10-K 1 fncb20171231_10k.htm FORM 10-K fncb20171231_10k.htm
 

5  



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2017

 

OR

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to               

 

Commission File No. 000-53869

FNCB BANCORP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Pennsylvania

23-2900790

(State or Other Jurisdiction
of Incorporation or Organization)

(I.R.S. Employer
Identification No.)

   

102 E. Drinker St., Dunmore, PA

18512

(Address of Principal Executive Offices)

(Zip Code)

 

Registrant’s telephone number, including area code (570) 346-7667

 

Securities registered pursuant to Section 12(b) of the Act: NONE

 

Securities registered pursuant to Section 12(g) of the Act:

 

Common Stock, $1.25 par value

(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or section 15(d) of the Act. Yes ☐ No ☒

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒  No ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one)

 

Large Accelerated Filer

Accelerated Filer ☒

Non-Accelerated Filer

Smaller reporting company

   

(Do not check if a smaller reporting company)

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

The aggregate market value of the voting and non-voting common stock of the registrant, held by non-affiliates was $111,754,846 at June 30, 2017.

 

APPLICABLE ONLY TO CORPORATE REGISTRANTS

 

 

State the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 16,766,600 shares of common stock as of March 9, 2018.

 

DOCUMENTS INCORPORATED BY REFERENCE

Certain information required by Items 10, 11, 12, 13 and 14 is incorporated by reference into Part III hereof from portions of the Proxy Statement for the registrant’s 2018 Annual Meeting of Shareholders.

 

 

 

 

 

Contents

 

PART I

 

2

Item 1.   

Business

2

Item 1A.  

Risk Factors

11

Item 1B.

Unresolved Staff Comments.

18

Item 2.  

Properties.

18

Item 3.   

Legal Proceedings.

19

Item 4.

Mine Safety Disclosures.

20

PART II

 

20

Item 5.

Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.

20

Item 6.  

Selected Financial Data

23

Item 7.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

23

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk.

52

Item 8.  

Financial Statements and Supplementary Data.

54

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

109

Item 9A.

Controls and Procedures

109

Item 9B.

Other Information

110

PART III

 

111

Item 10.   

Directors, Executive Officers and Corporate Governance.

111

Item 11.  

Executive Compensation.

111

Item 12.   

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

111

Item 13.    

Certain Relationships and Related Transactions, and Director Independence.

111

Item 14.    

Principal Accounting Fees and Services.

111

PART IV

 

112

Item 15.

Exhibits and Financial Statement Schedules

112

Item 16. Form 10-K Summary 113

 

 

 

 

 

Cautionary Note Regarding Forward-Looking Statements.

 

This Annual Report on Form 10-K may contain forward-looking statements within the meaning of Section 27A of the Securities Act, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to risks and uncertainties. These statements are based on assumptions and may describe future plans, strategies, financial conditions, results of operations and expectations of FNCB Bancorp, Inc. and its direct and indirect subsidiaries (“FNCB”). These forward-looking statements are generally identified by use of the words “may”, “should”, “will”, “could”, “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project”, “plan”, “future” or similar expressions. All statements in this report, other than statements of historical facts, are forward-looking statements.

 

These forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties, some of which are beyond FNCB Bancorp’s control and ability to predict, that could cause actual results to differ materially from those expressed in the forward-looking statements. Important factors that could cause actual results of FNCB Bancorp, Inc. to differ materially from those in the forward-looking statements include, but are not limited to:

 

 

the effect of changes in market interest rates and the relative balances of interest-earning assets to interest-bearing liabilities on net interest margin and net interest income;

 

 

increases in non-performing assets, which may require FNCB to increase the allowance for loan and lease losses, charge off loans and incur elevated collection and carrying costs related to such non-performing assets;

 

 

the impact of adverse economic conditions, particularly in FNCB’s market area, on the performance of its loan portfolio and the demand for its products and services;

 

 

the effects of changes in interest rates on demand for FNCB’s products and services;

 

 

the effects of changes in interest rates or disruptions in liquidity markets on FNCB Bancorp Inc.’s sources of funding;

 

 

the impact of legislative and regulatory changes and the increasing amount of time and resources spent on compliance;

 

 

monetary and fiscal policies of the U.S. government, including policies of the U.S. Department of Treasury and the Federal Reserve System;

 

 

credit risk associated with lending activities and changes in the quality and composition of FNCB’s loan and investment portfolios;

 

 

demand for loans, deposits and other products;

 

 

the effect of competition on deposit and loan rates and growth and on the net interest margin;

 

 

changes in the values of real estate and other collateral securing the loan portfolio, particularly in FNCB Bancorp, Inc.’s market area;

 

 

the failure to identify and to address cyber-security risks;

 

 

the ability of FNCB Bancorp, Inc. to keep pace with technological changes;

 

 

the ability to attract and retain talented personnel;

 

 

capital and liquidity strategies, including FNCB Bancorp, Inc.’s ability to comply with applicable capital and liquidity requirements, and its ability to generate capital internally or raise capital on favorable terms;

 

 

FNCB Bancorp, Inc.’s reliance on its subsidiary, FNCB Bank, for substantially all of its revenues and its ability to pay dividends or other distributions;

 

 

the effects of changes in relevant accounting principles and guidelines on FNCB Bancorp, Inc.’s financial condition; and

 

 

the impact from the failure of third party service providers to perform their contractual obligations.

 

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. FNCB Bancorp, Inc. undertakes no obligation, other than as required by law, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

1

 

 

PART I

 

Item 1.

Business

 

Overview

 

The Company

 

FNCB Bancorp, Inc., formerly First National Community Bancorp, Inc., incorporated in 1997, is a Pennsylvania business corporation and a registered bank holding company headquartered in Dunmore, Pennsylvania. FNCB Bancorp, Inc. became an active bank holding company on July 1, 1998 when it acquired 100% ownership of the former First National Community Bank. In this report, the terms “FNCB,” “we,” “us,” and “our” refer to FNCB Bancorp, Inc. and its subsidiaries, unless the context requires otherwise. In certain circumstances, however, FNCB Bancorp, Inc. uses the term “FNCB” to refer to itself.

 

Effective June 30, 2016, following receipt of required regulatory approvals from the Pennsylvania Department of Banking and Securities, First National Community Bank completed a charter conversion from a national bank to a Pennsylvania state bank. Following the change in charter, First National Community Bank changed its legal name to FNCB Bank (the “Bank”). Subsequently, on October 4, 2016, the holding company filed an amendment to its articles of incorporation to change its name from First National Community Bancorp, Inc. to FNCB Bancorp, Inc. The name change became effective October 17, 2016.

 

FNCB’s primary activity consists of owning and operating the Bank, which provides substantially all of FNCB’s earnings as a result of its banking services.

 

FNCB had net income of $0.1 million, $6.3 million, and $35.8 million in 2017, 2016 and 2015, respectively. Total assets were $1.2 billion at December 31, 2017, $1.2 billion at December 31, 2016, and $1.1 billion at December 31, 2015.

 

The Bank

 

Established as a national banking association in 1910, as of December 31, 2017 the Bank operated 18 full-service branch offices within its primary market area, Northeastern Pennsylvania, and a Limited Purpose Banking Office (“LPO”) based in Allentown, Lehigh County, Pennsylvania.

 

Products and Services

 

Retail Banking

 

The Bank provides a wide variety of traditional banking products and services to individuals and businesses, including online, mobile and telephone banking, debit cards, check imaging and electronic statements. Deposit products include various checking, savings and certificate of deposit products, as well as a line of preferred products for higher-balance customers. The Bank is a member of the Promontory Interfinancial Network and participates in their Certificate of Deposit Account Registry (“CDARs”) and Insured Cash Sweep (“ICS”) programs, which provides customers with ability to secure Federal Deposit Insurance Corporation (“FDIC”) insurance on balances in excess of the standard limitations.

 

The Bank also offers customers the convenience of 24-hour banking, seven days a week, through FNCB Online Banking (“FNCB Online”) and FNCB Business Online Banking via a secure website, https://www.fncb.com. FNCB’s online product suite includes bill payment, internal and external funds transfer and POP Money (person to person transfers), and Purchase Rewards. Through FNCB Online, customers can directly access their accounts, open new accounts and apply for a mortgage or obtain a pre-qualification approval through the Bank’s mortgage center. Customers can also access FNCB Online through the Bank’s mobile application. Telephone banking (“Account Link”), a service that provides customers with the ability to access account information and perform related account transfers through the use of a touch tone telephone, is also available. In addition, customers can access money from their deposit accounts by using their debit card to make purchases or withdraw cash from any automated teller machines (“ATMs”) including ATMs located in each of the Bank’s branch offices as well as additional locations. FNCB’s mobile deposit, available to personal banking customers with access to FNCB Online and an eligible deposit account, allows customers to deposit checks, electronically from start to finish, from anywhere at any time.

 

FNCB Business Online Banking is a menu driven product that provides the Bank’s business customers direct access to their account information and the ability to perform internal and external account transfers, wire transfers and payments through ACH transactions, and process direct deposit payroll transactions for employees, 24 hours a day, 7 days a week, from their place of business.

 

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The Bank also offers business customers remote deposit capture and merchant services, as well as business debit cards. Remote deposit capture provides business customers the ability to process daily check deposits to their accounts through an online image capture environment. The Bank offers business customers merchant payment processing solutions, including state-of-the-art credit card terminals, integrated payment systems and a dedicated account manager. Business customers can also access money from their deposit account by using their “business” debit card, providing a faster, more convenient way to make purchases, track business expenses and manage finances.

 

The Bank offers several overdraft protection products including Bounce Protection, Instant Money and transfer from another FNCB checking or savings account, which provide customers with an added level of protection against unanticipated overdrafts due to cash flow emergencies and account reconciliation errors.

 

Lending Activities

 

FNCB offers a variety of loans, including residential real estate loans, construction, land acquisition and development loans, commercial real estate loans, commercial and industrial loans, loans to state and political subdivisions, and consumer loans, generally to individuals and businesses in its primary market area. These lending activities are described in further detail below.

 

Residential Mortgage Loans and Home Equity Term Loans

 

FNCB offers a variety of fixed-rate one- to four-family residential loans and home equity term loans. FNCB’s suite of residential mortgage products include First Time Homebuyer mortgages, FHA and Home Possible® mortgages with low down payments to meet the home financing needs of customers. Home equity term loans have fixed interest rates with terms up to 15 years. FNCB also offers a proprietary “WOW” mortgage, a first-lien, fixed-rate mortgage product with maturity terms ranging from 7.5 to 14.5 years. At December 31, 2017, one- to four-family residential mortgage loans totaled $158.0 million, or 20.6%, of the total loan portfolio. Except for the WOW mortgage, one- to four-family mortgage loans are originated generally for sale in the secondary market. However, FNCB may hold in portfolio one- to four-family residential mortgage loans as deemed necessary according to current asset/liability management strategies. During the year ended December 31, 2017, the Bank sold $12.4 million of one- to four-family mortgages. FNCB retains servicing rights on these mortgages.

 

Construction, Land Acquisition and Development Loans

 

FNCB offers interim construction financing secured by residential property for the purpose of constructing one- to four-family homes. FNCB also offers interim construction financing for the purpose of constructing residential developments and various commercial properties including shopping centers, office complexes and single purpose owner-occupied structures and for land acquisition. At December 31, 2017, construction, land acquisition and development loans amounted to $21.0 million and represented 2.7% of the total loan portfolio.

 

Commercial Real Estate Loans

 

Commercial real estate loans represent the largest portion of FNCB’s total loan portfolio and loans in this portfolio generally have larger loan balances. These loans are secured by a broad range of real estate, including but not limited to, office complexes, shopping centers, hotels, warehouses, gas stations, convenience markets, residential care facilities, nursing care facilities, restaurants, multifamily housing, farms and land subdivisions. At December 31, 2017, FNCB’s commercial real estate loans totaled $261.8 million, or 34.1%, of the total loan portfolio.

 

Commercial and Industrial Loans

 

FNCB generally offers commercial loans to sole proprietors and businesses located in its primary market area. The commercial loan portfolio includes, but is not limited to, lines of credit, dealer floor plan lines, equipment loans, vehicle loans and term loans. These loans are primarily secured by vehicles, machinery and equipment, inventory, accounts receivable, marketable securities and deposit accounts. At December 31, 2017, FNCB’s commercial and industrial loans totaled $150.1 million, or 19.5%, of the total loan portfolio.

 

Consumer Loans

 

Consumer loans include both secured and unsecured installment loans, direct new and used automobile financing, home equity and personal lines of credit and overdraft protection loans. The Bank is also in the business of underwriting indirect auto loans which are originated through various auto dealers in its market area. Home equity lines of credit have adjustable interest rates based on the National prime interest rate and are offered up to a maximum combined loan-to-value ratio of 90%, based on the property’s appraised value. At December 31, 2017, FNCB’s consumer loans totaled $134.7 million, or 17.5%, of the total loan portfolio.

 

3

 

 

State and Political Subdivision Loans

 

FNCB originates state and political subdivision loans, including general obligation and tax anticipation notes, primarily to municipalities in the Bank’s market area. At December 31, 2017, FNCB’s state and political subdivision loans totaled $42.5 million, or 5.5%, of the total loan portfolio.

 

For more information regarding FNCB’s loan portfolio and lending policies, please refer to Note 2, “Summary of Significant Accounting Policies” to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.

 

Wealth Management

 

FNCB offers customers wealth management services through a third-party provider. Customers are able to access alternative deposit products such as mutual funds, annuities, stocks, and bonds directly for purchase from an outside provider.

 

Deposit Activities

 

In general, deposits, borrowings and loan repayments are the major sources of funding for lending and other investment purposes. FNCB relies primarily on marketing, product innovation, technology and service to attract, grow and retain its deposits. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of deposit accounts, management considers the interest rates offered by its competitors, the interest rates available on FHLB advances and other wholesale funding, its liquidity needs and customer preferences. Management regularly reviews FNCB’s deposit mix and deposit pricing as part of its asset/liability management, taking into consideration rates offered by competitors in its market area and balance sheet interest-rate sensitivity.

 

Competition

 

The banking and financial services industries are highly competitive. FNCB faces direct competition in originating loans and in attracting deposits from a significant number of financial institutions operating in its market area, many with a statewide or regional presence, and in some cases, a national presence, as well as other financial and non-financial institutions outside of its market area through online loan and deposit product offerings. The competition comes principally from other banks, savings institutions, credit unions, mortgage banking companies, internet-based financial technology (“FinTech”) companies and, with respect to deposits, institutions offering investment alternatives, including money market funds and online deposit accounts. The increased competition has resulted from changes in the legal and regulatory guidelines, as well as from economic conditions. The cost of regulatory compliance remains high for community banks as compared to their larger competitors that are able to achieve economies of scale.

 

As a result of consolidation in the banking industry, some of the Bank’s competitors and their respective affiliates are larger and may enjoy advantages such as greater financial resources, a wider geographic presence, a wider array of services, or more favorable pricing alternatives and lower origination and operating costs. FNCB considers its major competitors to be local commercial banks as well as other commercial banks with branches in its market area. Competitors may offer deposits at higher rates and loans with lower fixed rates, more attractive terms and less stringent credit structures than FNCB has been able to offer. The growth and profitability of FNCB depends on its continued ability to successfully compete. Management believes interest rates on deposits, especially money market and time deposits, and interest rates and fees charged on loans within FNCB’s market area to be very competitive.

 

Supervision and Regulation

 

FNCB participates in a highly regulated industry and is subject to a variety of statutes, regulations and policies, as well as ongoing regulatory supervision and review. Federal statutes that apply to FNCB and the Bank include the Gramm Leach Bliley Act (“GLB Act”), the Bank Holding Company Act (“BHCA”), the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Federal Reserve Act and the Federal Deposit Insurance Act. In general, these statutes, regulations promulgated in accordance with these statutes, and interpretations establish the eligible business activities of FNCB and the Bank, certain acquisition and merger restrictions, limitations on intercompany transactions, such as loans and dividends, and capital adequacy requirements, among other things. These laws, regulations and policies are subject to frequent change and FNCB takes measures to comply with applicable requirements.

 

FNCB

 

FNCB is a bank holding company within the meaning of the BHCA and is registered with, and subject to regulation and examination by, the Reserve Bank and the Board of Governors of the Federal Reserve System (“FRB”). FNCB is required to file annual and quarterly reports with the FRB and to provide the FRB with such additional information that they may require. BHCA and other federal laws subject bank holding companies to restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations and unsafe and unsound banking practices.

 

4

 

 

The BHCA requires approval of the FRB for, among other things, the acquisition of direct or indirect ownership or control of more than five percent (5%) of the voting securities or substantially all the assets of any bank or bank holding company, or before the merger or consolidation with another bank holding company. 

 

With certain limited exceptions, a bank holding company is prohibited from acquiring control of any voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or furnishing services to or performing services for its authorized subsidiaries.  A bank holding company may, however, engage in, or acquire an interest in a company that engages in, activities that the FRB has determined by order or regulation to be so closely related to banking or managing or controlling banks as to be properly incident thereto.  In making such a determination, the FRB is required to consider whether the performance of such activities can reasonably be expected to produce benefits to the public, such as convenience, increased competition or gains in efficiency, which outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The FRB is also empowered to differentiate between activities commenced de novo and activities commenced by the acquisition, in whole or in part, of a going concern.  Some of the activities that the FRB has determined by regulation to be closely related to banking include making or servicing loans, performing certain data processing services, acting as a fiduciary or investment or financial advisor, and making investments in corporations or projects designed primarily to promote community welfare.

