 related modifications and specified that such modifications made on loans that were current as ofDecember 31, 2019 do not need to be classified as TDRs. These modifications provided borrowers with a short-term, typically three-month, interest-only period or full payment deferral. Management is closely monitoring all loans for which a payment deferral has been granted and will continue to follow regulatory guidance when working with the borrowers which have been impacted by COVID-19 and apply the provisions of the CARES Act in making any TDR determinations. As ofMarch 31, 2021 , there were 10 loans with an aggregate recorded investment of$5.3 million that were still under deferral. Asset Quality Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, net of unearned interest, deferred loan fees and costs, and reduced by the ALLL. The ALLL is established through a provision for loan and lease losses charged to earnings. FNCB has established and consistently applies loan policies and procedures designed to foster sound underwriting and credit monitoring practices. Credit risk is managed through the efforts of the Chief Lending Officer and loan officers, the Chief Credit Officer, the loan review function, and the Credit Risk Management, ALLL, Officers Loan and Directors Loan Committees, as well as through oversight of the Board of Directors. Management continually evaluates its credit risk management practices to ensure it is reacting to problems in the loan portfolio in a timely manner, although, as is the case with any financial institution, a certain degree of credit risk is dependent in part on local and general economic conditions that are beyond management's control. Under FNCB's risk rating system, loans that are rated pass, special mention, substandard, doubtful, or loss are reviewed regularly as part of the risk management practices. The Credit Risk Management Committee, which consists of key members of management fromfinance, legal, lending and credit administration, meet monthly or more often as necessary to review individual problem credits and workout strategies and provides monthly reports to the Board of Directors. A loan is considered impaired when it is probable that FNCB will be unable to collect all amounts due (including principal and interest) according to the contractual terms of the note and loan agreement. For purposes of the analysis, all TDRs, loan relationships with an aggregate outstanding balance greater than$100 thousand rated substandard and non-accrual, and loans that are identified as doubtful or loss are considered impaired. Impaired loans are analyzed individually to determine the amount of impairment. For collateral-dependent loans, impairment is measured based on the fair value of the collateral supporting the loans. A loan is determined to be collateral dependent when repayment of the loan is expected to be provided through the liquidation of the collateral held. For impaired loans that are secured by real estate, collateral evaluations and external appraisals are obtained annually, or more frequently as warranted, to ascertain a fair value so that the impairment analysis can be updated. Should a collateral evaluation or current appraisal not be available at the time of impairment analysis, other sources of valuation may be used, including current letters of intent, broker price opinions or executed agreements of sale. For non-collateral-dependent loans, impairment is measured based on the present value of expected future cash flows, net of any deferred fees and costs, discounted at the loan's original effective interest rate. Loans to borrowers that are experiencing financial difficulty that are modified and result in the granting of concessions to the borrowers are classified as TDRs. Such concessions generally involve an extension of a loan's stated maturity date, a reduction of the stated interest rate, payment modifications, capitalization of property taxes with respect to mortgage loans or a combination of these modifications. Non-accrual TDRs are returned to accrual status if principal and interest payments, under the modified terms, are brought current, are performing under the modified terms for six consecutive months, and management believes that collection of the remaining interest and principal is probable. FNCB conservatively considers all TDRs to be impaired. Non-performing loans are monitored on an ongoing basis as part of FNCB's loan review process. Additionally, work-out for non-performing loans and OREO are actively monitored through the Credit Risk Management Committee. A potential loss on a non-performing asset is generally determined by comparing the outstanding loan balance to the fair market value of the pledged collateral, less cost to sell. Loans are placed on non-accrual when a loan is specifically determined to be impaired or when management believes that the collection of interest or principal is doubtful. This generally occurs when a default of interest or principal has existed for 90 days or more, unless the loan is well secured and in the process of collection, or when management becomes aware of facts or circumstances that the loan would default before 90 days. FNCB determines delinquency status based on the number of days since the date of the borrower's last required contractual loan payment. When the interest accrual is discontinued, all unpaid interest income is reversed and charged back against current earnings. Any subsequent cash payments received are applied, first to the outstanding loan amounts, then to the recovery of any charged-off loan amounts, with any excess treated as a recovery of lost interest. A non-accrual loan is returned to accrual status when the loan is current as to principal and interest payments, is performing according to contractual terms for six consecutive months and future payments are reasonably assured. 36
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Management actively manages impaired loans in an effort to mitigate loss to FNCB by working with customers to develop strategies to resolve borrower difficulties, through sale or liquidation of collateral, foreclosure, and other appropriate means. In addition, management monitors employment and economic conditions within FNCB's market area, as weakening of conditions could result in real estate devaluations and an increase in loan delinquencies, which could negatively impact asset quality and cause an increase in the provision for loan and lease losses. Under the fair value of collateral method, the impaired amount of the loan is deemed to be the difference between the loan amount and the fair value of the collateral, less the estimated costs to sell. For real estate secured loans, management generally estimates selling costs using a factor of 10%, which is based on typical cost factors, such as a 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process. If the valuation indicates that the fair value has deteriorated below the carrying value of the loan, the difference between the fair value and the principal balance is charged off. For impaired loans for which the value of the collateral less costs to sell exceeds the loan value, the impairment is determined to be zero.
