10-K 1 d671933d10k.htm 10-K 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

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

For the fiscal year ended December 31, 2018

 

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

For the transition period from                      to                 

Commission file number: 001-38627

 

 

Riverview Financial Corporation

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania   38-3917371

State or other jurisdiction of

incorporation or organization

 

(I.R.S. Employer

Identification No.)

3901 North Front Street,

Harrisburg, PA 17110

(Address of principal executive offices) (Zip Code)

(717)957-2196

Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act: Voting Common Stock.

Securities registered pursuant to Section 12(g) of the Act: None

 

 

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

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

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

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

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer   ☐  (Do not check if a smaller reporting company)    Smaller reporting 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 Act).    Yes  ☐    No  ☒

The aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates of the registrant, on June 30, 2018, the last day of the registrant’s most recently completed second fiscal quarter, was approximately $111,869,748 (based on the closing sales price of the registrant’s common stock on that date). (1)

The number of shares of the registrant’s voting common stock outstanding as of February 28, 2019 was 7,801,010 shares. The number of shares of the registrant’s non-voting common stock outstanding as of February 28, 2019 was 1,348,809 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement to be filed in connection with solicitation of proxies for its 2019 annual meeting of shareholders, within 120 days of the end of registrant’s fiscal year, is incorporated by reference into Part III of this Annual Report on Form 10-K.

 

(1) 

The aggregate dollar amount of the voting stock set forth equals the number of shares of the Company’s voting and nonvoting common stock outstanding, reduced by the number of shares of voting and nonvoting common stock held by officers, directors, shareholders owning in excess of 10% of the Company’s Common Stock and the Company’s employee benefit plans multiplied by the last reported sale price for the Company’s Common Stock on June 30, 2018, the last business day of the registrants most recently completed second fiscal quarter. The information provided shall not be construed as an admission that any officer, director or 10% shareholder of the Company, or any employee benefit plan, may be deemed an affiliate of the Company or that such person or entity is the beneficial owner of the shares reported as being held by such person or entity, and any such inference is hereby disclaimed.

 

 

 


Table of Contents

Riverview Financial Corporation

Form 10K

For the Year Ended December 31, 2018

TABLE OF CONTENTS

 

          Page
Number
 

PART I

  

Item 1.

   Business      4  

Item 1A.

   Risk Factors      15  

Item 1B.

   Unresolved Staff Comments      15  

Item 2.

   Properties      15  

Item 3.

   Legal Proceedings      16  

Item 4.

   Mine Safety Disclosures      16  

PART II

  

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      16  

Item 6.

   Selected Financial Data      16  

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      17  

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk      40  

Item 8.

   Financial Statements and Supplementary Data      41  

Item 9.

   Changes in and Disagreements With Accountants on Accounting and Financial Disclosure      90  

Item 9A.

   Controls and Procedures      90  

Item 9B.

   Other Information      92  

PART III

  

Item 10.

   Directors, Executive Officers and Corporate Governance      92  

Item 11.

   Executive Compensation      92  

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      92  

Item 13.

   Certain Relationships and Related Transactions, and Director Independence      92  

Item 14.

   Principal Accounting Fees and Services      92  

PART IV

  

Item 15.

   Exhibits, Financial Statement Schedules      93  

SIGNATURES

     97  

 

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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 Riverview Financial Corporation and its direct and indirect subsidiaries. These forward-looking statements are generally identified by use of the words such as “may”, “should”, “will”, “could”, “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project”, “plan”, “goal”, “strategy”, “likely”, “seek”, “future”, “target”, “preliminary”, “range” or similar expressions. All statements in this report, other than statements of historical facts, are forward-looking statements.

Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:

 

   

the ability to achieve the intended benefits of the merger with CBT Financial Corp.;

 

   

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

 

   

increases in non-performing assets, which may require Riverview Financial Corporation to increase the allowance for credit 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 the Riverview Financial Corporation 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 Riverview Financial Corporation’s products and services;

 

   

the effects of changes in interest rates or disruptions in liquidity markets on Riverview Financial Corporation’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 our loan and investment portfolios;

 

   

demand for loan and other products;

 

   

our ability to attract and retain deposits;

 

   

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

 

   

changes in the values of real estate and other collateral securing the loan portfolio, particularly in our market area;

 

   

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

 

   

the ability to keep pace with technological changes;

 

   

the ability to attract and retain talented personnel;

 

   

capital and liquidity strategies, including Riverview Financial Corporation’s ability to comply with applicable capital and liquidity requirements, and its ability to generate capital internally or raise capital on favorable terms;

 

   

Riverview Financial Corporation’s reliance on its subsidiaries for substantially all revenues and its ability to pay dividends or other distributions;

 

   

the effects of changes in relevant accounting principles and guidelines on Riverview Financial Corporation’s financial condition; and

 

   

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

Any forward-looking statement made by us in this document is based only on information currently available to us and speaks only as of the date on which it is made. Riverview Financial Corporation undertakes no obligation, other than as required by law, to update or revise any forward-looking statements as a result of new information, future events or otherwise.

 

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Part I

 

Item 1.

Business.

General

Riverview Financial Corporation (the “Company”) was formed in 2013 as a bank holding company incorporated under the laws of Pennsylvania. The Company provides a full range of financial services through its wholly-owned bank subsidiary, Riverview Bank (the “Bank”), which is its sole operating segment. The Company has approximately 310 employees.

The Bank is a state-chartered bank and trust company regulated by the Pennsylvania Department of Banking and Securities (“DOB”) and the Federal Deposit Insurance Corporation (“FDIC”) that offers financial services through 28 community banking offices and four limited purpose offices.

Effective October 1, 2017, the Company merged with CBT Financial Corp. (“CBT”) and its subsidiary, CBT Bank, merged with and into the Bank. The Company’s financial results reflect the merger of CBT Bank and the Bank under the purchase method of accounting, with the Company treated as the acquirer from an accounting standpoint.

Unless the context indicates otherwise, all references in this annual report to the “Company”, “Bank”, “we,” “us” and “our” refer to Riverview Financial Corporation, its direct and indirect subsidiaries and its and their respective predecessors.

We primarily generate income through interest income derived from our loan and securities portfolios. Other income is generated primarily from transaction fees, trust and wealth management fees, mortgage banking fees and service charges on deposit accounts. Our primary costs are interest paid on deposits and borrowings and general operating expenses. We provide a variety of commercial and retail banking and financial services to businesses, non-profit organizations, governmental and municipal agencies, professional customers, and retail customers, on a personalized basis.

Market Areas

The Bank’s market area consists of Berks, Blair, Centre, Clearfield, Dauphin, Huntingdon, Lebanon, Lycoming, Northumberland, Perry, Schuylkill and Somerset Counties in Central Pennsylvania.

Products and Services

The Bank offers a variety of consumer and commercial banking products and services throughout its market area. Our primary lending products are real estate, commercial and consumer loans. Our primary deposit products are NOW, demand deposit accounts, and certificate of deposit accounts. We also offer ATM access, investment accounts, trust department services and other various lending, depository and related financial services.

Lending Activities

We provide a full range of retail and commercial lending products designed to meet the borrowing needs of consumers and small- and medium-sized businesses in our market area. A significant amount of our loans are made to customers located within our market area. We have no foreign loans or highly leveraged transaction loans, as defined by the Board of Governors of the Federal Reserve. Although we participate in loans originated by other banks, we have originated the majority of the loans in our portfolio.

Our primary commercial products are loans to small- and medium- sized businesses. Our consumer products include one-to-four family residential mortgages, consumer, automobile, home equity, educational and lines of credit loans. Our retail lending products include the following types of loans, among others: residential real estate; automobiles; manufactured housing; personal; student; and home equity. Our commercial lending products include the following types of loans, among others: commercial real estate; working capital; equipment and other commercial needs; construction; and agricultural and mineral rights. The terms offered on a loan vary depending on the type of loan and credit-worthiness of the borrower. We fund our loans, primarily, from our various deposit products which include certificates of deposits, savings, money market and various demand deposit accounts that are offered to both consumer and commercial customers.

Payment risk is a function of the economic climate in which our lending activities are conducted. Economic downturns in the economy generally, or in a particular sector, could cause cash flow problems for our customers, impairing their ability to repay loans we make to them. We attempt to minimize this risk by avoiding loan concentrations to a single customer or a group of similar customer types, the loss of any one or more of whom would have a materially adverse effect on its financial condition. One element of interest rate risk arises from making fixed rate loans in an environment of changing interest rates. We attempt to mitigate this risk by making adjustable rate loans and by limiting repricing terms to five years or less for commercial customers requiring fixed rate loans.

 

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Our lending activity also exposes us to the risk that any collateral we take as security is not adequate. We attempt to manage collateral risk by avoiding loan concentrations to particular types of borrowers, by perfecting liens on collateral and by obtaining appraisals on property prior to extending loans. We attempt to mitigate our exposure to these and other types of lending risks by stratifying authorization requirements by loan size and complexity.

We are not dependent upon a single customer, or a few customers, the loss of one or more of which would have a materially adverse effect on our operations. In the ordinary course of our business, our operations and earnings are not materially affected by seasonal changes or by Federal, state or local environmental laws or regulations.

We intend to continue to evaluate commercial real estate, commercial business and governmental lending opportunities, including small business lending. We continue to proactively monitor and manage existing credit relationships.

We have not engaged in sub-prime residential mortgage lending, which is defined as mortgage loans advanced to borrowers who do not qualify for market interest rates because of problems with their credit history. We focus our lending efforts within our market area.

Deposit Activities

Our primary source of funds is the cash flow provided by our financing activities, mainly deposit gathering. We offer a variety of deposit accounts with a range of interest rates and terms, including, among others: money market accounts; NOW accounts; savings accounts; certificates of deposit; individual retirement accounts, and demand deposit accounts. These deposits are primarily obtained from areas surrounding our branch offices. We rely primarily on marketing, product innovation, technology, service and long-standing relationships with customers to attract and retain deposits. Other deposit related services include: remote deposit capture; automatic clearing house transactions; cash management services; automated teller machines; point of sale transactions; safe deposit boxes; night depository services; direct deposit; and official check services.

Trust, Wealth Management and Brokerage Services

Through our trust department, we offer a broad range of fiduciary and investment services. Our trust and investment services include:

 

   

investment management;

 

   

IRA trustee services;

 

   

estate administration;

 

   

living trusts;

 

   

trustee under will;

 

   

guardianships;

 

   

life insurance trusts;

 

   

custodial services / IRA custodial services;

 

   

corporate trusts; and

 

   

pension and profit sharing plans.

We provide a comprehensive array of wealth management products and services through Riverview Wealth Management and Trust Management divisions to individuals, small businesses and nonprofit entities. These products and services include the following, among others: investment portfolio management; brokerage; estate planning assistance; annuities; business succession planning; insurance; education funding strategies; and tax planning assistance.

We have a third-party marketing agreement with a broker-dealer that allows us to offer a full range of securities, brokerage services and annuity sales to our customers. We have three dedicated locations that provide such investor services as well as accommodating customer meetings by appointment within our retail banking offices. Through these divisions, our clients have access to a wide array of financial products including stocks, bonds, mutual funds, annuities and insurance.

Competition

The banking and financial services industries are highly competitive. Within its geographic region, the Bank faces direct competition from other commercial banks, varying in size from local community banks to larger regional and nationwide banks, credit unions and non-bank entities. As a result of the wide availability of electronic delivery channels, the Bank also faces competition from financial institutions that do not have a physical presence in its geographic markets.

 

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Many of our competitors are substantially larger in terms of assets and available resources. Certain of these institutions have significantly higher lending limits than we do and may provide various services to their customers that we presently do not. In addition, we experience competition for deposits from mutual funds and broker dealers, while consumer discount, mortgage and insurance companies compete with us for various types of loans. Credit unions, finance companies and mortgage companies enjoy certain competitive advantages over us, as they are not subject to the same regulatory restrictions and taxation as commercial banks. Principal methods of competing for bank products, permitted nonbanking services and financial activities include price, nature of product, quality of service, convenience of location, and availability of banking convenience technology, including telephone and web-based banking services.

In our market area, interest rates on deposits, especially time deposits, and interest rates and fees charged to customers on loans are very competitive. In the current economic environment, we are experiencing increased competition in view of our loan demand and deposit gathering.

We believe that our most significant competitive advantage originates from our business philosophy, which includes offering direct access to senior management and other officers, providing friendly, informed and courteous service, local and timely decision making, flexible and reasonable operating procedures, and consistently applied credit policies. In addition, our success has been, and will continue to be, a result of our emphasis on community involvement and customer relationships. With consolidation continuing in the financial industry, and particularly in our market area, smaller community banks like us are gaining opportunities to increase market share as larger institutions reduce their emphasis on, or exit, the markets.

Seasonality

Generally, our operations are not seasonal in nature. Our deposit activities, however, have been somewhat influenced by fiscal funding appropriations related to municipalities and school districts in our market areas, which are to some extent seasonal in nature.

Supervision and Regulation

We are extensively regulated under federal and state laws. Generally, these laws and regulations are intended to protect consumers, not shareholders. The following is a summary description of certain provisions of law that affect the regulation of bank holding companies and banks. This discussion is qualified in its entirety by reference to applicable laws and regulations. Changes in laws and regulations may have a material effect on our business and prospects.

The Company is a bank holding company within the meaning of the BHCA and is subject to regulation, supervision, and examination by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”) or (“FRB”). We are required to file annual and quarterly reports with the FRB and to provide the FRB with such additional information as the FRB may require. The FRB also conducts periodic examinations of the Company. In addition, under the Pennsylvania Banking Code of 1965 of the Pennsylvania Department of Banking and Securities (“DOB”), has the authority to examine the books, records and affairs of the Company and to require any documentation deemed necessary to ensure compliance with the Pennsylvania Banking Code.

With certain limited exceptions, we are required to obtain prior approval from the FRB before acquiring direct or indirect ownership or control of more than 5% of any voting securities or substantially all assets of a bank or bank holding company, or before merging or consolidating with another bank holding company. Additionally, with certain exceptions, any person or entity proposing to acquire control through direct or indirect ownership of 25% or more of our voting securities is required to give 60 days’ written notice of the acquisition to the FRB, which may prohibit the transaction, and to publish notice to the public.

The Bank is primarily regulated by the DOB and the FDIC. The DOB may prohibit an institution, over which it has supervisory authority, from engaging in activities or investments that the agency believes constitute unsafe or unsound banking practices. Federal banking regulators have extensive enforcement authority over the institutions they regulate to prohibit or correct activities that violate law, regulation or a regulatory agreement or which are deemed to constitute unsafe or unsound practices.

Enforcement actions may include:

 

   

the appointment of a conservator or receiver;

 

   

the issuance of a cease and desist order;

 

   

the termination of deposit insurance, the imposition of civil money penalties on the institution, its directors, officers, employees and institution affiliated parties;

 

   

the issuance of directives to increase capital;

 

   

the issuance of formal and informal agreements and orders;

 

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the removal of or restrictions on directors, officers, employees and institution-affiliated parties; and

 

   

the enforcement of any such mechanisms through restraining orders or any other court actions.

We are subject to certain restrictions on extensions of credit to executive officers, directors, principal shareholders or any related interests of such persons which generally require that such credit extensions be made on substantially the same terms as are available to third parties dealing with us, and do not involve more than the normal risk of repayment or present other unfavorable features. Other laws limit the maximum amount that we may loan to any one customer as a percentage of our capital levels.

Permitted Non-Banking Activities

Generally, a bank holding company may not engage in any activities other than banking, managing or controlling its bank and other authorized subsidiaries, or providing service to those subsidiaries. With prior approval of the FRB, we may acquire more than 5% of the assets or outstanding shares of a company engaging in non-bank activities determined by the FRB to be closely related to the business of banking or of managing or controlling banks. The FRB provides expedited procedures for expansion into approved categories of non-bank activities.

Limitations on Dividends and Other Payments and Transactions

Our ability to pay dividends is largely dependent upon the receipt of dividends from the Bank. The Company relies on dividends from the Bank for its own ability to pay dividends to shareholders. Both federal and state laws impose restrictions on the ability of both the Company and the Bank to pay dividends.

Bank Holding Company Act (“BHCA”)

Subsidiary banks of a bank holding company are subject to certain quantitative and qualitative restrictions on extensions of credit to the bank holding company or its subsidiaries, and on the use of their securities as collateral for loans. These regulations and restrictions may limit the Company’s ability to obtain funds from the Bank for its cash needs, including funds for the payment of dividends, interest and operating expenses. Further, subject to certain exceptions, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements relating to any extension of credit, the lease or sale of property, or furnishing of services.

Under longstanding FRB policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to make capital injections into a troubled subsidiary bank, and the FRB may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. A required capital injection may be called for at a time when the holding company does not have the resources to provide it. In addition, depository institutions insured by the FDIC can be held liable for any losses incurred, or reasonably anticipated to be incurred, in connection with the default of or assistance provided to a commonly controlled FDIC-insured depository institution. Accordingly, in the event any insured subsidiary of a bank holding company causes a loss to the FDIC, other insured subsidiaries of a bank holding company could be required to compensate the FDIC by reimbursing it for the estimated amount of such loss. Such cross-guarantee liabilities generally are superior in priority to the obligation of the depository institutions to its shareholders, due solely to their status as shareholders, and obligations to other affiliates.

Pennsylvania Law

As a Pennsylvania bank holding company, the Company is subject to various restrictions on its activities as set forth in Pennsylvania law. This is in addition to those restrictions set forth in federal law. Under Pennsylvania law, a bank holding company that desires to acquire a bank or bank holding company that has its principal place of business in Pennsylvania must obtain permission from the DOB.

Financial Institution Reform, Recovery, and Enforcement Act (“FIRREA”)

FIRREA was enacted to address the financial condition of the Federal Savings and Loan Insurance Corporation, to restructure the regulation of the thrift industry, and to enhance the supervisory and enforcement powers of the federal bank and thrift regulatory agencies. As the primary federal regulator of the Bank, the FDIC, in conjunction with the DOB, is responsible for its supervision. When dealing with capital requirements, those regulatory bodies have the flexibility to impose supervisory agreements on institutions that fail to comply with regulatory requirements. The imposition of a capital plan, termination of deposit insurance, and removal or temporary suspension of an officer, director or other institution-affiliated person may cause enforcement actions.

 

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There are three levels of civil penalties under FIRREA:

 

   

The first tier provides for civil penalties of up to $5,500 per day for any violation of law or regulation;

 

   

The second tier provides for civil penalties of up to $27,500 per day if more than a minimal loss or a pattern is involved; and.

 

   

Finally, civil penalties of up to the lesser of $1.1 million or 1% of total assets per day may be assessed for knowingly or recklessly causing a substantial loss to an institution or taking action that results in a substantial pecuniary gain or other benefit.

Criminal penalties are increased to $1.1 million per violation and may be up to $5.5 million for continuing violations or for the actual amount of gain or loss. These penalties may be combined with prison sentences of up to five years. These penalties are subject to adjustment in accordance with inflation adjustment procedures prescribed under applicable law.

Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”)

FDICIA provides for, among other things:

 

   

publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants;

 

   

the establishment of uniform accounting standards by federal banking agencies;

 

   

the establishment of a “prompt corrective action” system of regulatory supervision and intervention, based on capitalization levels, with more scrutiny and restrictions placed on depository institutions with lower levels of capital;

 

   

additional grounds for the appointment of a conservator or receiver; and

 

   

restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements.

A central feature of FDICIA is the requirement that the federal banking agencies take “prompt corrective action” with respect to depository institutions that do not meet minimum capital requirements. Pursuant to FDICIA, the federal bank regulatory authorities have adopted regulations setting forth a five-tiered system for measuring the capital adequacy of the depository institutions that they supervise. Under these regulations, a depository institution is classified in one of the following capital categories:

 

   

“well capitalized”;

 

   

“adequately capitalized”;

 

   

“under capitalized”;

 

   

“significantly undercapitalized”; and

 

   

“critically undercapitalized”.

The Bank was categorized as “well capitalized” under the regulatory framework for prompt corrective action at December 31, 2018, based on the most recent notification from the FDIC. An institution may be deemed by the regulators to be in a capitalization category that is lower than is indicated by its actual capital position if, among other things, it receives an unsatisfactory examination rating with respect to asset quality, management, earnings or liquidity.

Beginning January 1, 2015, all insured depository institutions are required to incorporate the revised regulatory capital requirements, discussed below under the heading “Risk Based Capital Requirements”, into the prompt corrective action framework, including the new common equity tier 1 capital asset ratio and a higher tier 1 risk-based capital ratio.

FDICIA generally prohibits a depository institution from making any capital distributions, including payment of a cash dividend or paying any management fees to its holding company, if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized”. Significantly undercapitalized depository institutions may be subject to a number of other requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized and requirements to reduce total assets and stop accepting deposits from correspondent banks. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator generally within 90 days of the date such institution is determined to be critically undercapitalized.

FDICIA provides the federal banking agencies with significantly expanded powers to take enforcement action against institutions that fail to comply with capital or other standards. Such actions may include the termination of deposit insurance by the FDIC or the appointment of a receiver or conservator for the institution. FDICIA also limits the circumstances under which the FDIC is permitted to provide financial assistance to an insured institution before appointment of a conservator or receiver.

 

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Under FDICIA, as amended by the Riegle Community Development and Regulatory Improvement Act of 1994, the federal bank regulatory agencies adopted guidelines establishing general standards relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. Any institution that fails to meet these standards may be required to develop an acceptable plan, specifying the steps that the institutions will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. In July 2010, the federal banking agencies issued Guidance on Sound Incentive Compensation Policies (“Guidance”) that applies to all banking organizations supervised by the agencies, thereby including both the Company and the Bank. Pursuant to the Guidance, to be consistent with safety and soundness principles, a banking organization’s incentive compensation arrangements should: provide employees with incentives that appropriately balance risk and reward; be compatible with effective controls and risk management; and be supported by strong corporate governance, including active and effective oversight by the banking organization’s board of directors. Monitoring methods and processes used by a banking organization should be commensurate with the size and complexity of the organization and its use of incentive compensation. Specific regulatory requirements regarding incentive compensation are discussed in the section titled “Dodd-Frank Act”.

Risk-Based Capital Requirements

The federal banking regulators have adopted certain risk-based capital guidelines to assist in assessing capital adequacy of a banking organization’s operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse agreements, which are recorded as off-balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit-equivalent amounts of off-balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain US Treasury securities, to 100% for assets with relatively high credit risk, such as business loans.

A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets. The regulators measure risk-adjusted assets, which include off-balance-sheet items, against both total qualifying capital, Common Equity Tier 1 capital, and Tier 1 capital.

“Common Equity Tier 1 Capital” includes common equity and minority interest in equity accounts of consolidated subsidiaries, less goodwill and other intangibles, subject to certain exceptions and retained earnings.

“Tier 1”, or core capital, includes common equity, non-cumulative preferred stock and minority interest in equity accounts of consolidated subsidiaries, less goodwill and other intangibles, subject to certain exceptions.

“Tier 2”, or supplementary capital, includes, among other things, limited life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan and lease losses, subject to certain limitations less restricted deductions. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies.

In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations began January 1, 2015, while larger institutions (generally those with assets of $250 billion or more) began compliance on January 1, 2014. The final rules call for the following capital requirements:

A minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5%.

A minimum ratio of tier 1 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%.

In addition, the final rules establish a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets applicable to all banking organizations. If a banking organization fails to hold capital above the minimum capital ratios and the capital conservation buffer, it will be subject to certain restrictions on capital distributions and discretionary bonus payments to executives. The phase-in period for the capital conservation and countercyclical capital buffers for all banking organizations began on January 1, 2016, with final phase in to be completed by January 1, 2019.