 

Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or any of its subsidiaries, or investments in the stock or other securities thereof, and on the taking of such stock or securities as collateral for loans to any borrower.  Further, a holding company and any subsidiary bank are prohibited from engaging in certain tie-in arrangements in connection with the extension of credit.  A subsidiary bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that: (i) the customer obtain or provide some additional credit, property or services from or to such bank other than a loan, discount, deposit or trust service; (ii) the customer obtain or provide some additional credit, property or service from or to the bank holding company or any other subsidiary of the bank holding company; or (iii) the customer not obtain some other credit, property or service from competitors, except for reasonable requirements to assure the soundness of credit extended.

 

The GLB Act allows a bank holding company or other company to certify status as a financial holding company, which allows such company to engage in activities that are financial in nature, that are incidental to such activities, or are complementary to such activities without further approval. FNCB is not a financial holding company. The GLB Act enumerates certain activities that are deemed financial in nature, such as underwriting insurance or acting as an insurance principal, agent or broker, underwriting, dealing in or making markets in securities, and engaging in merchant banking under certain restrictions. The GLB Act also authorizes the FRB to determine by regulation what other activities are financial in nature, or incidental or complementary thereto.

 

FNCB also is subject to the jurisdiction of the Securities and Exchange Commission (“SEC”) and is subject to the disclosure and regulatory requirements under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended.

 

On December 29, 2017, FNCB filed an application with The Nasdaq Stock Market LLC (“Nasdaq”) requesting listing on the Nasdaq Capital Market®. FNCB subsequently received approval from Nasdaq on February 26, 2018 to list its common shares for trading on The Nasdaq Capital Market®. FNCB’s shares of common stock began trading on the Nasdaq effective with the market opening on Monday, March 5, 2018. As such, FNCB is now subject to certain financial, liquidity and corporate governance requirements imposed by Nasdaq. Non-compliance of these requirements could subject FNCB to potential denial of listing, or additional conditions, as necessary, to protect investors and the public interest. Prior to March 5, 2018, FNCB’s shares of common stock traded on the OTCQX marketplace under the symbol “FNCB”.

 

The Bank

 

Effective June 30, 2016, upon its conversion to a state charter, the Bank is regulated by the Pennsylvania Department of Banking and Securities (“PADOBS”). The Bank’s deposit accounts are insured up to the maximum legal limit by the Deposit Insurance Fund of the FDIC and accordingly, the Bank is also regulated by the FDIC. The regulations of the PADOBS and the FDIC govern most aspects of the Bank’s business, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowings, dividends and location and number of branch offices. The laws and regulations governing the Bank generally have been promulgated to protect depositors and the Deposit Insurance Fund, and not for protecting shareholders.

 

5

 

 

Branching and Interstate Banking. The federal banking agencies are authorized to approve interstate bank merger transactions without regard to whether such transactions are prohibited by the law of any state, unless the home state of one of the banks has opted out of the interstate bank merger provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”) by adopting a law after the date of enactment of the Riegle-Neal Act and before June 1, 1997 that applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. Interstate bank mergers are also subject to the nationwide and statewide insured deposit concentration limitations described in the Riegle-Neal Act.

 

The Dodd-Frank Act permits national and state banks to establish de novo branches in other states to the same extent as a bank chartered by that state would be so permitted. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Pennsylvania law had previously permitted banks chartered in Pennsylvania to establish branches in other states without limitation, thereby permitting national banks in Pennsylvania to establish branches anywhere in the state, but only permitted out of state banks to branch in Pennsylvania if the home state of the out-of-state bank permits Pennsylvania banks to establish de novo branches. The branching provisions of the Dodd-Frank Act could result in more banks from other states establishing de novo branches in the Bank’s market area.

 

USA Patriot Act and the Bank Secrecy Act (“BSA”). Under the BSA, a financial institution is required to have systems in place to detect certain transactions, based on the size and nature of the transaction. Financial institutions are generally required to report cash transactions involving more than $10,000 to the United States Treasury. In addition, financial institutions are required to file suspicious activity reports for transactions that involve more than $5,000 and that the financial institution knows, suspects or has reason to suspect, involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. Under the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act, commonly referred to as the “USA Patriot Act” or the “Patriot Act,” financial institutions are subject to prohibitions against specified financial transactions and account relationships, as well as enhanced due diligence standards intended to detect, and prevent, the use of the United States financial system for money laundering and terrorist financing activities. The Patriot Act requires financial institutions, including banks, to establish anti-money laundering programs, including employee training and independent audit requirements, meet minimum specified standards, follow minimum standards for customer identification and maintenance of customer identification records, and regularly compare customer lists against lists of suspected terrorists, terrorist organizations and money launderers.

 

Capital Adequacy Requirements. Federal banking agencies have adopted risk based capital adequacy and leverage capital adequacy requirements pursuant to which they assess the adequacy of capital in examining and supervising banks and bank holding companies and in analyzing bank regulatory applications. Risk-based capital requirements determine the adequacy of capital based on the risk inherent in various classes of assets and off-balance sheet items.

 

Effective January 1, 2015, FNCB and the Bank are subject to the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act (“Basel III”). Basel III calls for the following capital requirements:

 

 

A minimum ratio of common equity tier I (“CET I”) capital to risk-weighted assets of 4.5%.

 

A minimum ratio of tier I capital to risk-weighted assets of 6%.

 

A minimum ratio of total capital to risk-weighted assets of 8%.

 

A minimum leverage ratio of 4%.

 

Basel III also establishes a “countercyclical capital buffer,” that is designed to absorb losses during periods of economic stress. Generally, the capital conservation buffer of 2.50% of risk-weighted assets, when fully phased in, will be imposed when federal banking regulators determine that excess aggregate credit growth becomes associated with a buildup of systemic risk. For all banking institutions, the phase-in period for the capital conservation buffer requirement began on January 1, 2016 at 0.625% and will increase by that amount each year until it reaches 2.50% on January 1, 2019.

 

Banking institutions with a ratio of CET I to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) may face constraints on their ability to pay dividends, to effect equity repurchases and pay discretionary bonuses to executive officers, which constraints vary based on the amount of the shortfall.

 

Basel III also included, as part of the definition of CET I capital, a requirement that banking institutions include the amount of Accumulated Other Comprehensive Income (“AOCI”), which primarily consists of unrealized gains and losses, net of tax, on available-for-sale securities, that are not other than temporarily impaired (“OTTI”) in calculating regulatory capital, unless the institution makes a one-time opt-out election from this provision in connection with the filing of its first regulatory reports after applicability of the Basel III Rule to that institution. The Basel III Rule also imposes a 4.00% minimum Tier I leverage ratio. Upon implementation of Basel III on January 1, 2015, FNCB and the Bank elected to exclude AOCI in calculating regulatory capital with the filing of their respective first regulatory reports after applicability of Basel III.

 

6

 

 

Basel III provides for new deductions from and adjustments to CET I. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET I to the extent that any one such category exceeds 10.00% of CET I or all such categories in the aggregate exceed 15.00% of CET I.

 

Basel III imposed changes to methodologies for determining risk weighted assets, including revisions to recognition of credit risk mitigation, such as a greater recognition of financial collateral and a wider range of eligible guarantors, the risk weighting of equity exposures and past due loans, and higher (greater than 100%) risk weighting for certain commercial real estate exposures that have higher credit risk profiles, including higher loan to value and equity components.

 

On November 21, 2017, the federal banking regulatory agencies jointly issued a final rule to extend the 2017 transition provisions under Basel III for certain capital deductions and risk weights as well as certain minority interest requirements for banking organizations not subject to the advanced approaches capital rules, including: mortgage servicing assets; deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks; significant investments in the capital of unconsolidated financial institutions; and non-significant investments in the capital of unconsolidated financial institutions; and significant investments in the capital of unconsolidated financial institutions that are not in the form of common stock. FNCB and the Bank are not subject to the advanced approaches capital rule.

 

As discussed below, Basel III also integrates the new capital requirements into the prompt corrective action provisions under Section 38 of the Federal Deposit Insurance Act (“FDIA”).

 

Prompt Corrective Action. Under Section 38 of the FDIA, each federal banking agency is required to implement a system of prompt corrective action for institutions which it regulates. The federal banking agencies have promulgated substantially similar regulations to implement the system of prompt corrective action established by Section 38 of the FDIA.

 

The following are the capital requirements under the Basel III Rules integrated into the prompt corrective action category definitions. As of December 31, 2017, the following capital requirements were applicable to the Bank for purposes of Section 38 of the FDIA.

 

   

Total 

 

Tier I

           
   

Risk-Based

 

Risk-Based

 

CET I

 

Leverage

 

Tangible Equity

Capital Category

 

Capital Ratio

 

Capital Ratio

 

Capital Ratio

 

Ratio

 

to Assets

Well capitalized

 

>/= 10.0%

 

>/= 8.0%

 

>/= 6.5%

 

>/= 5.0%

 

N/A

Adequately capitalized with converation buffer

 

>/= 9.25%

 

>/= 7.25%

 

>/= 5.75%

 

>/= 4.0%

 

N/A

Adequately capitalized

 

>/= 8.0%

 

>/= 6.0%

 

>/= 4.5%

 

>/= 4.0%

 

N/A

Undercapitalized

 

< 8.0%

 

< 6.0%

 

< 4.5%

 

< 4.0%

 

N/A

Significantly undercapitalized

 

< 6.0%

 

< 4.0%

 

< 3.0%

 

< 3.0%

 

N/A

Critically undercapitalized

 

N/A

 

N/A

 

N/A

 

N/A

 

Less than 2.0%

 

Additionally, FNCB’s outstanding subordinated notes are subject to phase out and will cease to qualify as capital for regulatory purposes. Overall, management believes that implementation of Basel III did not have a material adverse effect on FNCB’s or the Bank’s capital ratios, earnings, shareholder’s equity, or its ability to pay discretionary bonuses to executive officers. At December 31, 2017, the Bank was “well capitalized” under the aforementioned requirements with a common equity Tier I capital and Tier I capital to risk-weighted assets ratios of 11.36%, a total capital to risk-weighted assets ratio of 12.49% and a Leverage ratio of 8.24%. Similarly, at December 31, 2017, FNCB met its capital requirements with a common equity Tier I capital to risk-weighted assets of 9.74%, a Tier I capital to risk-weighted assets ratio of 10.66%, a total capital to risk-weighted assets ratio of 12.08%, and a Leverage ratio of 7.74%.

 

Regulatory Enforcement Authority. Federal banking law grants substantial enforcement powers to federal banking regulators. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.

 

The Bank and its “institution-affiliated parties,” including its management, employees, agents, independent contractors, consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a governmental agency. In addition, regulators are provided with greater flexibility to commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance and cease-and-desist orders. Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the ordering agency to be appropriate.

 

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Under provisions of the federal securities laws, a determination by a court or regulatory agency that certain violations have occurred at a company or its affiliates can result in fines, restitution, a limitation of permitted activities, disqualification to continue to conduct certain activities and an inability to rely on certain favorable exemptions. Certain types of infractions and violations can also affect a public company in its timing and ability to expeditiously issue new securities into the capital markets.

 

The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss allowances for regulatory purposes.

 

The Dodd-Frank Act. The Dodd-Frank Act made significant changes to the bank regulatory structure and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act has required a number of federal agencies to adopt a broad range of new rules and regulations, and to prepare various studies and reports for Congress. The federal agencies have been given significant discretion in drafting these rules and regulations. To date, the following provisions of the Dodd-Frank Act are considered to be of greatest significance to FNCB:

 

 

expands the authority of the FRB to examine bank holding companies and their subsidiaries, including insured depository institutions;

 

 

requires a bank holding company to be well capitalized and well managed to receive approval of an interstate bank acquisition;

 

 

changes standards for federal preemption of state laws related to national banks and their subsidiaries;

 

 

provides mortgage reform provisions regarding a customer’s ability to pay and making more loans subject to provisions for higher-cost loans and new disclosures;

 

 

creates the Consumer Financial Protection Bureau (the “CFPB”) that has rulemaking authority for a wide range of consumer protection laws that apply to all banks and has broad powers to supervise and enforce consumer protection laws;

 

 

creates the Financial Stability Oversight Council with authority to identify institutions and practices that might pose a systemic risk;

 

 

introduces additional corporate governance and executive compensation requirements on companies’ subject to the Securities and Exchange Act of 1934, as amended;

 

 

permits FDIC-insured banks to pay interest on business demand deposits;

 

 

requires that holding companies and other companies that directly or indirectly control an insured depository institution serve as a source of financial strength;

 

 

makes permanent the $250 thousand limit for federal deposit insurance at all insured depository institutions; and

 

 

permits national and state banks to establish interstate branches to the same extent as the branch host state allows establishment of in-state branches.

 

President Donald J. Trump has indicated that one of the goals of his administration is to reduce federal government regulation, including, among other things, reconsidering certain regulations promulgated under the Dodd-Frank Act. On February 3, 2017, President Donald J. Trump issued an executive order that directs the Secretary of the Treasury Department to consult with the heads of the member agencies of the Financial Stability Oversight Council and report to President Trump on the extent to which the laws and regulations governing the U.S. financial system are in accord with certain enumerated “core principles” (the “Executive Order”). The “core principles” set forth in the Executive Order relate to U.S. financial system regulation, and include fostering economic growth and vibrant financial markets through more rigorous regulatory impact analysis, and making “regulation more efficient, effective and appropriately tailored.” More recently, the U.S. House of Representatives and Senate have both considered legislation that would roll-back or eliminate portions of the Dodd-Frank Act, and a bipartisan bill, “The Economic Growth, Regulatory Relief and Consumer Protection Act,” has been introduced in the Senate which includes a roll back of certain key provisions of the Dodd-Frank Act. At this time, it is not possible to predict whether any legislation will be enacted that amends the Dodd-Frank Act or, if enacted, what provisions the legislation would include or the impact of any such legislation on FNCB and the Bank. 

 

8

 

 

Consumer Financial Protection Bureau. The Dodd-Frank Act created the CFPB, which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act (“TILA”), Real Estate Settlement Procedures Act (“RESPA”), Fair Credit Reporting Act, Fair Debt Collection Act, Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act, and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB, but continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.

 

Ability to Repay and Qualified Mortgage Rule

 

Pursuant to the Dodd Frank Act, the CFPB issued a final rule on January 10, 2013, which became effective January 10, 2014, amending Regulation Z as implemented by the Truth in Lending Act, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Mortgage lenders are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the mortgage lender to consider the following eight underwriting factors when making the credit decision:

 

 

current or reasonably expected income or assets;

 

 

current employment status;

 

 

the monthly payment on the covered transaction;

 

 

the monthly payment on any simultaneous loan;

 

 

the monthly payment for mortgage-related obligations;

 

 

current debt obligations, alimony, and child support;

 

 

the monthly debt-to-income ratio or residual income; and

 

 

credit history.

 

Alternatively, the mortgage lender can originate “qualified mortgages,” which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage, the points and fees paid by a consumer cannot exceed 3% of the total loan amount. Loans which meet these criteria will be considered qualified mortgages, and as a result generally protect lenders from fines or litigation in the event of foreclosure. Qualified mortgages that are “higher-priced” (e.g. subprime loans) garner a rebuttable presumption of compliance with the ability-to-repay rules, while qualified mortgages that are not “higher-priced” (e.g. prime loans) are given a safe harbor of compliance. The final rule, as issued, did not have a material impact on our lending activities or our results of operations or financial condition.

 

TILA/RESPA Integrated Disclosures (“TRID”). On October 3, 2015, the CFPB implemented a final rule combining the mortgage disclosures consumers previously received under TILA and RESPA. For more than 30 years, the TILA and RESPA mortgage disclosures had been administered separately by, respectively, the Federal Reserve Board and the U.S. Department of Housing and Urban Development. The final rule requires lenders to provide applicants with the new Loan Estimate and Closing Disclosure and generally applies to most closed-end consumer mortgage loans for which the creditor or mortgage broker receives an application on or after October 3, 2015.

 

The CFPB’s rulemaking, examination and enforcement authority has and will continue to significantly affect financial institutions offering consumer financial products and services, including FNCB and the Bank. These regulatory activities may limit the types of financial services and products the Bank may offer, which in turn may reduce FNCB’s revenues.

 

9

 

 

FDIC Insurance Premiums. The FDIC maintains a risk-based assessment system for determining deposit insurance premiums. Four risk categories (I-IV), each subject to different premium rates, are established based upon an institution’s status as well capitalized, adequately capitalized or undercapitalized, and the institution’s supervisory rating.

 

The Dodd-Frank Act permanently increased the maximum deposit insurance amount for banks, savings institutions and credit unions to $250,000 per depositor. The Dodd-Frank Act also broadened the base for FDIC insurance assessments. Assessments are now based on a financial institution’s average consolidated total assets less tangible equity capital. The Dodd-Frank Act requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. The Dodd-Frank Act eliminated the statutory prohibition against the payment of interest on business checking accounts.

 

An insured institution is required to pay deposit insurance premiums on its assessment base in accordance with its risk category. There are three adjustments that can be made to an institution’s initial base assessment rate: (1) a potential decrease for long-term unsecured debt, including senior and subordinated debt and, for small institutions, a portion of Tier I capital; (2) a potential increase for secured liabilities above a threshold amount; and (3) for non-Risk Category I institutions, a potential increase for brokered deposits above a threshold amount. The FDIC may also impose special assessments from time to time.