The following table presents information about non-performing assets and
accruing TDRs at
Non-performing Assets and Accruing TDRs
March 31, December 31,
(dollars in thousands) 2021 2020
Non-accrual loans $ 4,842 $ 5,581
Loans past due 90 days or more and still accruing - -
Total non-performing loans 4,842 5,581
Other real estate owned 58 58
Other non-performing assets 1,900 1,900
Total non-performing assets $ 6,800 $ 7,539
Accruing TDRs $ 6,962 $ 6,975 Non-performing loans as a percentage of gross loans 0.52 %
0.62 % FNCB's asset quality was favorable during the first quarter of 2021. Total non-performing assets decreased$739 thousand , or 9.8%, to$6.8 million atMarch 31, 2021 from$7.5 million atDecember 31, 2020 . The improvement was attributable to a decrease in non-accrual loans, which primarily reflected the payoff of one commercial loan relationship and the return of two commercial loan relationships to accrual status. FNCB's ratio of non-performing loans to total gross loans improved to 0.52% atMarch 31, 2021 from 0.62% atDecember 31, 2020 . Additionally, FNCB's ratio of non-performing assets as a percentage of shareholders' equity improved to 4.4% atMarch 31, 2021 from 4.8% atDecember 31, 2020 , due to the reduction in non-performing assets. While asset quality metrics improved comparingMarch 31, 2021 andDecember 31, 2020 , management believes fallout from the COVID-19 pandemic may still have an adverse effect on asset quality in the future. Prolonged disruption to FNCB's customers could result in increased loan delinquencies, defaults and collateral devaluations. Management actively manages problem credits through workout efforts focused on developing strategies to resolve borrower difficulties through liquidation of collateral and other appropriate means. Additionally, management continues to monitor non-accrual loans, delinquency trends and economic conditions within FNCB's market area on an on-going basis in order to proactively address any collection-related issues and mitigate any potential losses. Other non-performing assets atMarch 31, 2021 andDecember 31, 2020 was comprised solely of a classified account receivable secured by an evergreen letter of credit in the amount of$1.9 million , received in 2011 as part of a settlement agreement for a large construction, land acquisition and development loan for a residential development project in thePocono region ofMonroe County, Pennsylvania . The agreement provides for payment to FNCB as real estate building lots are sold. The project was stalled due to a decline in real estate values in this area following the financial crisis of 2008. In 2019, economic development in this market area began improving and the developer for this project had resumed construction activity, including the completion of substantial infrastructure, and had increased marketing and sales initiatives related to the project. To date, no single-unit lots have been sold, however, the developer completed the construction of a seven-unit building that houses timeshare units and owners began occupying the units in the fourth quarter of 2020. Management continues to monitor this project closely and is currently in negotiations with the developer to establish a repayment plan beginning in 2021. However, uncertainty and economic volatility associated with the COVID-19 pandemic are unknown and could negatively impact the timing of sales and payments.