 

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Under the proposed rules, accumulated other comprehensive income (“AOCI”) would have been included in a banking organization’s common equity tier 1 capital. The final rules allow community banks to make a one-time election not to include these additional components of AOCI in regulatory capital and instead use the existing treatment under the general risk-based capital rules that excludes most AOCI components from regulatory capital. The opt-out election was required to be made in the first call report or FR Y-9 series report that is filed after the financial institution becomes subject to the final rule. The Bank “opted-out” of the inclusion of the components of AOCI in regulatory capital.

Consistent with the Dodd-Frank Act, the new rules replace the ratings-based approach to securitization exposures, which is based on external credit ratings, with the simplified supervisory formula approach in order to determine the appropriate risk weights for these exposures. Alternatively, banking organizations may use the existing gross-up approach to assign securitization exposures to a risk weight category or choose to assign such exposures a 1,250 percent risk weight.

Under the new rules, mortgage servicing assets (“MSAs”) and certain deferred tax assets (“DTAs”) are subject to stricter limitations than those applicable under the current general risk-based capital rule. The new rules also increase the risk weights for past-due loans, certain commercial real estate loans, and some equity exposures, and makes selected other changes in risk weights and credit conversion factors.

Failure to meet applicable capital guidelines could subject a banking organization to a variety of enforcement actions including:

 

   

limitations on its ability to pay dividends;

 

   

the issuance by the applicable regulatory authority of a capital directive to increase capital, and in the case of depository institutions, the termination of deposit insurance by the FDIC, as well as to the measures described under FDICIA as applicable to undercapitalized institutions.

In addition, future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the Bank to grow and could restrict the amount of profits, if any, available for the payment of dividends to the Company.

At December 31, 2018, the Bank was “well capitalized” under the foregoing requirements with a common equity tier 1 risk-based capital ratio of 10.7%, tier 1 leverage capital ratio of 8.4%, tier 1 risk-based capital ratio of 10.7% and a total capital ratio of 11.4%.

Interest Rate Risk

Regulatory agencies include in their evaluations of a bank’s capital adequacy, an assessment of the bank’s interest rate risk exposure. The standards for measuring the adequacy and effectiveness of a banking organization’s interest rate risk management includes a measurement of board of directors and senior management oversight, and a determination of whether a banking organization’s procedures for comprehensive risk management are appropriate to the circumstances of the specific banking organization. We utilize internal interest rate risk models to measure and monitor interest rate risk. Finally, regulatory agencies, as part of the scope of their periodic examinations, evaluate our interest rate risk.

Community Reinvestment Act (“CRA”)

Under the CRA, the Bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to ascertain and meet the credit needs of its entire community, including low- and moderate-income areas. CRA is designed to create a system for bank regulatory agencies to evaluate a depository institution’s record in meeting the credit needs of its community. CRA regulations were completely revised as of July 1, 1995, to establish performance-based standards for use in examining for compliance. Assessment by bank regulators of CRA compliance focuses on three tests: (i) a lending test, to evaluate the institution’s record of making loans, including community development loans, in its designated assessment areas; (ii) an investment test, to evaluate the institution’s record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and areas and small businesses; and (iii) a service test, to evaluate the institution’s delivery of banking services throughout its CRA assessment area, including low and moderate income areas. The Bank had its last completed CRA compliance examination conducted January 30, 2017 and received a “satisfactory” rating.

Bank Secrecy Act, USA Patriot Act of 2001 (“Patriot Act”), and Related Rules and Regulations

The Patriot Act contains anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. Among other requirements, the Patriot Act and the related regulations impose the following requirements with respect to financial institutions:

 

   

Establishment of anti-money laundering programs;

 

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Establishment of a program specifying procedures for obtaining identifying information from customers seeking to open new accounts, including verifying the identity of customers within a reasonable period of time;

 

   

Establishment of enhanced due diligence policies, procedures and controls designed to detect and report money laundering; and

 

   

Prohibition on correspondent accounts for foreign shell banks and compliance with recordkeeping obligations with respect to correspondent accounts of foreign banks.

Failure to comply with the Patriot Act’s requirements could have serious legal, financial, regulatory and reputational consequences. In addition, bank regulators will consider a holding company’s effectiveness in combating money laundering when ruling on BHCA and Bank Merger Act applications.

In May 2018, a Financial Crimes Enforcement Network rule requiring banks to implement strengthened customer due diligence requirements took effect. Among other requirements, the rules contain explicit customer due diligence requirements and require banks to identify and verify the identity of beneficial owners of legal entity customers, subject to certain exclusions and exemptions.

Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank)

In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act became law. Dodd-Frank is intended to effect a fundamental restructuring of federal banking regulation. Among other things, Dodd-Frank created the Financial Stability Oversight Council to identify systemic risks in the financial system and gave federal regulators the authority to take control of and liquidate financial firms. Dodd-Frank additionally created the Consumer Financial Protection Bureau, an independent federal regulator that administers federal consumer protection laws. Dodd-Frank has and is expected to continue to have a significant impact on our business operations as its provisions take effect. It is expected that, as various implementing rules and regulations continue to be released, they will increase our operating and compliance costs and could increase our interest expense. Among the provisions that affect us or are likely to affect us are the following:

Volker Rule

As mandated by the Dodd-Frank Act, in December 2013, the OCC, FRB, FDIC, SEC and Commodity Futures Trading Commission issued a final rule (the “Final Rules”) implementing certain prohibitions and restrictions on the ability of a banking entity and non-bank financial company supervised by the FRB to engage in proprietary trading and have certain ownership interests in, or relationships with, a “covered fund” (the “Volker Rule”). On May 24, 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”) was signed into law. Among other relief, the EGRRCPA exempts banking organizations with $10 billion or less in total consolidated assets, and total trading assets and trading liabilities that are 5% or less of total consolidated assets, from the Volcker Rule.

Incentive-Based Compensation

The Dodd-Frank Act requires, in part, that the federal banking agencies and the SEC establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities that encourage inappropriate risk-taking by providing an executive officer, employee, director or principal shareholder with excessive compensation, fees, or benefits or that could lead to material financial loss to the entity. The federal banking agencies issued such proposed rules in April 2011 and issued a revised proposed rule in June 2016, implementing these requirements and prohibitions. The revised proposed rule would apply to all banks, among other institutions, with at least $1 billion in average total consolidated assets, for which it would go beyond the existing Guidance to (i) prohibit certain types and features of incentive-based compensation arrangements for senior executive officers, (ii) require incentive-based compensation arrangements to adhere to certain basic principles to avoid a presumption of encouraging inappropriate risk, (iii) require appropriate board or committee oversight and (iv) establish minimum recordkeeping and (v) mandate disclosures to the appropriate federal banking agency. The Company believes that it meets substantially all the standards that have been adopted.

Holding Company Capital Requirements

Dodd-Frank requires the FRB to apply consolidated capital requirements to bank holding companies that are no less stringent than those currently applied to depository institutions. Under these standards, trust preferred securities will be excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010, by a bank holding company with less than $15 billion in assets. Dodd-Frank additionally requires that bank regulators issue countercyclical capital requirements so that the required amount of capital increases in times of economic expansion are consistent with safety and soundness. EGRRCPA also requires the federal banking agencies to adopt a community bank leverage ratio of 8% to 10%, for qualifying banking organizations with total consolidated assets of less than $10 billion. Such institutions that satisfy the community bank leverage ratio would be deemed to satisfy generally applicable risk-based and leverage capital requirements, and to have the capital ratios that are required to be considered “well capitalized” under the prompt corrective action framework. Additionally, the EGRRCPA amends the federal banking agencies’ regulatory capital rules to narrow the definition of high volatility commercial real estate (“HVCRE”) loans, which receive a higher risk weighting than other commercial real estate loans under risk-based capital requirements.

 

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Deposit Insurance

Dodd-Frank permanently increases the maximum deposit insurance amount for banks, savings institutions and credit unions to $250,000 per depositor. Substantially all deposits of the Bank are insured up to that limit. Dodd-Frank also broadens the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. Dodd-Frank requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund (“DIF”) 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 reaches 1.50% of insured deposits. In lieu of the dividend payments, the FDIC has adopted progressively lower assessment rate schedules that become effective when the reserve ratio exceeds 2.0% and 2.5%. In setting the assessment rates necessary to meet the new 1.35% requirement, the FDIC is required to offset the effect of this provision on insured depository institutions with total consolidated assets of less than $10 billion, so that more of the cost of raising the reserve ratio will be borne by the institutions with more than $10 billion in assets. In October 2010, the FDIC adopted a restoration plan to ensure that the DIF reserve ratio reaches 1.35% by September 30, 2020. Additionally, on December 22, 2017, the Tax Cuts and Jobs Act was enacted, which, among other things, disallows the deduction of FDIC insurance premiums for tax purposes, effective January 1, 2018, where previously, FDIC insurance premiums were fully deductible for tax purposes.

The FDIC annually establishes for the DIF a designated reserve ratio, or DRR, of estimated insured deposits. The FDIC announced that the DRR for 2018 will remain at 2.00%, which is the same ratio that has been in effect since January 1, 2011. The FDIC is authorized to change deposit insurance assessment rates as necessary to maintain the DRR, without further notice-and-comment rulemaking, provided that: (i) no such adjustment can be greater than three basis points from one quarter to the next, (ii) adjustments cannot result in rates more than three basis points above or below the base rates and (iii) rates cannot be negative. On October 22, 2015, the FDIC issued a proposal to increase the reserve ratio for the DIF to the minimum level of 1.35%. The FDIC adopted the final rule on March 15, 2016, which imposes on insured depository institutions with $10 billion or more in total consolidated assets, a quarterly surcharge equal to an annual rate of 4.5 basis points applied to the deposit insurance assessment base, after making certain adjustments. The rule became effective on July 1, 2016.

Pursuant to the Dodd-Frank Act, the FDIC has backup enforcement authority over a depository institution holding company, such as the Company, if the conduct or threatened conduct of such holding company poses a risk to the DIF, although such authority may not be used if the holding company is generally in sound condition and does not pose a foreseeable and material risk to the DIF.

Corporate Governance

Dodd-Frank requires publicly-traded companies to give stockholders a non-binding vote on executive compensation at least every three years, a non-binding vote regarding the frequency of the vote on executive compensation at least every six years, and a non-binding vote on “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by stockholders. Additionally, Dodd-Frank directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the company is publicly traded. Dodd-Frank also gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.

Prohibition Against Charter Conversions of Troubled Institutions

Dodd-Frank prohibits a depository institution from converting from a state to a federal charter, or vice versa, while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of the conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days. The notice must include a plan to address the significant supervisory matters. The converting institution must also file a copy of the conversion application with its current federal regulator, which must notify the resulting federal regulator of any ongoing supervisory or investigative proceedings that are likely to result in an enforcement action and provide access to all supervisory and investigative information relating thereto.

Interstate Branching

Dodd-Frank authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be 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. Accordingly, banks are able to enter new markets more freely.

 

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Limits on Interstate Acquisitions and Mergers

Dodd-Frank precludes a bank holding company from engaging in an interstate acquisition–the acquisition of a bank outside its home state–unless the bank holding company is both well capitalized and well managed. Furthermore, a bank may not engage in an interstate merger with a bank headquartered in another state unless the surviving institution will be well capitalized and well managed. The previous standard in both cases was adequately capitalized and adequately managed.

Limits on Interchange Fees

Dodd-Frank amended the Electronic Fund Transfer Act to give the Federal Reserve the authority, among other things, to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. The Federal Reserve issued its final rule, Regulation II, effective October 1, 2011. Consistent with Dodd-Frank, issuers with less than $10 billion in assets, like the Company, are exempt from debit card interchange fee standards.

Consumer Financial Protection Bureau

Dodd-Frank 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, TILA, 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. Dodd-Frank 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, Dodd-Frank allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. Dodd-Frank 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 Consumer Financial Protection Bureau 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 will 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, is not expected to have a material impact on our lending activities or our results of operations or financial condition.

 

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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.

Consumer Lending Laws

Bank regulatory agencies are increasingly focusing attention on consumer protection laws and regulations. To promote fairness and transparency for mortgages, credit cards, and other consumer financial products and services, the Dodd-Frank Act established the CFPB. This agency is responsible for interpreting and enforcing federal consumer financial laws, as defined by the Dodd-Frank Act, that, among other things, govern the provision of deposit accounts along with mortgage origination and servicing. Some federal consumer financial laws enforced by the CFPB include the Equal Credit Opportunity Act, TILA, the Truth in Savings Act, the Home Mortgage Disclosure Act, RESPA, the Equal Credit Opportunity Act, the Fair Debt Collection Practices Act, and the Fair Credit Reporting Act. The CFPB is also authorized to prevent any institution under its authority from engaging in unfair, deceptive, or abusive acts or practices in connection with consumer financial products and services. As a residential mortgage lender, the Company and the Bank are subject to multiple federal consumer protection statutes and regulations, including, but not limited to, TILA, the Home Mortgage Disclosure Act, the Equal Credit Opportunity Act, RESPA, the Fair Credit Reporting Act, the Fair Debt Collection Act and the Flood Disaster Protection Act. Failure to comply with these and similar statutes and regulations can result in the Company and the Bank becoming subject to formal or informal enforcement actions, the imposition of civil money penalties, and consumer litigation.

Commercial Real Estate Guidance

In December 2015, the federal banking agencies released a statement entitled “Statement on Prudent Risk Management for Commercial Real Estate Lending” (the “CRE Statement”). In the CRE Statement, the agencies express concerns with institutions that ease commercial real estate underwriting standards, direct financial institutions to maintain underwriting discipline and exercise risk management practices to identify, measure and monitor lending risks, and indicate that they will continue to pay special attention to commercial real estate lending activities and concentrations going forward. The agencies previously issued guidance in December 2006, entitled “Interagency Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices”, which states that an institution is potentially exposed to significant commercial real estate concentration risk, and should employ enhanced risk management practices, where total commercial real estate loans represents 300% or more of its total capital and the outstanding balance of such institution’s commercial real estate loan portfolio has increased by 50% or more during the prior 36 months.

Privacy Protection and Cybersecurity

The Bank is subject to regulations implementing the privacy protection provisions of the GLB Act. These regulations require the Bank to disclose its privacy policy, including identifying with whom it shares “nonpublic personal information,” to customers at the time of establishing the customer relationship and annually thereafter. The regulations also require the Bank to provide its customers with initial and annual notices that accurately reflect its privacy policies and practices. In addition, to the extent its sharing of such information is not covered by an exception, the Bank is required to provide its customers with the ability to “opt-out” of having the Bank share their nonpublic personal information with unaffiliated third parties.

The Bank is subject to regulatory guidelines establishing standards for safeguarding customer information. These regulations implement certain provisions of the GLB Act. The guidelines describe the federal bank regulatory agencies’ expectations for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer. These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third parties in the provision of financial services. In October 2016, the federal banking agencies issued an advance notice of proposed rulemaking on enhanced cybersecurity risk-management and resilience standards that would apply to large and interconnected banking organizations and to services provided by third parties to these firms. These enhanced standards would apply only to depository institutions and depository institution holding companies with total consolidated assets of $50 billion or more.

 

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Federal Reserve System

FRB regulations require depository institutions to maintain cash reserves against their transaction accounts (primarily NOW and demand deposit accounts). A reserve of 3% is to be maintained against aggregate transaction accounts between $16.0 million and $122.3 million (subject to adjustment by the FRB) plus a reserve of 10% (subject to adjustment by the FRB between 8% and 14%) against that portion of total transaction accounts in excess of $122.3 million. The first $16.0 million of otherwise reservable balances (subject to adjustment by the FRB) is exempt from the reserve requirements. The Bank is in compliance with the foregoing requirements.

Required reserves must be maintained in the form of vault cash, an account at a Federal Reserve Bank or a pass-through account as defined by the FRB. Pursuant to the Emergency Economic Stabilization Act of 2008, the Federal Reserve Banks pay interest on depository institution required and excess reserve balances. The interest rate paid on required reserve balances is currently the average target federal funds rate over the reserve maintenance period. The rate on excess balances will be set equal to the lowest target federal funds rate in effect during the reserve maintenance period.

Future Legislation

Proposed legislation is introduced in almost every legislative session that would dramatically affect the regulation of the banking industry. We cannot predict if any such legislation will be adopted nor if adopted how it would affect our business. History has demonstrated that new legislation or changes to existing laws or regulations usually results in greater compliance burden and therefore generally increases the cost of doing business.

Employees

As of December 31, 2018, we had 310 employees. We are not parties to any collective bargaining agreements and we consider our employee relations to be good.

Availability of Securities Filings

Effective February 11, 2015, the Company became a reporting company and was required to file certain periodic reports under the Securities and Exchange Act of 1934 as required by Section 15(d) of that act. Effective August 10, 2018, the Company registered its stock under Section 12(b) of the Exchange Act and thereby became required to file certain additional periodic reports under the Exchange Act. We file the required annual, quarterly, and current reports, proxy statements, and other documents with the Securities and Exchange Commission (“SEC”). The SEC maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers, including us, that file electronically with the SEC. The public can obtain any documents that we file with the SEC at http://www.sec.gov.

In addition, we maintain an Internet website at www.riverviewbankpa.com. We make available, free of charge, through the “Investor Relations” link on our Internet website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

 

Item 1A.

Risk Factors.

Not required for smaller reporting companies.

 

Item 1B.

Unresolved Staff Comments.

None.

 

Item 2.

Properties.

Our corporate headquarters is located at 3901 North Front Street, Harrisburg, Pennsylvania, and includes our executive offices as well as portions of our finance, information services, credit, and branch administration departments. Portions of our deposit operations, human resource administration, as well as trust service offices are located at 2638 Woodglen Road, Pottsville, Pennsylvania. Portions of our loan operations, credit administration, BSA and IT departments are located at 200 Front Street, Marysville, Pennsylvania. Additionally, compliance and portions of finance operations, human resource administration and operations, loan and deposit operations, credit administration and trust operations and services are located at 11 North Second Street, Clearfield, Pennsylvania. Each of these facilities is owned by the Bank.

 

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The Bank operates 28 community banking offices and four limited purpose offices within Berks, Blair, Centre, Clearfield, Dauphin, Huntingdon, Lebanon, Lycoming, Northumberland, Perry, Schuylkill and Somerset Counties in Pennsylvania. Eight of the branch offices are leased by the Bank, while the remainder of the facilities are owned. All retail banking offices have ATMs and are equipped with closed circuit security monitoring.

We consider our properties to be suitable and adequate for our current and immediate future purposes.

 

Item 3.

Legal Proceedings.

In the opinion of the Company, after review with legal counsel, there are no proceedings pending to which the Company is party to or to which its property is subject, which, if determined to be adverse to the Company, would be material in relation to the Company’s consolidated financial condition. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Company by governmental authorities.

 

Item 4.

Mine Safety Disclosures.

Not applicable.

 

Item 5.

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

As of February 28, 2019, there were approximately 1,091 registered holders of our common stock, no par value. Our common stock trades on the Nasdaq Global Market under the symbol “RIVE.”

 

Item 6.

Selected Financial Data.

Not required for smaller reporting companies

 

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Item 7.

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

Management’s Discussion and Analysis

(Dollars in thousands, except per share data)

Management’s Discussion and Analysis appearing on the following pages should be read in conjunction with the Consolidated Financial Statements contained in this Annual Report on Form 10-K.

Forward-Looking Discussion:

In addition to the historical information contained in this document, the discussion presented may contain and, from time to time, may make, certain statements that constitute forward-looking statements. Words such as “expects,” “anticipates,” “believes,” “estimates” and other similar expressions or future or conditional verbs such as “will,” “should,” “would” and “could” are intended to identify such forward-looking statements. These statements are not historical facts, but instead represent the current expectations, plans or forecasts of the Company and its subsidiary regarding its future operating results, financial position, asset quality, credit reserves, credit losses, capital levels, dividends, liquidity, service charges, cost savings, effective tax rate, impact of changes in fair value of financial assets and liabilities, impact of new accounting and regulatory guidance, legal proceedings and other matters relating to us and the securities that we may offer from time to time. These statements are not guarantees of future results or performance and involve certain risks, uncertainties and assumptions that are difficult to predict, change over time and are often beyond our control. Actual outcomes and results may differ materially from those expressed in, or implied by, forward-looking statements.

You should not place undue reliance on any forward-looking statements, which speak only as of the date they are made, and we undertake no obligation to update any forward-looking statement to reflect the impact of circumstances or events that arise after the date the forward-looking statement was made. Notes to the Consolidated Financial Statements referred to in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) are incorporated by reference into the MD&A. Certain prior period amounts have been reclassified to conform with the current year’s presentation.

Critical Accounting Policies:

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of consolidated financial statements in conformity with GAAP requires us to establish critical accounting policies and make accounting estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements, as well as the reported amounts of revenues and expenses during those reporting periods.

For a discussion of the recent Accounting Standards Updates (“ASU”) issued by the Financial Accounting Standards Board (“FASB”), refer to Note 1 entitled “Summary of significant accounting policies — Recent accounting standards”, in the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report.

An accounting estimate requires assumptions about uncertain matters that could have a material effect on the consolidated financial statements if a different amount within a range of estimates was used or if estimates changed from period to period. Readers of this report should understand that estimates are made considering facts and circumstances at a point in time, and changes in those facts and circumstances could produce results that differ from when those estimates were made. Significant estimates that are particularly susceptible to material change within the near term relate to the determination of the allowance for loan losses, determination of other-than-temporary impairment of investment securities, fair value of financial instruments, the valuation of real estate acquired in connection with foreclosures or satisfaction of loans, the valuation of deferred tax assets, the valuation of acquired assets and liabilities assumed in business combinations and the impairment of goodwill. Actual amounts could differ from those estimates.

We maintain the allowance for loan losses at a level we believe adequate to absorb probable credit losses related to individually evaluated loans, as well as probable incurred losses inherent in the remainder of the loan portfolio as of the balance sheet date. The balance in the allowance for loan losses account is based on past events and current economic conditions.

The allowance for loan losses account consists of an allocated element and an unallocated element. The allocated element consists of a specific portion for the impairment of loans individually evaluated and a formula portion for loss contingencies on those loans collectively evaluated. The unallocated element, if any, is used to cover inherent losses that exist as of the evaluation date, but which have not been identified as part of the allocated allowance using our impairment evaluation methodology due to limitations in the process.

We monitor the adequacy of the allocated portion of the allowance quarterly and adjust the allowance as necessary through normal operations. This ongoing evaluation reduces potential differences between estimates and actual observed losses. The determination of the level of the allowance for loan losses is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Accordingly, management cannot ensure that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance for loan losses will not be required, resulting in an adverse impact on operating results.

 

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In determining the requirement to record an other-than-temporary impairment on debt securities owned by us, four main characteristics are considered including: (i) the length of time and the extent to which the fair value has been less than amortized cost; (ii) the financial condition and near-term prospects of the issuer; (iii) whether the market decline was affected by macroeconomic conditions and (iv) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary impairment exists involves a high degree of subjectivity and judgment and is based on information available to us at a point in time.

Fair values of financial instruments, in cases where quoted market prices are not available, are based on estimates using present value or other valuation techniques which are subject to change.

Real estate acquired through foreclosure, deeds in lieu of foreclosure, or in satisfaction of loans is adjusted to fair value based upon current estimates derived through independent appraisals less anticipated costs to sell. However, proceeds realized from sales may ultimately be higher or lower than those estimates.

Deferred tax assets and liabilities are recognized for the estimated future tax effects of temporary differences by applying enacted statutory tax rates to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The amount of deferred tax assets is reduced, if necessary, to the amount that, based on available evidence, will more likely than not be realized. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

The acquired assets and liabilities assumed in business combinations are measured at fair value as of the acquisition date. In many cases, determining the fair value of the acquired assets and assumed liabilities requires the Company to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest, which require the utilization of significant estimates and judgment in accounting for the acquisition.

Goodwill is evaluated at least annually for impairment, or more frequently if conditions indicate potential impairment exists. Any impairment losses arising from such testing are reported in the income statement in the current period as a separate line item within operations.