 

At December 31, 2017, the Bank was considered risk category I, the lowest risk category, for deposit insurance assessments and paid an annual assessment rate ranging from 0.0005 basis points to 0.0006 basis points on the assessment base of average consolidated total assets less the average tangible equity during the assessment period.

 

Dividend Restrictions

 

FNCB Bancorp, Inc. is a legal entity separate and distinct from the Bank. FNCB Bancorp, Inc.’s revenues (on a parent company only basis) and its ability to pay dividends to its shareholders are almost entirely dependent upon the receipt of dividends from the Bank. The right of FNCB Bancorp, Inc., and consequently the rights of its creditors and shareholders to participate in any distribution of the assets or earnings of any subsidiary through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the subsidiary (including depositors) except to the extent that claims of FNCB Bancorp, Inc., in its capacity as a creditor, may be recognized. Additionally, the ability of the Bank to pay dividends to FNCB Bancorp, Inc. is subject to Pennsylvania state law and various regulatory restrictions.

 

The declaration of cash dividends on FNCB’s common stock is at the discretion of its board of directors, and any decision to declare a dividend is based on a number of factors, including, but not limited to, earnings, prospects, financial condition, regulatory capital levels, applicable covenants under any credit agreements, notes and other contractual restrictions, Pennsylvania law, federal bank regulatory law, and other factors deemed relevant.

 

Employees

 

As of December 31, 2017, FNCB, including the Bank employed 242 persons, including 25 part-time employees.

 

Available Information

 

FNCB files reports, proxy and information statements and other information electronically with the SEC. You may read and copy any materials that FNCB files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information may be obtained on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The SEC’s website site address is https://www.sec.gov. FNCB makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments thereto available through its website at https://www.fncb.com. The information contained on our website is not included as a part of, or incorporated by reference in, this Annual Report on Form 10-K. These reports may also be obtained free of charge as soon as practicable after filing or furnishing them to the SEC upon request by sending an email to corporatesecretary@fncb.com. Information may also be obtained via written request to FNCB Bancorp, Inc. Attention: Chief Financial Officer, 102 East Drinker Street, Dunmore, PA 18512.

 

10

 

 

Item 1A.

Risk Factors

 

FNCB, like other financial companies, is subject to a number of risks that may adversely affect our financial condition or results of operations, many of which are outside of our direct control. Among these risks are:

 

 

Credit risk, which is the risk of loss due to borrowers or other counterparties not being able to meet their financial obligations under agreed upon terms;

 

Market risk, which occurs when fluctuations in interest rates impact earnings and capital. Financial impacts are realized through changes in the interest rates of balance sheet assets and liabilities (net interest margin) or directly through valuation changes of capitalized MSR and/or trading assets (noninterest income);

 

Liquidity risk, which is the risk to current or anticipated earnings or capital arising from an inability to meet obligations when they come due. Liquidity risk includes the inability to access funding sources or manage fluctuations in funding levels. Liquidity risk also results from the failure to recognize or address changes in market conditions that affect our ability to liquidate assets quickly and with minimal loss in value;

 

Operational and Legal risk, which is the risk of loss arising from inadequate or failed internal processes or systems, human errors or misconduct, or adverse external events. Operational losses result from internal fraud; external fraud, inadequate or inappropriate employment practices and workplace safety, failure to meet professional obligations involving customers, products, and business practices, damage to physical assets, business disruption and systems failures, and failures in execution, delivery, and process management.  Legal risk includes, but is not limited to, exposure to orders, fines, penalties, or punitive damages resulting from litigation, as well as regulatory actions;

 

Compliance risk, which exposes us to money penalties, enforcement actions or other sanctions as a result of non-conformance with laws, rules, and regulations that apply to the financial services industry;

 

Strategic risk, which is defined as risk to current or anticipated earnings, capital, or enterprise value arising from adverse business decisions, improper implementation of business decisions or lack of responsiveness to industry / market changes; and

 

Reputation risk, which is the risk that negative publicity regarding an institution's business practices, whether true or not, will cause a decline in the customer base, costly litigation, or revenue reductions.

 

The risk factors discussed below, which could materially affect FNCB’s business, operating results or financial condition, should be considered in addition to the other information presented in this Annual Report on Form 10-K. However, the risk factors described below are not meant to be all inclusive. Additional risks and uncertainties not currently known or that FNCB currently deems to be insignificant may also materially adversely affect its business, operating results or financial condition.

 

Credit Risk

 

Weakness in the economic environment, in general, and within FNCB’s market area could pose significant challenges for FNCB and could adversely affect its financial condition and results of operations.

 

FNCB’s success depends primarily on the general economic conditions in the Commonwealth of Pennsylvania and the specific local markets in which it operates. Unlike larger national or other regional banks that are more geographically diversified, FNCB provides banking and financial services to customers primarily in the Lackawanna, Luzerne, Lehigh and Wayne County markets. The local economic conditions in these areas have a significant impact on the demand for FNCB’s products and services as well as the ability of customers to repay loans, the value of the collateral securing loans, and the stability of deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, severe weather or natural disasters, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities markets or other factors could impact these local economic conditions and, in turn, have a material adverse effect on FNCB’s financial condition and results of operations. Specifically, weakness in economic conditions could result in one or more of the following:

 

 

A decrease in the demand for FNCB’s loans and other products and services;

 

A decrease in customer savings generally and in the demand for FNCB’s savings and other deposit products; and

 

An increase in the number of customers and counterparties who become delinquent, file for protection under bankruptcy laws, or default on their loans or other obligations.

 

An increase in the number of delinquencies, bankruptcies, or defaults could result in a higher level of non-performing assets, net charge-offs, and provision for loan and lease losses. The markets we serve are dependent on retail and service-related businesses and, thus, are particularly vulnerable to adverse changes in economic conditions affecting these sectors.

 

11

 

 

As of December 31, 2017, approximately 36.8% of FNCB’s loan portfolio consisted of commercial real estate loans and construction, land acquisition and development loans. These types of loans are generally viewed as having a higher risk of default than residential real estate loans or consumer loans. These types of loans are also typically larger than residential real estate loans and consumer loans. Because FNCB’s loan portfolio contains a significant number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. All non-performing loans totaled $2.6 million, or 0.3% of total gross loans, as of December 31, 2017, and $2.2 million, or 0.3% of total gross loans, as of December 31, 2016. Although non-performing loans as a percentage of gross loans remained steady from the prior year, an increase in non-performing loans in the future could result in an increase in the provision for loan and lease losses and an increase in loan charge-offs, both of which could have a material adverse effect on FNCB’s financial condition and results of operations. The lending activities in which the Bank engages carry the risk that the borrowers will be unable to perform on their obligations. As such, general economic conditions, nationally and in FNCB’s primary market area, will have a significant impact on its results of operations. To the extent that economic conditions deteriorate, business and individual borrowers may be less able to meet their obligations to the Bank in full, in a timely manner, resulting in decreased earnings or losses to the Bank. To the extent that loans are secured by real estate, adverse conditions in the real estate market may reduce the ability of the borrowers to generate the necessary cash flow for repayment of the loan, and reduce the ability to collect the full amount of the loan upon a default. To the extent that the Bank makes fixed-rate loans, general increases in interest rates will tend to reduce its spread as the interest rates FNCB must pay for deposits would increase while interest income is flat. Economic conditions and interest rates may also adversely affect the value of property pledged as security for loans.

 

FNCB’s concentrations of loans, including those to insiders and related parties, may create a greater risk of loan defaults and losses.

 

A substantial portion of FNCB’s loans are secured by real estate in the Northeastern Pennsylvania market, and substantially all of its loans are to borrowers in that area. FNCB also has a significant amount of commercial real estate, commercial and industrial, construction, land acquisition and development loans and land-related loans for residential and commercial developments. At December 31, 2017, $462.2 million, or 60.2%, of gross loans were secured by real estate, primarily commercial real estate. Management has taken steps to mitigate commercial real estate concentration risk by diversification among the types and characteristics of real estate collateral properties, sound underwriting practices, and ongoing portfolio monitoring and market analysis. Of total gross loans, $21.0 million, or 2.7%, were construction, land acquisition and development loans. Construction, land acquisition and development loans have the highest risk of uncollectability. An additional $150.1 million, or 19.5%, of portfolio loans were commercial and industrial loans not secured by real estate. Historically, commercial and industrial loans generally have had a higher risk of default than other categories of loans, such as single family residential mortgage loans. The repayment of these loans often depends on the successful operation of a business and are more likely to be adversely affected by adverse economic conditions. While management believes that the loan portfolio is well diversified in terms of borrowers and industries, these concentrations expose FNCB to the risk that adverse developments in the real estate market, or in the general economic conditions in its general market area, could increase the levels of non-performing loans and charge-offs, and reduce loan demand. In that event, FNCB would likely experience lower earnings or losses. Additionally, if, for any reason, economic conditions in its market area deteriorate, or there is significant volatility or weakness in the economy or any significant sector of the area’s economy, FNCB’s ability to develop business relationships may be diminished, the quality and collectability of its loans may be adversely affected, the value of collateral may decline and loan demand may be reduced.

 

Commercial real estate, commercial and industrial and construction, land acquisition and development loans tend to have larger balances than single family mortgage loans and other consumer loans. Because FNCB’s loan portfolio contains a significant number of commercial and industrial loans, commercial real estate loans and construction, land acquisition and development loans with relatively large balances, the deterioration of one or a few of these loans may cause a significant increase in non-performing assets. An increase in non-performing loans could result in a loss of earnings from these loans, an increase in the provision for loan and lease losses, or an increase in loan charge-offs, which could have an adverse impact on FNCB’s results of operations and financial condition.

 

Guidance adopted by federal banking regulators provides that banks having concentrations in construction, land development or commercial real estate loans are expected to have and maintain higher levels of risk management and, potentially, higher levels of capital, which may adversely affect shareholder returns, or require FNCB to obtain additional capital sooner than it otherwise would. Excluded from the scope of this guidance are loans secured by non-farm nonresidential properties where the primary source of repayment is the cash flow from the ongoing operations and activities conducted by the party, or affiliate of the party, who owns the property.

 

Outstanding loans and line of credit balances to directors, officers and their related parties totaled $55.6 million as of December 31, 2017. At December 31, 2017, there were no loans to directors, officers and their related parties that were categorized as criticized loans within the Bank’s risk rating system, meaning they are not considered to present a higher risk of collection than other loans. For more information regarding loans to officers and directors and/or their related parties, please refer to Note 11, “Related Party Transactions” to the consolidated financial statements included in Item 8 and Item 13, “Certain Relationships and Related Transactions, and Director Independence” to this Annual Report on Form 10-K.

 

12

 

 

FNCB’s financial condition and results of operations would be adversely affected if the ALLL is not sufficient to absorb actual losses or if increases to the ALLL were required.

 

The lending activities in which the Bank engages carry the risk that the borrowers will be unable to perform on their obligations, and that the collateral securing the payment of their obligations may be insufficient to assure repayment. FNCB may experience significant credit losses, which could have a material adverse effect on its operating results. Management makes various assumptions and judgments about the collectability of FNCB’s loan portfolio, including the creditworthiness of its borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of its loans, which it uses as a basis to estimate and establish its reserves for losses. In determining the amount of the ALLL, management reviews loans, loss and delinquency experience, and evaluates current economic conditions. If these assumptions prove to be incorrect, the ALLL may not cover inherent losses in FNCB’s loan portfolio at the date of its financial statements. Material additions to FNCB’s allowance or extensive charge-offs would materially decrease its net income. At December 31, 2017, the ALLL totaled $9.0 million, representing 1.17% of total loans.

 

Although management believes FNCB’s underwriting standards are adequate to manage normal lending risks, it is difficult to assess the future performance of its loan portfolio due to the ongoing economic environment and the state of the real estate market. The assessment of future performance of the loan portfolio is inherently uncertain. FNCB can give no assurance that non-performing loans will not increase or that non-performing or delinquent loans will not adversely affect its future performance.

 

In addition, federal and state regulators periodically review the ALLL and may require increases to the ALLL or further loan charge-offs. Any increase in ALLL or loan charge-offs as required by these regulatory agencies could have a material adverse effect on FNCB’s results of operations and financial condition.

 

If management concludes that the decline in value of any of FNCB’s investment securities is other-than-temporary, FNCB is required to write down the security to reflect credit-related impairments through a charge to earnings.

 

Management reviews FNCB’s investment securities portfolio at each quarter-end reporting period to determine whether the fair value is below the current carrying value. When the fair value of any of FNCB’s debt investment securities has declined below its carrying value, management is required to assess whether the decline represents an OTTI. If management concludes that the decline is other-than-temporary, it is required to write down the value of that security to reflect the credit-related impairments through a charge to earnings. Changes in the expected cash flows of securities in FNCB’s portfolio and/or prolonged price declines in future periods may result in OTTI, which would require a charge to earnings. Due to the complexity of the calculations and assumptions used in determining whether an asset is impaired, any impairment disclosed may not accurately reflect the actual impairment in the future. In addition, to the extent that the value of any of FNCB’s investment securities is sensitive to fluctuations in interest rates, any increase in interest rates may result in a decline in the value of such investment securities.

 

FNCB held approximately $2.8 million in capital stock of the Federal Home Loan Bank of Pittsburgh (“FHLB”) as of December 31, 2017. FNCB must own such capital stock to qualify for membership in the Federal Home Loan Bank system which enables it to borrow funds under the FHLB advance program. If the FHLB were to cease operations, FNCB’s business, financial condition, liquidity, capital and results of operations may be materially and adversely affected.

 

Market Risk

 

Changes in interest rates could reduce income, cash flows and asset values.

 

FNCB’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond FNCB’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the FRB. Changes in monetary policy, including changes in interest rates, could influence not only the interest FNCB receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) FNCB’s ability to originate loans and obtain deposits, (ii) the fair value of FNCB’s financial assets and liabilities, and (iii) the average duration of FNCB’s mortgage-backed securities portfolio.

 

If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and investments, FNCB’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and investments fall more quickly than the interest rates paid on deposits and other borrowings. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on FNCB’s financial condition and results of operations.

 

13

 

 

FNCB may not be able to successfully compete with others for business.

 

FNCB competes for loans, deposits and investment dollars with numerous regional and national banks and other community banking institutions, online divisions of banks located in other markets as well as other kinds of financial institutions and enterprises, such as securities firms, insurance companies, savings associations, credit unions, mortgage brokers, private lenders and Fintech companies. There is also competition for banking business from competitors outside of its market area. As noted above, FNCB and the Bank are subject to extensive regulations and supervision, including, in many cases, regulations that limit the type and scope of activities. Many competitors have substantially greater resources and may offer certain services that FNCB and the Bank does not provide, and operate under less stringent regulatory environments. The differences in available resources and applicable regulations may make it harder for FNCB to compete profitably, reduce the rates that it can earn on loans and investments, increase the rates it must offer on deposits and other funds, and adversely affect its overall financial condition and earnings. For additional discussion of FNCB’s competitive environment, refer to the section entitled “Business – Competition” included in Item 1 of this Annual Report on Form 10-K.

 

Liquidity Risk

 

Changes in either FNCB’s financial condition or in the general banking industry could result in a loss of depositor confidence.

 

Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost. The Bank uses its liquidity to extend credit and to repay liabilities as they become due or as demanded by customers. The Board of Directors establishes liquidity policies, including contingency funding plans, and limits and management establishes operating guidelines for liquidity. FNCB’s primary source of liquidity is customer deposits. The continued availability of this funding source depends on customer willingness to maintain deposit balances with banks in general and FNCB in particular. The availability of deposits can also be impacted by regulatory changes (e.g. changes in FDIC insurance, the liquidity coverage ratio, etc.), changes in the financial condition of FNCB, or the banking industry in general, and other events which can impact the perceived safety and soundness or economic benefits of bank deposits. While FNCB makes significant efforts to consider and plan for hypothetical disruptions in our deposit funding through the use of liquidity stress testing, market related, geopolitical, or other events could impact the liquidity derived from deposits.

 

FNCB is a bank holding company and depends on dividends from its subsidiary, FNCB Bank, to operate.

 

FNCB is an entity separate and distinct from the Bank. The Bank conducts most of our operations and FNCB depends upon dividends from the Bank to service FNCB's debt, pay FNCB’s expenses and to pay dividends to FNCB's shareholders. The availability of dividends from the Bank is limited by various statutes and regulations. It is possible, depending upon the financial condition including liquidity and capital adequacy of the Bank and other factors, that the Bank’s regulators could limit the payment of dividends or other payments to FNCB by the Bank. In the event that the Bank was unable to pay dividends, FNCB in turn would likely have to reduce or stop paying dividends to its shareholders. Failure to pay dividends to FNCB shareholders could have a material adverse effect on the market price of our Common Stock. For additional information regarding dividend restrictions, refer to the section entitled “Regulatory Matters” included in Item 1 of this Annual Report on Form 10-K.

 

If we lose access to wholesale funding sources, we may not be able to meet the cash flow requirements of our depositors, creditors, and borrowers, or have the operating cash needed to fund corporate expansion and other corporate activities.