There were no loans modified as TDRs during the three months ended
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The following table presents the changes in non-performing loans for the three
months ended
Changes in Non-Performing Loans
Three Months Ended March 31,
(in thousands) 2021 2020
Balance, beginning of period
391 719
Loans returned to performing status (224 ) (48 )
Loan foreclosures - -
Loans charged-off (346 ) (314 )
Loan payments received (560 ) (865 )
Balance, end of period $ 4,842 $ 8,576 The average balance of impaired loans was
The additional interest income that would have been earned on non-accrual and
restructured loans had the loans been performing in accordance with their
original terms for the three months ended
The following table presents accruing loan delinquencies and non-accrual loans
as a percentage of gross loans at
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Loan Delinquencies and Non-Accrual Loans
March 31, December 31,
2021 2020
Accruing:
30-59 days 0.15 % 0.31 %
60-89 days 0.03 % 0.06 %
90+ days 0.00 % 0.00 %
Non-accrual 0.52 % 0.62 %
Total delinquencies 0.70 % 0.99 %
Total delinquencies as a percent of gross loans were 0.70% at March 31,
2021 compared to 0.99% at December 31, 2020 . The decrease in total delinquent
loans was primarily due to a decrease in non-accrual loans of $739 thousand ,
coupled with a $0.4 million decrease in accruing loans past due 60-89 days.
Allowance for Loan and Lease Losses
The ALLL represents management's estimate of probable loan losses inherent in the loan portfolio. The ALLL is analyzed in accordance with GAAP and is maintained at a level that is based on management's evaluation of the adequacy of the ALLL in relation to the risks inherent in the loan portfolio.
As part of its evaluation, management considers qualitative and environmental factors, including, but not limited to:
• changes in national, local, and business economic conditions and developments,
including the condition of various market segments;
• changes in the nature and volume of the loan portfolio;
• changes in lending policies and procedures, including underwriting standards,
collection, charge-off and recovery practices and results;
• changes in the experience, ability and depth of lending management and staff;
• changes in the quality of the loan review system and the degree of oversight by
the Board of Directors;
• changes in the trend of the volume and severity of past due and classified
loans, including trends in the volume of non-accrual loans, TDRs and other loan
modifications;
• the existence and effect of any concentrations of credit and changes in the
level of such concentrations;
• the effect of external factors such as competition and legal and regulatory
requirements on the level of estimated credit losses in the current loan
portfolio; and
• analysis of customers' credit quality, including knowledge of their operating
environment and financial condition.
Evaluations are intrinsically subjective, as the results are estimated based on management knowledge and experience and are subject to interpretation and modification as information becomes available or as future events occur. Management monitors the loan portfolio on an ongoing basis with emphasis on weakness in both the real estate market and the economy in general and its effect on repayment. Adjustments to the ALLL are made based on management's assessment of the factors noted above.
For purposes of management's analysis of the ALLL, all loan relationships with an aggregate balance greater than$100 thousand that are rated substandard and non-accrual, identified as doubtful or loss, and all TDRs are considered impaired and are analyzed individually to determine the amount of impairment. Circumstances such as construction delays, declining real estate values, and the inability of the borrowers to make scheduled payments have resulted in these loan relationships being classified as impaired. FNCB utilizes the fair value of collateral method for collateral-dependent loans and TDRs for which repayment depends on the sale of collateral. For non-collateral-dependent loans and TDRs, FNCB measures impairment based on the present value of expected future cash flows discounted at the loan's original effective interest rate. With regard to collateral-dependent loans, appraisals are received at least annually to ensure that impairment measurements reflect current market conditions. Should a current appraisal not be available at the time of impairment analysis, other valuation sources including current letters of intent, broker price opinions or executed agreements of sale may be used. Only downward adjustments are made based on these supporting values. Included in all impairment calculations is a cost to sell adjustment of approximately 10%, which is based on typical cost factors, including a 6% broker commission, 1% transfer taxes and 3% various other miscellaneous costs associated with the sales process. Sales costs are periodically reviewed and revised based on actual experience. The ALLL analysis is adjusted for subsequent events