For a further discussion of our critical accounting policies refer to Note 1 entitled “Summary of significant accounting policies” in the Notes to Consolidated Financial Statements to this Annual Report. This Note lists the significant accounting policies used by us in the development and presentation of the consolidated financial statements. This MD&A, the Notes to Consolidated Financial Statements and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary to understand and evaluate our financial position, results of operations and cash flows.

Operating Environment:

The gross domestic product (“GDP”), the value of all goods and services produced in the Nation, increased at an annual rate of 2.9% in 2018, as compared to the 2.2% pace in 2017. The acceleration in annual GDP reflects upturns in personal consumption expenditures and government spending. Despite the annual improvement, the GDP for the fourth quarter of 2018 declined to 2.6% from 3.4% in the prior quarter, reflecting a downturn in personal consumption spending and an increase in imports. Inflationary concerns continue to be contained as the consumer price index (“CPI”) was 1.9% in 2018 and 2.1% in 2017. The Federal Reserve Board’s Federal Open Market Committee’s (“FOMC”) preferred measure of inflation, which excludes food and energy costs, rose 2.2% in 2018 and moved above the FOMC’s benchmark of 2.0%. In keeping inflation in check, the FOMC increased rates four times in 2018 for a total of 100 basis points based on expectations that the job market and the economy will continue to strengthen further. The FOMC stated at its December 2018 meeting that they anticipate the pending need for more rate increases throughout 2019, with determinations to be made based on information at the time rate change decisions are considered.

FOMC actions have a direct impact on our business and profitability. Similar to most banks, we have experienced deposit disintermediation from time deposits to interest-bearing non-maturity transaction accounts as a result of the continuation of the relatively low interest rate environment. Further FOMC actions resulting in acceleration of the increasing interest rate cycle may increase our cost of funds as depositors may be enticed to transfer funds from lower cost interest-bearing transaction accounts to higher cost time deposits. Many of our competitors have a high dependence on short-term borrowed funds. If rates continue to rise, these banks may aggressively increase rates offered on their deposits in an effort to mitigate the risk of corresponding changes in their funding costs with changes in the federal funds rate. These actions may impact us as we may have to raise rates to retain customers and provide liquidity for funding loans. A continuation in the rising rate cycle can also impact our primary business of lending in a number of ways. In order to offset increases in funding costs we may have to seek higher yielding loan types that could have an

 

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impact on loan concentration levels. Our asset quality may be adversely impacted if borrowers with adjustable rate loans are unable to cover debt service in the future as rates rise. We continually monitor adjustable rate relationships to mitigate this risk through stress testing over various rate scenarios. In addition, adjustable rate borrowers may request renegotiation of existing loans to longer-term fixed rate loans to avoid the possibility of future increases in their debt service costs. There is a possibility we may lose customers to competitors if we are unable or unwilling to provide longer term fixed rate funding.

Employment conditions overall improved in the United States in 2018. The number of people employed increased at a greater pace as compared to the increase in the civilian labor force in 2017. As a result, the annual unemployment rate for the United States fell to 3.9% in 2018 from 4.1% in 2017. The improvements in job growth were offset partially by slower wage growth in 2018.

Similarly, employment conditions in 2018 improved for the Commonwealth of Pennsylvania as evidenced by a decrease in the unemployment rate to 4.0% in 2018 from 4.4% in 2017. With respect to the markets we serve, the unemployment rate decreased in all of the twelve counties in which we have branch locations. The average unemployment rate for Counties in our market area decreased to 4.4% in 2018 from 4.9% in 2017. The lowest 2018 unemployment rate within the counties we serve was in Centre County at 3.1%. Continued improvement in unemployment rates could favorably impact the rate of economic growth in our market and may have a corresponding impact on our loan and deposit growth and profitability.

National, Pennsylvania and our market area’s non-seasonally-adjusted annual unemployment rates in 2018 and 2017 are summarized as follows:

 

     2018     2017  

United States

     3.9     4.1

Pennsylvania

     4.0       4.4  

Berks County

     3.8       4.0  

Blair County

     4.0       4.3  

Centre County

     3.1       3.2  

Clearfield County

     5.3       5.9  

Dauphin County

     3.6       4.1  

Huntingdon County

     5.6       6.3  

Lebanon County

     3.6       3.8  

Lycoming County

     4.8       5.4  

Northumberland County

     5.4       5.6  

Perry County

     3.4       4.0  

Schuylkill County

     5.0       5.4  

Somerset County

     5.5       6.2  

The banking industry operating performance increased in 2018 as net income for all Federal Deposit Insurance Corporation (“FDIC”)-insured banks in 2018, totaled $236.7 billion, an increase of $72.4 billion, or 44.1%, from 2017. Excluding one-time income tax expenses associated with the enactment of the new tax law in the fourth quarter, net income for all FDIC insured banks in 2018 would have been $207.9 billion, an increase of 13.5% over 2017 industry results. FDIC-insured community banks’ net income in 2018 improved to $26.1 billion, an increase of $5.9 million, or 29.4%, over 2017. Excluding the one-time income tax expense, net income for all FDIC-insured community banks in 2018 would have been $24.1 billion, an increase of 10.7% when compared to 2017. The improvement in earnings was largely the result of increases in net interest income of $5.8 billion, or 8.3%, offset partially by an increase in noninterest expense of $3.0 million, or 5.3%.

The forecasted improvements in employment conditions and economic growth, coupled with reductions in the tax rates enacted by recent tax reform legislation, could spur continued expansion in the United States and local economies beyond 2019. This could affect interest rates paid on deposits, which may adversely impact bank earnings as net interest margins compress from the inability of management to keep funding costs low. Increased loan growth, continuous expense control and sound balance sheet management could offset some of the negative impact of the reduction in net interest margins from funding costs.

Review of Financial Position:

Riverview Financial Corporation, (“Riverview” or the “Company”), a bank holding company incorporated under the laws of Pennsylvania, provides a full range of financial services through its wholly-owned subsidiary, Riverview Bank (the “Bank”). On October 2, 2017, The Company announced the completion of its merger of equals with CBT Financial Corp. (“CBT”), effective October 1, 2017 pursuant to the Agreement and Plan of Merger between Riverview and CBT, dated April 19, 2017. On the effective date, CBT was merged with and into Riverview, with Riverview surviving (the “merger”). Additionally, CBT Bank, the wholly-owned subsidiary of CBT, merged with and into Riverview Bank, the wholly-owned subsidiary of Riverview, with Riverview Bank as

 

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the surviving institution. The Company’s financial results reflect the merger of CBT Bank with and into Riverview Bank under the purchase method of accounting, with the Company treated as the acquirer for accounting and reporting purposes. In accordance with the acquisition accounting for the merger, the historical assets and liabilities of CBT have been recorded at their respective estimated fair values on the date of the merger. The historical financial information included in the Company’s consolidated financial statements and related notes as reported in this Form 10-K is that of Riverview and, consequently, comparisons may not be particularly meaningful. The results for the year ended December 31, 2018 include the operating results of Riverview and the CBT division for the entire year, as compared with the results for the year ended December 31, 2017, which included three months of the operating results of the CBT. The merger had a significant impact on the results of operations for the year ended December 31, 2017.

Riverview Bank, with 28 community banking offices and four limited purpose offices, is a full-service commercial bank offering a wide range of traditional banking services and financial advisory, insurance and investment services to individuals, municipalities and small to medium sized businesses in the Pennsylvania market areas of Berks, Blair, Centre, Clearfield, Dauphin, Huntington, Lebanon, Lycoming, Northumberland, Perry, Schuylkill and Somerset Counties.

The Bank is state-chartered under the jurisdiction of the Pennsylvania Department of Banking and Securities and the Federal Deposit Insurance Corporation. The Bank’s primary product is loans to small- and medium-sized businesses. Other lending products include one-to-four family residential mortgages and consumer loans. The Bank primarily funds its loans by offering interest-bearing transaction accounts to commercial enterprises and individuals. Other deposit product offerings include certificates of deposits and various demand deposit accounts. The Bank offers a broad range of financial advisory, investment and fiduciary services through its wealth management and trust operating divisions.

The wealth management and trust divisions did not meet the quantitative thresholds for required segment disclosure in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The Bank’s 28 community banking offices, all similar with respect to economic characteristics, share a majority of the following aggregation criteria: (i) products and services; (ii) operating processes; (iii) customer bases; (iv) delivery systems; and (v) regulatory oversight. Accordingly, they were aggregated into a single operating segment.

The Company faces competition primarily from commercial banks, thrift institutions and credit unions within the northern, central and southwestern Pennsylvania markets, many of which are substantially larger in terms of assets and capital. In addition, mutual funds and security brokers compete for various types of deposits, and consumer, mortgage, leasing and insurance companies compete for various types of loans and leases. Principal methods of competing for banking and permitted nonbanking services include price, nature of product, quality of service and convenience of location.

The Company and the Bank are subject to regulations of certain federal and state regulatory agencies and undergo periodic examinations.

Readers of this Management Discussion and Analysis are encouraged to refer to the note entitled “Merger accounting,” in the Notes to the Consolidated Financial Statements to more fully understand the impact that the merger had on the Company’s financial position and results of operations.

Total assets, loans and deposits were $1.1 billon, $893.2 million and $1,004.6 million, respectively, at December 31, 2018. Comparatively, total assets, loans and deposits were $1.2 billon, $956.0 million and $1,026.5 million, respectively, at December 31, 2017. All major categories of loans declined in 2018. Business lending, including commercial and commercial real estate decreased $40.7 million, while retail lending, including residential mortgages and consumer loans decreased $22.1 million during 2018. Investment securities increased $11.5 million, or 12.3%, in 2018. Noninterest-bearing deposits increased $6.7 million, while interest-bearing deposits decreased $28.6 million in 2018 as compared with 2017.

The loan portfolio consisted of $660.1 million of business loans, including construction, commercial and commercial real estate loans, and $233.1 million in retail loans, including residential mortgage and consumer loans at December 31, 2018. Total investment securities were $104.7 million at December 31, 2018, all of which were classified as available-for sale. Total deposits consisted of $162.6 million in noninterest-bearing deposits and $842.0 million in interest-bearing deposits at December 31, 2018.

Stockholders’ equity equaled $113.9 million, or $12.49 per share, at December 31, 2018, and $106.3 million or $11.72 per share, at December 31, 2017. Dividends declared for the 2018 amounted to $0.30 per share, representing an annual yield of 2.8% based on the closing price of the Company’s common stock of $10.90 per share on December 31, 2018.

Nonperforming assets equaled $7,202 or 0.81% of loans, net and foreclosed assets at December 31, 2018, an improvement from $8,151, or 0.85%, at December 31, 2017. Nonperforming loans at December 31, 2018 and December 31, 2017 exclude $3,825 and $8,512, respectively, of loans acquired with deteriorated credit quality, which were recorded at their fair value at acquisition. The allowance for loan losses equaled $6,348, or 0.71%, of loans, net, at December 31, 2018, compared to $6,306, or 0.66%, of loans, net at year-end 2017. The increase in the ratio of the allowance for loan losses as a percentage of loans, net, was the result of reduced loan balances. Loans charged-off, net of recoveries equaled $573, or 0.06%, of average loans in 2018, compared to $160, or 0.03%, of average loans in 2017.

 

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Investment Portfolio:

Our investment portfolio provides a source of liquidity needed to meet expected loan demand and generates a reasonable return in order to increase our profitability. Additionally, we utilize the investment portfolio to meet pledging requirements. At December 31, 2018, our portfolio consisted primarily of taxable and tax-exempt state and municipal bonds and mortgage-backed securities, which provide a source of income and liquidity.

Our investment portfolio is subject to various risk elements that may negatively impact our liquidity and profitability. The greatest risk element affecting our portfolio is market risk or interest rate risk (“IRR”). Understanding IRR, along with other inherent risks and their potential effects, is essential in effectively managing the investment portfolio.

Market risk or IRR relates to the inverse relationship between bond prices and market yields. It is defined as the risk that increases in general market interest rates will result in market value depreciation. A marked reduction in the value of the investment portfolio could subject us to liquidity strains and reduced earnings if we are unable or unwilling to sell these investments at a loss. Moreover, the inability to liquidate these assets could require us to seek alternative funding, which may further reduce profitability and expose us to greater risk in the future. In addition, since our entire investment portfolio is designated as available-for-sale and carried at estimated fair value, with net unrealized gains and losses reported as a separate component of stockholders’ equity, market value depreciation could negatively impact our capital position.

During 2018, the FOMC increased its target federal funds rate 25 basis points four times, totaling 100 basis points for the year. The FOMC stated that they expect economic conditions will continue to improve and may warrant additional increases in the federal funds rate but that the timing and magnitude of these changes will depend ultimately on incoming economic data. Our investment portfolio consists primarily of fixed-rate bonds. As a result, changes in general market interest rates have a significant influence on the fair value of our portfolio. Specifically, the parts of the yield curve most closely related to our investments include the 2-year and 7-year U.S. Treasury securities. The yield on the 2-year U.S. Treasury note affects the values of our U.S. Government agency and U.S. Governments-sponsored enterprises mortgage-backed securities, whereas the 7-year U.S. Treasury note influences the value of taxable and tax-exempt state and municipal obligations. The yield on the 2-year U.S. Treasury increased from 1.89% at year-end 2017 to 2.48% at year-end 2018. The yield on the 7-year U.S. Treasury increased 26 basis points from 2.33% at December 31, 2017, to 2.59% at December 31, 2018. Since bond prices move inversely to yields, we reported net unrealized holding losses, included as a separate component of stockholders’ equity of $1,725, net of income taxes of $458, at December 31, 2018.

In order to monitor the potential effects interest rate fluctuations could have on the value of our investments, we perform stress test modeling on the portfolio. Stress tests conducted on our portfolio at December 31, 2018, indicated that should there be a parallel increase in the yield curve over one year by 100, 200 and 300 basis points, we would anticipate declines of 4.1%, 8.1% and 12.0% in the market value of our portfolio.

 

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The carrying values of the major classifications of investment securities and their respective percentages of total investment securities for the past three years are summarized as follows:

Distribution of investment securities

 

     2018     2017     2016  

December 31

   Amount      %     Amount      %     Amount      %  

U.S. Treasury securities

             $ 5,021        6.87

U.S. Government-sponsored enterprises

               

State and municipals:

               

Taxable

   $ 33,278        31.79   $ 35,002        37.56     42,394        57.98  

Tax-exempt

     12,776        12.21       16,308        17.50       5,674        7.76  

Mortgage-backed securities:

               

U.S. Government agencies

     23,670        22.61       22,817        24.48       1,890        2.59  

U.S. Government-sponsored enterprises

     26,195        25.02       10,089        10.82       8,896        12.17  

Corporate debt obligations

     8,758        8.37       8,985        9.64       9,050        12.38  

Equity securities, financial services

               188        0.25  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 104,677        100.00   $ 93,201        100.00   $ 73,113        100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Investment securities increased $11.5 million to $104.7 million at December 31, 2018 from $93.2 million at December 31, 2017`. At December 31, 2018, the entire investment portfolio was classified as available-for-sale, which allows for greater flexibility in using the investment portfolio for liquidity purposes by allowing securities to be sold when favorable market opportunities exist. While there were no investment purchases in 2017, there were 15 securities purchased in 2018 totaling $31.0 million. Repayments of investment securities totaled $12.8 million in 2018 and $5.7 million in 2017. Proceeds from the sale of investment securities available-for-sale totaled $4.8 million in 2018 and consisted of U.S. Treasury securities. This compares to proceeds of $19.0 million from the sale of investment securities available-for-sale in 2017, where the majority of the sales were mortgage-backed securities and tax-exempt municipal securities. Gross gains of $40 without incurring any gross losses, resulted in a net gain of $40 that was recognized from the sale of investment securities in 2018. Gross gains of $166 and gross losses of $77, resulting in a net gain of $89, were recognized from the sale of investment securities in 2017.

The composition of the investment portfolio changed during 2018 due to the purchase of U.S. Government Agency and U.S. Government-sponsored enterprise investments. U.S. Government agency and U.S. Government-sponsored enterprise mortgage-backed securities comprised 47.6% of the total portfolio at year-end 2018 compared to 35.3% at the end of 2017. Tax-exempt municipal obligations decreased as a percentage of the total portfolio to 12.2% at year-end 2018 from 17.5% at the end of 2017, while taxable municipal securities decreased to 31.8% of the total portfolio at year-end 2018 from 37.6% at the end of 2017. Corporate debt comprised 8.4% of the portfolio at the end of 2018 from 9.6% at year ended 2017. As a result of the changes that occurred within the portfolio during 2018, the average life and the modified duration of the investment portfolio decreased to 6.5 years and 5.3 years, respectively, at December 31, 2018 as compared with 8.4 years and 6.7 years at December 31, 2017.

There were no other-than-temporary impairments (“OTTI”) recognized for the years ended December 31, 2018 and 2017. For additional information related to OTTI refer to Note 4 entitled “Investment securities” in the Notes to Consolidated Financial Statements to this Annual Report.

Investment securities averaged $94.3 million and equaled 8.9% of average earning assets in 2018, compared to $78.4 million and equaled 11.4% of average earning assets in 2017. The tax-equivalent yield on the investment portfolio decreased 35 basis points to 2.84% in 2018 from 3.19% in 2017. In addition to measuring our performance using the book yield, we monitor and evaluate our investment portfolio with respect to total return in comparison to national benchmarks. Total return is a comprehensive industry-wide approach measuring investment portfolio performance. This measure is superior to measuring performance strictly on the basis of yield since it not only considers income earned similar to the yield approach, but also includes the reinvestment income on repayments and capital gains and losses, whether realized or unrealized. The total return of our investment portfolio improved to 3.43% in 2018 from 3.01% in 2017, and was significantly better than the Bloomberg Barclays aggregate-bond index, a benchmark used by most investment managers, of 0.01% in 2018.

At December 31, 2018 and 2017, there were no securities of any individual issuer, except for U.S. Government agencies and U.S. Government -sponsored enterprises, that exceeded 10.0% of stockholders’ equity.

 

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The maturity distribution based on amortized cost, fair value and weighted-average, tax-equivalent yield of the investment portfolio at December 31, 2018, is summarized as follows. The weighted-average yield, based on amortized cost, has been computed for tax-exempt state and municipals on a tax-equivalent basis using the prevailing federal statutory tax rate. The distributions are based on contractual maturity. Expected maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

Maturity distribution of investment securities

 

                  After one but     After five but                            
     Within one year     within five years     within ten years     After ten years     Total  

December 31, 2018

   Amount      Yield     Amount      Yield     Amount      Yield     Amount      Yield     Amount      Yield  

Amortized Cost:

                         

State and municipals:

                         

Taxable

        $ 2,581        3.32   $ 7,724        3.84   $ 23,720        3.39   $ 34,025        3.49

Tax-exempt

   $ 2,288        1.40     2,127        2.52       3,149        2.47       5,406        4.02       12,970        2.94  

Mortgage-backed securities:

                         

U.S. Government agencies

               140        3.66       23,575        3.01       23,715        3.01  

U.S. Government-sponsored enterprises

          2,075        3.12       15,524        2.89       9,036        2.87       26,635        2.90  

Corporate debt obligations

               3,500        2.60       6,015        4.01       9,515        3.49  
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Total

   $ 2,288        1.40   $ 6,783        3.01   $ 30,037        3.06   $ 67,752        3.29   $ 106,860        3.17
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Fair Value:

                         

State and municipals:

                         

Taxable

        $ 2,583        $ 7,691        $ 23,004        $ 33,278     

Tax-exempt

   $ 2,283          2,119          3,081          5,293          12,776     

Mortgage-backed securities:

                         

U.S. Government agencies

               136          23,534          23,670     

U.S. Government-sponsored enterprises

          2,063          15,334          8,798          26,195     

Corporate debt obligations

               3,187          5,571          8,758     
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Total

   $ 2,283        $ 6,765        $ 29,429        $ 66,200        $ 104,677     
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Loan Portfolio:

Economic factors and how they affect loan demand are important to us and the overall banking industry, as lending is a primary business activity. Loans are the most significant component of earning assets and they generate the greatest amount of revenue for us. Similar to the investment portfolio there are risks inherent in the loan portfolio that must be understood and considered in managing the lending function. These risks include IRR, credit concentrations and fluctuations in demand. Changes in economic conditions and interest rates affect these risks, which influence loan demand, the composition of the loan portfolio and profitability of the lending function.

The composition of the loan portfolio at year-end for the past five years is summarized as follows:

Distribution of loan portfolio

 

     2018     2017     2016     2015     2014  

December 31

   Amount      %     Amount      %     Amount      %     Amount      %     Amount      %  

Commercial

   $ 122,919        13.76   $ 140,116        14.65   $ 51,166        12.50   $ 46,076        11.24   $ 37,301        10.88

Real estate:

                         

Construction

     39,556        4.43       34,405        3.60       8,605        2.10       18,599        4.54       11,441        3.34  

Commercial

     497,597        55.71       526,230        55.05       212,550        51.93       205,500        50.14       199,782        58.30  

Residential

     221,115        24.76       240,626        25.17       130,874        31.97       135,106        32.97       91,688        26.76  

Consumer

     11,997        1.34       14,594        1.53       6,148        1.50       4,564        1.11       2,481        0.72  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Loans, net

     893,184        100.00     955,971        100.00     409,343        100.00     409,845        100.00     342,693        100.00
     

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Less: allowance for loan loss

     6,348          6,306          3,732          4,365          3,792     
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Net loans

   $ 886,836        $ 949,665        $ 405,611        $ 405,480        $ 338,901     
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

 

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Loans, net decreased $62.8 million in 2018 to $893.2 million at December 31, 2018 as compared with $956.0 million at December 31, 2017. The reduction in loan volumes was a result of merger related attrition, including payoffs of acquired purchase credit impaired loans and management’s steadfast adherence to strong credit quality underwriting standards and pricing discipline. Business loans, including construction, commercial loans and commercial real estate loans, were $660.1 million, or 73.9%, of loans, net at December 31, 2018, and $700.8 million, or 73.3%, at year-end 2017. Residential mortgages and consumer loans totaled $233.1 million, or 26.1%, of loans, net at year-end 2018 and $255.2 million, or 26.7%, at year-end 2017. Acquired loans from the merger with CBT amounted to $382.5 million at the effective date of the merger. Loan balances reduced by $62.8 million, or 6.6%, in 2018, realizing decreases of $21.8 million in the first quarter, $24.4 million in the third quarter and $22.3 million in the fourth quarter, offset by a $5.7 million increase in the second quarter.

Loans averaged $928.4 million in 2018 compared to $597.1 million in 2017. Taxable loans averaged $892.3 million, while tax-exempt loans averaged $36.1 million in 2018. The increase in average loans year-over-year was attributable to the merger with CBT during October 2017. The loan portfolio continues to play a prominent role in our earning asset mix. As a percentage of earning assets, average loans equaled 88.0% in 2018 as compared with 86.7% in 2017.

The prime rate increased 100 basis points in 2018 to 5.50% at year end from 4.50% at the beginning of the year. The tax-equivalent yield on our loan portfolio increased 68 basis points to 5.27% in 2018 from 4.59% in 2017. Included in loan interest income in 2018 was the recognition of fair value accretion of $5.2 million on acquired loans, which increased the tax-equivalent net interest margin by 56 basis points. Excluding accretion on acquired loans, the tax equivalent yield on the loan portfolio improved 27 basis points to 4.71% in 2018 from 4.44% in 2017. The change was attributable to increases in yields on adjustable rate loans from increases in the prime rate along with the addition of higher yielding loans acquired from CBT.