 

Wholesale funding sources include brokered deposits, reciprocal and one-way CDARS and ICS deposits federal funds lines of credit, securities sold under repurchase agreements, non-core deposits, and long-term debt. The Bank is also a member of the Federal Home Loan Bank of Pittsburgh, which provides members access to funding through advances collateralized with certain qualifying assets within the Bank’s loan portfolio. In addition, FNCB’s available-for-sale securities provide an additional source of liquidity. Disruptions in availability of wholesale funding can directly impact the liquidity of FNCB and the Bank. The inability to access capital markets funding sources as needed could adversely impact FNCB’s financial condition, results of operations, cash flows, and level of regulatory-qualifying capital. 

 

Operational and Legal Risk

 

Interruptions or security breaches of FNCB’s information systems could negatively affect its financial performance or reputation.

 

In conducting its business, FNCB relies heavily on its information systems. FNCB collects and stores sensitive data, including proprietary business information and personally identifiable information of its customers and employees, in its data centers and on its networks. The secure processing, maintenance and transmission of this information is critical to FNCB’s operations and business strategy. Maintaining and protecting those systems is difficult and expensive, as is dealing with any failure, interruption or breach of those systems. Despite security measures, FNCB’s information technology and infrastructure may be vulnerable to security breaches, cyber-attacks by hackers or breaches due to employee error, malfeasance or other disruptions. Any damage, failure or breach could cause an interruption in operations. Computer break-ins, phishing and other disruptions could also jeopardize the security of information stored in and transmitted through FNCB’s computer systems and network infrastructure. The occurrence of any failures, interruptions or breaches could damage FNCB’s reputation, disrupt operations and the services provided to customers, cause a loss of confidence in the products and the services provided, cause FNCB to incur additional expenses, result in a loss of customer business and data, result in legal claims or proceedings, result in liability under laws that protect the privacy of personal information, result in regulatory penalties, or expose FNCB to other liability, any of which could have a material adverse effect on its business, financial condition and results of operations and competitive position.

 

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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, financial performance may suffer.

 

Effective and competitive delivery of FNCB’s products and services increasingly depends on information technology resources and processes, both those provided internally as well as those provided through third party vendors. In addition to better serving customers, the effective use of technology can improve efficiency and help reduce costs. FNCB’s future success will depend, in part, upon its ability to address the needs of its customers by using technology to provide products and services to enhance customer convenience, as well as to create efficiencies in its operations. There is increasing pressure to provide products and services at lower prices. This can reduce net interest income and non-interest income from fee-based products and services. In addition, the widespread adoption of new technologies could require FNCB to make substantial capital expenditures to modify or adapt existing products and services or develop new products and services. FNCB may not be successful in introducing new products and services in response to industry trends or developments in technology, or those new products may not achieve market acceptance. Many of FNCB’s competitors have greater resources to invest in technological improvements. Additionally, as technology in the financial services industry changes and evolves, keeping pace becomes increasingly complex and expensive. There can be no assurance that FNCB will be able to effectively implement new technology-driven products and services, which could reduce its ability to compete effectively. As a result, FNCB could lose business, be forced to price products and services on less advantageous terms to retain or attract customers, or be subject to cost increases.

 

FNCB relies on management and other key personnel and the loss of any of them may adversely affect its operations.

 

FNCB believes each member of the executive management team is important to its success and the unexpected loss of any of these persons could impair day-to-day operations as well as its strategic direction.

 

FNCB’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by FNCB can be intense and it may not be able to hire people or retain them. The unexpected loss of services of one or more of FNCB’s key personnel could have a material adverse impact on its business due to the loss of their skills, knowledge of its market, years of industry experience and to the difficulty of promptly finding qualified replacement personnel.

 

FNCB may be a defendant from time to time in a variety of litigation and other actions, which could have a material adverse effect on its financial condition, results of operations and cash flows.

 

FNCB has been and may continue to be involved from time to time in a variety of litigation matters arising out of its business. An increased number of lawsuits, including purported class action lawsuits and other consumer driven litigation, have been filed and will likely continue to be filed against financial institutions, which may involve substantial compensatory and/or punitive damages. Management believes the risk of litigation generally increases during downturns in the national and local economies. FNCB’s insurance may not cover all claims that may be asserted against it, and any claims asserted against it, regardless of merit or eventual outcome, may harm its reputation and may cause it to incur significant expense. Should the ultimate judgments or settlements in any litigation exceed insurance coverage, they could have a material adverse effect on its financial condition, results of operations and cash flows. In addition, FNCB may not be able to obtain appropriate types or levels of insurance in the future, nor may it be able to obtain adequate replacement policies with acceptable terms, if at all. For additional discussion of FNCB’s current legal matters, refer to Item 3, “Legal Proceedings” of this Annual Report on Form 10-K.

 

FNCB’s disclosure controls and procedures and internal controls over financial reporting may not achieve their intended objectives.

 

FNCB maintains disclosure controls and procedures designed to ensure the timely filing of reports as specified in the rules and forms of the Securities and Exchange Commission. FNCB also maintains a system of internal control over financial reporting. These controls may not achieve their intended objectives. Control processes that involve human diligence and compliance, such as its disclosure controls and procedures and internal controls over financial reporting, are subject to lapses in judgment and breakdowns resulting from human failures. Controls can also be circumvented by collusion or improper management override. Because of such limitations, there are risks that material misstatements due to error or fraud may not be prevented or detected and that information may not be reported on a timely basis. If FNCB’s controls are not effective, it could have a material adverse effect on its financial condition, results of operations, and market for its common stock, and could subject it to additional regulatory scrutiny.

 

15

 

 

The price of FNCB’s common stock may fluctuate significantly, which may make it difficult for investors to resell common stock at a time or price they find attractive.

 

FNCB’s common stock per share price may fluctuate significantly as a result of a variety of factors, many of which are beyond its control. These factors include, in addition to those described above:

 

 

actual or anticipated quarterly fluctuations in operating results and financial condition;

 

changes in financial estimates or publication of research reports and recommendations by financial analysts or actions taken by rating agencies with respect to FNCB or other financial institutions;

 

speculation in the press or investment community generally or relating to FNCB’s reputation or the financial services industry;

 

strategic actions by FNCB or its competitors, such as acquisitions, restructurings, dispositions or financings;

 

fluctuations in the stock price and operating results of FNCB’s competitors;

 

future sales of FNCB’s equity or equity-related securities;

 

proposed or adopted regulatory changes or developments;

 

anticipated or pending investigations, proceedings, audits or litigation that involve or affect FNCB;

 

domestic and international economic factors unrelated to FNCB’s performance; and

 

general market conditions and, in particular, developments related to market conditions for the financial services industry.

 

During 2017, the per share closing bid price of FNCB’s common stock on the OTCQX Marketplace (“OTCQX”) ranged from a low of $6.05 on January 5, 2017, to a high of $8.13 on May 24, 2017.

 

In addition, in recent years, the stock market in general has experienced extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies, including for reasons unrelated to their operating performance. These broad market fluctuations may adversely affect FNCB’s share price, notwithstanding its operating results. Management expects that the market price of its common stock will continue to fluctuate and there can be no assurances about the levels of the market prices for its common stock.

 

An active public market for FNCB’s common stock does not currently exist. As a result, shareholders may not be able to quickly and easily sell their shares of common stock.

 

Until March 5, 2018, FNCB’s shares of common stock were quoted on the OTCQX.  An average of 5,669 shares of FNCB’s common stock traded on the OTCQX during 2017 on a daily basis. On March 5, 2018, FNCB’s shares of common stock began trading on The Nasdaq Capital Market®.  An active, liquid market for FNCB’s shares of common stock has not previously existed, and there can be no assurance that an active and liquid market will develop, or if one does develop, if it can be maintained. The absence of an active trading market may make it difficult for FNCB shareholders to sell FNCB’s shares of common stock at the prevailing price when desired or at all, particularly in large quantities. For a further discussion, see Item 5, “Market for Registrant’s Common Equity, Related Shareholder Matters, and Issuer Purchases of Equity Securities” to this Annual Report on Form 10-K.

 

New or changed legislation or regulation and regulatory initiatives could adversely affect FNCB through increased regulation and increased costs of doing business.

 

Changes in federal and state legislation and regulation may affect FNCB’s operations. New and modified regulations, such as the Dodd-Frank Act and Basel III, may have unforeseen or unintended consequences on the banking industry. The Dodd-Frank Act has implemented significant changes to the U.S. financial system, including the creation of new regulatory agencies (such as the Financial Stability Oversight Council to oversee systemic risk and the CFPB to develop and enforce rules for consumer financial products), changes in retail banking regulations, and changes to deposit insurance assessments. For example, the Dodd-Frank Act has implemented new requirements with respect to “qualified mortgages” and new mortgage servicing standards have, and may continue to, increase costs associated with this business. For a more detailed description, see the section entitled “Business – The Bank – Consumer Financial Protection Bureau” included in Item 1 to this Annual Report on Form 10-K.

 

16

 

 

Additionally, final rules to implement Basel III adopted in July 2013 revise risk-based and leverage capital requirements and limit capital distributions and certain discretionary bonuses if a banking organization does not hold the required “capital conservation buffer.” The rule became effective for FNCB on January 1, 2015, with some additional transition periods. This additional regulation could increase compliance costs and otherwise adversely affect operations. For a more detailed description of the final rules, see the description in Item 1 of this Annual Report on Form 10-K under the heading “Capital Adequacy Requirements”. The potential also exists for additional federal or state laws or regulations, or changes in policy or interpretations, affecting many of FNCB’s operations, including capital levels, lending and funding practices, insurance assessments, and liquidity standards. The effect of any such changes and their interpretation and application by regulatory authorities cannot be predicted, may increase FNCB’s cost of doing business and otherwise affect FNCB’s operations, may significantly affect the markets in which it does business, and could have a materially adverse effect on FNCB.

 

FNCB is also subject to the guidelines under the GLB Act. The GLB Act guidelines require, among other things, that each financial institution develop, implement and maintain a written, comprehensive information security program containing safeguards that are appropriate to the financial institution’s size and complexity, the nature and scope of the financial institution’s activities and the sensitivity of any customer information at issue. In recent years there also has been increasing enforcement activity in the areas of privacy, information security and data protection in the United States, including at the federal level. Compliance with these laws, rules and regulations regarding the privacy, security and protection of customer and employee data could result in higher compliance and technology costs. In addition, non-compliance could result in potentially significant fines, penalties and damage to FNCB’s reputation and brand.

 

Changes in accounting standards could impact reported earnings.

 

From time to time there are changes in the financial accounting and reporting standards that govern the preparation of financial statements. These changes can materially impact how FNCB records and reports its financial condition and results of operations. In some instances, FNCB could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.

 

Compliance Risk

 

FNCB is subject to extensive government regulation, supervision and possible regulatory enforcement actions, which may subject it to higher costs and lower shareholder returns.

 

The banking industry is subject to extensive regulation and supervision that govern almost all aspects of its operations. The extensive regulatory framework is primarily intended to protect the federal deposit insurance fund and depositors, not shareholders. Compliance with applicable laws and regulations can be difficult and costly and, in some instances, may put banks at a competitive disadvantage compared to less regulated competitors such as finance companies, mortgage banking companies, leasing companies and internet-based Fintech companies. FNCB’s regulatory authorities have extensive discretion in their supervisory and enforcement activities, including with respect to the imposition of restrictions on the operation of a bank or a bank holding company, the imposition of significant fines, the ability to delay or deny merger or other regulatory applications, the classification of assets by a bank, and the adequacy of a bank’s allowance for loan losses, among other matters. If they deem FNCB to be operating in a manner inconsistent with safe and sound banking practices, these regulatory authorities can require the entry into informal and formal supervisory agreements, including board resolutions, memoranda of understanding, settlement agreements and consent or cease and desist orders, pursuant to which FNCB would be required to implement identified corrective actions to address cited concerns and/or to refrain from taking certain actions in the form of injunctive relief. In recent years, the banking industry has faced increased regulation and scrutiny; for instance, areas such as BSA compliance (including BSA and related anti-money laundering regulations) and real estate-secured consumer lending (such as Truth-in-Lending regulations, changes in Real Estate Settlement Procedures Act regulations, implementation of licensing and registration requirements for mortgage originators and more recently, heightened regulatory attention to mortgage and foreclosure-related activities and exposures) are being confronted with escalating regulatory expectations and scrutiny. Non-compliance with laws and regulations such as these, even in cases of inadvertent non-compliance, could result in litigation, significant fines and/or sanctions. Any failure to comply with, or any change in, any applicable regulation and supervisory requirement, or change in regulation or enforcement by such authorities, whether in the form of policies, regulations, legislation, rules, orders, enforcement actions, or decisions, could have a material impact on FNCB, the Bank and other affiliates, and its operations. Federal economic and monetary policy may also affect FNCB’s ability to attract deposits and other funding sources, make loans and investments, and achieve satisfactory interest spreads. Any failure to comply with such regulation or supervision could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on FNCB’s business, financial condition and results of operations. In addition, compliance with any such action could distract management’s attention from FNCB’s operations, cause it to incur significant expenses, restrict it from engaging in potentially profitable activities and limit its ability to raise capital.

 

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Strategic Risk

 

FNCB may need to raise additional capital in the future, but that capital may not be available when it is needed and on terms favorable to current shareholders.

 

Laws, regulations and banking regulators require FNCB and the Bank to maintain adequate levels of capital to support their operations. In addition, capital levels are determined by FNCB’s management and Board of Directors based on capital levels that they believe are necessary to support business operations. Management regularly evaluates its present and future capital requirements and needs and analyzes capital raising alternatives and options. Although FNCB succeeded in meeting its current regulatory capital requirements, it may need to raise additional capital in the future to support growth, possible loan losses or potential OTTI during future periods, to meet future regulatory capital requirements or for other reasons.

 

The Board of Directors may determine from time to time that FNCB needs to raise additional capital by issuing additional shares of common stock or other securities. FNCB is not restricted from issuing additional shares of common stock, including securities that are convertible into or exchangeable for, or that represent the right to receive, common stock. Because FNCB’s decision to issue securities in any future offering will depend on market conditions and other factors beyond its control, FNCB cannot predict or estimate the amount, timing or nature of any future offerings, or the prices at which such offerings may be affected. Such offerings will likely be dilutive to common shareholders from ownership, earnings and book value perspectives. New investors also may have rights, preferences and privileges that are senior to, and that adversely affect, its then current common shareholders. Additionally, if FNCB raises additional capital by making additional offerings of debt or preferred equity securities, upon liquidation, holders of its debt securities and shares of preferred shares, and lenders with respect to other borrowings, will receive distributions of available assets prior to the holders of common stock. Additional equity offerings may dilute the holdings of existing shareholders or reduce the market price of FNCB’s common stock, or both. Holders of FNCB’s common stock are not entitled to preemptive rights or other protections against dilution.

 

FNCB cannot provide any assurance that additional capital will be available on acceptable terms or at all. Any occurrence that may limit access to the capital markets may adversely affect FNCB’s capital costs and its ability to raise capital and, in turn, its liquidity. Moreover, if FNCB needs to raise capital, it may have to do so when many other financial institutions are also seeking to raise capital and would have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a material adverse effect on FNCB’s business, financial condition and results of operations.

 

Reputation Risk

 

Damage to FNCB’s reputation could significantly harm its businesses, competitive position and prospects for growth.

 

FNCB’s ability to attract and retain investors, customers, clients, and employees could be adversely affected by damage to our reputation resulting from various sources, including employee misconduct, litigation, or regulatory outcomes; failure to deliver minimum standards of service and quality; compliance failures; unethical behavior; unintended breach of confidential information; and the activities of our clients, customers, and/or counterparties. Actions by the financial services industry in general, or by certain entities or individuals within it, also could have a significantly adverse impact on our reputation.

 

FNCB’s actual or perceived failure to identify and address various issues, including failure to properly address operational risks, could also give rise to reputational risk that could negatively impact business prospects. These issues include legal and regulatory requirements; consumer protection, fair lending, and privacy issues; properly maintaining customer and associated personal information; record keeping; protecting against money laundering; sales and trading practices; and ethical issues.

 

Item 1B.

Unresolved Staff Comments.

 

None.

 

Item 2.

Properties.

 

FNCB currently conducts business from its headquarters, which also houses the Bank’s main office, located at 102 East Drinker Street, Dunmore, Pennsylvania, 18512. At December 31, 2017, FNCB also operated seventeen additional branches located throughout Lackawanna, Luzerne and Wayne counties, an LPO located in Allentown, Lehigh County, Pennsylvania and a lending center and two administrative offices located in Dunmore, Lackawanna County, Pennsylvania. Fourteen of the offices are leased and the balance are owned by the Bank. Except for potential remodeling of certain facilities to provide for the efficient use of work space and/or to maintain an appropriate appearance, each property is considered reasonably suitable and adequate for current and immediate future purposes.

 

As part of its responsibilities, management regularly evaluates FNCB’s delivery system and facilities including analyzing each office’s operating efficiency, location, foot traffic, structure and design. As a result of these evaluations, on May 1, 2017, FNCB announced that the Bank will implement a comprehensive branch network improvement program that will focus on strengthening, better positioning and expanding its market coverage by developing new state-of-the-art customer facilities, as well as relocating and consolidating select locations. In accordance with the branch network improvement program, on June 30, 2017, FNCB consolidated its branch office located at 1127 Texas Palmyra Highway, Honesdale, Wayne County, Pennsylvania with its branch located at 1001 Main Street, Honesdale, Pennsylvania.