that may arise after the end of the reporting period but before the financial reports are filed. The ALLL equaled$12.1 million , or 1.30% of total loans atMarch 31, 2021 , compared to$11.9 million atDecember 31, 2020 . The slight increase resulted from$186 thousand in provisions for loan and lease losses for the three months endedMarch 31, 2021 , which was partially offset by$60 thousand in net charge-offs for the same time period. The ALLL consists of both specific and general components. The component of the ALLL that is related to impaired loans that are individually evaluated for impairment, the guidance for which is provided by ASC 310 "Impairment of a Loan" ("ASC 310"), was$473 thousand , or 3.9%, of the total ALLL atMarch 31, 2021 , compared to$416 thousand , or 3.5%, of the total ALLL atDecember 31, 2020 . A general allocation of$11.6 million was calculated for loans analyzed collectively under ASC 450 "Contingencies" ("ASC 450"), which represented 96.1% of the total ALLL of$12.1 million . Comparatively, atDecember 31, 2020 , the general allocation for loans collectively analyzed for impairment amounted to$11.5 million , or 96.5%, of the total ALLL. Included in the general component of the ALLL was an unallocated reserve of$1.1 million , at bothMarch 31,2021 andDecember 31, 2020 . Based on its evaluations, management may establish an unallocated component to cover any inherent losses that exist as of the evaluation date, but which may not have been identified under the methodology. The increase in the unallocated reserve was directly related to the increase in credit provisioning during the year endedDecember 31, 2020 due to the economic disruption caused by the COVID-19 pandemic. Based on its evaluation atMarch 31, 2021 , management decided to maintain the unallocated component at a similar level to the level atDecember 31, 2020 . As ofMarch 31, 2021 , FNCB has not experienced asset quality deterioration or an increase in credit losses related to the pandemic. However, management continues to monitor the loan portfolio for any potential adverse impact to FNCB's asset quality that may develop due to fallout from the pandemic. The ratio of the ALLL to total loans decreased to 1.30% of total loans, net of net deferred loan origination fees and unearned income, of$931.9 million atMarch 31, 2021 from 1.33% of total loans, net of net deferred loan costs and unearned income, of$901.1 million atDecember 31, 2020 . Excluding PPP loans, the ALLL as a percentage of gross loans equaled 1.46% atMarch 31, 2021 and 1.45% atDecember 31, 2020 . 39
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The following table presents an allocation of the ALLL by major loan category and percent of loans in each category to total loans atMarch 31, 2021 andDecember 31, 2020 : Allocation of the ALLL March 31, 2021 December 31, 2020 Percentage Percentage of Loans of Loans in Each in Each Category Category Allowance to Total Allowance to Total (dollars in thousands) Amount Loans Amount Loans Residential real estate$ 1,732 21.22 %$ 1,715 21.73 % Commercial real estate 4,521 30.63 % 4,268 30.32 % Construction, land acquisition and development 516 6.08 % 538 6.62 % Commercial and industrial 2,603 28.24 % 2,619 26.39 % Consumer 1,219 8.82 % 1,319 9.51 % State and political subdivision 387 5.01 % 405 5.43 % Unallocated 1,098 0.00 % 1,086 0.00 % Total$ 12,076 100.00 %$ 11,950 100.00 %
The following table presents an analysis of the ALLL by loan category for the
three months ended
Reconciliation of the ALLL
For the Three Months Ended March 31,
(dollars in thousands) 2021 2020
Balance at beginning of period $ 11,950 $ 8,950
Charge-offs:
Residential real estate - -
Commercial real estate - 56
Construction, land acquisition and development - -
Commercial and industrial 19 35
Consumer 342 238
State and political subdivisions - -
Total charge-offs 361 329
Recoveries of charged-off loans:
Residential real estate 3 2
Commercial real estate 46 -
Construction, land acquisition and development - -
Commercial and industrial 25 59
Consumer 227 74
State and political subdivisions - -
Total recoveries 301 135
Net charge-offs 60 194
Provision for loan and lease losses 186 1,151
Balance at end of period $ 12,076 $ 9,907
Net charge-offs as a percentage of average loans 0.01 % 0.02 %
Allowance for loan and lease losses as a percentage of gross loans outstanding at period end
1.30 % 1.19 %
Allowance for loan and lease losses as a percentage of
gross loans outstanding at period end, excluding PPP
Loans 1.46 % 1.19 %
Other Real Estate Owned
There was one piece of commercial land with a carrying value of $58 thousand
held in OREO at March 31, 2021 and December 31, 2020 . There were no valuation
adjustments recorded to the carrying value of OREO property during the three
months ended March 31, 2021 and 2020. The expenses related to maintaining OREO,
not including adjustments to property values subsequent to foreclosure, and net
of any income from operation of the properties, amounted to $10 thousand and
$55 thousand for the three months ended March 31, 2021 and 2020, respectively.
