Note 1 – Basis of Presentation

 

Embassy Bancorp, Inc. (the “Company”) is a Pennsylvania corporation organized in 2008 and registered as a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Company was formed for purposes of acquiring Embassy Bank For The Lehigh Valley (the “Bank”) in connection with the reorganization of the Bank into a bank holding company structure, which was consummated on November 11, 2008.  Accordingly, the Company owns all of the capital stock of the Bank, giving the organization more flexibility in meeting its capital needs as the Company continues to grow. Embassy Holdings, LLC (the “LLC”) is a wholly-owned subsidiary of the Bank organized to engage in the holding of property acquired by the Bank in satisfaction of debts previously contracted.  As such, the consolidated financial statements contained herein include the accounts of the Company, the Bank and the LLC. All significant intercompany transactions and balances have been eliminated.

 

The Bank, which is the Company’s principal operating subsidiary, was originally incorporated as a Pennsylvania bank on May 11, 2001 and opened its doors on November 6, 2001. It was formed by a group of local business persons and professionals with significant prior experience in community banking in the Lehigh Valley area of Pennsylvania, the Bank’s primary market area.

 

The accompanying unaudited financial statements have been prepared in accordance with United States of America generally accepted accounting principles (“US GAAP”) for interim financial information and in accordance with instructions for Form 10-Q and Rule 10-01 of the Securities and Exchange Commission Regulation S-X. Accordingly, they do not include all of the information and footnotes required by US GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.

 

The consolidated financial statements presented in this report should be read in conjunction with the audited consolidated financial statements and the accompanying notes for the year ended December 31, 2013, included in the Company’s Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 28, 2014.  

 

In preparing these consolidated financial statements, the Company evaluated the events and transactions that occurred after June 30, 2014 through the date these consolidated financial statements were issued.

 

Certain amounts in the 2013 financial statements may have been reclassified to conform to 2014 presentation. These reclassifications had no effect on 2013 net income.

 

Note 2 - Summary of Significant Accounting Policies

 

The significant accounting policies of the Company as applied in the interim financial statements presented are substantially the same as those followed on an annual basis as presented in the Company’s Form 10-K for the year ended December 31, 2013.

Note 3 – Stockholders’ Equity

 

On November 11, 2008, the Company consummated its acquisition of Embassy Bank For The Lehigh Valley pursuant to a Plan of Merger and Reorganization dated April 18, 2008, pursuant to which the Bank was reorganized into a bank holding company structure. At the effective time of the reorganization, each share of common stock of Embassy Bank For The Lehigh Valley issued and outstanding was automatically converted into one share of Company common stock. The issuance of Company common stock in connection with the reorganization was exempt from registration pursuant to Section 3(a)(12) of the Securities Act of 1933, as amended.

Note 4 – Stock Incentive Plan

 

At the Company’s annual meeting on June 16, 2010, the shareholders approved the Embassy Bancorp, Inc. 2010 Stock Incentive Plan (the “SIP”).  The SIP authorizes the Board of Directors, or a committee authorized by the Board of Directors, to award a stock based incentive to (i) designated officers (including officers who are directors) and other designated employees at the Company and its subsidiaries, and (ii) non-employee members of the Board of Directors and advisors and consultants to the Company and its subsidiaries.  The Board of Directors believes that the SIP will encourage the designated participants to contribute materially to the growth of the Company. The SIP provides for stock based incentives in the form of incentive stock options as provided in Section 422 of the Internal Revenue Code of 1986, non-qualified stock options, stock appreciation rights, restricted stock and deferred stock awards.  The term of the option, the amount of time for the option to vest after grant, if any, and other terms and limitations will be determined at the time of grant. Options granted under the SIP may not have an exercise period that is more than ten years from the time the option is granted. 

 