 

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As part of this network improvement program, FNCB announced its intention to relocate three branches located in Luzerne County, Pennsylvania to a new location. The three branches that will be relocated are: 1) a branch located at 734 San Souci Parkway, Hanover Township, Pennsylvania; 2) a branch located at 27 North River Street, Plains, Pennsylvania; and 3) a branch located at 3 Old Boston Road, Pittston, Pennsylvania. These three branches will be relocated into a brand-new facility to be built in the Richland 315 development located at 1150 Route 315, Wilkes-Barre (Plains Township), Luzerne County, Pennsylvania. FNCB currently leases the three branches, as well as the aforementioned Honesdale branch, that was consolidated, and will lease the future Luzerne County facility. FNCB does not expect to incur any significant disposal costs on either the Wayne County or Luzerne County branch consolidations. The construction of the new facility began in the fourth quarter of 2017 and is expected to be completed in the second quarter of 2018, at which time the Luzerne County branch consolidation will occur. The three existing branches will continue to operate as full-service branches until that time.

 

On December 21, 2016, the Bank purchased a building located immediately adjacent to its main office at 106-108 East Drinker Street, Dunmore, Pennsylvania, 18512 for the purpose of housing its commercial and retail lending units. The lending center opened on March 7, 2017.

 

On January 20, 2017, FNCB opened a LPO in Allentown, Lehigh County, Pennsylvania and began offering its retail and commercial lending products in this new market area. This LPO is located in an office leased by the Bank at 3500 Winchester Road, Suites 101 and 102, Allentown, Pennsylvania, 18104.

 

On September 27, 2017, the Board of Directors of FNCB approved the purchase of the Bank’s corporate center located at 200 South Blakely Street, Dunmore, Pennsylvania, for $2.15 million. FNCB had been leasing this property since 1994. The purchase, which was finalized on January 12, 2018, was funded by cash generated from operations and is anticipated to reduce occupancy expenses by approximately $100,000 annually.

 

Item 3.

Legal Proceedings.

 

On May 24, 2012, a putative shareholder filed a complaint in the Court of Common Pleas for Lackawanna County (“Shareholder Derivative Suit”) against certain present and former directors and officers of FNCB (the “Individual Defendants”) alleging, inter alia, breach of fiduciary duty, abuse of control, corporate waste, and unjust enrichment. FNCB was named as a nominal defendant. On February 4, 2014, the Court issued a Final Order and Judgment for the matter granting approval of a Stipulation of Settlement (the “Settlement”) and dismissing all claims against FNCB and the Individual Defendants. As part of the Settlement, without admitting any fault, wrongdoing or liability, the Individual Defendants agreed to settle the derivative litigation for $5.0 million. The $5.0 million Settlement payment was made to FNCB on March 28, 2014. The Individual Defendants reserved their rights to indemnification under FNCB’s Articles of Incorporation and Bylaws, resolutions adopted by the Board, the Pennsylvania Business Corporation Law and any and all rights they have against FNCB’s and the Bank’s insurance carriers. In addition, in conjunction with the Settlement, FNCB accrued $2.5 million related to fees and costs of the plaintiff’s attorneys, which was included in non-interest expense in the consolidated statements of income for the year ended December 31, 2013. On April 1, 2014, FNCB paid the $2.5 million related to fees and costs of the plaintiff’s attorneys and partial indemnification of the Individual Defendants in the amount of $2.5 million. On July 1, 2017, FNCB continued to make partial indemnification to the Individual Defendants by commencing monthly principal payments, on behalf of the Individual Defendants, of $25,000 plus accrued interest due to First Northern Bank and Trust Co. As of December 31, 2017, $2.5 million plus accrued interest remains accrued in other liabilities related to the potential indemnification of the Individual Defendants.

 

On September 5, 2012, Fidelity and Deposit Company of Maryland (“F&D”) filed an action against FNCB and the Bank, as well as several current and former officers and directors of FNCB, in the United States District Court for the Middle District of Pennsylvania. F&D has asserted a claim for the rescission of a directors’ and officers’ insurance policy and a bond that it had issued to FNCB. On November 9, 2012, FNCB and the Bank answered the claim and asserted counterclaims for the losses and expenses already incurred by FNCB and the Bank. FNCB and the other defendants are defending the claims and have opposed F&D’s requested relief by way of counterclaims, breaches of contract and bad faith claims against F&D for its failure to fulfill its obligations to FNCB and the Bank under the insurance policy. Discovery is complete and the parties have exchanged expert reports. Dispositive motions have been submitted by the parties and the Court heard oral arguments on the motions on August 9, 2017. FNCB is awaiting the Court’s rulings on the dispositive motions. At this time, FNCB cannot reasonably determine the outcome of potential range of loss, if any, in connection with this matter.

 

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On February 16, 2017, FNCB and the Bank entered into a Class Action Settlement Agreement and Release (the “Settlement Agreement”) in the matters filed in the Court of Common Pleas of Lackawanna County to Steven Antonik, Individually, and as Administrator of the Estate of Linda Kluska, William R. Howells and Louise A. Howells, Summer Benjamin, and Joshua Silfee, on behalf of themselves and all other similarly situated vs. First National Community Bancorp, Inc. and First National Community Bank, Civil Action No. 2013-CV-4438 and Charles Saxe, III, Individually and on behalf of all others similarly situated vs. First National Community Bank No. 2013-CV-5071 (collectively, the “Actions”). By entering into this Settlement Agreement, the parties to the Actions have resolved the claims made in the complaints to their mutual satisfaction. FNCB has not admitted to the validity of any claims or allegations and denies any liability in the claims made and the Plaintiffs have not admitted that any claims or allegations lack merit or foundation. Under the terms of the Settlement Agreement, the parties have agreed to the following: 1) FNCB is to pay the Plaintiffs’ class members the aggregate sum of Seven Hundred Fifty Thousand Dollars ($750,000) (an amount which FNCB recorded as a liability and corresponding expense in its 2015 operating results); 2) Plaintiffs shall release all claims against FNCB related to the Actions; 3) FNCB shall move to vacate or satisfy any judgments against any class members arising from the vehicle loans that are the subject of the Actions; and 4) FNCB shall waive the deficiency balance of each class member and remove the trade lines on each class members’ credit report associated with the subject vehicle loans that are at issue in the Actions for Experian, Equifax, and Transunion. The Settlement Agreement provides for an Incentive Award for the representative Plaintiffs and an award to Plaintiffs’ counsel of attorney’s fees and reimbursement of expenses in connection with their roles in these Actions, subject to Court approval. The Settlement Agreement was preliminarily approved by Court Order on February 16, 2017. On March 2, 2017, FNCB paid the Settlement Administrator Seven Hundred Fifty Thousand ($750,000) pursuant to the terms and conditions of the Settlement Agreement. The Settlement Agreement received final Court approval on May 31, 2017. Additionally, in association with the subject vehicle loans, FNCB has completed the removal of trade lines on each class members' credit report and has substantially completed satisfying judgments, where applicable, in favor of class members. As previously mentioned above and in connection with the primary terms of the tentative settlement agreement entered by Order of Court on December 17, 2015, FNCB recorded a liability and corresponding expense in the amount of Seven Hundred Fifty Thousand ($750,000), which was included in FNCB’s 2015 operating results.

 

FNCB has been subject to tax audits, and is also a party to routine litigation involving various aspects of its business, such as employment practice claims, workers compensation claims, claims to enforce liens, condemnation proceedings on properties in which FNCB holds security interests, claims involving the making and servicing of real property loans and other issues incident to its business, none of which has or is expected to have a material adverse impact on the consolidated financial condition, results of operations or liquidity of FNCB.

 

Item 4.

Mine Safety Disclosures.

 

Not Applicable.

 

 

PART II

 

Item 5.

Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.

 

Market Prices of Stock and Dividends Paid

 

During the years ended December 31, 2017 and 2016, FNCB’s common shares were quoted on the OTCQX under the symbol “FNCB.” Quarterly market highs and lows and dividends paid for each of the past two years are presented below.  These prices represent actual transactions.

 

   

Market Price

   

Dividends Paid

 
   

High

   

Low

   

Per Share

 

Quarter

 

2017

   

2017

 

First

  $ 7.50     $ 6.05     $ 0.03  

Second

    8.13       6.35       0.03  

Third

    8.00       7.41       0.03  

Fourth

    7.99       6.54       0.04  

 

Quarter

 

2016

   

2016

 

First

  $ 6.90     $ 5.11     $ 0.02  

Second

    6.12       5.50       0.02  

Third

    6.00       4.75       0.02  

Fourth

    6.30       5.00       0.03  

 

On December 29, 2017, FNCB filed a listing application with The Nasdaq Stock Market LLC (“Nasdaq”). FNCB subsequently received approval from Nasdaq on February 26, 2018 to list its common shares for trading on The Nasdaq Capital Market®. FNCB’s shares of common stock began trading on Nasdaq effective with the market opening on Monday, March 5, 2018.

 

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Holders

 

As of February 28, 2018, there were approximately 1,811 holders of record of FNCB’s common shares. Because many of FNCB’s shares are held by brokers and other institutions on behalf of shareholders, FNCB is unable to estimate the total number of shareholders represented by these record holders.

 

Dividends

 

FNCB had been under a Written Agreement with the Federal Reserve Bank of Philadelphia from November 24, 2010 until it was fully and completely released from the enforcement action on September 2, 2015. The Bank had been under a Consent Order with the Office of the Comptroller of the Currency from September 1, 2010 until it was fully and completely released from the enforcement action on March 25, 2015. While under the Written Agreement, FNCB was precluded from paying dividends, and accordingly, did not pay dividends to shareholders during the tenure of the Written Agreement. FNCB resumed quarterly dividend payments effective with a quarterly dividend paid on March 15, 2016. In addition to the resumption of dividend payments, on April 27, 2016, FNCB’s Board of Directors approved the reinstatement of the Dividend Reinvestments and Stock Purchase Plan effective June 1, 2016.

 

On January 31, 2018, the Board of Directors declared a dividend of $0.04 per share for the first quarter of 2018. The dividend is payable on March 15, 2018 to shareholders of record as of March 1, 2018.

 

It is the present intent of the Board of Directors to continue paying quarterly dividends going forward. However, FNCB’s ability to declare and pay future dividends is dependent upon earnings, financial position, appropriate restrictions under applicable laws, legal and regulatory restrictions and other factors relevant at the time FNCB’s Board of Directors considers any declaration of any dividends. For a further discussion of FNCB’s and the Bank’s dividend restrictions, refer to Note 14, “Regulatory Matters/Subsequent Events” in the notes to consolidated financial statements in this Annual Report on Form 10-K.

 

Equity Compensation Plans

 

For more information regarding FNCB’s equity compensation plans, see Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” in this Annual Report on Form 10-K.

 

Performance Graph

 

The following graph compares the cumulative total shareholder return (i.e. price change, reinvestment of cash dividends and stock dividends received) on FNCB’s common stock against the cumulative total return of the NASDAQ Stock Market (U.S. Companies) Index, the SNL Bank Index for banks with $1 billion to $5 billion in assets, the KBW NASDAQ Regional Banking Index, and the SNL Bank NASDAQ Index. For the year ended December 31, 2017, FNCB elected to include the SNL Bank Index for banks with $1 billion to $5 billion in assets to replace the previously referenced SNL Bank Index for banks with $500 million to $1 billion in assets, as FNCB has remained over $1 billion in total assets for each of the preceding three years. The SNL Bank Index for banks with $500 million to $1 billion continues to be represented on the graph below for comparison purposes for 2017. The stock performance graph assumes that $100 was invested on December 31, 2012. The graph further assumes the reinvestment of dividends into additional shares of the same class of equity securities at the frequency with which dividends are paid on such securities during the relevant fiscal year. The yearly points marked on the horizontal axis correspond to December 31 of that year. FNCB calculates each of the referenced indices in the same manner. All are market-capitalization-weighted indices, so companies judged by the market to be more important (i.e. more valuable) count for more in all indices.

 

21

 

 

 

Recent Sales of Unregistered Securities

 

None.

 

Purchase of Equity Securities by the Issuer and Affiliated Purchasers

 

None.

 

22

 

 

Item 6.

Selected Financial Data

 

The selected consolidated financial and other data and management’s discussion and analysis of financial condition and results of operations set forth below and in Item 7 hereof is derived in part from, and should be read in conjunction with, FNCB’s consolidated financial statements and notes thereto contained elsewhere herein. Certain reclassifications have been made to prior years’ consolidated financial statements to conform to the current year’s presentation. Those reclassifications did not impact net income.

 

   

For the Years Ended December 31,

 

(dollars in thousands, except per share data)

 

2017

   

2016

   

2015

   

2014

   

2013

 

Balance Sheet Data:

                                       

Total assets

  $ 1,162,305     $ 1,195,599     $ 1,090,618     $ 970,029     $ 1,003,808  

Securities, available-for-sale

    290,387       276,015       257,042       219,989       204,867  

Securities, held-to-maturity

    -       -       -       -       2,308  

Net loans

    761,609       722,860       721,926       657,747       628,880  

Total deposits

    1,002,448       1,015,139       821,546       795,336       884,698  

Borrowed funds

    60,278       78,847       160,112       96,504       62,433  

Shareholders' equity

    89,191       90,371       86,178       51,398       33,578  
                                         

Income Statement Data:

                                       

Interest income

  $ 37,848     $ 34,748     $ 32,201     $ 32,673     $ 32,953  

Interest expense

    4,800       4,197       4,801       6,147       7,176  

Net interest income before provision (credit) for loan and lease losses

    33,048       30,551       27,400       26,526       25,777  

Provision (credit) for loan and lease losses

    769       1,153       (1,345 )     (5,869 )     (6,270 )

Non-interest income

    7,225       6,203       7,800       14,920       9,283  

Non-interest expense

    28,069       27,545       28,464       33,569       34,948  

Income before income taxes

    11,435       8,056       8,081       13,746       6,382  

Income tax expense (benefit)

    11,288       1,747       (27,759 )     326       -  

Net income

    147       6,309       35,840       13,420       6,382  

Earnings per share, basic and diluted

    0.01       0.38       2.17       0.81       0.39  
                                         

Capital and Related Ratios:

                                       

Cash dividends declared per share

  $ 0.13     $ 0.09     $ -     $ -     $ -  

Book value per share

    5.32       5.43       5.22       3.12       2.04  

Tier I leverage ratio

    7.74 %     7.53 %     7.27 %     6.05 %     4.71 %

Total risk-based capital to risk-adjusted assets

    12.08 %     12.06 %     11.79 %     13.67 %     11.58 %

Average equity to average total assets (1)

    8.36 %     8.42 %     5.64 %     4.66 %     3.60 %

Tangible equity to tangible assets

    7.67 %     7.56 %     7.89 %     5.27 %     3.30 %
                                         

Selected Performance Ratios:

                                       

Return on average assets (1)

    0.01 %     0.57 %     3.57 %     1.38 %     0.67 %

Return on average equity (1)

    0.15 %     6.82 %     63.24 %     29.50 %     18.65 %

Net interest margin (2)

    3.23 %     3.13 %     2.99 %     3.08 %     3.21 %

Noninterest income/operating income (2)

    15.79 %     14.88 %     18.73 %     30.30 %     20.79 %
                                         

Asset Quality Ratios:

                                       

Allowance for loan and lease losses/total loans

    1.17 %     1.15 %     1.20 %     1.72 %     2.18 %

Nonperforming loans/total loans

    0.34 %     0.31 %     0.52 %     0.82 %     0.99 %

Allowance for loan and lease losses/nonperforming loans

    350.43 %     376.86 %     232.05 %     208.62 %     219.87 %

Net charge-offs/average loans

    0.02 %     0.21 %     0.20 %     (0.51 %)     (0.28 %)

Loan loss provision/net charge-offs

    499.35 %     75.66 %     ***       ***       ***  

 

*** Ratio is not meaningful for 2015, 2014 and 2013.

(1) Average balances were calculated using average daily balances. Average balances for loans include non-accrual loans.

(2) Tax-equivalent adjustments were calculated using the prevailing statutory rate of 34.0 percent.

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Management’s discussion and analysis (“MD&A”) represents an overview of the financial condition and results of operations of FNCB and should be read in conjunction with our consolidated financial statements and notes thereto included in Item 8 and Risk Factors detailed in Item 1A of Part I to this Annual Report on Form 10-K.

 

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FNCB is 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’s 18 full-service branch offices within its primary market area, Northeastern Pennsylvania, and a LPO based in Allentown, Lehigh County, Pennsylvania.

 

FORWARD-LOOKING STATEMENTS

 

FNCB may from time to time make written or oral “forward-looking statements,” including statements contained in our filings with the SEC, in 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,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” 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 strength of the United States economy in general and the strength of the local economies in our markets; the effects of, and changes in trade, monetary, corporate tax and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the timely development of and acceptance of new products and services; the ability of FNCB to compete with other institutions for business; the composition and concentrations of FNCB’s lending risk and the adequacy of our reserves to manage those risks; the valuation of FNCB’s investment securities; the ability of FNCB to pay dividends or repurchase common shares; the ability of FNCB to retain key personnel; the impact of any pending or threatened litigation against FNCB; the marketability of shares of FNCB stock and fluctuations in the value of FNCB’s share price; the effectiveness of FNCB’s system of internal controls; the ability of FNCB to attract additional capital investment; the impact of changes in financial services’ laws and regulations (including laws concerning capital adequacy, taxes, banking, securities and insurance); the impact of technological changes and security risks upon our information technology systems; changes in consumer spending and saving habits; the nature, extent, and timing of governmental actions and reforms, 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 the SEC.