There were no OREO properties sold during the three months ended March 31, 2021 .
At March 31, 2021 , FNCB was in the process of negotiating a deed in lieu of
foreclosure for one residential mortgage loan with a recorded investment of $133
thousand . The deed in lieu of foreclosure was finalized and the property
transferred to OREO in April 2021 . During the three months ended March 31, 2020 ,
there was one residential real estate property in OREO which was sold, with a
carrying value of $204 thousand . The property sold was collateral supporting an
investor-owned residential mortgage loan. The agreement with the investor
requires FNCB to take title to the property upon foreclosure and FNCB is
responsible for the property liquidation on behalf of the investor after
foreclosure. FNCB did not realize any gain or loss upon the sale.
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FNCB actively markets OREO properties for sale through a variety of channels including internal marketing and the use of outside brokers/realtors. The carrying value of OREO is generally calculated at an amount not greater than 90% of the most recent fair market appraised value unless specific conditions warrant an exception. A 10% factor is generally used to estimate costs to sell, which is based on typical cost factors, such as 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process. This fair value is updated on an annual basis or more frequently if new valuation information is available. Deterioration in the real estate market could result in additional losses on these properties. Liabilities Total liabilities consist primarily of total deposits and borrowed funds. During the first quarter of 2021, FNCB experienced strong deposit growth, which was the main factor contributing to a$35.3 million , or 2.7%, increase in total liabilities to$1.345 billion atMarch 31, 2021 from$1.310 billion atDecember 31, 2020 . Specifically, non-interest-bearing demand deposits increased$48.0 million , or 17.7%, to$319.5 million atMarch 31, 2021 from$271.5 million atDecember 31, 2020 . The increase in non-interest bearing deposits was related to the origination and funding of the second round of PPP loans, coupled with additional fiscal stimulus payments received by depositors in the first quarter of 2021. Conversely, interest-bearing deposits decreased$12.7 million , or 1.2%, to$1.003 billion atMarch 31, 2021 from$1.016 billion atDecember 31, 2020 , which was concentrated in interest-bearing demand deposits and time deposits. Specifically, interest-bearing demand deposits decreased$14.8 million , or 2.1%, to$698.6 million atMarch 31, 2021 from$713.4 million atDecember 31, 2020 , which primarily reflected cyclical deposit trends of FNCB's municipal customers. Additionally, continued deposit migration was the primary factor contributing to an$8.2 million , or 4.3%, decrease in total time deposits to$184.7 million atMarch 31, 2021 from$192.9 million atDecember 31, 2020 . Partially offsetting these decreases was a$10.3 million , or 9.4%, increase in savings deposits to$120.0 million atMarch 31, 2021 from$109.7 million atDecember 31, 2020 . Comprised entirely of$10.3 million in junior subordinated debentures, total borrowed funds remained constant at$10.3 million atMarch 31, 2021 andDecember 31, 2020 . Due to the strong deposit influx and favorable liquidity position, FNCB had no advances through the FHLB ofPittsburgh outstanding atMarch 31, 2021 andDecember 31, 2020 . Equity Total shareholders' equity decreased$930 thousand , or 0.6%, to$154.9 million atMarch 31, 2021 from$155.9 million atDecember 31, 2020 . The primary factor contributing to the reduction in capital was a$5.6 million , or 40.2%, decrease in accumulated other comprehensive income related primarily to depreciation in the fair value of FNCB's available-for-sale debt securities, net of deferred taxes. Also contributing to the decrease in capital were dividends declared and paid of$1.2 million for the three months endedMarch 31, 2021 . These reductions were partially offset by net income for the three months endedMarch 31, 2021 of$5.8 million . Book value per common share was$7.65 atMarch 31, 2021 , a decrease of$0.05 , or 0.6%, compared to$7.70 atDecember 31, 2020 . The Bank's total regulatory capital increased$6.1 million to$155.2 million atMarch 31, 2021 from$149.2 million atDecember 31, 2020 .FNCB Bank's total risk-based capital and Tier 1 leverage ratios improved to 16.26% and 9.88% atMarch 31, 2021 , respectively, compared to 15.79% and 9.57% atDecember 31, 2020 , respectively. The Bank's risk-based capital ratios exceeded the minimum regulatory capital ratios required for well capitalized under prompt corrective action regulations. Based on the most recent notification from its primary regulator, the Bank was considered well capitalized atMarch 31, 2021 andDecember 31, 2020 . There were no conditions or events since that notification that management believes would have changed this capital designation. Liquidity The term liquidity refers to the ability to generate sufficient amounts of cash to meet