The maturity distribution and sensitivity information of the loan portfolio by major classification at December 31, 2018, is summarized as follows:

Maturity distribution and interest sensitivity of loan portfolio

 

December 31, 2018

   Within one
year
     After one but
within five years
     After five
years
     Total  

Maturity schedule:

           

Commercial

   $ 3,411      $ 22,174      $ 97,334      $ 122,919  

Real estate:

           

Construction

     11,733        10,837        16,986        39,556  

Commercial

     6,136        23,856        467,605        497,597  

Residential

     8,010        18,656        194,449        221,115  

Consumer

     2,186        5,985        3,826        11,997  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 31,476      $ 81,508      $ 780,200      $ 893,184  
  

 

 

    

 

 

    

 

 

    

 

 

 

Predetermined interest rates

   $ 16,137      $ 57,251      $ 164,791      $ 238,179  

Floating or adjustable interest rates

     15,339        24,257        615,409        655,005  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 31,476      $ 81,508      $ 780,200      $ 893,184  
  

 

 

    

 

 

    

 

 

    

 

 

 

As previously mentioned, there are numerous risks inherent in the mortgage loan portfolio. We manage the portfolio by employing sound credit policies and utilizing various modeling techniques in order to limit the effects of such risks. In addition, we utilize private mortgage insurance (“PMI”) to mitigate credit risk in the loan portfolio.

In an attempt to limit IRR and liquidity strains, we continually examine the maturity distribution and interest rate sensitivity of the loan portfolio. Given the potential for rates to rise in the future, we continued to place emphasis on originating short term fixed-rate and adjustable-rate loans. Fixed-rate loans represented 26.7% of the loan portfolio at December 31, 2018, compared to floating or adjustable-rate loans at 73.3%. Approximately 46.3% of the loan portfolio is expected to reprice within the next 12 months.

Additionally, our secondary market mortgage banking program provides us with an additional source of liquidity and a means to limit our exposure to IRR. Through this program, we are able to competitively price conforming one-to-four family residential mortgage loans without taking on IRR which would result from retaining these long-term, low fixed-rate loans on our books. The loans originated are subsequently sold in the secondary market, with the sales price locked in at the time of commitment, thereby greatly reducing our exposure to IRR.

In addition to the risks inherent in our portfolio in the normal course of business, we are also party to financial instruments with off-balance sheet risk to meet the financing needs of our customers. These instruments include legally binding commitments to extend credit, unused portions of lines of credit and commercial letters of credit, and may involve, to varying degrees, elements of credit risk and IRR in excess of the amount recognized in the consolidated financial statements.

 

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Credit risk is the principal risk associated with these instruments. Our involvement and exposure to credit loss in the event that the instruments are fully drawn upon and the customer defaults is represented by the contractual amounts of these instruments. In order to control credit risk associated with entering into commitments and issuing letters of credit, we employ the same credit quality and collateral policies in making commitments that we use in other lending activities.

We evaluate each customer’s creditworthiness on a case-by-case basis, and if deemed necessary, obtain collateral and personal guarantees. The amount and nature of the collateral obtained, or personal guarantees are based on our credit evaluation and overall assessment of risk.

The contractual amounts of off-balance sheet commitments at year-end for the past three years are summarized as follows:

Distribution of off-balance sheet commitments

 

December 31

   2018      2017      2016  

Commitments to extend credit

   $ 96,431      $ 52,706      $ 26,042  

Unused portions of lines of credit

     59,512        72,157        28,516  

Standby and performance letters of credit

     5,789        4,871        3,917  
  

 

 

    

 

 

    

 

 

 

Total

   $ 161,732      $ 129,734      $ 58,475  
  

 

 

    

 

 

    

 

 

 

We record a valuation allowance for off-balance sheet credit losses, if deemed necessary, separately as a liability. The valuation allowance amounted to $73 and $66 at December 31, 2018 and 2017, respectively. We do not anticipate that losses, if any, that may occur as a result of funding off-balance sheet commitments, would have a material adverse effect on our operating results or financial position.

Asset Quality:

We are committed to developing and maintaining sound, quality assets through our credit risk management policies and procedures. Credit risk is the risk to earnings or capital which arises from a borrower’s failure to meet the terms of their loan agreement. We manage credit risk by diversifying the loan portfolio and applying policies and procedures designed to foster sound lending practices. These policies include certain standards that assist lenders in making judgments regarding the character, capacity, cash flow, capital structure and collateral of the borrower.

With regard to managing our exposure to credit risk, we have established maximum loan-to-value ratios for commercial mortgage loans not to exceed 80.0% of the lower of cost or appraised value. With regard to residential mortgages, customers with loan-to-value ratios between 80.0% and 100.0% are generally required to obtain PMI. The 80.0% loan-to-value threshold provides a cushion in the event the property is devalued. PMI is used to protect us from loss in the event loan-to-value ratios exceed 80.0% and the customer defaults on the loan. Appraisals are performed by an independent appraiser engaged by us, not the customer, who is either state certified or state licensed depending upon collateral type and loan amount.

With respect to lending procedures, loan relationship managers, centralized underwriters, working with independent credit department analysts in the case of self-employed borrowers or commercial entities, must determine the borrower’s ability to repay the credit based on prevailing and expected market conditions prior to requesting approval for the loan. The Board of Directors establishes and reviews, at least annually, the lending authority for all approving authorities. Credits beyond centralized underwriting or joint officer signature authorities are elevated to an Officer’s Loan Committee and, if necessary, to a Director’s Loan Committee, for approval. All credit decisions attempt to assure the quality of the loan portfolio through careful analysis of credit applications, adherence to credit policies, and the examination of outstanding loans and delinquencies. These procedures assist in the early detection and timely follow-up of problem loans.

Credit risk is also managed by quarterly loan quality reviews of our loan portfolio by the asset quality committee as well as an annual loan portfolio review conducted by an independent loan review company. These reviews aid us in identifying deteriorating financial conditions of borrowers, allowing us to proactively develop plans to either assist customers in remedying these situations or exit a relationship.

 

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Nonperforming assets consist of nonperforming loans and foreclosed assets. Nonperforming loans include nonaccrual loans, troubled debt restructured loans and accruing loans past due 90 days or more. For a discussion of our policy regarding nonperforming assets and the recognition of interest income on impaired loans, refer to the notes entitled, “Summary of significant accounting policies — Nonperforming assets,” and “Loans, net and allowance for loan losses” in the Notes to Consolidated Financial Statements to this Annual Report.

Information concerning nonperforming assets for the past five years is summarized as follows. The table includes credits classified for regulatory purposes and all material credits that cause us to have serious doubts as to the borrower’s ability to comply with present loan repayment terms.

Distribution of nonperforming assets

 

December 31

   2018     2017     2016     2015     2014  

Nonaccruing loans:

          

Commercial

   $ 1,141     $ 75     $ 356     $ 1,143     $ 515  

Real estate:

          

Construction

             215  

Commercial

     702       363       359       1,118       1,247  

Residential

     886       1,307       671       921       2,268  

Consumer

          
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     2,729       1,745       1,386       3,182       4,245  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accruing troubled debt restructured loans:

          

Commercial

     107       702       617       644       678  

Real estate:

          

Construction

          

Commercial

     752       2,670       3,229       3,305       2,960  

Residential

     2,054       2,106       1,959       2,717       1,331  

Consumer

          
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     2,913       5,478       5,805       6,666       4,969  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accruing loans past due 90 days or more:

          

Commercial

     82          

Real estate:

          

Construction

     247          

Commercial

     170       150           426  

Residential

     290       533       357       89       214  

Consumer

     50       9       2         3  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     839       692       359       89       643  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     6,481       7,915       7,550       9,937       9,857  

Other real estate owned

     721       236       625       885       1,022  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 7,202     $ 8,151     $ 8,175     $ 10,822     $ 10,879  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratios:

          

Nonperforming loans to total loans, net

     0.73     0.83     1.84     2.42     2.88

Nonperforming assets to total loans, net and OREO

     0.81     0.85     1.99     2.63     3.17

We experienced an improvement in our asset quality, evidenced by a decrease in nonperforming assets of $949, or 11.6%, to $7,202, or 0.81%, of loan, net of unearned income and foreclosed assets at December 31, 2018, from $8,151, or 0.85%, of loans, net of unearned income and foreclosed assets at December 31, 2017. The improvement resulted from a decrease of $2,565 in accruing troubled debt restructured loans partially offset by increases of $485 in other real estate owned, $984 in nonaccrual loans and $147 in accruing loans past due 90 days or more. Nonperforming loans at December 31, 2018 and December 31, 2017 exclude $3,825 and $8,512, respectively, of loans acquired with deteriorated credit quality, which were recorded at their fair value at acquisition. For further discussion of assets classified as nonperforming assets, refer to the note entitled, “Loans, net and the allowance for loan losses”, in the Notes to the Consolidated Financial Statements to this Annual Report.

We maintain the allowance for loan losses at a level we believe adequate to absorb probable credit losses related to individually evaluated loans, as well as probable incurred losses inherent in the remainder of the loan portfolio as of the balance sheet date. The balance in the allowance for loan losses account is based on past events and current economic conditions. We employ the FFIEC Interagency Policy Statement, as amended and GAAP in assessing the adequacy of the allowance account. Under GAAP, the adequacy of the allowance account is determined based on the provisions of FASB Accounting Standards Codification (“ASC”) 310 for loans specifically identified to be individually evaluated for impairment and the requirements of FASB ASC 450, for large groups of smaller-balance homogeneous loans to be collectively evaluated for impairment.

 

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We follow our systematic methodology in accordance with procedural discipline by applying it in the same manner regardless of whether the allowance is being determined at a high point or a low point in the economic cycle. Each quarter our Chief Credit Officer identifies those loans to be individually evaluated for impairment and those to be collectively evaluated for impairment utilizing a standard criterion. Internal risk ratings are assigned quarterly to loans identified to be individually evaluated. A loan’s grade may differ from period to period based on current conditions and events. However, we consistently utilize the same grading system each quarter. We consistently use loss experience from the latest eight quarters in determining the historical loss factor for each pool collectively evaluated for impairment. Qualitative factors are evaluated in the same manner each quarter and are adjusted within a relevant range of values based on current conditions to assure directional consistency of the allowance for loan loss account. Regulators, in reviewing the loan portfolio as part of the scope of a regulatory examination, may require us to increase our allowance for loan losses or take other actions that would require increases to our allowance for loan losses.

For a further discussion of our accounting policies for determining the amount of the allowance and a description of the systematic analysis and procedural discipline applied, refer to the note entitled, “Summary of significant accounting policies — Allowance for loan losses”, in the Notes to Consolidated Financial Statements to this Annual Report.

A reconciliation of the allowance for loan losses and an illustration of charge-offs and recoveries by major loan category for the past five years are summarized as follows:

Reconciliation of allowance for loan losses

 

December 31

   2018     2017     2016     2015     2014  

Allowance for loan losses at beginning of year

   $ 6,306     $ 3,732     $ 4,365     $ 3,792     $ 3,663  

Loans charged-off:

          

Commercial

     206       43       767       650       36  

Real estate:

          

Construction

       78       249      

Commercial

         65       187       337  

Residential

     104       38       68       60       140  

Consumer

     437       58       25       35       11  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     747       217       1,174       932       524  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loan recovered:

          

Commercial

     11       5       70       8       119  

Real estate:

          

Construction

          

Commercial

     6       10         19    

Residential

     31       17       7         3  

Consumer

     126       25       11       6       5  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     174       57       88       33       127  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loans charged-off

     573       160       1,086       899       397  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan losses

     615       2,734       453       1,472       526  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses at end of year

   $ 6,348     $ 6,306     $ 3,732     $ 4,365     $ 3,792  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs to average loans

     0.06     0.03     0.27     0.26     0.12

Allowance for loan losses to total loans, net

     0.71     0.66     0.91     1.07     1.11

The allowance for loan losses increased $42 to $6,348 at December 31, 2018, from $6,306 at the end of 2017. The increase resulted from a provision for loan losses of $615, which was partially offset by net loans charged-off of $573. The decrease in the loan loss provision to $615 in 2018 from $2,734 in 2017 was the result of a decrease in loans, net, of $62.8 million, or 6.6%, from 2017, and improved credit quality. The allowance for loan losses, as a percentage of loans, net of unearned income, was 0.71% at the end of 2018, compared to 0.66% at the end of 2017. The increase in this ratio compared to that of the prior year-end was a result of reduced loan balances.

Past due loans not satisfied through repossession, foreclosure or related actions are evaluated individually to determine if all or part of the outstanding balance should be charged against the allowance for loan losses account. Any subsequent recoveries are credited to the allowance account. Net loans charged-off increased $413 to $573 in 2018 from $160 in 2017. Net charge-offs, as a percentage of average loans outstanding, equaled 0.06% in 2018 and 0.03% in 2017.

 

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Allocation of the allowance for loan losses

The allocation of the allowance for loan losses compared to the percentage of loans by major loan category for the past five years is summarized as follows:

 

     2018     2017     2016     2015     2014  

December 31

   Amount      %     Amount      %     Amount      %     Amount      %     Amount      %  

Allocated allowance:

                         

Specific:

                         

Commercial

   $ 382        0.16   $ 56        0.14   $ 8        0.24   $ 700        0.44        0.35

Real Estate:

                         

Construction

                            0.06  

Commercial

     78        0.54       76        1.04       140        0.96       8        1.15     $ 77        1.25  

Residential

     28        0.30       92        0.37          0.61       7        0.74       5        0.80  

Consumer

                         
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total specific

     488        1.00       224        1.55       148        1.81       715        2.33       82        2.46  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Formula:

                         

Commercial

     780        13.60       1,150        14.52       621        12.26       598        10.80       330        10.53  

Real Estate:

                         

Construction

     404        4.43       379        3.60       160        2.10       202        4.54       115        3.28  

Commercial

     3,220        55.17       2,887        54.00       1,970        50.97       2,219        48.99       2,385        57.05  

Residential

     1,258        24.46       1,248        24.80       789        31.36       606        32.23       800        25.96  

Consumer

     50        1.34       37        1.53       44        1.50       25        1.11       15        0.72  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total formula

     5,712        99.00       5,701        98.45       3,584        98.19       3,650        97.67       3,645        97.54  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total allocated allowance

     6,200        100.00     5,925        100.00     3,732        100.00     4,365        100.00     3,727        100.00
     

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Unallocated allowance

     148          381                    65     
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

Total

   $ 6,348        $ 6,306        $ 3,732        $ 4,365        $ 3,792     
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

The allocated element of the allowance for loan losses account increased $275 to $6,200 at December 31, 2018, compared to $5,925 at December 31, 2017. Both the specific and formula portions of the allowance for loan losses increased from the end of 2017. The specific portion of the allowance for impairment of loans individually evaluated under FASB ASC 310 increased $264 to $488 at December 31, 2018, from $224 at December 31, 2017. The formula portion of the allowance for loans collectively evaluated for impairment under FASB ASC 450, increased $11 to $5,712 at December 31, 2018, from $5,701 at December 31, 2017. The increase in the specific portion of the allowance was a result of an allocation related to the addition of one specifically identified and individually evaluated loan. The increase in the formula portion was due to changes in qualitative factors used to evaluate the portfolios. There was a $148 unallocated reserve balance at December 31, 2018 and a $381 unallocated element at December 31, 2017. The unallocated balance is used to cover inherent losses that exist as of the evaluation date, but which have not been identified as part of the allocated allowance using the above impairment evaluation methodology due to limitations in the process. One such limitation is the imprecision of accurately estimating the impact current economic conditions will have on historical loss rates. Variations in the magnitude of impact may cause estimated credit losses associated with the current portfolio to differ from historical loss experience, resulting in an allowance that is higher or lower than the anticipated level. Management establishes the unallocated element of the allowance by considering a number of environmental risks similar to those used to determine the qualitative factors. Management continually monitors trends in historical and qualitative factors, including trends in the volume, composition and credit quality within the portfolio. The reasonableness of the unallocated element is evaluated through monitoring trends in its level to determine if changes from period to period are directionally consistent with changes in the loan portfolio.

The coverage ratio, the allowance for loan losses account as a percentage of nonperforming loans, is an industry ratio used to test the ability of the allowance account to absorb potential losses arising from nonperforming loans. The coverage ratio was 97.9% at December 31, 2018 and 79.7% at December 31, 2017. We believe that our allowance was adequate to absorb probable credit losses at December 31, 2018.

Deposits:

Our deposit base is the primary source of funds to support our operations. We offer a variety of deposit products to meet the needs of our individual and commercial customers. Total deposits decreased $21.9 million in 2018. Noninterest-bearing deposits grew $6.7 million while interest-bearing deposits decreased $28.6 million in 2018. Noninterest-bearing deposits represented 16.2% of total deposits while interest-bearing deposits accounted for 83.8% of total deposits at December 31, 2018. Total deposits grew $574.0 million in 2017 including deposits assumed from the merger with CBT of $438.8 million at the effective date of the merger and

 

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organic deposit growth totaling $135.2 million. Deposit volume changes were mixed for the four quarters of 2018. Quarterly deposit growth in 2018 totaled $12.1 million, or 1.2%, in the first quarter and $3.0 million, or 0.3%, in the third quarter offset by decreases of $20.9 million, or 2.0%, in the second quarter and $16.1 million, or 1.6%, in the fourth quarter.

Interest-bearing transaction accounts, which include money market accounts, NOW accounts, and savings accounts, decreased $35.3 million in 2018. The decrease in interest-bearing transaction accounts during 2018 consisted of decreases of $22.5 million in money market accounts and $60.3 million in savings accounts, offset by an increase of $47.5 million in NOW accounts. Total time deposits increased $6.7 million to $313.9 million at December 31, 2018 from $307.2 million at December 31, 2017. Our customers were drawn to higher yielding time deposit accounts as general market rates increased throughout 2018.

The average amount of, and the rate paid on major classifications of deposits for the past three years are summarized as follows:

Deposit distribution

 

     2018     2017     2016  

Year ended December 31

   Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
 

Interest-bearing:

               

Money market accounts

   $ 118,175        0.94   $ 104,698        0.79   $ 46,410        0.38

NOW accounts

     273,953        0.62       158,504        0.42       137,484        0.29  

Savings accounts

     148,441        0.08       114,731        0.14       74,814        0.18  

Time deposits

     316,418        1.34       171,834        1.07       131,343        0.83  
  

 

 

      

 

 

      

 

 

    

Total interest-bearing

     856,987        0.84     549,767        0.63     390,051        0.46

Noninterest-bearing

     159,751          94,906          70,456     
  

 

 

      

 

 

      

 

 

    

Total deposits

   $ 1,016,738        $ 644,673        $ 460,507     
  

 

 

      

 

 

      

 

 

    

Total deposits averaged $1,016.7 million in 2018, increasing $372.1 million, or 57.7%, compared to 2017. The increase in average deposits was primarily attributable to the CBT merger, which was effective October 1, 2017. Average noninterest-bearing deposits increased $64.9 million, while average interest-bearing accounts grew $307.2 million. Average interest-bearing transaction deposits, including money market, NOW and savings accounts, increased $162.6 million, while average total time deposits increased $144.6 million comparing 2018 with 2017.

Our cost of interest-bearing deposits increased 21 basis points to 0.84% in 2018 from 0.63% in 2017. Specifically, the cost of interest-bearing transaction accounts increased 10 basis points to 0.54%, while the cost of time deposits increased 27 basis points to 1.34% comparing 2018 and 2017.

Volatile deposits, defined as time deposits $100 or more, averaged $115.9 million in 2018, an increase of $49.4 million, or 74.4%, from $66.5 million in 2017. Our average cost of these funds increased 3 basis points to 1.19% in 2018 from 1.16% in 2017. This type of funding is considered to be volatile since it is susceptible to withdrawal by the depositor as they are particularly price sensitive and are therefore not considered to be a reliable source of long-term liquidity.

Maturities of time deposits $100 or more for the past three years are summarized as follows:

Maturity distribution of time deposits $100 or more

 

December 31

   2018      2017      2016  

Within three months

   $ 9,044      $ 8,938      $ 6,137  

After three months but within six months

     10,308        16,193        6,102  

After six months but within twelve months

     19,316        18,584        13,636  

After twelve months

     77,394        70,734        21,899  
  

 

 

    

 

 

    

 

 

 

Total

   $ 116,062      $ 114,449      $ 47,774  
  

 

 

    

 

 

    

 

 

 

In addition to deposit gathering, we have in place a secondary source of liquidity to fund operations through exercising existing credit arrangements with the Federal Home Loan Bank of Pittsburgh (“FHLB-Pgh”). For a further discussion of our borrowings and their terms, refer to the notes entitled, “Short-term borrowings” and “Long-term debt,” in the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report.

 

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Market Risk Sensitivity:

Market risk is the risk to our earnings and/or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. Our exposure to market risk is primarily IRR associated with our lending, investing and deposit gathering activities. During the normal course of business, we are not exposed to foreign exchange risk or commodity price risk. Our exposure to IRR can be explained as the potential for change in our reported earnings and/or the market value of our net worth. Variations in interest rates affect the underlying economic value of our assets, liabilities and off-balance sheet items. These changes arise because the present value of future cash flows, and often the cash flows themselves, change with interest rates. The effects of the changes in these present values reflect the change in our underlying economic value and provide a basis for the expected change in future earnings related to interest rates. Interest rate changes affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. IRR is inherent in the role of banks as financial intermediaries. However, a bank with a high degree of IRR may experience lower earnings, impaired liquidity and capital positions, and most likely, a greater risk of insolvency. Therefore, banks must carefully evaluate IRR to promote safety and soundness in their activities.

The FOMC increased its target federal funds rate by a total of 100 basis points in 2018. The final increase in December 2018 was the ninth consecutive increase of 25 basis point increments since the fourth quarter of 2015. The FOMC has recently signaled that it may slow or delay its future monetary actions until the latter part of 2019. As a result, the timing and the magnitude of future monetary policy actions that will impact the current interest rate environment are uncertain. Given these conditions, IRR and the ability to effectively manage it are extremely critical to both bank management and regulators. The FFIEC, through its advisory guidance, reiterates the importance of effective corporate governance, policies and procedures, risk measuring and monitoring systems, stress testing and internal controls related to the IRR exposure of depository institutions. According to the guidance, bank regulators believe the current financial market and economic conditions present significant risk management challenges to all financial institutions. Although bank regulators recognize that some degree of IRR is inherent in banking, they expect institutions to have sound risk management practices in place to measure, monitor and control IRR exposure. The guidance states that the adequacy and effectiveness of an institution’s IRR management process, and the level of IRR exposure, are critical factors in the bank regulators’ evaluation of an institution’s sensitivity to changes in interest rates and capital adequacy. Material weaknesses in risk management processes or high levels of IRR exposure relative to capital will require corrective action. We believe our risk management practices regarding IRR were suitable and adequate given the level of IRR exposure at December 31, 2018.

The Asset/Liability Committee (“ALCO”), comprised of members of executive and senior management and other appropriate officers, oversees our IRR management program. Specifically, ALCO analyzes economic data and market interest rate trends, as well as competitive pressures utilizing several computerized modeling techniques to reveal potential exposure to IRR. This allows us to monitor and attempt to control the influence these factors may have on our rate sensitive assets (“RSA”), rate sensitive liabilities (“RSL”) and overall operating results and financial position.

With respect to evaluating our exposure to IRR on earnings, we utilize a gap analysis model that considers repricing frequencies of RSA and RSL. Gap analysis attempts to measure our interest rate exposure by calculating the net amount of RSA and RSL that reprice within specific time intervals. A positive gap occurs when the amount of RSA repricing in a specific period is greater than the amount of RSL repricing within that same time frame and is indicated by an RSA/RSL ratio greater than 1.0. A negative gap occurs when the amount of RSL repricing is greater than the amount of RSA and is indicated by an RSA/RSL ratio less than 1.0. A positive gap implies that earnings will be impacted favorably if interest rates rise and adversely if interest rates fall during the period. A negative gap tends to indicate that earnings will be affected inversely to interest rate changes.

Our interest rate sensitivity gap position, illustrating RSA and RSL at their related carrying values, is summarized as follows. The distributions in the table are based on a combination of maturities, call provisions, repricing frequencies and prepayment patterns. Adjustable-rate assets and liabilities are distributed based on the repricing frequency of the instrument. Mortgage instruments are distributed in accordance with estimated cash flows, assuming there is no change in the current interest rate environment.