 

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.

 

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 subject to revision as new information becomes available.

 

The judgments used by management in applying the critical accounting policies discussed below may be affected by 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.

 

24

 

 

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 nonaccrual status above the $100 thousand loan relationship threshold and all loans considered troubled debt restructurings (“TDRs”) are classified as impaired.

 

See Note 2, “Summary of Significant Accounting Policies” and Note 5, “Loans” of the notes to consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” to this Annual Report on Form 10-K for additional information about the ALLL.

 

Securities Valuation 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 4, “Securities” and Note 15, “Fair Value Measurements” of the notes to consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” to this Annual Report on Form 10-K for additional information about 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 analysis of OTTI requires the use of various assumptions, including but not limited to, the length of time an investment’s fair value is less than book value, the severity of the investment’s decline, any credit deterioration of the issuer, whether management intends to sell the security, and whether it is more-likely-than-not that 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 years ended December 31, 2017, 2016 and 2015 within the consolidated statements of income.

 

See Note 2, “Summary of Significant Accounting Policies” and Note 4, “Securities” of the notes to consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” to this Annual Report on Form 10-K for additional information about valuation of securities.

 

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 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 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.

 

25

 

 

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.

 

FNCB records an income tax provision or benefit based on the amount of tax, including alternative minimum tax, currently payable or receivable and the change in deferred tax assets and liabilities. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial and tax reporting purposes. Management conducts quarterly assessments of all available positive and negative evidence to determine the amount of deferred tax assets that will more likely than not be realized. 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. On December 31, 2010, management established a valuation allowance equal to 100 percent of FNCB’s net deferred tax asset, excluding deferred tax assets and liabilities related to unrealized holding gains and losses on available-for-sale securities, and maintained such an allowance through December 31, 2014. As part of its evaluation conducted as of December 31, 2015, management reviewed all the positive and negative evidence available at that time and concluded that significant positive evidence outweighed any negative evidence and the valuation allowance previously established for FNCB’s deferred tax assets should be reversed, except for the amount established for charitable contribution carryovers. Management’s subsequent evaluation as of December 31, 2016 concluded that the previously established valuation allowance for charitable contributions should be reversed, and as such, FNCB did not have any valuation allowances for deferred tax assets as of December 31, 2016. Similarly, management’s evaluation as of December 31, 2017 concluded that no valuation allowance was necessary for net deferred tax assets as of December 31, 2017.

 

On December 22, 2017, President Trump signed into law “H.R.1.,” formally known as the Tax Cuts and Jobs Act (the “Tax Act”), which among other things, reduces the federal maximum corporate income tax rate from 35.0% to 21.0% effective January 1, 2018. In accordance with generally accepted accounting principles (“GAAP”), the enactment of this new tax legislation required FNCB to revalue its deferred tax assets at the new corporate statutory rate of 21.0% as of December 31, 2017. The revaluation of FNCB’s deferred tax assets, net of deferred tax liabilities, resulted in a reduction in the value of its net deferred tax assets of $8.0 million in the fourth quarter of 2017, with a corresponding increase in the income tax provision. This revaluation adjustment had an impact of ($0.48) per diluted share, and tangible book value of ($0.48) per share based on weighted-average diluted shares for the year ended December 31, 2017 and shares outstanding at December 31, 2017, respectively. There was no significant impact to FNCB’s regulatory capital ratios or liquidity resulting from the revaluation.

 

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 of December 31, 2017 and 2016, management determined that FNCB did not have any uncertain tax positions or tax strategies and that no liability was required to be recorded.

 

See Note 2, “Summary of Significant Accounting Policies” and Note 10, “Income Taxes” of the notes to consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” to this Annual Report on Form 10-K for additional information about the accounting for income taxes.

 

26

 

 

New Authoritative Accounting Guidance and Accounting Guidance to be Adopted in Future Periods

 

For information regarding new authoritative accounting guidance adopted by FNCB during the year ended December 31, 2017 and accounting guidance that FNCB will adopt in future periods, see Note 2, “Summary of Significant Accounting Policies” of the notes to consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” to this Annual Report on Form 10-K.

 

EXECUTIVE OVERVIEW

 

The following overview should be read in conjunction with this MD&A in its entirety.

 

Results of Operations

 

The enactment of the Tax Act significantly impacted FNCB’s results of operations for the year ended December 31, 2017. As required by GAAP, upon enactment FNCB revalued its net deferred tax assets at 21.0%, the new corporate statutory tax rate which became effective January 1, 2018. The revaluation resulted in additional, non-recurring, non-cash income tax expense of $8.0 million in the fourth quarter of 2017, which caused a decrease in basic and diluted earnings-per-share of ($0.48) in 2017, and tangible book value of ($0.48) per share based on weighted-average basic and diluted shares outstanding for the year ended December 31, 2017 and actual shares outstanding at December 31, 2017, respectively.

 

FNCB reported earnings in 2017 of $0.1 million, or $0.01 per diluted common share, a decrease of $6.2 million, or 97.7%, compared to $6.3 million, or $0.38 per diluted common share, in 2016. The decrease in 2017 net income compared to 2016 was primarily attributable to the increase in income tax expense, offset in part by strong improvement in net interest income and non-interest income, coupled with a reduction in the provision for loan and lease losses. Net interest income improved $2.5 million, or 8.2%, to $33.0 million in 2017 from $30.5 million in 2016. The improvement resulted primarily from solid growth in interest earning assets, higher yields on taxable loans and investments and reduced borrowing costs. Non-interest income increased $1.0 million, or 16.5%, to $7.2 million in 2017 from $6.2 million in 2016. An increase in net gains on the sale of securities of $0.6 million, coupled with increases in other income and net gains on the sales of loans guaranteed by the Small Business Administration (“SBA”), other real estate owned and other repossessed assets, were the primary factors driving the increase in non-interest income comparing 2017 and 2016. The provision for loan and lease losses, driven by a reduction in net charge-offs, decreased $0.4 million, or 33.3%, to $0.8 million in 2017 from $1.2 million in 2016. These positive factors were offset by a $0.5 million, or 1.9%, increase in non-interest expenses to $28.0 million in 2017 from $27.5 in 2016.

 

Return on average assets and return on average shareholders’ equity equaled 0.01% and 0.15%, respectively, in 2017, compared to 0.57% and 6.82%, respectively, in 2016. For the three months ended December 31, 2017, return on average assets and return on average shareholders’ equity were (2.09%) and (24.98%), respectively, compared to 0.55% and 6.43%, respectively, for the same three months of 2016. FNCB paid dividends to holders of common stock of $0.13 per share and $0.09 per share for the years ended December 31, 2017 and 2016, respectively.

 

Balance Sheet Profile

 

Total assets decreased $33.3 million, or 2.8%, to $1.162 billion at December 31, 2017 from $1.196 billion at December 31, 2016. The decrease in total assets was led by a reduction in cash and cash equivalents, as cash was used to fund growth in interest-earning assets and pay down borrowings, coupled with a reduction in interest-bearing deposits. Loans, net of net deferred loan costs and unearned income, grew $39.3 million, or 5.4%, to $770.6 million at December 31, 2017 from $731.3 million at December 31, 2016. In addition, securities available for sale increased $14.4 million, or 5.2%, to $290.4 million at December 31, 2017 from $276.0 million at the end of 2016. Total deposits decreased $12.7 million, or 1.3%, to $1.002 billion at December 31, 2017 from $1.015 billion at December 31, 2016. The decrease in total deposits reflected cyclical deposit trends of public funds, coupled with the anticipated exit of short-term funds in the first quarter of 2017 that were received at the end of 2016 related to the sale of a municipal utility. Borrowed funds declined $18.6 million, including $13.6 million in advances from the Federal Home Loan Bank of Pittsburgh and $5.0 million in subordinated debentures.

 

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Total shareholders’ equity declined $1.2 million, or 1.3%, to $89.2 million at December 31, 2017 from $90.4 million at the end of 2016, which resulted primarily from dividends declared and paid of $2.2 million and an increase in accumulated other comprehensive loss of $0.2 million. Partially offsetting these reductions in 2017 were common shares issued through the dividend reinvestment and optional cash purchase plans of $0.4 million, stock-based compensation of $0.3 million, and net income of $0.1 million.

 

At December 31, 2017, FNCB’s total risk-based capital ratio and the Tier 1 leverage ratio were 12.08% and 7.74%, respectively. The respective ratios for the Bank at December 31, 2017 were 12.49% and 8.24%. The ratios for both FNCB and the Bank exceeded the 10.00% and 5.00% required to be well capitalized under the prompt corrective action provisions of the Basel III capital framework for U.S. banking organizations.

 

Management’s Focus in 2017

 

In 2017, management focused on developing strategies aimed at increasing net interest income through commercial and retail loan growth initiatives, improving retail delivery systems, strengthening corporate governance and enhancing the marketability and liquidity of FNCB’s common stock.

 

In line with its commercial and retail loan growth initiatives, on January 20, 2017, FNCB opened a LPO in Allentown, Lehigh County, Pennsylvania, and began offering its retail and commercial lending products in this new market area. Additionally, in order to facilitate loan growth initiatives, on March 7, 2017, FNCB opened a lending center immediately adjacent to its main office in Dunmore, Lackawanna County, Pennsylvania, which houses part of its commercial and retail lending units.

 

As part of its responsibilities, management regularly evaluates FNCB’s delivery system and facilities including analyzing each office’s operating efficiency, location, foot traffic, structure and design. As a result of these evaluations, on May 1, 2017, FNCB announced that the Bank will implement a comprehensive branch network improvement program that will focus on strengthening, better positioning and expanding its market coverage by developing new state-of-the-art customer facilities, as well as relocating and consolidating select locations. In accordance with the branch network improvement program, on June 30, 2017, FNCB consolidated its branch office located at 1127 Texas Palmyra Highway, Honesdale, Wayne County, Pennsylvania with its branch located at 1001 Main Street, Honesdale, Pennsylvania.

 

As part of this network improvement program, FNCB also announced its intention to relocate three branches located in Luzerne County, Pennsylvania to a new location. The three branches that will be relocated are: 1) a branch located at 734 San Souci Parkway, Hanover Township, Pennsylvania; 2) a branch located at 27 North River Street, Plains, Pennsylvania; and 3) a branch located at 3 Old Boston Road, Pittston, Pennsylvania. These three branches will be relocated into a brand-new facility to be built in the Richland 315 development located at 1150 Route 315, Wilkes-Barre (Plains Township), Luzerne County, Pennsylvania. FNCB currently leases the three branches, as well as the aforementioned Honesdale branch, that was consolidated, and will lease the future Luzerne County facility. FNCB did not incur any significant disposal costs on the Wayne County consolidation and does not expect to incur any significant disposal costs on Luzerne County branch consolidation. The construction of the new Luzerne County facility began in the fourth quarter of 2017 and is expected to be completed in the second quarter of 2018, at which time the Luzerne County branch consolidation will occur. The three existing branches will continue to operate as full-service branches until that time.

 

Following continued analysis of FNCB’s locations and facilities, on September 27, 2017, the Board of Directors approved the purchase of the Bank’s corporate center located at 200 South Blakely Street, Dunmore, Pennsylvania, for $2.15 million. FNCB has been leasing this property since 1994. The purchase of the corporate center, which was funded by cash generated by operations, was finalized on January 15, 2018. The purchase of this building is anticipated to reduce occupancy expenses in excess of $100,000 annually going forward.

 

The network improvement program also calls for the continued evaluation of FNCB’s delivery systems. In the second quarter of 2017, FNCB commenced a project to upgrade its entire automated teller machine network. In addition, in 2018 management plans to evaluate the development of new state-of-the-art facilities on properties already owned by FNCB located in Dunmore, Lackawanna County, Pennsylvania and in Taylor Borough, Lackawanna County, Pennsylvania. Also in 2018, management plans to implement a bank-wide customer relationship management (“CRM”) system to improve customer service, enhance market share and create cross-sales opportunities between retail and commercial business units.

 

With respect to strengthening FNCB’s corporate governance structure, on September 27, 2017, the board of directors of FNCB and the Bank elected three new independent members to the boards of both entities. The addition of the new members extends both boards to 12 directors. On the same date, the board of directors also approved the formation of a community advisory board to consist of members from Northeastern Pennsylvania and the Lehigh Valley who will advise, support and serve as liaisons for the Bank in developing and furthering relationships with businesses and the community in our market area. The initial advisory board members were appointed on January 31, 2018.

 

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In addition to expanding the board and approving the formation of an advisory board, on September 27, 2017, the Board of Directors approved revisions to its Corporate Governance Guidelines to set a retirement age for FNCB’s and the Bank’s directors and executive officers. According to the approved revisions, no person can be nominated to serve as a Director after he or she has passed his or her 80th birthday. In the event that a director turns the age of 80 during his or her term as a Director, he or she may serve the remaining time of his or her term until his or her successor is duly elected and qualified or until the earlier of his or her death, resignation or removal. In addition, FNCB’s and the Bank’s executive officers are now subject to a mandatory retirement age of 75. Such retirement age may be waived for the President and Chief Executive Officer for strategic planning purposes in the sole discretion of the Board of Directors of FNCB and the Bank

 

Aligned with enhancing the marketability and liquidity of FNCB’s stock on December 29, 2017, FNCB filed a listing application with The Nasdaq Stock Market LLC (“Nasdaq”). FNCB subsequently received approval from Nasdaq on February 26, 2018 to list its common shares for trading on The Nasdaq Capital Market®. FNCB’s shares of common stock began trading on Nasdaq effective with the market opening on Monday, March 5, 2018.

 

SUMMARY OF FINANCIAL PERFORMANCE

 

Net Interest Income

 

2017 compared to 2016

 

Net interest income is the difference between (i) interest income, interest and fees on interest-earning assets, and (ii) interest expense, interest paid on deposits and borrowed funds. Net interest income represents the largest component of FNCB’s operating income and, as such, is the primary determinant of profitability. Net interest income is impacted by variations in the volume, rate and composition of earning assets and interest-bearing liabilities, changes in general market rates and the level of non-performing assets. Interest income is shown on a fully tax-equivalent basis and is calculated by adjusting tax-free interest using FNCB’s historic federal marginal tax rate of 34.0% to equate the income to that of taxable interest.

 

Since the first 25-basis point increase in the federal funds target rate on December 16, 2015, the Federal Open Market Committee (“FOMC”) increased the target rate a total of 100 basis points in four 25-basis point actions on December 14, 2016, March 15, 2017, June 14, 2017 and December 13, 2017. These actions resulted in corresponding increases in the national prime rate. At December 31, 2017, the national prime rate was 4.50%, 75 basis points higher than 3.75% at December 31, 2016. FNCB experienced an increase in loan yields throughout 2017 as compared to 2016, as variable- and adjustable-rate loans repriced upward. The increase in market interest rates has also led to notable increases in funding costs.

 

Tax-equivalent net interest income improved in 2017, increasing $2.5 million to $33.8 million compared to $31.3 million in 2016. The 7.9% increase in tax-equivalent net interest income primarily reflected a $3.1 million increase in tax-equivalent interest income, partially offset by a $0.6 million increase in interest expense. Tax-equivalent interest income in 2017 was positively impacted by increases in the yields earned across all interest-earning asset categories, coupled with significant growth in average earning assets. The increase in interest expense largely reflected an increase in the rates paid on interest-bearing demand deposits, partially mitigated by a reduction in the interest expense paid on borrowings attributable to lower average balances of borrowed funds.

 

FNCB’s tax-equivalent interest margin improved 10 basis points to 3.23% in 2017 from 3.13% in 2016. 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. Rate spread, the difference between the average yield on interest-earning assets shown on a fully tax-equivalent basis and the average cost of interest-bearing liabilities, was 3.13% for the year ended December 31, 2017, an increase of 8 basis points compared to 3.05% for the year ended December 31, 2016.

 

Tax-equivalent interest income increased $3.1 million, or 8.6%, to $38.6 million in 2017 from $35.5 million in 2016. The growth in tax-equivalent interest income reflected a 13-basis point improvement in the tax-equivalent yield on average earning assets to 3.68% in 2017 from 3.55% in 2016. Comparing 2017 and 2016, the tax-equivalent yield earned on the loan portfolio increased 19 basis points, the tax-equivalent yield earned on the investment portfolio increased 16 basis points, and the tax-equivalent yield earned on interest-bearing deposits in other banks increased 54 basis points, contributing $1.4 million, $0.5 million, and $0.1 million, respectively, to the improvement in tax-equivalent interest income. Accompanying the improvement in the tax-equivalent yields was strong growth in interest-earning assets, which increased $45.7 million, or 4.6%. Average loans increased $9.7 million, or 1.3%, to $732.3 million in 2017 from $725.6 million, resulting in an increase to tax-equivalent interest income of $0.3 million. In addition, average investments increased $25.2 million, or 9.5%, to $290.0 million in 2017 from $264.8 million in 2016, resulting in an increase to tax-equivalent interest income of $0.7 million, and average interest-bearing deposits in other banks increased $10.8 million, or 152.1%, to $17.9 million in 2017 from $7.1 million in 2016, resulting in an increase to tax-equivalent interest income of $0.1 million.