At inception, the aggregate number of shares available for issuance under the SIP was 500,000.  The SIP provides for appropriate adjustments in the number and kind of shares available for grant or subject to outstanding awards under the SIP to avoid dilution in the event of merger, stock splits, stock dividends or other changes in the capitalization of the Company.  The SIP expires on June 15, 2020.  There were no awards granted under the SIP for the years ended December 31, 2011 and 2010.  In January 2014, February 2013 and February 2012, the Company granted 10,209,  8,764 and 7,992 shares of restricted stock, respectively, to certain members of its Board of Directors as compensation for their service in 2013, 2012 and 2011, respectively, in accordance with the Company’s Non-employee Directors Compensation program adopted in October of 2010.  Such compensation was accrued for as of December 31, 2013, 2012 and 2011.   In January 2014, February 2013 and February 2012, the Company also granted stock options to purchase 29,663, 29,742 and 52,611 shares of stock, respectively to certain executive officers in accordance with their respective employment agreements.  Stock compensation expense related to these options was $24 thousand and $48 thousand for the three and six months ended June 30, 2014 and $16 thousand and $29 thousand for the three and six months ended June 30, 2013.  At June 30, 2014, approximately $122 thousand unrecognized cost related to stock options granted in 2014, 2013 and 2012 will be recognized over the next 2.55, 1.65 and 0.65 years, respectively.  The fair value of the options granted in 2014, 2013 and 2012 was determined with the following weighted average assumptions: dividend yield of 0%, risk free interest rate of  2.30%, 1.34% and 1.43%, respectively, expected life of 6.0 years, 6.0 years and 7.5 years, respectively, and expected volatility of 28.93%, 28.79% and 31.10%, respectively.  The weighted average fair value of options granted in 2014, 2013 and 2012 was $2.46 per share, $2.14 per share and $2.56 per share, respectively.  At June 30, 2014, there were 361,019 shares available for issuance under the SIP.

 

Note 5 – Other Comprehensive Income (Loss)

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income (loss).

The components of other comprehensive income (loss), both before tax and net of tax, are as follows:

 

 

 

 

 

 

 

There were no realized gains on securities available-for-sale for the three months ended June 30, 2014 and 2013.  A summary of the realized gains on securities available for sale, net of tax, for the six months ended June 30, 2014 and 2013 is as follows:

 

 

 

A summary of the accumulated other comprehensive income, net of tax, is as follows:

 

 

 

 

 

Note 6 – Basic and Diluted Earnings per Share

 

Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period, as adjusted for stock dividends and splits. 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 adjustments to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.

Stock options of 94,752 and 149,692 for the three and six months ended June 30, 2014 and 2013, respectively, were not considered in computing diluted earnings per common share because they are not dilutive to earnings.

Note 7 – Guarantees

 

The Company, through the Bank, does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued, have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Bank generally holds collateral and/or personal guarantees supporting these commitments. The Company had $4.7 million of standby letters of credit outstanding as of June 30, 2014. The approximate value of underlying collateral upon liquidation that would be expected to cover this maximum potential exposure was $4.4 million. Management does not consider the current amount of the liability as of June 30, 2014 for guarantees under standby letters of credit issued to be material.

Note 8 – Short-term and Long-term Borrowings

 

Securities sold under agreements to repurchase, federal funds purchased and Federal Home Loan Bank of Pittsburgh (“FHLB”) short term advances generally represent overnight or less than twelve month borrowings. Long term advances from the FHLB are for periods of twelve months or more and are generally less than sixty months. The Bank has an agreement with the FHLB which allows for borrowings up to a percentage of qualifying assets. At June 30, 2014, the Bank had a maximum borrowing capacity for short-term and long-term advances of approximately $337.2 million, none of which was outstanding.  This borrowing capacity with the FHLB includes a line of credit of $25.0 million. Short-term loans with FHLB of $10 million were outstanding at December 31, 2013, and no long-term advances were outstanding at December 31, 2013. All FHLB borrowings are secured by qualifying assets of the Bank.

 

The Bank has a federal funds line of credit with the Atlantic Central Bankers Bank (“ACBB”) of approximately $6.0 million, of which none was outstanding at June 30, 2014 and December 31, 2013. Advances from this line are unsecured.

 

The Company has two lines of credit with Univest Bank and Trust Co. (“Univest”) totaling $10 million. As of June 30, 2014 and December 31, 2013, the outstanding balance was $3.4 million and $3.9 million, respectively. Advances from these lines of credit are secured by 833,333 shares of Bank common stock. Under the terms of the loan agreement, the Bank is required to remain well capitalized. The proceeds of the loan were primarily used for the holding company’s investment in the Bank, thus providing additional capital to support the Bank’s growth.

 

Note 9 – Securities Available For Sale

 

At June 30, 2014 and December 31, 2013, respectively, the amortized cost and approximate fair values of securities available-for-sale were as follows:

 

 

The amortized cost and fair value of securities as of June 30, 2014, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without any penalties.

There were no gains realized in the three months ended June 30, 2014.  Gross gains of $31 thousand were realized on sales of securities for the six months ended June 30, 2014. There were no gross losses on the sales of securities during the three and six months ended June 30, 2014.  There were no sales of securities for the three and six months ended June 30, 2013.

 

Securities with a carrying value of $57.3 million and $43.6 million at June 30, 2014 and December 31, 2013, respectively, were subject to agreements to repurchase, pledged to secure public deposits, or pledged for other purposes required or permitted by law.