cash flow needs. Liquidity is required to fulfill the borrowing needs of FNCB's credit customers and the withdrawal and maturity requirements of its deposit customers, as well as to meet other financial commitments. FNCB's liquidity position is impacted by several factors, which include, among others, loan origination volumes, loan and investment maturity structure and cash flows, deposit demand and time deposit maturity structure and retention. FNCB has liquidity and contingent funding policies in place that are designed with controls in place to provide advanced detection of potentially significant funding shortfalls, establish methods for assessing and monitoring risk levels, and institute prompt responses that may alleviate a potential liquidity crisis. Management monitors FNCB's liquidity position and fluctuations daily, forecasts future liquidity needs, performs periodic stress tests on its liquidity levels and develops strategies to ensure adequate liquidity at all times. Additionally, management regularly monitors FNCB's wholesale funding sources taking into consideration the cost of funds, diversification between funding sources and asset/liability management strategies. FNCB utilizes brokered deposits, including one-way purchases through the IntraFi® Network, deposits acquired through a national listing service, as well as overnight and term advances through the FHLB ofPittsburgh as wholesale sources of funds to supplement its deposit gathering initiatives. The statements of cash flows present the change in cash and cash equivalents from operating, investing and financing activities. Cash and due from banks and interest-bearing deposits in other banks, which comprise cash and cash equivalents, are FNCB's most liquid assets. AtMarch 31, 2021 , cash and cash equivalents totaled$98.5 million , a decrease of$57.3 million compared to$155.8 million atDecember 31, 2020 . For the three months endedMarch 31, 2021 net cash inflows from operating and financing activities were entirely offset by net cash used in investing activities during that same time frame. Operating activities, net of reconciling adjustments for the three months endedMarch 31, 2021 provided net cash of$6.0 million . Financing activities provided$34.1 million in net cash flow for the three months endedMarch 31, 2021 , which resulted primarily from the net increase in deposits of$35.4 million . These net cash inflows were more than entirely offset by the$97.4 million in net cash used by FNCB's investing activities for the three months endedMarch 31, 2021 , which resulted primarily from the cash used in purchases of available-for-sale debt securities and equity securities of$73.6 million and$0.9 million , respectively, coupled with$29.6 million for new loan funding, primarily PPP loans. These investing cash outflows were partially offset by cash received from sales, maturities, calls and repayments of available-for-sale debt securities totaling$8.8 million . Management is actively monitoring FNCB's liquidity position and capital adequacy in light of the changing circumstances related to economic uncertainty brought on by the COVID-19 pandemic. While management believes FNCB's liquidity position is favorable, they are keenly aware that changes in economic conditions related to COVID-19, or in general, could pose potential stress on liquidity should deposits begin exiting the Bank or FNCB's asset quality deteriorates. Additionally, FNCB could experience an increase in the utilization of existing lines of credit as customers manage their own liquidity needs during this time of economic uncertainty. Management believes FNCB's current liquidity position and available sources of liquidity were sufficient to meet its cash flow needs and fulfill its obligations atMarch 31, 2021 . In addition to cash and cash equivalents of$98.5 million atMarch 31, 2021 , FNCB had ample sources of additional liquidity including approximately$296.9 million in available borrowing capacity from the FHLB ofPittsburgh , and available borrowing capacity through the Federal Reserve Discount Window of$98.7 million under the PPPLF and$14.4 million under the borrower-in-custody program. The$98.7 million in funding availability through the PPPLF expires onJune 30, 2021 . FNCB also has available unsecured federal funds lines of credit totaling$47.0 million atMarch 31, 2021 . 41
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Interest Rate Risk
Interest Rate Sensitivity
Market risk is the risk to earnings and/or financial position resulting from
adverse changes in market rates or prices, such as interest rates, foreign
exchange rates or equity prices. FNCB's exposure to market risk is primarily
interest rate risk associated with our lending, investing and deposit gathering
activities, all of which are other than trading. Changes in interest rates
affect earnings by changing net interest income and the level of other
interest-sensitive income and operating expenses. In addition, variations in
interest rates affect the underlying economic value of our assets, liabilities
and off-balance sheet items.