 

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Interest rate sensitivity

 

December 31, 2018

   Due within
three months
     Due after
three months
but within
twelve months
     Due after
one year
but within
five years
     Due after
five years
    Total  

Rate-sensitive assets:

             

Interest-bearing deposits in other banks

   $ 37,108              $ 37,108  

Investment securities

     6,240      $ 15,281      $ 32,437      $ 50,719       104,677  

Loans held for sale

     637                637  

Loans, net

     260,957        152,715        445,195        34,317       893,184  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total rate-sensitive assets

   $ 304,942      $ 167,996      $ 477,632      $ 85,036     $ 1,035,606  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Rate-sensitive liabilities:

             

Money market accounts

   $ 113,220              $ 113,220  

NOW accounts

     8,582      $ 25,747      $ 137,320      $ 114,433       286,082  

Savings accounts

     3,863        11,589        61,806        51,504       128,762  

Time deposits

     42,419        71,615        192,167        7,754       313,955  

Long-term debt

     6,892                6,892  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total rate-sensitive liabilities

   $ 174,976      $ 108,951      $ 391,293      $ 173,691     $ 848,911  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Rate-sensitivity gap:

             

Period

   $ 129,966      $ 59,045      $ 86,339      $ (88,655  

Cumulative

   $ 129,966      $ 189,011      $ 275,350      $ 186,695    

RSA/RSL ratio:

             

Period

     1.74        1.54        1.22        0.49    

Cumulative

     1.74        1.67        1.41        1.22       1.22  

At December 31, 2018, we had cumulative one-year RSA/RSL ratios of 1.67. As previously mentioned, this positive gap position indicated that if interest rates increase, our earnings would likely be favorably impacted. Given current improvement in economic conditions and the recent monetary policy actions of the FOMC increasing short-term rates and the possibility that they will continue to raise short-term rates in 2019, the focus of ALCO has been to maintain the positive gap position to safeguard future earnings from the potential risk of rising interest rates. ALCO will continue to focus efforts on strategies in 2019 that maintain a positive gap position between RSA and RSL. However, these forward-looking statements are qualified in the aforementioned section entitled “Forward-Looking Discussion” in this Management’s Discussion and Analysis.

Static gap analysis, although a credible measuring tool, does not fully illustrate the impact of interest rate changes on future earnings. First, market rate changes normally do not equally or simultaneously affect all categories of assets and liabilities. Second, assets and liabilities that can contractually reprice within the same period may not do so at the same time or to the same magnitude. Third, the interest rate sensitivity table presents a one-day position and variations occur daily as we adjust our rate sensitivity throughout the year. Finally, assumptions must be made in constructing such a table. For example, the conservative nature of our Asset/Liability Management Policy assigns money market accounts to the “Due within three months” repricing interval. In reality, these accounts may reprice less frequently and in different magnitudes than changes in general market interest rate levels.

We utilize a simulation model to address the failure of the static gap model to address the dynamic changes in the balance sheet composition or prevailing interest rates and to enhance our asset/liability management. This model creates pro forma net interest income scenarios under various interest rate shocks. Given a gradual nonparallel shift in general market rates of plus 100 basis points, our projected net interest income for the 12 months ending December 31, 2019, would increase at 3.1% from model results using current interest rates.

We will continue to monitor our IRR position in 2019 and employ deposit and loan pricing strategies, as well as directing the reinvestment of loan and investment cash flow to maintain a favorable IRR position.

Financial institutions are affected differently by inflation than commercial and industrial companies that have significant investments in fixed assets and inventories. Most of our assets are monetary in nature and change correspondingly with variations in the inflation rate. It is difficult to precisely measure the impact inflation has on us however, we believe that our exposure to inflation can be mitigated through our asset/liability management program.

 

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Liquidity:

Liquidity management is essential to our continuing operations as it gives us the ability to meet our financial obligations as they come due, as well as to take advantage of new business opportunities as they arise. Our financial obligations include, but are not limited to, the following:

 

   

Funding new and existing loan commitments;

 

   

Payment of deposits on demand or at their contractual maturity;

 

   

Repayment of borrowings as they mature;

 

   

Payment of lease obligations; and

 

   

Payment of operating expenses.

Our liquidity position is impacted by several factors which include, among others, loan origination volumes, loan and investment maturity structure and cash flows, demand for core deposits and certificate of deposit maturity structure and retention. We manage these liquidity risks daily, thus enabling us to effectively monitor fluctuations in our position and adapt our position according to market influence and balance sheet trends. We also forecast future liquidity needs and develop strategies to ensure adequate liquidity at all times.

Historically, core deposits have been our primary source of liquidity because of their stability and lower cost, in general, than other types of funding. Providing additional sources of funds are loan and investment payments and prepayments and the ability to sell both available-for-sale securities and mortgage loans held for sale. As a final source of liquidity, we have available borrowing arrangements with various financial intermediaries, including the FHLB-Pgh. At December 31, 2018, our maximum borrowing capacity with the FHLB-Pgh was $458.5 million, of which there were no outstanding borrowings while $39.2 million was utilized to issue letters of credit. We believe our liquidity is adequate to meet both present and future financial obligations and commitments on a timely basis.

We maintain a Contingency Funding Plan to address liquidity in the event of a funding crisis. Examples of some of the causes of a liquidity crisis include, among others, natural disasters, war, events causing reputational harm, and severe and prolonged asset quality problems. The Plan recognizes the need to provide alternative funding sources in times of crisis that go beyond our core deposit base. As a result, we have created a funding program that ensures the availability of various alternative wholesale funding sources that can be used whenever appropriate. Identified alternative funding sources include:

 

   

FHLB-Pgh advances;

 

   

Federal Reserve Bank discount window;

 

   

Repurchase agreements;

 

   

Brokered deposits; and

 

   

Federal funds purchased.

Based on our liquidity position at December 31, 2018, we do not anticipate the need to have a material reliance on any of these sources in the near term.

We employ a number of analytical techniques in assessing the adequacy of our liquidity position. One such technique is the use of ratio analysis to illustrate our reliance on noncore funds to fund our investments and loans maturing after 2018. At December 31, 2018, our noncore funds consisted of time deposits in denominations of $250 or more, short-term borrowings and long-term debt. Large denomination time deposits are not considered to be a strong source of liquidity since they are interest rate sensitive and are considered to be highly volatile. At December 31, 2018, our net noncore funding dependence ratio, the difference between noncore funds and short-term investments to long-term assets, was 0.65%. Our net short-term noncore funding dependence ratio, noncore funds maturing within one year, less short-term investments to long-term assets equaled 1.73%. Comparatively, our ratios equaled 3.73% and 1.96% at the end of 2017, which indicated a decrease in our reliance on noncore funds. We believe that by supplying adequate volumes of short-term investments and implementing competitive pricing strategies on deposits, we can ensure adequate liquidity to support future growth.

The Consolidated Statements of Cash Flows present the change in cash and cash equivalents from operating, investing and financing activities. Cash and cash equivalents consist of cash on hand, cash items in the process of collection, noninterest-bearing and interest-bearing deposits with other banks and federal funds sold. Cash and cash equivalents increased $28,030 for the year ended December 31, 2018, whereas, for the year ended December 31, 2017, cash and cash equivalents increased $6,666. During 2018, cash provided by operating and investing activities more than offset cash used in financing activities.

 

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Operating activities provided net cash of $11,755 in 2018 and used net cash of $673 in 2017. Net income, adjusted for the effects of noncash expenses such as depreciation, amortization and accretion of tangible and intangible assets and investment securities, mortgage loans originated for sale, bank owned life insurance investment income and the provision for loan losses, is the primary source of funds from operations.

Our primary investing activities involve transactions related to our investment and loan portfolios. Net cash provided by investing activities totaled $52,676 in 2018 as compared to net cash used of $111,113 in investing activities in 2017. Net cash provided by lending activities was $66,698 in 2018, as compared to net cash of $163,790 used lending activities in 2017. Activities related to our investment portfolio used net cash of $13,312 in 2018 and provided cash of $24,712 in 2017.

Net cash used by financing activities equaled $36,401 in 2018 while net cash provided by financing activities in 2017 was $118,452. Deposit gathering, which is our predominant financing activity, decreased $21,887 in 2018 and as compared to an increase of $135,075 in 2017. In addition, we used cash to pay down short- and long-term borrowings by $12,341 in 2018 and $30,822 in 2017. A capital offering in the first quarter of 2017 provided net cash of $15,941 in 2017.

We anticipate our liquidity position to be stable in 2019. We are expecting positive loan demand throughout 2019 and anticipate funding this demand through deposit growth, payments and prepayments on loans and investments and advances from the FHLB-Pgh. If economic conditions were to weaken it may result in increased interest in bank deposits, as consumers continue to save rather than spend. However, we cannot predict the economic climate or the savings habits of consumers. Should economic conditions continue to improve, deposit gathering may be negatively impacted as depositors seek alternative investments in the market. Regardless of economic conditions and stock market fluctuations, we believe that through constant monitoring and adherence to our liquidity plan, we believe we will have the means to provide adequate cash to fund normal operations in 2019.

Capital Adequacy:

We believe a strong capital position is essential to our continued growth and profitability. We strive to maintain a relatively high level of capital to provide our depositors and stockholders with a margin of safety. In addition, a strong capital base allows us to take advantage of profitable opportunities, support future growth and provide protection against any unforeseen losses.

On January 20, 2017, Riverview announced that it entered into agreements with accredited investors and qualified institutional buyers to raise approximately $17.0 million in common and preferred equity, before expenses, through the private placement of 269,885 shares of its no par value common stock at a price of $10.50 per share and 1,348,809 shares of a newly created Series A convertible, perpetual preferred stock (the “Series A preferred stock”) at a price of $10.50 per share.

Effective as of the close of business on June 22, 2017, the Company filed an amendment to the Articles of Incorporation to authorize a class of non-voting common stock after obtaining shareholder approval on June 21, 2017. As a result, each share of Series A preferred stock was automatically converted into one share of non-voting common stock as of the effective date. The non-voting common stock has the same relative rights as, and is identical in all respects with, each other share of common stock of the Company, except that holders of non-voting common stock do not have voting rights.

Our ALCO reviews our capital position quarterly. As part of its review, the ALCO considers: (i) the current and expected capital requirements, including the maintenance of capital ratios in excess of minimum regulatory guidelines; (ii) potential changes in the market value of our securities due to interest rate changes and effect on capital; (iii) projected organic and inorganic asset growth; (iv) the anticipated level of net earnings and capital position, taking into account the projected asset/liability position and exposure to changes in interest rates; (v) significant deteriorations in asset quality; and (vi) the source and timing of additional funds to fulfill future capital requirements.

To assure capital adequacy, our Board of Directors annually reviews and approves a Capital Plan. Among other specific objectives, this comprehensive plan: (i) attempts to ensure that we remain well capitalized under the regulatory framework for prompt corrective action; (ii) evaluates our capital adequacy exposure through risk assessment; (iii) establishes event triggers and action plans to ensure capital adequacy; and (iv) identifies realistic and readily available alternative sources for augmenting capital if higher capital levels are required.

On August 30, 2018, the Federal Reserve enacted changes to Regulation Y to increase the threshold to qualify as a small holding company from $1 billion to $3 billion. As a result, and for the foreseeable future, the Company will not be subject to capital ratio computations and limitations on dividends. Our ability to declare and pay dividends in the future is based on our operating results, financial and economic conditions, capital and growth objectives, appropriate dividend restrictions and other relevant factors. We rely on dividends received from our subsidiary, Riverview Bank, for payment of dividends to stockholders. The Bank’s ability to pay dividends is subject to federal and state regulations. For a further discussion on our ability to declare and pay dividends in the future and dividend restrictions, refer to the note entitled, “Regulatory matters,” in the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report.

 

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In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. As a result, new risk-based capital rules became effective January 1, 2015 requiring us to maintain a “capital conservation buffer” of 250 basis points in excess of the “minimum capital ratio.” The minimum capital ratio is equal to the prompt corrective action adequately capitalized threshold ratio. The capital conservation buffer is phased in over four years beginning on January 1, 2016, with a maximum buffer of 0.625% of risk weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. The phased in minimum ratios for 2018 include a common equity Tier 1 to risk-weighted assets ratio of 6.375%, Tier 1 capital to risk-weighted assets ratio of 7.875% and a Total capital to risk-weighted assets ratio of 9.875%. For a further discussion of the incorporation of the revised regulatory requirements into the prompt corrective action framework, refer to the section entitled, “Supervision and Regulatory – Risk-Based Capital Requirements,” in Part I of this Annual Report.

Bank regulatory agencies consider capital to be a significant factor in ensuring the safety of depositors’ accounts. These agencies have adopted minimum capital adequacy requirements that include mandatory and discretionary supervisory actions for noncompliance. The Bank’s Tier I and total risk-based capital ratios are strong and have consistently exceeded the well capitalized regulatory capital ratios of 8.0% and 10.0% required for well capitalized institutions. The Bank’s ratio of Tier 1 capital to risk-weighted assets and off-balance sheet items was 10.7% at December 31, 2018, and 9.7% at December 31, 2017. The total risk-based capital ratio was 11.4% at December 31, 2018 and 10.4% at December 31, 2017. In addition, the Bank is required to maintain a minimum common equity Tier 1 capital to risk-weighted assets ratio in order to be considered well capitalized of 6.5% at December 31, 2018 and 2017. The Bank’s common equity Tier I capital to risk-weighted assets ratio was 10.7% at December 31, 2018 and 9.7% at December 31, 2017. The Bank’s Leverage ratio, which equaled 8.4% at December 31, 2018, and 7.9% at December 31, 2017, exceeded the minimum of 5.0% for well capitalized adequacy purposes. Based on the most recent notification from the FDIC, the Bank was categorized as well capitalized at December 31, 2018 and 2017. There are no conditions or negative events since this notification that we believe have changed the Bank’s category. For a further discussion of these risk-based capital standards and supervisory actions for noncompliance, refer to the note entitled, “Regulatory matters,” in the Notes to Consolidated Financial Statements to this Annual Report.

Stockholders’ equity was $113.9 million, or $12.49 per share, at December 31, 2018, and $106.3 million, or $11.72 per share, at December 31, 2017. Stockholders’ equity increased primarily due to the retention of earnings during 2018. Average stockholders’ equity to average total assets equaled 9.61% in 2018 and 9.37% in 2017. We declared dividends of $0.30 per share in 2018 and $0.55 in 2017. The dividend payout ratio, dividends declared as a percent of net income (loss), equaled 25.2% in 2018 and (0.66)% in 2017.

Review of Financial Performance:

For the year ended December 31, 2018, Riverview reported net income of $10.9 million, or $1.19 per basic and diluted weighted average common share, compared to a net loss of $4.9 million, or $(0.91) per basic and diluted weighted average common share, for the year-ended December 31, 2017. Return on average assets and return on average equity were 0.94% and 9.81% for the year ended December 31, 2018 and (0.65)% and (6.97)% for the year ended December 31, 2017.

The merger with CBT had a significant impact on the results of operations. The merger of equals between Riverview and CBT was accounted for using the acquisition method of accounting and adjusted the acquired assets and liabilities assumed of CBT to fair value as of the acquisition date. Accordingly, the results for the year ended December 31, 2018, include the operating results of Riverview and CBT for the entire year and while the operating results for the year ended December 31, 2017 include the operating results Riverview for the entire year and CBT since October 1, 2017. All prior period information represents the results of Riverview and, consequently, comparisons may not be particularly meaningful. The results for the year ended December 31, 2018 include pre-tax merger expenses of approximately $553. Pre-tax merger related expenses amounted to $3,674 in 2017.

Another significant event impacting the financial results of Riverview in 2017 was the enactment of the Tax Cuts and Jobs Act (the “Act”) on December 22, 2017. The Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits, and deductions for individuals and business. For businesses, the Act reduces the corporate federal tax rate from a maximum rate of 35% to a flat rate of 21%. Under generally accepted accounting principles, Riverview uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to be recovered or settled. As of a result of the reduction in the corporate income tax rate to 21%, Riverview reduced its deferred tax asset by recording an adjustment in tax expense of $3.9 million during the quarter ended December 31, 2017.

 

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Net Interest Income:

Net interest income is the fundamental source of earnings for commercial banks. Moreover, fluctuations in the level of net interest income can have the greatest impact on net profits. Net interest income is defined as the difference between interest revenue, interest and fees earned on interest-earning assets, and interest expense, the cost of interest-bearing liabilities supporting those assets. The primary sources of earning assets are loans and investment securities, while interest-bearing deposits and borrowings comprise interest-bearing liabilities. Net interest income is impacted by:

 

   

Variations in the volume, rate and composition of earning assets and interest-bearing liabilities;

 

   

Changes in general market interest rates; and

 

   

The level of nonperforming assets.

Changes in net interest income are measured by the net interest spread and net interest margin. Net interest spread, the difference between the average yield earned on earning assets and the average rate incurred on interest-bearing liabilities, illustrates the effects changing interest rates have on profitability. Net interest margin, net interest income as a percentage of average earning assets, is a more comprehensive ratio, as it reflects not only the spread, but also the change in the composition of interest-earning assets and interest-bearing liabilities. Tax-exempt loans and investments carry pretax yields lower than their taxable counterparts. Therefore, to make the analysis of net interest income more comparable, tax-exempt income and yields are reported in this analysis on a tax-equivalent basis using the prevailing federal statutory tax rate.

Similar to all banks, we consider the maintenance of an adequate net interest margin to be of primary concern. The current economic environment has been challenging for the banking industry with respect to historically low interest rates and competition. No assurance can be given as to how general market conditions will change or how such changes will affect net interest income. Therefore, we believe through prudent deposit and loan pricing practices, careful investing, and constant monitoring of nonperforming assets, our net interest margin will remain strong.

We analyze interest income and interest expense by segregating rate and volume components of earning assets and interest-bearing liabilities. The impact changes in the interest rates earned and paid on assets and liabilities, along with changes in the volumes of earning assets and interest-bearing liabilities, have on net interest income are summarized as follows. The net change or mix component, attributable to the combined impact of rate and volume changes within earning assets and interest-bearing liabilities’ categories, has been allocated proportionately to the change due to rate and the change due to volume.

Net interest income changes due to rate and volume

 

     2018 vs 2017     2017 vs 2016  
     Increase (decrease)     Increase (decrease)  
     attributable to     attributable to  
     Total     Rate     Volume     Total     Rate     Volume  

Interest income:

            

Loans:

            

Taxable

   $ 21,259     $ 4,774     $ 16,485     $ 8,909     $ 441     $ 8,468  

Tax-exempt

     268       (183     451       226       (237     463  

Investments:

            

Taxable

     118       (181     299       220       (37     257  

Tax-exempt

     60       (124     184       (150     (56     (94

Interest-bearing deposits

     454       150       304       67       50       17  

Federal funds sold

     8       9       (1     10       3       7  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     22,167       4,445       17,722       9,282       164       9,118  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

            

Money market accounts

     282       168       114       654       302       352  

NOW accounts

     1,049       415       634       260       194       66  

Savings accounts

     (50     (86     36       34       (32     66  

Time deposits

     2,419       558       1,861       748       367       381  

Short-term borrowings

     (200     65       (265     146       108       38  

Long-term debt

     345       248       97       106       110       (4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     3,845       1,368       2,477       1,948       1,049       899  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 18,322     $ 3,077     $ 15,245     $ 7,334     $ (885   $ 8,219  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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For the years ended December 31, tax-equivalent net interest income was $44,221 in 2018 and $25,899 in 2017. The improvement in net interest income was a result of both favorable rate and volume variances caused primarily by assets acquired and liabilities assumed from the merger. Total tax-equivalent interest income increased $22,167 offset partially by an increase in total interest expense of $3,845, which resulted in a total improvement in tax-equivalent net interest income of $18,322.

An overall favorable rate variance resulted from an increase in the tax-equivalent yield on earning assets that exceeded an increase in the cost of funds. As a result, tax-equivalent net interest income increased $3,077 due to changes in earning asset yields, and fund costs comparing 2018 and 2017. The tax-equivalent yield on earning assets improved 59 basis points to 4.95% in 2018 from 4.36% in 2017, resulting in an increase in interest income of $4,445. The tax-equivalent yield on the loan portfolio increased 68 basis points to 5.27% in 2018 from 4.59% in 2017 and resulted in an improvement in interest income of $4,591. The recognition of fair value accretion on acquired CBT loans more than offset lower reinvestment rates on originated loans in 2018. The tax-equivalent yield on the investment portfolio decreased 35 basis points to 2.84% in 2018 from 3.19% in 2017 as a result of the inclusion of the investments of CBT, which were shorter terms and lower yielding as compared to Riverview’s investments.

The favorable rate variance in earning asset yields was offset by an increase of 20 basis points in fund costs to 0.91% in 2018 from 0.71% in 2017. The increase in the fund costs accounted for a $1,368 increase in interest expense in 2018. We experienced increases in the rates paid on all major categories of interest-bearing deposits with the exception of savings accounts. Specifically, the cost of money market accounts increased 15 basis points resulting in an addition to interest expense of $168 comparing 2018 and 2017. The cost of NOW accounts increased 20 basis points and caused interest expense to increase $415. With regard to time deposits, the average rate paid for time deposits increased 27 basis points resulting in a $558 increase in interest expense. Savings account costs declined six basis points resulting in a $86 decline in interest expense. The average rate paid on short-term borrowings increased 47 basis points in line with the change in the federal funds rate causing interest expense on these borrowings to increase $65. Long-term debt costs increased by 2.02% with a resulting increase to interest expense of $248 for 2018.

The growth in average earning assets of $366.6 million exceeded that of average interest-bearing liabilities of $292.2 million, resulting in additional tax-equivalent net interest income of $15,245. Average earning assets increased to $1,055.3 million in 2018 from $688.7 million in 2017 and accounted for a $17,722 increase in tax-equivalent interest income. Average loans, net increased $331.4 million, which caused tax-equivalent loan interest income to increase $16,936. Average investments increased $15.9 million, resulting in an increase in interest income of $483. Average interest-bearing deposits in other banks increased $19.4 million, resulting in an increase in interest income of $150.

Average interest-bearing liabilities rose $292.2 million to $871.7 million in 2018 from $579.5 million in 2017 causing interest expense to increase $2,477. Average interest-bearing transaction accounts, including money market, NOW and savings accounts grew $162.6 million, which in aggregate caused a $784 increase in interest expense. Time deposits averaged $144.6 million more in 2018 and caused interest expense to increase $1,861. Average short-term borrowings were $17.3 million less and lowered interest expense by $265, while long-term debt averaged $2.2 million more and increased interest expense by $97 comparing 2018 and 2017.

 

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The average balances of assets and liabilities, corresponding interest income and expense, and resulting average yields or rates paid are summarized as follows. Investment averages include available-for-sale securities at amortized cost. Income on investment securities and loans is adjusted to a tax-equivalent basis using the prevailing federal statutory tax rates in 2018 and 2017.