 

29

 

 

Increases in interest rates also drove an increase in interest expense of $0.6 million, or 14.4%, to $4.8 million in 2017 from $4.2 million in 2016. Rates paid on interest-bearing deposits increased 7 basis points to 0.44% in 2017 from 0.37% in 2016. The increase in deposit rates was concentrated in interest-bearing demand deposits which increased 14 basis points to 0.36% in 2017 as compared to 0.22% in 2016, resulting in an increase to interest expense of $0.7 million. The rate paid on savings deposits increased to a lesser extent, increasing by only 3 basis points to 0.13% in 2017 from 0.10% in 2016, while the rate paid on time deposits remained steady at 0.80% for both 2017 and 2016. Similarly, the rate paid on borrowed funds increased 34 basis points to 1.76% in 2017 from 1.42% in 2016, contributing $0.3 million to the overall increase in interest expense.

 

Average interest-bearing liabilities increased $30.8 million, or 3.6%, to $875.1 million in 2017 from $844.3 million in 2016. Despite the increase, changes in the volumes of interest-bearing liabilities resulted in a $0.4 million decrease in interest expense, as a reduction in higher-costing average borrowed funds more than offset an increase in lower-costing average interest-bearing deposits. Specifically, a $30.4 million, or 29.5%, decrease in average borrowed funds to $72.8 million in 2017 from $103.2 million in 2016 resulted in a reduction to interest expense of $0.5 million. The decline in interest expense paid on borrowed funds was partially offset by an $88 thousand increase in interest expense resulting from a $61.2 million, or 8.3%, increase in average interest-bearing deposits to $802.3 million in 2017 from $741.1 million in 2016. An increase in municipal deposits was the primary factor contributing to an increase of $67.1 million, or 15.4%, in average interest-bearing demand deposits to $502.2 million in 2017 from $435.1 million in 2016, which led to an increase in interest expense of $168 thousand. In addition, average savings deposits increased $4.8 million, or 4.9%, to $102.0 million in 2017 from $97.2 million in 2016, which caused a corresponding increase in interest expense of $5 thousand. Partially offsetting these increases was a reduction in the average balance of time deposits of $10.6 million, or 5.1%, to $198.1 million in 2017 from $208.8 million in 2016, which resulted in an $85 thousand reduction in interest expense.

 

2016 compared to 2015

 

Tax-equivalent net interest income in 2016 improved $3.2 million to $31.3 million compared to $28.1 million in 2015. The 11.2% increase in tax-equivalent net interest income primarily reflected a $2.5 million increase in tax-equivalent interest income, coupled with a $0.6 million reduction in interest expense. Tax-equivalent interest income was positively impacted by an increase in average earning assets, coupled with a slight increase in the yield earned on loans and investment securities. The decrease in interest expense largely reflected a reduction in funding costs due to the realization of a full year of the modification of the interest rate of the subordinated debentures from 9.0% to 4.5% during 2015. In addition, FNCB’s cost of funds was also favorably impacted by a reduction in the rate paid on other time deposits, as higher-costing certificates of deposit matured and were reinvested at lower rates. FNCB’s tax-equivalent interest margin improved 14 basis points to 3.13% in 2016 from 2.99% in 2015. Similarly, FNCB’s rate spread increased 16 basis points to 3.05% for the year ended December 31, 2016 from 2.89% for the year ended December 31, 2015.

 

Tax-equivalent interest income increased $2.5 million, or 7.7%, to $35.5 million in 2016 from $32.9 million in 2015. The growth in tax-equivalent interest income comparing 2016 and 2015 reflected strong growth in interest-earning assets, as average loans increased $33.2 million, or 4.8%, resulting in an increase to tax-equivalent interest income of $1.3 million, and average investments increased $36.3 million or 15.9%, resulting in an increase to tax-equivalent interest income of $0.9 million. Accompanying the growth in average earning assets was a 5-basis point improvement in the tax-equivalent yield on average earning assets to 3.55% in 2016 from 3.50% in 2015. Specifically, the tax-equivalent yield earned on the loan portfolio increased 2 basis points, while the tax-equivalent yield earned on the investment portfolio increased 8 basis points, contributing $0.1 million and $0.2 million, respectively, to the improvement in tax-equivalent interest income. The tax-equivalent yield earned on interest-bearing deposits in other banks improved 22 basis points, reflecting the 25-basis point increase in the federal funds target rate on December 16, 2015. However, the increase was more than offset by a decrease in the average balance of interest-bearing deposits in other banks of $11.0 million, or 60.8%.

 

Interest expense decreased $0.6 million, or 12.6%, to $4.2 million in 2016 from $4.8 million in 2015. The decrease in interest expense was driven almost entirely by an 11-basis point decrease in the cost of funds to 0.50% in 2016 compared to 0.61% in 2015, which resulted in a $0.6 million corresponding decrease in interest expense due to changes in rates. Specifically, the modification of the interest rate on the Notes from 9.0% to 4.5% effective July 1, 2015 had the greatest impact on interest expense, as it was the leading factor driving a 59-basis point decrease in the cost of borrowed funds to 1.42% in 2016 from 2.01% in 2015. The decrease in borrowing costs resulted in a $0.6 million reduction in interest expense. Partially offsetting the decrease in borrowing costs was a slight increase in FNCB’s cost of interest-bearing demand deposits and savings deposits of 3 basis points each, which were more than offset by a 5-basis point decrease in the cost of time deposits. Changes in the average deposit rates resulted in a $66 thousand increase in interest expense.

 

Average interest-bearing liabilities increased $61.8 million, or 7.9%, to $844.3 million in 2016 from $782.5 million in 2015. Despite the increase, changes in the volumes of interest-bearing liabilities resulted in a $66 thousand decrease in interest expense, as a reduction in higher-costing average borrowed funds more than offset an increase in lower-costing average interest-bearing deposits. Specifically, a $4.7 million, or 4.4%, decrease in average borrowed funds, resulted in a reduction to interest expense of $99 thousand. The decline in interest expense paid on borrowed funds was partially offset by a $33 thousand increase in interest expenses resulting from a $66.5 million increase in average interest-bearing deposits. An increase in municipal deposits was the primary factor contributing to an increase of $76.7 million, or 21.4%, in average interest-bearing demand deposits, which led to an increase in interest expense of $158 thousand. Partially offsetting this increase was a decrease in the average balance of time deposits of $15.6 million, or 7.0%, which resulted in a $129 thousand reduction in interest expense.

 

30

 

 

Non-accrual loans

 

The interest income that would have been earned on non-accrual and restructured loans outstanding at December 31, 2017, 2016 and 2015 in accordance with their original terms approximated $157 thousand, $221 thousand, and $406 thousand, respectively. Interest income on impaired loans of $392 thousand, $202 thousand, and $258 thousand was recognized based on payments received in 2017, 2016 and 2015, respectively.

 

The following table presents the components of net interest income for each of the three years ended December 31, 2017, 2016 and 2015:

 

Summary of Net Interest Income

 

   

Year ended December 31,

   

Year ended December 31,

   

Year ended December 31,

 
   

2017

   

2016

   

2015

 
   

Average

           

Yield/

   

Average

           

Yield/

   

Average

           

Yield/

 

(dollars in thousands)

 

Balance

   

Interest

   

Cost

   

Balance

   

Interest

   

Cost

   

Balance

   

Interest

   

Cost

 

ASSETS

                                                                       

Earning assets (2)(3)

                                                                       

Loans-taxable (4)

  $ 697,377     $ 28,519       4.09 %   $ 682,289     $ 26,623       3.90 %   $ 653,303     $ 25,256       3.87 %

Loans-tax free (4)

    40,903       1,973       4.82 %     46,305       2,076       4.48 %     42,135       1,988       4.72 %

Total loans (1)(2)

    738,280       30,492       4.13 %     728,594       28,699       3.94 %     695,438       27,244       3.92 %

Securities-taxable

    288,823       7,798       2.70 %     263,624       6,676       2.53 %     226,122       5,478       2.42 %

Securities-tax free

    1,212       74       6.11 %     1,192       70       5.87 %     2,419       165       6.82 %

Total securities (1)(5)

    290,035       7,872       2.71 %     264,816       6,746       2.55 %     228,541       5,643       2.47 %

Interest-bearing deposits in other banks

    17,874       180       1.01 %     7,089       33       0.47 %     18,076       46       0.25 %

Total earning assets

    1,046,189       38,544       3.68 %     1,000,499       35,478       3.55 %     942,055       32,933       3.50 %

Non-earning assets

    99,993                       107,061                       73,587                  

Allowance for loan and lease losses

    (8,626 )                     (8,684 )                     (10,729 )                

Total assets

  $ 1,137,556                     $ 1,098,876                     $ 1,004,913                  
                                                                         

LIABILITIES AND SHAREHOLDERS' EQUITY

                                                                       

Interest-bearing liabilities

                                                                       

Interest-bearing demand deposits

  $ 502,170       1,800       0.36 %   $ 435,092       973       0.22 %   $ 358,442       672       0.19 %

Savings deposits

    101,952       136       0.13 %     97,188       94       0.10 %     91,603       60       0.07 %

Time deposits

    198,143       1,585       0.80 %     208,783       1,663       0.80 %     224,538       1,899       0.85 %

Total interest-bearing deposits

    802,265       3,521       0.44 %     741,063       2,730       0.37 %     674,583       2,631       0.39 %

Borrowed funds and other interest-bearing liabilities

    72,795       1,279       1.76 %     103,239       1,467       1.42 %     107,965       2,170       2.01 %

Total interest-bearing liabilities

    875,060       4,800       0.55 %     844,302       4,197       0.50 %     782,548       4,801       0.61 %

Demand deposits

    156,670                       148,746                       139,945                  

Other liabilities

    10,770                       13,263                       25,744                  

Shareholders' equity

    95,056                       92,565                       56,676                  

Total liabilities and shareholders' equity

  $ 1,137,556                     $ 1,098,876                     $ 1,004,913                  

Net interest income/interest rate apread (6)

            33,744       3.13 %             31,281       3.05 %             28,132       2.89 %

Tax equivalent adjustment

            (696 )                     (730 )                     (732 )        

Net interest income as reported

          $ 33,048                     $ 30,551                     $ 27,400          
                                                                         

Net interest margin (7)

                    3.23 %                     3.13 %                     2.99 %

 

 

(1)

Interest income is presented on a tax-equivalent basis using a 34% 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 are 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 average interest bearing liabilities and is presented on a tax equivalent basis.

 

(7)

Net interest income as a percentage of total average interest earning assets.

 

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 FNCB’s historic statutory federal income tax rate of 34%.

 

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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.

 

Rate Volume Analysis

 

   

For the Year Ended December 31,

   

For the Year Ended December 31,

 
   

2017 vs. 2016

   

2016 vs. 2015

 
   

Increase (Decrease) Due to Change in

   

Increase (Decrease) Due to Change in

 

(in thousands)

 

Volume

   

Rate

   

Total

   

Volume

   

Rate

   

Total

 

Interest income:

                                               

Loans - taxable

  $ 598     $ 1,298     $ 1,896     $ 1,129     $ 238     $ 1,367  

Loans - tax free

    (253 )     150       (103 )     190       (102 )     88  

Total loans

    345       1,448       1,793       1,319       136       1,455  

Securities - taxable

    663       459       1,122       941       257       1,198  

Securities - tax free

    1       3       4       (74 )     (21 )     (95 )

Total securities

    664       462       1,126       867       236       1,103  

Interest-bearing deposits in other banks

    83       64       147       (38 )     25       (13 )

Total interest income

    1,092       1,974       3,066       2,148       397       2,545  
                                                 

Interest expense:

                                               

Interest-bearing demand deposits

    168       659       827       158       143       301  

Savings deposits

    5       37       42       4       30       34  

Time deposits

    (85 )     7       (78 )     (129 )     (107 )     (236 )

Total interest-bearing deposits

    88       703       791       33       66       99  

Borrowed funds and other interest-bearing liabilities

    (489 )     301       (188 )     (99 )     (604 )     (703 )

Total interest expense

    (401 )     1,004       603       (66 )     (538 )     (604 )

Net Interest Income

  $ 1,493     $ 970     $ 2,463     $ 2,214     $ 935     $ 3,149  

 

Provision for Loan and Lease Losses

 

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. The provision for loan and lease losses is an expense charged against net interest income to provide for probable losses attributable to uncollectible loans and is based on management’s analysis of the adequacy of the ALLL. A credit to loan and lease losses reflects the reversal of amounts previously charged to the ALLL.

 

2017 compared to 2016

 

FNCB recorded a provision for loan and lease losses of $0.8 million for the year ended December 31, 2017, a decrease of $0.4 million compared to $1.2 million for the year ended December 31, 2016. The decrease in the provision for loan and lease losses was due largely to a $1.3 million reduction in net charge-offs to $0.2 million in 2017, compared to $1.5 million in 2016. Net charge-offs within the commercial and industrial and commercial real estate segments decreased significantly, declining $0.5 million and $0.3 million, respectively, comparing 2017 and 2016. Partially offsetting the decrease in the provision for loan and lease losses due to the reduction in net loans charged-off was an increase in the provision for loan and lease losses in 2017 to reflect the $39.3 million growth in total loans as compared to 2016.

 

2016 compared to 2015

 

For the year ended December 31, 2016, FNCB recorded a provision for loan and lease losses of $1.2 million compared to a credit for loan and lease losses of $1.3 million for the year ended December 31, 2015. The provision for loan and lease losses in 2016 was due largely to net charge-offs of $1.5 million during 2016. Net charge-offs within the commercial real estate, commercial and industrial and consumer segments were the most elevated, totaling $0.4 million, $0.6 million, and $0.4 million, respectively. The credit for loan and lease losses in 2015 was due largely to improvement in FNCB’s historical loss and certain qualitative factors and levels of classified loans. The balance of loans classified as “Substandard” decreased $8.9 million, or 34.7%, to $16.8 million at December 31, 2015 from $25.7 million at the end of 2014.

 

32

 

 

Non-Interest Income

 

The following table presents the components of non-interest income for the years ended December 31, 2017, 2016 and 2015:

 

 

Components of Non-Interest Income

 

   

Year Ended December 31,

 

(in thousands)

 

2017

   

2016

   

2015

 

Deposit service charges

  $ 2,903     $ 2,892     $ 2,960  

Net gain on the sale of securities

    1,597       960       2,296  

Net gain on the sale of mortgage loans held for sale

    304       340       292  

Net gain on the sale of SBA guaranteed loans

    79       51       -  

Net gain on the sale of other repossessed assets

    47       -       -  

Net gain on the sale of other real estate owned

    79       49       162  

Loan-related fees

    384       439       442  

Income from bank-owned life insurance

    527       552       564  

Other

    1,305       920       1,084  

Total non-interest income

  $ 7,225     $ 6,203     $ 7,800  

 

2017 compared to 2016

 

For the year ended December 31, 2017, non-interest income increased $1.0 million, or 16.5%, to $7.2 million compared to $6.2 million for the same period of 2016. The increase was due largely to an increase in net gains on the sale of securities of $0.6 million, or 66.4%, coupled with an increase in other income of $0.4 million, or 41.9%. Net gains on the sale of other real estate owned were $79 thousand in 2017, an increase of $30 thousand, or 61.2%, compared to $49 thousand in 2016. Also affecting non-interest income was an increase in net gains on the sale of guaranteed principal balances of loans guaranteed by the SBA of $28 thousand, or 54.9%, to $79 thousand in 2017 from $51 thousand in 2016. FNCB also recorded a net gain on the sale of other repossessed assets of $47 thousand during 2017.

 

Partially offsetting these increases in non-interest income were decreases of $55 thousand, or 12.5%, in loan-related fees, concentrated in reduced letter of credit fees, coupled with decreases of $36 thousand in net gains on the sale of mortgage loans and $25 thousand, or 4.5%, in income from bank-owned life insurance policies. Service charges on deposit accounts remained steady, increasing by $11 thousand, or 0.4%, in 2017 as compared to 2016.

 

2015 compared to 2014

 

Non-interest income decreased $1.6 million, or 20.5%, to $6.2 million in 2016 compared to $7.8 million in 2015. Non-interest income levels in 2016 were largely impacted by a reduction in net gains on the sale of securities of $1.3 million, or 58.2%, from $2.3 million during 2015 to $1.0 million during 2016. In addition, FNCB received non-recurring income from legal settlements of $0.2 million in 2015.

 

Also affecting non-interest income were reductions in deposit services charges and net gains on the sale of OREO, which were partially mitigated by increases in gains from loan sales. Deposit service charges also declined slightly by $68 thousand, or 2.3%. The sale of OREO properties generated net gains of $49 thousand in 2016, a decrease of $113 thousand, or 69.8%, from $162 thousand in 2015. Partially offsetting these decreases was an increase in net gains on the sale of mortgage loans held for sale of $48 thousand, or 16.4%, from $292 thousand in 2015 to $340 thousand in 2016. Also during 2016, FNCB realized a net gain of $51 thousand on the sale of the guaranteed principal balance of three loans that were guaranteed by the SBA. Loan-related fees, income from bank-owned life insurance policies, and other income remained steady comparing 2016 and 2015.