LIBOR Replacement
The Alternative Reference Rates Committee ("ARRC") has proposed that the Secured
Overnight Funding Rate ("SOFR") replace USD-LIBOR. ARRC had initially proposed
that the transition to SOFR from USD-LIBOR would take place by the end of 2021.
At the end of 2020, the ICE Benchmark Administration ("IBA"), which complies and
oversees LIBOR, commenced a consultation on its intention to extend most of the
USD-LIBOR tenors to June 30, 2023 , and U.S. banking regulators have expressed
support for the extension. Results of the consultation, which concluded on
January 25, 2021 , reaffirmed the extension of the overnight, 1, 3, 6 and 12
month LIBOR tenors through June 30, 2023 . FNCB has various loans, investments,
borrowings and interest rate swap contracts that are indexed to USD-LIBOR, and
management is actively monitoring its LIBOR exposures and evaluating the risks
involved.
Asset and Liability Management
The ALCO, comprised of members of the Bank's board of directors, executive management of other appropriate officers, oversees FNCB's interest rate risk management program. Members of ALCO meet quarterly, or more frequently as necessary, to develop balance sheet strategies affecting the future level of net interest income, liquidity and capital. The major objectives of ALCO are to:
The major objectives of ALCO are to:
? manage exposure to changes in the interest rate environment by limiting the
changes in net interest margin to an acceptable level within a reasonable
range of interest rates;
? ensure adequate liquidity and funding;
? maintain a strong capital base; and
? maximize net interest income opportunities.
FNCB utilizes the pricing and structure of loans and deposits, the size and
duration of the investment securities portfolio, the size and duration of the
wholesale funding portfolio, and off-balance sheet interest rate contracts to
manage interest rate risk. The off-balance sheet interest rate contracts may
include interest rate swaps, caps and floors. These interest rate contracts
involve, to varying degrees, credit risk and interest rate risk. Credit risk is
the possibility that a loss may occur if a counterparty to a transaction fails
to perform according to terms of the contract. The notional amount of the
interest rate contracts is the amount upon which interest and other payments are
based. The notional amount is not exchanged, and therefore, should not be taken
as a measure of credit risk.
ALCO monitors FNCB's exposure to changes in net interest income over both a
one-year planning horizon and a longer-term strategic horizon. ALCO uses net
interest income simulations and economic value of equity ("EVE") simulations as
the primary tools in measuring and managing FNCB's position and considers
balance sheet forecasts, FNCB's liquidity position, the economic environment,
anticipated direction of interest rates and FNCB's earnings sensitivity to
changes in these rates in its modeling. In addition, ALCO has established policy
tolerance limits for acceptable negative changes in net interest income.
Furthermore, as part of its ongoing monitoring, ALCO requires quarterly back
testing of modeling results, which involves after-the-fact comparisons of
projections with FNCB's actual performance to measure the validity of
assumptions used in the modeling techniques.
Earnings at Risk and Economic Value at Risk Simulations
Earnings at Risk Earnings-at-risk simulation measures the change in net interest income and net income under various interest rate scenarios. Specifically, given the current market rates, ALCO looks at "earnings at risk" to determine anticipated changes in net interest income from a base case scenario with scenarios of +200, +400, and -100 basis points for simulation purposes. The simulation takes into consideration that not all assets and liabilities re-price equally and simultaneously with market rates (i.e., savings rate). Economic Value at Risk While earnings-at-risk simulation measures the short-term risk in the balance sheet, economic value (or portfolio equity) at risk measures the long-term risk by finding the net present value of the future cash flows from FNCB's existing assets and liabilities. ALCO examines this ratio regularly, and given the current rate environment, has utilized rate shocks of +200, +400, and -100 basis points for simulation purposes. Management recognizes that, in some instances, this ratio may contradict the "earnings at risk" ratio.
While ALCO regularly performs a wide variety of simulations under various strategic balance sheet and treasury yield curve scenarios, the following results reflect FNCB's sensitivity over the subsequent twelve months based on the following assumptions:
? asset and liability levels usingMarch 31, 2021 as a starting point;
? cash flows are based on contractual maturity and amortization schedules with
applicable prepayments derived from internal historical data and external
sources; and
? cash flows are reinvested into similar instruments so as to keep
interest-earning asset and interest-bearing liability levels constant.