Summary of net interest income

 

     2018     2017  
     Average
Balance
     Interest Income/
Expense
     Average
Interest
Rate
    Average
Balance
     Interest Income/
Expense
     Average
Interest
Rate
 

Assets:

                

Earning assets:

                

Loans:

                

Taxable

   $ 892,331      $ 47,733        5.35   $ 574,116      $ 26,474        4.61

Tax-exempt

     36,120        1,177        3.26       22,973        909        3.96  

Investments:

                

Taxable

     79,731        2,276        2.85       69,707        2,158        3.10  

Tax-exempt

     14,519        405        2.79       8,670        345        3.98  

Interest-bearing deposits

     31,307        575        1.84       11,901        121        1.02  

Federal funds sold

     1,285        20        1.56       1,367        12        0.88  
  

 

 

    

 

 

      

 

 

    

 

 

    

Total earning assets

     1,055,293        52,186        4.95     688,734        30,019        4.36

Less: allowance for loan losses

     6,436             4,704        

Other assets

     104,019             67,897        
  

 

 

         

 

 

       

Total assets

   $ 1,152,876           $ 751,927        
  

 

 

         

 

 

       

Liabilities and Stockholders’ Equity:

                

Interest-bearing liabilities:

                

Money market accounts

   $ 118,175        1,113        0.94   $ 104,698        831        0.79

NOW accounts

     273,953        1,709        0.62       158,504        660        0.42  

Savings accounts

     148,441        115        0.08       114,731        165        0.14  

Time deposits

     316,418        4,252        1.34       171,834        1,833        1.07  

Short-term borrowings

     1,799        30        1.67       19,106        230        1.20  

Long-term debt

     12,912        746        5.78       10,669        401        3.76  
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-bearing liabilities

     871,698        7,965        0.91     579,542        4,120        0.71

Noninterest-bearing deposits

     159,751             94,906        

Other liabilities

     10,692             7,003        

Stockholders’ equity

     110,735             70,476        
  

 

 

         

 

 

       

Total liabilities and stockholders’ equity

   $ 1,152,876           $ 751,927        
  

 

 

    

 

 

      

 

 

    

 

 

    

Net interest income/spread

      $ 44,221        4.04      $ 25,899        3.65
     

 

 

         

 

 

    

Net interest margin

           4.19           3.76

Tax-equivalent adjustments:

                

Loans

      $ 247           $ 309     

Investments

        85             117     
     

 

 

         

 

 

    

Total adjustments

      $ 332           $ 426     
     

 

 

         

 

 

    

 

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     2016  
     Average
Balance
     Interest Income/
Expense
     Average
Interest
Rate
 

Assets:

        

Earning assets:

        

Loans:

        

Taxable

   $ 390,668      $ 17,565        4.50

Tax-exempt

     12,335        683        5.54  

Investments:

        

Taxable

     61,439        1,939        3.16  

Tax-exempt

     10,904        495        4.54  

Interest-bearing deposits

     9,440        53        0.56  

Federal funds sold

     489        2        0.41  
  

 

 

    

 

 

    

Total earning assets

     485,275        20,737        4.27

Less: allowance for loan losses

     3,849        

Other assets

     54,023        
  

 

 

       

Total assets

   $ 535,449        
  

 

 

       

Liabilities and Stockholders’ Equity:

        

Interest-bearing liabilities:

        

Money market accounts

   $ 46,410        177        0.38

NOW accounts

     137,484        400        0.29  

Savings accounts

     74,814        131        0.18  

Time deposits

     131,343        1,085        0.83  

Short-term borrowings

     14,063        84        0.60  

Long-term debt

     10,824        295        2.73  
  

 

 

    

 

 

    

Total interest-bearing liabilities

     414,938        2,172        0.52

Noninterest-bearing deposits

     70,456        

Other liabilities

     6,638        

Stockholders’ equity

     43,417        
  

 

 

       

Total liabilities and stockholders’ equity

   $ 535,449        
  

 

 

    

 

 

    

Net interest income/spread

      $ 18,565        3.75
     

 

 

    

Net interest margin

           3.83

Tax-equivalent adjustments:

        

Loans

      $ 232     

Investments

        169     
     

 

 

    

Total adjustments

      $ 401     
     

 

 

    

Note: Average balances were calculated using average daily balances. Average balances for loans include nonaccrual loans. Loan fees are included in interest income on loans.

Provision for Loan Losses:

We evaluate the adequacy of the allowance for loan losses account on a quarterly basis utilizing our systematic analysis in accordance with procedural discipline. We take into consideration certain factors such as composition of the loan portfolio, volume of nonperforming loans, volumes of net charge-offs, prevailing economic conditions and other relevant factors when determining the adequacy of the allowance for loan losses account. We make monthly provisions to the allowance for loan losses account in order to maintain the allowance at an appropriate level. The provision for loan losses equaled $615 in 2018 and $2,734 in 2017. The primary causes for the decrease were improvement in the credit quality of the portfolio and a $62.8 million reduction in loan balance in 2018. Based on our most recent evaluation at December 31, 2018, we believe that the allowance was adequate to absorb any known or potential losses in our portfolio.

Noninterest Income:

Noninterest income increased $4,469, or 101.3%, to $8,880 in 2018 from $4,411 in 2017. The primary reason for the significant increase was a result of the acquisition of CBT during the fourth quarter of 2017. Most of the categories of noninterest income increased with the exception wealth management income, mortgage banking income and net gains on sale of investment securities.

 

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Service charges, fees and commissions increased to $5,697 in 2018 from $2,037 in 2017. Commissions and fees on fiduciary activities increased $571 as a result of adding a sizable trust department from CBT in the fourth quarter of 2017. Income from investments in bank owned life insurance increased to $776 in 2018 from $449 in 2017.

Noninterest Expense:

In general, noninterest expense is categorized into three main groups, salary and employee benefit expense, occupancy and equipment expense and other expenses. Salary and employee benefit expenses are costs associated with providing salaries, employer payroll taxes and benefits to our employees. Occupancy and equipment expenses, or the costs related to the maintenance of facilities and equipment, include depreciation, general maintenance and repairs, real estate taxes, rental expense offset by any rental income, insurance, common area maintenance expenses, and utility costs. Other expenses include general operating expenses such as marketing, other taxes, stationery and supplies, contractual services, insurance, including FDIC assessment and loan collection costs. Several of these costs and expenses are variable while the remainder are fixed. We utilize budgets and other related strategies in an effort to control the variable expenses.

The major components of noninterest expense for the past three years are summarized as follows:

Noninterest expense

 

Year ended December 31

   2018      2017      2016  

Salaries and employee benefits expense:

        

Salaries and payroll taxes

   $ 18,759      $ 13,313      $ 7,705  

Employee benefits

     3,305        1,883        1,556  
  

 

 

    

 

 

    

 

 

 

Salaries and employee benefits expense

     22,064        15,196        9,261  
  

 

 

    

 

 

    

 

 

 

Occupancy and equipment expenses:

        

Occupancy expense

     2,472        1,849        1,415  

Equipment expense

     1,681        1,422        750  
  

 

 

    

 

 

    

 

 

 

Occupancy and equipment expenses

     4,153        3,271        2,165  
  

 

 

    

 

 

    

 

 

 

Other expenses:

        

Amortization of intangible assets

     867        538        340  

Net cost of operating other real estate

     48        172        331  

Advertising

     647        456        248  

Professional fees

     892        1,503        578  

FDIC insurance and assessments

     609        443        387  

Telecommunications and processing fees

     4,436        1,884        1,365  

Director fees

     685        705        344  

Bank shares tax

     736        372        215  

Stationary and supplies

     497        344        265  

Other

     3,291        3,676        1,830  
  

 

 

    

 

 

    

 

 

 

Other expenses

     12,708        10,093        5,903  
  

 

 

    

 

 

    

 

 

 

Total noninterest expense

   $ 38,925      $ 28,560      $ 17,329  
  

 

 

    

 

 

    

 

 

 

Noninterest expense was $38,925 for the year ended December 31, 2018 compared to $28,560 for the year ended December 31, 2017. Merger related expenses included in noninterest expense were $553 in 2018 and $3,674 in 2017. All categories of noninterest expense were impacted by the inclusion of CBT effective October 1, 2017.

Salaries and employee benefits expense constitute the majority of our noninterest expenses, accounting for 56.7% of total noninterest expense. Salaries and employee benefits expense increased $6,868, or 45.2%, to $22,064 in 2018 from $15,196 in 2017. Salaries and payroll taxes increased $5,446 while employee benefits expense increased $1,422. The addition of CBT and related costs account for the majority of the increase in salaries and employee benefits costs.

Occupancy and equipment expense increased $882, or 27.0%, to $4,153 in 2018 from $3,271 in 2017. Specifically, building-related costs increased $623, while equipment-related costs increased $259. Additions to leased facilities for newly opened community banking offices along with offices to support the lending teams and the addition of CBT occupancy expenses were primarily responsible for the increase in occupancy and equipment costs.

 

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Other expenses increased $2,615, or 25.9%, to $12,708 in 2018 from $10,093 in 2017. The increase along most categories of other expenses were a direct result of the business combination with CBT.

Income Taxes:

Our income tax expense was $2,371 in 2018 compared to $3,501 in 2017. On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act tax reform legislation. This legislation makes significant changes in U.S. tax law including a reduction in the corporate tax rates, changes to net operating loss carryforwards and carrybacks, and a repeal of the corporate alternative minimum tax. The legislation reduced the highest U.S. corporate tax rate from the current rate of 35% to 21%, effective January 1, 2018. As a result of the enacted law, the Company was required to revalue deferred tax assets and liabilities at the enacted rate. This revaluation resulted in an additional charge of $3,888 to 2017 income tax expense in continuing operations and a corresponding reduction in the net deferred tax assets. The Company’s tax expense was also influenced by tax-exempt income on loans and investments, bank owned life insurance investment income and investment tax credits related to our limited partnership investment in a low- to moderate-income residential housing program, which allow us to mitigate our tax burden.

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk.

Not required for smaller reporting companies.

 

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Item 8.

Financial Statements and Supplementary Data.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Riverview Financial Corporation

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of Riverview Financial Corporation (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income (loss), changes in stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2018, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 14, 2019 expressed an unqualified opinion thereon.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement whether due to error or fraud.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Dixon Hughes Goodman LLP

We have served as the Company’s auditor since 2016.

Gaithersburg, Maryland

March 14, 2019

 

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Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors of Riverview Financial Corporation

Opinion on Internal Control Over Financial Reporting

We have audited Riverview Financial Corporation’s (the “Company”) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of Riverview Financial Corporation as of December 31, 2018 and 2017, and for each of the years in the two years ended December 31, 2018, and our report dated March 14, 2019, expressed an unqualified opinion on those consolidated financial statements.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ Dixon Hughes Goodman LLP

Gaithersburg, Maryland

March 14, 2019

 

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Riverview Financial Corporation

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

 

December 31

   2018     2017  

Assets:

    

Cash and due from banks

   $ 16,708     $ 9,413  

Interest-bearing deposits in other banks

     37,108       16,373  

Investment securities available-for-sale

     104,677       93,201  

Loans held for sale

     637       254  

Loans, net

     893,184       955,971  

Less: allowance for loan losses

     6,348       6,306  
  

 

 

   

 

 

 

Net loans

     886,836       949,665  

Premises and equipment, net

     18,208       18,631  

Accrued interest receivable

     3,010       3,237  

Goodwill

     24,754       24,754  

Intangible assets

     3,509       4,376  

Other assets

     42,156       43,703  
  

 

 

   

 

 

 

Total assets

   $ 1,137,603     $ 1,163,607  
  

 

 

   

 

 

 

Liabilities:

    

Deposits:

    

Noninterest-bearing

   $ 162,574     $ 155,895  

Interest-bearing

     842,019       870,585  
  

 

 

   

 

 

 

Total deposits

     1,004,593       1,026,480  

Short-term borrowings

       6,000  

Long-term debt

     6,892       13,233  

Accrued interest payable

     484       468  

Other liabilities

     11,724       11,170  
  

 

 

   

 

 

 

Total liabilities

     1,023,693       1,057,351  
  

 

 

   

 

 

 

Stockholders’ equity:

    

Common stock, no par value, authorized 20,000,000 shares, issued and outstanding: 2018; 9,121,555 shares; 2017; 9,069,363 shares

     101,134       100,476  

Capital surplus

     332       423  

Retained earnings

     15,063       6,936  

Accumulated other comprehensive loss

     (2,619     (1,579
  

 

 

   

 

 

 

Total stockholders’ equity

     113,910       106,256  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,137,603     $ 1,163,607  
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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Riverview Financial Corporation

CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands, except per share data)

 

Year Ended December 31

   2018     2017  

Interest income:

    

Interest and fees on loans:

    

Taxable

   $ 47,733     $ 26,474  

Tax-exempt

     930       600  

Interest and dividends on investment securities:

    

Taxable

     2,276       2,155  

Tax-exempt

     320       228  

Dividends

       3  

Interest on interest-bearing deposits in other banks

     575       121  

Interest on federal funds sold

     20       12  
  

 

 

   

 

 

 

Total interest income

     51,854       29,593  
  

 

 

   

 

 

 

Interest expense:

    

Interest on deposits

     7,189       3,489  

Interest on short-term borrowings

     30       230  

Interest on long-term debt

     746       401  
  

 

 

   

 

 

 

Total interest expense

     7,965       4,120  
  

 

 

   

 

 

 

Net interest income

     43,889       25,473  

Provision for loan losses

     615       2,734  
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     43,274       22,739  
  

 

 

   

 

 

 

Noninterest income:

    

Service charges, fees and commissions

     5,697       2,037  

Commission and fees on fiduciary activities

     915       344  

Wealth management income

     811       832  

Mortgage banking income

     641       660  

Bank owned life insurance investment income

     776       449  

Net gain on sale of investment securities available-for-sale

     40       89  
  

 

 

   

 

 

 

Total noninterest income

     8,880       4,411  
  

 

 

   

 

 

 

Noninterest expense:

    

Salaries and employee benefits expense

     22,064       15,196  

Net occupancy and equipment expense

     4,153       3,271  

Amortization of intangible assets

     867       538  

Net cost of operating other real estate

     48       172  

Other expenses

     11,793       9,383  
  

 

 

   

 

 

 

Total noninterest expense

     38,925       28,560  
  

 

 

   

 

 

 

Income (loss) before income taxes

     13,229       (1,410

Income tax expense

     2,371       3,501  
  

 

 

   

 

 

 

Net income (loss)

     10,858       (4,911
  

 

 

   

 

 

 

Other comprehensive income (loss):

    

Unrealized gain (loss) on investment securities available-for-sale

     (1,012     1,471  

Reclassification adjustment for net gain on sales included in net income

     (40     (89

Change in pension liability

     (265     (54

Income tax expense (benefit) related to other comprehensive loss

     (277     451  
  

 

 

   

 

 

 

Other comprehensive income (loss), net of income taxes

     (1,040     877  
  

 

 

   

 

 

 

Comprehensive income (loss)

   $ 9,818     $ (4,034
  

 

 

   

 

 

 

Per share data:

    

Net income (loss):

    

Basic

   $ 1.19     $ (0.91

Diluted

   $ 1.19     $ (0.91

Average common shares outstanding:

    

Basic

     9,096,142       5,260,537  

Diluted

     9,148,297       5,260,537  

Dividends declared

   $ 0.30     $ 0.55  

See notes to consolidated financial statements.

 

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Riverview Financial Corporation

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Dollars in thousands, except per share data)

 

For the two years ended December 31, 2018

   Preferred
Stock
    Common
Stock
     Capital
Surplus
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total  

Balance, January 1, 2017

     $ 29,052      $ 220     $ 14,845     $ (2,197   $ 41,920  

Net loss

            (4,911       (4,911

Other comprehensive income, net of income taxes

              877       877  

Compensation cost of option grants

          203           203  

Issuance of 269,885 common shares

       2,658              2,658  

Issuance of 1,348,809 preferred shares

   $ 13,283                13,283  

Preferred shares converted into common shares

     (13,283     13,283           

Issuance under ESPP, 401k and Dividend Reinvestment plans: 40,032 shares

       504              504  

Exercise of stock options: 38,833 shares

       411              411  

Tax Cuts and Jobs Act reclassification from other comprehensive income to retained earnings

            259       (259  

Dividends declared: $0.55 per share

            (3,257       (3,257

Issuance of 4,133,945 shares in fair value of consideration exchanged in merger

       54,568              54,568  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2017

   $       $ 100,476      $ 423     $ 6,936     $ (1,579   $ 106,256  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net income

            10,858         10,858  

Other comprehensive loss, net of income taxes

              (1,040     (1,040

Compensation cost of option grants

          9           9  

Issuance under ESPP, 401k and Dividend Reinvestment plans: 40,791 shares

       517              517  

Exercise of stock options: 11,401 shares

       141        (100         41  

Dividends declared: $0.30 per share

            (2,731       (2,731
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2018

   $       $ 101,134      $ 332     $ 15,063     $ (2,619   $ 113,910  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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Riverview Financial Corporation

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands, except per share data)

 

Year Ended December 31

   2018     2017  

Cash flows from operating activities:

    

Net income (loss)

   $ 10,858     $ (4,911

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

    

Depreciation and amortization of premises and equipment

     1,219       702  

Provision for loan losses

     615       2,734  

Stock based compensation

     9       203  

Net amortization of investment securities available-for-sale

     824       540  

Net cost of operation of other real estate owned

     48       172  

Net gain on sale of investment securities available-for-sale

     (40     (89

Amortization of purchase adjustment on loans

     (5,191     (895

Amortization of intangible assets

     867       538  

Deferred income taxes

     2,340       3,501  

Proceeds from sale of loans originated for sale

     23,967       29,602  

Net gain on sale of loans originated for sale

     (641     (660

Loans originated for sale

     (23,709     (28,544

Bank owned life insurance investment income

     (776     (449

Net change in:

    

Accrued interest receivable

     227       (617

Other assets

     568       (1,851

Accrued interest payable

     16       20  

Other liabilities

     554       (669
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     11,755       (673
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Investment securities available-for-sale:

    

Purchases

     (30,981  

Proceeds from repayments

     12,844       5,760  

Proceeds from sales

     4,825       18,952  

Proceeds from the sale of other real estate owned

     174       767  

Net decrease in restricted equity securities

     252       859  

Net (increase) decrease in loans

     66,698       (163,790

Net cash acquired in business combination

       32,022  

Business disposition (acquisitions), net of cash

       329  

Purchases of premises and equipment

     (1,115     (1,008

Proceeds from sale of equipment

       19  

Purchase of bank owned life insurance

     (21     (5,023
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     52,676       (111,113
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net increase (decrease) in deposits

     (21,887     135,075  

Net decrease in short-term borrowings

     (6,000     (25,500

Repayment of long-term debt

     (6,341     (5,322

Proceeds from long-term debt

       600  

Issuance under DRP, 401k and ESPP plans

     517       504  

Issuance of common stock

       15,941  

Proceeds from exercise of options

     41       411  

Cash dividends paid

     (2,731     (3,257
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (36,401     118,452  
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     28,030       6,666  

Cash and cash equivalents - beginning

     25,786       19,120  
  

 

 

   

 

 

 

Cash and cash equivalents - ending

   $ 53,816     $ 25,786  
  

 

 

   

 

 

 

Supplemental disclosures:

    

Cash paid during the period for:

    

Interest

   $ 7,949     $ 3,844  

Federal income taxes

   $ 300    

Noncash items from investing activities:

    

Other real estate acquired in settlement of loans

   $ 707     $ 358  

Acquisition:

    

Assets acquired excluding cash:

    

Investment securities available-for-sale

     $ 43,869  

Loans, net

       382,461  

Accrued interest receivable

       894  

Premises and equipment

       6,143  

Other assets

       21,730  

Liabilities assumed:

    

Deposits

       438,845  

Long-term debt

       6,801  

Accrued interest payable

       256  

Other liabilities

     $ 6,323  

See notes to consolidated financial statements.

 

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Riverview Financial Corporation

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

1. Summary of significant accounting policies:

Nature of Operations:

Riverview Financial Corporation, (the “Company” or “Riverview”), a bank holding company incorporated under the laws of Pennsylvania, provides a full range of financial services through its wholly-owned subsidiary, Riverview Bank (the “Bank”). On October 2, 2017, the Company announced the completion of its merger of equals with CBT Financial Corp. (“CBT”), effective October 1, 2017 pursuant to the Agreement and Plan of Merger between Riverview and CBT, dated April 19, 2017. On the effective date, CBT was merged with and into Riverview, with Riverview surviving (the “merger”). Additionally, CBT Bank, the wholly-owned subsidiary of CBT, merged with and into Riverview Bank, the wholly-owned subsidiary of Riverview, with Riverview Bank as the surviving institution. The Company’s financial results reflect the merger of CBT Bank with and into Riverview Bank under the purchase method of accounting, with the Company treated as the acquirer from an accounting and reporting purposes. As a result, the historical financial information included in the Company’s consolidated financial statements and related notes as reported in this Form 10-K is that of Riverview.

Riverview Bank, with 28 full service offices and four limited purpose offices, is a full-service commercial bank offering a wide range of traditional banking services and financial advisory, insurance and investment services to individuals, municipalities and small to medium sized businesses in the Pennsylvania market areas of Berks, Blair, Centre, Clearfield, Dauphin, Huntingdon, Lebanon, Lycoming, Northumberland, Perry, Schuylkill and Somerset Counties.

The Bank is state-chartered under the jurisdiction of the Pennsylvania Department of Banking and Securities and the Federal Deposit Insurance Corporation. The Bank’s primary product is loans to small- and medium-sized businesses. Other lending products include one-to-four family residential mortgages and consumer loans. The Bank primarily funds its loans by offering interest-bearing transaction accounts to commercial enterprises and individuals. Other deposit product offerings include certificates of deposits and various demand deposit accounts. The Bank offers a broad range of financial advisory, investment and fiduciary services through its wealth management and trust operating divisions.

The wealth management and trust divisions did not meet the quantitative thresholds for required segment disclosure in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The Bank’s thirty community banking offices, all similar with respect to economic characteristics, share a majority of the following aggregation criteria: (i) products and services; (ii) operating processes; (iii) customer bases; (iv) delivery systems; and (v) regulatory oversight. Accordingly, they were aggregated into a single operating segment.

The Company faces competition primarily from commercial banks, thrift institutions and credit unions within the Central, Northern and Southwestern Pennsylvania markets, many of which are substantially larger in terms of assets and capital. In addition, mutual funds and security brokers compete for various types of deposits, and consumer, mortgage, leasing and insurance companies compete for various types of loans and leases. Principal methods of competing for banking and permitted nonbanking services include price, nature of product, quality of service and convenience of location.

The Company and the Bank are subject to regulations of certain federal and state regulatory agencies and undergo periodic examinations.

Basis of presentation:

The consolidated financial statements of the Company have been prepared in conformity with GAAP, Regulation S-X and reporting practices applied in the banking industry. All significant intercompany balances and transactions have been eliminated in consolidation. The Company also presents herein condensed parent company only financial information regarding Riverview Financial Corporation (“Parent Company”). Prior period amounts are reclassified when necessary to conform with the current year’s presentation. Such reclassifications had no effect on financial position or results of operations.

The Company has evaluated events and transactions occurring subsequent to the balance sheet date of December 31, 2018, for items that should potentially be recognized or disclosed in these consolidated financial statements. The evaluation was conducted through the date these consolidated financial statements were issued.

 

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Estimates:

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates that are particularly susceptible to material change in the near term relate to the determination of the allowance for loan losses, fair value of financial instruments, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, the valuation of deferred tax assets, determination of other-than-temporary impairment losses on securities, impairment of goodwill and fair value of assets acquired and liabilities assumed in business combinations. Actual results could differ from those estimates.

Investment securities:

Investment securities are classified and accounted for as either held-to-maturity, available-for-sale, or trading account securities based on management’s intent at the time of acquisition. Management is required to reassess the appropriateness of such classifications at each reporting date. The Company classifies debt securities as held-to maturity when management has the positive intent and ability to hold such securities to maturity. Held-to-maturity securities are stated at cost, adjusted for amortization of premium and accretion of discount. Investment securities are designated as available-for-sale when they are to be held for indefinite periods of time as management intends to use such securities to implement asset/liability strategies or to sell them in response to changes in interest rates, prepayment risk, liquidity requirements, or other circumstances identified by management. Available-for-sale securities are reported at fair value, with unrealized gains and losses, net of income taxes, excluded from earnings and reported in a separate component of stockholders’ equity. Estimated fair values for investment securities are based on market prices from a national pricing service. Realized gains and losses are computed using the specific identification method and are included in noninterest income. Premiums are amortized, and discounts are accreted using the interest method over the contractual lives of investment securities. Investment securities that are bought and held principally for the purpose of selling them in the near term, in order to generate profits from market appreciation, are classified as trading account securities. Trading account securities are carried at market value. Interest on trading account securities is included in interest income. Profits or losses on trading account securities are included in noninterest income. All of the Company’s investment securities were classified as available-for-sale in 2018 and 2017. Transfers of securities between categories are recorded at fair value at the date of the transfer, with the accounting treatment of unrealized gains or losses determined by the category into which the security is transferred.