 

 

The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2014 and December 31, 2013, respectively:

 

 

The Company had eight (8) securities in an unrealized loss position at June 30, 2014. The unrealized losses are due only to market rate fluctuations. As of June 30, 2014, the Company either has the intent and ability to hold the securities until maturity or market price recovery, or believes that it is more likely than not that it will not be required to sell such securities. Management believes that the unrealized loss only represents temporary impairment of the securities.  None of the individual losses are significant.

 

Note 10 – Restricted Investment in Bank Stock

 

Restricted investments in bank stock consist of Federal Home Loan Bank of Pittsburgh (“FHLB”) stock and Atlantic Central Bankers Bank (“ACBB”) stock.  The restricted stocks are carried at cost.  Federal law requires a member institution of the FHLB to hold stock of its district FHLB according to a predetermined formula.  The Bank had FHLB stock at a carrying value of $224 thousand and $1.1 million repurchased during the three and six months ended June 30, 2014 and no repurchases were made during the three and six months ended June 30, 2013, respectively.  Stock purchases of $335 thousand were made during the three and six months ended June 30, 2014 and $431 thousand during the three and six months ended June 30, 2013.  Dividend payments of $14 and $27 thousand were received during the three and six months ended June 30, 2014 and $1 thousand and $2 thousand were received during the three and six months ended June 30, 2013, respectively.

 

Management evaluates the FHLB and ACBB restricted stock for impairment. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the issuer as compared to the capital stock amount for the issuer and the length of time this situation has persisted, (2) commitments by the issuer to make payments required by law or regulation and the level of such payments in relation to the operating performance of the issuer, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the issuer.

 

Based upon its evaluation of the foregoing criteria, management believes no impairment charge is necessary related to the FHLB or ACBB stock as of June 30, 2014.

Note 11 – Loans Receivable and Credit Quality

 

The following table presents the composition of loans receivable at June 30, 2014 and December 31, 2013, respectively:

 

 

 

The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention (potential weaknesses), substandard (well defined weaknesses) and doubtful (full collection unlikely) within the Company's internal risk rating system as of June 30, 2014 and December 31, 2013, respectively:

 

 

 

 

The following table summarizes information in regards to impaired loans by loan portfolio class as of June 30, 2014 and December 31, 2013, respectively:

 

 

 

 

The following table presents non-accrual loans by classes of the loan portfolio as of June 30, 2014 and December 31, 2013, respectively:

 

 

 

The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due.  The following table presents the classes of the loan portfolio summarized by the past due status as of June 30, 2014 and December 31, 2013, respectively:

 

 

 

 

The following tables detail the activity in the allowance for loan losses for the three and six months ended June 30, 2014 and 2013:

 

 

 

 

The following tables represent the allocation for loan losses and the related loan portfolio disaggregated based on impairment methodology at June 30, 2014 and December 31, 2013.

 

 

Troubled Debt Restructurings

 

The Company may grant a concession or modification for economic or legal reasons related to a borrower’s financial condition than it would not otherwise consider, resulting in a modified loan which is then identified as troubled debt restructuring (“TDR”).  The Company may modify loans through rate reductions, extensions to maturity, interest only payments, or payment modifications to better coincide the timing of payments due under the modified terms with the expected timing of cash flows from the borrowers’ operations.  Loan modifications are intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral.  TDRs are considered impaired loans for purposes of calculating the Company’s allowance for loan losses.

 

The Company identifies loans for potential restructure primarily through direct communication with the borrower and the evaluation of the borrower’s financial statements, revenue projections, tax returns, and credit reports.  Even if the borrower is not presently in default, management will consider the likelihood that cash flow shortages, adverse economic conditions, and negative trends may result in a payment default in the near future.

 

The following table presents TDRs outstanding:

 

 

As of June 30, 2014,  no available commitments were outstanding on TDRs.

 

The following table presents newly restructured loans that occurred during the three and six months ended June 30, 2014.

 

 

 

 

The impairment reserve on the TDR described above was $55 thousand recorded in the allowance for loan loss for the three and six months ending June 30, 2014.  There were no newly restructured loans that occurred during the three and six months ended June 30, 2013.

 

There were no loans that were modified and classified as a TDR within the prior twelve months that experienced a payment default (loans ninety days or more past due) during the three and six months ended June 30, 2014.  The following table presents loans that were classified as a TDR within the prior twelve months that experienced a payment default (loans ninety or more days past due) during the three and six months ended June 30, 2013.