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The following table illustrates the simulated impact of parallel and instantaneous interest rate shocks of +400 basis points, +200 basis points, and -100 basis points on net interest income and the change in economic value over a one-year time horizon from theMarch 31, 2021 levels: Rates +200 Rates +400 Rates -100 Simulation Simulation Simulation Results Policy Limit Results Policy Limit Results Policy Limit Earnings at risk: Percent change in net interest income 0.8 % (12.5 )% 3.7 % (20.0 )% (0.1 )% (10.0 )% Economic value at risk: Percent change in economic value of equity 1.4 % (20.0 )% 1.3 % (35.0 )% (20.6 )% (10.0 )% Similar to model results atDecember 31, 2020 , results from the simulation atMarch 31, 2021 indicated that FNCB's asset/liability position was relatively well matched in the near term, exhibiting only minor sensitivity to changes in interest rates over the next twelve months. According to the model results atMarch 31, 2021 , net interest income is expected to increase 0.8% under a +200-basis point interest rate shock and decrease 0.1% under a -100-basis point rate shock, Additionally, under a parallel shift in interest rates of +200 basis points, FNCB's economic value of equity ("EVE") is expected to increase 1.4%. However, EVE is expected to decrease 20.6% under a parallel shift in interest rates of -100 basis points, which is outside of ALCO policy guidelines. With the exception of the -100 basis point rate shock on EVE, all modeled exposures of net interest income and EVE were within internal policy guidelines for the next twelve months. Management does not believe that EVE policy exception under the -100-basis point rate shock poses any undue interest rate risk atMarch 31, 2021 . Included in the model was the assumptions that FNCB would receive forgiveness for PPP loans outstanding atMarch 31, 2021 and recognize the associated loan origination fees to interest income by the end of the first year of the model. Accordingly, results of model project a substantial decrease to net interest income in Year 2 of the model based on these assumptions. This analysis does not represent a forecast for FNCB and should not be relied upon as being indicative of expected operating results. These simulations are based on numerous assumptions, including but not limited to: the nature and timing of interest rate levels, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacements of asset and liability cash flows, and other factors. While assumptions reflect current economic and local market conditions, FNCB cannot make any assurances as to the predictive nature of these assumptions, including changes in interest rates, customer preferences, competition and liquidity needs, or what actions ALCO might take in responding to these changes. In response to the economic disruption and uncertainty brought on by the COVID-19 pandemic, theFOMC lowered the federal funds target rate a total of 150 basis points in two emergency actions with an expectation that the Committee will maintain a low interest rate environment for the foreseeable future. Given FNCB's current asset/liability position, the significantly lower market interest rates may have a negative impact on FNCB's earning asset yields and variable-rate loans and securities indexed to prime and LIBOR will continue to reprice downward. As previously mentioned, as part of its ongoing monitoring, ALCO requires quarterly back testing of modeling results, which involves after-the-fact comparisons of projections with FNCB's actual performance to measure the validity of assumptions used in the modeling techniques. As part of its quarterly review, management compared tax-equivalent net interest income recorded for the three months endedMarch 31, 2021 with tax-equivalent net interest income that was projected for the same three-month period. There was a positive variance between actual and projected tax-equivalent net interest income for the three-month period endedMarch 31, 2021 of approximately$0.8 million , or 7.3%. The variance primarily reflected a difference in the assumption for the volume and timing of the forgiveness of PPP loans, including fee income recognition, used in the model with that actually experienced. Additionally, the previous model atDecember 31, 2020 did not anticipate the origination of PPP loans under the second round of funding. ALCO performs a detailed rate/volume analysis between actual and projected results in order to continue to improve the accuracy of its simulation models.
Off-Balance Sheet Arrangements
In the ordinary course of operations, FNCB engages in a variety of financial transactions that, in accordance with GAAP, are not recorded in our consolidated financial statements or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions may be used for general corporate purposes or for customer needs. Corporate purpose transactions would be used to help manage credit, interest rate and liquidity risk or to optimize capital. Customer transactions are used to manage customers' requests for funding.
For the three months ended
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