Management evaluates each investment security at least quarterly, to determine if a decline in fair value below its amortized cost is an other-than-temporary impairment (“OTTI”), and more frequently when economic or market concerns warrant an evaluation. Factors considered in determining whether an other-than-temporary impairment was incurred include: (i) the length of time and the extent to which the fair value has been less than amortized cost; (ii) the financial condition and near-term prospects of the issuer; (iii) whether a decline in fair value is attributable to adverse conditions specifically related to the security or specific conditions in an industry or geographic area; (iv) the credit-worthiness of the issuer of the security; (v) whether dividend or interest payments have been reduced or have not been made; (vi) an adverse change in the remaining expected cash flows from the security such that the Company will not recover the amortized cost of the security; (vii) whether management intends to sell the security; and (viii) if it is more likely than not that management will be required to sell the security before recovery. If a decline is judged to be other-than-temporary, the individual security is written-down to fair value with the credit related component of the write-down included in earnings and the non-credit related component included in other comprehensive income or loss. The assessment of whether an other-than-temporary impairment exists involves a high degree of subjectivity and judgment and is based on information available to management at a point in time.

Loans held for sale:

Loans held for sale consist of one-to-four family residential mortgages originated and intended for sale in the secondary market with servicing rights released. The loans are carried in aggregate at the lower of cost or estimated market value, based upon current delivery prices in the secondary mortgage market. Gains or losses on the sale of these loans are recognized in noninterest income at the time of sale using the specific identification method. Loan origination fees, net of certain direct loan origination costs, are included in net gains or losses upon the sale of the related mortgage loan. These loans are generally sold without servicing rights retained and without recourse.

Loans, net:

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of deferred fees or costs. Interest income is accrued on the principal amount outstanding. Loan origination fees, net of certain direct origination costs, are deferred and recognized over the contractual life of the related loan as an adjustment to yield using the effective interest method. Premiums and discounts on purchased loans are amortized as adjustments to interest income using the effective interest method. Delinquency fees are recognized in income when chargeable, assuming collectability is reasonably assured.

 

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Transfers of financial assets, which include loan participation sales, are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (i) the assets have been isolated from the Company; (ii) the transferee obtains the right, free of conditions that constrain it from taking advantage of that right, to pledge or exchange the transferred assets and (iii) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

The loan portfolio is segmented into commercial and retail loans. Commercial loans consist of commercial and commercial real estate loans. Retail loans consist of residential real estate and other consumer loans.

The Company makes commercial loans for real estate development and other business purposes required by the customer base. The Company’s credit policies determine advance rates against the different forms of collateral that can be pledged against commercial loans. Typically, the majority of loans will be limited to a percentage of their underlying collateral values such as real estate values, equipment, eligible accounts receivable and inventory. Individual loan advance rates may be higher or lower depending upon the financial strength of the borrower and/or term of the loan. The assets financed through commercial loans are used within the business for its ongoing operation. Repayment of these kinds of loans generally comes from the cash flow of the business or the ongoing conversion of assets. Commercial real estate loans include long-term loans financing commercial properties. Repayment of these loans is dependent upon either the ongoing cash flow of the borrowing entity or the resale of or lease of the subject property. Commercial real estate loans typically require a loan to value of not greater than 80% and vary in terms. Commercial and commercial real estate loans generally have higher credit risk compared to residential mortgage loans and consumer loans, as they typically involve larger loan balances concentrated with single borrowers or groups of borrowers. In addition, the payment expectations on loans secured by income-producing properties typically depend on the successful operations of the related business and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy.

Loans secured by commercial real estate generally have larger balances and involve a greater degree of risk than one-to-four family residential mortgage loans. Of primary concern in commercial real estate lending is the borrower’s and any guarantor’s creditworthiness and the feasibility and cash flow potential of the financed project. Additional considerations include: location, market and geographic concentrations, loan to value, strength of guarantors and quality of tenants. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject, to a greater extent than residential real estate loans, to adverse conditions in the real estate market or the economy. To monitor cash flows on income properties, we require borrowers and loan guarantors, if any, to provide annual consolidated financial statements on commercial real estate loans and rent rolls where applicable. In reaching a decision on whether to make a commercial real estate loan, we consider and review a cash flow analysis of the borrower and guarantor, when applicable, and considers the net operating income of the property, the borrower’s expertise, credit history and profitability and the value of the underlying property. We have generally required that the properties securing these real estate loans have debt service coverage ratios, the ratio of earnings before debt service to debt service, of at least 1.2 times. An environmental report is obtained when the possibility exists that hazardous materials may have existed on the site, or the site may have been impacted by adjoining properties that handled hazardous materials.

Residential mortgages, including home equity loans, are secured by the borrower’s residential real estate in either a first or second lien position. Residential mortgages have varying loan rates depending on the financial condition of the borrower and the loan to value ratio. Residential mortgages may have amortizations up to 30 years.

Consumer loans include installment loans, car loans, and overdraft lines of credit. The majority of these loans are secured. Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as motor vehicles. In the latter case, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and a small remaining deficiency often does not warrant further substantial collection efforts against the borrower. Consumer loan collections depend on the borrower’s continuing financial stability, and therefore are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state insolvency laws, may limit the amount that can be recovered on such loans.

Off-balance sheet financial instruments:

In the ordinary course of business, the Company enters into off-balance sheet financial instruments consisting of commitments to extend credit, unused portions of lines of credit and standby letters of credit. These financial instruments are recorded in the consolidated financial statements when they are funded. Fees on commercial letters of credit and on unused available lines of credit are recorded as service charges, fees and commissions and are included in noninterest income when earned. The Company records an allowance for off-balance sheet credit losses, if deemed necessary, separately as a liability.

 

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Nonperforming assets:

Nonperforming assets consist of nonperforming loans and other real estate owned. Nonperforming loans include nonaccrual loans, troubled debt restructured loans and accruing loans past due 90 days or more. Past due status is based on contractual terms of the loan. Generally, a loan is classified as nonaccrual when it is determined that the collection of all or a portion of interest or principal is doubtful or when a default of interest or principal has existed for 90 days or more, unless the loan is well secured and in the process of collection. When a loan is placed on nonaccrual, interest accruals are discontinued, and uncollected accrued interest is reversed against income in the current period. Interest collections after a loan has been placed on nonaccrual status are credited to the principal balance. Interest earned that would have been recognized is credited to income over the remaining life of the loan using the effective yield method if the nonaccrual loan is returned to performing status. A nonaccrual loan is returned to performing status when the loan is current as to principal and interest and has performed according to the contractual terms for a minimum of six months.

Troubled debt restructured loans are loans with original terms, interest rate, or both, that have been modified as a result of a deterioration in the borrower’s financial condition and a concession has been granted that the Company would not otherwise consider. Unless on nonaccrual, interest income on these loans is recognized when earned, using the interest method. The Company offers a variety of modifications to borrowers that would be considered concessions. The modification categories offered can generally fall within the following categories:

 

   

Rate Modification — A modification in which the interest rate is changed to a below market rate.

 

   

Term Modification — A modification in which the maturity date, timing of payments or frequency of payments is changed.

 

   

Interest Only Modification — A modification in which the loan is converted to interest only payments for a period of time.

 

   

Payment Modification — A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

 

   

Combination Modification — Any other type of modification, including the use of multiple categories above.

The Company segments loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. Loans are individually analyzed for credit risk by classifying them within the Company’s internal risk rating system. The Company’s risk rating classifications are defined as follows:

 

   

Pass — A loan to borrowers with acceptable credit quality and risk that is not adversely classified as Substandard, Doubtful, Loss or designated as Special Mention.

 

   

Special Mention — A loan that has potential weaknesses that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the institution’s credit position at some future date. Special Mention loans are not adversely classified since they do not expose the Company to sufficient risk to warrant adverse classification.

 

   

Substandard — A loan that is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

 

   

Doubtful — A loan classified as Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make the collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

   

Loss — A loan classified as Loss is considered uncollectible and of such little value that its continuance as a bankable loan is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future.

Other real estate owned is comprised of properties acquired through foreclosure proceedings or in-substance foreclosures. A loan is classified as in-substance foreclosure when the Company has taken possession of the collateral regardless of whether formal foreclosure proceedings take place. Other real estate owned is included in other assets and recorded at fair value less cost to sell at the time of acquisition, establishing a new cost basis. Any excess of the loan balance over the recorded value is charged to the allowance for loan losses. Subsequent declines in the recorded values of the properties prior to their disposal and costs to maintain the assets are included in other expenses. Any gain or loss realized upon disposal of other real estate owned is included in noninterest expense.

 

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Allowance for loan losses:

The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date. The allowance for loan losses account is maintained through a provision for loan losses charged to earnings. Loans, or portions of loans, determined to be confirmed losses are charged against the allowance account and subsequent recoveries, if any, are credited to the account. A loss is considered confirmed when information available at the financial statement date indicates the loan, or a portion thereof, is uncollectible. Nonaccrual, troubled debt restructured, and loans deemed impaired at the time of acquisition are reviewed monthly to determine if carrying value reductions are warranted or if these classifications should be changed. Consumer loans are considered losses and charged-off when they are 120 days past due.

Management evaluates the adequacy of the allowance for loan losses account quarterly. This assessment is based on past charge-off experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. Regulators, in reviewing the loan portfolio as part of the scope of a regulatory examination, may require the Company to increase its allowance for loan losses or take other actions that would require the Company to increase its allowance for loan losses.

The allowance for loan losses is maintained at a level believed to be adequate to absorb probable credit losses related to specifically identified loans, as well as probable incurred losses inherent in the remainder of the loan portfolio as of the balance sheet date. The allowance for loan losses consists of an allocated element and an unallocated element. The allocated element consists of a specific allowance for impaired loans individually evaluated under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310, “Receivables,” and a formula portion for loss contingencies on those loans collectively evaluated under FASB ASC 450, “Contingencies.”

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest and principal payments of a loan will be collected as scheduled in the loan agreement. Factors considered by management in determining impairment include payment status, ability to pay and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The Company recognizes interest income on impaired loans, including the recording of cash receipts for nonaccrual, restructured loans or accruing loans depending on the status of the impaired loan. Loans considered impaired under FASB ASC 310 are measured for impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. If the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent, is less than the recorded investment in the loan, a specific allowance for the loan will be established.

The formula portion of the allowance for loan losses relates to large pools of smaller-balance homogeneous loans and those identified loans considered not individually impaired having similar characteristics as these loan pools. Loss contingencies for each of the major loan pools are determined by applying a total loss factor to the current balance outstanding for each individual pool. The total loss factor is comprised of a historical loss factor using a loss migration method plus qualitative factors, which adjust the historical loss factor for changes in trends, conditions and other relevant factors that may affect repayment of the loans in these pools as of the evaluation date. Loss migration involves determining the percentage of each pool that is expected to ultimately result in loss based on historical loss experience. Historical loss factors are based on the ratio of net loans charged-off to loans, net, for each of the major groups of loans evaluated and measured for impairment under FASB ASC 450. The historical loss factor for each pool is an average of the Company’s historical net charge-off ratio for the most recent rolling eight quarters. Management adjusts these historical loss factors by qualitative factors that represent a number of environmental risks that may cause estimated credit losses associated with the current portfolio to differ from historical loss experience. These environmental risks include: (i) changes in lending policies and procedures including underwriting standards and collection, charge-off and recovery practices; (ii) changes in the composition and volume of the portfolio; (iii) changes in national, local and industry conditions, including the effects of such changes on the value of underlying collateral for collateral-dependent loans; (iv) changes in the volume and severity of classified loans including past due, nonaccrual, troubled debt restructures and other loan modifications; (v) changes in the levels of, and trends in, charge-offs and recoveries; (vi) the existence and effect of any concentrations of credit and changes in the level of such concentrations; (vii) changes in the experience, ability and depth of lending management and other relevant staff; (viii) changes in the quality of the loan review system and the degree of oversight by the board of directors; and (ix) the effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the current loan portfolio. Each environmental risk factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation.

 

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Management revised its calculation for, and application of, qualitative factors applied to their identified segments of homogenous loan pools. Prior to the fourth quarter of 2018, management calculated separate and distinct qualitative factors for Riverview Bank and each of its three purchased portfolios as a result of loans previously acquired in business combinations. Management determined that it would calculate qualitative factors on a weighted average basis combined for Riverview Bank and all purchased portfolios for each identified segment of homogenous loan pools. This had the impact of reducing the overall rate of qualitative adjustment to historical losses but was offset by an increased level of reserve on acquired performing loans as a result of normal accretion of acquisition related fair value marks. This change in methodology did not have a material impact on the amount of the allowance for loan losses at December 31, 2018, the date of the change, as compared to the prior methodology.

The unallocated element, if any, is used to cover inherent losses that exist as of the evaluation date, but which have not been identified as part of the allocated allowance using the above impairment evaluation methodology due to limitations in the process. One such limitation is the imprecision of accurately estimating the impact current economic conditions will have on historical loss rates. Variations in the magnitude of impact may cause estimated credit losses associated with the current portfolio to differ from historical loss experience, resulting in an allowance that is higher or lower than the anticipated level. Management establishes the unallocated element of the allowance by considering environmental risks similar to the ones used for determining the qualitative factors. Management continually monitors trends in historical and qualitative factors, including trends in the volume, composition and credit quality of the portfolio. The reasonableness of the unallocated element is evaluated through monitoring trends in its level to determine if changes from period to period are directionally consistent with changes in the loan portfolio.

Management believes the level of the allowance for loan losses was adequate to absorb probable credit losses as of December 31, 2018.

Premises and equipment, net:

Land is stated at cost. Premises, equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. The cost of routine maintenance and repairs is expensed as incurred. The cost of major replacements, renewals and betterments is capitalized. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation and amortization are eliminated, and any resulting gain or loss is reflected in noninterest income. Depreciation and amortization are computed principally using the straight-line method based on the following estimated useful lives of the related assets, or in the case of leasehold improvements, to the expected terms of the leases, if shorter:

 

Premises and leasehold improvements

   7 – 50 years

Leasehold improvements

   10 – 30 years

Furniture, fixtures and equipment

   3 – 10 years

Business combinations, goodwill and other intangible assets, net:

The Company accounts for its acquisitions using the purchase accounting method. Purchase accounting requires the total purchase price to be allocated to the estimated fair values of assets acquired and liabilities assumed, including certain intangible assets that must be recognized. Typically, this allocation results in the purchase price exceeding the fair value of net assets acquired, which is recorded as goodwill. Core deposit intangibles are a measure of the value of checking, money market and savings deposits acquired in business combinations accounted for under the purchase method. Core deposit intangibles and other identified intangibles with finite useful lives are amortized using the sum of the year’s digits over their estimated useful lives of up to ten years.

Loans that the Company acquires in connection with acquisitions are recorded at fair value with no carryover of the related allowance for credit losses. Fair value of the loans involves estimating the amount and timing of principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non-accretable discount. The non-accretable discount includes estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows will require the Company to evaluate the need for an additional allowance for credit losses. Subsequent improvement in expected cash flows will result in the reversal of a corresponding amount of the non-accretable discount which the Company will then reclassify as accretable discount that will be recognized into interest income over the remaining life of the loan. Acquired loans that met the criteria for nonaccrual of interest prior to the acquisition may be considered performing upon acquisition, regardless of whether the customer is contractually delinquent. As such, the Company may no longer consider the loan to be nonaccrual or nonperforming and may accrue interest on these loans, including the impact of any accretable discount. In addition, charge-offs on such loans would be first applied to the non-accretable difference portion of the fair value adjustment.

 

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The Company accounts for performing loans acquired in business combinations using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for loan losses established at the acquisition date for purchased performing loans. A provision for loan losses is recorded for any further deterioration in these loans subsequent to the acquisition.

Customer list intangibles are also included in intangible assets as a result of the purchase of the wealth management companies. These intangibles are amortized as an expense over ten years using the sum of the years’ amortization method.

Goodwill and other intangible assets are tested for impairment annually during the fourth quarter of each year or when circumstances arise indicating impairment may have occurred. In making this assessment that impairment has occurred, management considers a number of factors including, but not limited to, operating results, business plans, economic projections, anticipated future cash flows, and current market data. There are inherent uncertainties related to these factors and management’s judgment in applying them to the analysis of impairment. Changes in economic and operating conditions, as well as other factors, could result in impairment in future periods. Any impairment losses arising from such testing would be reported in the Consolidated Statements of Income and Comprehensive Income as a separate line item within operations. There were no impairment losses recognized as a result of periodic impairment testing in each of the two-years ended December 31, 2018.

Restricted equity securities:

As a member of the Federal Home Loan Bank of Pittsburgh (“FHLB-Pgh”) and Atlantic Community Bankers Bank (“ACBB”), the Company is required to purchase and hold stock in these entities to satisfy membership and borrowing requirements. This stock is restricted in that it can only be redeemed by these entities or to another member institution and all redemptions of stock must be at par. As a result of these restrictions, restricted equity stock is unlike other investment securities as there is no trading market in it and the transfer price is determined by the FHLB-Pgh and ACBB membership rules and not by market participants. Therefore, it is accounted for at historical cost and evaluated for impairment. The carrying value of restricted stock is included in other assets.

Bank owned life insurance:

The Company invests in bank owned life insurance (“BOLI”) as a source of funding for employee benefit expenses. BOLI involves the purchasing of life insurance by the Bank on certain of its directors and employees. The Bank is the owner and beneficiary of the policies. This life insurance investment is carried at the cash surrender value of the underlying policies and is included in other assets. Income from increases in cash surrender value of the policies is included in noninterest income.

Pension and post-retirement benefit plans:

The Company sponsors various pension plans covering substantially all employees. The Company also provides post-retirement benefit plans other than pensions, consisting principally of life insurance benefits, to eligible retirees. The liabilities and annual income or expense of the Company’s pension and other post-retirement benefit plans are determined using methodologies that involve several actuarial assumptions, the most significant of which are the discount rate and the long-term rate of asset return, based on the market-related value of assets. The fair values of plan assets are determined based on prevailing market prices or estimated fair value for investments with no available quoted prices.

Statements of Cash Flows:

The Consolidated Statements of Cash Flows are presented using the indirect method. For purposes of cash flow, cash and cash equivalents include cash on hand, cash items in the process of collection, noninterest-bearing and interest-bearing deposits in other banks and federal funds sold.

Fair value of financial instruments:

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosure under GAAP. Fair value estimates are calculated without attempting to estimate the value of anticipated future business and the value of certain assets and liabilities that are not considered financial. Accordingly, such assets and liabilities are excluded from disclosure requirements.

 

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In accordance with FASB ASC 820, “Fair Value Measurements and Disclosures”, fair value is the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets. In many cases, these values cannot be realized in immediate settlement of the instrument.

Current fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction that is not a forced liquidation or distressed sale between participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

In accordance with GAAP, the Company groups its assets and liabilities, generally measured at fair value, into three levels based on market information or other fair value estimates in which the assets and liabilities are traded or valued, and the reliability of the assumptions used to determine fair value. These levels include:

 

   

Level 1: Unadjusted quoted prices of identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

   

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

   

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The following methods and assumptions were used by the Company to construct the summary table in Note 13 containing the fair values and related carrying amounts of financial instruments:

Cash and cash equivalents: The carrying values of cash and cash equivalents as reported on the balance sheet approximate fair value.

Investment securities available-for-sale: The fair values of debt securities are based on pricing from a matrix pricing model.

Loans held for sale: The fair values of loans held for sale are based upon current delivery prices in the secondary mortgage market.

Net Loans: At December 31, 2018, the exit price observations are obtained from an independent third-party using its proprietary valuation model and methodology and may not reflect actual or prospective market valuations. The valuation is based on the probability of default, loss given default, recovery delay, prepayment, and discount rate assumptions. The new methodology is a result of the adoption of ASU No. 2016-01.

At December 31, 2017, for adjustable-rate loans that reprice frequently and with no significant credit risk, fair values are based on carrying values. The fair values of other non-impaired loans are estimated using discounted cash flow analysis, using interest rates currently offered in the market for loans with similar terms to borrowers of similar credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis determined by the loan review function or underlying collateral values, where applicable.

In conjunction with the merger, the loans purchased were recorded at their acquisition date fair value. In order to record the loans at fair value, management made three different types of fair value adjustments. A market rate adjustment was made to adjust for the movement in market interest rates, irrespective of credit adjustments, compared to the stated rates of the acquired loans. A credit adjustment was made on pools of homogeneous loans representing the changes in credit quality of the underlying borrowers from the loan inception to the acquisition date. The credit adjustment on distressed loans represents the portion of the loan balance that has been deemed uncollectible based on the management’s expectations of future cash flows for each respective loan.

Accrued interest receivable: The carrying value of accrued interest receivable as reported on the balance sheet approximates fair value.

Restricted equity securities: The carrying values of restricted equity securities approximate fair value, due to the lack of marketability for these securities.

 

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Deposits: The fair values of noninterest-bearing deposits and savings, NOW and money market accounts are the amounts payable on demand at the reporting date. The fair value estimates do not include the benefit that results from such low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. The carrying values of adjustable-rate, fixed-term time deposits approximate their fair values at the reporting date. For fixed-rate time deposits, the present value of future cash flows is used to estimate fair values. The discount rates used are the current rates offered for time deposits with similar maturities.

Short-term borrowings: The carrying values of short-term borrowings approximate fair value.

Long-term debt: The fair value of fixed-rate long-term debt is based on the present value of future cash flows. The discount rate used is the current rate offered for long-term debt with the same maturity.

Accrued interest payable: The carrying value of accrued interest payable as reported on the balance sheet approximates fair value.

Off-balance sheet financial instruments:

The majority of commitments to extend credit, unused portions of lines of credit and standby letters of credit carry current market interest rates if converted to loans. Because such commitments are generally unassignable of either the Company or the borrower, they only have value to the Company and the borrower. None of the commitments are subject to undue credit risk. The estimated fair values of off-balance sheet financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of off-balance sheet financial instruments was not material at December 31, 2018 and December 31, 2017.

Advertising:

The Company follows the policy of charging marketing and advertising costs to expense as incurred. Advertising expense for the years ended December 31, 2018 and 2017 was $647 and $456, respectively.

Income taxes:

The Company accounts for income taxes in accordance with the income tax accounting guidance set forth in FASB ASC 740, “Income Taxes”. ASC 740 sets out a consistent framework to determine the appropriate level of tax reserves to maintain for uncertain tax positions.

The calculation of the provision for income taxes is complex and requires the use of estimates and judgments. The Company has two accruals for income taxes: (i) an income tax payable representing the estimated net amount currently due to the federal government, net of any reserve for potential audit issues and any tax refunds; and (ii) a deferred federal income tax and related valuation accounts, representing the estimated impact of temporary differences between how the Company recognizes its assets and liabilities under GAAP, and how such assets and liabilities are recognized under federal tax law.

Deferred income taxes are provided on the balance sheet method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the effective date. A tax position is recognized as a benefit only if it is more likely than not that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that has a likelihood of being realized on examination of more than 50 percent. For tax positions not meeting the more likely than not threshold, no tax benefit is recorded. Under the more likely than not threshold guidelines, the Company believes no significant uncertain tax positions exist, either individually or in the aggregate, that would give rise to the non-recognition of an existing tax benefit. The Company had no material unrecognized tax benefits or accrued interest and penalties for any year in the three-year period ended December 31, 2018.

On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (“TCJA”). The legislation significantly changes U.S. tax law by, among other things, lowering the corporate income tax rate and changes to business-related exclusions. The TCJA permanently reduces the U.S. corporate income tax rate from a maximum of 35% to a flat 21% rate, effective January 1, 2018. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income at the time of enactment of such change in tax rates. Accordingly, in the fourth quarter 2017 a tax expense of $3,888 was recorded for the effects of the legislation.