 

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Non-Interest Expense

 

The following table presents the major components of non-interest expense for the years ended December 31, 2017, 2016 and 2015:

 

Components of Non-Interest Expense

 

   

Year Ended December 31,

 

(in thousands)

 

2017

   

2016

   

2015

 

Salaries and employee benefits

  $ 14,161     $ 14,320     $ 13,810  

Occupancy expense

    2,105       1,777       2,284  

Equipment expense

    1,815       1,732       1,657  

Advertising expense

    623       554       483  

Data processing expense

    2,023       1,997       1,976  

Regulatory assessments

    686       729       950  

Bank shares tax

    800       836       705  

Expense of other real estate

    488       409       400  

Legal expense

    128       362       437  

Professional fees

    956       961       1,014  

Insurance expense

    519       516       659  

Legal settlements

    -       -       777  

Other losses

    503       277       281  

Other operating expenses

    3,262       3,075       3,031  

Total non-interest expense

  $ 28,069     $ 27,545     $ 28,464  

 

2017 compared to 2016

 

Non-interest expense totaled $28.0 million in 2017, an increase of $0.5 million, or 1.9%, from $27.5 million in 2016. The increase resulted primarily from increases in occupancy expense, other losses, other operating expenses, equipment expense, expenses of other real estate owned, and advertising expenses. Partially mitigating these increases were decreases in legal expense, salaries and employee benefits, regulatory expenses, and bank shares tax.

 

Long-term facilities planning contributed to an increase in occupancy expense of $0.3 million, or 18.5%, to $2.1 million in 2017 as compared to $1.8 million in 2016. Specifically, FNCB accelerated depreciation of certain leasehold improvements resulting from future facilities planning which contributed $0.2 million to the increase in occupancy expense over 2016, coupled with increases in rent expense and snow removal costs.

 

Other operating expenses increased $0.2 million, or 6.1%, to $3.3 million in 2017 from $3.1 million in 2016. The increase was attributable to increases in loan-related expenses related to a “No Closing Costs Loan Sale” for its real estate secured retail lending products launched during 2017, coupled with an increase in telecommunication expenses related to ongoing network improvement projects and an increase in the required provision for off-balance sheet commitments. FNCB also experienced an increase in other losses during 2017, due largely to losses resulting from external fraud activities and software abandonment costs. Also contributing to the increase in non-interest expenses for 2017 were increases in equipment expense of $83 thousand, expenses of other real estate owned of $79 thousand, and advertising expenses of $69 thousand.

 

Legal expenses continued to decline throughout 2017 as outstanding litigation was resolved. Legal expenses declined $0.2 million, or 64.6%, from $0.3 million in 2016 to $0.1 million in 2017.

 

FNCB experienced a decrease in salaries and employee benefit costs of $0.1 million, or 1.1%, to $14.2 million in 2017 as compared to $14.3 million in 2016. The decline was concentrated in salaries expense, resulting from a reduction in the number of full-time equivalent employees to 230 at December 31, 2017 from 236 at December 31, 2016, coupled with a reduction in severance-related costs. These decreases were partially offset by increases in health insurance premiums.

 

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During 2016, FNCB converted from a national charter to a state charter, which contributed to the $43 thousand, or 5.9%, reduction in regulatory expenses for 2017 as compared to 2016. FNCB also experienced a reduction in bank shares tax expense of $36 thousand, or 4.3%, comparing 2017 and 2016.

 

2016 compared to 2015

 

Non-interest expense totaled $27.5 million in 2016, a decrease of $0.9 million, or 3.2%, from $28.5 million in 2015. The decrease resulted primarily from reductions in legal settlements, occupancy expense, regulatory assessments, insurance expenses, legal expenses, and professional fees. Partially offsetting these decreases were increases in salaries and employee benefits, bank shares tax, equipment expense and advertising expenses.

 

Long-term facilities planning and the relocation of one of the Bank’s corporate offices contributed to occupancy expense reductions of $0.5 million, or 22.2%, to $1.8 million in 2016 as compared to $2.3 million in 2015. Specifically, FNCB experienced decreases in rent expense, maintenance expenses, snow removal costs, and utilities expenses.

 

Included in regulatory assessments expense are FDIC insurance assessments and semi-annual assessments imposed by the Bank’s primary regulator. FNCB experienced a $0.2 million, or 23.3%, reduction in regulatory assessment expense comparing 2016 and 2015. The decrease largely reflected the Bank’s conversion from a national charter to a state charter and continued improvement in the Bank’s risk profile. The change in charter resulted in a reduction in semi-annual regulatory assessments of $150 thousand, or 53.4%, to $131 thousand in 2016 from $281 thousand in 2015. In addition, during the second quarter of 2015, FNCB was notified by the FDIC that the Bank’s risk category for FDIC assessments had improved to a risk category I, the lowest risk category from risk category II based upon the results of its most recent regulatory examination. The change in risk categories became effective on February 1, 2015, and as a result the Bank’s initial base assessment rate for deposit insurance decreased from 0.14 basis points to a range of 0.05 – 0.09 basis points. FNCB was able to realize a full-year of lower assessment rates in 2016, which resulted in a $71 thousand, or 10.6%, reduction in FDIC assessments comparing 2016 and 2015. Moreover, FNCB’s improved risk profile contributed to a $0.1 million, or 21.7%, reduction in insurance expenses.

 

Legal and professional fee expenses continued to decline throughout 2016 as outstanding litigation was resolved and reliance on outside consulting firms declined. Legal expenses declined $75 thousand, or 17.2%, as compared to 2015, while professional fees decreased $53 thousand, or 5.2%.

 

FNCB experienced an increase in salaries and employee benefit costs of $0.5 million, or 3.7%, to $14.3 million in 2016 as compared to $13.8 million in 2015. Despite a reduction in the number of full-time equivalent employees to 236 at December 31, 2016 from 250 at December 31, 2015, total salary expense increased $245 thousand, or 2.1%, due to annual merit increases and severance-related costs. Payroll taxes and employee benefits increased $265 thousand, or 11.1%, which largely reflected higher health insurance premiums and an increase in the state unemployment compensation rate.

 

On October 1, 2015, the Bank executed a Supplemental Executive Retirement Plan (“SERP”) for a select group of management or highly compensated employees within the meaning of Sections 201(2), 301(a)(3) and 401(a)(1) of The Employee Retirement Income Security Act of 1974. The general provisions of the SERP provide for annual year-end contributions, performance contingent contributions and discretionary contributions. The SERP contributions are unfunded for federal tax purposes and constitute an unsecured promise by the Bank to pay benefits in the future. Participants in the SERP shall have the status of general unsecured creditors of the Bank. Annual accrued unfunded contributions included in salaries and employee benefits expense totaled $147 thousand in 2016 and $130 thousand in 2015.

 

Provision for Income Taxes

 

FNCB recorded income tax expense of $11.3 million in 2017, an increase of $9.5 million as compared to $1.7 million in 2016. The increase in income tax expense was due largely to a non-recurring revaluation of deferred tax assets, net of deferred tax liabilities, resulting in a decrease in net deferred tax assets and a corresponding increase in income tax expense of $8.0 million during 2017, coupled with higher pre-tax income. The revaluation of FNCB’s deferred tax assets resulted from the reduction in the statutory corporate tax rate from a maximum federal corporate income tax rate of 35% to 21%, under the Tax Act signed into law on December 22, 2017. FNCB recorded a benefit for income taxes during 2015 of $27.8 million, resulting primarily from the reversal of a previously established valuation allowance for deferred tax assets.

 

Management evaluates the carrying amount of its deferred tax assets on a quarterly basis, or more frequently, if necessary, in accordance with guidance set forth in ASC Topic 740 “Income Taxes,” and applies the criteria in the guidance to determine whether it is more likely than not that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight of available evidence. If management determines based on available evidence, both positive and negative, that it is more likely than not that some portion or all of the deferred tax asset will not be realized in future periods, a valuation allowance is calculated and recorded. These determinations are inherently subjective and depend upon management’s estimates and judgments used in their evaluation of both positive and negative evidence.

 

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In evaluating available evidence, management considers, among other factors, historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. In assessing the need for a valuation allowance, management carefully weighs both positive and negative evidence currently available.

 

Management performed an evaluation of FNCB’s deferred tax assets at December 31, 2015 and determined that based on its consistent methodology the negative evidence that had been present at December 31, 2014 no longer existed, and accordingly reversed the previously established valuation allowance for deferred tax assets. Similarly, based on management’s evaluation of available positive and negative evidence at December 31, 2017 and 2016, a valuation allowance for deferred tax assets was not required.

 

The decrease in the federal corporate income tax rate to 21.0% under the Tax Act became effective on January 1, 2018. Management anticipates a reduction in income tax expense going forward due to the reduction in corporate tax rate.

 

FINANCIAL CONDITION

 

Total assets were $1.162 billion at December 31, 2017, a decrease of $33.3 million, or 2.8%, from $1.196 billion, at December 31, 2016. The decrease in total assets was led by a reduction in cash and cash equivalents, as cash was used to fund growth in interest-earning assets and pay down borrowings, coupled with a reduction in interest-bearing deposits. Loans, net of net deferred loan costs and unearned income grew $39.4 million, or 5.4%, to $770.6 million at December 31, 2017 from $731.3 million at December 31, 2016. Securities available for sale increased $14.4 million, or 5.2%, to $290.4 million at December 31, 2017 from $276.0 million at the end of 2016. Total deposits decreased $12.7 million, or 1.3%, and borrowed funds declined $18.6 million, or 23.6%.

 

Total shareholders’ equity declined $1.2 million, or 1.3%, to $89.2 million at December 31, 2017 from $90.4 million at the end of 2016. Dividends declared during 2017 of $2.2 million and an increase in the accumulated other comprehensive loss of $0.2 million were the primary factors causing the reduction in capital, partially offset by common shares issued through the dividend reinvestment and optional cash purchase plans of $0.4 million, stock-based compensation of $0.3 million and net income of $0.1 million. Dividends declared and paid by FNCB on its common stock totaled $0.13 per share during 2017. On January 31, 2018, the Board of Directors of FNCB declared a $0.04 per share dividend for the first quarter of 2018, payable on March 15, 2018 to shareholders of record on March 1, 2018.

 

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. Management classifies investment securities as either held-to-maturity or available-for-sale at the time of purchase based on its 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. At December 31, 2017 and 2016, all securities were classified as available-for-sale. 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. Securities with limited marketability and/or restrictions, such as FHLB of Pittsburgh stock, are carried at cost.

 

At December 31, 2017, FNCB’s investment portfolio was comprised principally of fixed-rate securities issued by U.S. government or U.S. government-sponsored agencies, which include mortgage-backed securities and residential and commercial CMOs, fixed-rate taxable obligations of state and political subdivisions, and corporate debt securities. Except for U.S. government and government-sponsored agencies, there were no securities of any individual issuer that exceeded 10.0% of shareholders’ equity as of December 31, 2017.

 

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Because of the predominantly fixed-rate nature of the portfolio, FNCB’s debt securities are inherently subject to interest rate risk, defined as the risk that an investment’s value will change due to a change in interest rates, in the spread between two rates and in the shape of the yield curve. A security’s value is usually affected inversely by changes in rates. U.S. Treasury rates fell to near-historical lows mid-2016 following the United Kingdom’s referendum to exit the European Union. During 2017, short-term U.S. Treasury rates rose steadily due to a more expansionary fiscal and monetary policy. However, spreads between short- and long-term rates narrowed causing the yield curve to flatten. The 2-year Treasury rate, which was 1.19% at December 31, 2016, rose 18 basis points to 1.38% at June 30, 2017 and then climbed 51 basis points to 1.89% at December 31, 2017. Conversely, the 10-year Treasury rate, which was 2.45% at December 31, 2016, fell 14 basis points to 2.31% at June 30, 2017 before rebounding 9 basis points to close 2017 5basis points lower than at close of 2016. The spread between the 2-year and 10-year U.S. Treasury rate compressed 75 basis points from 126 basis points at December 31, 2016 to 51 basis points at December 31, 2017. FNCB reported a net unrealized holding loss on its investment portfolio of $1.7 million, net of income taxes of $464 thousand, at December 31, 2017, compared to an unrealized holding loss of $1.6 million, net of income taxes of $0.8 million, at December 31, 2016. Any additional increases in interest rates could result in further depreciation in the fair value of FNCB’s securities portfolio and capital position.

 

The following table presents the carrying value of available-for-sale securities, which are carried at fair value at December 31, 2017, 2016 and 2015:

 

Composition of the Investment Portfolio

 

   

December 31,

 

(in thousands)

 

2017

   

2016

   

2015

 

Available-for-sale

                       

Obligations of U.S. government agencies

  $ -     $ 12,188     $ 44,043  

Obligations of state and political subdivisions

    145,999       117,873       75,407  

U.S. government/government-sponsored agencies:

                       

Collateralized mortgage obligations - residential

    35,657       18,084       22,269  

Collateralized mortgage obligations - commercial

    75,418       99,350       89,423  

Mortgage-backed securities

    22,311       20,576       18,098  

Corporate debt securities

    4,058       3,792       3,692  

Asset-backed securities

    3,086       -       -  

Negotiable certificates of deposit

    2,930       3,216       3,162  

Equity securities

    928       936       948  

Total available-for-sale securities

  $ 290,387     $ 276,015     $ 257,042  

 

Management monitors the investment portfolio regularly and adjusts the investment strategy to reflect changes in liquidity needs, asset/liability strategy and tax-planning requirements. FNCB currently has $40.5 million in net operating loss (“NOL”) carryovers, which it uses to offset any taxable income. Because of this tax position, there is no benefit from holding tax-exempt obligations of state and political subdivisions. Accordingly, management’s actions during recent periods with regard to managing the investment portfolio have reflected current tax-planning initiatives focused on generating sustained taxable income to be able to reduce NOL carryovers.

 

FNCB’s investment strategy involved selling lower-yielding securities of U.S. government and government-sponsored agencies and reinvesting the proceeds from the sales, as well as normal monthly cash flows from the portfolio, into higher-yielding taxable obligations of state and political subdivisions and multi-family mortgage-backed securities and CMOs of U.S. government/government-sponsored agencies. During 2017, management sold 38 available-for-sale securities with an aggregate amortized cost of $130.6 million and a weighted-average yield of 2.40%. Gross proceeds received totaled $132.2 million, with net gains of $1.6 million realized upon the sales and included in non-interest income.

 

Securities purchased during the year ended December 31, 2017 totaled $154.7 million, including $100.8 million in CMOs of U.S. government-sponsored agencies, $39.7 million in obligations of state and political subdivisions, $8.2 million in mortgage-backed securities of U.S. government-sponsored agencies, $4.0 million in asset-backed securities and $2.0 million in corporate debt securities. Securities purchased during 2017 had a weighted-average yield of 2.76%.

 

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The following table presents the maturities of available-for-sale securities, based on carrying value at December 31, 2017, 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 states and political subdivisions are presented on a tax-equivalent basis using FNCB’s historic effective tax rate of 34.0%. Because residential and commercial 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.

 

Maturity Distribution of the Investment Portfolio

 

   

December 31, 2017

 

(dollars in thousands)

 

Within

One Year

   

> 1 – 5

Years

   

6 - 10

Years

   

Over

10 Years

    Collateralized Mortgage Obligations, Mortgage-Backed and Asset-Backed Securities    

No Fixed

Maturity

   

Total

 

Available-for-sale securities

                                                       

Obligations of U.S. government agencies

  $ -     $ -     $ -     $ -     $ -     $ -     $ -  

Yield

                                                       

Obligations of state and political subdivisions

    -       36,515       109,484       -       -       -       145,999  

Yield

            2.49 %     2.84 %                             2.75 %

U.S. government/government-sponsored agencies:

                                                       

Collateralized mortgage obligations - residential

    -       -       -       -       35,657       -       35,657  

Yield

                                    2.77 %             2.77 %

Collateralized mortgage obligations - commercial

    -       -       -       -       75,418       -       75,418  

Yield

                                    2.50 %             2.50 %

Mortgage-backed securities

    -       -       -       -       22,311       -       22,311  

Yield

                                    2.88 %             2.88 %

Corporate debt securities

    -       -       4,058       -       -       -       4,058  

Yield

                    6.63 %                             6.63 %

Asset-backed securities

    -       -       -       -       3,086       -       3,086  

Yield

                                    2.46 %             2.46 %

Negotiable certificates of deposit

    496       2,434       -       -       -       -       2,930  

Yield

    1.85 %     2.14 %                                     2.09 %

Equity securities

    -       -       -       -       -       928       928  

Yield

                                            3.45 %     3.45 %

Total available-for-sale securities

  $ 496     $ 38,949     $ 113,542     $ -     $ 136,472     $ 928     $ 290,387  

Weighted average yield

    1.85 %     2.47 %     2.97 %     0.00 %     2.63 %     3.45 %     2.75 %

 

OTTI Evaluation

 

There was no OTTI recognized during the years ended December 31, 2017, 2016 and 2015. For additional information regarding management’s evaluation of securities for OTTI, see Note 4, “Securities” of the notes to consolidated financial statements included in Item 8, “Financial Statement and Supplementary Data” of this Annual Report on Form 10-K.

 

Investment in the Federal Home Loan Bank (“FHLB”) of Pittsburgh stock has limited marketability and is carried at cost. FNCB’s investment in FHLB of Pittsburgh stock totaled $2.8 million and $3.3 million at December 31, 2017 and 2016, respectively. Management noted no indicators of impairment for the FHLB of Pittsburgh stock at December 31, 2017. During the year ended December 31, 2016, the Bank canceled its membership with the Federal Reserve Bank of Philadelphia (“FRB”), and as a result, the entire balance of FRB stock totaling $1.3 million was redeemed.

 

During the year ended December 31, 2017, FNCB purchased $1.7 million, representing a 4