As applicable, the Company recognizes accrued interest and penalties assessed as a result of a taxing authority examination through income tax expense. The Company files consolidated income tax returns in the United States of America and various states’ jurisdictions. With limited exception, the Company is no longer subject to federal and state income tax examinations by taxing authorities for years before 2015.

 

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Other comprehensive income (loss):

The components of other comprehensive income (loss) and their related tax effects are reported in the Consolidated Statements of Income and Comprehensive Income (Loss). The accumulated other comprehensive income (loss) included in the Consolidated Balance Sheets relates to net unrealized gains and losses on investment securities available-for-sale and benefit plan adjustments.

The components of accumulated other comprehensive income (loss) included in stockholders’ equity at December 31, 2018 and 2017 are as follows:

 

December 31

   2018      2017  

Net unrealized gain (loss) on investment securities available-for-sale

   $ (2,183    $ (1,131

Income tax expense (benefit)

     (458      (238
  

 

 

    

 

 

 

Net of income taxes

     (1,725      (893
  

 

 

    

 

 

 

Benefit plan adjustments

     (1,132      (869

Income tax expense (benefit)

     (238      (183
  

 

 

    

 

 

 

Net of income taxes

     (894      (686
  

 

 

    

 

 

 

Accumulated other comprehensive loss

   $     (2,619    $     (1,579
  

 

 

    

 

 

 

Other comprehensive income (loss) and related tax effects for the years ended December 31, 2018 and 2017 are as follows:

 

Year ended December 31

   2018      2017  

Unrealized gain (loss) on investment securities available-for-sale

   $ (1,012    $ 1,471  
  

 

 

    

 

 

 

Net (gain) loss on the sale of investment securities available-for-sale (1)

     (40      (89
  

 

 

    

 

 

 

Benefit plans:

     

Amortization of actuarial loss (gain)(2)

     81        49  

Actuarial (loss) gain

     (346      (103
  

 

 

    

 

 

 

Net change in benefit plan liabilities

     (265      (54
  

 

 

    

 

 

 

Other comprehensive income (loss) gain before taxes

     (1,317          1,328  

Income tax expense (benefit)

     (277      451  
  

 

 

    

 

 

 

Other comprehensive income (loss)

   $     (1,040    $ 877  
  

 

 

    

 

 

 

 

(1)

Represents amounts reclassified out of accumulated comprehensive income and included in gains on sale of investment securities on the consolidated statements of income and comprehensive income.

(2)

Represents amounts reclassified out of accumulated comprehensive income and included in the computation of net periodic pension expense. Refer to Note 15 included in these consolidated financial statements.

Earnings per share:

Basic earnings per share is computed by dividing net income (loss) allocated to common stockholders divided by the weighted-average number of common shares outstanding during the period. Net income (loss) allocated to common stockholders is net income (loss) adjusted for preferred stock dividends including dividends declared, less income (loss) allocated to participating securities. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.

 

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The following table provides a reconciliation between the computation of basic earnings per share and diluted earnings per share for the years ended December 31, 2018 and 2017:

 

For the Year Ended December 31

   2018      2017  

Numerator:

     

Net income (loss)

   $ 10,858      $ (4,911

Dividends on preferred stock

        (371
  

 

 

    

 

 

 

Net income (loss) available to common stockholders

     10,858        (5,282

Undistributed income (loss) allocated to preferred stockholders

        475  
  

 

 

    

 

 

 

Income (loss) allocated to common stockholders

   $ 10,858      $ (4,807
  

 

 

    

 

 

 

Denominator:

     

Basic

     9,096,142        5,260,537  

Dilutive options

     52,155     
  

 

 

    

 

 

 

Diluted

     9,148,297        5,260,537  
  

 

 

    

 

 

 

Earnings per share:

     

Basic

   $ 1.19      $ (0.91

Diluted

   $ 1.19      $ (0.91

Common stock equivalents outstanding that are anti-dilutive and thus excluded from the calculation of the diluted number of shares represented above were 43,350 in 2018 and 298,246 in 2017.

On January 20, 2017, Riverview announced that it entered into agreements with accredited investors and qualified institutional buyers to raise approximately $17.0 million in common and preferred equity, before expenses, through the private placement of 269,885 shares of its no par value common stock at a price of $10.50 per share and 1,348,809 shares of a newly created Series A convertible, perpetual preferred stock (the “Series A preferred stock”) at a price of $10.50 per share.

Effective as of the close of business on June 22, 2017, the Company filed an amendment to the Articles of Incorporation to authorize a class of non-voting common stock after obtaining shareholder approval on June 21, 2017. As a result, each share of Series A preferred stock was automatically converted into one share of non-voting common stock as of the effective date. The non-voting common stock has the same relative rights as, and is identical in all respects with, each other share of common stock of the Company, except that holders of non-voting common stock do not have voting rights.

Stock-based compensation:

The Company recognizes all share-based payments to employees in the consolidated statement of operations based on their grant date fair values. The fair value of such equity instruments is recognized as an expense in the historical consolidated financial statements as services are performed. The Company uses the Black-Scholes Model to estimate the fair value of each option on the date of grant. The Black-Scholes Model estimates the fair value of employee stock options using a pricing model which takes into consideration the exercise price of the option, the expected life of the option, the current market price and its expected volatility, the expected dividends on the stock and the current risk-free interest rate for the expected life of the option. The Company typically grants stock options to employees with an exercise price equal to the fair value of the shares at the date of grant. The fair value of restricted stock is equivalent to the fair value on the date of grant and is amortized over the vesting period.

Recent Accounting Standards

In January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities”. This ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments by making targeted improvements to GAAP as follows: (i) require equity investments, except those accounted for under the equity method of accounting or those that result in consolidation of the investee, to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (ii) simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value; (iii) eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (iv) eliminate the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (v) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (vi) require an entity to present separately in other

 

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comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (vii) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset , securities or loans and receivables, on the balance sheet or the accompanying notes to the financial statements; and (viii) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The Company measured the fair value of its loan portfolio using an exit price notion for the fiscal years beginning after December 31, 2017, including interim periods thereafter. The adoption of ASU 2016-01 did not have a material effect on our consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases”. From the lessee’s perspective, the new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessee. From the lessor’s perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing. If the lessor doesn’t convey risks and rewards or control, an operating lease results. In July 2018, the FASB issued ASU No. 2018-10, “Codification Improvements to Topic 842, Leases”. The amendments in this Update corrects inconsistencies in the guidance and clarifies how to apply certain provisions of the lease standard. The amendments target 16 issues including: residual value guarantees; rate implicit in the lease; lessee reassessment of lease classification; lessor reassessment of lease term and purchase option; variable lease payments that depend on an index or a rate; investment tax credits; lease term and purchase option; transition guidance for amounts previously recognized in business combinations; recognition of certain transition adjustments in earnings rather than equity; transition guidance for leases previously classified as capital leases under Topic 840; transition guidance for modifications to leases previously classified as direct financing or sales-type leases under Topic 840; transition guidance for sale and leaseback transactions; impairment of net investment in the lease; unguaranteed residual asset; effect of initial direct costs on rate implicit in the lease; and failed sale and leaseback transaction. In July 2018, the FASB also issued ASU No. 2018-11, “Leases (Topic 842): Targeted Improvements”. This amendment provides an optional transition method for adopting the new leases guidance in Topic 842 that will eliminate comparative period reporting under the new guidance in the year of adoption. This option addresses preparer feedback about the related costs of presenting comparative periods under Topic 842. Under the optional transition method, only the most recent period presented will reflect the adoption of Topic 842 with a cumulative-effect adjustment to the opening balance of retained earnings, and the comparative prior periods will be reported under the previous guidance in Topic 840. In addition, the ASU offers lessors a practical expedient that mirrors the practical expedient already provided to lessees in ASU 2016-02, “Leases (Topic 842).” The new practical expedient will allow lessors to elect, by class of underlying asset, to not separate non-lease components from the associated lease component when specified conditions are met. Examples of non-lease components include equipment maintenance services, common area maintenance services in real estate, or other goods or services provided to the lessee apart from the right to use the underlying asset. The practical expedient must be applied consistently for all lease contracts. In December 2018, the FASB issued ASU 2018-20, “Leases (Topic 842)—Narrow-Scope Improvements for Lessors,” which provides for certain policy elections and changes lessor accounting for sales and similar taxes and certain lessor costs. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Upon adoption of ASU 2016-02, ASU 2018-10, ASU 2018-11 and ASU 2018-20 on January 1, 2019, we expect to recognize right-of-use assets and related lease liabilities totaling $3,719. We expect to elect to apply certain practical expedients provided under ASU 2016-02 whereby we will not reassess (i) whether any expired or existing contracts are or contain leases, (ii) the lease classification for any expired or existing leases and (iii) initial direct costs for any existing leases. We also do not expect to apply the recognition requirements of ASU 2016-02 to any short-term leases, as defined by related accounting guidance. We expect to account for lease and non-lease components separately because such amounts are readily determinable under our lease contracts and because we expect this election will result in a lower impact on our balance sheet. We expect to utilize the transition approach prescribed by ASU 2018-11. The adoption of the guidance on January 1, 2019, is not expected to have a significant impact on the Company’s financial position or operating results.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. ASU 2016-13 requires an entity to utilize a new impairment model known as the current expected credit loss (“CECL”) model to estimate its lifetime “expected credit loss” and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The CECL model is expected to result in earlier recognition of credit losses. ASU 2016-13 also requires new disclosures for financial assets measured at amortized cost, loans and available-for-sale debt securities. In November 2018, the FASB issued ASU No. 2018-19—Codification Improvements to Topic 326, Financial Instruments—Credit Losses. The amendments clarify that receivables arising from operating leases are not within the scope of Subtopic 326-20. Instead, impairment of receivables arising from operating leases should be accounted for in accordance with Topic 842, Leases. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. During the third quarter of 2018, we selected a vendor-based solution and are currently collecting and reviewing loan data for use in this model. The Company is currently assessing the impact that this new guidance will have on its consolidated financial statements.

 

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In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments”. The update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. This new accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2019. The Company does not expect the adoption of the new accounting guidance to have a material effect on the statement of cash flows.

In December 2016, the FASB issued ASU No. 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers”. ASU 2016-20 updates the new revenue standard by clarifying issues that have arisen from ASU 2014-09, but does not change the core principle of the new standard. The issues addressed in this ASU include: (i) Loan guarantee fees; (ii) Impairment testing of contract costs; (iii) Interaction of impairment testing with guidance in other topics; (iv) Provisions for losses on construction-type and production-type contracts; (v) Scope of Topic 606; (vi) Disclosure of remaining performance obligations; (vii) Disclosure of prior-period performance obligations; (viii) Contract modifications; (ix) Contract asset vs. receivable; (x) Refund liability; (xi) Advertising costs; (xii) Fixed-odds wagering contracts in the casino industry; and (xiii) Cost capitalization for advisors to private funds and public funds. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017. The amendments can be applied retrospectively to each prior reporting period or retrospectively with the cumulative effect of initially applying this new guidance recognized at the date of initial application. Since the guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, the new guidance did not have a material impact on revenue most closely associated with financial instruments, including interest income and expense. The Company completed its overall assessment of revenue streams and review of related contracts potentially affected by the ASU, including trust and asset management fees, deposit related fees, and interchange fees. Based on this assessment, the Company concluded that ASU 2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue streams. The Company adopted ASU 2014-09 and its related amendments on its required effective date of January 1, 2018 utilizing the modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary. The adoption of ASU 2016-20 and 2014-09 did not have a material effect on our consolidated financial statements. See Note 14 Revenue Recognition for more information.

In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business”. The ASU clarifies the definition of a business to assist with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of ASU No. 2017-01 did not have a material effect on our consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”. The ASU simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. The Company should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. The impairment charge is limited to the amount of goodwill allocated to that reporting unit. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for goodwill impairment tests performed on testing dates after January 1, 2017. The guidance is not expected to have a significant impact on the Company’s financial positions, results of operations or disclosures.

In February 2017, the FASB issued ASU No. 2017-05, “Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Topic 610): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets”. The amendments clarify that a financial asset is within the scope of Topic 610 if it meets the definition of an in substance nonfinancial asset. The amendments also define the term in substance nonfinancial asset. The amendments clarify that nonfinancial assets within the scope of Topic 610 may include nonfinancial assets transferred within a legal entity to a counterparty. For example, a parent may transfer control of nonfinancial assets by transferring ownership interests in a consolidated subsidiary. A contract that includes the transfer of ownership interests in one or more consolidated subsidiaries is within the scope of Topic 610 if substantially all of the fair value of the assets that are promised to the counterparty in a contract is concentrated in nonfinancial assets. The amendments clarify that an entity should identify each distinct nonfinancial asset or in substance nonfinancial asset promised to a counterparty and derecognize each asset when a counterparty obtains control of it. The guidance is effective for public business entities for annual periods beginning after December 15, 2017 and interim periods therein. Entities may use either a full or modified approach to adopt the ASU. The adoption of ASU No. 2017-05 did not have a material effect on our consolidated financial statements.

In March 2017, the FASB issued ASU No. 2017-07, “Compensation—Retirement Benefits (Topic 715)”, which requires employers that offer or maintain defined benefit plans to disaggregate the service component from the other components of net benefit cost and provides guidance on presentation of the service component and the other components of net benefit cost in the statement of operations. The guidance is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The adoption of ASU No. 2017-07 did not have a material effect on our consolidated financial statements.

 

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In March 2017, the FASB issued ASU No. 2017-08, “Receivables—Nonrefundable Fees and Other Costs (Topic 310), Premium Amortization on Purchased Callable Debt Securities”. These amendments shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The guidance is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. If an entity early adopts in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The amendments should be applied on a modified retrospective basis, with a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company does not expect the adoption of ASU No. 2017-08 to have a material effect on our consolidated financial statements.

In May 2017, the FASB issued ASU No. 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting”. This ASU clarifies which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. This ASU is effective for fiscal years beginning after December 15, 2017, and interims periods within those fiscal years. The adoption of ASU No. 2017-09 did not have a material effect on our consolidated financial statements.

In August 2017, the FASB issued ASU No. 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities”. The amendments in the Update better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. To meet that objective, the amendments expand and refine hedge accounting for both nonfinancial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The Company does not expect the adoption of ASU No. 2017-12 to have a material effect on our consolidated financial statements.

In September 2017, the FASB issued ASU No. 2017-13, “Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842)”. This Accounting Standards Update adds SEC paragraphs pursuant to the SEC Staff Announcement at the July 20, 2017 Emerging Issues Task Force (EITF) meeting. The July announcement addresses Transition Related to Accounting Standards Updates No. 2014-09, Revenue from Contracts with Customers (Topic 606), and No. 2016-02, Leases (Topic 842). This Update also supersedes SEC paragraphs pursuant to the rescission of SEC Staff Announcement, “Accounting for Management Fees Based on a Formula,” effective upon the initial adoption of Topic 606, Revenue from Contracts with Customers, and SEC Staff Announcement, “Lessor Consideration of Third-Party Value Guarantees,” effective upon the initial adoption of Topic 842, Leases. The amendments in this Update also rescind three SEC Observer Comments effective upon the initial adoption of Topic 842. One SEC Staff Observer comment is being moved to Topic 842. The adoption of ASU 2017-13 did not have a material effect on our consolidated financial statements.

In November 2017, the FASB issued ASU No. 2017-14 “Income Statement—Reporting Comprehensive Income (Topic 220), Revenue Recognition (Topic 605), and Revenue from Contracts with Customers (Topic 606)”. This Accounting Standards Update amends SEC paragraphs pursuant to the SEC Staff Accounting Bulletin No. 116 and SEC Release No. 33-10403, which bring existing guidance into conformity with Topic 606, Revenue from Contracts with Customers. The adoption of ASU No. 2017-14 did not have a material effect on our consolidated financial statements.

In February 2018, the FASB issued ASU No. 2018-02, “Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income”. The amendments in this Update allow for a reclassification of stranded tax effects resulting from the Tax Cuts and Jobs Act from accumulated other comprehensive income to retained earnings. The amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, and the Company elected to early adopt this guidance effective December 31, 2017. The adoption of ASU No. 2018-02 resulted in a reclassification of stranded tax effects of $259 from accumulated other comprehensive income (loss) to retained earnings.

In February 2018, the FASB issued ASU No. 2018-03, “Technical Corrections and Improvements to Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities”, which makes minor changes to the ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities”. The technical corrections affect the following aspects of the ASU: (i) equity securities without a readily determinable fair value — discontinuation; (ii) equity securities without a readily determinable fair value — adjustments; (iii) forward contracts and purchased options; (iv) presentation requirements for certain fair value option liabilities; (v) fair value option liabilities denominated in a foreign currency and (vi) transition guidance for equity securities without a readily determinable fair value. The amendments in this Update are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018. The adoption of ASU No. 2018-03 did not have a material effect on our consolidated financial statements.

 

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In March 2018, the FASB issued ASU No. 2018-05, “Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin [SAB] No. 118”. The ASU adds seven paragraphs to ASC 740, Income Taxes, that contain SEC guidance related to SAB 118 codified as SEC SAB Topic 5.EE, “Income Tax Accounting Implications of the Tax Cuts and Jobs Act”). The adoption of ASU No. 2018-05 did not have a material effect on our consolidated financial statements.

In May 2018, the FASB issued ASU No. 2018-06, “Codification Improvements to Topic 942, Financial Services—Depository and Lending”. The amendments in this Update supersede the guidance in Subtopic 942-740, Financial Services—Depository and Lending—Income Taxes, that is related to Circular 202 because that guidance has been rescinded by the Office of the Comptroller of the Currency (“OCC”) and no longer is relevant. The amendments in this Update were effective upon issuance of this Update. The adoption of ASU No. 2018-06 did not have a material effect on our consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement”. The amendments in this Update improve the effectiveness of fair value measurement disclosures by modifying the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, based on the concepts in FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements, including the consideration of costs and benefits. The ASU is effective for all entities in fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. In addition, an entity may early adopt any of the removed or modified disclosures immediately and delay adoption of the new disclosures until the effective date. The guidance is not expected to have a significant impact on the Company’s financial positions, results of operations or disclosures.

In August 2018, the FASB issued ASU No. 2018-14, “Compensation—Retirement Benefits—Defined Benefit Plans—General (Subtopic 715-20)—Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans”. Subtopic 715-20 addresses the disclosure of other accounting and reporting requirements related to single-employer defined benefit pension or other postretirement benefit plans. The amendments in this Update remove disclosures that no longer are considered cost-beneficial, clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant. Although narrow in scope, the amendments are considered an important part of the Board’s efforts to improve the effectiveness of disclosures in the notes to financial statements by applying concepts in the FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements. The amendments in this Update apply to all employers that sponsor defined benefit pension or other postretirement plans. The ASU is effective for all entities in fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. Early adoption is permitted. The guidance is not expected to have a significant impact on the Company’s financial positions, results of operations or disclosures.

2. Merger accounting:

On April 20, 2017, the Company and CBT announced the execution of a definitive merger agreement, providing for the merger of CBT with and into the Company. Immediately following the holding company merger, CBT Bank merged with and into Riverview Bank, the wholly-owned subsidiary of Riverview. This merger became effective prior to the start of business on October 1, 2017. Pursuant to the terms of the merger agreement, the merger was effected by the issuance of shares of Riverview stock to CBT shareholders. Each share of CBT common stock was converted into the right to receive 2.86 shares of Riverview common stock, with cash paid in lieu of fractional shares. The merger provided an expanded geographic footprint for the Company and increased the size of the balance sheet wherein the combined companies can realize economies of scale and other operating efficiencies.

The merger has been accounted for using the acquisition method of accounting. To determine the accounting treatment of the merger, management utilized the following factors in concluding that Riverview is considered to be the accounting acquirer:

 

   

The roles of the Chief Executive Officer and President of the post-combination entity has been assumed by the executive officers of Riverview;

 

   

After the closing of the merger and as a result of the fixed share exchange ratio of 2.86 shares of Riverview common stock for each CBT common share, the former CBT shareholders, as a group, held approximately 45.8 percent of the outstanding shares of Riverview’s stock; and

 

   

Riverview contributed greater than fifty percent of the total assets and tangible equity to the combined entity.

Based on consideration of all the relevant facts and circumstances of the merger, including the above factors, for accounting purposes, Riverview is considered to have acquired CBT in this transaction with the surviving legal entity operating under Riverview’s Articles of Incorporation. As a result, the historical financial statements of the combined company are the historical financial statements of Riverview. The assets and liabilities of CBT as of the effective date of the merger were recorded at their respective estimated fair values and added to those of Riverview. The excess of purchase price over the net estimated fair values of the acquired assets and liabilities of CBT Financial was allocated to all identifiable intangible assets. The remaining excess was allocated to goodwill. The goodwill resulting from the merger will not be amortized to expense, but instead will be reviewed for impairment at least annually. To

 

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the extent goodwill is impaired, its carrying value would be written down to its implied fair value and a charge would be made to earnings. Customer related intangibles and other intangibles with definite useful lives will be amortized to expense over their estimated useful lives. These financial statements will reflect the results attributable to the acquired operations of CBT, as the acquired company for accounting purposes, beginning on the effective date of the merger. The Company utilized the closing price of its common stock on September 29, 2017, the last trading day prior to the merger, of $13.20 per share to determine the acquisition date fair value of the consideration transferred.

The acquired assets and assumed liabilities were measured at fair value as of the acquisition date. In many cases, determining the fair value of the acquired assets and assumed liabilities required the Company to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest, which required the utilization of significant estimates and judgment in accounting for the acquisition. As of October 1, 2017, goodwill totaled $19,675, which is equal to the excess of the consideration transferred over the fair value of the identifiable net assets acquired in connection with the merger. Goodwill recorded in the Merger resulted from the expected synergies of the combined operations of the newly merged entities as well as intangibles that do not qualify for separate recognition such as the acquired workforce. There was no tax-deductible goodwill in the transaction.

 

Purchase Price Consideration in Common Stock:

     

CBT shares outstanding exchanged

     1,445,474     

Exchange ratio

     2.86     
  

 

 

    

Riverview shares issued

     4,134,056     

Less: fractional shares issued to CBT shareholders

     111     
  

 

 

    

Riverview shares issued to CBT shareholders

     4,133,945     

Value assigned to Riverview shares

   $ 13.20     
     

 

 

 

Purchase price

      $   54,568  

Purchase price consideration for fractional shares

        1  
     

 

 

 

Total Purchase Price

        54,569  
     

 

 

 

Net Assets Acquired:

     

Cash and due from banks

   $ 32,022     

Investment securities available-for-sale

     43,869     

Loans, net

     382,461     

Accrued interest receivable

     894     

Premises and equipment

     6,143     

Other assets

     21,730     

Deposits

     (438,845   

Long-term debt

     (6,801   

Accrued interest payable

     (256   

Other liabilities

     (6,323   
     

 

 

 

Net assets acquired

        34,894  
     

 

 

 

Goodwill resulting from merger

      $ 19,675  
     

 

 

 

The estimated fair values of cash and due from banks, accrued interest receivable, other assets, accrued interest payable and other liabilities approximate their stated values.

The estimated fair values of the investment securities available-for-sale were calculated primarily using level 2 inputs. The prices for these instruments are obtained through an independent pricing service and are derived from market quotations and matrix pricing. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Management reviewed the data and assumptions used in pricing the securities to ensure the highest level of significant inputs are derived from market observable data.

Land and buildings included in premises and equipment, net, and real estate acquired through foreclosure included in other assets were primarily valued based on appraised collateral values. The Company prepared an internal market rent analysis to compare the lease contract obligations to comparable market rental rates. The Company believed that the leased contract rates were in a reasonable range of market rental rates and concluded that no fair value adjustment related to leasehold interest was necessary.

The most significant fair value determination related to the valuation of acquired loans using level 3 input. The business combination resulted in the acquisition of loans with and without evidence of credit quality deterioration. Fair values are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, expected life time losses, environmental factors, collateral values, discount rates, expected payments and expected prepayments. Specifically, the Company prepared three separate